Tax Havens: The Global Black Hole

Author: VAIBHAVI HEMANT BHAGAT, DR. AMBEDKAR COLLEGE OF LAW

“The difference between tax avoidance and tax evasion is the thickness of a prison wall”

- Denis Healey

In astronomical terms, a "black hole" usually refers to a specific region of space wherein no matter or items can be escaped but are doomed. Speaking in financial terms, "black holes" are usually proclaimed to be sketched to conceal the wealth and income of the rich and influential people around the world. Tax Havens, often known as "Offshore Financial Centres" (OFC), are directly linked to black holes because of their similar nature. Though there is no universal definition of the term "tax haven", in a literal sense, it can be defined as a jurisdiction or country wherein the tax liability for foreign investors is very low, possibly as zero as compared to their home country. In traditional terminology, it refers to financial secrecy.

Tax revenues are the ultimate source of income for countries to maintain their civilization and social development. They are the source of income for the government to improve the betterment of the economy. Though the same set of rules for income tax is applied to every individual or taxpayer in the country, not all are regulated the same. The ultimate aim of every taxpayer is to save taxes and shift the burden to others. Hence, with the help of professional experts, lawyers, and accountants, the affluent have avoided paying millions in taxes. Either through tax avoidance, which can be considered legal, or through illegal means such as tax evasion, or by corroborating secrecy in their financial operations and breaking out with legal accountability, many of them are able to save large chunks of income. Tax Havens are considered one of the globalized harbors for parking the income of wealthy taxpayers. Multinational companies such as Apple, Google, Nike, Goldman Sachs, IBM, and Walmart are few of the examples who has used tax havens to save taxes. 

Do Tax Havens Exist in reality?

The answer is Yes, they exist all over the world. As per Tax Justice Network 2021 records (Tax Haven Countries 2022), the top 10 tax haven countries in the world are as follows:

The British Virgin Islands

Cayman Islands

Bermuda

Netherlands 

Switzerland 

Luxembourg 

Hong Kong 

Jersey

Singapore 

United Arab Emirates 

 

List of a few of the lucrative Tax Havens in the world 

( https://best-citizenships.com/2020/07/08/top-10-pure-tax-havens/)

 

Switzerland:

As one of the most popular tourist destinations, Switzerland is also known for the resilience and success of its financial institutions.

 

Bankers are prohibited from providing any information about their customers to any inquirer dealing with strict confidentiality. This trustworthiness makes it easy for both individuals and corporations alike to hide wealth with great effectiveness. 

 

Over the years, many companies and individuals from around the world have used Swiss tax benefits. However, strict confidentiality found in other tax havens has been compromised by investigations and subsequent laws by the European Union.

Summary:

No corporation tax on profit.

No VAT.

Has an elite reputation in the world of finance and immediately gives your business credibility.

Flexible corporate structure.

 

Panama:

Panama has a local tax system wherein income from the country is taxable. However, any income earned elsewhere is exempt.A Panamanian company can own property anywhere in the world. 

 

The law also protects the privacy of Panama companies, so you can be sure that your business dealings and financial statements will be kept confidential and discreet in Panama. These laws protect your investments in Panamanian companies.

 

However, there were fears about how safe the area was after the Panamanian papers were smashed and spread like wildfire. It has led to the country losing some of its overseas territories. Nevertheless, Panama continues to be an exciting option.

Summary:

No income tax.

No capital gains tax.

No property tax.

No estate tax.

No gift tax.

 

 The Cayman Island:

Perhaps the most efficient taxpayer in the world, the Cayman Islands has a strong international reputation for providing a wide range of financial services to many clients. 

In the Cayman Islands, there is no business tax. For companies, this is a good idea to use. The Cayman Islands can be very helpful in protecting many companies from growing and growing taxes. 

 

Cayman has a scheme for permanent residency even for investors.

Summary:

No Corporate tax.

No Personal Income tax.

No VAT. 

No Capital gains tax.

 

Luxembourg:

One of the richest countries in the world, Luxembourg is also one of the world's leading tax havens.

 

According to a report from Citizens for Tax Justice and the U.S. PIRG Education Fund, about 30% of U.S. companies in the Fortune 500 have subsidiaries in Luxembourg.

 

For example, the web retailer Amazon.com makes all its sales in Europe through its official European headquarters in Luxembourg.

Summary:

It gives benefits such as tax incentives and 0% withholding taxes.

 

The British Virgin Islands:

It is known as one of the world's leading tax haven centers. The island is said to be worth more than 5,000 times it's economy.

 

The country does not charge any taxes on overseas accounts and does not have tax agreements with other countries, thus protecting the financial privacy of bank account holders.

 

The advantage for overseas bank customers and overseas companies included in the British Virgin Islands is that there are no exchange controls. This makes it much easier to transfer funds from one place to another for trading and investment purposes while protecting financial privacy.

Summary:

No Corporate tax.

No Personal Income tax.

No VAT. 

 

UAE:

The UAE (Dubai) is now the fastest-growing overseas tax center and financial center in the east-central Gulf region.

 

Its strategic location, oil wealth, luxury housing market, and 100% foreign ownership have made the UAE the world's largest financial institution.

 

In recent years, the UAE has grown into a huge market for second citizenship and passports. 

 

The UAE grants residency rights to foreign investors.The UAE government has used value-added tax (VAT) on the country since January 1, 2018, at an average rate of 5%. Personal income taxes are not levied on individuals but foreign banks and oil companies. Residential and vacant accommodation is exempt from VAT.

