Tax haven

From Wikipedia, the free encyclopedia

A tax haven is a place where certain taxes are levied at a low rate or not at all. This encourages wealthy individuals and/or firms to establish themselves in areas that would otherwise be overlooked. Different jurisdictions tend to be havens for different types of taxes, and for different categories of people and/or companies.

Often described in different ways, it is difficult to find a satisfactory or generally accepted definition for what constitutes a tax haven. The Economist has tentatively adopted the description by Colin Powell (former Economic Adviser to Jersey): "What ... identifies an area as a tax haven is the existence of a composite tax structure established deliberately to take advantage of, and exploit, a worldwide demand for opportunities to engage in tax avoidance." The Economist points out that this definition would still exclude a number of jurisdictions traditionally thought of as tax havens.^[1]

Contents 1 Origins 1.1 Developments 1.2 Failures 2 Avoidance 2.1 Country of residence 2.2 Country of citizenship 2.3 Double taxation 2.4 Legal entities 3 Methodology 4 Anti-avoidance 5 Incentives 6 Examples 7 Amounts 8 Modern developments 9 See also 10 Notes 11 Further reading 12 External links

[edit] Origins

The use of differing tax laws between two or more countries to try and mitigate tax liability is probably as old as taxation itself. It is sometimes suggested that the practice first reached prominence relating to the use (or avoidance of) the staple ports in the fourteenth century. Others suggest that the Hanseatic League first embraced the concept of tax competition as early as 1241, while others argue that the tax status of the Vatican City was the earliest example of a tax haven (the first Papal States being recognised in 756).

Various countries claim to be the oldest tax haven in the world; the Channel Islands claim tax independence dating from the Norman Conquest, and the Isle of Man can trace its fiscal independence to even earlier times. Nonetheless, the modern concept of a tax haven is generally accepted to have emerged at an uncertain point in the immediate aftermath of World War I.^[2] Bermuda sometimes optimistically claims to have been the first tax haven based upon the creation of the first offshore companies legislation in 1935 by the newly created law firm of Conyers Dill & Pearman.^[3] However, the Bermudan claim is debatable when compared against the enactment of a Trust Law by Liechtenstein in 1926 to attract offshore capital.^[4]

Most commentators suggest that the first true tax haven was Switzerland, followed closely by Liechtenstein.^[5] During the early part of the twentieth century, Swiss banks had long been a capital haven for people fleeing social upheaval in Russia, Germany, South America and elsewhere. However, in the years immediately following World War I, many European governments raised taxes sharply to help pay for reconstruction. Switzerland, having remained neutral, avoided these costs and was able to keep taxes low, leading to an inflow of capital for purely tax related reasons. Nonetheless, it is difficult to point to a single event or date which constituted the emergence of the modern tax haven.

[edit] Developments

The use of modern tax havens has gone through several phases of development subsequent to the inter-war years. From the 1920s to the 1950s, tax havens were usually referenced as the avoidance of personal taxation. The terminology was often used with reference to countries to which a person could retire and mitigate their post retirement tax position.^[6] However, from the 1950s onwards, there was significant growth in the use of tax havens by corporate groups to mitigate their global tax burden. This strategy generally relied upon there being a double taxation treaty between a large jurisdiction with a high tax burden (that the company would otherwise be subject to), and a smaller jurisdiction with a low tax burden (which, by structuring the group ownership through the smaller jurisdiction, they could take advantage of the double taxation treaty and pay taxes at the much lower rate). Although some of these double tax treaties survive,^[7] in the 1970s, most major countries began repealing their double taxation treaties with micro-states to prevent corporate tax leakage in this manner.

In the early to mid-1980s, most tax havens changed the focus of their legislation to create corporate vehicles which were "ring-fenced" and exempt from local taxation (although they usually could not trade locally either). These vehicles were usually called "exempt companies" or "International Business Corporations". However, in the late 1990s and early 2000s, the OECD began a series of initiatives aimed at tax havens to curb the abuse of what the OECD referred to as "unfair tax competition". Under pressure from the OECD, most major tax havens repealed their laws permitting these ring-fenced vehicles to be incorporated, but concurrently they amended their tax laws so that a company which did not actually trade within the jurisdiction would not accrue any local tax liability.^[8]

[edit] Failures

Although tax havens are traditionally linked with images of prosperity,^[9] there have also been notable failures.

• Beirut formerly enjoyed a reputation as the only tax haven in the Middle East. However, its reputation took a severe dent after the Intra Bank crash of 1966,^[10] and the subsequent political and military deterioration of Lebanon destroyed any notion of the necessary stability for a successful tax haven.
• Liberia enjoyed a prosperous ship registration industry. 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, but the series of violent and bloody civil wars in the 1990s and early 2000s severely damaged confidence in the jurisdiction.
• Monaco is still regarded as a tax haven, but it only has a shadow of the former success which it enjoyed up until 1963, when it surrendered to French demands to align its tax system with France in relation to French companies and French individuals.
• Tangier enjoyed a brief but colourful 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 literally closed up shop (although not formally) in response to OECD demands for better regulation and transparency in the late 1990s.

