The Origin of Tax Havens and Their Impending Doom

For A Few Dollars More

Every couple of years some scandalous documents emerge mysteriously and reveal to the vast majority of have-nots the most jealously guarded secrets of the rich and powerful. These leaks have a reputation for precipitating political chaos, social uproar and even regime changes as they divulge the details of financial gymnastics that your neighbourhood politician or favourite celebrity adopted to avoid taxes and in some extreme cases, international sanctions. In some cases, they also reveal cases of fraud, money-laundering, kleptocracy and cronyism running through the highest echelons of power. A lot of this may be unethical but not all of it is, strictly speaking, illegal which is why there is little achieved by way of prosecution following such leaks. 

The latest collection of leaked documents is aptly named Pandora papers and is the biggest of its kind; 11.9 million confidential files from 14 offshore services firms have found their way to the general public thanks to the painstaking efforts of the International Consortium of Investigative Journalists (ICIJ). To give context regarding the size of this leak, two of its predecessors, the Panama and Paradise papers, revealed details obtained from one offshore service firm each – Panama-based Mossack Fonseca and Bermuda-based Appleby respectively. Two-thirds of the dubious companies exposed by the Pandora papers come from the British Virgin Islands and concern. 

Now, if you have been paying attention so far, you must have noticed a pattern: all these leaks seem to emanate from relatively unknown locations, from idyllic but sparsely populated Caribbean islands to be precise. This is not a coincidence, nor is it an aberration. These countries, along with a number of others such  as Singapore, Luxembourg, and Switzerland are called ‘tax havens’ – a term loathed by most tax-paying citizens. But do they really understand what a tax haven is?

To the common man, a tax haven is a country with no tax liability for account holders. While largely true, this is an incomplete definition. Apart from offering low taxes, these countries need to be able to guarantee long term stability – political  and legal – and a high degree of confidentiality. So, while tiny nation states comprise the bulk of tax havens, there are some major economies on the list too as they can guarantee the same privileges. For example, there exists a tax haven of sorts even within the United States; the state of Delaware does not impose corporate tax which has made it the state of choice for corporate incorporation. The Netherlands and Ireland are also seen as tax havens operating from within the EU. Now while these countries deny the accusations, the migration of big companies like Google and Twitter to these nations indicates otherwise.

The beginning of the end?

The 2008 crisis and the subsequent decade of global austerity has turned the world’s attention to these tax havens. Earlier, they were seen as paper cuts – superficial and harmless, but swingeing budget restrictions in the aftermath of the 2008 crisis, proved  that these havens are bleeding major economies to death with a thousand cuts. The IMF estimates that governments lose $500-600 billion a year in corporate tax revenue. This is concerning for all countries but more so for the richer ones, given that the biggest multinationals (and for arguments sake, the biggest tax evaders) operate predominantly in these countries. 

Thus, it was no surprise for anyone when the OECD – an intergovernmental economic organisation of 38 member countries – announced that efforts are underway to implement a global corporate tax floor of 15% by next year. According to the OECD, 136 countries have already given their assent in principle to the move. Experts believe the proposal has been under consideration within the G7 for years and was fast-tracked owing to the regime change in the US and the economic effects of the Covid-19 pandemic. The current agreement calls for signatories roll out laws by 2022 that would mandate the following: 

• A global minimum tax rate of 15% to overseas profits of multinational firms with revenue in excess of €750 million. While nations are still free to have their own local tax structure, they can eliminate the advantage of shifting profits by imposing a tax ‘top-up’ on firms that take advantage of tax havens. 
• Allow countries where the multinational company operates to tax the multinational’s excess profits – profits exceeding 10% of firm revenue.

While the deal needs to be formally endorsed by the finance ministers of G20 nations in the upcoming G20 convention, it is a certainty that the world is stepping away from a never-ending ‘race to the bottom’ that saw countries outdoing each other to attract foreign investment and multinational companies. However, one must be cautious in celebrations as this deal still does not concern individuals who have stashed away $8.7 trillion in tax havens. Oxfam has also raised serious doubts on the underlying motivations of this deal as it fails to address the problem of ‘onshore’ tax havens. In conclusion, this agreement does seem like a step in the right direction with loopholes the size of Cayman islands, intent and implementation will decide its fate.