Sovereign Rights Of Tax Havens And The Charge Of Harmful Tax Competition
12 November 2011
Posted by: Author: Abiola Sanni
Sovereign Rights Of Tax Havens And The Charge Of Harmful Tax Competition
The ongoing financial meltdown resulting mainly from the failure of national financial institutions in the United States and United Kingdom has brought into focus the need to overhaul domestic financial supervisory system and create transnational or global regulatory institutions.For reasons that are far-fetched, part of the blame had been put at the doorsteps of tax havens and offshore financial centres (OFC).There are extreme arguments by protagonists of tax haven and anti-tax haven pressure groups that need to be moderated.For example, some see tax havens as friendly or a soft tax system, fiscal refuge or fiscal paradise from the confiscatory hands of the Leviathans.Others see them as financial cesspools teeming with dirty money, crooks and tax evaders.
We interrogate the tension between the right of a nation to design its tax policies based on its own priority and the claim by developing countries that such policies are harmful to their own economies. The paper briefly examines the concept of fiscal sovereignty, the historical development of tax havens and the multilateral pressure being exerted on the tax havens to share information on taxable activities within their jurisdictions.I am of the view that it is unfair for the developed countries (who helped create the tahavens in the first instance) to encroach on their fiscal sovereignty in a bid to protect their own tax base especially when they have not violated any rule of international law.
Fiscal sovereignty can simply be described as the legal right of a country to maintain control over its fiscal policy without any supervisory control from any other country. As far back as 1735 in the case of Boucher v Lawson, it has been firmly established that a forum court will not take notice of the revenue law of another country.In Government of India v Taylor, the House of Lords rejected the claim for the recovery of capital gains tax levied by the Indian Government on a company trading in India but whose assets had been transferred to England shortly before it was wound up.Thus, the foremost criterion for taxation is physical presence within a jurisdiction.The challenge posed by this rule is that a country must devise means of collecting the taxes due to it from a taxpayer while the taxpayer or his property are still within its jurisdiction or enter into double taxation agreement with its trading partners.
Tax competition and foreign direct investment
The rights of the taxpayers have to be considered vis-à-vis that of the states.An aspect of fiscal sovereignty is that every country is free to determine its tax policy and what tax(es) to impose at what rate.This principle inexorably leads to the existence of different types of taxes and rates from one country to another. In an international market place, taxpayers who consider the tax rate of a particular country to be too high or its system too complex may be tempted to engage in forum shopping.
In this regard, the right of taxpayers to engage in tax planning or tax avoidance is trite.In recognition of the propensity to allocate more resources to more conducive jurisdictions with low or no tax rate,every nation seeks to implement fiscal policies that would make it a preferred destination for foreign direct investments (FDI). Every nation, no matter how well developed, desires to attract FDI into its economy. Foreign direct investments generally provide long-term investments that generate multiplier effect through the entire value chain of production to consumption.Generally the flow of FDI is from developed nations that have accumulated capital to developing or less developed nations. Foreign investments do not come cheap.There is a long check list of what investors would look for before throwing their hat into the ring.So countries that desire to attract FDI must do a reality check of the requirements.
Tax haven and tax policies
Tax haven is a fluid concept in the sense that there is no consensus on what it means.Hence, it is difficult for two commentators to agree on a list of tax havens.A tax haven is a state or a territory that imposes little or no tax on the income from transactions carried on there.Tax havens grew out of the late 19th century British System that began granting independent economic governance to protectorates like the Channel Islands,which then became easy placesfor people to protect money, hence the term ‘off-shore accounts’. Modern tax havens can be organised into three groups. The first is the UKbased or British Empire-based tax havens.This includes British Crown dependencies such as the Channel Islands, Jersey, Guernsey and the Isle of Man, British overseas territories among which the most significant are the Cayman Islands, Bermuda, British Virgin Islands, Turks and Caicos and Gibraltar, and recently independent British Imperial colonies such as Hong Kong, Singapore, the Bahamas, Bahrain and Dubai.Less significant in terms of impact, but more numerous, are newly independent British Pacific territories.The second is European havens consisting of the Benelux countries – Belgium, Netherlands and Luxembourg – Ireland, and of course, Switzerland and Liechtenstein.The third category is the new tax havens from the transitional economies in South America and Africa.This will include Mauritius, Seychelles, Panama and Uruguay.
Most tax havens are tiny islands with small economies.They produce few goods locally. In fact, many do not have domestic industries and are therefore import-dependent. In recognition of the limitation of their productive capacity and other factors, they have adopted the policy of imposing little or no tax with the hope of attracting high net-worth individuals and corporations to transfer needed skills and resources to their territories.Invariably, they are able to attract capital in excess of their actual requirements that are routed to other locations where they are invested in actual productive assets. What the countries lose in form of direct taxes, they are able to make up from indirect taxes, tourism, increased volume of professional services, and real estate transactions among others.
Through this policy, the jurisdictions have become relatively prosperous and major players in movement of funds for financing massive FDIs across the world.For example, six of the Forbes billionaires reside in Monaco making one in every 5 400 residents worth over a billion Dollars. Luxemburg is said to be the richest member state of the European Union and perhaps the world-leading hub for global fund distribution. Ireland was able to diversify its economy by using structures such as the Shannon Free Zone and the International Financial Centres in Dublin.
