Tax Haven or Heaven?

The term tax haven usually conjures up images of exotic destinations with shady criminals sitting pool-side sipping tropical fruit cocktails. (Kudos Hollywood!) However, the main impetus of the existence of tax havens is not to facilitate illegal international activity, but to attract business to otherwise over-looked developing economies. And this is done by reducing or eliminating tax completely. So, in essence, tax havens are incentives by countries to increase their economic activity.

A tax haven is defined as “a state, country, or territory where, on a national level, certain taxes are levied at a very low rate or not at all”. It also refers to countries which have a system of financial secrecy in place. This financial secrecy is often used by individuals and corporations to circumvent taxes levied on income or inheritance as the funds on which the said taxes are to be levied are themselves invisible to the countries which have the right to issue those taxes. But because individual nations have National Sovereignty, it is not illegal for one nation to offer lower tax rates to people who either or both wish to do business there, or even emigrate there. Thus, despite this abuse of the system, countries do have the right to have a system of financial secrecy in place.

This however doesn’t imply every country turn into a tax haven to attract investor’s attention. Tax havens have to be developed with strong rules of law and a history of it. Money that is diverted there should be retrievable at a later date and while that can be assured for a country like Switzerland or Luxembourg, for example, the same can’t necessarily be said for say, Somalia. Another vital factor is the existence of a close to insurmountable military or defense alliance without which there’s no question of high-earning individuals and corporations risking any connections with countries outside their own.

Popular tax havens include Mauritius, Switzerland, British Virgin Islands, Monaco, Isle of Man, Cayman Islands, Luxembourg. In Europe, many small city-states such as Andorra and Monaco have been transformed into lucrative tax havens as can be seen from Monaco’s description by most investment analysts as a “sunny place for shady people”.

Most tax havens require little or no taxes from companies “domiciled” there. This is too lucrative an offer that many individuals and businesses just cannot pass up. Hence many international companies set up subsidiaries in international tax havens. Tax havens end up being the perfect place for companies to book their profits. For example, an Indian company exporting spices, may set up an offshore company in the Mauritius and take advantage of the off shore company’s tax-free status by selling the spices to the Mauritius company at an artificially low price and then immediately reselling the spices to companies in Europe at the higher market level. This allows exporter to pocket the profits offshore where there are no taxes. The home country government may feel cheated out of its legitimate tax on the real profit, but because a tax haven was used as a go-between, the money that would normally be paid as tax ends up in the pockets of the exporter.

Similarly many individuals also set up their “domicile” in tax havens such as the Bahamas or Cayman Islands. Just as a company avoids taxes on profits in these havens, individuals avoid paying taxes on income.

Most tax havens today are domiciles-of-choice for corporations which have many ways of hiding their income there, the most notable of which, is by registering their intellectual property there. (I mean, how many new technological inventions actually happen in the Cayman Islands?)

The Wall Street Daily recently reported that Corporate tax payments averaged 46% of profits in the 1950s, according to the Bureau of Economic Analysis. But in the five years from 2010-14, the same payments averaged only 22% of profits.

This trend is startling for many reasons. If corporations are going to be allowed to evade taxes on this scale, the burden of these taxes will eventually fall on the middle class as well as aid the increase in the US Federal Budget deficit. Other countries have begun to take notice, notably of which, France and Britain have begun cracking down on market leaders. Britain recently reached a $200 million deal with Alphabet Inc.– better known as Google – for back taxes. French Finance Minister Michel Spain also said Google would pay “way more” to France.

To avoid tax competition, many high tax jurisdictions have enacted legislation to counter the tax sheltering potential of tax havens, the yang, to the yin that was globalization. Just as globalization made it easier to move capital around the world, it also made it easier to hide illegal money-and tax havens provide the ideal place to do it. Illegal money often getting covered up by the billions of dollars that flow through tax haven banks on any given day of the year.

-Vijitha Gunta