[Submitted by CA. Vibhuti Gupta,
Chartered Accountant,
New Delhi]

August 31, 2010

TAX HAVEN : A tax haven is a country or territory where certain taxes are levied at a low rate or not at all.

In its December 2008 report on the use of tax havens by American corporations, the U.S. Government Accountability Office regarded the following characteristics as indicative of a tax haven:

  1. nil or nominal taxes;
  2. lack of effective exchange of tax information with foreign tax authorities;
  3. lack of transparency in the operation of legislative, legal or administrative provisions;
  4. no requirement for a substantive local presence; and
  5. self-promotion as an offshore financial center.

Advantages of tax havens are viewed in four principal contexts :-

  • Personal residency. Since the early 20th century, wealthy individuals from high-tax jurisdictions have sought to relocate themselves in low-tax jurisdictions. In most countries in the world, residence is the primary basis of taxation. In some cases the low-tax jurisdictions levy no, or only very low, income tax. But almost no tax haven assesses any kind of capital gains tax, or inheritance tax.
     
  • Asset holding. Asset holding involves utilizing a trust or a company, or a trust owning a company. The company or trust will be formed in one tax haven, and will usually be administered and resident in another. The function is to hold assets, which may consist of a portfolio of investments under management, trading companies or groups, physical assets such as real estate. The essence of such arrangements is that by changing the ownership of the assets into an entity which is not resident in the high-tax jurisdiction, they cease to be taxable in that jurisdiction. Often the mechanism is employed to avoid a specific tax. For example, a wealthy testator could transfer his house into an offshore company; he can then settle the shares of the company on trust (with himself being a trustee with another trustee, whilst holding the beneficial life estate) for himself for life, and then to his daughter. On his death, the shares will automatically vest in the daughter, who thereby acquires the house, without the house having to go through probate and being assessed with inheritance tax. (Most countries assess inheritance tax (and all other taxes) on real estate within their jurisdiction, regardless of the nationality of the owner, so this would not work with a house in most countries. It is more likely to be done with intangible assets.)
     
  • Trading and other business activity. Many businesses which do not require a specific geographical location or extensive labor are set up in tax havens, to minimize tax exposure, for examples include internet based services and group finance companies. In the 1970s and 1980s corporate groups were known to form offshore entities for the purposes of "re-invoicing". These re-invoicing companies simply made a margin without performing any economic function, but as the margin arose in a tax free jurisdiction, it allowed the group to "skim" profits from the high-tax jurisdiction. Most sophisticated tax codes now prevent transfer pricing scams of this nature.
     
  • Financial intermediaries. Much of the economic activity in tax havens today consists of professional financial services such as mutual funds, banking, life insurance and pensions. Generally the funds are deposited with the intermediary in the low-tax jurisdiction, and the intermediary then on-lends or invests the money (often back into a high-tax jurisdiction). Although such systems do not normally avoid tax in the principal customer's jurisdiction, it enables financial service providers to provide multi-jurisdictional products without adding an additional layer of taxation. This has proved particularly successful in the area of offshore funds.
     

The OECD and tax havens -

The Organisation for Economic Co-operation and Development (OECD) identifies three key factors in considering whether a jurisdiction is a tax haven:

  1. Nil or only nominal taxes : Tax havens impose nil or only nominal taxes (generally or in special circumstances) and offer themselves, or are perceived to offer themselves, as a place to be used by non-residents to escape high taxes in their country of residence.
     
  2. Protection of personal financial information: Tax havens typically have laws or administrative practices under which businesses and individuals can benefit from strict rules and other protections against scrutiny by foreign tax authorities. This prevents the transmittance of information about taxpayers who are benefiting from the low tax jurisdiction.
     
  3. Lack of transparency: A lack of transparency in the operation of the legislative, legal or administrative provisions is another factor used to identify tax havens.
     

Anti-avoidance

To avoid tax competition, many high tax jurisdictions have enacted legislation to counter the tax sheltering potential of tax havens. Generally, such legislation tends to operate in one of five ways:

  1. Attributing the income and gains of the company or trust in the tax haven to a taxpayer in the high-tax jurisdiction on an arising basis. Controlled Foreign Corporation legislation is an example of this.
     
  2. Transfer pricing rules, standardization of which has been greatly helped by the promulgation of OECD guidelines.
     
  3. Restrictions on deductibility, or imposition of a withholding tax when payments are made to offshore recipients.
     
  4. Taxation of receipts from the entity in the tax haven, sometimes enhanced by notional interest to reflect the element of deferred payment. The EU withholding tax is probably the best example of this.
     
  5. Exit charges, or taxing of unrealized capital gains when an individual, trust or company emigrates.
     

Incentives

There are several reasons for a nation to become a tax haven. Some nations may find they do not need to charge as much as some industrialized countries in order for them to be earning sufficient income for their annual budgets. Some may offer a lower tax rate to larger corporations, in exchange for the companies locating a division of their parent company in the host country and employing some of the local population. Other domiciles find this is a way to encourage conglomerates from industrialized nations to transfer needed skills to the local population.

