Audit: Criminals have become e-residents, better background checks needed ({{contentCtrl.commentsTotal}})

An e-Residency ad in the London Underground during Brexit.
An e-Residency ad in the London Underground during Brexit. Source: Enterprise Estonia

It is difficult to carry out background checks on e-Residency applicants and digital IDs have been issued to criminals and people with business bans, an analysis carried out by the National Audit Office into the effectiveness of the e-Residency program shows.

The audit released on Wednesday by the National Audit Office (Riigikontroll) looked at the effectiveness of the e-residency programme and asked the question: "Do the revenues of the e-Residency programme exceed the expenses, and are the participants in the programme law-abiding?"

The e-Residency programme launched in 2014 and since then Estonia has granted e-Residency digital ID cards to over 63,000 foreigners from 174 countries. The digital ID allows e-residents to use public e-services of both Estonia and other EU countries and create an Estonian company.

Auditor General Janar Holm said e-residents have created more than 1,300 jobs in Estonia, with the average wages around the country's average: "The e-Residency programme is something that has added to the reputation of Estonia and brought income.

"On the other hand, we must keep in mind that the more well known the e-Residency programme, the wider spread the news, should something go wrong.

"It has been stated in the e-Residency white paper that a small country's greatest enemy is a poor reputation, whether it's being thought of as a tax haven or a refuge for criminals. Major risks are not mitigated right now."

The National Audit Office found that the Police and Border Guard Board (PPA) has issued digital IDs to foreigners with valid criminal offences in a foreign country.

"We made an inquiry to the Finnish criminal records database and it appeared that 48 e-residents with Finnish citizenship had, during the application for the digital ID, a valid criminal penalty in Finland, whereas a quarter of them were serving an actual prison sentence and a fifth had been punished for economic offences," Holm said. "They probably would never have become e-residents, had this information been available to the PPA earlier."

The PPA has also issued digital IDs to foreigners with a valid business ban abroad and has not revoked the digital IDs. As a result, the e-residents with business bans are board members in Estonian companies. The main reason for this is it is difficult to carryout background checks in other countries without international cooperation, the audit office said.

Managing Director of e-Residency Ott Vatter does not agree with the assessment that it is too easy for people with suspicious backgrounds to become e-residents.

"The ratio of e-residents of dubious origin is very small, considering that we have almost 70,000 e-residents," he said.

The audit also said neither Enterprise Estonia, the governing body of the program nor any state agency, have a consistent and uniform overview of the total revenue and expenses of the programme, which makes it difficult to manage. 

Vatter said in a statement sent to ERR News he is pleased that the audit office considers the unique development of this initiative and recognizes that it is profitable for the state.

However, contrary to what is stated in the report, the Estonian Government has a clear overview of the revenues and expenses of the e-Residency programme, he said.

"The calculation of the programme's revenues was agreed by all state agencies in 2018, is transparent, and extremely conservative. We have the same sources and facts as the audit office, but the methodology is different.

"We calculate revenue using the method recommended by the international auditing firm Deloitte, which is recognized and transparent, while the audit office follows a method that they themselves developed.

"As we were not able to get acquainted with their calculation process concerning the costs, we do not know to what extent the costs of IT developments concerning all Estonian citizens were also written into the cost line. The process has not been transparent."

Speaking about the security concerns, Ruth Annus, head of the Citizenship and Migration Policy Department of the Ministry of the Interior, said e-residents give their fingerprints to the Estonian Government and undergo a thorough check.

"E-Residency is a part of the Estonian economy. Just as people with bad intentions can physically enter Estonia in the Schengen Open Visa Area, we cannot completely exclude people with bad intentions from the more than 70,000 e-residents that we have today. However, when operating in the Estonian economic space, an e-resident leaves a digital footprint, which considerably lowers the risks. We don't have any information about other non residents."

She added that unfortunately, it is not possible to reduce the number of malicious people to zero without stopping the economy

The National Audit Office is not recommending the program be terminated, it said in a statement: "In the course of the audit, the National Audit Office found several shortcomings and made proposals on how to solve them.

"The aim of the recommendations of the National Audit Office is to ensure that those foreigners who need it can continue using the Estonian e-services safely and engage in business comfortably.

"However, the risks identified have to be mitigated in order to prevent problems in business (e.g. tax fraud, use of figureheads, etc.) and potential international reputational damage."

Audit summary

ERR News has published the summary of the State Audit Office's assessment below. Responses to the audit from the relevant government ministries can be found at the end of the article.

The audit assessed if:

  • the e-Residency programme encourages e-Resident founded companies to bring income to Estonia;
  • control systems ensure that the participants in the e-Residency programme are law-abiding;
  • sufficient platforms for business and services have been created for e-Residents;
  • whether the major risks involved in the implementation of the e-Residency programme have been mitigated.

