Tax haven 101

Not all financially-friendly jurisdictions are created equal

Bermuda-based law firm Appleby is in the news for potentially naughty financial behavior by some of its clients. The company suffered an apparent cyber-security breach of sensitive client information last year. According to The Daily Telegraph, multiple media organizations are preparing to release details of the leak shortly.

As the data leaks, it could come to light that the offshore firm—which “advises clients on legitimate and lawful ways to conduct their business”—was employed by individuals with dubious dealings. They obviously maintain that “there is no evidence of any wrongdoing, either on the part of ourselves or our clients.”

Appleby operates in a number of territories typically lumped into the category of “tax haven”. Bermuda is one such country.

The term tax haven has dishonorable connotations and is almost always levied as an insult at best. Never have I heard a politician or journalist speak or write “tax haven” in an agreeable tone. The only positive imagery it might bring to mind is a sunny beach on a tropical island (perhaps one hiding buried treasure).

Never have I heard a politician or journalist speak or write “tax haven” in an agreeable tone

Tax havens are often in the headlines—never more prominently than following the Panama Papers leak of 2016. Yet they’re poorly understood outside of financial circles. Politicians especially seem to have a poor grasp of what they are and how they work (although some are more savvy).

With the revelations of this latest potential leak—some are already calling it “Panama Papers 2.0” and “the Paradise Papers”—it is a perfect time to address a subject that most people don’t know they don’t know about.

What is a tax haven?

The International Monetary Fund (IMF) states the definition of Offshore Financial Centers—of which tax havens are an example—as “anything but straightforward”; it can include any city where international finance is done. That means international metropolises like New York, London, and Singapore all classify.

However, more practically, the IMF offers the following description:

Jurisdictions that have relatively large numbers of financial institutions engaged primarily in business with non-residents;

Financial systems with external assets and liabilities out of proportion to domestic financial intermediation designed to finance domestic economies; and

More popularly, centers which provide some or all of the following services: low or zero taxation; moderate or light financial regulation; banking secrecy and anonymity.

This narrows them down to smaller domiciles which are economically reliant on international businesses like banking, (re)insurance, and other financial services.

More specifically, I would further sort tax havens into two groups: personal and corporate.

Personal tax havens include countries that have lax financial regulations and strong banking secrecy laws. The traditional culprits are the likes of Switzerland, Singapore, and Luxembourg (although several are purportedly cleaning up their acts of late). Perhaps surprisingly, many American states also fit this description. Such jurisdictions can be used by individuals to hide wealth from their home-territory’s tax collectors or launder profits from illegal activities.

In cases like the British Overseas Territories of Bermuda, the British Virgin Islands, and the Cayman Islands—along with several American states—the corporate tax rate is 0%

Territories which maintain low or no taxes on corporations can be considered corporate tax havens. These jurisdictions create what you might call an unfair competitive advantage. In cases like the British Overseas Territories of Bermuda, the British Virgin Islands, and the Cayman Islands—along with several American states—the corporate tax rate is 0%. (This does not include paltry licensing fees, which companies must pay the local government.)

Are tax havens legal?

How, despite watershed dossiers like the Panama Papers and the impending Bermuda leak, do tax havens continue to operate? Is it legal for mega-rich companies and individuals to stash their profits away from national income coffers? Many voters ask this question of their elected officials, shocked that such shady dealings are allowed to continue.

The answer is: sorta.

Is it legal for mega-rich companies and individuals to stash their profits away from national income coffers?

Corporate tax havens are legal in theory. This is largely because corporations are not treated like people. Multinationals are often involved in tax avoidance, which is not a crime. In fact, cutting costs by locating offices in low-tax domiciles could be described as smart business, so long as there is actually business being carried out. This practice may be politically frowned upon, but many companies don’t seem to mind.

Personal tax havens, i.e. countries within which high-net-worth individuals hide their wealth through secrecy laws, are also technically legal, so long as they are in compliance with whichever international tax and data exchange agreements they have signed up to. However, those individuals trying to escape their home country’s tax laws—either for greedy or nefarious purposes—are usually considered to be involved in illegal tax evasion. So certain institutions, individuals, and businesses within personal tax havens may be complicit in facilitating illegal activities.

The war on loopholes

As the IMF points out, such definitions leave a massive grey area. Due to the ever-changing nature of international finance, as well as good old politics, regulations are often ridden with loopholes and difficult to enforce.

For example, take the European Commission’s landmark ruling last year that Apple pay €13 billion (plus interest) in back taxes to the Irish government. The commission alleged that favorable deals were cut by previous Irish governments to benefit the tech giant. Even if this was the case, Apple did not technically break any laws—yet has been charged with a hefty bill. They probably won’t pay it though: the current Irish government has filed an appeal along with Apple against the commission’s ruling.

There have also been many cases where multinationals were set up by wealthy individuals to serve as offshore, tax-exempt shell companies for their funds, without any business being carried out. These are essentially tax-free bank accounts for the rich. Such behavior is clearly illegal, and in the case of Bermuda and many other jurisdictions, there are regulations in place against it.

Unfortunately, as with any country involved with international trade — that is to say, every country (including North Korea) — such rules are not foolproof

There are, of course, countries which refuse to fully comply with international financial regulations. This includes America, which decided against signing up to the Organization of Economic Cooperation and Development’s newly created Common Reporting Standard in 2014. For context, 96 countries had signed the data-swapping agreement as of last year—including Switzerland, Luxembourg, Bermuda, and the Cayman Islands.

Unfortunately, as with any country involved in international trade—that is to say, every country (including North Korea)—such rules are not foolproof.

Global capital and sovereignty

Ultimately, if Britain wants to make London a “Singapore-upon-Thames” by substantially lowering its corporate tax rate (a hypothetical yet imaginable scenario), it has every right within its national sovereignty to do so. Same as Bermuda, New York, and the rest. Similarly, if America decides against playing ball on widely-accepted rules, there’s little way to force them to comply.

Capital is—increasingly—inherently global. All territories and their citizens produce, consume, and trade on the international market. Should there be more stringent regulations? Definitely. Nevertheless, there will always be businesses and individuals seeking to bend the rules and take advantage.

Are tax havens fair? Perhaps not. But they are, in one form or another, an inevitability of the current system of global capital—and they’re more common than you would think.

Bermudian-American journalist based in London 🇧🇲🇺🇸 Formerly @TheEconomist 🖋 weather + climate stan 🌎

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