1.

What is a Tax Haven?

‘Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again, the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.’

– Judge Learned Hand.

1. Definition

There is no generally accepted definition of what renders a country or jurisdiction a tax haven. The Cambridge Dictionary defines a tax haven as ‘a place where people pay less tax than they would pay if they lived in their own country’. The term most commonly refers to those countries or jurisdictions that have a low-tax or no-tax regime or which offer generous tax incentives.

Even the U.S. Government has been unable to find a satisfactory definition of a tax haven. Instead, they have come up with a list of characteristics that are indicative of it:

• No or nominal taxes,
• Lack of effective exchange of tax information with foreign tax authorities,
• Lack of transparency in the operation of legislative, legal or administrative provisions,
• No requirement for a substantive local presence, and
• Self-promotion as an offshore financial centre.

The Organisation for Economic Co-operation and Development (OECD) has identified three key factors in considering whether a jurisdiction is a tax haven:

• No or only nominal taxes,
• Protection of personal financial information, and
• Lack of transparency.

2. Oldest Tax Haven

Taxation has been around since 6,000 BC (in Ancient Mesopotamia). Mesopotamia is the name of the Tigris-Euphrates river system (corresponding to most of Iraq, Kuwait, the eastern parts of Syria, and regions along the Turkish-Syrian and Iran-Iraq borders). Since then taxpayers have been reducing their tax liabilities by utilising the differing tax laws operating in different countries. In Ancient Greece, some of the Greek Islands were used as depositories by the sea traders of the era to place their foreign goods. In doing so they avoided the two-percent tax imposed by the city-state of Athens on imported goods.

Switzerland was the first ‘true’ tax haven and became a tax haven immediately following World War I. As Switzerland remained neutral during the Great War, they could maintain a low level of taxes, as they did not have the high infrastructure costs other countries had. In contrast, many European governments raised taxes sharply to help pay for reconstruction efforts following the devastation of World War I. This resulted in an influx of capital into Switzerland for tax-related reasons.

3. Benefits for Tax Haven Countries

Countries restructure and redesign their tax system to become a tax haven for two main reasons—jobs and money.

Some countries may offer a lower tax rate to large corporations, in exchange for the companies locating a division of their parent company in the host country and employing some of the local population. Apple, for example, has a special tax agreement with Ireland which reduces their effective tax rate to only 0.05%. In 2011, Apple recorded profits of €16 billion in Ireland, but under the terms of the tax ruling, only €50 million was considered taxable in Ireland. Ireland benefits though, as Apple is the largest employer in the country (with over 6,000 employees), and is the country’s biggest taxpayer (employee PAYE taxes and VAT).

Although many tax havens impose no corporate income taxes, they financially benefit from having thousands of companies registered in their jurisdiction. Income is generated from a combination of registration fees on all newly incorporated business entities, annual renewal fees, and licence fees payable by service providers (banks, solicitors, accountants, and trust companies). These fees can be a substantial source of government revenue. The British Virgin Islands, for example, has over 1 million registered companies and collects over $200 million fees each year.

Other tax havens raise substantial tax revenue from their low corporate tax rates. Receiving 5%, 10%, or 15% of substantial amounts of taxable income raises more revenue than 35% of nothing. Although the US has a company tax rate of 35%, Apple is structured so that the majority of its annual US$60 billion profits are taxed overseas. This reduces their tax rate to only 17% and the actual tax paid in the US to US$8 billion (an effective tax rate of 13%). Singapore has a low corporate tax rate of 17% but raised a substantial S$13.8 billion in company taxes in 2016. In addition, the companies attracted by Singapore’s low corporate tax rate paid another S$20 billion in goods and services tax, stamp duty, and property taxes.

4. Number of Tax Havens

Although there is no consensus on the number of tax havens in the world, it is estimated at over 150. Some of these tax havens are whole countries (like Bermuda), and others just a state or territory within a country (like Nevada). The list of tax havens is constantly changing as new tax havens are added (like Labuan in the Asia-Pacific region), and others ceasing (like Vanuatu).

5. Wealth in Tax Havens

The Tax Justice Network (an anti-tax haven pressure group) estimated that capital held offshore amounted to between $21 trillion and $32 trillion (between 24–32% of total global investments). The US Public Interest Research Group said in 2014 that the United States loses roughly $184 billion per year due to corporations such as Pfizer, Apple, Facebook, Microsoft, and Citigroup using offshore tax havens to avoid paying US taxes. In 2010-2012 Pfizer paid no US income taxes despite earning $43 billion. Microsoft held $76.4 billion overseas in 2013, thus saving the corporation $24.4 billion in taxes.

