The time when tax havens consisted of exotic islands where a few gangsters or corrupt dictators hid their fortunes is long gone. Tax havens have become sanctuaries for an array of multinational firms and their subsidiaries or corporate parents. They form part of the background to most of the financial crises and scandals of the last 20 years. “Madoff Spotlight Turns to Role of Offshore Funds,” ran a New York Times headline on December 30, 2008. It had taken just 19 days after Bernard Madoff’s $65 billion swindle broke into the open on December 11 to draw the link between the swindle and tax havens.¹

Since the financial crisis of 2008, politicians’ attitudes toward tax havens have changed. Government leaders now recognize that tax havens endanger public finances and their countries’ political stability. The OECD is stepping up the fight against international tax fraud and, increasingly, promoting international tax transparency. At the London G20 summit in April 2009, countries announced the advent of a new era of transparency and tax cooperation.²

Despite these advances, the problem remains unresolved. Trillions of dollars continue to accumulate beyond the reach of government in tax havens, with the middle class left to fill the public coffers and make up for this shortfall. As protesters outside the G20 summit at Cannes, France, in November 2011 called for an end to tax havens, officials of the G20 inside issued a list of 11 countries, including Switzerland, that they said were doing too little to cooperate.³ However, no sanctions were announced.

What is a tax haven?

According to a study published in December 2006 by the U.S. National Bureau of Economic Research, about 15 per cent of countries around the world are tax havens. Most of these countries appear to be financially well off and are relatively small in size.⁴ Few OECD member countries have precise definitions, though. Most see tax havens as states with systems enabling nonresidents to shirk tax obligations to other governments, along with bank secrecy.

The OECD uses three criteria to determine whether a country is a tax haven: absence or near-absence of income taxes; absence of transparency in the tax system; and a refusal to exchange financial or tax information with other governments. In addition to tax havens, there are three other types of haven-type zones. In offshore zones that are home to banks, insurance companies or fund managers but lack a true financial regulatory apparatus, companies can avoid various restrictions by having addresses only in these states. Then there are bank havens, states characterized by a high level of bank or financial secrecy. Finally, there are judicial havens, which evade criminal and other laws generally adopted by other states and refuse any exchange of information with other states.

Some may be multihaven zones, falling into more than one of these categories. Strictly speaking, a tax haven differs from the three other types, but in practice these distinctions are often blurred. It is not uncommon for offshore zones to be regarded as tax havens.

Where are these tax havens located?

Ronen Palan, professor of international political economy at the University of Birmingham, separates tax havens into two geopolitical poles.⁵ The first group gravitates around the London financial centre, mainly encompassing dependencies of the British Crown such as the Isle of Man, the Channel Islands of Jersey and Guernsey, the Cayman Islands, Bermuda, the British Virgin Islands, the Turks and Caicos and Gibraltar, as well as former parts of the British Empire such as Hong Kong, Singapore, Malta, the Bahamas, Bahrain and Dubai. The other group developed around economic activities in the rest of Europe and includes the Benelux countries (Belgium, the Netherlands and Luxembourg) together with Ireland and, of course, Switzerland and Liechtenstein. Two other tax havens, Panama and – to a small extent – Uruguay, operate independently of these poles.

Each year, the OECD draws up a list of uncooperative tax havens. In 2000, the OECD identified 38 such entities, most of them Caribbean and Pacific islands and European microstates. In 2009, in coordination with the G20 summit, the OECD published a new listing of tax havens divided into four categories, depending on the level of noncooperation (white, pale grey, dark grey and black). The white list encompasses jurisdictions that have broadly applied a standard of transparency and information exchange. This standard involves an obligation to exchange information on request in all taxation-related areas for the administration and application of national tax laws. The two grey lists cover tax havens and financial centres that have made commitments concerning this standard but have not yet applied it. To go from a grey list to the white list, countries must sign at least 12 agreements with other countries. Finally, the black list consists of jurisdictions that have not agreed to apply the internationally recognized tax standard. As of December 15, 2011, there weren’t any countries on the black list and just three on the two grey lists (Nauru, Niue, Guatemala).⁶

These results are surprising. It is not as if there is any reason to believe tax havens are disappearing. In one year, tax havens such as Liechtenstein, the Cayman Islands, Monaco, the Bahamas, Bermuda and Singapore ended up on the white list by signing most of their information exchange agreements with other tax havens.⁷ At the very least, it is too early to judge the effectiveness of the recently signed agreements, the application of which will be subject to meticulous follow-up by the Global Forum on Transparency and Exchange of Information for Tax Purposes. We will take a closer look at this body’s role further on.

