A critical analysis of tax havens

Most of developed countries have recently been faced by serious abusive transactions in regard to tax havens. However, it has been reported that Australia faces less of this threat albeit the increase of tax evasion tendencies among small enterprises and at individual level. With regard to Australia, the financial losses are faced by both individuals, who lack are ignorant of financial matters or do not have access to descent financial advice; the other casualty are Australia’s regional and national governments that see a decrease in their tax revenues.

In order to understand and track tax evasion behaviours that poses threat to Australian economy, local authorities, especially the ATO, accesses and analyses different data sets. The major source of this data is AUSTRAC that keeps track of international financial transactions in collaboration with foreign government agencies among other international agencies. The second source of data includes the local financial institutions that are mandated to submit the required data to ATO.

Some of the information that local financial institutions submit to ATO includes debit and credit card transactions undertaken by Australians locally and internationally. The third source of ATO data comes from the local, regional and international tax professionals, most of which are provided through treaties. Australian authorities respond to these treaties by providing data needed by foreign countries. The OECD, UN and EU are trying very hard to develop measures to counter the distorting effects of harmful tax competition on investment and financing decisions and the consequences for national tax regimes.

Globalisation is creating the challenges in the field of tax policy. Tax schemes aimed at attracting financial and other geographically mobile activities can create harmful tax competition between states, carrying risks of distorting trade and investment and could lead to the erosion of national tax bases. Australia has been a member of the OECD since 7th June 1971. Governments and other stakeholders tend to attack and condemn tax havens because of the competition and pressure thy put on national tax receipts.

Indeed, tax heavens competition force national governments to review their tax rates, reduce government sizes and improve collection mechanisms, all of which require fiscal discipline that lacks in the responsible agencies. Most of these accusations are, however, baseless considering that economic successes that come with tax revenues. Tax Haven Defined A Tax haven is often called as the “unknown known” by academics. A tax haven is a country which provides no tax or a low tax environment.

In some offshore jurisdictions the reduced tax regime is aimed towards entities organized in the country with all operations occurring outside the country. These countries seek to encourage investment and make up revenue losses by charging a variety of fees for the start up of the entity and on an annual basis. Even the Unites States of America (USA) is considered a tax haven by some countries. Definition given by OECD of “Tax Haven”: 1) Minimal investment and income tax regimes

2) Legal frameworks diluting foreign governments’ ability to tax income originating from low tax regimes 3) Exceptionally attractive tax breaks 4) Competitive tax rates for foreigners compared to locals. Politicians and tax bureaucrats are viscerally hostile to jurisdictions that offer refuge for the world’s over-burdened taxpayers. Laws often are enacted to hinder economic transactions with these so-called tax havens, but these national efforts are just the tip of the iceberg.

High-tax nations also have enlisted international bureaucracies such as the European Commission, United Nations (UN), and the Organization for Economic Cooperation and Development (OECD) in a coordinated attack on low-tax jurisdictions. Tax havens, we are told, are illegitimate lairs for tax evasion and money laundering. Effects of Globalisation and emergence of Tax havens Historically, tax policies have been developed primarily to address domestic economic and social concerns.

The forms and level of taxation were established on the basis of desired level of publicly providing goods and transfers, with regards also taken to the allocative, stabilizing, and redistributive aims though appropriate for a country. While domestic tax systems of essentially closed economies also had a international dimension in that they potentially effected the amount of tax imposed on foreign source income of domestic residents and typically included in the tax base the domestic income of non-residents, the interaction of the domestic tax systems was relatively unimportant, given the limited mobility of capital.

The decision to have a high rate of tax and a high rate of government spending or low taxes and limited public outlays, the mix of direct and indirect taxes, and the use of tax incentives, were all matters which were decided primarily on the basis of domestic concerns and had principally domestic effects. While there were some international spillover effects on other economies, those effects were generally limited. The accelerating and continual process of globalisation of trade and investment has fundamentally changed the relationship among domestic tax systems.

The removal of non-tax barriers to international commerce and investment and the resulting integration of national economies has greatly increased the potential impact that domestic tax policies can have on other economies. Among other driving factors in the introduction of competitive tax reforms has been globalization that have focused on broadening tax national tax bases and deduction in tax rates, both of which have resulted to a reduction of any possible distortions.

Globalisation has also encouraged countries to assess continually their tax systems and public expenditures with a view to making adjustments where appropriate to improve the “fiscal climate” for investment. Globalization and the increased mobility of capital has also promoted the development of capital and financial markets and has encouraged countries to reduce tax barriers to capital flows and to modernize their tax systems to reflect these developments. Many of these reforms have also addressed the need to adapt tax systems to this new global environment.

