Tax Havens

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Dealing with Tax Havens: Lessons for Emerging Markets

Dr. R. Vaidyanathan Professor of finance Indian Institute of Management -Bangalore India –560076 Ph: 918026993086[W] 919742221357[M] E-mail [email protected]

Prof.R.Vaidyanathan,iimb,2013

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Introduction
• In the last decade there have been three major trends in the global financial markets which are of utmost importance to the emerging countries. One is the convergence of different financial services wherein the banking sector, securities industry and insurance business are being conducted by the same institution. The second is the significant increase of the role of information technology particularly Internet in these activities, which provide clues to the extinction of traditional intermediation. The third is the global reach of the off shore centers or Tax havens with their instruments and institutions which brings to focus the inadequacies of the existing premises and policies of the national regulatory authorities. This issue of tax Havens have occupied the Centre stage in the discussions on Global financial architecture particularly in the context of the Global meltdown in Financial markets and 9/11 terror attacks. There exist more than seventy tax havens or secretive tax jurisdictions and all of them are facing pressures from G-20 and OECD type organizations to become transparent and cooperative in finding tax evaders.





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Definitions of Tax Havens-1
• With the world governments, particularly those in the West that suffered the most by the global financial meltdown, becoming alert about their black wealth stashed away in tax havens, their Inland Revenue establishments are working hard to estimate the illicit monies abroad and also to develop knowledge and techniques for unearthing and chasing them. The kind of efforts under way is evident from a paper of the Internal Revenue Service [IRS] of United States Department of Treasury dated 2008 titled “abusive Offshore Tax Avoidance schemes –Talking points”. We quote from that paper:




[Quote]
These are foreign jurisdictions that offer financial secrecy laws in an effort to attract investment from outside their borders. These jurisdictions are commonly referred to as “tax havens”, because in addition to the financial secrecy they provide, they impose little or no tax on income from sources outside these jurisdictions. It is difficult to quantify the amount of assets being held offshore or the rate at which the industry is growing. But it is estimated that some USD 5 trillion in assets is held ‘’offshore “in tax havens. One authority estimate that the annual revenue loss to the USA at a minimum of USD 70 billion. Tax haven service providers and their clients know their actions are veiled from tax authorities by banking and commercial secrecy laws and by lack of tax treaties or tax information exchange agreements. They create paper entities to disguise the real parties to the transactions, and many are willing to create false documents to disguise the real nature of transactions. At least forty countries aggressively market themselves as tax havens. Some have gone so far as to offer asylum or immunity to criminals who invest sufficient funds. They permit the formation of companies without any proof of identity perhaps even by remote computer connections. Generally though such extremes are found in emerging nations where the stability and security of the financial, legal, political systems is questionable The largest concentrations of assets are attracted to the stable secure environments of the established tax havens –those that have existed a number of years and enjoy the diplomatic protection of former colonial powers.
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Definitions of Tax Havens-2
• The definitions of Tax havens vary but one can identify many of these jurisdictions by their Characteristics. Raymond Baker, in his pioneering work on the issues of dirty money and renewing the free market system, mentions in detail about the extent of tax havens [Quote] • There are some delightful places where you can situate or purchase your secret companies. In the Caribbean you have Anguilla, Antigua and Barbuda, Aruba, Bahamas, Belize, Bermuda, the British Virgin Islands, Barbados, Cayman Islands, Dominica, Grenada, Montserrat, the Netherlands Antilles, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, and the Turks and Caicos Islands. Or there are Panama and Costa Rica in Central America and Uruguay in South America. If you prefer the Pacific the choices include the Cook Islands, the Marshall Islands, Tonga, the Maldives, the Marianas, Nauru, Niue, Vanuatu, and Western Samoa. Asian and Middle Eastern secrecy jurisdictions include Hong Kong, Macau, Singapore, Labuan off the coast of Malaysia, Bahrain, Dubai, and Lebanon. Africa is getting into the game with Mauritius, the Seychelles, South Africa, Liberia, São Tomé and Principe and the little enclave of Melilla, one of two parts of Spanish Morocco. And, of course, Europe offers some of the most experienced and discreet jurisdictions, including the Isle of Man, the Channel Islands of Jersey, Guernsey, Alderney and Sark, the Åland Islands, the islands of Cyprus, Malta, and Madeira, plus Gibraltar and Monaco at the southern edges of Europe, as well as Switzerland, Austria, Liechtenstein, Luxembourg, Belgium, Hungary, Ireland, the lovely enclave of Campione d’Italia surrounded by Switzerland, and the Principality of Andorra tucked in between France and Spain. Off the coast of Newfoundland the French territory of Saint Pierre et Miquelon is reportedly a player in this business. This totals 63 jurisdictions providing varying degrees of incorporation concealment and protection from probing eyes.

