Just blindly throw a dart on the world map and the chances are you would hit one tax haven or the other. The abundant supply of tax havens, it seems, is creating its own demand. With mushrooming growth of tax havens, tax evasion has really become a global problem.
Johnny: Well, I don’t understand what motivates people to evade their taxes. But I want to first understand the basics. Can you explain what a tax haven is?
Jinny: We often hear about the so-called tax havens receiving their share of brickbats from the rest of world. But even after many years of controversial existence, there seems to be no universal definition of a tax haven. However, the Organisation for Economic Co-operation and Development (OECD)—a Paris-based group of 30 developed countries, which has become a sort of global anti-tax haven squad—uses three key attributes to identify any jurisdiction as a tax haven. First, a country acting as a tax haven imposes no or very low taxes within its jurisdiction. Tax havens offer themselves as a place where non-residents can escape the high taxes of their own country by putting their assets or businesses there. Just as some countries offer better infrastructure or cheap labour to attract investment, some countries offer lower taxes as an incentive. But no or lower taxes only do not make a country a tax haven. The second and most important attribute of a tax haven is that it zealously protects personal financial information of people or firms located within its jurisdiction. There is no or minimal sharing of information with foreign tax authorities.
Third, tax havens have the least transparent legal and administrative systems. It is easier for tax evaders to get behind-closed-doors secret tax rulings or negotiated tax rates about which the rest of the world would never know. But that’s not all. Apart from the three attributes cited by OECD, tax havens also have some other attributes. For instance, most tax havens do not impose any requirement of substantial local presence on outside entities. Tax evaders could take away all tax benefits without actually producing any goods or services within the jurisdiction of a tax haven. For all practical purpose they continue to work from the place of their choice but take the shelter of a tax haven when it is time to pay taxes.
Johnny: That sounds like your neighbours spoiling your kids by offering them a place to hide when they don’t do their homework. But tell me, why are some tax havens more popular than others?
Illustration: Jayachandran / Mint
Jinny: There is no dearth of tax havens—Andorra, the Bahamas, Cayman Islands, Channel Islands, Cook Islands... The list can go on and on. All these countries are known for offering one kind of tax incentive or other. Switzerland, although strictly not a tax haven, has become a famous offshore destination for money due to strict banking secrecy practices. Tax havens fiercely compete among themselves to attract tax evaders. All in all, it’s all about how you do the marketing. Many tax havens like to call themselves “international financial centres”. However, there are several factors that could give one centre an edge over the other. For example, political and economic stability often plays an important role in bringing outside investors. Likewise, efficient corporate laws and better infrastructure also play an important role. Some locations have become popular solely because of their geographical location. For instance, the Bahamas has become a popular destination for US-based tax evaders due to its proximity to one of the states, Florida. So it’s not only lower taxes and secrecy, there are many other socio-economic factors that lead to greater popularity of some of the tax havens.
Johnny: Growing popularity of tax havens must surely be stirring a hornets’ nest. But I wonder, what would be the fate of tax havens in future?
Jinny: The existence of tax havens affects the global economy in many ways. At one level, tax havens encourage competition in tax matters. Lower taxes or no taxes in one country puts pressure on other countries to keep their taxes low, which many would consider unhealthy. In the long run, the world economy has much more to lose. Growing opacity and secrecy behind many tax havens could provide the perfect breeding ground for money laundering and other illegal activities. With mounting pressure from different organizations such as OECD and the Group of Twenty, tax havens may have to mend their ways. The crackdowns on tax evaders in some countries such as Germany, the UK and France after stolen data from Liechtenstein banks reached tax authorities show that tough time awaits tax evaders. To save their own skin, many tax havens have started signing tax information exchange agreements that make it compulsory to share tax information between signatory countries.
Johnny: That’s surely a good development. Sharing of information could be the biggest blow to opaque systems. Sunlight, after all, is said to be the best disinfectant.
What:Tax havens are leading to problem of tax evasion and money laundering on a global scale.
How: Tax havens charge lower or nil taxes with maximum financial secrecy, making it difficult for enforcement authorities in other countries to trace the money.
Who: International organizations such as OECD and the Group of Twenty are campaigning for reforms in tax havens.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at email@example.com