Multinational enterprises (MNEs) are increasingly developing global strategies and their links with any one country are becoming more tenuous. International markets continue to expand, a development that facilitates global welfare-enhancing cross-boarder capital flows. This process has improved welfare and living standards around the world by creating a more efficient allocation and utilization of resources. Therefore, Globalization has had a positive effect on the development of tax systems.

Globalization has, however, also had the negative effects of opening up new ways by which companies and individuals can minimize and avoid taxes and in which countries can exploit these new opportunities by developing tax policies aimed primarily at diverting financial and geographically mobile capital. These schemes can erode national tax bases of other countries, may alter the structure of taxation (by shifting part of the tax burden from mobile to relatively immobile factors and from income to consumption) and may hamper the progressive tax rates and the achievement of redistributive goals.

Pressure of this sort can result in changes in tax structures in which all countries may be forced by spillover effects to modify their tax bases, even though a more desirable result could have been achieved through intensifying international co-operation. More generally, tax policies in one economy are now are more likely to have repercussions on the other economies. These new pressures on tax systems apply to both business income in the corporate sector and to personal investment income.

Countries face public spending obligations and constraints because they have to finance outlays on, for example, national defence, education, social security, and other public services. Investors in tax havens, imposing zero or nominal taxation, who are residents of non-haven countries may be able to utilise in various ways those tax haven jurisdictions to reduce their domestic tax liability. Such taxpayers are in effect “free riders” who benefit from public spending in their home country and yet avoid contributing to its financing.

However, an OECD report has recognized that there is no particular reason why any two countries should have same level and structure of taxation. Although differences in tax levels and structures may have implications for other countries, these are essentially political decisions for national governments. The fact that a country has modernised its fiscal infrastructure earlier than other countries, for instance by lowering rates and broadening the base to promote greater neutrality, is principally a matter of domestic policy.

Countries should remain free to design their own tax systems as long as they abide by internationally accepted standards in doing so. Arguments In Favour Of Tax Havens Since tax regimes are the ones lead to qualification of individual countries as tax havens, it means that any country has the ability of becoming a tax haven. Indeed, IMF has on several occasions classified United States as a tax heaven, reason being the country’s competitive tax regime.

As mentioned earlier, tax havens are criticized because of the competition they pose on national governments, which must change their tax regimes, social policies and reduce size of their governments in order to compete in the market of foreign capital. Politicians form the biggest chunk of complainants because of their failure to enact competitive tax policies. The proper definition of tax haven confuses academicians and policy makers alike. This is explained by the lack of proper definition for these regions.

As shown in the OECD definition above, there has not been one term that can be used to classify tax competitive regions. This has resulted to several definitions. As further seen in OECD definitions, policymakers and academicians have come up with characteristics of tax heavens and not what the term means. It however remains to be seen whether a country or region can meet all the criteria listed by OECD. Tax havens: Myths vs. facts MYTH: Tax havens operate away from rules not consistent with international financial system.

FACT: It is competitive tax rates that qualify jurisdictions for tax havens. However, these competitive regimes have been well exemplified in smaller countries and islands. It has to be understood that even countries such as Britain, United States, Hong Kong and Switzerland have recently been classified as tax haves, reason being their competitive tax laws. The most important condition for countries to meet on their route of becoming tax havens is having lower taxes, which require a lot of sacrifice from politicians and interest groups.

Fact that smaller countries and jurisdictions are able to do this should not be condemned as operating outside international financial laws. Tax havens have been condemned from left and right; ironically, organisations like OECD do not blacklist its own member nations, such as United States, that happen to be classified as tax havens. Indeed, by following OECD criteria, the US emerges as one of the world’s largest tax havens.

Mitchell in his article has pointed out that In USA: foreigners don’t pay tax on US-source interest from certain deposits and other financial institutions; foreign Corporations that are not connected with a U. S. trade or business, generally do not have to pay capital gains tax; non resident capital gains attracts only 30 percent tax when individuals have been in the country for the last 1832 days. In addition, Delaware, Nevada and Florida companies are among the world’s best offshore vehicles.

A vast majority of US states do not require ownership information (let alone verify) when a company is formed. Favourable rules for non-residents have attracted foreign investment of more than US$9 trillion to the US economy at the end of year 2000, and a big portion of that money is untaxed and unreported which has boosted its economic growth. Therefore, USA is a “tax haven” according to the OECD’s definition even though US has “world wide” tax system as USA seeks to tax income earned in other nations and tax authorities in US generally favour information exchange with other nations.

