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  Date: 4th November 2009

 Compiled by: M Sathya Kumar  

Tax Havens 

Tax Havens : Meaning :

A tax haven is a place where certain taxes are low or not levied at all. It’s a geographical area over which a country modifies its tax laws to invite foreign capital. U.S. Government Accountability office has identified key indicatives of tax havens to be the following :

This article gives brief insight on relations between DTAAs and tax havens and suggests measures to reduce revenue loss to governments on account of tax havens. More importance has been given to explain the nature, reasons for, features and list of tax havens.

Birth of tax havens can be traced to ancient Greece, where sea traders used certain Greek islands as depositories to place their foreign goods to avoid two percent tax imposed by city-state of Athens on imported goods. In the middle ages (from 13th to 17th centuries) Hanseatic Traders (Hanseatic league was an alliance of trading cities in Northern Europe) who set up business in London were exempt from tax. While there are many countries that claim themselves to be the first tax haven, most of the economists are of the view that Switzerland was the first true tax haven followed by Liechtenstein.

The primary growth of tax havens is due to offshore banking facilities. In the early to mid 1980s most tax havens through their legislations focussed on promoting creation of corporate vehicles that were ‘ring-fenced’ and exempt from local taxation. How- ever in late 1990s and early 2000s, many of these laws were repealed due to efforts of Organisation for Economic Co-operation and Development (OECD), which took a series of initiatives to curb this unfair tax competition.

There are several reasons for a nation becoming a tax haven. Primary reasons could be creation of employment opportunities for the local population, achieving technological advancements and improvements in infrastructure. Some countries do not need to charge its residents as much as other countries in order to earn sufficient income for their annual budgets.

Some of the common features in major tax havens include, low or non-existence of taxes for specified persons, few compliance procedures, quick execution, total freedom to conduct international money transactions and support from big financial centres, good brand image, secured banking secrets, and economical and political stability.

This list of tax havens is based on the OECD list of tax havens 2004.They are Albania, Andorra, Anguilla, Antigua and Barbuda, Aruba, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Canada, Canary Islands, Cayman Islands, Cook Islands, Costa Rica, Cyprus, Dominica, Dominican Republic, Dubai, Gibraltar, Grenada, Caribbean island, Guernsey, Ireland, Isle of Man, Isle of Wight, Jersey, Liberia, Liechtenstein, Luxembourg, Maldives, Malta, Marshall Islands, Mauritius, Monaco, Montserrat, Nauru, Netherland Antilles, New Zealand, Niue, Panama, Samoa, San Marin, Seychelles, Sri Lanka, St. Lucia, St. Kitts and Nevis, St. Vincent and the Grenadines, Switzerland, Tonga, Turks and Caicos, UK-US Virgin Islands, and Vanuatu.

This is an illustrative list of most favorable tax havens for different type of users.

Double taxation occurs when the same transaction or income source is subject to two or more taxing authorities. This can occur within a single country when independent governmental units have the power to tax a single transaction or source of income, or may result when different sovereign states impose separate taxes, in which case it is called international double taxation. The source of the double taxation problem is that the taxing jurisdictions do not follow a common principle of taxation. One taxing jurisdiction might tax income at its source, while others will tax income based on the residence or nationality of the recipient.

The governments of two countries enter into an agreement which is worked out mutually in order to provide full or partial relief from double taxation. In India, Section 90 of the Income-tax Act deals with double taxation avoidance through bilateral agreements relief. Under it, the Central Government of India has entered into agreements with the governments of other countries. These agreements are called ‘Double Taxation Avoidance Agreements (DTAAs)’, and provide for the following :

This is with a view to promote economic relations, trade and investment, prevent discrimination between tax payers, and to provide reasonable certainty to investors.

India is also in the list of nations who lose a lot of revenue because of tax havens. Indian government which takes all efforts to bridge the fiscal deficit does not tax earnings of foreign entities which funnel their capital through tax havens. But the issue is much more than lost revenues. The question is of equity. Can ordinary citizens be asked to pay taxes when foreign entities are not asked to pay even a fraction of their earnings made through speculation on Indian soil ?

