Tax havens - good or bad?

Is the reputation of tax havens really justified? asks Peter Williams

A German tax scandal has provoked a storm across the globe over the existence of so-called tax havens. Over the past decade, the Organisation for Economic Co-operation and Development (OECD) has been waging a persistent battle against countries and territories that it claimed indulge in anti-competitive tax practices.

The story took a dramatic and maybe decisive twist earlier this year. Germany launched a tax enquiry after reportedly paying a former Liechtenstein bank employee €5m for a list of wealthy Germans with money stashed away in the tiny Alpine principality that has tight bank secrecy laws. A move that provoked fury from Liechtenstein, but did not stop a whole host of countries' tax investigators across the globe joining in hunting for taxpayers from their jurisdiction hiding their money in Liechtenstein.

Broad challenge

This sort of story gives tax havens their poor reputation. But is it deserved? The question of tax havens certainly provokes strong reactions, even the title is controversial with some preferring the less emotive nomenclature of 'offshore financial centres'. And it is also a sensitive issue - one large firm approached by accounting & business declined to comment - while another tax professional declined to go on the record. The OECD has no such qualms. It claims the German disclosures highlight a much broader challenge in today's globalised economy: how to respond to countries and territories that seek to profit from tax dodging by residents of other jurisdictions. Angel Gurría, OECD's Secretary-General, said: 'This is a fundamental issue in our increasingly interdependent world. As long as there are financial centres that refuse to co-operate in bilateral tax information exchange and that fail to meet international transparency standards, residents in other countries will continue to be tempted to continue to evade their tax obligations.'

The OECD has worked to develop standards of transparency and exchange of information in tax matters that balance the interests of financial privacy with the need for countries to be able to enforce their own tax laws. Despite these efforts, says the OECD, a few jurisdictions still fall short of best practice standards, effectively providing a basis for illegal tax evasion on the part of some of their customers.

In 2002, the OECD published a list of unco-operative tax havens, initially including seven countries. Several have now made commitments to work with OECD and its partners to improve transparency. But three remain on the list: Andorra, Monaco and (you guessed it) Liechtenstein.

But is the OECD campaign justified? Tax professionals suggest that a distinction has to be made between three fundamental uses of tax havens. The first use of a tax haven is by criminals wanting to hide or launder the proceeds of crime. Second is the individual (for instance, a German dentist) who puts money legally earned or acquired into accounts that are held in offshore locations and then fails to report the interest income to the appropriate tax authorities. The third is the use of tax havens by corporates for legitimate tax planning and avoidance (as opposed to evasion) and which is fully reported and transparent. These three separate strands often appear to become interwoven, or the difference not fully understood and appreciated by politicians and other commentators.

The OECD rather begrudgingly admits that many jurisdictions have improved but, according to tax experts, that underestimates the advances in attitude and practice that has been made in terms of making life difficult for the professional criminal. One tax practitioner said: 'Most tax havens have cleaned up their act with varying degrees of success. For instance, in terms of money laundering, you could claim that Jersey is as clean as London.'

John Whiting, a spokesman for the Chartered Institute of Taxation, says that he starts from the basis that countries and territories should be free to set their own tax regime. He refers, for instance, to the UK's right to set relatively high rates of duty for tobacco and alcohol. The question then, as Whiting puts it, is in a free market economy what business is it of the OECD or the European Union if some countries have low or even nil tax rates? Whiting said: 'Some talk about unfair competition, but that is odd. How can Monaco compete with Germany? What this is coming down to is elements of secrecy and transparency. Seemingly, there is scope for people to use these places to evade taxes back home.'

Here, geography plays its part. Physical proximity with Liechtenstein has always given German authorities a problem with its citizens putting deutschmarks, or nowadays euros, into a briefcase in the back of the Mercedes and driving over the border to deposit the Geld out of reach of the German taxman. Hence, Germany's keenness to engage the EU in issues of compliance and exchanging information cross-border between authorities and financial institutions. But we are not talking just about relatively simple information on bank accounts.

It is clear that the OECD and the EU are enjoying substantial success in persuading many territories to toe the line in terms of reporting, enabling the fight against criminals and tax dodgers. But we are not talking just about relatively simple information on bank accounts. The tax authorities certainly take cross-border issues seriously and become more sophisticated in their interest. Tax authorities from Australia, Canada, the UK, the US and Japan have been running a joint task force - the Joint International Tax Shelter Information Centre (JITSIC) - for four years to identify and curb abusive tax transactions through information exchange and knowledge sharing.

JITSIC raises the question for multinational companies whether the way that they are ordering their tax affairs through the use of tax havens and offshore financial centres will be the next target. Companies and their advisers insist that tax evasion is not something large multinationals and their subsidiaries do. Such companies are much more interested in planning their tax affairs efficiently and, perhaps even more important, certainty.

Legitimate practice

For international tax partners helping their clients set up in a zero tax entity is a standard and perfectly legitimate part of the day job. One tax adviser accounting & business spoke with had just helped a pension scheme set up as a Cayman Island limited liability partnership. Why? Because it was tax neutral and they could receive assurance that the jurisdiction would not change its mind on the tax regime it was imposing.

Chas Roy-Chowdhury, ACCA's head of tax, emphasises the right to freedom of action. He said: 'Individuals and business are entitled to money where they want to as long as they are not evading tax. On a similar basis, they are also entitled to confidentiality. Tax havens have this mystique as a mechanism for tax evasion, but the fact is that they also provide a stable regime. These jurisdictions will stay low tax for the foreseeable future where other more complex economies cannot be counted on for doing that.

'In the Cayman Islands, over 97% of transactions are overnight deposits; it is unlikely that they are doing that for tax evasion. Just like London and New York, offshore financial centres have grown up over time because they offer flexibility.'

Commentators like Whiting and Roy-Chowdhury say that countries such as Bermuda have the right to set out their tax and regulatory stall to attract particular legitimate businesses. For instance, in the case of Bermuda, it is the reinsurance capital of the world with 13 of the world's top 40 reinsurers located there, and total capitalisation of the industry based there, hitting US$129bn at the end of the third quarter of 2007. In the same vein, Holland is seen as a good place to base holding companies and Ireland boasts of its favourable corporation tax rates. One tax adviser said: 'Neither we nor our clients want anything to do with obfuscation or secrecy; everything we do, we expect the cards to be placed face up on the table.'

But will such reassurances work? In the UK, Austin Mitchell MP recently asked the Chancellor, Alistair Darling, if he will commission research on the levels of use of offshore tax havens by UK banks and the economic effects of that use. A suggestion that the Chancellor declined. The legitimate business sector may protest their right to organise their international tax affairs in the most efficient manner possible within the boundaries of the law. But as globalisation increases, and as governments work hard to protect or increase their tax take, it seems hard to believe that questions over the relationship between legitimate businesses and tax havens will disappear.

Peter Williams is a journalist and a chartered accountant. He writes on accounting, financial reporting and auditing issues.