[edit] Avoidance

Note: Tax avoidance is legal. Tax evasion, which is illegal, is not discussed below.

[edit] Country of residence

Many countries tax their residents (individuals and companies) on all their worldwide income. In these cases, taxation can not be avoided by simply transferring assets abroad. One way a person or company may take advantage of tax havens is by becoming a tax exile - moving to, and becoming resident for tax purposes in, a low tax country - a tax haven.

[edit] Country of citizenship

The United States is unlike almost all other countries in that its citizens are subject to U.S. tax on their worldwide income even if they reside permanently outside the USA. U.S. citizens therefore cannot avoid U.S. taxes by emigrating. According to Forbes magazine some nationals choose to give up their United States citizenship rather than be subject to the U.S. tax system.^[11] However, U.S. citizens who reside (or spend long periods of time) outside the U.S. may be able to exclude some salaried income earned overseas (but not other types of income) from U.S. tax. The 1995 limit on the amount which can be excluded was US$80,000.

[edit] Double taxation

Most countries impose taxes on income earned or gains realised within that country regardless of the country of residence of the person or firm. Most countries have entered into bilateral double taxation treaties with many other countries to avoid taxing non-residents twice - once where the income is earned and again in the country of residence (and perhaps, for US citizens, taxed yet again in the country of citizenship.) Often, however, there are no double taxation treaties with countries widely recognised as tax havens. To avoid tax, it is usually not enough to simply move one's assets to a tax haven. One must also move to a tax haven (and, for U.S. nationals, renounce one's citizenship) to avoid tax.

[edit] Legal entities

Without changing country of residence (or, if a U.S. citizen, giving up one's citizenship), personal taxation may be legally avoided by creation of a separate legal entity to which one's property is donated. The separate legal entity is often a company, trust or foundation. Assets are transferred to the new company or trust so that gains may be realised, or income earned, within this legal entity rather than earned by the original owner. Usually one is only taxed on property and earnings which actually are one's own. Thus, by donating assets to a separate legal entity, personal taxation is usually avoided. If located in a tax haven, the company/trust/foundation may also escape taxation (see offshore company, offshore trust or offshore foundation). As settlor (creator of the trust), in order to escape tax, there may be restrictions on the type and purpose and beneficiaries of the trust. E.g. the settlor of the trust may not be allowed to be a trustee or even a beneficiary and may thus lose control of the assets transferred and/or may be unable to benefit from them.

[edit] Methodology

At the risk of massive oversimplification, it is sometimes said that the advantages of tax havens are seen in four principle contexts:^[12]

• Personal residency. Since the early twentieth 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. Individuals who are unable to return to a high-tax country in which they used to reside for more than a few days a year are sometimes referred to as tax exiles.
• Asset holding. Asset holding involves utilising 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 or valuable chattels. 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 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.^[13]
• Trading and other business activity. Many businesses which do not require a specific geographical location or extensive labour are set up in tax havens, to minimise tax exposure. Perhaps the best illustration of this is the number of reinsurance companies which have migrated to Bermuda over the years. Other 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 "reinvoicing". These reinvoicing 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.^[14]

[edit] Anti-avoidance

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 probably the best example of this.
2. transfer pricing rules, standardisation 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 unrealised capital gains when an individual, trust or company emigrates.

However, many jurisdictions employ blunter rules. For example, in France securities regulations are such that it is not possible to have a public bond issue through a company incorporated in a tax haven.^[15]

Also becoming increasingly popular is "forced disclosure" of tax mitigation schemes. Broadly, these involve the revenue authorities compelling tax advisors to reveal details of the scheme, so that the loopholes can be closed during the following tax year, usually by one of the five methods indicated above.^[16] Although not specifically aimed at tax havens, given that so many tax mitigation schemes involve the use of offshore structures, the effect is much the same.

[edit] 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 industrialised 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 industrialised nations to transfer needed skills to the local population. Still yet, some countries simply find it costly to compete in many other sectors with industrialised nations and have found a low tax rate mixed with a little self-promotion can go a long way to lure companies to their domiciles.

Many industrialised countries claim that tax havens act unfairly by reducing tax revenue which would otherwise be theirs. Various pressure groups also claim that money launderers also use tax havens extensively,^[17] although extensive financial and KYC regulations in tax havens can actually make money laundering more difficult than in large onshore financial centers with significantly higher volumes of transactions, such as New York City or London.^[18] In 2000 the Financial Action Task Force published what came to be known as the "FATF Blacklist" of countries which were perceived to be uncooperative in relation to money laundering; although several tax havens have appeared on the list from time to time (including key jurisdictions such as the Cayman Islands, Bahamas and Liechtenstein), no offshore jurisdictions appear on the list at this time.