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Definitions of Tax Havens-3
• As you select a place to acquire your anonymous international business corporation and plan your circuitous travels to meet clandestinely with a shady lawyer prepared to provide you with a dummy corporation to serve your unrevealed interest in moving ill-gotten gains with the utmost secrecy, you may actually be disappointed to learn that you don’t need to go there at all. In almost every one of these jurisdictions, the whole thing can generally be done with a phone call or fax or online. Using your search engine, enter “international business companies” or “offshore corporations,” and scores of web sites will pop into view offering instant service, comparing the pros and cons of various jurisdictions and quoting fee schedules for creating your own shadowy company. “I have lost count of the number of anonymous entities existing in these jurisdictions. Several years ago, the British Virgin Islands alone reportedly had 180,000 and the Caribbean as a whole had 500,000. More were being formed at a reported rate of nearly 200,000 a year. The total is certainly well over a million by now, and some experts put the number as high as three million. According to various estimates, half of cross-border trade and investment passes through a tax haven or a secrecy jurisdiction at some point along the way.” Unquote
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Definitions of Tax Havens-4
• The other researchers like Nicholas Shaxson suggests that tax haven is a place “That seeks to attract business by offering politically stable facilities to help people or entities get around the rules, laws and regulations of jurisdictions elsewhere,”



It is similar to the definition offered by Richard Murphy of Tax Justice Network. Shaxson also suggests that More than half of world trade passes, at least on paper, through tax havens. Over half of all banking assets and a third of foreign direct investment by multinationals corporations are routed off shore.
The US Government accountability office reported in 2008 that 83 of the USA’s biggest 100 corporations had subsidiaries in tax havens. Tax justice Network discovered that ninety nine of Europe’s hundred largest companies used off shore subsidiaries. In each country the largest user by far was a bank. IMF estimated in 2010 that the balance sheets of small island financial centers alone added up to $18 trillion –a sum equivalent to about a third of the world GDP.





These tax havens are estimated to number more than 70 but as the IRS [USA] discussion reveals that around forty of them aggressively market themselves as tax havens. The popular one is Switzerland, besides Luxemburg, Lichtenstein, Channel Islands, and Bahamas etc.

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Estimates of the Illegal Funds
• First let us look at the volume of the untaxed black money that is estimated to circulate in and dominate the global financial markets unquestioned and unsupervised. These monies, which have no declared or known owners, are laundered into the official financial markets of the world through the intervention of tax havens, which are countries that levy no tax or levy what is an apology for tax, so as to attract capital to their countries. These tax havens are largely tiny tots in the global geography and demography but they hold the rest of the world to ransom, as explained in detailed later. These are currently called “Secretive Jurisdictions”.



IMF estimates global black money – excluding Switzerland, China, Taiwan and Oil exporting economies -- at $18 trillion; that still an underestimate, says IMF.
The latest available IMF figures show portfolio assets held by foreigners in Luxembourg to be worth $1.5 trillion at the end of 2008. But looking at statistics provided by the Luxembourg Government on portfolio investment liabilities for the country – the mirror image of the asset information held by the IMF – there is a big discrepancy. The investment liabilities in Luxembourg were $2.5 trillion – $1 trillion (€726bn) more than the assets reported. Milesi-Ferretti said: “This is a huge difference, almost 40%, and is unlikely to be entirely accounted for by the fact that some countries do not report their portfolio investments or their destination to the fund.”





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Black Money in Swiss Banks
• Now let us look at what kind of black money from elsewhere is lodged in secret Swiss bank accounts. Nearly one trillion out of 2.8 trillion of Swiss money –CHR—is black money says Konrad Hummler –The Chairman of the Swiss private Bankers association. [see August 2009 Swiss review. In the article “Atlantic hurricane hits Switzerland in full force” Konrad Hummler says: Quote Black day for banking confidentiality. Switzerland has become a paradise for foreign capital on which tax is not paid. The uproar from foreign governments is understandable.” Around 30% or CHF.1000 billion, of the CHF 2800 billion or so of foreign assets in Swiss banks is untaxed “black money”. Unquote As to what this means, in August 2009 one Swiss franc –CHR- is nearly same as one US dollar. It means that one trillion US dollars out of the $2.8 trillion kept in Swiss banks is black money. [Wikileaks-Assange says Indians are largest investors' in Swiss Banks]





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Chasing the black money – the success stories of different countries-1
• US officials have tried to crack down on this off-shore tax abuse at least since 1961, when President Kennedy asked Congress for legislation to drive these Tax havens “out of existence”. The US coerced and threatened the UBS to give the details Under sheer geo-political pressure and coercive national measures taken by USA, UBS – the largest Banking Institution from Switzerland -- has committed to provide names of top 250 persons who have kept money in offshore account out of 19,000 accounts mentioned earlier, to US authorities. UBS has also originally committed to pay a fine of USD 780 million to settle claims that it has abetted in defrauding US Internal Revenue service. Now US State department is compelling it to disclose about 52000 American accounts kept with UBS. The original charges are that the UBS off shore accounts have helped Americans to hide USD 18 billion in 19,000 accounts. As of now the settlement is that anyone opening off-shore account has to do it through US regulatory bodies.

