Tax Haven Meaning Features How Does Tax Haven System Work

Tax Haven Meaning

In simple words, it means a country that offers meager taxation rates along with financial secrecy for foreign individuals and corporate entities. Tax haven rather accepts a nominal charge against the services they offer.

It plays a very prominent role in the financial system of the world. Introduced to support and develop the broken economy of countries after World War II, now have become a vital tool for big corporations and wealthy individuals worldwide to evade taxes.It constitutes the single largest drain on the economies of the countries globally.A report by Citizen for Tax Justice during 2016 says that more than 370 companies out of Fortune 500 operate subsidiaries in such countries.

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How Tax Haven Works?

The working can be better understood with a hypothetical case study. Say Banana Inc, a giant multinational US-based company headquartered in California, creates extraordinary income worldwide and falls under the corporate taxThe Corporate TaxCorporate tax is a tax levied by the government on the profits earned by a company at a fixed rate each year and is calculated in accordance with specific tax regulations.read more bracket of 30% as per US tax codes.

Now Banana, in order to pay fewer taxes, forms Mango Ltd, a shell corporation in Jersey popular tax haven destination for US corporations, including Apple Inc that does not carry any operations related to trade or commerce and does not own any significant asset.Banana transfers its profits, property titles, and other major investments to Mango Ltd and thus makes its profits earned in the USA to be taxable under Jersey’s Tax Jurisdiction. Jersey typically does not tax corporate income.So Banana Inc has successfully saved itself a 30% tax.

Remember, taxes are the single source of revenue for the governments and also their legal right. Practices of Banana Inc is a loophole under US tax laws that is violating the legitimate right of the US government.

Features of Tax Haven

The Organization for Economic Co-operation and Development (OECDOECDOECD is an abbreviation for Organization for Economic Co-operation and Development. It is a 38-member international organization established for the purpose of encouraging economic development and world trade by making essential policies.read more) provides various features to identify whether a country or jurisdiction is a tax haven:-

#1 – Extremely Low Tax Rates

It offers or imposes negligible taxes for earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more made under their jurisdiction; this may vary with different countries. However, a nominal charge is levied against the services they offer.

#2 – Secrecy of Information

The other most important feature of a tax haven is that they protect the personal and financial information of their clients with high credibility. Without the client’s consent, no information is shared with foreign tax authorities.

#3 – Lack of Transparency

The biggest problem with offshore financial centers is their system is entirely opaque. Financial information is not even disclosed to the national governments. The system is thus manipulated for tax evasion practices and other illegal activities, including money launderingMoney LaunderingMoney laundering is a criminal act of legitimizing the money acquired through illegal or unethical means by disguising the origin of the crime.read more.

#4 – No Substantial Activities Required

Tax haven does not require outside entities to actually produce goods or services within their jurisdiction. Entities can bypass their earnings and wealth created in tax-paying countries to be taxable under its jurisdiction by just opening the company’s head offices in such havens or transferring significant financial transactions of the company to subsidiaries or shell companies located in tax havens. E.g., you can commence your trade practices in London and be liable to pay taxes under the jurisdiction of Cayman Islands

The Panama Papers

The Panama Papers refers to a leak of very confidential documents related to the world’s fourth-largest offshore law firm based in Panama, Mossack Fonseca.

The documents released in 2016 exposed the network of more than 2,14,000 shell companies incorporated in various tax havens and revealed the identities and financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more about a number of wealthy individuals and entities from 200 different nations.

The leak involves various famous individuals, including world leaders, politicians, celebrities, and business peoples. The leak revealed how the rich could exploit offshore tax regimes.

Shell companies or business entities in tax havens are not illegal in general, and the leak also did not show inappropriate or unlawful operations by such entities, excluding a few. However, offshore-companies in the majority were established to conceal the identities of the true company owners.

Disadvantages

The biggest disadvantage is the fact that low or middle-income families and individuals struggle to meet their tax obligations. In contrast, big corporations and rich individuals evade taxes using offshore financial centers.Companies in the USA, yearly, avoid payments of taxes of more than $90 billion. General Electric somehow managed to pay $0 as taxes during 2010.Tax evasion can be drastic for the economy of the country as taxes are the only source of revenue for the governments.

Tax Havens: Steps against Tax Evasion

Offer zero tax incentives to those who transfer their profits and jobs in such countries.Identify and minimize loopholes in offshore taxation policies.The world forums should force tax haven authorities to increase financial transparency and share confidential information in case of illegal practices.Penalize and/ or punish heavily who practice trade and finance inappropriately or illegally.

Final Note

Remember, the incorporation of companies in tax havens, transferring money, property titles, and investments, for saving taxes are technically legal. But practices to conceal financial transactions, evasion of taxesEvasion Of TaxesTax Evasion is an illegal act in which the taxpayers deliberately misreport their financial affairs to reduce or evade the actual tax liability. This includes using multiple financial ledgers, hiding or representing lesser income, gains, or profits than actually earned, overstating deductions, & failing to file returns. read more, money laundering, etc. are not permissible and not legal.