What are the results of tax havens?

Tax havens cause harm to countries that are not tax havens, which suffer deterioration of public finances, increased financial instability and injustice. Let us take a closer look at each of these problems.

The existence of tax havens leads to capital flight from non–tax havens, which are deprived of taxes they would otherwise collect as companies move head offices or activities to tax havens. On January 5, 2010, Canada’s then–Revenue Minister Jean-Pierre Blackburn stated that Canadian companies and individuals had a total of C$146 billion invested in tax havens in 2009, a substantial increase from the $88 billion total in 2003. “Safeguarding cash in those places is not illegal,” noted a Reuters report, “but makes it easier to avoid declaring income for tax purposes.”⁸

The reported amounts are just approximations. Whether at the national or international level, nobody has yet managed to put an exact figure on the scale of revenues lost to tax havens. But there are some credible estimates.

• A study published in March 2010 by Global Financial Integrity, a Washington-based international organization that works to curtail illicit financial flows, estimates the total amount deposited by nonresidents in offshore financial centres and tax havens at about US$10 trillion (for the sake of comparison, annual worldwide GDP in 2010 was $74 trillion). The study also states that these deposits are growing by an average of 9 per cent a year, substantially more than the rate of increase of worldwide wealth in the last decade.⁹
• According to an October 2007 reportpublished by Tax Analysts, a U.S. tax policy organization, “At the end of 2006, there were $491.6 billion of assets in the Jersey financial sector beneficially owned by non-Jersey individuals who were likely to be illegally avoiding tax on those assets in their home jurisdictions. We estimated the comparable figure for Guernsey to be $293.1 billion.” If we add $150 billion in investments in the Isle of Man, as estimated by Tax Analysts in a November 2007 report, we get assets totalling $935.2 billion in these three islands alone.¹⁰
• According to a March 2005 study published by the Tax Justice Network, a pressure group that opposes tax havens, the total of large private fortunes held in tax havens was about $11.5 trillion, producing an annual return of about $860 billion (at a rate of 7.5 per cent) and a $255 billion loss of tax receipts.¹¹ These figures do not take into account tax losses resulting from the multinationals’ offshore tax strategies or transfer costs or assets below $1 million held by individuals. Rates of return were probably less than 7.5 per cent in recent years, but international capital markets have grown substantially in that time.
• A report issued on July 16, 2008, by a U.S. bipartisan Senate Permanent Subcommittee on Investigations estimated that offshore abuses cost U.S. taxpayers an estimated $100 billion each year.¹² And again, that study did not consider the public revenues that are lost by industrialized countries because of tax strategies of the multinationals in tax havens.
• An analysis produced for Oxfam in March 2009 by James Henry, former chief economist of McKinsey & Company,¹³ suggests that at least $6.2 trillion from developing countries is held by individuals in offshore accounts, depriving these countries of $64 billion to $124 billion annually in tax receipts. Total losses may thus exceed the $103 billion these countries receive annually in development assistance. And if the amounts held by private companies in offshore accounts were included, this shortfall would be much higher. Henry indicates that this capital flight from developing countries is growing quickly, with an additional $200 billion to $300 billion moving into offshore accounts each year.

It should also be noted that tax havens cause a deterioration of public finances in non–tax havens by exposing them to fierce tax competition. Because of the existence of tax havens, other countries are tempted to reduce their tax rates to attract new investment or retain companies already established on their territory. In Canada, the federal government is planning substantial tax reductions for multinational corporations. In 2012, Canadian multinationals were to be taxed at a legal rate of 15 per cent at the federal level (or a total of about 25 per cent a year with provincial tax added), compared to 35 per cent in the United States (to which must be added the corporate taxes applied in certain states).

The opaque nature of tax and banking havens prevents fiscal, judicial and financial authorities in other countries from enforcing laws and regulations. Free from requirements to publish statistics, financial statements and other information, multinationals can place dicey assets outside public scrutiny and hide the origin of funds. These veritable black holes are obviously valuable to transnational criminal organizations as well.

This opacity also leads to significant errors in trade and financial statistics. It disconnects a country’s real economy from what shows on the books, depriving governments and investors of information they need to assess risks and make the right decisions. For example, going strictly by public information, one would learn that Europe’s largest importer of bananas is the tiny island of Jersey, off the coast of Normandy, but in fact no containers of bananas have ever been unloaded in the port of Jersey.

