Tax Haven is a place or countries where there is very low or nil rate of income tax for the business or individuals or foreign investors and also provide attractive macroeconomic environment like financial and economic stability as well as financial secrecy from tax authorities.
Tax Haven Meaning
Tax haven means a country that offers extremely low taxation rates along with financial secrecy for foreign individuals and corporate entities. Tax haven rather accepts a nominal charge against the services they offer.
- It plays an extremely prominent role in the financial system of the world. Introduced to support and develop the broken economy of countries after World War II, now have become a very important tool for big corporations and rich individuals worldwide to evade taxes.
- Tax haven constitutes the single largest drain on economies of the countries globally.
- A report by Citizen for Tax Justice during 2016 says that more than 370 companies out of Fortune 500 operate subsidiaries in various tax haven countries.
How Tax Haven Works?
The working can be better understood with a hypothetical case study. Say Banana Inc, a big multinational US based company headquartered in California creating extraordinary income worldwide and fall under the corporate tax bracket of 30% as per US tax codes.
- Now Banana, in order to pay fewer taxes, forms Mango Ltd, a shell company in Jersey (popular tax haven destination for US corporations including Apple Inc) that does not carry any operations related to trade or commerce and does not own any significant asset.
- Banana transfers its profits, property titles and other major investments to Mango Ltd and thus makes its profits earned in the USA to be taxable under Jersey’s Tax Jurisdiction. Jersey typically does not tax corporate income.
- So Banana Inc has successfully saved itself a 30% tax.
Remember taxes are the single source of revenue for the governments and also their legal right. Practices of Banana Inc is a loophole under US tax laws that is violating the legitimate right of the US government.
Features of Tax Haven
The Organization for Economic Co-operation and Development (OECD) provides various features to identify whether a country or jurisdiction is a tax haven:-
#1 – Extremely Low Tax Rates
Tax havens offer or impose negligible taxes for earnings made under their jurisdiction; this may vary with different countries. However, a nominal charge is levied against the services they offered.
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#2 – Secrecy of Information
The other most important feature about tax haven is that they protect the personal and financial information of their clients with high credibility. Without the client’s consent, no information is shared with foreign tax authorities.
#3 – Lack of Transparency
The biggest problem with offshore financial centers is their system is completely opaque. Financial information is not even disclosed to the national governments. The system thus manipulated for tax evasion practices and other illegal activities including money laundering.
#4 – No Substantial Activities Required
Tax haven does not require outside entities to actually produce goods or services within their jurisdiction. Entities can bypass their earnings and wealth created in tax-paying countries to be taxable under the jurisdiction of tax havens by just opening company’s head offices in such tax havens or transferring major financial transactions of the company to subsidiaries or shell companies located in tax havens. E.g. you can commence your trade practices in London and be liable to pay taxes under the jurisdiction of Cayman Islands
The Panama Papers
The Panama Papers refers to a leak of very confidential documents related to the world’s fourth largest offshore law firm based in Panama, Mossack Fonseca.
The documents released in 2016 exposed the network of more than 2,14,000 shell companies incorporated in various tax havens and revealed the identities and financial information about a number of wealthy individuals and entities from 200 different nations.
The leak involves various popular individuals including world leaders, politicians, celebrities and business peoples. The leak revealed how rich can exploit offshore tax regimes.
Shell companies or business entities in tax havens are not illegal in general and the leak also did not show illegal or inappropriate operations by all such entities excluding some of them. However, offshore-companies in the majority were established in order to conceal the identities of the true company owners.
- The biggest disadvantage is a fact that low or middle-income families and individual struggles to meet their tax obligations while big corporations and rich individuals evade taxes using offshore financial centers.
- Companies in the USA on a yearly basis avoid payments of taxes of more than $90 billion. General Electric somehow managed to pay $0 as taxes during 2010.
- Tax evasion can be drastic for the economy of the country as taxes are the only source of revenue for the governments.
Tax Havens: Steps against Tax Evasion
- Offer zero tax incentives to those who transfer its profits and jobs at tax haven countries.
- Identify and minimize loopholes in offshore taxation policies.
- The world forums should force tax haven authorities to increase financial transparency and share confidential information in case of illegal practices.
- Penalize and/ or punish heavily who practice trade and finance inappropriately or illegally.
This has been a guide to Tax Haven and its meaning. Here we discuss the working of the tax haven system along with the features and disadvantages. You can learn more about accounting from the following articles –