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Excerpt: Black Money and Tax Havens by R Vaidyanathan

What exactly is a tax haven and how do individuals and companies squirrel away their wealth there? This excerpt from R Vaidyanathan’s new book explains

books Updated: Oct 28, 2017 00:03 IST
R Vaidyanathan
R Vaidyanathan
Hindustan Times
Switzerland,Antigua and Barbuda,Maldives

A country which has no taxes or levies low taxes on individuals and corporations is a tax haven in layman’s language. Further, in order to attract investment, these tax havens offers additional benefits like maintaining financial secrecy and providing legal protection and passport facility in some cases.

In June 2008, Norway appointed a government commission to examine the link between tax havens and capital flight from poor countries. Its report submitted on 18 June 2009 was exhaustive.

Among other things, it says:

Tax haven is often used as synonymous with or an alternative to ‘offshore financial centre’ (OFC) and ‘secrecy jurisdiction’, which reinforces the lack of clarity. No consensus exists on which functions must be exercised for a state to be characterized as an OFC.

Regardless of the definitions used, the principal objectives remain the same. The regulatory regime is constructed in a way which caters to circumventing private and public interests in other states — in other words, those states where the owners of the companies are domiciled or have their obligations. The tax base in other states is particularly affected, but structures in tax havens are in many cases also suitable for concealing a number of other forms of criminal activity. Depending on the definition chosen, the world currently has between 30 and 70 ‘tax havens’. This implies that 15-30 per cent of the world’s states might be classified in one way or another as tax havens.

History of Tax Havens

The concept of tax havens has probably been around ever since countries decided to finance their governments by taxing their citizens.

Some countries might choose to compete by keeping taxes low and thus attracting business from high tax countries. For instance, in India this is true for even states — wherein they try to attract investments from other states or countries. Sometimes, a country will designate a region or city as a low tax or as a tax-free zone, to stimulate its economy.

Ancient Rome was a master in using tax-free areas, an early version of free enterprise zones. The first recorded instance took place in the second century BC when Rome decided to undercut the then-independent Greek island state of Rhodes by establishing a tax-free port on the island of Delos. Even though Rhodes only charged a 2 per cent tax on trade, it quickly lost trade to the new tax-free port and its era as a commercial power was effectively ended.

European colonial powers attracted settlers to the New World — USA — with favourable tax policies. Ironically, the main cause of the American Revolution stemmed from an attempt by the English government to raise taxes on the citizens of the American colonies to pay for their defence and administration.

Various countries claim to be the oldest tax haven in the world. For example, the Channel Islands claim their tax independence dating back to the Norman Conquest (1066), while the Isle of Man traces its fiscal independence to even earlier times. Nonetheless, the modern concept of a tax haven is generally accepted to have emerged at some 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 viewed against the enactment of a Trust Law by Liechtenstein in 1926 to attract offshore capital.

Most economic observers propose that the original tax haven was Switzerland, with Liechtenstein being a close second. The banking industry in Switzerland was historically known as a capital haven, particularly for citizens running away from social disturbances in many countries, such as Germany, Russia, and also from South American countries.

In the nineteenth century itself, the landlocked Swiss had come to realize that neutrality was their trump card. They then began championing banking services that offered the ‘utmost discretion’. This resulted in large sums of money coming into Swiss banks after the First World War.

Following the First World War and its widespread devastation, a large number of governments in Europe raised taxes abruptly to help pay for reconstruction efforts. For the most part, Switzerland, having stayed neutral during the First World War, evaded these increased costs of rebuilding infrastructure. It was, therefore, perfectly positioned to maintain a low tax base. Consequently, there was a substantial stream of capital into Switzerland for tax-related reasons. Switzerland’s low tax rates also helped. Many wealthy Europeans quietly took their money to Switzerland to escape contributing to the war effort.

Another world war twenty-one years later brought more wealth to Switzerland, this time in the form of riches looted by the Nazis. So great was the Nazi hunger for gold that even gold from the dental fillings of murdered Jews was not spared. The bankers accepted everything that came their way without question, though public hatred for Hitler’s regime was huge.

