Aditya Sarkar
WHAT ARE ‘TAX HAVENS’?
Before we go into a detailed analysis of the various consequences that Tax Havens have on the Indian economy, let us understand what exactly ‘Tax Havens’ are. A Tax Haven, in short, can be defined as a country/place/jurisdiction where the rate of taxation is very low. This low rate of taxation usually varies from 2% to sometimes as low as 0.02%. Some countries do not even have an ascertained tax rate at all. Usually, countries engage in upholding such a low rate of taxation in order to increase foreign investment as well as the cash flow in their economy. By charging a very minimal amount of tax, it encourage big multinational corporations and firms to incorporate themselves in these countries, which in turn, helps in the development of their economy and helps bring them into a somewhat global limelight. This practice of multinational corporations of shifting their profits from high-tax jurisdictions to low-tax jurisdictions (tax havens) is known as Base Erosion and Profit Shifting (BEPS).
Tax Havens can be categorized into different types based on the amount of taxation that they charge. An insight into the different types of Tax Havens are provided below[1]:
- Pure Havens: Income or Capital gains are not charged at all (example – Bermuda, Cayman Islands, Vanuatu etc.)
- Tax Havens where the state-approved rate of taxation is low due to the implementation of tax agreements between different countries regarding double taxation (example – Liechtenstein, Switzerland, Republic of Ireland etc.)
- Tax Havens where tax payers are exempted from paying taxes for cross-border transactions (example – Costa Rica, The Philippines, Panama etc.)
- Tax Havens that engage in a preferential treatment towards offshore and holding companies (example – Austria, Luxembourg, Thailand etc.)
- Tax Havens that offer exemptions for industries that have been made for the development of exports (example – Ireland, Madeira in Portugal etc.)
- Tax Havens that provide financial benefits and privileges to companies classified as ‘Offshore Companies’ (example – Bahamas, Antigua & Barbuda, British Virgin Islands etc.)
- Tax Havens that provide specific benefits to banking companies or financial companies which engage in offshore activities (example – Anguilla, Grenada, Jamaica etc.)
Now, let us try and understand how exactly a Tax Haven works. The same will be done by providing specific case scenarios. The concept of Base Erosion and Profit Shifting can be understood by Google’s practice in relation to transferring its profits from royalty payments (for non-US customers) through various tax havens. This phenomenon, popularly known as the Double Irish Dutch Sandwich, had resulted in Google saving as much as 3.1 billion USD in taxes between 2007 to 2010 by shuttling its non-US profits through Ireland, the Netherlands and finally into Bermuda. By doing so, they had to pay taxes at a rate of as low as 2.3%, which otherwise, in major non-US countries such as England would have amounted to almost 28%. Here we see that Ireland, the Netherlands and Bermuda have been used as a tax haven by Google with regards to the royalty profits it has received from non-US based usage. All three of the locations serve favourable locations for Google as all of them have a very low rate of taxation and the taxation rate on transfer of profits from one country to the other is also quite low (which is inherently evident by the low amount of tax that Google had to pay while transferring its Royalty profits from its subsidiary in the Netherlands to that in Ireland. Inter-EU transfers are usually subject to a very low taxation rate). Other than that, many corporations engage in the practice of ‘Shelling’ vis-à-vis these Tax Havens[2]. ‘Shell Companies’ are companies with no physical office or employees (sometimes the holding company or any of its subsidiaries). An example of this would be if Company A incorporates itself in the Cayman Islands but there is no actual office or employees carrying out functions from that location. Most of Company A’s offices and employees are based in the United States because that is where they carry out their major operations, but a non-physical form of the holding company/subsidiary has been incorporated in the Cayman Islands for the sole purpose of reduction of tax liability. Base Erosion and Profit Shifting in order to reduce Tax liability is usually considered as Tax Avoidance.