A wide array of events proves that the presence of tax havens lurks in the background of the 2007–10 financial crisis. For example, the failed British bank Northern Rock charged its short-term debt to Granite, a Jersey-based subsidiary. According to a February 2008 BBC News report, Granite, a “legal vehicle ultimately controlled by Northern Rock but registered as a trust in Jersey,” was “set up to allow the Northern Rock to sell off large parts of its mortgage book to bondholders. It was this financing model which got Northern Rock in trouble when the market for such mortgage-backed bonds dried up in August .”¹⁴

An investigative report by McClatchy News in 2009 showed how the investment bank Goldman Sachs used the Cayman Islands to promote $40 billion in AAA-rated junk securities to private and institutional clients.¹⁵ The McClatchy report noted that Goldman Sachs “used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean that companies use to bypass U.S. disclosure requirements.” In addition, Goldman “was the lead firm in marketing about $83 billion in complex securities, many of them backed by subprime mortgages, via the Caymans and other offshore sites, according to an analysis of unpublished industry data by Gary Kopff, a securitization expert. In at least one of these offshore deals, Goldman exaggerated the quality of more than $75 million of risky securities, describing the underlying mortgages as ‘prime’ or ‘midprime,’ although in the U.S. they were marketed with lower grades.”

This was how Goldman Sachs got rid of all the subprime mortgages it held shortly before their value collapsed in 2007. At the same time, the bank was speculating on the markets by taking short positions on these same securities. Goldman Sachs used its Cayman Islands branches to promote these securities without having to comply with U.S. regulations, which would have required it to warn its clients that it was using its own money to bet against its customers.

The first form of injustice caused by the existence of tax havens arises from the fact that it creates a two-tier international tax system: one tier for ordinary people and another for the rich. Tax havens are used by the wealthy and the powerful to hide wealth and avoid taxes. They help shape a certain type of globalization in which the gap between the very wealthy and everyone else keeps growing. A report issued in July 2010 by the American group Business and Investors Against Tax Haven Abuse noted that “Wainwright Bank, a socially responsible local lender based in Boston, paid 11.8 per cent of their income in federal taxes in 2009. Yet they have to compete against Bank of America, which paid no federal taxes in 2009, thanks in part to overseas tax havens.”¹⁶

The second form of injustice tax havens create is that they facilitate abuse by multinational firms of the natural wealth of undeveloped or developing countries. Jersey’s bananas are an example of this. These bananas, transiting virtually through Jersey, generate untaxed profits that accumulate in the accounts of multinationals. In 2008, OECD secretary-general Angel Gurría said that developing countries lose huge amounts to tax havens – three times what they get in assistance from developed countries.¹⁷

A third form of injustice caused by tax havens is the way they lead citizens and tax authorities to bend and possibly break laws. The HSBC-2010 and Liechtenstein-2008 affairs are examples.

In the HSBC-2010 affair, Hervé Falciani, a former bank executive with HSBC in Geneva, was arrested by the Swiss police on suspicion of data smuggling. He took refuge in France and helped authorities decrypt the stolen data. France opened a money laundering investigation and used the information obtained from Falciani to identify the alleged fraudsters. France then shared its information with other countries, including Canada. In response to the ensuing criticism, French President Nicolas Sarkozy defended the use of stolen data: “The fight against tax fraud is normal and moral. It is up to the justice system to say what happened. But what would you have said if the finance ministry had disregarded these data when it received them? Would we have been congratulated for abiding by French law?”¹⁸

The Liechtenstein-2008 scandal involved taxpayers from various countries, including Germany, France, Australia, the United States and Canada, who had transferred funds to trust accounts in Liechtenstein with the complicity of banks such as LGT Bank, owned by the Liechtenstein royal family. In February 2008, computer technician Heinrich Kieber sold financial data that incriminated 4,500 taxpayers to the German government for €4.2 million. The German government was criticized for using secret information stolen by an informer.¹⁹ Two lawyers took action against Germany’s federal government for “infidelity toward the taxpayer” and “spying of data.” Questions were raised as to the legality and ethics of the government’s move in paying a bribe to an officer of a foreign bank to essentially steal confidential data.

How tax haven planning is done

Using new means of communication, and aided by e-commerce and capital mobility, residents of countries with high rates of taxation may easily establish, or pretend to establish, their tax residence or income source in tax havens. Here are the main ways this is done.

