2017 saw the European Union step up its campaign against tax havens. Having spent the year reviewing 92 jurisdictions around the world the EU named a total of 17 locations that it alleges fall short of its standards on financial transparency and haven’t enlisted in the campaign to combat tax avoidance.
The EU’s ‘name and shame’ list singled out:
- American Samoa
- the Marshall Islands
- St Lucia
- South Korea
- Trinidad & Tobago
- the United Arab Emirates.
According to the EU, the 17 locations on its blacklist failed to meet international standards and hadn’t committed to improving their performance in future. However, there are no proposals for EU member states to impose sanctions or otherwise penalise the worst offenders.
A further 47 locations were put on notice that their performance also needs to swiftly improve. They include the British territories and dependencies of Bermuda, the Cayman Islands, Guernsey, Jersey and the Isle of Man. Each has been given a year’s grace in which to improve their performance or face blacklisting.
Those on this ‘grey list’ have pledged to revise their tax structures, for example to end the ability of companies to exploit their zero corporate tax rates for shielding their profits.
The EU’s finance ministers believe that more than £500bn (€565bn) is lost annually as the result of aggressive tax avoidance. They also suspect that while the shell companies set up in many tax havens are often perfectly legal, many conceal a host of activities ranging from the morally dubious to the illicit.
As The Guardian observed when publishing the leaked so-called Paradise Papers in November 2017: “Over the past 40 years, offshore tax regimes have grown exponentially.
“Back in the 1970s, they were a way for individuals to hide their money from corrupt and predatory governments in unstable countries, or for banks to move cash around to avoid fluctuations in currency rates.
“Then, the lack of transparency and advantageous tax regimes made them the investment place of choice for the rich and famous, who wanted legitimate but tax-efficient investments for their wealth.
“That cottage industry has developed into a sprawling kingdom for the rich, and there has been little political appetite to thoroughly review what has been going on in this new realm.”
Lifting the stone
Publication of the Paradise Papers confirmed what was already common knowledge: that many of the world’s wealthiest – from Formula One racing champion Lewis Hamilton to U2’s lead singer Bono – use offshore tax havens to shelter their money.
Even the Queen was embroiled, with the revelation that several million pounds from her private estate was invested in a Cayman Islands fund as part of a hitherto unpublicised offshore portfolio.
The Paradise Papers episode came less than two years after the publication in April 2016 of the Panama Papers, a leak of 11.5m files from the database of Panama-based Mossack Fonseca, the world’s fourth-biggest offshore law firm.
The Panama Papers exposed in some detail how the rich and famous – including 12 national leaders – used secretive offshore tax havens to conceal their wealth. It apparently galvanised the EU into accelerating its efforts to crack down on tax avoidance.
At the beginning of this year, Brussels contacted the 92 countries identified as tax havens – which ranged from the US and China to small countries such as Monaco and Andorra – to inform them that they would be assessed.
The assessment would be based on three criteria; their transparency on tax issues, how fair their tax system is and whether they are committed to the Organisation for Economic Co-operation and Development’s (OECD) initiative to prevent countries ‘poaching’ the tax base of others.
From the list of 92 locations, Brussels whittled the total down to 41 and wrote to each at the end of October warning that they would be included on a blacklist unless their performance based on the three criteria improved.
The figure is similar to an assessment by the charity Oxfam, which believes that 39 countries are serial offenders and should be blacklisted. The figure includes four EU states: Ireland, Luxembourg, Malta and the Netherlands.
Yet in most cases there is no suggestion that what these tax havens are doing is illegal – even when it is morally dubious.
Often the location of choice for a tax shelter is a British Overseas Territory and Crown Dependency, which can operate autonomously and apply its own rules on taxation and company law.
As one of the most vocal critics of tax havens, Oxfam, is urging cooperation between governments to reform the international tax system so there are no longer advantages in using them.
Its report issued in December 2016, Tax Battles, reveals how tax havens “are leading a global race to the bottom on corporate tax that is starving countries out of billions of dollars needed to tackle poverty and inequality.”
Esme Berkhout, Oxfam’s tax policy advisor (above) commented: “Corporate tax havens are helping big business cheat countries out of billions every year. They are propping up a dangerously unequal economic system that is leaving millions of people with few opportunities for a better life.”