Other than that, tax avoidance is also facilitated by means of ‘Treaty Shopping’. Treaty Shopping is a method of tax avoidance, whereby a third party takes advantage of a taxation treaty entered into by two countries in order to reduce their tax liability on the income deriving from those countries. An ideal example of this would be the Azadi Bachao Andolan[3], where it came into the public eye that multinational corporations engaging in business within India were incorporating themselves in Mauritius in order to seek advantage of the Indo-Mauritian DTAA. The DTAA, entered by both countries in 1982, stated that any resident of Mauritius (engaging in business transactions in India) was to be taxed only in Mauritius (which has a very low rate of taxation) and not in India. Mauritius’ leniency in granting individuals/corporations with the residence status only added to the problem. As a result of this DTAA, many companies were incorporating themselves in Mauritius (and fulfilling its residency requirement), conducting business in India but only getting taxed minimally in Mauritius. This led to a huge amount of loss of revenue in the hands of the Indian authorities and corporations/individuals saved up a lot by conveniently avoiding tax.
Furthermore, individuals often use tax havens in order to store unaccounted money that has been received through illicit/illegitimate gains. This money, coined in India popularly with the term “Black Money”, are stored in such tax havens because of the latter’s low rate of taxation and upheld secrecy with regards to providing information regarding the finances of their clients. The same has also been done in order to avoid paying taxes in the foremost country from which the money has derived and this amounts of Tax Evasion[4].
IMPACT THAT TAX HAVENS HAVE ON THE INDIAN ECONOMY
Though, traditionally, tax havens have been used for both Tax Avoidance and Tax Evasion, they have had a numerous number of negative repercussions upon the Indian economy. In this part of the paper, we shall be discussing and subsequently analysing some of these repercussions.
The foremost and probably the most fundamental effect that the usage of Tax Havens has on the Indian economy is that it prevents the various mobilization efforts as made by the government of India[5]. Reduction of Tax liability by the usage of Tax Havens considerably decreases the tax base (as available to the taxation authorities) and this leads to a significant shortage of funds in the hands of the government. This shortage of funds, in turn, leads to the distortion of the government’s plans regarding economic growth and development. In India, tax havens have been a significant barrier towards government expenditure and has had the negative impact of restricting/slowing down the growth rate.
Reduction of Tax liability by the usage of Tax Havens also interferes with the Indian government’s efforts to implement its economic policies[6]. Though the economic policies have been structured by the government for the benefit of the people, Tax Havens have served as a significant barrier towards the proper execution/implementation of the former. This, too, occurs due to a shortage of funds in the hands of the government.
Tax evasion by the usage of Tax Havens to store “Black Money” also dismantles the equity attribute of any tax system[7]. In India, specifically, reduction of their tax liability by many leads to an increase in the rates of taxes as charged by the government for every assessment year (for the purpose of increasing its revenue) and the burden of that unfortunately ends up falling upon the honest tax payers. As a consequence of this, even the tax payers who always pay their taxes honestly end up engaging in practices such as tax evasion in order to reduce an already incremental burden.
Though the policies of the government aim at the redistribution of wealth and a decrease in the income/financial margin between the various economic classes of people within the country, Tax Havens have majorly constricted such efforts[8]. Redistribution of Wealth is considered one of the most important pillars on which the Law of Taxation was developed. Today, the redistribution of wealth and reduction of income disparity is a very essential need for a country like India, where the gap between the wealthy and the poor is increasing significantly on a daily basis. Under such circumstances, the need for the proper implementation of government policies aimed at such are required in utmost urgency. However, Tax Havens and its usage to reduce tax liability restricts such policies and in fact, manages to increase the income disparity present in India. It leads to the concentration of economic power in the hands of a few, which is a threat to the economy itself. As a result of this, the rich in India become richer day by day whereas the poor in India get poorer day by day.
Base Erosion and Profit Shifting through the usage of Tax Havens leads to an unnecessary consumption of time, effort and energy on behalf of the Indian tax authority[9]. The Indian tax authorities have to constantly engage themselves in developing various policies for the purpose of countering the intricate mechanisms that corporations use in order to shift their profits for the purpose of reducing their tax liability.
With the usage of tax havens for tax evasion comes unsocial and immoral activities such as bribery, intimidation, tampering of official records, submission of fake documents etc[10]. These activities create a significant impact on the social and moralistic values of the Indian society. In simple words, by engaging in such activities, individuals provide other people with an alternative with regards to the honest payment of taxes. This takes a huge toll on the Indian economy in the present as well as for the future.