Results

The revenues of the e-Residency programme have started to exceed the expenses by the end of the first five years of operation.

However, control systems are deficient because foreigners with a valid criminal penalty and business ban can participate in the programme.

What is the e-Residency programme and why is this important to taxpayers? 

The e-Residency programme launched in 2014 and since then Estonia has granted e-Residency digital ID cards to over 63,000 foreigners from 174 countries.

The digital ID allows e-residents to use public e-services of both Estonia and other EU countries and create an Estonian company. Last November, ERR News reported more than 10,000 businesses had been started by e-residents. It was also reported last year that e-residents had paid €10 million in taxes.

The audit office found, in total, €15.7 million has been spent on the e-Residency programme.

In June the e-Residency program said it had earned the state €41 million in total, €31 million of which is direct tax revenue since it launched in 2014.

Last year, Government Chief Information Officer (CIO) and Deputy Secretary-General for IT and Telecoms Siim Siikut said the program is a form of soft power which has increased Estonia's reputation abroad and cannot be measured financially. Siikut also co-founded e-Residency.

In December, it was reported Russia and Ukraine were the countries which had opened the most companies using e-residency and had the most e-residents.

The State Audit Office believes it is important that e-Residents using e-services and pursuing commercial activities be law-abiding and that they bring income to Estonia. It is also essential that the risks involved in the implementation of the programme are mitigated.

What did the audit show? 

Revenue

The revenues of the e-Residency programme exceed expenses by almost €10 million.

However, 95 percent of the revenue is paid by 6 percent of the companies meaning the income of the programme depends on a small number of companies.

The companies which pay the most taxes are generally up to five years old and they have up to five employees in Estonia. These companies mainly operate in the following sectors: information and communication; manufacturing industry; professional, research and technical activities; wholesale and retail trade; and administrative and support activities.

At the same time, the list of companies that pay taxes also include companies with several dozen employees and that have operated for over a decade. The latter have been operating since before the e-Residency programme, and the e-residents there have either acquired a holding or the entire company.

It cannot be known for sure which countries e-residents pay their taxes in, a statement by the audit office said.

The e-Residency programme has introduced new entrepreneurs to the Estonian business landscape, and the taxes paid by their companies have helped to bring the programme into profit.

However, neither Enterprise Estonia, the governing body of the programme, nor any state agency, have a consistent and uniform overview of the total revenue and expenses of the programme, which makes it difficult to manage.

When calculating revenue and expenditure in the audit, the National Audit Office did not check the revenue and expenditure presented by the e-Residency team of Enterprise Estonia and calculated both by itself, the audit office said in a statement.

Applicants may not be law-abiding

The checks carried out do not ensure the participants in the e-Residency programme are law-abiding.

The Police and Border Guard Board (PPA) has issued digital IDs to foreigners with valid criminal offences abroad. They have also not revoked the documents of some e-Residents who have committed a crime in Estonia during the validity of the digital ID.

According to the PPA, one of the reasons for this is that there are no IT solutions which can make mass inquiries to the Criminal Records Database and identify foreigners convicted in Estonia.

In administrative proceedings, the PPA is unable to identify persons convicted in a foreign country if the information has not been entered in international databases.

A statement by the audit office said for the most part, the problem is that it is difficult for the PPA to obtain information on punishments from foreign countries, and the PPA nor the state of Estonia alone can change much about this. This requires international cooperation. 

Applicants with business bans can apply

The checks do not protect Estonian entrepreneurs against e-residents with a business ban.

The PPA has issued digital IDs to foreigners with a valid business ban abroad and they have not revoked digital IDs for e-residents who have received a business ban abroad during the validity of the document. As a result, the e-residents with business bans are board members in Estonian companies.

Estonia recognizes Finland's business bans. According to the PPA, they cannot make necessary inquiries into Finnish business bans during the follow-up inspection due to a lack of IT solutions.

With other countries there is no existing exchange of data on business bans.

As explained by the Tax and Customs Board, they have no means and options for assessing a person's tax behaviour, including the presence of business ban, which is why inquiries are made to Estonian databases only.

At the same time, most of the e-residents have never been to Estonia or engaged in business here. Due to that, the use of Estonian databases only is not sufficient to assess the law-abidingness of the applicants and e-Residents regarding taxes and business.

Applicants do not have to contribute to Estonia

The digital ID is issued without an obligation for foreigners to contribute to the development of the Estonian economy, education, science, or culture, even though it is the legal purpose of issuing the document.

Also, the renewal of the digital ID does not depend on whether the foreigner has contributed to Estonia or not.

Implementation of the obligation to contribute to Estonia would ensure the activity of the e-residents is in line with the purpose for which the digital ID is issued.