Critics and defenders
According to Oxfam, the world’s worst tax havens, in order of significance are:
- Cayman Islands
- the Netherlands
- Hong Kong
- British Virgin Islands
The report found that the average corporate tax rate across the G20 countries that represent the world’s leading economies stood at 40% at the start of the Nineties. However, over the next 25 years it declined to less than 30% as new tax avoidance locations and schemes proliferated.
“The use of unproductive and wasteful tax incentives is also ballooning – particularly in the developing world,” said Oxfam. “For example, tax incentives cost Kenya $1.1bn a year – almost double their entire national health budget.
“When corporate tax bills are cut, governments balance their books by reducing public spending or by raising taxes such as VAT, which fall disproportionately on poor people. For example, a 0.8% cut in corporate tax rates across OECD countries between 2007 and 2014 was partially offset by a 1.5% increase in the average standard VAT rate between 2008 and 2015.”
Yet tax havens have their defenders, whose ranks include Conservative MP for North East Somerset, Jacob Rees-Mogg.
“The Paradise Papers, which reveal people’s holdings in offshore activities, show three things, none of which are surprising,” says Rees-Mogg.
“The first is that most offshore investment is entirely legitimate. The Queen’s holdings fall squarely into this category.
“The second category is for tax avoidance. It is, however, legitimate. No taxpayer has any obligation to pay more than the law requires.
“The third category is the deliberate and illegal hiding of income or capital gain to evade legitimate taxes. This does not require offshore havens but can be as rudimentary as receiving cash for a service rendered.
“The socialist hysteria that assumes that all offshore investment is of this kind is as wrong as thinking that all taxpayers are receiving cash bungs.”
History of tax havens
Just when and where tax havens originated is a matter of debate, but the US states of New Jersey and Delaware are widely accepted to be pioneers.
In the late 19th century, New Jersey began attracting corporates through the twin incentives of liberal incorporation laws and a relatively low rate of corporate tax. By the end of the 1890s, Delaware sought to replicate New Jersey’s success.
The next stage came in the aftermath of the First World War, when the technique of attracting non-resident companies through a favourable economic environment was adopted by several of Switzerland’s cantons and also Lichtenstein, and took hold in Europe.
Rulings by the British law courts furthered the concept of ‘virtual’ residencies, in which companies could incorporate in the UK without paying tax.
The 1929 case of Egyptian Delta Land and Investment Co. vs. Todd legalised tax loopholes, finding that a company registered in London but without any activities in the UK was not liable for British tax.
The ruling extended beyond the UK to the entire British Empire, paving the way for jurisdictions such as Bermuda and the Bahamas to become tax havens and later employed to maximum effect in the Seventies by the Cayman Islands.
At the end of the Twenties, Luxembourg also introduced the concept of the holding company, which could claim exemption from income taxes. Bermuda, the Bahamas, Jersey and Panama were all used, to a limited extent, as tax havens in the 1920s and 1930s.
In the post-war period, tax havens got a further fillip in 1957 from the Bank of England. The Bank conceded that transactions undertaken by UK banks on behalf of a lender and borrower located outside the UK would not be regarded as having taken place in the UK for regulatory purposes even though it took place in London.
The ruling spurred the development of the Euromarket – an inter-bank or 'wholesale' financial market in the City of London – as a driving force for an integrated offshore economy, centred on London and including remnants of the British Empire.
The Euromarket was not regulated by the Bank, but as transactions took place in London it was exempt from any other authority and became effectively unregulated or ‘offshore’.
By the 1960s a number of tax havens were established and able to benefit as taxation levels in developed countries rose during the decade.
British banks extended their Euromarket activities in Jersey, Guernsey, and the Isle of Man and in 1964 were joined by three major US banks - Citibank, Chase Manhattan and Bank of America.
In 1966 the Cayman Islands legislated to relax a range of regulations and swiftly established itself as one of the world’s leading tax havens, growing over the next 40 years to become the fourth largest financial centre in the world.
By the late 1960s Singapore was also developing as tax haven, after a tightening of credit sparked rising interest rates in the Eurodollar market and dollar balances in the Asia-Pacific region became attractive to banks.
Singapore responded by introducing incentives for branches of international banks to relocate to the city state. A Bank of America branch set up a special international department to handle transactions for non-residents in what was dubbed the Asian Currency Unit (ACU).
The success of European and Caribbean tax havens established a template for locations in other regions of the world to copy. In 1966 the first Pacific tax haven was set up in Norfolk Island, a self-governing external territory of Australia.
Over the next 30 years, it was joined by Vanuatu, Nauru, the Cook Islands, Tonga, Samoa, the Marshall Islands and Nauru.