Tax evasion through Tax Havens by a significant population of India’s upper-middle or upper class always leads to a shortage in the funds in the hands of the government[11]. The class of the people that have to bear the ill-consequences of this shortage of funds are the people belonging to the lower strata of Indian society. Due to the government’s inability to implement welfare schemes and measures due to its lack of funding, the quality of life of the lower class of India has significantly worsened over the last few years of time. An increasing amount of the lower economic class population continues to fall below the poverty line (BPL) continuously. Shortage of funds also imposes a restriction on the government’s infrastructural plans with regards to rural governance. As a result of this, the living conditions as well as the general infrastructure in the rural areas of India continue to worsen on a daily basis.
The practices of Base Erosion and Profit Shifting (BEPS) or storage of “Black Money” in Tax Havens is not really a secretive practice anymore[12]. And more importantly, when an individual/corporation does that today, the world generally understands the reason as to why he/she/it has done so. This takes a significant toll upon the reputation of the country. Evasion of taxes and structuring businesses in such a manner so as to facilitate tax avoidance are often considered the same. Though it is debatable whether both are the same or not, they have a negative effect on the general public who perceive the evader and the avoider as the same. The increasing practices carried out by Indian corporations/individuals of seeking tax relief in the form of Tax Havens has been damaging to the reputation of India. This loss of reputation/image can have consequences related to trade deals, financial loans, international relations etc. between India and other countries.
Due to tax evasion through the usage of tax havens to store “Black Money”, a significant part of the upper class of India has an abundance of funds in their hands and this leads to an inflation in the economy[13]. The same is only logical and understandable as per economic policies as an increase in the amount of money in the economy creates an increase in the demand with regards to the available supply and hence, inflation occurs. Inflation leads to the imposition of negative consequences upon the poorer class of society, for whom even the basic amenities of life (such as food, clothing etc.) become costlier and sometimes, unaffordable up to a certain extent. Other than that, inflation also leads to an increase in the price of land and housing. As a result of not being able to afford accommodation within the city due to a rise of rental/sale prices, skilled workers often have to immigrate back to their respective rural base and this leads to a decrease in the supply of skilled workers in metropolitan areas. Other than that, homelessness and poverty increases on a rapid level due to the constant increase of property prices.
From the analysis of the same, it is quite understandable that Tax Havens have significantly restricted India’s growth and progress. With unimplemented developmental and economic policies, the economic balance in India fell into an unprecedented low in the fiscal year of 2012-13. But it is not only India that is suffering from such a problem. Money stored or profits shifted into tax havens costs governments all around the world an economic loss valuing up to 200 billion USD every year and this amount is increasing very steeply on an annual basis[14]. However, the government of India along with its tax authorities have tried their utmost to limit such practices and the improvement of the Indian economy from the year 2012-13 to today shows that their newly-introduced economic mechanisms and taxes have been successful in curbing down BEPS or Tax evasion by many up to a considerable extent.
REGULATORY MECHANISMS ADOPTED BY THE GOVERNMENT OF INDIA
In order to limit the practices of Base Erosion and Profit Shifting, the Organisation for Economic Co-operation and Development (OECD) introduced a set of action plans. These plans, collectively named as the BEPS Action Plan, were discussed and subsequently approved by all members of the G20. The BEPS Action Plan consists of 15 different action plans, each for a different issue relating to Base Erosion and Profit Shifting. India, like many other countries, have adopted these action plans in order to resolve complications arising out of the various number of issues discussed above[15]. Provided below is the list of 15 action plans and what objective each plan is sought to achieve –
- ACTION 1 (DIGITAL ECONOMY): The primary aim of the Action 1 is to identify and address the main challenges that the digitalization of the economy poses for the existing tax laws and rules.
- ACTION 2 (HYBRIDS): The primary aim of the Action 2 is to countervail the effects of hybrid mismatch arrangements by making changes to the model tax convention and providing recommendations with regards to making changes to the various existing domestic taxation laws and rules.
