A tax haven is a country where taxes are levied at extremely low rates. One country’s tax laws and rules can have an effect on other countries and their economies. Most multinationals operating in developing countries use tax havens. These tax havens often prove to be a way for multinational companies to avoid taxes.

More often than not, tax havens are detrimental to developing economies. When multinational companies avoid taxes in these developing countries, it is harmful to the economy. A large part of developing countries’ economy is dependent on the tax revenue. Therefore, if this tax revenue is eaten up by tax havens, it is extremely harmful to the developing countries. Tax havens are also a reason for rise in corruption, money laundering as well as tax avoidance. The BEPS Action Plan aims to end the use of shell companies used to store profits offshore.

What are Tax Havens?

According to the OECD, there are 4 criteria to be qualified as a tax haven: the jurisdiction imposes no or only nominal taxes; there is a lack of transparency; a lack of effective exchange of information with other governments and no requirement that a taxpayer’s activity in the jurisdiction is “substantial”.

Tax havens are usually countries that have zero or close to zero corporate taxes. This is an incentive for outsiders to easily set up business there. Tax havens also limit public disclosure about companies and their owners. Some examples of tax havens are Panama, Cayman Islands and the Netherlands, amongst others. Tax havens came into being for two reasons – benefit of the companies and the benefit of the tax haven itself. The companies that do transactions across borders can save massive amount of tax by routing payments and profits through these offshore tax havens. In turn, job opportunities are created in the tax haven.[1]

How do tax havens affect the economy as well as social and political stability of developing countries?

Tax havens massively impact the economy of other countries, more specifically developing countries. The explanation given by the tax havens is that capital flight (phenomenon where assets or money rapidly flow out of a country) from developing countries to tax havens occurs due to corruption and oppression. However, this is only the case for the wealthy 1 percent. These wealthy citizens are the ones with the power to bring about any sort of reform in developing countries. By giving them a way out, and allowing them to protect their assets offshore, it is in turn undermining the pressure for change. And therefore political change becomes close to impossible in developing countries. [2]

Tax havens also encourage people engaged in rimes such as illegal arm trading, human trafficking, etc. Such people may use these tax havens to protect their assets, purely based on the confidentiality that a tax haven provides. This helps to finance larger crimes such as wars and terrorism. In turn, this weakens the social stability of a developing country, and any other country for that matter.[3]

The hardest hit aspect by tax havens is the economy. This occurs mainly through corporate tax avoidance. Tax haven secrecy makes it difficult for financial regulators to identify and mitigate risk in capital markets. Tax havens play a huge role in creating economic inequality. They are responsible for economic crashes. For example, the financial crash in 2007 was largely due to the national regulators being unaware of the offshore activities of subsidiaries of major financial institutions. This created high profits in the short term, enjoyed by the wealthy, in turn causing a global crisis. Therefore, tax havens are corrupting the global market due to their secrecy. [4]

There are numerous examples of how tax havens affect the economy of developing countries. Tax havens provide protection for illegal tax evaders, in turn depriving developing countries from revenue that could be used for public schools, hospitals, infrastructure, etc. In order to make up for the gap in revenue created by tax havens, developing countries resort to loans.

There will always be incentive to place profits and assets in tax havens as long as there is secrecy. Therefore, there is a need to urge tax havens to disclose financial assets of their taxpayers. [5]

What are the disadvantages of Tax Havens?

Tax havens are disadvantageous to the economy of developing countries. Tax revenue is important for utilities such as education, health, infrastructure, etc, However, tax havens create a shortage of tax revenue for countries because MNCs take advantage of these tax havens. By doing so, they create an economic inequality.  For this issue to be tackled, there is a need for a thorough reform of the global tax system.

The financial secrecy that many tax havens provide facilitates corruption, money laundering, hiding of political conflicts of interests, manipulation of markets and the evasion of anti-trust law. This undermines democracy. Tax avoidance by MNCs is nothing but a form of corruption, It is stealing from the poor for their own benefit.

The Norwegian Government Commission made a strong case on Capital Flight Out of Developing Countries: “Potentially the most serious consequences of tax havens are that they can contribute to weakening the quality of institutions and the political system in developing countries. This is because tax havens encourage the self-interest that politicians and bureaucrats in such countries have in weakening these institutions”. This goes to show that tax havens also impact the governance of a state.[6]

How does the BEPS Action Plan affect tax havens?

Firstly, what is the BEPS Action Plan? It is a tax planning strategy with 15 actions. These actions are to bring about changes in international tax standards.

The BEPS Action Plan focuses mainly on effective legal tax planning techniques rather than offshore tax evasion. However, it aims to end the use of shell companies to stash profits offshore or unduly claim tax treaty protection. Although the BEPS Action Plan does not dictate how a country should structure its tax regimes, it will seek to change the regimes that bring in foreign investors without requiring a tax.[7] Along with BEPS Action Plan, the OECD has also published anti avoidance measures such as Controlled Foreign Corporation Rules (CFC), Transfer Pricing Regulations and Country-by-Country Reporting. According to an OECD Report published in June 2019, there have been indications that tax havens are becoming less attractive in the face of anti avoidance measures. [8]

Should Tax Havens be outlawed?