• •

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Chasing the black money – the success stories of different countries-2
• • It has also been successfully demonstrated by countries, which are comparatively less powerful and less influential in geo-politics that monies illegally stashed abroad by their corrupt leaders and businessmen could be recovered. They had been able to accomplish it by exposing and prosecuting the corrupt leaders of their countries who had stashed and secreted away their national wealth in Swiss banks and making their judiciary to seek the cooperation of Swiss government and banks. They had also appealed to the conscience of the world generating the empathy of the world. This feat has been accomplished by small and insignificant countries, like those as under [7] Philippines slogged for 18 years but finally successfully got repatriated the bribe money of its former President Ferdinand Marcos ($ 624 million) held in Swiss Bank accounts. Between 2001-2004, Peru recovered $180 millions stashed away in tax havens by Vladimiro Montesinos. Between 2005-2006, Nigeria recovered USD 505 million of the Sani Abacha money frozen and forfeited by Swiss authorities. The Jews got back the money [in 2002] appropriated by these banks from Jews in the 1936-1945 period of Hitler’s dictatorship and mass deaths. This could be accomplished by these countries by first exposing the corruption and the corrupt leaders of their countries and thereafter by tracking their corrupt wealth into the secret banks

• • • • •

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Chasing the black money – the success stories of different countries-3

• • • •

Recent Examples Tunisia- Zine El Abidine Ben ali Egypt- Hosni Mubarak Pakistan- Benezir Bhutto/ Haiti-Baby Doc Duvalier Freezing of Assets of -- Politically Exposed Persons

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Indian Scene-1
• The Global financial Integrity – a Non-profit research organization – working in the area of Tax Havens has estimated for India that the present value of illegal financial flows held abroad is nearly $500 Billions [12] Our GDP or national income at that time was nearly USD 1200 billons. And so nearly 40 % is outside as illegal wealth. At say 50 rupees to a USD it comes to INR 25000 Billions. So now there can be no dispute about the amount of Indian wealth stashed away abroad. GFI says that more than two-thirds of this amount has been stashed away after the liberalization of the Indian economy in 1990s. It means that those aspects of the liberalization policies, which must have facilitated this process, must be scrutinized as part of the preventive efforts needed to tackle the accumulation of Indian black wealth abroad on an ongoing basis.

• •



Prof.R.Vaidyanathan,iimb,2013

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Indian Scene-2
• Now let us look at what kind of black money from elsewhere is lodged in secret Swiss bank accounts. We saw that nearly one trillion out of 2.8 trillion of Swiss money –CHR—is black money says Konrad Hummler –The Chairman of the Swiss private Bankers Association. Julian Assange of Wiki leaks fame has told an Indian TV channel that Indians are largest investors in Swiss Banks. That means out of 1 trillion USD [the Swiss Currency is nearly same as US Dollar] more than 50 % is owned by Indians. This alone comes to USD 500 billion. This is only Bank deposits. Then there are other exotic financial products offered by Swiss Banks –offshore also-where Indians are invested. Plus there are funds accumulated directly abroad through commissions in defense contracts [remember Bofors!] which is not going out of the country due to trade mis-pricing. The International Narcotics Control Strategy Report –Money Laundering and Financial Crimes –March 2009—by US department of state suggests that 30-40 percent of the inflows may be by Hawala market –not accounted. During 2007-2008 according that report formal inflows were USD 42.6 billion and so 40 percent of this namely USD 18 Billion could be reflected as illegal “flows” not captured by the law. This sum could be paid for in rupees here but stored in tax havens abroad. This Hawala deals are for only one year. Hence one can conclude that GFI estimate of USD 500 billion is a lower band and 1.5 trillion USD can be an upper band. That means it is between Rs.25 000 Bn and 75 000Bn [at 50 Rs per USD].
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Indian scene-3
• • Not just tax evasion, but “theft” and “plunder” – says the Indian Supreme Court But on the 19th of January-2011 [Wednesday] the Supreme Court of India made an historic observation about this shameful phenomenon of Indian funds kept illegally abroad and the obstructionist attitude of the Central Government in unraveling the truth. The Bench was observing on the Petition filed by Ram Jethmalani and others with reference to the illegal money kept by Indians in the Lichtenstein bank Quote
Describing black money stashed away abroad by Indians as “pure and simple theft of national money,” the Supreme Court on Wednesday questioned the Centre's approach to tackling this menace and retrieving the huge amount kept in foreign banks. When Solicitor-General Gopal Subramaniam furnished in a sealed cover a list of 26 names who had accounts with Liechtenstein Bank, a Bench of Justices B. Sudershan Reddy and S.S. Nijjar was not convinced of the steps taken by the government for getting back black money. Justice Reddy, after perusing the list, told the SG: “This is all the information you have or you have something more! We are talking about the huge money. It is a plunder of the nation. It is a pure and simple theft of the national money. We are talking about mind-boggling crime. We are not on niceties of various treaties.” The Bench was hearing a petition filed by the former Union Law Minister, Ram Jethmalani, and others. Appearing for them, senior counsel Anil Divan earlier alleged inaction on the part of the Centre in bringing back black money parked in foreign banks. Unquote