The first way is by holding assets. A trust or corporation is set up in a tax haven to hold assets, normally administered by a resident of another tax haven. This stratagem means, in essence, that the nominal owners of these assets are not residents of a highly taxed country, enabling them to escape the tax burden that would apply to the real owner. This method is very popular. In Ireland and Switzerland, for example, total assets of these various subsidiaries work out to about $4.5 million per employee of the corporation. In Barbados, it comes to $22 million per employee, and in Bermuda to more than $45 million per employee.²⁰

A common tool for holding assets in a tax haven is the use of international business corporations (IBCs). These are companies that guarantee the owner’s anonymity, with no reporting requirements and a registration fee of about $500. There are 500,000 IBCs in Hong Kong and more than 60,000 in the Cayman Islands.²¹

Another way is by exporting commercial activities. Many companies (or portions of companies) that do not require a specific geographic location or qualified staff are set up in tax havens. Common examples are insurance or reinsurance (secondary insurance) companies with head offices in Bermuda. Others include various financial corporations, Internet-based firms and companies in the oil industry.

For example, Deepwater Horizon, the oil rig that exploded in the Gulf of Mexico on April 20, 2010, was registered in a tax haven. The Deepwater Horizon rig was leased by BP but remained the property of Transocean, an offshore drilling contractor. Transocean moved its country of registration from the United States to the Cayman Islands in 1999 and from there to Switzerland in 2008. Transocean justified its decision by the need to “improve our ability to maintain a competitive worldwide effective corporate tax rate.”²²

The growing scope of intangible assets within companies facilitates the use of these stratagems. According to a study published in March 2007 by the consulting arm of Ernst & Young, intangible assets accounted for more than 60 per cent of the value of Europe’s 100 largest corporate groups.²³ And it is relatively easy to justify the location of patents, copyrights, rights to the use of logos and the like in tax havens. In these cases, to export income to tax havens, all that is needed is to show that the offshore company is the entity legally holding the right to exploit these invisible assets. We have thus seen Microsoft, pharmaceutical firms Pfizer and Bristol-Myers Squibb and telecoms giant Vodafone relocate invisible assets and intellectual property to Dublin.

An article on the Bloomberg news wire in October 2010 reported that Google Inc. had reduced its tax payments by nearly $3.1 billion since 2007 and brought its international taxation rate down to a record low of 2.4 per cent. This tax optimization was made possible by a legal technique commonly called “Double Irish,” which apparently is open to various large companies in the technology sector, such as Microsoft, Apple and IBM. In Google’s case, its use relies on an agreement with the U.S. tax authorities on the transfer price of intellectual property. It enables Google to benefit from a lower tax rate provided these profits are not repatriated to the United States.²⁴

A third way is through financial intermediaries. Much of the economic activity in tax havens consists of financial services provided by mutual funds, hedge funds, life insurance companies and pension funds. Funds are usually deposited with an organization set up in a tax haven that serves as an intermediary and are then invested, most often in the original highly taxed jurisdiction. Although such stratagems do not normally allow taxation to be avoided in the taxpayer’s main jurisdiction, they enable suppliers of financial services to offer multijurisdictional products without adding an extra layer of taxation.

Efforts to overcome the scourge of tax havens

Banking secrecy for tax purposes came under scrutiny in a report on access to bank information issued by the OECD’s working party on tax avoidance and evasion in 2000. A Model Agreement on Exchange of Information in Tax Matters was reached between the OECD and certain non–OECD member countries in 2002. Since then, this model has served as a basis for several agreements on exchanges of tax information worldwide. This led, in 2004, to the first major revision of the OECD’s Model Tax Convention, specifying that banking secrecy should not constitute an obstacle to the exchange of information.²⁵

Following the HSBC and Liechtenstein affairs and the recent financial crisis, the issue of transparency and information exchange to fight tax evasion has been the focus of new activity. The standard of transparency and information exchange developed by the OECD is now approved by all the main players.²⁶

In 2009, the Global Forum on Transparency and Exchange of Information for Tax Purposes approved a process of peer examination that was set to last three years. All members of the Global Forum and all jurisdictions listed by the Global Forum must be examined in two phases. Phase 1 assesses the quality of each jurisdiction’s legal and regulatory framework on information exchange. Phase 2 focuses on practical implementation of frameworks. It was expected that, by 2014, all of its more than 90 members will have gone through Phase 1 and Phase 2 examination. Canada was one of the first countries to be scrutinized by the forum, and this examination found that the elements for effective information exchange are in place. ²⁷

The European Union has emerged in the last few years as the real leader in the worldwide fight against tax havens, especially through its Code of Conduct and its savings directive.