Summary:

No Corporate tax.

No Personal Income-tax. (for individuals)

VAT – 5%.

 

 

 

 

How does Tax Havens work? 

Tax Havens can be better understood by a hypothetical example. Consider ABC Ltd., a multinational US-based company based in California, which generates incredible revenue worldwide and falls under the bracket of 30% corporate tax as per US tax codes. 

Now ABC Ltd, to pay a few taxes, constitutes XYZ Ltd, a shell company in Jersey (quite a popular destination for US companies for tax havens) where it does not carry any commercial nor does it own any valuable assets.

ABC Ltd transfers its profits, property titles, and other major investments to XYZ Ltd and thus makes profits earned in the USA taxable under Jersey's Tax Jurisdiction. Jersey does not levy any corporate tax on corporations for its income. As a result, ABC Ltd has successfully saved 30% in tax. This is one of the many ways entities make use of tax havens. 

However, the formation of a transaction is not so simple. These transactions are likely to be regulated by the Multilateral Instrument between different countries to prevent tax evasion. In addition, other considerations such as transfer price concerns, arm's length price, issues related to permanent establishment, etc. are also there to prevent that huge tax evasion.

 

Now understanding what exactly are the “Shell Companies”: 

The OECD describes “Shell Company” as "a firm that does not get engage in any economic activity (other than a transit position), but is officially registered, invested in, or legally recognized in the economy." This leads to the question of why such a company could not be created if it did not make any real contribution to the company's operations. These shell companies are widely used to transfer parental income to another country, which often charges high taxes. 

 

Panama to Paradise: Analysis of offshore data leaks :    

(https://www.dw.com/en/from-panama-to-paradise-the-biggest-tax-evasion-data-leaks-in-history/a-41277967)

 

The Panama Papers (2015):

In 2015, the Panama Papers refer to the leaking of confidential documents related to the world's fourth-largest law firm based in Panama, "Mossack Fonseca".

 

Documents released in 2016 exposed a network of more than 2,14,000 shell companies deployed at various tax locations and disclosed IDs and financial information about the number of rich people and organizations from 200 different nations. 

 

The leak includes a variety of celebrities, including world leaders, politicians, celebrities, and businessmen. The leak of the scheme has revealed how rich people can spend their overseas taxes.

 

Shell companies or corporations owned by taxpayers are generally not considered as illegal, and the leak did not reflect the improper or illegal operation of such entities, except for a few. However, overseas companies in large numbers were established to hide the ownership of real company owners.

 

Paradise Papers (2017):

The Paradise Papers are a massive trove of 13.4 million records, many of which were leaked from the offshore law firm Appleby, which was founded more than 100 years ago and operates in places ranging from Bermuda and the Cayman Islands to the Isle of Man, Mauritius, Shanghai, and Hong Kong.  

 

Reflecting millions of loan deals, financial statements, emails, and other documents, the data reveals how specialty firms handle the money of wealthy individuals, families, and corporations.

 

Some 380 journalists collaborated to unravel the connections in the Paradise Papers' nearly 1.5 terabytes of data. The trove was acquired by the German newspaper Süddeutsche Zeitung, which says the records show how the wealthy and powerful sometimes duck taxes, regulations, sanctions, and "at least their social responsibility."

 

Pandora Papers (2021):

In October 2021, 11.9 million leaked documents with 2.9 terabytes of data were leaked by the International Consortium of Investigative Journalists (ICIJ). 

 

The leak exposed the secret accounts of 35 world leaders, including current and former presidents, prime ministers, heads of state, and over 100 billionaires, celebrities, and business leaders.

 

Legal provisions regulating Tax Havens:

The Global Black Holes are used to hide the wealth of the rich and powerful. When tax evasions are described in this way, they appear to be completely illegal programs designed to appease the rich rather than to promote development, which is one of the main objectives of tax collection. However, this is not entirely true.

Every independent nation has the sole power to control its internal affairs and its legal system. This means that it is entirely up to the nation to levy taxes and determine the amount of tax it wants to levy. Therefore, this creation of the tax haven process is not illegal in itself. In the era of globalization, establishing offshore companies is relatively easy, and many companies use those tax havens to shift their profits to those tax havens for the sole purpose of tax evasion, as shown in the example above. Such activity is considered illegal as it undermines the very tax base of the country, for which everyone living in that country is responsible.

To combat this situation, many countries have signed agreements with multilateral instruments with such tax havens to prevent such work. The OECD has come up with its BEPS program, which aims to limit the activities of base erosion and profit transfer while simplifying tax compliance.

 

Conclusion

Tax haven countries serve as a platform for black money and tax evasion to develop their economies. It encourages companies with illegal tax evasion practices to succeed and prosper without debt. This eliminates the profits and resources of the parent country where such organizations do business. Therefore, it is important to strengthen international tax treaties to curb such practices.

Efforts are being made by international organizations such as the Organization for Economic Co-operation and Development (OECD) and even countries to prevent tax evasion through international law enforcement. The introduction of the BEPS Action Plan and the subsequent amendment of DTAAs to build MLIs are major steps forward in preventing tax evasion. However, while efforts are being made to stem the tide of fundamental erosion and profit change, it is extremely difficult to close all loopholes as national sovereignty cannot be disrupted.