Tax Haven - What is it?

[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

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
    

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