What is Tax Haven?

Countries with no tax or meager tax rates are known as tax havens. The legal systems of these countries ensure secrecy and have no control over foreign exchange movement. Hence, foreign companies get the opportunity to open entities in such countries for financial engineering or tax avoidance purposes. Only foreigners can avail of this benefit, while residents are liable for tax. The main purpose of a tax haven is to help people hold their black money in these countries without paying taxes.

How does this work for corporations?

Corporations use profit-shifting techniques to avoid taxes by underreporting their actual income in the country they are based in. So how does this happen? Whoever holds the “Bearer Shares” in such countries is known as the owner of the company. So, the solicitor will be the first shareholder in the company and then they will transfer these shares to the original owners of the company.

Let’s see an example to elaborate on “Tax Haven”

XYZ Ltd. is manufacturing a machine in the USA. They are getting rubber from Singapore, designs from Japan, and Steel from India and they have subsidiaries in all these three countries.

Let’s assume, tax rates are as under:

USA:50%

Singapore:30%

Japan:50%

India:30%

The subsidiary company will sell its goods at an acceptable (5 to 10% margin) to tax heaven companies. The same goods will be sold to the USA at a price acceptable to US authorities with a high margin. So, most of the profit will be retained in the tax haven, and the cost of goods will be high for the US company.

In most cases, multinational companies are using profit-shifting techniques by establishing subsidiaries in tax haven countries, and due to this, governments are losing approximately $500 billion of corporate tax revenue as per the International Monetary Fund.

Individuals use tax havens to park their wealth using a legal entity without disclosing their identity, as the secrecy laws of these tax havens safeguard their personal details, and wealth is held by this legal entity. Hence, a tax haven is an important way for such individuals to hide the true value of wealth and avoid taxes.

Top tax havens around the world

1. The Cayman Islands: Cayman Island is a popular destination for hedge fund managers to avoid taxes as there is no income tax or corporate tax. Also, income from the investment is not liable for taxes in the Cayman Islands. There is a license fee for offshore companies instead of taxes.
2. Bermuda: If a company is incorporated in Bermuda, it is considered a resident of Bermuda. No corporate tax is levied on the same Also, individual tax is nil in Bermuda. Other income like capital gains, foreign exchange gains, and dividends is also not taxed in this country.
3. The Netherlands: The Netherlands is a popular tax haven for corporations as it has more bilateral treaties and is more transparent when it comes to taxation policy. The Netherlands does not levy high taxes on dividends and royalties, so shelter companies get a window to channel their money.
4. The Bahamas: There is no income tax, capital gains tax, or company tax in the Bahamas. Furthermore, foreign investors are permitted by law to register businesses as sole proprietorships. Also, some qualified businesses are treated as citizens, so they can enjoy the citizenship laws. Hence, the Bahamas is considered a favorite tax haven.
5. Mauritius: Mauritius is known as an open economy. It has liberal tax laws, and its democracy is based on English and French law. The banking structure of the country is open to foreigners. This country has strong economic agreements with other countries.
6. Singapore: Due to liberal tax laws and incentive schemes, Singapore is considered a tax haven for foreign investors. Capital gains are not taxable here. Various tax exemptions are available to qualified businesses; hence, it provides a gateway to foreign companies for investment.
7. Luxembourg: Dividends from companies are not taxed in Luxembourg. Also, if you hold more than 10% of stocks in a company, then capital gains on such stocks are exempt. Also, there are no taxes on interest and royalty payments. Hence, 80% of European countries like to shift their profits to Luxembourg.
8. Switzerland: Switzerland’s banking sector allows foreign individuals to store their income in a discreet way. A total of 48% of the money originated from abroad in Switzerland. Also, affordable tax rates and strong economic growth attract wealthy individuals. This technique is known as “fiscal tourism.”
9. The Isle of Man: This country has very low tax rates and zero for many qualified industries. Isle of Man laws is strict for the banking sector to maintain the confidentiality of the investor. Also, this country has no obligation to maintain taxes in line with the United Kingdom or European countries. No tax liability on capital growth and pension planning is attracting lots of offshore money as a portfolio management strategy.
10. Malta: Malta’s corporate tax starts at 5% for international companies and, thanks to their tax system, stakeholders can receive up to an 80% refund on the taxes paid. The average tax rate in other European countries is around 22%. Due to this, a lot of EU companies are operating through subsidiaries in Malta. Malta is famously known as ” the Panama of Europe”.

How tax havens are harming the world economy?

As taxes directly affect cash flow, companies like Nike, Goldman Sachs, and Apple are using offshore heaven for tax savings. Countries with high tax rates are facing adverse effects on economic growth and financial instability due to the migration of capital from high-tax-rate countries to tax havens. Not just developed countries, but tax havens are hurting developing countries the most, being corruption drivers. Poor countries are losing approximately $170 billion in taxes every year. This becomes a hurdle to their economic growth.

So, is it affecting ordinary people?

Local or small businesses cannot take advantage of the tax haven. Multinational companies enjoy this advantage by capitalizing on tax avoidance strategies. Ultimately, corporate tax is paid by the stakeholders, which are wealthier groups of people. Average global corporate taxes were reduced from 49% to 24% from 1985 to 2018. So, ultimately the tax burden is passed to ordinary workers from shareholders.

Conclusion

Transparency in the exchange of information, registration of beneficial owners, and country-wise reporting can help to stabilize this problem. However, more than 300 economists signed an open letter to end the tax haven era In 2016, an anti-corruption summit was organized in the UK. After the leak of the “Pandora Papers” in 2021, major impacts are coming from India, France, and Europe. The Organization for Economic Co-operation and Development(OECD) is also putting forth efforts to prevent the exploitation of tax laws.