Examples

  • Andorra – No personal income tax.
  • Anguilla – A British Overseas Territory and offshore banking centre
  • Antigua and Barbuda
  • Aruba
  • The Bahamas levies neither personal income nor capital gains tax, nor are there inheritance taxes.
  • Barbados – A 'Low-tax regime' not 'Tax haven'. The government of Barbados sent off a high level note to members of the United States Congress recently in protest of the label "Tax Haven" stating it has the potential to undermine or override the Barbados/United States double taxation agreement. Since appearing on the 2009 OECD/G-20 white-list, the Barbados government began an international ad-campaign to market the country as the only Caribbean country to be included on the white-list.
  • Belize – No capital gains tax.
  • Bermuda does not levy income tax on foreign earnings, and allows foreign companies to incorporate there under an "exempt" status. Exempt companies are also limited from doing local trade and may not hold real estate in Bermuda, nor may they be involved in banking, insurance, assurance, reinsurance, fund management or similar business, such as investment advice, without a license.

  • Bosnia and Herzegovina – 10% corporate income tax, 10% income tax, 10% capital gain tax

  • British Virgin Islands - the 2000 KPMG report to the United Kingdom government indicated that the British Virgin Islands was the domicile for approximately 41% of the world's offshore companies, making it by some distance the largest offshore jurisdiction in the world by volume of incorporations.

  • Bulgaria – 10% corporate income tax, 10% income tax, 10% capital gain tax

  • Campione d'Italia - an Italian enclave within Switzerland

  • Cayman Islands

  • In the Channel Islands, no tax is paid by corporations or individuals on foreign income and gains. Non-residents are not taxed on local income. Local taxation is at a fixed rate of 20% in Jersey, Guernsey, & Alderney and 0% in Sark.

  • Cook Islands

  • Cyprus - this jurisdiction has grown recently in popularity and anticipates further future growth. As a jurisdiction Cyprus is in a position to exploit its unusual position as an offshore jurisdiction which is within the EU. 10% corporate tax (0% for shipping companies), 20 - 30% income tax, 20% CGT

  • State of Delaware - a State in the USA which charges no income tax on corporations not operating within the state.

  • The Isle of Man does not charge corporation tax, capital gains tax, inheritance tax or wealth tax. Personal income tax is levied at 10–18% on the worldwide income of Isle of Man residents, up to a maximum tax liability of £115,000 (as of April 2010). Banking income tax is levied on the profits of Isle of Man based banks at 10% and income from the rent of Isle of Man property is levied at the same rate.

  • Labuan -  a Malaysian island off Borneo

  • Macau
  • Mauritius – based front companies of foreign investors are used to avoid paying taxes in India utilising loopholes in the bilateral agreement on double taxation between the two countries, with the tacit support of the Indian government, who are keen to improve figures relating to inward investment. The use of Mauritius as a gateway to funnel foreign investments into India has always been controversial. Mauritius's financial regime has a number of the key characteristics of a tax haven, which has helped to facilitate this.
  • Macedonia – corporate taxes 10%, income taxes 10%, tax on reinvestment profit 0%
  • Monaco does not levy a personal income tax.
  • Nauru – No taxes. Only tax in country is an airport departure tax.
  • Netherlands Antilles – In October 2008 the State Secretary of Finance announced that the Netherlands Antilles along with the Isle of Man would begin to seek ways to combat the 'Tax Haven ' label that has been placed on their territory by some governments.
  • Nevis
  • New Zealand does not tax foreign income derived by NZ trusts settled by foreigners of which foreign residents are the beneficiaries. Nor does it tax the foreign income of new residents for four years. No capital gains tax.
  • Norfolk Island – no personal income tax.
  • Panama 'Offshore' entities are not prohibited from carrying on business activities in Panama, other than banks with International or Representation Licenses but will be taxed on income arising from domestic trading, and will need to segregate such trading in their accounts.
  • Samoa
  • San Marino
  • Sark
  • Seychelles
  • St Kitts and Nevis
  • St Vincent and the Grenadines
  • Switzerland is a tax haven for foreigners who become resident after negotiating the amount of their income subject to taxation with the canton in which they intend to live. Typically taxable income is assumed to be five times the accommodation rental paid.
  • Turks and Caicos Islands - The attraction of the Exempt Company lies in a combination of its tax exempt status and minimal disclosure and administrative requirements. In order to obtain tax exempt status the subscribers must at the time of incorporation lodge at the Companies Registry a signed declaration stating that the business of the company will be mainly carried on outside the Turks and Caicos Islands. The subscribers are not required to inform the Registrar of the identity of the beneficial owners. An exempt company must nominate a representative resident in the Islands for the purpose of service of legal process. There are more than 15,000 International Business Companies registered in the Turks and Caicos Islands.
  • Ukraine – 15% income tax
  • United Arab Emirates for individuals and Jebel Ali Free Zone for companies.
  • United States Virgin Islands offers a 90% exemption from U.S. income taxes and 100% exemption from all other taxes and customs duties to certain qualified taxpayers.