Other areas of concern include possiblity of unscrupulous Indian businessmen sending out money through the hawala route, and then bringing it back as legal funds via tax havens. There is certainly impressive data to support such claims. Over the past few years, more money has come through the Mauritius route to India than through direct investments from almost any other country. Indian Finance Ministry officials claim that tax havens are increasingly being used by Indian businessmen as well as others to launder money, shore up their holdings in their own companies and to indulge in all manners of financial chicanery.

Mauritius, a tiny speck in Indian Ocean, is said to be the biggest exporter of capital to India. Over the past few years, our government’s revenue wings have been getting increasingly worried about the way many of the Mauritian management companies exploit the DTAA. What’s bothering them is the sudden emergence of Mauritius as India’s favorite offshore tax haven. The DTAA with Mauritius was signed in 1983 to make sure that businesses that operated in both countries did not get taxed twice has turned out to be a Trojan Horse. Mauritius has become the perfect conduit for anyone to bring in enormous sums of money to India or even take them out anonymously, and without paying any taxes.

The DTAA, however, pretends to be harmless. The treaty simply stipulates that a Mauritian firm investing into India will not be taxed in India and vice versa. Therefore, a firm registered in Mauritius investing in the Indian markets does not have to pay any sort of capital gains tax when it decides to book its profits and repatriate the money. The implicit Indian assumption behind signing this treaty was that these profits and firms would be taxed in the country of origin anyway and, therefore, it made little sense to tax them twice over.

Unfortunately, this was not how things actually worked out. After the opening up of the Indian economy in 1991-92, Mauritius passed a law that allowed any foreign investor to set up a global business company (GBC) in the country provided they fulfilled some basic conditions and paid a nominal fee to the Mauritian authority. Such GBCs have the advantage of operating in complete secrecy, and have to pay only a nominal tax (say, 3 per cent net) and such GBCs need not have any real operations or assets within Mauritius, but can enjoy all the privileges of the DTAA.

It has been great for the tax haven economies despite the low tax rates that apply to the GBCs. The sheer amount of money flowing through the country itself has given a massive boost to its economy, both directly and indirectly. Apart from the fees charged for setting up companies and the banking transaction fees, there are dozens of other ways a country benefits if it is known as a good offshore tax haven.

As the money flows from certain countries increased, the Revenue Department started looking closely at the transactions. And as they probed, many areas of tax losses were noticed. Firstly, the treaty, which had originally proposed to help firms in such countries to invest in India and vice versa, was increasingly being used by global investors instead. Though many companies claim to be incorporated in such countries, they have no real operations there. The main purpose of their formation has been to avoid paying taxes in India.

Our government should take more efficient steps to curb exploitation by tax havens. Amendments to taxation laws and treaties with foreign nations could prevent this unfair tax competition. However support from international organisations (like WTO, OECD) that are formed to promote fair trade between countries is also essential to keep a check on tax havens. Given below are some of the suggestions that could be adopted after refinement and thorough evaluation of their pros and cons.

Tax rates for foreign resident entities that incorporate companies in areas like SEZs should be made very marginal (say, 5%) provided all output is exported outside India and more that 90% of the employees are Indians.

DTAAs that seem unfair have to be cancelled and new agreements that are fair to both nations should be signed.

Member countries of international organisations that promote fair trade practices should make efforts to sign new treaties that make tax havens unattractive unless such tax havens’ laws meet the conditions stated in the treaties.

Our government may take more aggressive stance and turn Indian laws more stringent in such a way that severe penalties are levied for money laundering activities. Moreover controls to check money laundering could be tightened.

Internationally, there is a growing concern about tax havens. There is no evidence of who owns companies in many cases. The benefits go to people who are not genuine residents of the country with which DTAA has been signed. Not knowing the origin of the real investors and the money is certainly worrying. In certain tax havens, there have been complaints of money belonging to drug and crime cartels being laundered. That might not be the case with all tax havens, but then there is no real way of knowing because the data on the investors of these companies is not available to the government authorities. Measures have to be taken to reduce revenue leakage from these areas and prevent ourselves from being exploited.

Article by one of the reputed chartered accountant specialising in Taxation

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