Tax haven

Overview

A tax haven is a term, often used pejoratively, to describe a place with very low tax rates for non-domiciled investors, even if the official rates may be higher. In some older definitions, a tax haven also offers financial secrecy. However, while countries with high levels of secrecy but also high rates of taxation, most notably the United States and Germany in the Financial Secrecy Index (FSI) rankings, can be featured in some tax haven lists, they are often omitted from lists for political reasons or through lack of subject matter knowledge. In contrast, countries with lower levels of secrecy but also low "effective" rates of taxation, most notably Ireland in the FSI rankings, appear in most § Tax haven lists. The consensus on effective tax rates has led academics to note that the term "tax haven" and "offshore financial centre" are almost synonymous. In reality, many offshore financial centers do not have harmful tax practices and are at the forefront among financial centers regarding AML practices and international tax reporting. Developments since the early 21st century have substantially reduced the ability of individuals or corporations to use tax havens for tax evasion (illegal non-payment of taxes owed). These include the end of banking secrecy in many jurisdictions including Switzerland following the passing of the US Foreign Account Tax Compliance Act and the adoption by most countries, including typical tax havens, of the Common Reporting Standard (CRS) – a multilateral automatic taxpayer data exchange agreement initiated by the Organisation for Economic Co-operation and Development (OECD). CRS countries require banks and other entities to identify the residence of account holders, beneficial owners of corporate entities and record yearly account balances and communicate such information to local tax agencies, which will report back to tax agencies where account holders or beneficial owners of corporations reside. CRS was intended to end offshore financial secrecy and tax evasion giving tax agencies knowledge to tax offshore income and assets. However, huge and complex corporations, like multinationals, can still shift profits to corporate tax havens using intricate schemes. Traditional tax havens, like Jersey, are open to zero rates of taxation, and as a consequence, they have few bilateral tax treaties. Modern corporate tax havens have non-zero official (or "headline") rates of taxation and high levels of OECD compliance, and thus have large networks of bilateral tax treaties. However, their base erosion and profit shifting (BEPS) tools—such as ample opportunities to render income exempt from tax, for instance—enable corporations and non-domiciled investors to achieve de facto tax rates closer to zero, not just in the haven but in all countries with which the haven has tax treaties; thereby putting them on tax haven lists. According to modern studies, the § Top 10 tax havens include corporate-focused havens like the Netherlands, Singapore, the Republic of Ireland, and the United Kingdom; while Luxembourg, Hong Kong, the Cayman Islands, Bermuda, the British Virgin Islands, and Switzerland feature as both major traditional tax havens and major corporate tax havens. Corporate tax havens often serve as "conduits" to traditional tax havens. The use of tax havens results in a loss of tax revenues to countries that are not tax havens. Estimates of the § Financial scale of taxes avoided vary, but the most credible have a range of US$100–250 billion per annum. In addition, capital held in tax havens can permanently leave the tax base (base erosion). Estimates of capital held in tax havens also vary: the most credible estimates are between US$7–10 trillion (up to 10% of global assets). The harm of traditional and corporate tax havens has been particularly noted in developing nations, where tax revenues are needed to build infrastructure. Over 15% of countries are sometimes labelled tax havens. Tax havens are mostly successful and well-governed economies, and being a haven has brought prosperity. The top 10–15 GDP-per-capita countries, excluding oil and gas exporters, are tax havens. Because of § Inflated GDP-per-capita (due to accounting BEPS flows), havens are prone to over-leverage (international capital misprice the artificial debt-to-GDP). This can lead to severe credit cycles and/or property/banking crises when international capital flows are repriced. Ireland's Celtic Tiger, and the subsequent financial crisis in 2009–13, is an example. Jersey is another. Research shows § U.S. as the largest beneficiary, and the use of tax havens by U.S. corporates maximised U.S. exchequer receipts. The historical focus on combating tax havens (e.g. OECD-IMF projects) had been on common standards, transparency and data sharing. The rise of OECD-compliant corporate tax havens, whose BEPS tools were responsible for most of the lost taxes, led to criticism of this approach, versus actual taxes paid. Higher-tax jurisdictions, such as the United States and many member states of the European Union, departed from the OECD BEPS Project in 2017–18 to introduce anti-BEPS tax regimes, targeted raising net taxes paid by corporations in corporate tax havens (e.g. the U.S. Tax Cuts and Jobs Act of 2017 ("TCJA") GILTI-BEAT-FDII tax regimes and move to a hybrid "territorial" tax system, and proposed EU Digital Services Tax regime, and EU Common Consolidated Corporate Tax Base).