The Code of Conduct for Business Taxation, in force since 1998, provides an informal method of regulation that is much appreciated by member governments. This code is not a legally binding instrument, but it clearly has political backing. The countries adopting it agree to eliminate various harmful practices in tax competition and prevent new ones from arising. The goal is to ensure that all tax rules are applied uniformly to each firm in a country, whether national or foreign.

The savings directive,²⁸ in force since 2005, provides that income from savings in the form of interest paid in one country to a resident of another country is taxed effectively in accordance with legislative provisions in the country of residence. To this end, there are rules favouring the automatic exchange of information between governments. Since this directive does not cover corporate entities or trusts, it can be circumvented by creating a trust in Jersey, for example.

It is worth mentioning that the EU provides a way to overcome tax barriers faced by companies that operate in more than one member country in its Internal Market: companies can be taxed on the basis of a Common Consolidated Corporate Tax Base covering all their activities in the EU. In this way, a group’s profit would be taxed only once in the EU, and the proceeds would be divided among the countries based on an agreed-on criterion.²⁹

The EU had set itself a deadline of 2008 to come up with a directive on corporate taxation, but Irish voters’ rejection of the Lisbon Treaty in a referendum on June 12, 2008, motivated in part by the threat it posed to the Irish tax system, delayed the project. On March 16, 2011, the EU finally produced its directive.³⁰ It aims for a sizable reduction in administrative burdens, compliance costs and legal uncertainties faced by companies in the EU in complying with various national systems in establishing taxable profits. The common corporate tax base would enable companies to use a one-stop scheme for their tax statements and consolidate the profits and losses they record throughout the EU.

In the United States, one of the government’s key tools is the qualified intermediary (“QI”) program. QI status is a special standing given by U.S. tax authorities to banks worldwide enabling them to buy and sell U.S. securities for foreign investors. In exchange for this, they agree to provide the Internal Revenue Service with information on all income credited to American taxpayers who have accounts with them and, above all, to collect tax for the IRS by withholding up to 30 per cent at source on dividends or interest from these investments.³¹

In March 2010, the United States adopted foreign account tax compliance legislation that will oblige all financial institutions to reveal to the IRS the identity of all clients of American nationality. Clients who refuse to reveal their identity will face the automatic withholding of 30 per cent of income from these investments. In most cases, withholding will begin on or after January 1, 2014.³² The legislation has a far more extensive area of application than the QI system (which will continue to operate) and will involve more members of the public in an attempt to cover all foreign financial institutions and not just the traditional sector of deposit-taking banks.

Like other jurisdictions, Canada has instituted rules targeting the advantages that accrue to users of tax havens. The key measures that have been taken are: rules to manage the transfer price of goods and services transacted between related parties (e.g. corporations and subsidiaries); restrictions on the deductibility of expenses; imposition of a deduction at source when payments are made to beneficiaries living in tax havens; rules for taxing income from a company or trust established in a tax haven and controlled by a resident of a highly taxed country; imposition of a departure tax when an individual, company or trust ceases to reside in Canada; and compulsory disclosure to the authorities of improper tax planning in which tax havens play a prominent role.

In the 2007 federal budget, Finance Minister Jim Flaherty stated that his government would crack down on those who avoid paying corporate income tax by intensifying the fight against the use of offshore tax havens. Canada has asked countries that are not signatories to a convention to reach an agreement on exchanging tax information within five years of a request by Canada to do so. If a territory accepts such an agreement, corporate income earned in the territory by foreign companies affiliated with Canadian companies will be exempted from Canadian income tax. Otherwise, the income will be taxable in Canada as earned. Canada was negotiating tax information exchange agreements with various territories.³³ Among those signing deals with Canada have been the Bahamas, Bermuda and the Cayman Islands.

Despite these positive actions, Stephen Harper’s government seems ambivalent about tax havens, and some of its decisions have received mixed reviews. Its 2010–11 budget contained a measure making it possible for Canadian taxpayers to avoid tax on profits from the sale of shares in Canadian companies by having them held through an intermediary residing in a tax haven.

The various advances enumerated here have reduced the extent to which fraud and tax evasion are protected. However, the problem remains, and tax havens have not truly been challenged. It is necessary to go further, and to act more quickly.

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