A Tax Lawyer Explains Tax Havens

Offshore Tax Havens have been in the news a great deal lately. Stanford Financial utilized an offshore jurisdiction for their banking needs and now we've learned the AIG utilized certain offshore jurisdiction's secrecy laws to avoid oversight. However, none of these stories has placed any of these actions in context. The fact is offshore secrecy has been under assault and will be going away for the remainder of our lifetimes.

First, let me add this disclaimer. I am a tax lawyer who has a masters in domestic (US) and international taxation. Offshore jurisdictions can be used legitimately and legally in a variety of ways -- in ways which I have advocated and implemented for clients.

That being said, let's start with a definition: what is a tax haven? The following definition from the OECD is perhaps the most often cited definition:

"The absence of tax or a low effective tax rate on the relevant income is the starting point of any evaluation. No or only nominal taxation combined with the fact that a country offers itself as a place, or is perceived to be a place, to be used by non-residents to escape tax in their country of residence may be sufficient to classify that jurisdiction as a tax haven. Similarly, no or only nominal taxation combined with serious limitations on the ability of other countries to obtain information from that country for tax purposes would typically identify a tax haven."

So what we have is a combination low/no tax along with banking secrecy. Let's take these one at a time.

Why do tax havens have no taxation? The primary answer is the vast majority are small geographically. Consider most of the island jurisdictions in the Caribbean -- most are at the most 500 square miles with far smaller populations than the US/OECD countries. In other words, they don't have the need to pay for the physical infrastructure that a country like the US has.

As for secrecy, this is a long-standing tradition most famously practiced by the Swiss but later by most tax havens. Secrecy ties into the fact that most OECD/G-20 countries have a "self-reporting" tax system, meaning individual taxpayers tell the tax authority how much they make with the tax authority auditing suspicious transactions and/or reports. Fraud is a bit easier in such a system which dovetails into offshore secrecy's attraction. Therefore, the secrecy issue is incredibly important to the G-20 nations. What they need is a way to obtain compliance with their domestic anti-avoidance laws -- laws meant to prevent tax evasion.

Now let's go to a bit of history. Starting in the late 1990s, the OECD (Organisation for Economic Co-operation and Development) engaged in a very serious campaign to limit the impact and availability of offshore jurisdictions. The OECD reframed the debate claiming these jurisdictions engaged in "unfair tax competition." The reason is large industrialized countries were seeing their tax base move offshore and they needed to do something to stop it. The primary document is titled "Harmful Tax Competition" and is available from the OECD here.

With the terrorist attacks of 9/11 the OECD countries now had a very strong argument to use against these tax havens. Bank secrecy laws aided terrorists. Therefore, the veil of bank secrecy had to be lifted to prevent these jurisdictions from attracting illegal funds. This argument worked. Offshore jurisdictions are now signing "mutual assistance treaties". These essentially prevent an individual or company from hiding money offshore to evade taxation. While the ground rules of each jurisdiction vary, the bottom line is clear: the age of banking secrecy is over. For more information on mutual assistance treaties, see the Model agreement on exchange of information on tax matters. In addition, there are three model tax treaties -- the OECD, the US and the UN -- all of which have a "mutual assistance" provision.

In addition, US taxpayers are allowed by law to plan their affairs in a manner that provides for the lowest possible tax. This was sanctioned in the 1936 Supreme Court case Gregory v. Helvering which stated, " The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted." This is in contrast to tax evasion which is "a willful and esp. criminal attempt to evade the imposition or payment of a tax". In other words, tax evasion is a specific intent crime, which requires a specific state of mind.

Finally, US tax law has numerous "anti-avoidance" provisions. For example, the US has en entire set of foreign tax laws titled "controlled foreign corporation" laws which attribute international income to US corporate owners. Similar laws exist for foreign trusts, foreign personal holding companies and foreign partnerships. In other words, US taxpayers who comply with the law face numerous hurdles in hiding assets.

Let's wrap all this up.

1.) Bank secrecy has been under assault since September 11, 2001. It will continue to be under assault for our lifetimes. More and more jurisdictions are signing mutual assistance treaties which allow one jurisdiction to obtain confidential information from another jurisdiction in certain situations and cases.

