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Understanding Free ports - Tax-Exempt Warehouses For High-Value Goods

  • United Kingdom
  • Fraud and financial crime

23-05-2019

In this, the first of a series of articles considering different areas of the UK government’s consultation on the transposition of the EU’s Fifth Money Laundering Directive (5MLD), Ruth Paley and Daria Solovyeva of Eversheds Sutherland take a look at free ports, being brought into scope for AML checks on art transactions. This article considers what a free port is, what money laundering risks attach to their use, and the future of EU free ports in the light of 5MLD. 

WHAT ARE FREE PORTS?

Free ports are warehouses in free trade zones, which have become popular for the storage of high-value assets, including art, precious stones, antique, gold, vintage cars and wine collections, sometimes over long periods. Apart from secure storage, users benefit from the deferral of import duties and indirect taxes such as VAT or user tax, as well as a high degree of secrecy. Most free ports offer conference rooms and private offices to facilitate conduct of confidential business meetings.

Ownership of the goods can legally be traded within the free ports without goods physically leaving the warehouses, potentially enabling their owners to obtain large gains without notifying tax authorities. Information on price, buyer and seller is not publicly disclosable.

The main difference between a free port and a bonded warehouse is that products held in bonded warehouses are legally within the customs territory of the EU Member State, while products held in free ports are outside the customs territory despite their physical presence.

In the case of a bonded warehouse, imported dutiable merchandise may be stored, manipulated or undergo manufacturing operations without the payment of duties, usually for a set period. Excise duty and VAT payments are deferred until the bonded goods are sold or dispatched from the warehouse rather than paying at the point they are imported. The use of a bonded warehouse is ideal for those businesses wishing to re-export their goods outside of the UK to a country where VAT and duty may not be applicable.

Conversely, and although still inside the geographic boundary of a country, a free port is considered outside the country for customs purposes. This means that goods can enter and exit the free port without incurring usual import procedures or tariffs, which are only due when products enter the domestic economy. Typically, Free Trade Zones (where free ports are located) enjoy lower tax, trade tariff and duty environments than the rest of the domestic economy and are created with the explicit aim of attracting investment, promoting trade and boosting domestic manufacturing activity and local employment. Sales of goods in free ports generally incur no value-added or capital-gains taxes.

The best-known free ports are those in Geneva, Luxembourg, Singapore, Beijing, Monaco and Delaware. It is commonly considered that these jurisdictions judge the feature of a free port to be an attractive addition to their status as offshore financial centre.

WHAT ARE THE MONEY LAUNDERING RISKS OF FREE PORTS?

In most free ports, anyone can bring in goods on behalf of someone else without disclosing the ultimate beneficial owner (UBO). Luxembourg is a notable exception, where the Direct Tax Office has ‘access upon request’ to UBO data held by licensed free port operators. In most cases the registered value of the goods depends solely on self-declaration, which leaves significant room for over-valuing, or indeed under-valuing of items.

When the Luxembourg free port (known as Le Freeport) opened its doors in September 2014, Pierre Gramegna, Minister of Finance emphasised that “Luxembourg has implemented a robust legal framework to guarantee a total traceability of all goods stored at Le Freeport and to ensure that all activities strictly comply with international standards.

Le Freeport maintains that all the goods stored at its facilities are inventoried by companies operating at Le Freeport and that such inventories are available to government agencies. The Le Freeport website also claims that all movements of goods are known by Customs and that no other type of storage is subject to such an exhaustive control, stating that ‘Le Freeport is a model of transparency.’. Moreover, Le Freeport maintains that clients are submitted to a thorough check by operators similar to the same KYC procedures that are used by banks.

Nevertheless, following a visit to Le Freeport late last year, MEPs from a special European Parliamentary committee on financial crime and tax evasion expressed apprehension that the free port model could enable money laundering, circumventing international rules on transparency. Particular concerns around tax evasion were raised, with MEPs commenting that  ‘the controls were extremely perfunctory and we did not see any real attempt to establish who were the real owners of the goods’. The EU Commission has nonetheless praised the advantages of freeports, as "useful to simplify commercial operations", adding there was "no evidence showing that free zones in the EU are systematically used to commit fraud".

THE FUTURE OF EUROPEAN FREE PORTS

The Commission’s support for free ports has not prevented a wider European move towards their regulation, with a particular focus on the use of free ports in the storage, movement and exchange of art works. This has manifested recently in the provisions of the EU Fifth Money Laundering Directive (5MLD), which expands the scope of ‘obliged entities’ subject to regulation to include art intermediaries for transactions exceeding EUR 10,000, including art galleries, auction houses and free ports.

This expansion of scope goes beyond the requirements applied to high-value dealers (which are only regulated in respect of cash transactions of or exceeding EUR 10,000), and extends to payments at or above that threshold regardless of whether they are made in cash. It is thought that a significant number of art transactions conducted via free ports will consequently be caught by these new rules and it will be interesting to consider the impact on the movement and sale of artworks through free ports as a result, once 5MLD is in force at the beginning of 2020.

The UK Government is currently consulting on the transposition of 5MLD into UK law and is asking for views as to whether free ports should be defined within the UK money laundering regulations, particularly since  none currently exist within the UK and – if so - what the definition should include. It is also asking for responses on the risks attached in a UK context and how the risks of illicit activity could be managed within a free port.

It is interesting to note that the focus on free ports within 5MLD does not extend to other, similarly constituted, storage facilities. Free ports constitute only a small part of the high-end storage market. Bonded warehouses – the market for which is much bigger than for free ports – offer comparable security, indirect tax advantages and opportunities to maintain secrecy. It is surprising then, that it is not currently envisaged that these other storage facility types will fall within the ambit of 5MLD. With the transposition into UK law due by 20 January 2020, the impact of this extension of regulatory reach over free ports will take some time to measure.

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