 

 

Former tax havens

  • Beirut formerly had a reputation as the only tax haven in the Middle East. However, this changed after the Intra Bank crash of 1966 and the subsequent political and military deterioration of Lebanon dissuaded foreign use as a tax haven.
     
  • Liberia had a prosperous ship registration industry. The series of violent and bloody civil wars in the 1990s and early 2000s severely damaged confidence in the jurisdiction. The fact that the ship registration business still continues is partly a testament to its early success, and partly a testament to moving the national Shipping Registry to New York City.
     
  • Tangier had a brief but colorful existence as a tax haven in the period between the end of effective control by the Spanish in 1945 until it was formally reunited with Morocco in 1956.
     
  • A number of Pacific based tax havens have ceased to operate as tax havens in response to OECD demands for better regulation and transparency in the late 1990s.

 
Lost tax revenue

Estimates by the OECD suggest that by 2007 capital held offshore amounts to somewhere between US$5 trillion and US$7 trillion, making up approximately 6–8% of total global investments under management. Of this, approximately US$1.4 trillion is estimate to be held in the Cayman Islands alone.
In October 2009 research commissioned from Deloitte for the Foot Review of British Offshore Financial Centres indicated that much less tax had been lost to tax havens than previously had been thought. The report indicated "We estimate the total UK corporation tax potentially lost to avoidance activities to be up to £2 billion per annum, although it could be much lower." The report also dissected an earlier report by the TUC, which had concluded that tax avoidance by the 50 largest companies in the FTSE 100 was depriving the UK Treasury of approximately £11.8 billion. The TUC's analysis had looked at the reported profits of the companies and the amount of tax paid, which created a gap in tax revenues which was mostly due to differences in the accounting treatment of profit for taxation purposes, which were intended under the UK's tax rules.The report also stressed that British Crown Dependencies make a "significant contribution to the liquidity of the UK market". In the second quarter of 2009, they provided net funds to banks in the UK totalling $323 billion (£195 billion), of which $218 billion came from Jersey, $74 billion from Guernsey and $40 billion from the Isle of Man.

G20 tax havens blacklist

At the London G20 summit on 2 April 2009, G20 countries agreed to define a blacklist for tax havens, to be segmented according to a four-tier system, based on compliance with an "internationally agreed tax standard.” The list, drawn up by the OECD, was updated on 2 April 2009 in connection with the G20 meeting in London. Further changes were made to the list on 7 April 2009 to remove countries from the non-cooperative category. The four tiers are:

  1. Those that have substantially implemented the standard (includes countries such as Argentina, Australia, Brazil, Canada, China, Czech Republic, France, Germany, Greece, Guernsey, Hungary, Ireland, Italy, Japan, Jersey, Isle of Man, Mexico, the Netherlands, Poland, Portugal, Russia, Slovakia, South Africa, South Korea, Spain, Sweden, Turkey, United Arab Emirates, United Kingdom, and the United States)
     
  2. Tax havens that have committed to, but not yet fully implemented the standard (includes Andorra, the Bahamas, Cayman Islands, Gibraltar, Liechtenstein, and Monaco)
     
  3. Financial centres that have committed to, but not yet fully  implemented, the standard (includes Chile, Costa Rica,[51] Malaysia,[51] the Philippines,[51] Singapore, Switzerland, Uruguay[52] and three EU countries – Austria, Belgium, and Luxembourg)
     
  4. Those that have not committed to the standard/ 'non-cooperative tax havens'. For the record is a complete list of non-cooperative tax havens as published by the OECD ( as per the printed edition of the Spanish newspaper El Pais dated April 4th, 2009.) In fact, there are three lists: the blacklist (countries that ignore foreign fiscal authorities) a grey list (countries that supposedly lack fiscal transparency but have committed to change) and a third list, neither grey nor black, of countries that are “non-co-operative financial centers.”
     
    The Blacklist - Costa Rica, Philippines, Malaysia
     
    The Grey List - Andorra, Anguilla, Antigua and Barbuda, Aruba, Bahamas, Bahrein, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Cyprus, Dominica, Gibraltar, Grenada, Guernsey, Isle of Man, Jersey, Liberia, Liechtenstein, Malta, Marshall Islands, Mauritius, Monaco, Monserrat, Nauru, Netherlands Antilles, Niue, Panama, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and Grenadines, Samoa, San Marino, Seychelles, Turks and Caicos Islands, US Virgin Islands, Vanuatu (Uruguay was oficially added to this list a few days later)
     
    Non – Cooperative Financial Centres - Austria, Belgium, Brunei, Chile, Guatemala, Luxembourg, Singapore, Switzerland