Tax Shelters: Crime or Intelligence?

"The best things in life are free, but sooner or later, the government will find a way to tax them."

Being an Indian, you would have heard about the famous Panama Papers leak or Mauritius leak which revealed the names of some famous personalities like Amitabh Bachchan, Mohan Lal Lohia, Aishwariya Rai or Vijay Mallya.

After listening to such prominent names, you would have thought how come such people who are earning crores in revenues are related to stealing of taxes? And on the first note, why did they need to steal? Let's find out.

Geopolitically, India is the 5th largest economy in the world with a GDP of almost $3 Trillion. This ambitious country is constantly growing in terms of economy and leaving its impact on the world with its some of the cheapest and astounding projects like Mangalyaan.

Knowing such details, it comes as a surprise that a tiny island like Mauritius with an economy of $14 Billion and a population of just 1.3 million became one of the largest foreign investors in India.

What is Tax Shelter?

A tax shelter is a process or method to reduce taxable income, thus minimising one's taxes. In simple words, it is a way through which we can save our money by paying lower taxes and still be following the government tax norms.

But, there are still a lot of terms that one must know about, that include FDI, Tax Haven, DTAA, etc. 

Role of FDI

Foreign Direct Investment (FDI) happens when a company takes controlling ownership in a business entity in another country. It is a critical driver for the economic growth of any nation and is commonly made in open economies that have skilled workforce and growth prospects. FDI's not only bringing money with them but also skills, technology and knowledge.

In India, FDI is increasing rapidly, with a CAGR of 16.58% in the last 19 years. The reason behind this increase is India's constructive factors such as high economic growth, fast population growth, English speaking people, relatively lower wages and special investment privileges such as tax exemptions.

Now, there are two ways by which India gets FDI:

1. Automatic Route: A non-resident or Indian company does not require the prior nod of the RBI or Government of India for FDI. This is the route through which most of the scams and stealing of taxes happens.

2. Government Route: The Government's approval is mandatory in this route. The company will have to apply through the Foreign Investment Facilitation Portal, which facilitates single-window clearance. The application is then forwarded to the respective ministry for further processes.

After getting a nod on the above methods, the company/country can invest in India. Service sector receives the highest FDI inflows, and it is one of the reasons for the growth in sectors.

The top countries which invest in India through FDI are Singapore and Mauritius. 

This brings us back to one of our primary questions: How come to some small tiny islands like Mauritius, Cayman, or British Virgin are one of the top contributors in FDIs to the nation?

The reason is the tax rate in these countries. These countries are termed as tax havens, which is a major reason for FDI influxes in them. 

Let's understand it. 

Tax Haven: A refuge for global wealth

A tax haven or Offshore Financial Centers (OFC) is generally an offshore country that offers foreign businesses or individuals with little or no tax liability in a politically and economically static environment. 

Another 'benefit' that comes as an icing on the cake is that these countries share limited or no financial information with foreign tax authorities. In this way, your black money is kept safe and hidden from your native country's Government.

Meanwhile, you can also keep your influential brand image without letting people know of the crimes that you are committing.

The Bahamas, Bermuda, the British Virgin Islands, the Cayman Islands, Mauritius, Lichtenstein, Monaco, Panama and Hong Kong are some of the tax havens of the modern world. The Cayman Islands and Monaco are becoming amusement parks for the richest people around the globe.

Country Name	Corporate Tax	Income Tax
Bahamas	33.8%	Zero
Bermuda	Zero	Zero
British Virgin Islands	Zero	Zero
Cayman Islands	Zero	Zero
Mauritius	22.2%	20.9%
Cook Islands	Zero	Zero
Monaco	33%	Zero
Panama	37.2%	14.9%

Source: World Data

Essentially for a nation to become a tax haven, it should have three characteristics:

1.No or only nominal taxes.

2. Lack of effective exchange of information.

3. Lack of transparency in their legislative, legal or administrative provisions.

4. No substantial activities.

Having understood the above concept, you would have now guessed how one can benefit from tax havens. This brings us to our main topic, Tax Shelter.

How does a Company Save Taxes with the help of FDI and Tax Havens?

To avail a tax shelter, a company opens its subsidiary or shifts its headquarter from its native country to one of the tax havens. By doing this, they save a ton of money on taxes which goes into their pockets. 

Let's see an example: Suppose you are a steel company in India and are liable to pay an average corporate tax of 34%. That means on earning every 100 rupees you pay 34 rupees to the Government.

Now to save this, let's say you open your subsidiary in Cayman islands where you don't have to pay any corporate tax. So now, the entire 100 rupees goes into your pocket. 

This money may now look too small on paper, but big corporates are not earning in hundreds, they earn in thousands of crores.

Let's see how big MNC's do it their way:

1. Apple: It booked an offshore amount of USD 214.9 Billion by using Ireland as a tax haven. It would have owed the US Government $65.4 Billion in taxes otherwise.