- ACTION 3 (CONTROLLED FOREIGN COMPANIES): The primary aim of the Action 3 is to provide recommendations with regards to the strengthening of international as well as domestic laws/rules pertaining to Controlled Foreign Companies (CFCs). It also aims at identifying and addressing various issues relating to tax avoidance by resident corporations through a non-resident affiliate.
- ACTION 4 (INTEREST DEDUCTIONS): The primary aim of the Action 4 is to limit the base erosion practice of corporations by deducting the rate of interest as well as by introducing other financial payments. This Action Plan had been introduced by the OECD primarily in order to address issues relating to the various domestic tax laws of different countries.
- ACTION 5 (HARMFUL TAX PRACTICES): The primary aim of the Action 5 is to identify and defy various harmful tax practices. Through this Action Plan, the OECD attempted to extend its recommendations regarding the restructuring of laws to non-OECD members as well.
- ACTION 6 (PREVENTION OF TREATY ABUSE): The primary aim of the Action 6 is to prevent treaty abuse by providing recommendations to countries with regards to restructuring its domestic laws/rules in such a manner so as to prevent the granting of treaty benefits to parties in unbecoming circumstances.
- ACTION 7 (PERMANENT ESTABLISHMENT): Action 7 aims at the restructuring/redefining of the threshold to prove Permanent Establishment (“PE”) in order to put a hurdle on the practices of Base Erosion and Profit Shifting.
- ACTION 8, 9 & 10 (TRANSFER PRICING): Transfer Pricing, in simply words, can be defined as an accounting practice whereby the price that one division of a corporation charges another for its goods and services are represented. This, in turn, aids in the determination of the price of goods/services exchanged between subsidiaries, affiliates and CFCs (all which are part of the same holding company). Transfer Pricing is a very common method of tax base reduction and is commonly used by many companies. The primary and common aim of the Action Plans 8, 9 and 10 is to ensure that the transfer pricing outcomes (as represented) are proportional with the value creation of the goods/services. The same can only be done the ensuring that the value for tax is accordant to the economic activity that generates that value. The Action Plans 8, 9 and 10 are aimed at addressing issues/concerns relating to intangible assets, risks & capitals and high risk transactions respectively.
- ACTION 11 (DATA COLLECTION): The primary aim of the Action 11 is to ensure the proper collection and analysis of data relating to Base Erosion and Profit Shifting for the purpose of redressal.
- ACTION 12 (DISCLOSURES RELATING TO AGGRESSIVE TAX PLANNING): Action 12 aims at the development of mandatory disclosure rules by parties if they are engaging in aggressive tax planning (includes aggressive/abusive transactions, structures or arrangements). The same has been done in order to reduce the administrative costs relating to tax administration by the authorities.
- ACTION 13 (DOCUMENTATION OF TRANSFER PRICING): The primary aim of the Action 13 is to re-analyse and restructure the process relating to the documentation of transfer pricing arrangements in order to install a greater transparency to it.
- ACTION 14 (DISPUTE RESOLUTION): The Action 14 aims in making the existing dispute resolution mechanisms and procedures more effective and systematic in nature. Through the introduction of Action 14, the OECD has clearly shown demur upon the practice of countries to engage in mutual agreement procedures (MAPs) to resolve treaty-related disputes.
- ACTION 15 (MULTILATERAL INSTRUMENTS): Last but not the least, the Action 15 focuses on the amendment of bilateral treaty agreements in order to resolve issues arising out of Base Erosion and Profit Shifting.
Other than the adoption of the OECD’S BEPS Action Plans, India has also successfully implemented the Equalisation Levy to all business transactions irrespective of a corporation’s Permanent Establishment (PE). As a result of this, any corporation that has incorporated itself in a tax haven but engages in regular transactions with entities in India will be charged a fee (Equalisation Levy) for doing the same[16]. Many other countries have followed India’s footsteps and have implemented the Equalisation Levy for business transactions. Other than this, India has also implemented other Digital Taxes for corporations engaging in business in India, irrespective of where they are permanently established. Though there have been negative contentions against these digital taxes, India has always successfully justified its position. According to India, even they should benefit from a corporation’s business because they are allowing the latter an access to their market, which if not done, would reduce the latter’s geographical opportunities and cause losses.