Tax haven usage in modern times has undergone several phases of development, especially after the Second World War. Between the 1920’s and the 1950’s, ‘tax haven’ typically referred to personal taxation avoidance. Often times, the term was used to mean ‘countries that a person could retire to and reduce their post-retirement tax burden’. After the 1950’s, however, corporate entities increasingly began to use tax havens to lower their global tax obligations.

Soon governments, businesses and criminal masterminds from all over the world understood how they too could benefit from offshore structures. Such is the prevalence of tax havens that there are dedicated companies which promote and market the services they provide — right from helping you choose an appropriate tax haven to setting up the company, and other legal requirements thereof. In the nineties, tax havens were aggressively marketing themselves. However, of late they are trying to prove that they are not actually tax havens by concluding tax treaties. But, companies that promote tax havens still exist.

Definitions of Tax Havens

The definitions of tax havens vary but one can identify many of these jurisdictions by certain characteristics. Raymond Baker, in his pioneering work on the issues of dirty money and renewing the free market system, talks in detail about the extent of tax havens:

There are some delightful places where you can situate or purchase your secret companies. In the Caribbean you have Anguilla, Antigua and Barbuda, Aruba, Bahamas, Belize, Bermuda, the British Virgin Islands, Barbados, Cayman Islands, Dominica, Grenada, Montserrat, the Netherlands Antilles, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, and the Turks and Caicos Islands. Or there are Panama and Costa Rica in Central America and Uruguay in South America. If you prefer the Pacific the choices include the Cook Islands, the Marshall Islands, Tonga, the Maldives, the Marianas, Nauru, Niue, Vanuatu, and Western Samoa. Asian and Middle Eastern secrecy jurisdictions include Hong Kong, Macau, Singapore, Labuan off the coast of Malaysia, Bahrain, Dubai, and Lebanon.

Africa is getting into the game with Mauritius, the Seychelles, South Africa, Liberia, São Tomé and Principe and the little enclave of Melilla, one of two parts of Spanish Morocco. And, of course, Europe offers some of the most experienced and discreet jurisdictions, including the Isle of Man, the Channel Islands of Jersey, Guernsey, Alderney and Sark, the Åland Islands, the islands of Cyprus, Malta, and Madeira, plus Gibraltar and Monaco at the southern edges of Europe, as well as Switzerland, Austria, Liechtenstein, Luxembourg, Belgium, Hungary, Ireland, the lovely enclave of Campione d’Italia surrounded by Switzerland, and the Principality of Andorra tucked in between France and Spain. Off the coast of Newfoundland, the French territory of Saint Pierre et Miquelon is reportedly a player in this business. This totals 63 jurisdictions providing varying degrees of incorporation concealment and protection from probing eyes.

Read more: Explaining India Unincorporated | R. Vaidyanathan

As you select a place to acquire your anonymous international business corporation and plan your circuitous travels to meet clandestinely with a shady lawyer prepared to provide you with a dummy corporation to serve your unrevealed interest in moving ill-gotten gains with the utmost secrecy, you may actually be disappointed to learn that you don’t need to go there at all. In almost every one of these jurisdictions, the whole thing can generally be done with a phone call or fax or online. Using your search engine, enter ‘international business companies’ or ‘offshore corporations,’ and scores of web sites will pop into view offering instant service, comparing the pros and cons of various jurisdictions and quoting fee schedules for creating your own shadowy company.

I have lost count of the number of anonymous entities existing in these jurisdictions. Several years ago, the British Virgin Islands alone reportedly had 180,000 and the Caribbean as a whole had 500,000. More were being formed at a reported rate of nearly 200,000 a year. The total is certainly well over a million by now, and some experts put the number as high as three million. According to various estimates, half of cross-border trade and investment passes through a tax haven or a secrecy jurisdiction at some point along the way.

First Published: Oct 28, 2017 00:03 IST