2. Nike: It holds $10.7 Billion offshore by using Bermuda as a tax haven. It would have paid $3.6 billion for taxes otherwise.

3. Goldman Sachs: It holds $28.6 Billion offshore by using Bermuda as a tax haven.

4. IBM, Microsoft, General Electric, Exxon Mobil, Pfizer and Walmart are some other big fishes that have availed this facility of tax shelter. These cumulatively have stashed $1.6 trillion offshore.

Indian companies like Flipkart have its headquarters in Singapore where they pay only 17% in corporate taxes instead of 34% taxes in India. Having registered in Singapore, it is also free from Dividend Distribution Tax.

Meanwhile, in India, the value-added tax (GST) ranges from 5% to 28% while in Singapore, it is fixed at 7%. Having such tax treaties made Flipkart shift its base to Singapore instead of India.

India loses approximately Rs. 69000 Cr ($9,718 Million) in profits to tax havens across the world. Out of which $3,440 million, go to tax havens in the European Union, while $5,988 million goes to non-European Union tax havens.

Meanwhile, such companies also start other companies in those nations which bring back the same money as FDIs bring to their parent company. The new company started may not have them entirely as the Head but may include them in their board members list. This is done in order to inflate the stock price of their company.

So as an investor, the next time you hear an FDI inflow into your favourite company, stop celebrating and get cautious and check if the investing company includes any of the board members from the parent company.

How does a Tax Haven country earn?

We live in a world where even a piece of advice is not free, then how come a tax can be free. 

Well, Tax havens are not completely tax-free. They charge a lower tax rate than other countries. So to cover their losses in tax revenues, they generally charge high customs or import duties.

They also charge a registration fee for a new company or renewal charges or license fee, which is to be paid every year. Such fees would add up to a recurring fixed income for the tax havens.

An additional benefit that a country gets is its development. By barging in foreign investors/companies, the tax haven generates employment for its residents, ameliorates its infrastructure and improves its existence on the world map.  

A Tax Shelter is a Loss for our Nation, then why is it Allowed?

The answer relies on the DTAA or Double Tax Avoidance Agreement which applies in cases where a tax-payer resides in one country and earns income in another. As stated earlier, a company is free to shift its headquarter to a tax haven or start a new subsidiary there which makes them still a citizen of their native country but their earnings are in another country. 

DTAA is a tax treaty signed between two or more countries with a key objective that tax-payers in these countries can avoid being taxed twice for the same income. 

Let's see an example: Suppose an Indian work abroad and brings his income to India to settle here in the upcoming years. Now he would have already paid his taxes in that nation, then why should he pay the same taxes in India too? That's where DTAA comes into play to avoid the doubling of taxes.

So a DTAA can either be comprehensive to cover all sources of income or be limited to certain areas such as taxing of income from shipping, air transport, inheritance, etc. India currently has DTAAs with more than eighty countries, of which comprehensive agreements include those with Australia, Canada, Germany, Mauritius, Singapore, UAE, the UK and US.

DTAAs are intended to make a country an appealing investment destination by providing relief on dual taxation. But several individuals or corporations take undue advantage of this and move their money to tax haven nations such as Mauritius having a DTAA signed with India. 

Earning their money in Tax haven nations where they already pay less taxes, these individuals benefit due to DTAA and often end up paying no taxes.

Why should you care?

You might think that if rich people or big corporations are benefiting with not paying any taxes, then why does it even matter to me. Well, it should. Because when these companies don't pay their taxes, then the Government, to meet its fiscal budget, is only left with three options:

1. To increase taxes on corporates: This will be ineffective since they will again use this loophole of DTAA or find a new one to avoid taxes.

2. To start printing more money: This may result in hyperinflation due to the prevalent black money in the country.

3. To increase the income tax: This sounds effective to them since, the rich will extort more money, the middle class will hardly raise their voices, and the poor are already exempted from tax.

The Bottom Line

There is no doubt that the stealing of taxes just to fill one's pockets is a crime. This may sound just a concept, but millions of people suffer because the Government cannot avail the basic amenities required for their survival. 

The middle-class people suffer a lot, and this pain can be understood better by an employee earning a meagre salary, which is required to pay taxes. To reduce such activities, the Indian Government has passed strict laws for the individuals or corporations hiding their assets offshore.

In clarification, they must give proper disclosure of their assets kept offshore and their foreign portfolio holdings. Also, the Government is focusing on a cashless economy where an only certain sum of the deposit is allowed in cash.

Any amount greater than that needs to be paid online through which the Government would keep a record of that transaction and could tax it. Further, the Government is analysing and identifying such tax havens and negotiating on its DTAA policy. 

All these measures by the Government seem promising enough to avoid the exploitation of taxing policies or tax havens by big corporates. However, there is always a difference between policies and implementation. The poor are still poor, and the middle class is still burdened; meanwhile, the already rich are getting richer each day.

Will the DTAA and other tax regulation policies by the Government actually improve this situation? We will leave that to your thinking.