Each adopted legislation based on existing tax havens, including provision for zero or near-zero taxation for exempt companies and non-residential companies, Swiss-style bank secrecy laws, trust company laws, offshore insurance laws and flags of convenience for shipping fleets and aircraft leasing.
In the 21st century, to this list was added laws aimed at facilitating electronic commerce and online gambling.
The heyday of offshore tax havens
The 30 year period from the early 1970s to the late 1990s is regarded as the zenith of the tax haven, when both the number of locations available rose sharply, as did the scope and volume of financial assets that passed through them.
Tax havens established themselves as centres of expertise for routing financial payments and circumventing regulatory supervision. In some cases this meant that they facilitated illegal activities such as money laundering.
Developments over this period include Bahrain’s licensing of offshore banking units (OBUs) in 1975, which was quickly duplicated by Dubai.
Ireland joined the ranks of tax havens in 1987, when it established the Irish Financial Services Centre in Dublin, offering an attractive tax regime for certain financial activities and a corporate tax rate of 12.5%.
During the 1980s and 1990s, new tax havens were also established in regions of the world such as the Indian Ocean, Africa and now post-Soviet republics. By the early 1990s, depending on how strictly the definition of ‘tax haven’ was applied, the worldwide total had risen to between 60 and 100.
By the end of the 1990s, attitudes towards tax havens had begun to change as they were seen as facilitating tax avoidance and constituting a major drain on the economies of developing countries.
In 1998 the Organisation for Economic Co-operation and Development (OECD) published its report ‘Harmful Tax Competition; an Emerging Global Issue’, which identified tax havens and harmful preferential tax regimes as two problems to be eliminated
The OECD’s initiatives over nearly two decades to reduce international tax avoidance strategies include the Base Erosion and Profit Shifting (BEPS) project, a collaboration between more than 100 countries and jurisdictions.
It has put forward a number of proposals, which include the principle that the applicable tax rate should directly reflect where economic activity takes place.
Advocacy group the Tax Justice Network, a coalition of researchers and activists, praises the OECD’s initiatives on corporate tax, but warns: “The process has been continually undermined by the army of paid corporate tax advisers and lobbyists, as well as governments seeking to protect some of their pet tax breaks to business.”
Ten major tax haven countries:
Switzerland has a long-established reputation as one of the world’s leading tax havens but is not a member of the European Union.
The main contender for the title of the EU’s top tax haven is generally agreed to go to the Grand Duchy of Luxembourg, which maintains that it operates fully within the law. Its low rates of taxation have attracted many international companies to set up subsidiaries in Luxembourg to maximise their profits.
The Grand Duchy’s efforts to attract investors and corporates owes much to president of the European Commission, Jean-Claude Juncker, who was Luxembourg’s prime minister for a total of 18 years and shaped its tax policy during his time in office.
Foreign corporations began moving there in the early 1990s, when Luxembourg transposed into national law an EU directive enabling companies to choose to pay taxes in the European country where they were headquartered, rather than where their subsidiaries operated.
The so-called ‘Lux Leaks’ episode, in November 2014, resulted from an investigation by the International Consortium of Investigative Journalists, which released details of tax avoidance schemes set up for over 300 multinational companies based in Luxembourg.
It helped accelerate measures to increase the regulation of tax avoidance schemes beneficial to multinationals.
The island’s premier, Alden McLaughlin (left), prefers for the Caribbean island to be described as an “international finance centre” rather than a tax haven.
Nonetheless, Newsweek magazine placed the Caymans as a ‘top five’ global tax haven after Switzerland, Hong Kong, the US and Singapore and commented: “Cayman retains many secrecy features — not least a law that can put people in jail not just for revealing confidential information, but merely for asking for it.”
The island is a British dependency and its zero corporate tax rate has attracted nearly 20,000 companies to use it as a base for subsidiary entities. The zero rate extends to interest or dividends earned on investments, making the Caymans a popular choice among hedge fund managers.
Instead of tax, offshore corporations pay an annual licencing fee directly to the government, based on the amount of their authorised share capital. The Caymans makes an estimated $350m annually from fees and providing work permits.
Among the revelations of the recently-leaked Paradise Papers was that the Queen’s private estate invested nearly £6m in a fund held on the islands.
Reports also claim that the Cayman’s proximity to Miami and Cuba established it as a popular drop-off point for money laundering in the late 1960s and 1970s.