SA20. Tax Havens by John de Val

The issues raised by tax avoidance have featured heavily in the media over the last six months or so and were prominent on the agenda of the recent G8 summit. Tax havens play a prominent role in these issPandora Sale ues. This morning I will briefly describe what a tax haven is, how they developed, where they are located, and indicate their global significance. I will then explore the question of whether the use of tax havens to avoid tax necessarily gives rise to injustice.

What is a tax haven?

The term ‘tax haven’ is a bit of a misnomer, for these places don’t just offer an escape from tax.  One useful definition is ‘a place that seeks to attract business by offering politically stable facilities to help people or entities toPandora Bracelets UK Sale get around the rules, laws and regulations of jurisdictions elsewhere’. In other words thPandora Braceletsey offer escape routes from the duties that come with living in and obtaining benefits from society – tax, financial regulation, criminal laws, inheritance rules and so on. This is their core business. 

Several features help us to spot tax havens.

* They offer secrecy combined with varying degrees of refusal to co-operate with other jurisdictions in exchanging information.

* They offer very low or zero taxes.

* They often ring-fence their own economies from the facilities they offer, to protect themselves from their own offshore tricks.

* Their financial services sector is commonly very large compared to the size of the local economy.

How did they develop?

The term ‘tax haven’ did not enter the language until the 1950s, but the concept originated in the 19th century, when the American state of New Jersey eased its business-registration and tax laws to drum up revenues from incorporation during a fiscal squeeze. A few years later, Delaware copied its methods.

The first phase of rapid growth came after the First World war when numerous small jurisdictions, led by Switzerland, in concert with Liechtenstein, began to offer tax, banking and incorporation benefits. In 1934 Switzerland dramatically tightened its bank-secrecy laws. This was apparently in response to a Swiss bank’s exposure in a French tax scandal and not primarily to protect Jewish customers’ deposits, as is sometimes asserted.

A ruling by the Bank of England in 1957 spawned what would become a giant offshore business known as the ‘euromarkets’, dealing with dollar deposits held outside America, sterling deposits held outside Britain and so on. The Bank deemed the transactions not to take place in UK for regulatory purposes. Since this trading did in reality happen inside British sovereign space, this allowed a big chunk of cross-border lending to go essentially unregulated. International banks embraced this idea over the next decade, transforming places such as the Cayman Islands and the Channel Islands as the banks booked more and more of their euromarket activities through these centres.

The 1960s to 1990s were golden years during which dozens of new havens sprang up, largely unmolested by authorities in the developed world. In the 1979s and 1980s the number of offshore centres increased to more than 50 and the assets and holding structures they offered became more and more complex. It was not long before these centres had become conduits for at least one-third of all international lending and investment as well as ever larger amounts of undeclared income and ill-gotten gains.

Alarmed by this, richer countries began to push back in the late 1990s. A crackdown on ‘harmful’ tax competition turned into a war on tax evasion. When the global financial crisis struck they were forced to provide more information about their users. But despite the change in sentiment, few of them have disappeared, and offshore financial flows have remained more or less steady.

Where are these tax havens?

I have already mentioned some of them. But there are three main groups. First are the European havens e.g. Monaco, Switzerland, Luxembourg, Liechtenstein. Second, comes a British zone centred on the City of London, a kind of spider’s web which spans the world and is loosely shaped around Britain’s former empire. Third is a zone of influence focused on the United States.

The British offshore group, accounts for about half of the world’s secrecy jurisdictions, as they are known in the US, and is arguably the most important. It is a layered, hub-and-spoke array of tax havens centred on the City of London. The City’s offshore network has three main layers. There are two inner rings. The first of these are Britain’s Crown Dependencies of Jersey, Guernsey and the Isle of Man. The second inner ring consists of its so-called Overseas Territories such as the Cayman Islands. They are said to be substantially controlled from Britain. The outer ring is a more diverse array of havens, like Hong Kong, which are outside Britain’s direct control but nevertheless have strong historical and current links to the country and the City of London.

This particular network of offshore satellites gives the City, a truly global reach. The British havens scattered all around the world’s time-zones attract and catch mobile international capital flowing to and from nearby jurisdictions, much like a spider’s web catches passing insects. Much of the money attracted to these places, and the business of handling the money, is then funnelled through to London.

Wealthy US individuals and corporations use the British spider’s web extensively; of Enron’s 881 offshore subsidiaries before it went bust, 692 were in the Cayman Islands, 119 in the Turks and Caicos Islands, 43 in Mauritius and 8 in Bermuda; all in the British spider’s web.

Over time, the US government has shifted from being an outright opponent of tax havens towards adopting a half-hearted ‘if you can’t beat ‘em join ‘em’ attitude. The US-based offshore system operates in three tiers too. At the federal level, the US dangles a range of tax exemptions, secrecy provisions and laws designed to attract foreigners’ money in true offshore style. The second offshore tier involves individual US states, where a range of offshore lures are on offer. Florida, for example, is where the Latin American elites do their banking. Smaller states like Wyoming, Delaware and Nevada offer very low-cost and very strong forms of almost unregulated corporate secrecy that has attracted large amounts of money from around the globe. The USA’s third offshore rung is a small overseas satellite network. It includes the Marshall Islands which are primarily a ‘flag of convenience’, for among others, the Deepwater Horizon, the BP-operated oil rig that caused the oil spill off the US Gulf coast in 2010.

