Tax havens

In recent years there has been a significant increase in the number of centers offering tax haven facilities, such as the islands of Malta and Madeira.So, what makes a country or a territory a tax haven? The following are the key factors: (i)a high degree of investor protection; (ii)willingness to prevent money laundering; (iii)political and economic stability;(iv)low or zero taxes; (v)the existence of tax treaties with other countries; (vi)the absence of exchange controls; (vii)the presence of developed legal, banking and accounting systems;(viii)good transport and communication facilities; and (ix)the ability to form a company easily and cheaply.

A tax haven is defined as a “place where foreigners may receive income or own assets without paying high rates of tax on them”.According to the OECD’s Forum on Harmful Tax Practices, the main features of a tax haven are: (i)zero or only nominal effective tax rates;(ii)lack of effective exchange of information; (iii)lack of transparency; and (iv)absence of a requirement of substantial activity.

Tax havens offer a variety of benefits, such as low or zero taxes on certain classes of income.

Some tax havens impose tax on income from domestic sources but exempt tax on income from foreign sources.And some of these havens allow special privileges.For example, the Bahamas, Bermuda and the Cayman Islands are free from tax for overseas companies(including corporate income tax, capital gains tax, withholding tax and securities turnover tax).Others, such as the British Virgin Islands, offer low tax rates.Some tax havens, such as Luxembourg, specialize in facilities for establishing holding companies.Because of these benefits, thousands of so-called mailbox companies have appeared in places like Liechtenstein,Vanuatu and the Netherlands Antilles.As a result of this variety, tax havens fall into two specific categories: (i)pure tax havens, which impose zero or low tax rates; and (ii)hybrid tax havens, which offer specific tax incentives.

In international tax planning, there is obviously a clear theoretical advantage in arranging for profits to accrue to a company that is located in a tax haven because the tax imposed may be less than what would otherwise accrue to an entity in a high-tax country.To take advantage of a tax haven, a multinational firm would normally set up a subsidiary there through which different forms of income would pass.The subsidiary is then used as an intermediary for the purpose of shifting income from high-tax countries to the tax haven.For example, a multinational firm could sell its products at a cost to a subsidiary located in a tax haven and when the subsidiary sells these products to a third party, the profit will be concentrated in the tax haven.Of course, the alternative would be to sell the products directly, in which case the profit will be concentrated in the high-tax home country.