Overview

While areas of low taxation are recorded in Ancient Greece, tax academics identify what we know as tax havens as being a modern phenomenon, and note the following phases in their development:

19th century New Jersey and Delaware Corporations. In the 1880s, New Jersey was in financial difficulty and the governor, Leon Abbett, backed a plan by a New York lawyer, Mr. Dill, to create a more liberal regime for establishing corporate structures, including the availability of "off-the-shelf companies" (but not non-resident companies). Delaware followed with the General Incorporation Act in 1898, on the basis of lobbying from other New York lawyers. Because of the restrictive incorporation regime in the Anglo-Saxon world as a result of the South Sea Bubble, New Jersey and Delaware were successful, and though not explicitly tax havens (e.g. US federal and state taxes applied), many future tax havens would copy their "liberal" incorporation regimes. Post World War I. The modern concept of a tax haven is generally accepted to have emerged at an uncertain point in the immediate aftermath of World War I. Bermuda sometimes 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, most tax academics identify the Zurich-Zug-Liechtenstein triangle as the first "tax haven hub" created during the mid-1920s. Liechtenstein's 1924 Civil Code created the infamous Anstalt corporate vehicle, while Zurich and Zug developed the Aktiengesellschaft/Societé Anonyme and other brass plate companies. Tax academic Ronen Palan identifies two of the three major groups of tax havens, as emerging during this period: British Empire–based tax havens. The 1929 court case of Egyptian Delta Land and Investment Co. Ltd. V. Todd in Britain created the "non-resident corporation" and recognised a British-registered company with no business activities in Britain as not liable to British taxation. Tax academic Sol Picciotto noted the creation of such "non-resident" companies was "a loophole which, in a sense, made Britain a tax haven". The ruling applied to the British Empire, including Bermuda, Barbados, and the Cayman Islands. European-based tax havens. The Zurich-Zug-Liechtenstein triangle expanded and was joined by Luxembourg in 1929 when they created tax-free holding companies. However, in 1934, as a reaction to the global depression, the Swiss Banking Act of 1934 put bank secrecy under Swiss criminal law. Secrecy and privacy would become an important and distinctive part of the European-based tax havens, in comparison with other tax havens. Post–World War II offshore financial centres. Currency controls enacted post–World War II led to the creation of the Eurodollar market and the rise in offshore financial centres (OFCs). Many of these OFCs were traditional tax havens from the post-World War I phase, including the Cayman Islands and Bermuda, however new centres such as Hong Kong and Singapore began to emerge. The Tangier International Zone was an extreme case of tax leniency and banking secrecy in the period following its wartime suspension, but that was brought to an end in 1960 as a consequence of Moroccan independence. London's position as a global financial centre for these OFCs was secured when the Bank of England ruled in 1957 that transactions executed by British banks on behalf of a lender and borrower who were not located in the UK, were not to be officially viewed as having taken place in the UK for regulatory or tax purposes, even though the transaction was only ever recorded as taking place in London. The rise of OFCs would continue so that by 2008, the Cayman Islands would be the 4th largest financial centre in the world, while Singapore and Hong Kong had become major Regional Financial Centres (RFCs). By 2010, tax activists would promote the notion that OFCs are synonymous with tax havens, and that most of their services involved taxation. Emerging economy–based tax havens. As well as the dramatic rise in OFCs, from the late 1960s onwards, new tax havens began to emerge to service developing and emerging markets, which became Palan's third group. The first Pacific tax haven was Norfolk Island (1966), a self-governing external territory of Australia. It was followed by Vanuatu (1970–71), Nauru (1972), the Cook Islands (1981), Tonga (1984), Samoa (1988), the Marshall Islands (1990), and Nauru (1994). All these havens introduced familiar legislation modeled on the successful British Empire and European tax havens, including near-zero taxation for exempt companies, and non-residential companies, Swiss-style bank secrecy laws, trust companies laws, offshore insurance laws, flags of convenience for shipping fleets and aircraft leasing, and beneficial regulations for new online services (e.g. gambling, pornography, etc.). Corporate-focused tax havens. In 1981, the US IRS published the Gordon Report on the use of tax havens by US taxpayers, which highlighted the use of tax havens by US corporations. In 1983, US corporation McDermott International executed the first tax inversion to Panama. The EU Commission showed that Apple Inc. had begun to use the infamous Double Irish BEPS tool as early as 1991. US tax academic James R. Hines Jr. showed in 1994 that US corporations were achieving effective rates of taxation of circa 4% in corporate-focused OECD tax havens like Ireland. When in 2004, the US Congress stopped "naked tax inversions" by US corporations to Caribbean tax havens with the introduction of IRS Regulation 7874, a much larger wave of US corporate "merger inversions" started that involved moving to OECD tax havens. A new class of corporate tax haven had emerged that was OECD-compliant, and transparent, but offered complex base erosion and profit shifting (BEPS) tools that could achieve net tax rates similar to traditional tax havens. Initiatives by the OECD to curb tax havens would mainly impact Palan's third group of Emerging economy–based tax havens, however, the corporate-focused tax havens were drawn from the largest OFCs that had emerged from the British Empire–based tax havens and European-based tax havens, and included the Netherlands, Singapore, Ireland, USA and the U.K., and even reformed traditional tax havens such as Luxembourg, Hong Kong, the Caribbean (the Cayman, Bermuda, and the British Virgin Islands), and Switzerland. The scale of their BEPS activities meant that this group of 10 jurisdictions would dominate academic tax haven lists from 2010, including Hines' 2010 list, the Conduit and Sink OFC 2017 list, and Zucman's 2018 list.