European Union (EU) and OECD’s major tax harmonization initiative world wide tax harmonisation is seen as a direct threat to America’s economic interest. In Australia a non-resident or a foreign national pays only 10% withholding tax on interest as a final tax. In general, foreign source income (such as dividends, interest, rental income or capital gains) derived by a temporary resident will be exempt. (Section 768-910 ITAA1997). In UK, foreign domiciles do not pay taxes on foreign capital that stays out of British shores.

Ireland, too, has the same arrangement. Switzerland lets foreigners to negotiate taxable income (usually five times rental payable) with individual cantons. Therefore, despite common belief that tax havens are small isolated countries with nice beaches, the preceding analysis has shown they can exist in developed countries also. MYTH: Tax havens attract money laundering. Mitchell points out that, the FATF admits, for instance, that criminal “funds are usually processed relatively close to the under-lying activity; often…in the country where the funds originate.

” The launderer might choose an offshore financial centre, a large regional business centre, or a world banking centre-any location that provides an adequate financial and business infrastructure. And since most of the world’s criminal activity takes place in North America and Europe, it should come as no surprise that tax havens are not major money laundering centers. Also the fact is that USA and Europe has much bigger business and banking sector than tax havens. An Australian study conducted in 1995 estimated that AU$1.

45 billion was laundered worldwide from the proceeds of Australian crime. An estimated AU$7. 7 billion was brought into Australia from overseas for laundering. MYTH: Tax havens and their privacy laws are against human rights, They do not respect rule of law and encourage tax evasion. FACT: In the environment of corruption, expropriation, crime and discrimination, people with money frequently are targets of oppression. But if such people have the ability to place their assets in a jurisdiction that protects financial privacy, they are more likely to avoid prosecution.

Likewise, people who live in regimes plagued by political instability or economic mismanagement are at great risk of loosing all their assets and thus putting their families at risk. But if such people have ability to use tax havens, they are much more likely to avoid financial calamity. For instance, a merchant who lives in Congo which is a unfree nation makes himself the target of the government that routinely seizes private wealth of he accumulates any asset. And since the government controls the judiciary, there is no rule of law to protect him.

If a Congolese merchant has an account in Switzerland, unknown to the government, his freedom to provide goods and services to the community is less vulnerable. Also there are still many areas in the world where Jews are treated unfairly, particularly in the Middle East. And the prosecution is quite likely is linked to the wealth since bigots are especially likely to resent someone who is financially successful. Other faiths are also subject to persecution, either from other governments dominated by other religions or government hostile to any organized religion. Tax havens provide refuge to religious minorities.

Therefore, ability to maintain assets in Switzerland, unknown to oppressive government, may play a valuable role in helping people fight religious persecution. Persecuted people need the freedom to move their assets to jurisdictions with adequate privacy laws. These people are not primarily motivated by a desire to escape excessive taxation, but they nonetheless benefit from tax havens since financial institutions in these jurisdictions generally are not obliged to help enforce foreign laws particularly when those foreign governments are trying to investigate and prosecute activities that are not illegal in the low tax jurisdiction.

Elliott has pointed out that, the OECD Report on Improving Access to Bank Information for Tax Purposes, released on 24 March 2000 contains information insights into the scope of existing financial disclosure in OECD member states. Financial information is stored in a centralised computerised database of many OECD member countries. For instance, France requires financial institutions managing stocks, bonds or cash to report to the government on monthly basis regarding the opening, modifications and closings of accounts of all kinds.

This information is stored in a central computerised database which is used by French authorities for research control and collection purposes. Four other OECD countries also maintain centralised databases, namely Hungary, Korea, Norway and Spain. The International Trade and Investment Organisation wrote that affluent taxpayers in at least one major OECD member country also fear that tax data is routinely sold to criminals gangs seeking targets for kidnapping, common in that state. If bureaucracies such as OECD and EU succeed in destroying financial privacy, the consequences could be deadly.

As United Nations (UN) admitted, Global sharing of information means that criminal access can occur at the weakest point of entry, multiplying the risks associated with unauthorised disclosure. This is a pervasive problem. According to the World Bank, 113 nations get negative grades on upholding the rule of law and 117 countries get failing grades on corruption. The UN declaration of Human Rights recognises and protects privacy as a basic human right. The OECD also accepts that individuals and vehicles treated as corporate by the OECD Report have legitimate expectations of privacy and business confidentiality in their affairs.

Littlewood has pointed out that, Hong Kong has been one the world’s fastest-growing economies. Per capita income in year 2007 was $30,000, up from less than $2,000 after World War II. A key reason for Hong Kong’s success is an low-rate optional flat tax system of 16% on personal income and no payroll tax. The corporate tax rate is only 17. 5%. Hong Kong generally does not double-tax dividends, interest, and capital gains. Tax rates are low by global standards and there is very little double-taxation of income that is saved and invested.