What is the global significance of tax havens today?

Various organisations, including the IMF, have had a stab at estimating their significance. They suggest that;

* More than one half of world trade passes, at least on paper, through tax havens

* Over half of all banking assets and a third of foreign investment by multinational corporations are routed offshore.

* In 2010 the balance sheets of small island financial centres alone added up to a sum equivalent to about a third of the world’s GDP.

* In 2009, 99 of Europe’s 100 largest companies used offshore subsidiaries. In each country, the largest user by far was a bank.

In addition there are other statistics which paint a picture of a somewhat bizarre and unreal world;

* The Cayman Islands is the fifth largest financial centre in the world, hosting 80,000 registered companies, over three-quarters of the world’s hedge funds and around $2 trillion on deposit – four times as much as in New York City banks. And, in 2009, it boasted one cinema.

* Asian businesses are particularly fond of using the British Virgin Islands for initial public offerings and international investments. The result is that on paper the British Virgin Islands rank as the second-largest investor in China.

* In Wilmington, the state capital of Delaware, a single low-rise, yellow-brick building, 1209 Orange Street, is the legally registered office of more than 200,000 companies including Ford, American Airlines, General Motors, Coca-Cola and Kentucky Fried Chicken. In fact,

Delaware has a rather dubious reputation amongst investigators of large-scale corporate corruption. They joke that Delaware stands for ‘Dollars and Euros Laundered And Washed At Reasonable Expense

The global offshore system also played its part in the latest financial crisis. The combination of impenetrable complexity and offshore secrecy, foxed regulators and fed the mutual distrust between market players that worsened the financial and banking crisis. Trust is a vital ingredient in any healthy economic system and there is nothing like the offshore system to erode trust. It is no coincidence that so many of the great houses of financial trickery like Enron, or the empire of the fraudster Bernie Madoff, or Long Term Capital Management, or Lehman Brothers or AIG, were so thoroughly entrenched offshore. When nobody can find out what a company’s true financial position is until the money has evaporated, bamboozling abounds.

I would like now to focus on the issue of tax avoidance. But first it is necessary to distinguish between tax avoidance and tax evasion. It is simply defined; tax avoidance is legal, tax evasion isn’t. But there is a large grey area in between.

How are tax havens used to avoid tax?

It is done by artificially manipulating paper trails of money across borders. For example, consider the humble banana.

Each banana takes two routes into your fruit bowl. The first route involves a worker in, say, Honduras, employed by a multinational, who picks the bananas, which are packaged and shipped to Britain. The multinational sells the fruit to a big supermarket chain, which sells it to you. Simple.

The second route – the accountant’s paper trail – is more roundabout. When a Honduran banana is sold in Britain, where are the final profits generated, from a tax point of view? In Honduras? In the British supermarket? In the multinational’s US head office? How much do management expertise, the brand name, or insurance contribute to profits and costs? Nobody can say for sure. So the accountants are more or less free to make it up. They might, for example, advise the banana company to run its purchasing network from the Cayman Islands and run its financial services out of Luxembourg. The multinational might locate the company brand in Ireland; its shipping arm in the Isle of Man; ‘management expertise in Jersey and its insurance subsidiary in Bermuda.

So the Luxembourg financing subsidiary now lends money to the Honduras subsidiary and charges interest at, say, $20 million per year. The Honduran subsidiary deducts this sum from its local profits, cutting or wiping them out (and its Honduran tax bill). The Luxembourg subsidiary’s $20 million in extra income, however, is only taxed at Luxembourg’s ultra-low tax haven rate. With a wave of an accountant’s wand, a hefty tax bill has disappeared and capital has shifted offshore.

Big Banana has performed a common offshore trick known as transfer pricing or, more accurately, transfer mispricing. In this banana example, tax revenue has been drained out of a poor country into a rich one. And poor countries with under-paid tax officials always lose out to multinationals’ aggressive, highly paid accountants.

Tax havens claim that they make global markets more efficient. But the system being described is profoundly inefficient. Nobody is producing a better or cheaper banana through this system. What has happened instead is a transfer of claims on wealth.

Does tax evasion through tax havens give rise to injustice?

I will start considering this question by looking at the various opinions of the interested parties and then try to make an assessment that an impartial observer might reach. The interested parties include governments, tax payers in the countries whose tax is being avoided, competitors of the tax avoiders and the tax avoiders themselves.

Governments in countries who are tax havens will of course see nothing wrong in offering companies registered in their territory lower taxes on corporate profits. It provides them with a source of revenue which is likely to be far greater and more reliable than other alternatives such as earnings from tourism. For countries such as Ireland, where the corporation tax rate is lower than elsewhere in the EU it is an inducement for companies to locate there physically and thus provide much needed employment and a stimulus to economic growth.

