A tax haven is a place where certain taxes are levied at a low rate or not at all.
Individuals and/or firms can find it attractive to move themselves to areas with lower tax rates. This creates a situation of tax competition among governments. Different jurisdictions tend to be havens for different types of taxes, and for different categories of people and/or companies.
There are several definitions of tax havens. The Economist has tentatively adopted the description by Geoffrey Colin Powell (former Economic Adviser to Jersey): "What ... identifies an area as a tax haven is the existence of a composite tax structure established deliberately to take advantage of, and exploit, a worldwide demand for opportunities to engage in tax avoidance." The Economist points out that this definition would still exclude a number of jurisdictions traditionally thought of as tax havens. Similarly, others have suggested that any country which modifies its tax laws to attract foreign capital could be considered a tax haven. According to other definitions, the central feature of a haven is that its laws and other measures can be used to evade or avoid the tax laws or regulations of other jurisdictions.
One argument in favor of tax havens is that they help pressure developed countries to reduce their tax rates.
To a certain extent, the founding concept of a tax haven appeared as an economic response to the principle of taxes. For instance, in Ancient Greece, some of the Greek Islands were used as depositories by the sea traders of the era to place their foreign goods to thus avoid the two-percent tax imposed by the city-state of Athens on imported goods. In the Middle Ages, Hanseatic traders who set up business in London were exempt from tax. The U.S. is not new to tax haven users. In 1721, American colonies traded from Latin America to avoid English taxes.
The use of differing tax laws between two or more countries to try and mitigate tax liability is probably as old as taxation itself. It is sometimes suggested that the practice first reached prominence relating to the use (or avoidance of) the Cinque ports and later the staple ports in the twelfth and fourteenth centuries respectively. Others suggest that the Hanseatic League first embraced the concept of tax competition as early as 1241, while others argue that the tax status of the Vatican City was the earliest example of a tax haven (the first Papal States being recognised in 756).
Various countries claim to be the oldest tax haven in the world. For example, the Channel Islands claim their tax independence dating as far back as Norman Conquest, while the Isle of Man claims to trace its fiscal independence to even earlier times. Nonetheless, 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 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 compared against the enactment of a Trust Law by Liechtenstein in 1926 to attract offshore capital.
Most economic commentators suggest that the first "true" tax haven was Switzerland, followed closely by Liechtenstein. During the early part of the twentieth century, Swiss banks had long been a capital haven for people fleeing social upheaval in Russia, Germany, South America and elsewhere. However, in the years immediately following World War I, many European governments raised taxes sharply to help pay for reconstruction effort following the devastation of World War I. By and large, Switzerland, having remained neutral during the Great War, avoided these additional infrastructure costs and was consequently able to maintain a low-level of taxes. As a result, there was a considerable influx of capital into the country for tax related reasons. It is difficult, nonetheless, to pinpoint a single event or precise date which clearly identifies the emergence of the modern tax haven.
Such disparities, however, are not enough for a nation to qualify itself as a tax haven. In brief, a favourable, overall national environment is needed to spur a definition as a tax haven. In general, essential elements such as a stable political and economic government, as well as a strong network of communication facilities are needed for a nation to identify itself as a tax haven. Discretion is the main tax havens’ attraction. It is therefore very delicate for countries’ tax authorities to measure or compare tax avoidance. Nevertheless, some countries such as the US published reports and statistics showing the economic impact and the expansion of tax havens. This tax avoidance phenomenon have impact in terms of tax’s loss of revenue but also on the country.
The use of modern tax havens has gone through several phases of development subsequent to the interwar period. From the 1920s to the 1950s, tax havens were usually referenced as the avoidance of personal taxation. The terminology was often used with reference to countries to which a person could retire and mitigate their post retirement tax position. However, from the 1950s onwards, there was significant growth in the use of tax havens by corporate groups to mitigate their global tax burden. This strategy generally relied upon there being a double taxation treaty between a large jurisdiction with a high tax burden (that the company would otherwise be subject to), and a smaller jurisdiction with a low tax burden. Thus, corporations, by structuring the group ownership through the smaller jurisdiction, could take advantage of the double taxation treaty, thereby paying taxes at the much lower rate. Although some of these double tax treaties survive, in the 1970s, most major countries began repealing their double taxation treaties with micro-states to prevent corporate tax leakage in this manner.
In the early to mid-1980s, most tax havens changed the focus of their legislation to create corporate vehicles which were "ring-fenced" and exempt from local taxation (although they usually could not trade locally either). These vehicles were usually called "exempt companies" or "International Business Corporations". However, in the late 1990s and early 2000s, the OECD began a series of initiatives aimed at tax havens to curb the abuse of what the OECD referred to as "unfair tax competition". Under pressure from the OECD, most major tax havens repealed their laws permitting these ring-fenced vehicles to be incorporated, but concurrently they amended their tax laws so that a company which did not actually trade within the jurisdiction would not accrue any local tax liability.
