Tax havens are jurisdictions that offer foreign businesses and individuals large tax incentives that aren’t typically available in their countries of origin. In addition, such jurisdictions are not restrictive on the residency of entities seeking tax relief.
Therefore, the majority of beneficiaries are typically non-residents. The tax havens, however, do not offer tax-free investment. But instead, they charge very low taxes. To cover the shortfalls caused by these incentives, they generally charge higher rates on imports.
Because of their low tax regimes, tax havens are attractive to some of the world’s biggest companies. This has made their financial sectors thrive, disproportionately to the size of their economies.
Tax havens are controversial because they provide an avenue for ultra-wealthy individuals and multi-billion corporations to avoid paying taxes in their native jurisdictions. This has been blamed for denying governments revenue and widening wealth disparities.
Criteria for qualification as a tax haven
The first qualification is that a tax haven must offer low taxes legally. Therefore, whichever entities choose to keep their money in these jurisdictions do so in a completely legal way. While at times such funds may have been obtained elsewhere illegally, their stay in offshore accounts is not, in itself, illegal.
Secondly, tax havens are politically stable, with good governance and respect for the rule of law. This is what gives wealthy individuals and corporations confidence when keeping their wealth in tax havens because they know that the safety of their investments is assured.
Thirdly, a tax haven must be able to offer privacy to foreign depositors. Privacy is a key consideration for those offshore operating accounts and shell companies. They go for tax havens to avoid scrutiny of their wealth and financial transactions.
For example, Switzerland built its reputation in banking because of the high level of privacy its banks offered foreign depositors. The banks kept the identities of their customers concealed, and governments around the world couldn’t trace billions of dollars deposited in Switzerland by their citizens.
Working mechanism for tax havens
As cited above, tax havens charge minimal taxes and, in turn, impose heavy taxation on imports. In the absence of a regulatory framework for taxing its citizens, the import tax duties go a long way in helping governments in these territories to meet their revenue targets.
Large corporations typically register their subsidiaries in tax havens and use them as vehicles to do their paperwork. Using this strategy, the companies increase their income significantly by paying minimal taxes. The companies can then re-invest the funds saved in other countries. This is replicated year after year, leading to the accumulation of significant revenue.
Tax havens are also known for helping high net worth individuals repatriate large portions of their wealth from their native countries to cushion them against paying high taxes. Such actions are carried out secretly, and they have caused an uproar among governments because they are perceived as tax evasion schemes.
The concept of secrecy jurisdictions has also come under sustained attacks by the G7, who have proposed a global minimum tax of 15% as a solution to the imbalance caused by the tax advantages enjoyed by the big corporations. Companies like Apple and Nike have been accused of denying their home countries their deserved taxes.
The biggest benefit to tax havens comes from the large amounts of fees paid by the thousands of companies and wealthy individuals operating shell companies. Shell companies exist only in paper, creating thousands of jobs in the tax havens’ financial sectors. These include corporate lawyers, secretaries, accountants, etc.
Benefits of tax havens
- They enable companies to increase their profit by paying minimal taxes.
- They enable individuals to grow their wealth by protecting them from high taxes.
- Tax havens attract many foreign companies and high net worth individuals, thus earning billions of dollars in transaction fees and taxes. In addition, this also leads to the creation of thousands of jobs.
- They provide a legal and safe way for companies to cut their expenses, thus freeing up more funds for re-investment.
- Because of their favorable tax regimes, many companies in tax havens are encouraged to invest in them, thereby benefiting their economies.
- Tax havens are known to offer safe custody for monies obtained through fraud, tax evasion, corruption, and other illegal activities.
- Tax havens pass the burden on importation by their citizens to offset the shortages caused by minimal tax charges. This is seen as unfair to importers in those countries.
- They enable shell companies to transact billions of dollars worth of business, but considering the secretive nature of such companies, it may at times lead to fraud.
- They deny taxes to the home countries of big corporations. These companies make most of their profits from their home countries but shift a significant portion of their benefits offshore.
Tax havens have created a safety net to cushion companies and individuals from harsh tax regimes. As a result, they continue to attract financial inflows from other nations. However, they have also denied governments taxes and promoted inequality. Despite all these, it isn’t illegal to transact business in these territories.