The tax havens have tried to justify the policy of little or no taxation of income flowing through their economies on the basis that they have little or no connection with their jurisdiction either in terms of source and ultimate destination for productive investment.It is argued that they consider it administratively more convenient to raise needed government revenue through indirect taxes (sales tax and import duties) than taxes on income. It is also argued that this is in tandem with economic theory that indirect taxes are preferable to direct taxes.Also, reporting income tax activities of non-residents will benefit foreign jurisdictions without creating a domestic benefit for the tax havens.
Tax havens have been accused of causing fiscal degradation and a race to the bottom; that is, they have caused other states to embark on reduction of tax rates in order to attract investment and protect the erosion of their tax base.The anti-tax haven pressure groups have argued that income taxes exist and are high(er) in the developed countries because of the recognition of the utility of income tax as a potent weapon for development and redistribution.
The main arguments against tax havens however are threepronged.First, they provide willing sanctuary for tax evasion.Second, they have poor financial regulations.Third, they offer opportunities for money laundering by offshore residents.
Unilateral and multilateral responses
There is no doubt that the existence of tax havens has telling effects on the revenue of the developed nations whose residents have found sanctuaries in tax havens.This is more so when the number of tax havens has multiplied dramatically in the past two decades and appears to be waxing stronger in their role as conduit for international financing and FDIs.Therefore, the nations that are hurt most by this development cannot be expected to stand by idly and watch their tax bases eroded in the face of rising domestic budget deficit with its concomitant sociopolitical implications.In developing their appropriate responses, the states are significantly hamstrung in one way.They are unable to ban their residents from investing in tax havens as this would amount to abridgment of their fundamental right.What could be done within the law is to strengthen the administration and enforcement of income tax to detect and tax foreign income of taxpayers.One of the surest strategies for achieving this would be to obtain credible information on taxable income of their residents in tax haven and OFCs.
The United States, being unable to withstand the effect of the activities of tax havens on its economy, had initiated some unilateral measures. In 1983, President Reagan signed into law the Caribbean Basin Economic Recovery Act, which provided economic benefits to tax havens that agreed to an information exchange agreement with the US. There was also a review of the tax law geared towards curbing tax evasion and tax planning induced by the activities of tax havens.Subsequent administrations in the US have continued to develop policies along this line with partial success.
However, in recognition of the limit of unilateral actions, developed nations have turned to Organisation for Economic Co-operation and Development (OECD). OECD has conducted useful researches and studies that portray the activities of tax havens as harmful, inappropriate and even illegal. OECD launched tax-havens campaigns around the mid-1990s. In 2000, it published a report titled ‘Towards Global Tax Cooperation’ which contains measures to be taken by its non-co-operative member countries in the fight against tax havens.It must, however, be noted that this was not satisfactory to even some developed countries as some members of OECD were caught by certain aspects of the definition of tax haven adopted in the report.
Apparently due to lack of convergence, the OECD changed its approach as from 2001 from the initial aggressive stance to non-belligerent approach, which regards the tax havens as dialogue partners in a conversation about harmful tax practices.The thrust of the approach is to encourage the conclusion and utilisation of bilateral tax information-exchange agreements particularly between tax havens and developed economies.The OECD has designed a model information-exchange agreement in this regard which has been adopted widely.There is yet no convergence that the tax havens are in breach of any generally accepted international law governing these issues.This has compelled OECD to look beyond the instrumentality of law in getting the listening ears of tax havens.
Surprisingly, a resort to persuasive tactics has achieved more results than coercive tactics or hard power could have achieved.Recently, the OECD established the Global Forum on Transparency and Exchange of Information for Tax Purposes (GFT).The GFT was initially created on an ad hoc basis in 2000 but it was later restructured in 2009.It now has 101 member countries including all G20 members, all OECD countries and all major tax havens and OFCs.The main objective of the GFT is to ensure that its members conform to certain standards viz. setting up mechanisms for exchange of information upon request, making available reliable information (in particular bank, ownership, identity and accounting information) and powers to obtain and provide such information in response to a specific request in a timely manner; and ensuring respect for safeguards and limitations and strict confidentiality rules for information exchanged.
Currently more than 600 agreements have been signed by jurisdictions that were hitherto identified by the OECD as not substantially implementing these standards.The existence of tax havens has generally helped to moderate tax rates. Attempts by developed countries to eliminate tax havens are primarily to protect their revenue base.Fiscal considerations should be disentangled from banking and exchange control considerations.While the international community may be justified in putting pressure on tax havens to adopt measures, which will promote transparency and minimise the risk of money laundering, the same cannot be said of fiscal matters.Fiscal matters remain the prerogative of each state unless such rights are voluntarily limited by treaty obligations.In this regard, the best approach for the developed countries is to deepen the existing dialogue instead of the use of duress or undue influence.
There is need for tax havens on their part to develop a model of tax treaty or information exchange agreement that will be fair and equitable in the distribution of taxing rights on businesses that have transnational dimension.Since agreements are based on freedom, tax havens are enjoined to carefully consider the terms of any information sharing agreement before ratification.
Source: By Abiola Sanni (TaxTALK)