Notable events

1929: British courts rule in Egyptian Delta Land and Investment Co. Ltd. V. Todd. that a British-registered company with no business activities in Britain is not liable to British taxation. Sol Picciotto noted the creation of such "non-resident" companies was "a loophole which, in a sense, made Britain a tax haven". The ruling applied to the British Empire, including Bermuda, Barbados, and the Cayman Islands. 1934: As a reaction to the global depression, the Swiss Banking Act of 1934 put bank secrecy under Swiss criminal law. The law required "absolute silence with respect to a professional secret" (i.e. accounts in Swiss banks). "Absolute" means protection from any government, including the Swiss. The law even made inquiry or research into the "trade secrets" of Swiss banks, a criminal offense. 1981: The US Treasury and the US Attorney General are given: Tax havens and their use by United States taxpayers: An Overview by Richard A. Gordon Special Counsel for International Taxation at the IRS. The Gordon Report identifies new types of corporate tax havens such as Ireland (described as a manufacturing tax haven). 1983: The first officially recognized US corporate tax inversion as McDermott International moves from Texas to a tax haven, Panama. 1994: James R. Hines Jr. publishes the important Hines–Rice paper, producing the first academic list of 41 tax havens, including 7 major tax havens. The Hines-Rice paper used the term profit shifting, and showed that while many tax havens had higher headline tax rates, their effective tax rates were much lower. Hines shows that the US is a major user of tax havens. 2000: The OECD produces its first formal list of 35 tax havens that have met two of three OECD Criteria; none of the existing 35 OECD members, or EU–28 members, were listed as tax havens. By 2008, only Trinidad & Tobago had met the OECD's criteria for being a tax haven. Academics have started using the terms "OECD tax havens" and "EU tax havens". 2000: The FSF–IMF define an offshore financial centre (OFC) with a list of 42–46 OFCs using a qualitative list of criteria; in 2007, the IMF produced a revised quantitative-based list of 22 OFCs, and in 2018, another revised quantitative-based list of 8 major OFCs, who are responsible for 85% of OFC financial flows. By 2010, tax academics consider OFCs and tax havens as synonymous. 2004: US Congress passed the American Jobs Creation Act of 2004 (AJCA) with IRS Section 7874 that effectively end naked inversions by US corporations to Caribbean tax havens. 2009: The Tax Justice Network introduced the Financial Secrecy Index ("FSI") and the term "secrecy jurisdiction", to highlight issues in regard to OECD-compliant countries that have high tax rates and do not appear on academic lists of tax havens, but have transparency issues. 