Introduction:
The concept of avoidance of paying taxes has always had a negative overtone, when it is brought on in a conversation or discussion. The idea behind this concept is for an individual or corporation to avoid paying taxes in a given country, either through legal channels or by using illegal methods. At this point is where there is a separation both in methodology as well as terminology. Illegal methods used in order to sidestep tax duties are typically known as tax evasion methods. Whereas legal channels that assist individuals and corporations to dodge taxes are referred to as tax avoidance tools. The margin between the two concepts is rather thin in a lot of cases and that is why the whole idea is generally looked at rather skeptically by the public eye. Having said that, tax evaders generally use the regulations in parallel with other methods such as secret bank accounts, not claiming income and faulty financial statements. Tax avoiders on the other hand, try to utilize the legal methods and regulations to their benefit as much as they can, while staying reluctant to incorporate illegal ways to reduce their taxes. Both tax evaders and tax avoiders bring along a massive hit to the domestic revenue of their country each year.
Tax Evasion & Avoidance:
While there are several methods for an individual or corporation to reduce tax duties, the issue that has been studied and reviewed many times over during the years is the issue of tax havens. Corporations and individuals alike, take advantage of tax havens that are all around the world.
Tax Havens:
A tax haven is often referred to as a territory or a country in which there are very low or no tax rates enforced. There are also other characteristics that are present in a tax haven. One that is often viewed as main tool for tax evasion is lack of a proper channel for exchange of information, which makes it easier for those who would like to conceal information to not report all the necessary information, or tweak what they report.
As mentioned previously, countries that are regarded as tax havens are all over the world. The Organization for Economic Cooperation and Development, also known as OECD, creates list of the countries that are considered as tax havens. Over the years, the list has been modified as regulations in those countries along with level of information exchange have been improved. Many countries have been added and dropped over the years. Currently the most well known tax havens are Monaco, Andorra and Liechtenstein. This issue is also a common talking point in the United States, where each state is allowed to have its own rules and regulations. This factor paves the way for tax fraud in various forms, including but not limited to setting up fake companies where beneficiaries remain unknown; an act that is most common in states such as Nevada.
Tax havens can be divided into four separate groups, based on various characteristics of their international tax regulations. The first category is the group in which there are countries or territories where there is no income tax and companies only a license fee (fee for obtaining business license), such as Bermuda. The second group is the countries with low tax rates, such as Switzerland. The third category includes those countries that only tax on domestic income and not on foreign income, such as Hong Kong. And the last group includes those countries and territories where special tax privileges and benefits are given to firms who operate in certain fields.
Inception of a Tax Haven:
Countries do not become tax havens overnight. Neither are they come into existence as a refuge for tax evaders and tax avoiders. Countries often become tax havens due a number of reasons. One of the most prominent reasons why a country becomes a tax haven is the result of new rules or regulations that sometimes are put in place and change the level of information exchange from and to that country. Another reason would be a country's lack of natural resources or trade capacities. In such case, the country is forced to do something in order to attract foreign investors and guide flow of capital towards the country's economy. They open their doors to investments with minimum supervision and transparency. Previous historical ties between countries also a reason why a certain country or territory would become a tax haven for residents/citizens of another country. This could be a result of previous political agreements or pacts arranged between the two countries, which may change in favor or against one or more countries involved.
International Policies & Reasons to Bend Them:
International tax policies are guidelines and regulations that are in place to serve a number of purposes as well as various countries. They are often in place to protect interests of countries practicing these laws and prevent individual and organizations to take advantage of the local tax policies. These regulations also try to prevent double taxation as well as under taxation.
The international tax policies also promote equality among taxpayers; or at least try to put equality in place as the basis of operations. These policies are also set in place in such way for an individual to prevent a forming a preference towards investing in his or her home country or to take the capital and invest elsewhere. This international neutrality encourages competition in different countries among various industries.
In this system of various policies and regulations, the tax havens come out as the territories that present an opportunity for individuals and firms to bend the rules. This can happen for a variety of reasons. One would be that the country is willing to take on the risk of going against the international regulations, because it is considered a manageable risk for the country to handle, and they are willing to accept and face the consequences. Another case is that a country simply stands firm on the belief that these international regulations are discriminatory and are having a considerable negative effect on the country's best interests. In what way and how far the country is willing to go against the rules and regulations is a factor that depends on all the elements mentioned above. Sometimes a country is willing to bend all the rules in order to achieve the country's desired tax policy. But as mentioned, these are to be determined according to the needs of that specific country.
Inspection and Determination of the Violation:
While the regulations are set and assumed to have been understood by governments around the world, it has to be said that finding an irregularity or violation of these rules is rather difficult. The most important obstacle in the way is the fact that it is very difficult to determine which actions taken by the country are illegal according to the international rules. Another issue that is taken advantage of whenever a country changes its domestic policy is the fact that even by signing a certain treaty, the country can still easily break away from it as circumstances change, both domestically and internationally. It also has to be noted that while a country may agree to sign a certain treaty to comply with the international regulations, this agreement does not force the issue for it to become part of the domestic regulations automatically. These obstacles are among various reasons as to why detection of non-compliance is rather a difficult task.
