A taxing subject

Tax havens – so what’s the problem?

Tax is the foundation of good government and a key to the wealth or poverty of nations. Yet many places allow big companies and wealthy individuals to escape their responsibilities in relation to paying fair taxes. 

Tax havens offer not only low or zero taxes, but something broader. What they do is to provide facilities for people or entities to get around the rules, laws and regulations of other jurisdictions, using secrecy as their prime tool. 

The offshore system is a blind spot in international economics– which helps explain why so few people have woken up to the scandal of  tax havens.  Yet tax havens are one of the structures that enable billions of dollars to be robbed from poorer countries. 

How big is the problem, and what is its nature?

Assets held offshore, beyond the reach of effective taxation, are equal to about a third of total global assets. Over half of all world trade passes through tax havens. The amount of money lost by developing countries due to tax havens is far greater than annual aid flows. 

Using secrecy and tax loopholes to avoid tax does not only happen in islands and small states. The largest financial centres such as London and New York, and countries like Switzerland and Singapore, offer secrecy and other special advantages to attract foreign capital flows. As corrupt dictators and other élites strip their countries’ financial assets and relocate them to these financial centres, developing countries’ economies are deprived of local investment capital and their governments are denied desperately needed tax revenues. Countries that lose tax revenues become more dependent on foreign aid. 

So what have tax havens got in common?

• Secrecy
• Allow non-residents to open bank accounts
• Low or no corporate tax rate
• No disclosure of information to other countries

Where are they?

Many locations around the world are considered tax havens, though there is no list everyone agrees on. The following are tax havens according to the Tax Justice Network, in order of how much they facilitate tax dodging (2021):

• British Virgin Islands (British Overseas Territory)
• Cayman Islands (British Overseas Territory)
• Bermuda (British Overseas Territory)
• Netherlands
• Switzerland
• Luxembourg
• Hong Kong
• Jersey (British Crown Dependency)
• Singapore
• United Arab Emirates
• Ireland
• Bahamas

Transfer mispricing 

Transfer mispricing, also referred to as ‘cooking the books’ may at first glance this might seem like a matter that’s only of interest to accountants or lawyers. However it is relevant to anyone who cares about tackling global poverty and inequality. It is about the manner in which businesses, in particular multinational corporations, shift billions of pounds of profits between countries to reduce, or even dodge completely, their tax bill.

With multinationals, a system called transfer pricing works when a subsidiary of a parent company sells something to another subsidiary in another country – it could be anything from nuclear reactors to cornflakes. It may also apply to the sale of things such as management services and insurance. As long as the subsidiaries of the same multinational charge each other a fair market price – known in regulatory circles as an ‘arm’s length’ price such transactions are perfectly legal.

So what’s the problem? 

In practice, transfer pricing means that a subsidiary of a company can charge a vastly reduced, or inflated, rate for goods and services to another subsidiary elsewhere in order to minimise their tax liability. So goods are exported and sold to a sister company at knockdown prices from the country where they were produced, and this keeps the profits low – which means the tax paid in that country is also low. 

The company buying them then sells them on at their true market value from a country where the tax rate is much lower. This practice is usually not possible where there is a rival product to provide a price comparison – e.g. cornflakes made by another manufacturer – but it often works is when the company has a unique product, e.g. its own trademark, which is harder for revenue authorities to place an independent value on, or in some cases where it claims that the original product has had value added in some way in the second, lower-tax country.  

In other situations, goods from wealthy countries are sold to developing countries at hugely inflated prices to enable the company that is the buyer to shift large amounts of money abroad while at the same time reducing its tax bill at home.

The OECD introduced global tax reforms to address the abuse of transfer pricing called the BEPS process. However, many activists are concerned that it doesn’t go far enough, and that developing countries weren’t involved in writing the rules.

With 60 per cent of world trade now taking place within, rather than between multinational companies this practice has been called ‘the ugliest chapter in global economic history since slavery’ by businessman and author, Raymond Baker.