[edit] Examples

See also: List of offshore financial centres

Andorra. No personal income tax. Anguilla - A British Colony and offshore banking center 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'.[19][20][21] Belize Bermuda does not levy income tax on foreign earnings, and allows foreign companies to incorporate there under an "exempt" status. Exempt companies may not hold real estate in Bermuda or trade there, nor may they be involved in banking, insurance, assurance, reinsurance, fund management or similar business, such as investment advice, without a license. The island also maintains a stable, clean reputation in the business world. At present, there are no benefits for individuals. In fact, for a non-Bermudian to own a house on the island, they would have to pay a minimum of $15,000 a year in land tax alone. 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. The British Virgin Islands has, so far, avoided the scandals which have tainted less well regulated offshore jurisdictions. Bulgaria - corporate taxes 10 % since 2007.01.01, dividents - 7 % 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. Dubai Gibraltar Hong Kong's tax rates are so low that it can be considered a tax haven.[22] Ireland did not tax the foreign income of authors and artists until 2006. Corporation tax is only 10% or 12%. The Isle of Man does not charge corporation tax. Income tax from local sources is 10% and 18% from non-local sources. Liechtenstein Luxembourg Macau Malta

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.[23] Macedonia - corporate taxes 10 % since 2008 (now 12 %), income taxes 10 % since 2008 (now 12 %), tax on reinvestment profit 0 % Monaco does not levy a personal income tax. Nauru Netherlands Antilles 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. Norfolk Island - no personal income tax. Panama 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. Vaud is the most popular canton for this scheme. For businesses, the canton of Zug is popular, with over 6000 holding companies. Turks and Caicos Islands The UK is a tax haven for people of foreign domicile, even if they are UK resident (residence and domicile being separate legal concepts in the UK), in that they pay no tax on foreign income so long as it is not remitted to the UK. Similar arrangements are to be found in a few other countries including Ireland. Some states within the United States, particularly Delaware, offer incentives for businesses to locate there. Many banks and other financial companies are domiciled in the state of Delaware even though Delaware is one of the smallest states in the USA. Uruguay no personal income tax. 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. Vanuatu

Some tax havens including some of the ones listed above do charge income tax as well as other taxes such as capital gains, inheritance tax, and so forth. Criteria distinguishing a taxpayer from a non-taxpayer can include citizenship and residency and source of income.

[edit] Amounts

While incomplete, and with the limitations discussed below, the available statistics nonetheless indicate that offshore banking is a very sizeable activity. IMF calculations based on BIS data suggest that for selected OFCs (Offshore Financial Centres), on balance sheet OFC cross-border assets reached a level of US$4.6 trillion at end-June 1999 (about 50 percent of total cross-border assets), of which US$0.9 trillion in the Caribbean, US$1 trillion in Asia, and most of the remaining US$2.7 trillion accounted for by the IFCs (International Financial Centers), namely London, the U.S. IBFs, and the JOM (Japanese Offshore Market).^[24]

Tax Justice Network, an anti-tax haven pressure group, suggests that global tax revenue lost to tax havens exceeds US$255 billion per annum, although those figures are not widely accepted. 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.^[25]

[edit] Modern developments

On 25 January 2007 Senator Byron Dorgan (for himself and on behalf of Carl Levin and Russ Feingold) presented a bill to the U.S. Senate to amend the U.S. Internal Revenue Code 1986 to treat controlled foreign corporations which are established in tax havens as domestic corporations, and subject to full taxation as such within the U.S.^[26]

The proposed amendment would define the following countries as tax havens for the purposes of the legislation: Andorra, Anguilla, Antigua and Barbuda, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Cyprus, Dominica,^[27] Gibraltar, Grenada, Guernsey, Isle of Man, Jersey, Liberia, Liechtenstein, Maldives, Malta, Marshall Islands, Mauritius, Monaco, Montserrat, Nauru, Netherlands Antilles, Niue, Panama, Samoa, San Marino, St. Kitts and Nevis,^[28] St. Lucia, St. Vincent and the Grenadines, Seychelles, Tongo, Turks and Caicos, and Vanuatu.

[edit] See also

• Anarcho-capitalism
• Asset protection
• ATTAC NGO's criticism of tax haven and underground economy
• Corporate haven
• Free port
• Free economic zone
• International Business Corporation
• List of offshore financial centres
• "Margolis Schemes"
• Offshore bank
• Offshore company
• Offshore Financial Centres
• Offshore trust
• Tax avoidance and tax evasion
• Tax resistance
• Tax exile
• Tax slavery

[edit] Notes

[edit] Further reading

• Baker, Raymond W., "Capitalism's Achilles' Heel: Dirty Money, and How to Renew the Free-Market System.", (2005)
• Henry, James S., "The Blood Bankers: Tales from the Global Underground Economy.", (2003)

[edit] External links

• Offshore Banking and Financial Centers
• Offshore Financial Centers -- IMF Background Paper
• Congressional Research Service (CRS) Reports regarding tax havens
• Tax Justice Network
• An OECD Proposal To Eliminate Tax Competition Would Mean Higher Taxes and Less Privacy - Heritage Foundation: Washington D.C.