Obvious vs. Obscure Violators:
Another matter that needs to be taken into consideration is the issue of how nations actually comply with the regulations. There are those countries that actively participate in conferences and sign the treaties that bind them to respect international regulations. However, when it comes to actually practicing those rules, they refuse to put them into effect and continue to serve the domestic interests. These are known as obscure violators of the regulations, because they do so without declaring their interest and compliance in the regulations. Ireland and Switzerland are among prime examples of this group of countries.
There is another group of countries, which are more obvious to notice when it comes to determining their true commitment in complying with international regulations. These nations are among those who publicly refuse to have any connection with the international rules and regulations and avoid participating in signing treaties. These are known as obvious violators of the regulations. The United Arab Emirates and Andorra are among examples of this group of countries.
There is also a third group of territories. This group of countries officially has no ties with the international taxation system. But they still maintain their connection with some of the nations who are actively complying with the international regulations. By doing so, they enjoy benefits of not committing to the international regime and serving the interests that suits their nation best and also take advantage of some benefits that can be gained from participating in the international taxation regime. It has to be noted that most tax havens often have or have had a strong relationship with another nation that is complying with the regulations.
Possible Solutions:
In the past as well as currently, many countries tried to reduce the effects of having a relationship with a tax haven individually. Implementing and increasing tax duties on passive income or eliminating tax deferral on the income earned in certain foreign countries are among attempts made by domestic tax authorities in order to bring some kind of order or justice to their domestic tax system as well as international relations. As mentioned, many countries continue their attempts in providing solutions. But with the issue being a rather global matter and not a domestic or regional one, there needs to be a leader on the international scale to provide guidance; and this is where OECD's Committee of Fiscal Affairs (CFA) comes in. They continue to guide these domestic attempts as well as coordinate them in order for them to have a much stronger effect on the neutrality of the international tax system.
The CFA along with other sectors of OECD has designed a recommended taxy system that is focused on providing an anti-haven approach. In this tax system there are general provisions that are designed to act against international tax avoidance. There is also a section, which is specifically designed to work against tax havens and also in order to prevent countries turning into a tax haven. One of the most important parts of this act is that the taxpayer must handle the burden of proof. Previously the burden of proof was on the tax authority. "Other provisions such as requiring emigrants to pay tax for a specified number of years after emigration, 'rent-a-star' company legislation, requiring the arm's-length principle be applied to the transfer of assets abroad, taxing the income from offshore investment funds on an annual basis, and using foreign exchange controls to screen taxes."
Even with all the efforts that have been put in this matter, there are still countries and territories that are reluctant to participate in the international taxation regime and continue to ignore its policies; focusing instead on their own individual economies and serving their own interest. The OECD also has and continues to publish lists of these nations and territories that are considered "non-cooperative havens". In the year 2000, there were 35 countries with this status. Most of these countries were nations with weak economic capacity, as well as small island nations, where capacity for industry, trade, technology and agriculture is extremely limited.
Some experts and professionals in the international taxation argue that little of the benefit from tax havens actually enters their sometimes weak economy and their residents. The benefits and profits rather to the professionals providing banking and legal services, who more often than not, live in a completely different location anyway. They suggest transitional aid to move away from these offshore activities. For non-cooperating tax havens, they suggest the Treasury use its existing authority to deny benefits of the interest exemption. They suggest that tax havens cannot continue to exist unless the wealthy countries permit it, because funds are not productive in tax havens.
The proposed Stop Tax Haven Abuse Act would extend to tax enforcement the sanctions of the Patriot Act used to impose penalties for money laundering and terrorist financing. Sanctions vary in severity and range from increased reporting on transactions to prohibitions. Sullivan points out that the U.S. government has used the Patriot Act sparingly, however, and questions whether this change would be a credible threat.
Recent Developments:
Under the regime of President Barack Obama, there have been new proposals in terms of international taxation. These proposals attempt to tackle the issue of under-reporting of income and include various suggestions, quoted below:
Require greater reporting by Qualified Intermediaries regarding US account holders.
Require withholding on payments of FDAP income made through Non-qualified Intermediaries
Require withholding on gross proceeds paid to certain Non-qualified Intermediaries
Require reporting of certain transfers of money or property to foreign financial accounts
Require disclosure of FBAR accounts to be filed with tax return
Require third-party information reporting regarding the transfer of assets to foreign financial accounts and the establishment of foreign financial accounts
Require third-party information reporting regarding the establishment of offshore entities
Negative presumption for foreign accounts with respect to which an FBAR has not been filed
Negative presumption regarding failure to file an FBAR for accounts with Non-qualified Intermediaries
Negative presumption regarding withholding on FDAP payments to certain foreign entities
Extend statute of limitations for certain reportable cross-border transactions and foreign entities
Double accuracy-related penalties on understatements involving undisclosed foreign accounts
Improve the foreign trust reporting penalty
Conclusion & Final Remarks:
Overall, it has to be noted that OECD has put in a strong effort into coming up various techniques and regulations in not only preventing growth in number of tax havens, but also to minimize the current number of tax havens and protect the international tax regime. Suggestion and even implementation of sanctions on certain economies that have been blacklisted as a tax haven often are presented as a tool to decrease the number of tax haven and their impact on global taxation regime. In my opinion, this will be the last resort in order to sufficiently put an end to this global matter, as there are many beneficiaries who do whatever within their powers to stop the proper implementation of international regulations. But it remains to be seen whether or not these efforts will have the impact that is desired by the OECD as well as other international organizations.