2010: James R. Hines Jr. publishes a list of 52 tax havens, and unlike all past tax haven lists, were scaled quantitatively by analysing corporate investment flows. The Hines 2010 list was the first to estimate the ten largest global tax havens, only two of which, Jersey and the British Virgin Islands, were on the OECD's 2000 list. 2015: Medtronic completes the largest tax inversion in history in a US$48 billion merger with Covidien plc in Ireland, while Apple Inc. complete the largest hybrid-tax inversion in history moving US$300 billion of intellectual property to Ireland (called leprechaun economics); by 2016, the US Treasury tightened the inversion rules, causing Pfizer to abort their US$160 billion merger with Allergan plc. 2017: The University of Amsterdam's CORPNET group using a purely quantitive approach, splits the understanding of OFCs into Conduit OFCs and Sink OFCs. CORPNET's lists of the top five Conduit OFCs and top five Sink OFCs, matched 9 of the top 10 havens in Hines' 2010 list, only differing in the United Kingdom, which only transformed their tax code in 2009–12. 2017: The EU Commission produces its first formal list of tax havens with 17 countries on its 2017 blacklist and 47 on its 2017 greylist; however, as with the previous 2010 OECD list, none of the jurisdictions are OECD or EU–28 countries, nor are they in the list of § Top 10 tax havens. 2018: Tax academic Gabriel Zucman (et alia) estimates aggregate corporate "profit shifting" (i.e. BEPS) is shielding over US$250 billion per year from taxes. Zucman's 2018 list of top 10 havens matched 9 of the top 10 havens in Hines' 2010 list, but with Ireland as the largest global haven. Zucman shows that US corporations are almost half of all profits shifted. 2019: European Parliament votes to accept a report by 505 votes in favour to 63 against, identifying five "EU tax havens" that should be included on the EU Commission list of tax havens.

Context

There is no established consensus regarding a specific definition of what constitutes a tax haven. This is the conclusion from non-governmental organisations, such as the Tax Justice Network in 2018, from the 2008 investigation by the U.S. Government Accountability Office, from the 2015 investigation by the U.S. Congressional Research Service, from the 2017 investigation by the European Parliament, and from leading academic researchers of tax havens. The issue, however, is material, as being labelled a "tax haven" has consequences for a country seeking to develop and trade under bilateral tax treaties. When Ireland was "blacklisted" by G20 member Brazil in 2016, bilateral trade declined.

Academic non-quantitative (1994–2016)

One of the first § Important papers on tax havens, was the 1994 Hines–Rice paper by James R. Hines Jr. It is the most cited paper on tax haven research, even in late 2017, and Hines is the most cited author on tax haven research. As well as offering insights into tax havens, it took the view that the diversity of countries that become tax havens was so great that detailed definitions were inappropriate. Hines merely noted that tax havens were: "a group of countries with unusually low tax rates". Hines reaffirmed this approach in a 2009 paper with Dhammika Dharmapala. In December 2008, Dharmapala wrote that the OECD process had removed much of the need to include "bank secrecy" in any definition of a tax haven and that it was now "first and foremost, low or zero corporate tax rates", and this has become the general "financial dictionary" definition of a tax haven. Hines refined his definition in 2016 to incorporate research on § Incentives for tax havens on governance, which is broadly accepted in the academic lexicon.

