Published by the CIPS Network of the National Association of REALTORS®
Third Quarter 2009
A Place in the Shade?
By K. Christopher Soester, CIPS
Author W. Somerset Maugham famously referred to tax haven Monaco as “A sunny place for shady people.” Those who are regularly drawn to its sunny Mediterranean shores looking for tax anonymity have, perhaps unfairly, tainted the tiny (550 acres) principality’s image—and, by extension, the reputation of tax havens everywhere. Indeed, just the name “tax haven” has a certain pejorative ring that tends to sound like something that is shady at best and illegal at worst.
U. S. President Barack Obama, seeking additional means for reducing the burgeoning U.S. budget deficit, recently proposed legislation1 to severely curb the huge tax benefits derived by U.S. corporations and wealthy individuals—estimated to be $268 billion over ten years. A huge legislative battle is brewing as armies of lobbyists, representing all sides of this issue, gear up for the fight.
Offshore Financial Centers
Now is a good time to take a close look at what has increasingly become one of the most mysterious and contentious subjects in international business. Tax havens, also less provokingly known as offshore financial centers (OFCs)2 have grown tremendously over the past ten years. About half of all world trade is said to pass through OFCs even though their home countries account for only three percent of worldwide GDP.
With the advent of the computer age,and the elimination of capital controls3, it is now,more than ever,quicker,cheaper, and more anonymous for individuals worldwide to transfer and manage their wealth from anywhere on the globe. It is no longer the sole purview of the affluent. The Economist magazine has reported that ads for establishing OFCs, once found only in airline first class magazines, have now worked their way back through the cabin to magazines in business and coach classes.
Billions of dollars worth of real estate around the world is regularly bought in and through accounts held in OFC countries, where about a third of the assets of the global rich are held. Some rank and file workers from around the world have left their home countries and moved to OFCs in order to avoid taxation on their income, estates, and capital gains. Many expatriates seek homes in no-tax or low-tax OFCs where capital gains and property estate taxes simply do not exist. The U.S. is the only major country that taxes its citizens on the basis of citizenship and not residency, and U.S. tax laws generally do not afford Americans the same OFC benefits that some other nationals enjoy. Although the U.S.Congress has tightened the laws on this sort of activity, some Americans still attempt to participate in OFC benefits in some way. Annually, some 500 U.S. citizens renounce their citizenship4 to avoid U.S. taxes, many taking up residence in OFCs.
A Good Thing or Bad?
But what exactly is an OFC? Are they a good thing or bad? Well,like so much else,it depends.The first “offshore” financial center was actually offshore—in the British Channel Islands,off the coast of France.Today,OFCs can be found on shore—in landlocked Switzerland and double-landlocked Lichtenstein—and offshore—in the island nations of Bermuda, the Bahamas, and Singapore. Many of the most successful OFCs today were developed by the old British Empire, which put strong trusts and legal and government institutions in place years ago, and which still gives assurances to investors worldwide.According to the Financial Stability Forum, there are 42 countries worldwide designated as OFCs5 . Others put the number at close to 75—and growing. Ultimately, what characterizes an OFC is not so much where it is, as what it does.
Many OFCs exist because of the confidentiality they provide.Individuals,wanting to shield accounts from the reach of upheaval in their home countries,political enemies,plaintiff attorneys,or grasping government tax authorities,seek out OFCs because they generally shield information on accounts established in their countries. In countries such as Singapore, Luxembourg, and Switzerland, the use of tax havens is not illegal. Indeed, many so-called tax havens have no taxation at all in their countries—at least on offshore accounts—and have no laws on their books addressing the subject of tax evasion.
There is great money in being a tax haven. Almost all OFCs keep their taxes low,if not at zero.Their income is derived from assessing fees on offshore accounts—which are much easier to collect. The British Virgin Islands,for example, maintains approximately 700,000 offshore companies.The tiny British overseas territory of Bermuda is one of the richest places in the world per capita because of the fees collected from its offshore clients. Now, locations as disparate as Dubai,Saudi Arabia,Shanghai,Khartoum,and Kuwait are in on the action.Many small countries,devoid of large populations or natural resources,find that being an OFC is a great way to make a living.
An Established Practice
Approximately 200,000 OFC companies are established annually worldwide. Several million are currently in existence.Corporations use them for many reasons, but one of the primary reasons is to avoid taxation in their home countries.Much of this is attributed to “transfer pricing,” in which a company undercharges its own OFC-based subsidiary for shipped goods, which are then sold to an end user for a greater price,thus putting the lion’s share of its income and profit offshore, away from domestic taxing authorities.The infamous Enron, for example, had approximately 700 companies—no more than registered names sitting in small law offices—in the British overseas territory of the Cayman Islands.