Nevertheless, a country’s political stability is a very important specification to look for when choosing a tax haven. Especially for long term users. Some stable countries are easily foreseeable. They are those attached to economically powerful countries : Monaco, Liechtenstein, Channel Islands, Bermuda, Andorra, etc. Others, even though independent are stable : Switzerland, Luxembourg, Holland.
The Bahamas closest island is fifty miles off the coast of Florida and its culture is heavily influenced by the United States of America. It is an archipelago composed of 700 islands, of which twenty-two islands are inhabitated with human settlements. The country's demographics are composed of approximately 75% of Sub-Saharan African descent and 25% White and other decent. The economy is capitalistic in nature, drawing from its colonial British history. However the division of wealth of the residential population is sharp, even though its GNP is one of the highest in the Caribbean.
Nonetheless, the Bahamas has had political stability since independence was granted by the British Crown in 1973. The country's proximity to the US has fostered considerable economic growth in the Tourism industry. With a thriving legal industry and strong adherence to the rule of law the Banking industry is recognized as stable and reliable by the Organisation for Economic Co-operation and Development (OECD).
Lebanon’s politic instability has scared off its investors. On the other hand , Bermudas is considered as a very stable country probably due to the good relations and the treaties signed with the US.
The CFCE (Centre Français du Commerce Exterieur) created a data bank to those wishing to trade or invest in foreign countries. Private specialist cabinet also provide this kind of information using different method and specialised in geographic areas. These specialist cabinets are : Data Resources Incorporated (DRI), World Political Risk Forecast (WPRF), Multinational Risk Inc., BERI periodically produces a « Political Risk Review ». The monthly UK magazine « Euromoney » published a political risk survey of over 30 countries.
The risk evaluation is an old practice for important international companies as political instability can lead to the loss of all investments in the country. Therefore the best protection is diversification according to the tax havens specificity. In addition, the possibility to move assets quickly from a country without jeopardising the company should also be an important factors to take into account when choosing a tax haven.
Although tax havens are traditionally linked with images of prosperity, there have also been notable failures.
Most of the tax havens have a double monetary control system which distinguish residents from non resident as well as foreign currency from the domestic one. In general, residents are subject to monetary controls but not non residents.
A company, belonging to a non resident, when trading overseas is seen as non resident in terms of exchange control. Therefore, it is possible for a foreigner to create a company in a tax haven to trade on an international basis. The company’s operations will not be subject to exchange controls as long as it uses foreign currency to trade outside. On the other hand, if the country does not have a stable currency , the authorisation to transfer profits and assets in convertible currency would not be granted. This situation can lead to a loss of interest to trade with that country.
Some tax havens have complex exchange control laws, it is therefore necessary to have, prior to any investment, the country authorisation. Investors have to be prudent in their commercial agreements if they have not received the country authorisation.
Tax havens, also have to have an easily convertible currency or linked to an easily convertible one. Most of them are convertible to US dollar or to pounds sterling. US dollars are nevertheless the more widely used and is welcome in all tax havens situated in the Caribbean. In Liberia, the US dollar is considered legal tender and US notes circulate in the country. The euro is used in Monaco.
However the OECD found that its definition caught certain aspects of its members' tax systems (most developed countries have low or zero taxes for certain favoured groups). Its later work has therefore focused on the single aspect of information exchange. This is generally thought to be an inadequate definition of a tax haven, but is politically expedient because it includes the small tax havens (with little power in the international political arena) but exempts the powerful countries with tax haven aspects such as the USA and UK.
In deciding whether or not a jurisdiction is a tax haven, the first factor to look at is whether there are no or nominal taxes. If this is the case, the other two factors – whether or not there is an exchange of information and transparency – must be analysed. Having no or nominal taxes is not sufficient, by itself, to characterise a jurisdiction as a tax haven. The OECD recognises that every jurisdiction has a right to determine whether to impose direct taxes and, if so, to determine the appropriate tax rate.
However, many jurisdictions employ blunter rules. For example, in France securities regulations are such that it is not possible to have a public bond issue through a company incorporated in a tax haven.
Also becoming increasingly popular is "forced disclosure" of tax mitigation schemes. Broadly, these involve the revenue authorities compelling tax advisors to reveal details of the scheme, so that the loopholes can be closed during the following tax year, usually by one of the five methods indicated above. Although not specifically aimed at tax havens, given that so many tax mitigation schemes involve the use of offshore structures, the effect is much the same.
The United States has entered into Tax Information Exchange Agreements (TIEA) with a number of tax havens.
Many industrialised countries claim that tax havens act unfairly by reducing tax revenue which would otherwise be theirs. Various pressure groups also claim that money launderers also use tax havens extensively, although extensive financial and KYC regulations in tax havens can actually make money laundering more difficult than in large onshore financial centers with significantly higher volumes of transactions, such as New York City or London. In 2000 the Financial Action Task Force published what came to be known as the "FATF Blacklist" of countries which were perceived to be uncooperative in relation to money laundering; although several tax havens have appeared on the list from time to time (including key jurisdictions such as the Cayman Islands, Bahamas and Liechtenstein), no offshore jurisdictions appear on the list at this time.