Tax havens are typically small, well-governed states that impose low or zero tax rates on foreign investors.

OECD–IMF (1998–2018)

In April 1998, the OECD produced a definition of a tax haven, as meeting "three of four" criteria. It was produced as part of their "Harmful Tax Competition: An Emerging Global Issue" initiative. By 2000, when the OECD published their first list of tax havens, it included no OECD member countries as they were now all considered to have engaged in the OECD's new Global Forum on Transparency and Exchange of Information for Tax Purposes, and therefore would not meet Criteria ii and Criteria iii. As the OECD has never listed any of its 35 members as tax havens, Ireland, Luxembourg, the Netherlands, and Switzerland are sometimes defined as "OECD tax havens". In 2017, only Trinidad & Tobago met the 1998 OECD definition; that definition thus fell into disrepute.

(†) The 4th criterion was withdrawn after objections from the new U.S. Bush Administration in 2001, and in the OECD's 2002 report the definition became "two of three criteria". The 1998 OECD definition is most frequently invoked by the "OECD tax havens". However, that definition (as noted above) lost credibility when, in 2017, under its parameters, only Trinidad & Tobago qualified as a tax haven and has since been largely discounted by tax haven academics, including the 2015 U.S. Congressional Research Service investigation into tax havens, as being restrictive, and enabling Hines' low-tax havens (i.e. to which the first criterion applies), to avoid the OECD definition by improving OECD cooperation (so the second and third criteria do not apply).

Thus, the evidence (limited though it undoubtedly is) does not suggest any impact of the OECD initiative on tax-haven activity. [...] Thus, the OECD initiative cannot be expected to have much impact on corporate uses of tax havens, even if (or when) the initiative is fully implemented In April 2000, the Financial Stability Forum (or FSF) defined the related concept of an offshore financial centre (or OFC), which the IMF adopted in June 2000, producing a list of 46 OFCs. The FSF–IMF definition focused on the BEPS tools havens offer, and on Hines' observation that the accounting flows from BEPS tools are "out-of-proportion" and thus distort the economic statistics of the haven. The FSF–IMF list captured new corporate tax havens, such as the Netherlands, which Hines considered too small in 1994. In April 2007, the IMF used a more quantitative approach to generate a list of 22 major OFCs, and in 2018 listed the eight major OFCs that handle 85% of all flows. From about 2010, tax academics considered OFCs and tax havens to be synonymous terms.

Academic quantitative (2010–2018)

In October 2010, Hines published a list of 52 tax havens, which he had scaled quantitatively by analysing corporate investment flows. Hines' largest havens were dominated by corporate tax havens, which Dharmapala noted in 2014 accounted for the bulk of global tax haven activity from BEPS tools. The Hines 2010 list was the first to estimate the ten largest global tax havens, only two of which, Jersey and the British Virgin Islands, were on the OECD's 2000 list. In July 2017, the University of Amsterdam's CORPNET group ignored any definition of a tax haven and focused on a purely quantitive approach, analysing 98 million global corporate connections on the Orbis database. CORPNET's lists of top five Conduit OFCs, and top five Sink OFCs, matched 9 of the top 10 havens in Hines' 2010 list, only differing in the United Kingdom, which only transformed their tax code in 2009–12. CORPNET's Conduit and Sink OFCs study split the understanding of a tax haven into two classifications:

24 Sink OFCs: jurisdictions in which a disproportionate amount of value disappears from the economic system (i.e. the traditional tax havens). 5 Conduit OFCs: jurisdictions through which a disproportionate amount of value moves toward sink OFCs (i.e. the modern corporate tax havens). In June 2018, tax academic Gabriel Zucman (et alia) published research that also ignored any definition of a tax haven, but estimated the corporate "profit shifting" (i.e. BEPS), and "enhanced corporate profitability" that Hines and Dharmapala had noted. Zucman pointed out that the CORPNET research under-represented havens associated with US technology firms, like Ireland and the Cayman Islands, as Google, Facebook and Apple do not appear on Orbis. Even so, Zucman's 2018 list of top 10 havens also matched 9 of the top 10 havens in Hines' 2010 list, but with Ireland as the largest global haven. These lists (Hines 2010, CORPNET 2017 and Zucman 2018), and others, which followed a purely quantitive approach, showed a firm consensus around the largest corporate tax havens.

Related definitions

In October 2009, the Tax Justice Network introduced the Financial Secrecy Index ("FSI") and the term "secrecy jurisdiction", to highlight issues in regard to OECD-compliant countries that have high tax rates and do not appear on academic lists of tax havens, but have transparency issues. The FSI does not assess tax rates or BEPS flows in its calculation; but it is often misinterpreted as a tax haven definition in the financial media, particularly when it lists the US and Germany as major "secrecy jurisdictions". However, many types of tax havens also rank as secrecy jurisdictions.

Groupings

While tax havens are diverse and varied, tax academics sometimes recognise three major "groupings" of tax havens when discussing the history of their development:

European-related tax havens

As discussed in § History, the first recognized tax haven hub was the Zurich-Zug-Liechtenstein triangle created in the mid-1920s, later joined by Luxembourg in 1929. Privacy and secrecy were established as an important aspect of European tax havens. However, modern European tax havens also include corporate-focused tax havens, which maintain higher levels of OECD transparency, such as the Netherlands and Ireland. European tax havens act as an important part of the global flows to tax havens, with three of the five major global Conduit OFCs being European (i.e. the Netherlands, Switzerland, and Ireland). Four European-related tax havens appear in the various notable § Top 10 tax havens lists, namely: the Netherlands, Ireland, Switzerland, and Luxembourg.

British Empire–related tax havens

Many tax havens are former or current dependencies of the United Kingdom and still use the same core legal structures. Six British Empire–related tax havens appear in the § Top 10 tax havens lists, namely: Caribbean tax havens (e.g., Bermuda, the British Virgin Islands, and the Cayman Islands), Channel Islands tax havens (e.g. Jersey) and Asian tax havens (e.g., Singapore and Hong Kong). As discussed in § History, the United Kingdom created its first "non-resident company" in 1929, and led the Eurodollar offshore financial centre market post–World War II. Since the reform of its corporate tax code in 2009–2012, the UK has re-emerged as a major corporate-focused tax haven. Two of the five major global Conduit OFCs are from this grouping (i.e. the U.K. and Singapore). In November 2009, Michael Foot, a former Bank of England official and Bahamas bank inspector, delivered an integrated report on the three British Crown Dependencies (Guernsey, Isle of Man and Jersey), and the six Overseas Territories (Anguilla, Bermuda, British Virgin Islands, Cayman Islands, Gibraltar, Turks and Caicos Islands), "to identify the opportunities and challenges as offshore financial centres", for the HM Treasury.

Emerging market-related tax havens

As discussed in § History, most of these tax havens date from the late 1960s and effectively copied the structures and services of the above groups. Most of these tax havens are not OECD members, or in the case of British Empire–related tax havens, do not have a senior OECD member at their core. Some have suffered setbacks during various OECD initiatives to curb tax havens (e.g. Vanuatu and Samoa). However, others such as Taiwan (for AsiaPAC), and Mauritius (for Africa), have grown materially in the past decades. Taiwan has been described as the "Switzerland of Asia", with a focus on secrecy. Although no Emerging market-related tax haven ranks in the five major global Conduit OFCs or any § Top 10 tax havens lists, both Taiwan and Mauritius rank in the top ten global Sink OFCs.