The crackdown on global tax havens

Perhaps nothing is more representative of modern greed than tax havens that cheat governments and regular taxpayers of much-needed revenue.

It is estimated that between US$160-250 billion is lost globally each year from tax avoidance and evasion through their use.

Yet in the wake of the financial crisis, there have been calls for a crackdown on the world’s tax havens. But will there be any real changes, or will it stay business as usual for the world’s richest men?

How do they work?

A tax haven is a country or territory where taxes are low or non-existent to attract the business of wealthy individuals and companies.

They are often characterised by strong privacy laws protecting the handing over of information (such as bank account details) to foreign tax authorities, and a lack of transparency in some government processes.

Think the Cayman Islands, Virgin Islands, Monaco, Dubai and Switzerland. Less acknowledged, particularly by Britain and the US, are the British Channel Islands and the US state of Delaware.

A person can move to a tax haven to qualify as a tax resident. Or they can stay living in their home country and electronically send income to an established ‘offshore’ bank account in a tax haven (generally only available to people worth a lot of money).

An offshore bank account is advantageous for wealthy people who want to hide income from the tax man at home, and also for criminals making money through drugs and other illegal means because there is no IRS (tax department) wondering where all your money came from.

By doing this, it allows people to avoid some or all forms of income tax, withholding tax, capital gains tax and inheritance tax, and keep substantially more of their income – regardless of what country that income comes from.

For a company, the attraction of tax havens is the same – lower taxes and stronger privacy laws. But often it is not so much where the main operations of the business are that determines its tax bill – but where a parent company is registered or incorporated (created).

A complex set of payment arrangements between the parent (holding) company and the local trading company can mean a higher profit in the cheaper tax haven.

Therefore, tax haven registrations have encouraged companies and creative accountants to set up holding companies, trusts and other complex ownership structures to minimise their business’s tax bill. These ‘offshore’ companies are often called International Business Corporations (IBCs).

It was fun and games for a long time. But since the financial crisis, the idea of tax havens has become offensive to the average tax payer.

Governments around the have world pumped trillions of tax payer money into banks and the economy to prevent the collapse of both.

The thought that major banks, companies and wealthy individuals would continue to engage in tax avoidance after benefitting from the use of tax payer funds, is infuriating people and fuelling calls for change.

The crackdown

Cracking down on tax cheats is not an easy task.

Governments can’t prosecute citizens suspected of tax evasion because they can’t prove it. They can’t prove it because they can’t get the information. They can’t get the information because the banks in the tax havens won’t give it to them. And the banks won’t give it to them because they are forbidden to do so by their country’s privacy laws.

This was the exact dilemma facing the US government this year when they tried to force Swiss banking giant UBS to reveal the names of 52,000 account holders believed to be US citizens evading tax. They handed over the names of 4,450 US clients, only after the Obama Administration threatened them with ‘monetary sanctions’.

Then there’s the old school way. Heinrich Kieber, a former employee of a bank in Liechtenstein (a tax haven near the Swiss-German border), sold CDs to the German government for €4.2 million, containing bank account details of over a thousand of their citizens.

Germany is now negotiating with the bank as to how to deal with the wealthy, powerful culprits. Kieber is in hiding.

As a result of the current difficulties, leaders such as Gordon Brown (UK), Angela Merkel (Germany) and Barack Obama (US) have called for tougher legislation to combat the tax havens that deprive them of vital tax revenue.

In April 2009 the G20 (the group of 20 wealthiest countries) blacklisted countries that failed to comply with OECD tax standards.

Last week, the US Congress produced a bill stating foreign banks will be charged more tax on income from their US-based assets unless they provide the details of their American account holders.

It is hoped this decrease in privacy protection will deter individuals and companies from using tax havens due to the increased risk of being caught.
The regulation, however, may not stop wealthy people and businesses from moving overseas which is bad for the economy.

In the UK this year, the government raised the top tax rate to 50% to cover its growing debt. This forced an exodus of the city’s profitable hedge funds, with a reported 18 major investors leaving London for Switzerland in 2009.

This issue is harder to tackle. G20 governments cannot tell tax havens what tax rates they can charge so the lure of tax competition will always be there.

The trick is to make it less desirable for people to move to tax havens by ensuring that tax is based on citizenship like in the US, and not just residency everywhere else.

With public discontent over unfairness and greed high after the financial crisis, this may be the best chance governments have to change the engrained system of tax havens.

But once public interest dies, so will the pressure. And as a result, governments may not bother to make any real changes at all.

By Victoria Craw

Photo/Freedom’s Phoenix – The often sunny island climates of tax havens.