Corporations using this methodology say it is necessary to remain competitive in a global business environment. Microsoft, for example, has transferred many of its trademarks and patents to a subsidiary in Ireland—a tax haven country— collecting much of its software licensing income from around the world in Ireland instead of in the U.S., where it would pay more taxes.Today, 83 of the 100 largest publicly-traded corporations maintain offshore accounts.
Simple Cost Reduction Practices
When I was in the corporate world, we used our Panamanian OFC company to invoice the Brazilian government for our multimillion dollar operations in Brazil. For years, this kept taxes in Brazil, the U.S., and Panama, all virtually nonexistent.In the financial world,three-quarters of the hedge funds in the U.S.have clones in OFCs in order to attract foreign investor clients. This ensures client anonymity and incomes free from U.S. taxation.
Multinational companies compete globally and operate without borders. They argue that minimizing taxes is a necessity in today’s world. They view the practice of reducing tax burdens in the same way as reducing labor costs and overhead by moving operations offshore, with call centers in India and the Philippines.
Nevertheless, many say that tax havens are used as a vehicle to hide nefarious activities by drug-traffickers, money-launderers, fraudsters, terrorists of all stripes,tax evaders,politicians and dictators who excel in looting the public coffers,all use the secrecy and anonymity of OFCs to protect their operations and lifestyles.
The numbers are staggering. A 2005 briefing paper estimated the stock of private wealth held ‘offshore’ by rich individuals,and largely undeclared in the country of residence, is about US$11.5 trillion6. The annual worldwide income on these undeclared assets is estimated at about US$860 billion, and the annual worldwide tax revenue lost on such undeclared income is about US$255 billion. It is estimated, however, that over 50 percent of cash and listed securities of rich individuals in Latin America is held offshore.
Flight Capital
Frequently, funds desperately needed for development in poorer countries is transferred to wealthier countries via so-called flight capital (the deliberate and illicit disguised expatriation of money) to OFCs—never to return again—reducing domestic resources available for development and financing public services, depressing economic activity, and negatively impacting long-term growth rates. In Africa, for example, it is estimated that US$148 billion of flight capital is drained and sent to OFCs each year.
Nauru,a small South Pacific island with a population of 11,000,requires no disclosures, and has no taxes. It played a major role in the pillaging of Russia after the fall of the Soviet Union. For example, in 1998 alone, the Russian Central Bank admitted that US$74 billion had been transferred from Russian banks to offshore accounts—US$70 billion of which went to accounts held by banks in Nauru.
Many in the U.S. argue that, whether it is corporate wealth, private wealth, or stolen wealth, the results are the same—income needed for government services is being severely eroded by the use of OFCs. From 1996 to 2000, for example, approximately 61 percent of U.S. companies paid no federal income tax, largely because of offshore income. According to a recent Government Accountability Office report,in 2004,large U.S.corporations paid an average effective tax rate of 25.2 percent on domestic income and an effective rate of about 4 percent on foreign income, not including taxes paid to foreign countries.7 In the U.S., the Internal Revenue Service estimates that between US$5 billion and US$30 billion annual tax income is lost as a result, placing an undue burden on the individual taxpayer to carry the burden of maintaining essential public services.
The World Reacts
Great pressure is being placed on tax haven countries by world organizations to tighten controls and reduce anonymity for account holders. Many OFCs are willing to comply—to an extent. To most, however, the anonymity of account holders is sacrosanct. Some OFCs, like the Cayman Islands, don’t even require disclosure of the beneficial owners of the accounts. Even if they want to cooperate with other countries, they don’t have the necessary information. Many small, tax haven countries are reluctant to cooperate with stronger economies seeking information and risk losing lucrative OFC business,believing these demands provide evidence that globalization mainly benefits richer countries at the expense of the developing world. They argue that they need the revenue this business generates, saying that it is essential for them to compete in the world and raise living standards for their own population.
More stringent rules would cause a loss of income to OFCs, but also multinational companies would certainly become less able to compete with competitors in countries with lower taxes.Countries who wish to attract and maintain more business to their own shores in order to generate employment and more tax revenues are being forced to compete with the low-tax or no-tax OFCs— a situation they fear will create a “race to the bottom,” and be disastrous for all in terms of tax revenues.
No matter which side one favors, OFCs will remain, in one form or another, a place for shady and not-so-shady people.
1 www.ustreas.gov/press/releases/tg119.htm
2 www.imf.org/external/np/ofca/ofca.asp
3 www.uiowa.edu/ifdebook/faq/faq_docs/capital_controls.shtml
4 www.nytimes.com/2006/12/18/world/18expat.html?pagewanted=print
5 www.fsforum.org/press/pr_000526.pdf?noframes=1
6www.taxjustice.net/cms/upload/pdf/Briefing_Paper_-_The_Price_of_Offshore_14_MAR_2005.pdf
7www.gao.gov/new.items/d08950.pdf
More articles >> |