Governments who lose out from tax avoidance such as UK see the situation very differently. Their argument runs along the following lines; even large global corporations are dependent on the state in that their property rights are defended by the state, capping the downside risk for investors and stopping their ideas and products from being ripped off. They often depend on government-funded research and development either directly or through tax credits for their own R & D activity. They depend upon publicly provided infrastructure such as road and rail. They need a workforce educated by state-provided schools and universities, and kept healthy by the health service. Some of the banks they rely on were rescued by the taxpayer. So corporations have a moral obligation to pay all their taxes owed to the state not just the ones they cannot avoid.

Governments in the less-developed countries are, as already noted, particularly harmed when global companies located there avoid paying taxes on their profits. Collecting tax is difficult enough in poor countries both because of the often dispersed nature of the population and the tax collecting resources they can afford. Such taxes as import taxes and corporation taxes, particularly from large firms should in theory be much easier to collect.

Ordinary tax payers will not generally be sympathetic to the activities of tax avoiders. In order to replace the revenue lost through avoidance, governments will need either to raise more money from taxes or cut public expenditure or postpone the pain by increased borrowing. None of these are positive outcomes for the taxpayer and they will, and do, resent the apparent unfairness.

Full tax paying competitors of tax avoiders are also entitled to feel particularly aggrieved. Tax avoiders will presumably enjoy lower costs which can be passed on in lower prices or they will be better able to spend more on advertising and/or research to give them a competitive edge. In 2012 when Amazon were in the spotlight, the Managing Director of John Lewis warned in rather apocalyptic terms that Amazon’s tax avoidance would drive UK’s companies out of business. He was quoted as saying, ‘There is less money to invest if you are giving 27% of your profits to the Exchequer. Clearly if you are domiciled in a tax haven you’ve got much more money. Amazon will out-invest and ultimately out-trade us. And that means there will not be the tax base in the UK’.

The tax avoiders’ defence is usually brutally simple. It is legal. If it is possible to so arrange your activities so that the payment of tax is minimised this is just another aspect of business efficiency. Don’t blame us. Blame the governments who designed the tax system. This argument can be somewhat disingenuous. Many of the loopholes that are made use of are there because of lobbying, sometimes by the corporations themselves and sometimes by other offshore interests. A second argument made by think tanks funded by big business, is that the taxes are far too high in most developed countries and are stifling business and economic growth. The existence of tax havens provides a competitive spur for these countries to reduce taxation on businesses.

A refinement of this argument is that corporate taxes are a penalty for success. It was put very bluntly by one American political scientist, Alvin Rabushka;

‘The truth of the matter is a poor person never gave anyone a job, and a poor person never created a company and a poor person never built a business and an ordinary working class guy never drove economic growth and expansion and it’s the top 5% to 10% who generate the growth for the other 90% who pay the taxes to support the 40% in government.’ You need to feed them…..’ i.e. the top 5-10%.

So where does all that leave us? How would an impartial observer assess whether the use of tax havens gives rise to injustice? Well, it all depends. This, of course, is a most unsatisfactory answer. Depends on what? At the risk of being over-simplistic, it depends to a great extent on whether, by avoiding tax, companies are hanging onto a share of wealth created not by them, but by others, in particular a share of wealth which rightfully belongs to the community. Much public outrage in the UK arises from the fact that taxes are being avoided on the profits made by large multinational companies who do a lot of business here. But this is primarily an emotional response rather than one based on facts. It is by no means obvious why a tax on profits is a just tax in the first place.

Profit as measured by accountants is a mixed bag. It can reflect both the ability of a company to create wealth and the enjoyment of some benefit which it has done nothing to earn. For example, a business owning land which has appreciated in value because of infrastructure improvements arising from public investment will gain a competitive edge over other businesses not enjoying that advantage. Their profits are likely to reflect that advantage. But by how much is very difficult to ascertain from the outside and the company itself may not know. Some years ago, Marks and Spencers announced that they were dividing their company into two parts; one part to engage in the trading of clothing etc and another part to take responsibility for the high street property they owned. When the company’s finances were reviewed with this change in place, it became clear that the rents from their land-owning activities had been hiding the fact that their trading activities were less ‘profitable’ than had been hitherto assumed.

So a uniform rate of tax applied to the profits of all companies is a very blunt instrument and for some companies whose profits reflect very little unearned benefit may very well be unjust.

Corporation tax is not the only tax currently levied that when considered from the point of view of justice does not stand up very well to scrutiny. The current furore over tax avoidance has put the spotlight on companies such as Google, Amazon and Starbucks but the spotlight should be on the taxation system itself. It is doubtful whether the closing of tax loopholes and greater transparency will provide a greater measure of justice while the underlying system for collecting public revenue has so many flaws. A move towards a system based on ownership rather than earnings would appear to have the potential for greater justice. If the existence of tax havens is a catalyst for a serious examination of such a possibility then perhaps tax havens have their uses – but not, hopefully, for long