Some tax havens including some of the ones listed above do charge income tax as well as other taxes such as capital gains, inheritance tax, and so forth. Criteria distinguishing a taxpayer from a non-taxpayer can include citizenship and residency and source of income.
Tax Justice Network, an anti-tax haven pressure group, suggests that global tax revenue lost to tax havens exceeds US$255 billion per year, although those figures are not widely accepted. Estimates by the OECD suggest that by 2007 capital held offshore amounts to somewhere between US$5 trillion and US$7 trillion, making up approximately 6-8% of total global investments under management. Of this, approximately US$1.4 trillion is estimate to be held in the Cayman Islands alone.
The Center for Freedom and Prosperity disputes claims about foregone tax revenue. Academic researchers also have found that tax havens actually boost prosperity in neighboring jurisdictions by creating tax-efficient platforms for economic activity - much of which would not occur if subject to onerous taxes if controlled by a domestic entity. Some support for this is found in academic studies which suggests that the tax elasticity of investment is approximately -0.6.
A 2006 academic paper indicated that: "in 1999, 59% of U.S. firms with significant foreign operations had affiliates in tax haven countries", although they did not define "significant" for this purpose.
On 25 January 2007 Senator Byron Dorgan (for himself and on behalf of Carl Levin and Russ Feingold) presented a bill to the U.S. Senate to amend the U.S. Internal Revenue Code 1986 to treat controlled foreign corporations which are established in tax havens as domestic corporations, and subject to full taxation as such within the U.S.
The proposed amendment would define the following countries as tax havens for the purposes of the legislation: Andorra, Anguilla, Antigua and Barbuda, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Cyprus, Dominica, Gibraltar, Grenada, Guernsey, Isle of Man, Jersey, Liberia, Liechtenstein, Maldives, Malta, Marshall Islands, Mauritius, Monaco, Montserrat, Nauru, Netherlands Antilles, Niue, Panama, Samoa, San Marino, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Seychelles, Tongo, Turks and Caicos, and Vanuatu.
That draft legislation was superseded late in the same year by the unambiguously named Stop Tax Haven Abuse Act which was introduced by Senator Levin together with Presidential candidate Barack Obama and Senator Norm Coleman. The Act would introduce a large number of measures designated to attack transactions perceived to facilitate unlawful tax avoidance by the use of offshore tax havens. Broadly same list of countries above was included in the earlier bill as designated tax havens, but with the addition of Aruba, Costa Rica, Sark and Alderney (which are treated, curiously, as sub-sets of Guernsey rather than independent jurisdicions), Hong Kong, Latvia, Luxembourg, Singapore, Switzerland and the removal of Andorra, Bahrain, Liberia, Maldives, Marshall Islands, Monaco, Montserrat, Niue, San Marino, Seychelles and Tongo.
Some of the measures highlighted include:
Many of the intiatives appear politically populist rather than a serious attempt to curb tax mitigation schemes. Other aspects of the legislation seem to be predicated on outdated stereotypes of tax havens, and assume that most tax havens continue to operate a culture of secrecy and with complete disregard for modern know-your-client requirements, and bear little relationship to modern commercial practice. The fact that the bill is expressed to designate four European Union countries (Cyprus, Latvia, Luxembourg and Malta) and three other leading global economies (Hong Kong, Singapore and Switzerland) automatically as non-cooperative tax havens might indicate the limited prospects of the bill becoming law in its current form.
Although the Stop Tax Haven Abuse Act ran out of time in 2007, Senator Levin has promised to re-introduce it during 2008.
Led by the Center for Freedom and Prosperity, various free-market groups, think tanks, and taxpayer organizations have encouraged the Bush Administration to reject legislation seeking to penalize low-tax jurisdictions. The Cato Institute has been particularly scathing in its commentary on the draft legislation.
In February 2008 Germany announced that it had paid €4.2 million to Heinrich Kieber, a former data archivist of LGT Treuhand, a Liechtenstein bank, for a list of 1,250 customers of the bank and their accounts details. Investigations and arrests followed relating to charges of illegal tax evasion. The German authorities shared the data with U.S. tax authorities, but the British government paid a further ₤100,000 for the same data. Other governments, notably Denmark and Sweden, refused to pay for the information regarding it as stolen property. The Liechtenstein authorities subsequently accused the German authorities of espionage.
However, regardless of whether unlawful tax evasion was being engaged in, the incident has fuelled the perception amongst European governments and press that tax havens provide facilities shrouded in secrecy designed to facilitate unlawful tax evasion, rather than legitimate tax planning and legal tax mitigation schemes. This in turn has led to a call for "crackdowns" on tax havens. Whether the calls for such a crackdown are mere posturing or lead to more definitive activity by mainstream economies to restrict access to tax havens is yet to be seen. No definitive announcements or proposals have yet been made by the European Union or governments of the member states.
Whether or not unlawful tax avoidance was going on, Liechtenstein's reputation has inevitably been damaged, as customers expect their banks, whether onshore or offshore, to protect their data against unauthorised disclosure.