Combined with a modest burden of government, Hong Kong is well-positioned to continue its rapid growth. Globalization has made it increasingly easy for jobs and investment to cross national borders. Most amazingly, even one of the most anti-tax competition reports produced by the OECD included the language admitting that, the more open and competitive environment of the last decades had many positive effects on tax system, including the reduction of tax rates and broadening the tax bases which have characterised tax reforms over that last 15 years.

In part these developments can be seen as a result of competitive forces that have encouraged countries to make their tax system more attractive to the investors. In addition to lowering overall tax rates, a competitive environment can promote greater efficiency in government expenditure program. MYTH: Tax havens are responsible for rising “Tax Gap” in High-tax jurisdictions which is leading to emergence of “shadow economy”. FACT: According to Schneider, the “Shadow economy” is defined as all currently unregistered economic activities that contribute to the officially calculated (or observed) Gross National Product (GNP).

The shadow economy includes all marker-based legal production of goods and services that are deliberately concealed from public authorities for the following reasons: (a) to avoid payment of income, value added or other taxes; (b) to avoid payment of social security contributions; (c) to avoid having to meet certain legal labour market standards, such as minimum wages, maximum working hours, safety standards, etc and (d) to avoid complying with certain administrative procedures, such as completing statistical questionnaires or other administrative forms.

In Switzerland (which is a tax haven), shadow economy was 9% of Gross Domestic Product (GDP) in year 1999-2001. In US (which is also considered as a tax haven by many economists), shadow economy was 10% of the GDP in year 1999-2001. In Australia shadow economy was 13. 5% of GDP in 2003. During this period among 21 OCED nations, Greece and Italy had the largest shadow economies, at 30% and 27% of GDP respectively. For the OECD countries, the growth in shadow economies has been fastest in the 1990s: in the group as a whole, the shadow economy rose from 13 percent in 1990–93 to 17 percent in 1999–2000.

Late in the decade, the shadow economy was still growing in most OECD countries. Sproule has pointed out that, high taxes needed to pay for all this government spending is clearly driving businesses and entrepreneurs underground. Countries with high government spending and high taxes have also found their shadow economies have tripled since 1970 — Denmark, France and Germany all have over 15% of economic activity now taking place in the shadow economy.

Contrast this with relatively low-tax America, where government spending accounts for only 31% of the economy and the shadow economy is roughly 10% of GDP in year 2001. People are not moving into the shadow economy simply to avoid taxes-the shadow lands are also refreshingly free of many bureaucratic hassles. But bringing many small businesses into compliance is simply going to result in most of those enterprises shutting down and will deter future start ups. European taxes have been too high for too long. But tax evasion is a learned behaviour.

Only tax cuts can restore respect for the law and save Europe from becoming a continent of tax cheats. In a stunning admission, the European Commission has produced a report acknowledging that rampant tax evasion in Europe is largely the result of confiscatory tax rates. A European Commission report shows a strong correlation between high income and social taxes and the magnitude of the black market economy. This problem can create a vicious cycle, as the state is likely to increase taxes to compensate for the loss of income.

However, as the tax burden increases, the incentive to perform and hire undeclared work also increases. Therefore, it is not zero or low tax rates in tax havens, but it is high tax rates and complex tax code that are real causes of increase in shadow economies. Tax havens like Singapore and Switzerland have least tax evasion where as OECD member countries have much bigger tax gaps which is eroding their economic prosperity. Tax Competition should be encouraged, not discouraged

Most amazingly, even one of the most anti-tax competition reports produced by the OECD included the language admitting that, the more open and competitive environment of the last decades had many positive effects on tax system, including the reduction of tax rates and broadening the tax bases which have characterised tax reforms over that last 15 years. In part these developments can be seen as a result of competitive forces that have encouraged countries to make their tax system more attractive to the investors.

In addition to lowering overall tax rates, a competitive environment can promote greater efficiency in government expenditure program. The OECD published a blacklist of 35 tax havens and threatened potential national economic sanctions if they failed to agree to share fiscal information. Now a “carrot” is on offer to tax havens to encourage them to improve financial transparency, cooperate with overseas tax authorities and eliminate laws that provide advantages to international investors.

Although the OECD has no jurisdiction or means to enforce such measures, its constituent members can apply a variety pressures like economic sanctions as most of the tax havens are small nations. If trade liberalisation and globalisation are designed to integrate economies and peoples, tax competition is the best way for many developing countries to participate in the world economy. Dependency used to characterize the relationship between the developed and developing world, but tax competition is a means of breaking that cycle.

