In the wake of the global financial crisis of 2007-2008, tax havens became a controversial topic as political leaders zeroed in on low-tax jurisdictions as a source of fiscal instability that aggravated the crisis.
For years, governments globally have been grappling with extensive profit-shifting from multinational firms. This involves companies moving profits to subsidiaries in low or no-tax jurisdictions to reduce their tax burden, even when their business operations are elsewhere. In the process, they’ve exacerbated income inequality, increased global financial instability, and allowed multinational corporations and their shareholders to pocket trillions of dollars in what they should have paid in taxes.
Worldwide economies are struggling with tax revenues down sharply, and governments will turn over rocks to reduce deficits. Further, to ensure that they get a fair share of taxes, they have instituted conditions on paying out dividends, buying back shares, and executive bonuses. We already saw countries like India, Brazil, Mexico, Spain, France, and Turkey, Indonesia rapidly introduce digital taxes to harness additional revenues from the surging digital economy thereby targeting tech giants that have long been subject to regulatory scrutiny and resultant fines for their tax affairs. The new taxes were levied to account for the value generated by companies with digital models through their users/customers even if they didn’t have a physical presence.
With the mounting pressure from International organizations like the OECD and the G-20, tax havens may find it difficult to sustain their carefree existence. Some of the key initiatives already making tax havens difficult to sustain their charmed existence are:
Base Erosion and Profit Shifting (BEPS)
BEPS was OECD’s effort to realign taxation with economic substance/real economic activity without disrupting the long-held international consensus supporting the arm’s-length principle. BEPS is the most expansive internationally coordinated effort aimed at preventing tax avoidance, giving recommendations aimed at preventing perceived tax abuses (some specifically aimed at preventing arbitrage schemes). It changed the discourse about tax avoidance, with multiple countries signing binding international instruments.
Information Exchange/Mutual Support Agreements
The OECD-initiated and G-20-embraced Global Forum on Transparency and Exchange of Information for Tax Purposes. Growing numbers of Tax Information Exchange Agreements and Mutual Legal Assistance Treaties between tax havens and other countries would take away tax havens’ competitive advantage. Many tax havens like Mauritius, Singapore and UAE have signed agreements to avoid double non-taxation and committed to facilitate effective exchange of information for tax purposes.
In 2019, the OECD initiated idea of “unitary taxation with formulary apportionment.” It refers to the taxation of a multinational firm as a single entity, apportioning profits to each country it operates based on the worldwide consolidated accounts, according to a formula reflecting real economic activity, (a mix of sales/employment/tangible assets etc.). This simpler and fair method should cut out tax havens.
Though there is no international consensus on this yet, but a move is already underway requiring multinationals to break down and even publish financial/accounting information on a country-by-country basis, which could provide relevant data for an international allocation formula.
The OECD, in 2014, established Common Reporting Standards (CRS), to exchange financial information automatically across borders to help tax authorities track the offshore holdings of their taxpayers. The CRS is bringing results. Per the OECD estimate (July 2019), 90 countries shared information on 47 million accounts worth 4.9 trillion euros ($4.87 billion); bank deposits in tax havens reduced by 20% to 25%; and voluntary disclosures generated 95 billion euros ($116 billion) additional tax revenue.
Evolving Domestic Legislation and Disclosure Requirements
Several large economies are having disclosure norms built-in in their domestic laws to closely monitor and accurately report foreign income. Foreign Account Tax Compliance Act (FATCA) by the U.S. is a prominent example.
Action Steps for Countries
Although much work has happened, this is a complex problem and there is no silver bullet solution. A few action steps to end tax havens:
A responsible and fair system to curb abuse of tax havens can be implemented through multilateral action so as to reach a sustainable consensus among the largest number of participants ensuring a permanent solution characterized by openness and cooperation between governments and other regulatory bodies. Unilateral Tax Information Exchange Agreements and Double Taxation Conventions are a step towards global cooperation and elimination of harmful tax havens. Rigorous transparency, disclosure, and accountability in domestic laws are important to check abuse. Developed/developing countries may have a comprehensive strategy and include tax havens in the solution through incentives and penalties. A solution may be to harmonize tax laws of countries and incentives they create regarding poorer countries, and only then pursue punishment as an option. One of ideas is to temporarily grant favorable tax treatment for all of the funds that would be brought back from a tax haven.
Action Steps for Global Companies
In this changing world regime, I would submit the following actions for corporations that use/plan to use tax havens.
Tax planning is always subjective and an evolving issue. In general, laws are going to be stricter for structures devised just to obtain tax benefits. Hence the global corporations need to devise tax efficient structures that are well within the four corners of the laws of the resident country, investing country, and intermediary location to ensure that anti-avoidance rules don’t have an impact on their current investments as well as in the long run. As stakeholder capitalism takes deeper roots and goes mainstream, there is reputational correlation for businesses using tax havens. Even if technically and legally right, global companies need to consider if it’s worth the reputational risk in these changing times. They will be expected to be aware of their ethical and civic responsibilities towards paying fair taxes in each jurisdiction of operation. From looking for minimum standards and regulatory compliance, the focus should move on to doing the “right” thing to ensure fairness, even in terms of tax. It’s only a matter of time before the companies that have been teetering around the edges of what may be “unethical” practice will be called to account. And, when they are, the consequences won’t be just reputational.
More and more developed economies are acting to change their own laws in order to deny the benefits associated with tax avoidance through tax havens.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Anshu Khanna is a partner at Nangia Andersen LLP in San Francisco.