In other words, it would give the ability assess the issue of the digital ID and during follow up checks and renewals, whether the e-resident's activity contributes to the development of Estonian economy, science, education or culture.

Increased risk of reputational damage to Estonia

The amendment to the law due to the e-Residency programme has increased the risk of reputational damage to Estonia.

Due to the e-Residency program an amendment was made to the Commercial Code, which allows the company's management board to be located abroad.

Together with the incomplete requirements for applying for licenses of virtual currency service providers, a situation has occurred in which a number of Estonian companies were established operating abroad and licensed by Estonia in a field that the Financial Intelligence Unit has assessed to be at high risk for money laundering and terrorist financing.

The PPA was unable to supervise the companies due to their location abroad.

Even though the management board of a virtual currency service provider is no longer allowed to be located abroad, this option was available for two years. If Estonian-licensed virtual currency service providers committed fraud and it becomes public, it could damage Estonia's reputation

Banking service bottlenecks

E-services are available to e-Residents, except for banking services. According to e-Residents, they do not have major issues in finding public e-services or private sector services, and 90 percent of the e-Residents are happy with the services offered.

However, e-Residents also claim insufficient access to banking services to be an important bottleneck.

For example, banks are closing the accounts of e-Residents and it is difficult for new e-Residents to open a bank account in Estonia.

The main reason why banks refuse to open accounts is that there is no certainty that the e-Residents and their companies will be operating in Estonia. If the business is done in another country, this does not allow banks to supervise the activities of the e-Residents to the required extent and ensure that the bank account is only used for lawful activities. If a company's activity had a relevant connection to Estonia, it would reduce the risks for banks.

Many e-residents do not renew their digital IDs

Few e-residents who have had the option, have renewed their digital IDs. The digital ID has been renewed by almost 1,900 e-residents - one in 10 - whose digital ID card has expired.

The results of the survey held among e-residents showed that they justified the non-renewal with the fact that the e-Residency programme did not meet their expectations. Problems with opening a bank account were mentioned the most.  

Managing Director of e-Residency Ott Vatter told Postimees as digital IDs are issued for a five year period many people have not needed to renew yet. The scheme celebrated its fifth anniversary earlier this year.

Recommendations 

The main recommendations made by the National Audit Office are:

Consider the use of reverse burden of proof for e-Residency applicants and e-residents more often. It would then be possible to request evidence of valid criminal records and absence of business bans during the application or, where appropriate, during follow-up inspection.

Establish a condition for the issue of an e-resident's digital ID, which obliges the applicant to contribute to Estonia as well as verifying it upon extension of the ID or if required in follow up inspection.

Provide IT solutions for the PPA for more efficient control procedures for the e-Residents to allow making mass inquiries to the necessary registers (e.g. the Criminal Records Database).

Keep as accurate an overview as possible of the total expenses and revenues of the e-Residency programme so that Enterprise Estonia and the Ministry of Economic Affairs and Communications can make informed decisions in managing the programme.

Explain the conditions for starting a company and opening a bank account in Estonia when marketing the e-Residency programme.

Responses of the auditees:

Minister of the Interior Mart Helme (EKRE) and the Minister of Justice Raivo Aeg (Isamaa) agreed to the need to provide the PPA with the required IT solutions that would allow making mass queries to the necessary registers.

Helme said he does not find it necessary to establish a condition for e-Residency applicants to contribute to Estonia and verify the contribution at the renewal of the digital ID.

The Director General of the PPA Elmar Vaher said the making of mass queries is also aggravated by the restrictions arising from administrative proceedings. Also, as stated by the Director General, it is particularly difficult to obtain information on third country nationals.

Vaher said one of the solutions is a political decision which would only allow eResidency with countries doing judicial and security cooperation with Estonia.

Vaher agreed the requirement to provide evidence on the absence of any punishments and business ban contributes to the management of risks but added that it is difficult to verify the correctness of such evidence.

The Minister of Foreign Trade and Information Technology Raul Siem (EKRE) agreed in the interests of better management decisions, it is important to keep a consistent and uniform overview of the revenues and expenses of the e-Residency programme.

The Minister also agreed that it is important to adequately explain the conditions for opening a bank account in Estonia to those applying for e-Residency and take these into account in marketing the programme.

Managing Director of e-Residency Ott Vatter said: "This audit deals with the past; e-Residency has matured into a significant phenomenon in the world, copied by Lithuania, Portugal, and Ukraine. E-Residency has also been discussed as an option in the UK. Our e-Government and e-Residency are valued in the post-COVID-19 world."

He added that in the COVID-19 period, tax revenues from e-resident companies have increased by more than 50 percent compared to the same period last year, and e-residents see e-Residency as a tool to keep their companies running in this difficult situation.

Read the full audit summary here in Russian or English. The full report is also available to read in Estonian.

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Editor: Helen Wright

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