It provides for the establishment of a level playing field; countries compete on the basis of tax, regulation and human capital. Some level of tax competition is a healthy and natural economic process that weeds out inefficient taxes. OECD fears that tax competition will lead to a loss of domestic revenue do not amount to an argument that tax competition is unfair. Many citizens in high-taxing countries do not accept their tax systems as fair, and failing to obtain equity from their political systems, do what they can to protect themselves and their families.

Offshore havens may serve as an economic and political safety valve, forestalling the physical emigration of talented labour and capital or the emergence of violent protest movements (oppressive taxes have created more than a few rebellions and revolutions). There is nothing inherently wrong in countries competing with others to provide investors with a choice between differing legal systems. Ultimately, an individuals ability to choose the laws of one jurisdiction over another involve considerations of individual freedom as well as national sovereignty.

If a significant number of individuals or entities choose an offshore jurisdiction, the home country may well have reason to revisit its own taxation policies as part of a self-critical examination in the light of tax competition, rather than attack offshore jurisdictions. In essence, the OECD is saying that the rest of the world should be forced to design their legal and administrative systems to facilitate the application of residence-based income taxation by OECD countries.

Even in the heyday of colonialism, imperial powers tended not to make such demands of their colonies. OECD Contradictions The OECD argues that low-tax countries must eliminate financial privacy so there will be transparency (i. e. , so politicians can spy on people), yet an audit of the OECD discovered that its records were so poorly kept that reaching “an informed opinion as to the organization’s financial health, including its liquidity and solvency, is difficult. “

The OECD has stated that, “Liberalisation open markets is at the core of the Organisation’s work and is aimed at facilitating cross-border flows of trade and investment. ” Yet this rhetoric rings hollow, given the organisation’s current support for financial protectionism against low-tax competitors. Hell-bent on forcing low or no-tax nations to suspend their financial privacy laws, and impelling them, through the threat of sanctions, to provide information to foreign tax collectors, the OECD has set about framing their practices as harmful, if not criminal.

With the aid of the media, tax havens have been depicted as cauldrons of counterfeiting and money laundering (a strange accusation coming from governments whose national banks regularly inflate the money supply and dilute with fiat money the value of people’s assets). According to the OECD, to be guilty of “harmful tax practices,” a country must be an area of “no or nominal effective tax rates. ” The OECD further suggests that a haven transgresses when it is bereft of “transparency” and “effective exchange of information.

” According to Mercer, by demanding information exchange when this defies a tax haven’s own laws, the OECD disregards the comity of nations in international law — the courtesy by which one nation respects and recognizes the laws of another. This principle implies deference and goodwill towards the legislative, judicial and executive acts of another country. It is uncivil, not to mention coercive, for the OECD to force tax havens to prostrate their laws before those of the aggressor governments. UN Contradictions In December 2000, Kofi Annan endorsed the creation of an “International tax organization.

” The new organisation, will be able to gather information from the UN’s 191 member countries (as opposed to the OECD, which has just 30 members). It will also be involved in the development of new anti-evasion initiatives. There is a proposal to have global taxes, levies that would be imposed on the entire world. The revenues generated by these taxes would be made available for income redistribution and other purposes. Mitchell points out that, not only does the UN want to impose taxes on a global basis, it also want to help individual governments tax income on a global basis.

This is why the UN endorses “information exchange,” which means every government would be expected to collect private financial data on individual taxpayers and then share that information with other governments. High-tax nations would then use this information to tax any income their residents earn in other countries. This can be said as “taxation of emigrants. ” This initiative is very similar to the information exchange schemes being pushed by the OECD and the EU. Information exchange makes sense, but only for jurisdictions with oppressive tax systems.

Low-tax nations should not be forced to suspend their financial privacy laws and act as vassal tax collectors for Europe’s welfare states. Indeed, information exchange violates an important principle of international law – dual criminality – by seeking to force low-tax countries to put the laws of other nations above their own. The proposal of UN to give governments permanent taxing rights over their people. UN thinks “taxation of emigrants” is supposedly necessary to protect nations from economic loss when productive citizens emigrate.

The UN proposes that taxation of emigrants could be one of the responsibilities of the new International Tax Organisation. This idea implicitly assumes that people are a form of chattel, the property of a government even if they seek opportunity elsewhere. Like OECD employees, UN employees also get tax free salaries. Ironically, UN employees are also preaching the persecution of nations who refuse to cooperate with OECD and UN in pursuit of harmo