Understanding Tax Havens

The story goes that the Swiss bankers had invented secret banks to protect the assets of Jews from the Nazis. But in reality, they were invented to protect the bankers from prosecution by other states. This was among the first instances of ‘safe havens’ for people with special monetary needs. 

Since then, people have interpreted different meanings of it and put them to different uses. But the intention behind all of it is the same- to save the additional money they earn. 

Tax havens sound classy and mischievous. Let’s mull over it today. 

What is Tax Haven?

Also called as an offshore financial center, these are places with defined geographical jurisdictions that intentionally create laws to support transactions by people who are not of the said jurisdiction. This is done with the intent to avoid taxation or regulations, which they execute by providing a legal blanket of secrecy so that it becomes difficult to identify the beneficiaries. 

Two types of entities use tax havens- individuals and institutions. While both use it to save taxes, and the techniques are similar, the intent of why they use it differs slightly. They use offshore companies and offshore trusts to do it. 

The major reason why the super-wealthy individuals use it is for tax avoidance on the income they do not wish to disclose. And as for the companies, some of these ‘tax havens’ charge no corporate tax whatsoever, allowing the company to use its complete revenue earned for growth and expansion. 

Where are these tax havens?

These tax havens are present all over the world. Some of them, which we will see below, are independent countries, and some of them are within a country and or are territories. 

What is a Shell Company?

A shell company is one that exists only on paper. It is just like a shell, hollow from the inside, hence the name. These shell companies do not have active business operations or any physical assets. They could hold money, intellectual property, luxury homes etc.

Shell companies have a reputation for being bad, but they are not necessarily all bad. There are some legitimate reasons why shell companies are created like, it could be used as a vehicle to raise funds. 

It is not illegal for large corporations to set up shell companies in tax havens, again, unlike popular belief. These corporations do so to save heavy taxes that otherwise would be levied on them in the domicile country. This process is called “offshoring”. 

What Are the Top 10 Overseas Tax Havens?

These tax havens offer the most tax benefits to individuals and institutions. The top 10 tax havens are- Luxembourg, Cayman Islands, Isle of Man, Jersey, Ireland, Mauritius, Bermuda, Monaco, Switzerland, and the Bahamas.

Benefits of Tax Havens to the Companies

These are some benefits that companies enjoy if they decide to open an offshore account. 

1. The very first and major reason why businesses choose to open offshore accounts is that it helps them save a huge chunk of money on taxes. It does so by channelling the payments, profits, investments etc., through these offshore companies. 

2. Drug companies can save billions in taxes by selling patents to offshore companies and pay a big fat licensing fee, which enables them to record lower profits back at the home company. 

3. Since companies are left with a lot of capital that gets saved by avoidance of tax, they can invest it in the growth and expanding the business furthermore.

4. There is mostly no capital gain tax which encourages investors to invest more. 

Benefits of Tax Havens to a Nation and Government

The following are a few benefits that the host nation and its government enjoys:

1. Tax havens are not completely tax-free. They do charge tax, but it is at a lower rate compared to other countries. To cover the losses in tax revenue, high customs and import duties are levied on the institutions. 

2. When an institution brings a large sum of money into the banks of tax havens, that money is invested to earn profits or for the growth of the host company. 

3. Some tax havens may or may not charge a registration fee for companies, and some renewable charges to be paid each year. These fees become a source of fixed income for the host nation.

4. The host nation could benefit from companies that set up in tax havens as it could not only provide capital, but also offer jobs to the natives of the country.

The Bottom Line

The hide and seek is good as long as it is legitimate. The moment it steers into an illegal area, it could become a financial curse instead of a boon. It also creates a concern that labour migration will follow from poorer countries to these rich tax havens, which in turn could impact the poorer countries' growth. 

There goes a saying that “too much of anything isn’t good”. This rightfully applies here as individuals and companies sometimes forget the line that marks tax avoidance and tax evasion.

Ensure that you never fall into the trap. 

Till we meet again.