Tax haven Information
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.
Different definitions of tax havens exist. 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.
The Organisation for Economic Co-operation and Development (OECD) identifies three key factors in considering whether a jurisdiction is a tax haven:
1. No or only nominal taxes. Tax havens impose no 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 tax in their country of residence.
However the OECD found that its definition caught certain aspects of its members' tax systems (most developed countries have low or zero taxes for certain favoured groups). Its later work has therefore focused on the single aspect of information exchange. This is generally thought to be an inadequate definition of a tax haven, but is politically expedient because it includes the small tax havens (with little power in the international political arena) but exempts the powerful countries with tax haven aspects such as the USA and UK.
In deciding whether or not a jurisdiction is a tax haven, the first factor to look at is whether there are no or nominal taxes. If this is the case, the other two factors – whether or not there is a lack of effective exchange of information and transparency – must be analysed. Having no or nominal taxes is not sufficient, by itself, to characterise a jurisdiction as a tax haven. The OECD recognises that every jurisdiction has a right to determine whether to impose direct taxes and, if so, to determine the appropriate tax rate.
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 Cinque ports and later the staple ports in the twefth and fourteenth centuries respectively. 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. 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. However, the Bermudian claim is debatable when compared against the enactment of a Trust Law by Liechtenstein in 1926 to attract offshore capital.
Most commentators suggest that the first true tax haven was Switzerland, followed closely by Liechtenstein. 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.
The use of modern tax havens has gone through several phases of development subsequent to the interwar period. 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. 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, 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.
Although tax havens are traditionally linked with images of prosperity, 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, and the subsequent political and military deterioration of Lebanon destroyed any notion of the necessary stability for a successful tax haven.
At the risk of gross oversimplification, it can be said that the advantages of tax havens are viewed in four principle contexts:
* 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.
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.
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.
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. 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.
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, 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. 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.
* Andorra. No personal income tax.
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.
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).
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.
The Center for Freedom and Prosperity disputes claims about foregone tax revenue. Academic researchers also have found that tax havens actually boost prosperity in neighboring jurisdictions by creating tax-efficient platforms for economic activity - much of which would not occur if subject to onerous taxes if controlled by a domestic entity.
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.
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, 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, St. Lucia, Saint Vincent & The Grenadines and the Grenadines, Seychelles, Tongo, Turks and Caicos, and Vanuatu.
That draft legislation was superseded by the unambiguously named Stop Tax Haven Abuse Act which was introduced by Senator Levin together with Presidential candidate Barack Obama and Senator Norm Coleman. The Act would introduce a large number of measures designated to attack transactions perceived to facilitate unlawful tax avoidance by the use of offshore tax havens. Broadly same list of countries above was included in the earlier bill as designated tax havens, but with the addition of Aruba, Costa Rica, Sark and Alderney (which are treated, curiously, as sub-sets of Guernsey rather than independent jurisdicions), Hong Kong, Latvia, Luxembourg, Singapore, Switzerland and the removal of Andorra, Bahrain, Liberia, Maldives, Marshall Islands, Monaco, Montserrat, Niue, San Marino, Seychelles and Tongo.
Some of the measures highlighted include:
* creating a presumption that an offshore company or offshore trust is controlled by the U.S. taxpayer who formed it.
* empowering the U.S. Treasury to take special measures against foreign jurisdictions which "impede" U.S. tax enforcement.
* requiring U.S. financial institutions that open accounts for foreign entities controlled by U.S. clients, or open accounts in offshore secrecy jurisdictions for U.S. clients, or establish entities offshore for U.S. clients, to report such actions to the IRS.
* taxing income originating from offshore trusts used to buy real estate, artwork and jewelry for U.S. persons, and treating as trust beneficiaries those persons who actually receive offshore trust assets.
* increasing current penalties on promoters of unlawful tax shelter.
* prohibiting the U.S. Patent and Trademark Office from issuing patents for "inventions designed to minimize, avoid, defer, or otherwise affect liability for Federal, State, local, or foreign tax".
* requiring hedge funds and company formation agents to establish anti-money laundering programmes equivalent to those which apply to banks and other financial institutions.
Many of the intiatives appear politically populist rather than a serious attempt to curb tax mitigation schemes. Other aspects of the legislation seem to be predicated on outdated stereotypes of tax havens, and assume that most tax havens continue to operate a culture of secrecy and with complete disregard for modern know-your-client requirements, and bear little relationship to modern commercial practice. The fact that the bill is expressed to designate four European Union countries (Cyprus, Latvia, Luxembourg and Malta) and three other leading global economies (Hong Kong, Singapore and Switzerland) automatically as non-cooperative tax havens might indicate the limited prospects of the bill becoming law in its current form.
Led by the Center for Freedom and Prosperity, various free-market groups, think tanks, and taxpayer organizations have encouraged the Bush Administration to reject legislation seeking to penalize low-tax jurisdictions.
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