India also adopted the GAAR (General Anti-Avoidance Rules) via the Finance Act of 2012. However, due to various problems arising out of the retrospective taxation of overseas assets, the GAAR could not be implemented until the financial year 2018-19. The need for the provisions of GAAR arose from the Vodafone case[17] in 1992. In 1992, when Vodafone entered the Indian market by acquiring Hutchinson Essar, the transaction took place in the Cayman Islands. As a result of this, the Indian tax authorities loosed out on as much as 2.5 billion (USD) on taxes. This led to the need for Anti-Avoidance provisions and hence, the GAAR was proposed as a part of the DTC (Direct Taxes Code). However, due to the aforementioned problems, GAAR was implemented as late as the 2018-19 financial year and finds itself in Chapter X-A of the Income Tax Act, 1961 of India.
India has, furthermore, enabled itself to tackle the issue of Treaty-Shopping. Especially with regards to the India-Mauritius DTAA, Indian authorities can now tax Mauritius residents upon their transactions (to and from India) based on their own personal discretion[18]. This has, positively, limited the practice of third party corporations to incorporate themselves in Mauritius in order to conduct tax-free business in India. This has also, positively, led to the generation of a higher amount of revenue in the hands of Indian authorities.
Other than that, India has also put severe restrictions upon the practice of storage of money received in the form of illicit/illegitimate gains (“Black Money”) in tax havens by entering into Tax Information Exchange Agreements (TIEA) with several tax havens[19]. A TIEA provides India with the power to gather information from these havens upon requests relating to a criminal or civil tax-related investigation. This has subsequently reduced the secrecy provided by many of the tax havens and potential tax evaders find it risky to store their “Black Money” in these havens. India has entered into TIEAs with several tax havens such as Bahamas (2011), Bermuda (2011), Liberia (2012) and Belize (2014).
WHAT LIES IN THE NEAR FUTURE?
The adoption of the OECD’s BEPS Action Plans as well as the implementation of the equalisation levy and other digital taxes has already yielded positive results for India and its economy. Taxes received from digital transactions of companies (irrespective of whether or not they are based in India) have resulted in a greater amount of money in the hands of government/tax authorities and this has led to a greater implementation of developmental/welfare schemes and plans.
The period from 2013-2017 has seen a huge decline in the amount of money stored by Indian parties in Tax Havens (due to the implementation of TIEAs)[20]. Though TIEAs have not been entered into by India and various tax havens in which such decline has been showcased, TIEAs have aroused a sense of fear into tax evaders regarding the legal consequences of their actions. The amount of money stored by Indian parties in Luxembourg showed a 62% decline from the period-2013 to 2017. While there was a decline of 17.6% in offshore accounts held in Jersey, a decline in the money stored in Isle of Man was almost 39%. After the election of the Bharatiya Janata Party in the 2014, the money held in offshore accounts in Switzerland has seen a decline of as much as 80%.
The journey to put an absolute end to these unethical practices is still a long way out, but it is clearly evident that a lot of progress has been made. If things go about the way it is progressing, it won’t be long before we see a corruption-free India, only focusing on economic growth and development.
