Business Ethics in ‘Eastern Europe’ – Tax Evasion and Other Ills

There are all sorts of ways you can cheat your customers, your employees, your competitors, your partners and the taxman. Whilst you can find such mischief all over the world, in former socialist ‘Eastern Europe’ these tricks were especially common in the early years of democracy and capitalism in the 1990s, even if they’re a little less common now.

See my three previous posts on the background to and the development of business ethics in the region:

Ethics and Business – ‘Eastern Europe’ after the Revolutions

Business Ethics in ‘Eastern Europe’ -Everyday Misdemeanours

Business Ethics in ‘Eastern Europe’ – Further Opportunities for Mischief

Ethics and legality are necessarily different issues, even if ethics is the foundation on which law is built, but the law can only attempt to sanction the most egregiously immoral acts of business mischief, not the lesser, everyday kind. Even so, what is not illegal is nevertheless sometimes wrong, and almost always inexcusable and avoidable. It is no excuse to protest that many kinds of mischief are and always will be perfectly legal. In all aspects of life, there are more ways of doing wrong than of breaking the law – there is no law, for example, to prevent you cheating on your partner (in most of the developed world, at least).

taxevasion

Sadly, though, it’s often possible even to break the law without sanction. Tax evasion, for example, the deliberate flouting of the law, is often very hard to detect. What are the usual tricks?

Number 1: Many business owners put their personal expenses through the company.

This is an easy option if the sums aren’t too large. Who’s to say that those air tickets to New York aren’t a legitimate business expense? It might be hard to justify tickets to the Met (client entertainment perhaps?), but for auditors it would be difficult to establish that a visit to New York was pleasure, and not work. You can also use this trick as a tax-efficient way of rewarding your employees.

Number 2: Many companies bill phantom ‘services’ from tax-efficient jurisdictions

Unless you’re operating in a flat-tax jurisdiction (Slovakia was briefly one), it’s usually better to get money out of your company before the taxman levies corporation tax on the profit that remains. For example, you can siphon cash anonymously through tax-havens by invoicing spurious (but plausible) services from, say, Cyprus, thereby reducing the tax base. The company in the tax-haven, if it’s not actually entirely yours, takes a cut and passes the rest on to an offshore account.

In the early 1990s the Governments of Eastern Europe lacked the investigative powers and the devious imaginations required to chase this errant profit to its low-tax haven. Civil servants are often less talented than tax advisers and are paid a lot less. This also makes them more amenable to corruption.

A friend of mine worked as an accountant for a small British firm that set up shop in Prague in the 1990s precisely to perform this clever kind of service for expats like me who were running small businesses.

Number 3: You can get paid in cash to avoid revenue being booked and declared

Many businesses like to be paid in cash, especially black market cash that doesn’t find its way into the company’s accounts, and which doesn’t therefore get taxed. It’s cash that can be used to pay unofficial bonuses to employees, too, instead of taxable salary. You have to be a cash-based service business such as a hotel, or a restaurant, if you’re going to do this on a big scale.

In the end, companies and private individuals pay their taxes when they’re reasonable, and when they trust their government to collect them fairly and spend the money wisely. In the moral vacuum of post socialist Eastern Europe there was no such trust, and it would be rare for a businessman to feel that denying the Government tax meant that some poor pensioner, or needy child, might suffer.

Businessmen can cheat their partners, their customers, their employees, their competitors and the taxman. But the list doesn’t end there.

The Banking System.

Banks can also be easy prey. Before 1989 state banks in Eastern Europe operated under Government and Party rules. Unleashed, they were free to make unsafe loans at attractive rates of interest to friends of friends who wanted to purchase state assets at knockdown prices from other friends of friends. The limited liability company, especially when operating in a legally loose environment, was the perfect channel for cash to flow from the public domain into the private pocket. Set up a company, borrow from the banks, pay the money to yourself either directly or through another ‘service’ company, and then default on the loan and close the company you started with. I met a lady who had danced her way with this particular quickstep into an enormous fortune. Butter wouldn’t melt in her mouth.

Lending is now more sophisticated, but in Moldova they’re still dancing to this kind of tune. A billion dollars (nearly 10% of GDP) was ‘lent’ by state-controlled banks for unknown purposes to a number of anonymously owned shell companies (one or two of them located, I believe, in Glasgow) that have since defaulted and vanished from view. The former Prime Minister, Vlad Filat, is widely suspected of collusion, and has now been charged, but he’ll probably get away with it. What is possible appears to these perpetrators to be permissible, and it all takes place anonymously and at high altitude, as if there are no desperately poor villagers to pay the price.

The European Union.

The EU has sent billions into Eastern Europe. I won’t go into the detail of how these funds can be diverted, but suffice it to say that there’s a whole industry built around it.

There are also sins of omission:

Good Deeds.

In the West, businesses pride themselves on the good works they do that have little to do with their business, such as supporting charities, sponsoring the arts, and so on. This is good for employee morale, good in itself, and, let’s face it, good PR.

They also take care to pick suppliers who are ethical. High street clothes retailers are expected to make sure that their suppliers are also behaving ethically.

Good businesses also take care of the environment.

Awareness of these obligations is growing in Eastern Europe, but from a very low base.

As a businessman I’m aware of all these tricks, but have avoided them. At my company we refused to pay bribes, and I held firm to this policy despite the occasional entreaties of my sales staff (in the distant past). That meant we couldn’t bid for Government tenders, but the companies we worked for, large multinationals making new investments in new markets, were by and large clean. We were asked for bribes once or twice, but we refused.

Bribery isn’t lawful for most Western firms, but who can discover if bribes are delivered by third-party consultancies. Protection money shouldn’t be paid, either, but I was given to understand that when a large international oil firm set up its petrol stations around Moscow’s ring road, protection money was paid on its behalf by a third-party security firm.

And when is a bribe a bribe rather than, for example, an ‘educational trip’? The large pharmaceutical companies, who, on balance, do a lot of good in the world, send health care professionals on lavish educational or professional conferences, and sponsor their research. Do these benefits encourage them to recommend their products? We would be naïve to suggest not.

 

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One thought on “Business Ethics in ‘Eastern Europe’ – Tax Evasion and Other Ills

  1. Business Ethics in ‘Eastern Europe’ – Concluding Thoughts – Adam Bager

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