6. Who Uses Tax Havens?

Almost everyone. This includes individuals, small businesses, large businesses, Fortune 500 companies, governments, charities, and non-profit organisations. The numbers are staggering, with the British Virgin Islands, for example, having over 1 million registered companies. In the Cayman Islands, 40 of the world’s top 50 banks have licences and hold US$1 trillion on deposit.

Seventy-three percent of the US Fortune 500 companies have subsidiaries in offshore tax havens (actually an average of 28 per company for a combined total of 10,300). These multinational companies reported booking $2.5 trillion offshore, and by indefinitely stashing profits in offshore tax havens, have avoided $717 billion in U.S. taxes. The 30 companies with the most money booked offshore for tax purposes collectively operate 2,509 tax haven subsidiaries (an average of 84 each). These companies collectively hold nearly $1.65 trillion overseas. Apple is the leader of the pack with $246 billion cash sitting in tax havens.

Sixty-seven percent of Australia’s top 100 ASX listed companies have subsidiaries in tax havens or low-tax jurisdictions. News Corporation, Westfield and the Goodman Group are the most prolific with each having more than 50 entities in low-tax jurisdictions. Telstra (wholly owned by the Australian government until 1997) controls 20 subsidiaries registered in well-known tax havens—11 in the British Virgin Islands, four in Bermuda, four in Jersey, one in Mauritius and one in the Cayman Islands.

Almost 400 companies listed on the London Stock Exchange (LSE), with a collective market capitalisation of £225bn, are based in offshore havens connected to the UK.

2.

Legal Reasons to use a Tax Haven

‘A tax loophole is something that benefits the other guy.
If it benefits you, it’s tax reform.’

– Russell B. Long.

1. Saves Tax

Without a doubt, the dominant legal reason to use tax havens is to save tax. Many taxpayers, especially multi-national corporations, can legally save tax by structuring their affairs to use a tax haven. Apple, for example, has saved US$86 billion in US taxes by funnelling revenue through its tax haven entities and leaving the profits overseas. Currently, they have $US246 billion sitting in tax haven bank accounts (which is 77% of their 2016 balance sheet assets).

Chapter 4 details the different ways (strategies) tax havens are used in order to save tax.

2. Locating Holding Companies

Locating a holding company in a tax haven can be used to bring together investors from various countries who are investing in businesses that are in turn operating in numerous countries. This creates a single point through which all business operations and investors can be coordinated without the imposition of significant compliance costs or additional taxes.

PepsiCo is one of 500 multinational companies that have their holding company based in Denmark (which is a tax haven for holding companies). PepsiCo (headquartered in New York, US) has sales of US$63 billion, 269,000 employees, and operates in 195 countries. The company has a market capitalisation of US$160 billion and over 200,000 shareholders (including employees under the employee share plan).

3. Asset Protection

The Cook Islands claims to be the first country to have enacted an explicit asset protection law (i.e. in 1989 with its International Trusts Act). The asset-protection trust is a trust that splits the beneficial enjoyment of trust assets from their legal ownership. The beneficiaries of a trust are the beneficial owners of equitable interests in the trust assets, but they do not hold legal title to the assets. This provides asset protection benefits by insulating the trust assets from creditor claims against the beneficiaries. It is believed that the Cook Islands now has more registered asset protection trusts than any other country.

4. Privacy

Bank secrecy (or bank privacy) is a legal requirement in most tax havens and this prohibits banks providing authorities (foreign governments and their tax departments) personal and account information about their customers.

Bank secrecy was codified in Switzerland by the 1934 Federal Act on Banks and Savings Banks. This Act also created the famous ‘numbered bank accounts’. Under the Swiss principle of bank secrecy, privacy is statutorily enforced, with Swiss law strictly limiting any information shared with third parties, including tax authorities, foreign governments or even Swiss authorities (except when requested by a Swiss judge’s subpoena).

In the tax haven of Ras Al Khaimah, there is no public registry of companies, their shareholders or directors. As such it is virtually impossible to know which companies are operating there. This can protect a company and its directors from a public backlash following revelations of their use of the tax haven.

5. Lack of Exchange Controls

The key reason Hong Kong is among the world’s largest financial centres is that it doesn’t have any currency controls. You can freely send money to and from Hong Kong and there are no limits. The lack of exchange controls provides investors with confidence that their money is secure and safe, and can be quickly accessed as needed.