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[1] Gupta, Neha. “GSP Kendra.” GSP Kendra, 27 Dec. 2018, https://www.gspkendra.com/2018/12/27/tax-haven-virtuality-or-reality-to-indian-economy/
[2] Gupta, Neha. “GSP Kendra.” GSP Kendra, 27 Dec. 2018, https://www.gspkendra.com/2018/12/27/tax-haven-virtuality-or-reality-to-indian-economy/
[3] Union of India v Azadi Bachao Andolan & Another [2003] S.L.P.(C) Nos. 22521-22522 of 2002
[4] Das, Pradip Kumar. “An Insight into Black Money and Tax Evasion – Indian Context.” Journal of International Business Research and Marketing, vol. 3, no. 4, May 2018, pp. 30–39., https://researchleap.com/insight-black-money-tax-evasion-indian-context/
[5] Asen, Elke. “Tax Foundation.” Tax Foundation, 1 Aug. 2019, https://taxfoundation.org/tax-haven/
[6] Asen, Elke. “Tax Foundation.” Tax Foundation, 1 Aug. 2019, https://taxfoundation.org/tax-haven/
[7] Das, Pradip Kumar. “An Insight into Black Money and Tax Evasion – Indian Context.” Journal of International Business Research and Marketing, vol. 3, no. 4, May 2018, pp. 30–39., https://researchleap.com/insight-black-money-tax-evasion-indian-context/
[8] Gupta, Neha. “GSP Kendra.” GSP Kendra, 27 Dec. 2018, https://www.gspkendra.com/2018/12/27/tax-haven-virtuality-or-reality-to-indian-economy/
[9] Gupta, Neha. “GSP Kendra.” GSP Kendra, 27 Dec. 2018, https://www.gspkendra.com/2018/12/27/tax-haven-virtuality-or-reality-to-indian-economy/
[10] Das, Pradip Kumar. “An Insight into Black Money and Tax Evasion – Indian Context.” Journal of International Business Research and Marketing, vol. 3, no. 4, May 2018, pp. 30–39., https://researchleap.com/insight-black-money-tax-evasion-indian-context/
[11] Gupta, Neha. “GSP Kendra.” GSP Kendra, 27 Dec. 2018, https://www.gspkendra.com/2018/12/27/tax-haven-virtuality-or-reality-to-indian-economy/
[12] Kagan, Julia. “Tax Haven.” Investopedia, 22 Apr. 2020, www.investopedia.com/terms/t/taxhaven.asp
[13] Srinivasan, P R. “Indian Tax System, Black Money and Tax Havens .” The Economic Times, 24 Apr. 2012, https://economictimes.indiatimes.com/indian-tax-system-black-money-and-tax-havens/articleshow/12845364.cms
[14] Radu, Daniela Iuliana. “Tax Havens Impact on the World Economy.” Procedia – Social and Behavioral Sciences , vol. 62, 24 Oct. 2012, pp. 398–402., doi:https://www.sciencedirect.com/science/article/pii/S1877042812035057.
[15] “BEPS Actions.” Deloitte, www2.deloitte.com/global/en/pages/tax/articles/beps-actions
[16] “Digital Taxation, Scope of ‘Equalisation Levy.’” KMPG, home.kpmg/us/en/home/insights/2020/03/tnf-india-digital-taxation-enlarging-the-scope-of-equalisation-levy.html
[17] Naidu, Katya. “Vodafone Has to Wrap up ₹22,100 Crore Tax Case before It Can Think of Liquidating India Business.” Business Insider, 15 Nov. 2019, https://www.businessinsider.in/business/corporates/news/vodafone-has-to-settle-pending-tax-case-before-liquidating-india-business/articleshow/72069282.cms
[18] Union of India v Azadi Bachao Andolan & Another [2003] S.L.P.(C) Nos. 22521-22522 of 2002
[19] “View: Tax Regime Globally, as Well as in India, Is Heading for Some Significant Changes.” The Economic Times, 3 Jan. 2020, https://economictimes.indiatimes.com/news/economy/policy/view-tax-regime-globally-as-well-as-in-india-is-heading-for-some-significant-changes/articleshow/73090848.cms?from=mdr
[20] Arora, Rajat, and Dheeraj Tiwari. “Money Held by Indians in Tax Havens Plunges during ’13-17 Read More at: https://Economictimes.indiatimes.com/News/Economy/Finance/Money-Held-by-Indians-in-Tax-Havens-Plunges-during-13-17/Articleshow/65495600.Cms?utm_source=Contentofinterest&utm_medium=Text&utm_campaign=Cppst.” The Economic Times, 22 Aug. 2018, https://economictimes.indiatimes.com/news/economy/finance/money-held-by-indians-in-tax-havens-plunges-during-13-17/articleshow/65495600.cms?from=mdr
(Author ‘Aditya Sarkar’ is a law student, currently in his 5th year of the BBA-LLB (Hons.) course at the O.P. Jindal Global University in Sonepat, Haryana)
A very simple but most comprehensive article on tax haven. An article deserving full credits. Please keep writing to fulfill the intellectual vacuum.