There are two sides to everything, including tax havens. On one hand, they are detrimental to the economies of other countries. On the other hand, they play an important role in global economy. First, they stimulate foreign direct investment in high tax countries. Most investment for less developed countries comes from tax havens. Secondly, they discipline financial markets. Third, they promote tax competition between jurisdictions. This forces countries with very high taxes to lower their tax rates. Lastly, it fosters economic growth. It has been seen that tax havens have a rapid economic growth.[9]

However, despite these positives, the impact of the negatives is larger. Every year, close to $200 billion or 10%, is lost globally in revenues due to tax havens. 40% of the multinational profits are moved to tax havens. Foreign companies are significantly more profitable in tax havens as compared to non-haven countries. What is extremely interesting is that countries that are tax havens end up collecting more tax than other countries. Even though their tax rate is extremely low, they collect more tax due to the sheer attraction that is created.[10]

The recent leaks such as the Panama Papers go on to show that in spite of coaxing these countries to have transparency, the attractions of tax havens will remain. Leaks such as this will create headlines for a couple of days or weeks at maximum, and then die down but the appeal of tax havens will not go away any time soon.[11]

The solution to this is a global corporate tax harmonization. If the entire world agreed to a certain corporate tax rate, none of these problems would exist, because there would be no more tax havens. The OECD Secretariat has suggested something similar. In the current times, is almost unavoidable to fix corporate tax. Therefore, yes, tax havens need to be outlawed for the good of the global economy.

Conclusion

Out of the $200 billion globally lost to tax havens, $170 billion comes from the poor and developing countries. Such countries need this revenue more so than others for education, health, and public services in general. Such developing countries then resort to loans or increased tax rates to provide basic necessities for their citizens. However, this again negatively impacts the citizens itself. The poor have to pay taxes, while the wealthy evade taxes by moving their assets to tax havens. This is clearly unfair and a gross inequality that needs to be fixed as soon as possible.

[1] Fitzgibbon W and Hallman B., 2020. What Is A Tax Haven? Offshore Finance, Explained – ICIJ. [online] ICIJ. Available at: <https://www.icij.org/investigations/panama-papers/what-is-a-tax-haven-offshore-finance-explained/> [Accessed 16 May 2020].

[2] Herkenrath, M., 2014. Tax Havens And Capital Flight From Developing Countries: The Social And Political Implications. [online] Available at: <https://www.cairn.info/revue-d-economie-du-developpement-2014-HS02-page-131.html#> [Accessed 16 May 2020].

[3] Supra note 2

[4] Cadtm.org. 2016. Why Tax Havens Must Go!. [online] Available at: <https://www.cadtm.org/spip.php?page=imprimer&id_article=13847> [Accessed 16 May 2020].

[5] Miller, R., 2013. Tax Havens Are Entrenching Poverty In Developing Countries | Richard Miller. [online] the Guardian. Available at: <https://www.theguardian.com/commentisfree/2013/may/14/tax-havens-entrenching-poverty-developing-countries> [Accessed 16 May 2020].

[6] Supra note 4

[7] Oecd.org. BEPS Frequently Asked Questions. [online] Available at: <https://www.oecd.org/ctp/BEPS-FAQsEnglish.pdf> [Accessed 16 May 2020].

[8] Asen, E., 2019. Tax Haven | The Good And Bad About Tax Havens | Tax Foundation. [online] Tax Foundation. Available at: <https://taxfoundation.org/tax-haven/> [Accessed 16 May 2020].

[9] Ramanauskas, B., 2019. Clamping Down On Tax Havens Is No Way To Get More From The Super-Rich – Capx. [online] CapX. Available at: <https://capx.co/clamping-down-on-tax-havens-is-no-way-to-get-more-from-the-super-rich/> [Accessed 16 May 2020].

[10] Vier, L., 2020. Tax Havens Cost Governments $200 Billion A Year. It’S Time To Change The Way Global Tax Works. [online] World Economic Forum. Available at: <https://www.weforum.org/agenda/2020/02/how-do-corporate-tax-havens-work/> [Accessed 16 May 2020].

[11] Brooks, R., 2016. Tax Havens Don’T Need To Be Reformed. They Should Be Outlawed | Richard Brooks. [online] the Guardian. Available at: <https://www.theguardian.com/news/commentisfree/2016/apr/04/tax-havens-reformed-outlawed-panama-papers> [Accessed 16 May 2020].

Tags: ,

Author Bio

Qualification: LL.B / Advocate
Company: N/A
Location: Bangalore, Karnataka, IN
Member Since: 05 Aug 2020 | Total Posts: 2

My Published Posts

More Under Income Tax

2 Comments

  1. vvenkatvarun says:

    Great read. The author has made commendable observations on the drawbacks of tax havens. Looking forward to more content. Good work.

Leave a Comment

Your email address will not be published. Required fields are marked *

Search Posts by Date

October 2020
M T W T F S S
 1234
567891011
12131415161718
19202122232425
262728293031