In contrast, investing in countries with exchange controls adds a huge layer of risk and complexity. South Africa Exchange Control regulations ‘control’ the flow of money both in and out of South Africa. They affect every transaction, no matter what amount of rand gets transferred and who the sender or recipient of the money is. Permissible reasons for transfers abroad are limited to:

• Monetary gifts and loans.
• Donations to missionaries.
• Maintenance transfers.
• Travel allowance.
• Study allowance.
• R1 million foreign capital allowance.
• R10 million individual capital allowance.

6. Political and economic stability.

Without political and economic stability, no amount of tax inducement can bring in outside investors. No company or individual, whether local or international, will feel comfortable making any kind of capital investment in any country where the political climate is characterised by upheavals and a lot of uncertainty. African instability itself explains why Africa still lags far behind other parts of the world in terms of economic development and the inward flow of investment funds.

In contrast, the political and economic stability of tax havens like Switzerland is a magnet for huge capital inflows. This is illustrated by the fact, that since 2015 the Swiss Central Bank’s highest interest rate on deposits is -0.25 percent. The bank is charging depositors a fee for holding their money (investors are paying a fee for safety).

7. Corporate Laws.

The General Corporation Law (Title 8, Chapter 1 of the Delaware Code) is the statute governing corporate law in the U.S. state of Delaware. It has been the most important jurisdiction in United States corporate law since 10th March 1899 when it enacted corporate-friendly laws to attract businesses from New York. The general incorporation legislation made it simple for anyone to form a corporation by simply raising money and filing articles of incorporation with the state’s Secretary of State. Over 50% of publicly traded corporations in the United States and 60% of the Fortune 500 companies are incorporated in the state.

Businesses choose Delaware simply because of their flexible corporate laws, highly respected Court of Chancery, and a business-friendly State Government. Delaware maintains a separate corporate court system, called the Delaware Court of Chancery, which does not use juries, but only uses judges appointed for their expertise in corporate law. The Delaware Court of Chancery is a 210-year-old business court that has written most of the modern U.S. corporation case law.

8. Trading with the Tax Haven’s Local Population

Many companies have established entities in tax havens as they operate trading businesses in those tax havens servicing the local population.

Telstra, for example, controls 20 subsidiaries across five tax havens, including Jersey and Mauritius. Telstra uses several of these tax haven entities to provide telephone services to the local population.

9. Domicile Hedge Funds

Eighty percent of the world’s hedge funds worth US$800 billion are domiciled in the Cayman Islands. Hedge funds have been attracted to the Cayman Islands for the following reasons—their balanced regulatory framework (which recognises the purchasers of hedge funds as sophisticated investors), the absence of unnecessary licensing provisions, and significant flexibility with regard to investment objectives, risks, and structures.

10. Domicile Captive Insurance Businesses

A captive insurance business is an insurance company that is wholly owned and controlled by the insured. The company’s objectives are to provide themselves with better insurance coverage at lower costs (by avoiding the commercial insurer’s expenses and profit margins).

The Cayman Islands is a leading offshore domicile for captive insurance companies as it has modern straightforward insurance laws, user-friendly regulation, low minimum capitalisation requirements, an accessible regulator, and experienced insurance professional service firms.

11. Domicile Structured Finance Entities

Structured financial entities are established by financial institutions (banks and companies) to sell their debt securities to investors. This commonly involves the securitising of mortgages, credit card receivables, car loans, aircraft refinancing, etc. The issuers receive cheaper and more efficient funding combined with greater balance sheet flexibility, whilst the investors receive fixed income with a high credit rating and stable cash flows.

The Cayman Islands are attractive for domiciling structured finance entities as it has a creditor-friendly legal system, ability to readily obtain an investment grade rating and an absence of withholding tax and exchange controls.

12. Higher Interest Rates

Many tax haven banks offer attractive rates of interest to attract capital into the developing countries financial system. As developing countries are higher risk than developed countries, they must pay higher rates of interest to attract foreign investment.

An example of those higher risks is the 2012–2013 Cypriot financial crisis. The crisis was a result of the exposure of Cypriot banks to over-leveraged local property companies, the Greek government-debt crisis, and the downgrading of the Cypriot government’s bond credit rating to junk status. The €10 billion international bailout in March 2013 resulted in the Cypriot banks imposing a one-off 48% bank deposit levy. Basically, depositors lost 48% of their deposits (which was used to recapitalise the country’s banks).