Prof.R.Vaidyanathan,iimb,2013

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Indian Scene-4
• It is important to recall that our Honorable President in her address to joint session of Parliament on 4th June 2009, after the UPA II government took over immediately after the Lok Sabha elections 2009 when the illegal Indian monies abroad had become an election issue and the Congress Party after denying its existence had to promise to bring back illegal Indian monies abroad, states as under: “[36]. My Government has been able to significantly increase realization of direct taxes as a result of improved and simplified tax administration and this process will continue. The roadmap for moving towards a Goods and Services Tax will be vigorously pursued. My Government is fully seized of the issue of illegal money of Indian citizens outside the country in secret bank accounts. It will vigorously pursue all necessary steps in coordination with the countries concerned.” [http://presidentofindia.nic.in/sp040609.html] But the actions of this Government, detailed hereunder, do not match “the vigorous steps” promised by the honorable President.



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Corporate use of Tax Havens • Multinational Enterprises (MNEs) have spread their roots across the globe • Complex and obscure ownership structures • Tangle of hundreds of affiliates and subsidiaries • Opportunities to avoid taxes since their very inception! • Inter-group transactions used to shift taxable income from high-tax to low-tax jurisdictions • It is likely that less than 10% of the world’s corporations are part of multinational groups but it is estimated that about 60% of world trade in is in the nature of intra-group sales (sales between members of a common MNE group)! (TJN 2008)
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New Financial Architecture-1
• From Secrecy and Privacy to Transparency and Integrity • Emerging Markets should work for abolishing these secretive jurisdictions step by step.
Details of the Proposed Priorities as Enunciated by the Financial Integrity Task force—Bergen- Norway Declaration—September 28/29 2010 Quote Curtailment of mispricing in trade imports and exports; It is estimated that half of all illicit financial flows out of developing countries are related to the mispricing of trade. Stricter international accounting rules and standards for the pricing of goods and services will curtail the flow of illicit money due to trade mispricing Country-by-country accounting of sales, profits, and taxes paid by multinational corporations; Under current accounting rules corporations report consolidated financial results for all company operations. This provides an opportunity to shield from view profits attributed to subsidiaries in tax –havens where little or no company activity occurs. Country by country reporting will require firms to be completely transparent about sales, profits, and taxes in every jurisdiction where they are located





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New Financial architecture-2
• Confirmation of beneficial ownership in all banking and securities accounts; Providing beneficial ownership information will enable national authorities to better tax revenue [and plan for it utilization] and track and address illegal activity. Current and potential investors will have an enhanced understanding of the working of the corporation in which they invest. Banks will be in a better position to determine the credit worthiness of potential customers. Thus, a fully transparent corporate structure will foster a better functioning global financial system. • Automatic cross-border exchange of tax information on personal and business accounts; The current international standard of tax information exchange between governments requires a high level of certainty of tax evasion before information is provided by the requested state. A system whereby information is automatically exchanged will enable a more efficient collection of tax data. • Harmonization of predicate offenses under anti-money laundering laws across all Financial Action Task Force cooperating countries. Harmonizing and codifying predicate offenses for a money laundering charge within the OECD will create a bolstered defense against money laundering .The ultimate goal is to see that best practices are embraced by nations that have relatively weak anti-money laundering regimes and that a universal set of standards is adopted by all OECD countries to curb the flow of illicit capital. Quote

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Conclusions
• Tax Havens or Secretive jurisdictions are passe • USA/ Germany/France/UK are all for regulating/restricting Tax Havens • Global recession and anger on the illegal money • Terrorism related issues is also of concern • Emerging Markets are severely affected since for every 1 Dollar Aid 10 Dollars is sent as illicit money. • Emerging Markets need to have coordinated efforts • It is not just Tax evasion it is illicit wealth and it should be returned to the rightful owners—ordinary citizens of emerging markets.
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