2.) US taxpayers are allowed to plan their affairs to minimize taxation and have been allowed to do so since 1936. They are not allowed to deliberately evade taxation, which is criminal.

Comments

[Hdaryl01]

Y fail to detail, while implying the converse, the uniquely draconian nature of US tax policy compared to virtually every other country on the planet. Specifically, you cite unified US, UN and OECD efforts re: banking secrecy to show international cooperation, impying similarity of tax systems, as well as unity on the reasons for why the OECD, the UN, and the US are addressing bank secrecy.

This provides a disservice to US lay readers who lack specific understanding of international tax systems, and who assume all tax systems are the same as the US's. Reality couldn't be further from these assumptions.

In fact, the US is the only jurisdiction among the OECD countries, and virtually the only jurisdiction on the planet that taxes its CITIZENS on income generated from any activity, on a worldwide basis. Thus, for CITIZENS from virtually any other country on the planet, EXCEPT the US, investment income earned on deposits in foreign bank accounts, secret or not, are not taxed by the citizen's home country. Thus, it is a non-issue for OECD (except US) INDIVIDUALS to own an offshore account, and this has been the case for millenia.

The OECD countries (except the US) are unified in addressing bank secrecy primarily because of CORPORATE taxation issues, with some national security concerns. The US has joined the OECD and the UN to drive more bank transparency, but the US stands alone in wanting it for INDIVIDUAL CITIZEN taxation.

[francoise]

"the US is the only jurisdiction among the OECD countries, and virtually the only jurisdiction on the planet that taxes its CITIZENS on income generated from any activity, on a worldwide basis."
Do you mean that a US citizen who is living, working, and earning money abroad has to pay his taxes to the US government ?
Or is it only the US citizens living in the US, having some revenues from investments made abroad, who pay their taxes in the US ?

"Thus, it is a non-issue for OECD (except US) INDIVIDUALS to own an offshore account"
I don't get it. From this sentence, it's only interesting for the US individuals to own offshore accounts. But if US citizens have to pay their taxes on their revenues whereever in the world those revenues are made, then it's pointless whether those revenues are made in the US or offshore.

I don't understand. And I'd like to if you'd have time to explain.

[Hdaryl01]

Yes, I mean that a US citizen who is living, working, and earning money abroad must pay taxes to the US government. A US citizen regardless of where he or she lives must pay tax on worldwide income, wherever earned, whether passive (investment) or active (work) income, to the US government. This is why the US government is uniquely interested in Swiss bank accounts held by US CITIZENS.

In the US we get no balanced coverage detailing that the OECD authorities (except US) are not interested in Swiss bank accounts held by CITIZENS because these countries only tax their CITIZENS on income generated in their home countries. Now, these countries tax corporations differently, and ARE INTERESTED in SWISS ACCOUNTS held by CORPORATIONS. The media, including this writer cite the US, UN, and OECD cooperation to show that the US is not alone.....that Europe, the OECD, the UN are also interested and concerned about banking secrecy...­.....witho­ut of course accurately qualifying the interest. The US is the only OECD country interested in bank secrecy to go after CITIZENS. All other OECD countries are interested in going after CORPORATIONS. Because, in all other OECD countries it is not an issue for its CITIZENS to have secret or non secret bank accounts in other countries on which they earn income because it is not taxed by these governments anyway!

The US stands alone in this taxation approach. As I'm sure you'll agree, this is NOT what you're used to in Europe.

[schatsie]

Wait a minute, why is it necesary for me to pay taxes then while the rich guy goes offshore? We both work here, he gets profits here and yet he cannot afford to pay them..It seems prima facie to me that they are DELIBERATELY going offshore... that is as simple as one and one...

And i don't know what Frenchie is talking about with the taxes in FRANCE, but you do have to remember that they have a great healthcare system a great pension system and a great unemployment system and great education.... I am paying beaucoup bucks here if you include all the miscellaneous taxes 35% here and that is on income in the bottom 60%

[francoise]

And, Bonddad, if I succeed in obtaining an entrepreneur visa, will you agree with being my tax lawyer and adviser ? ;-)

[francoise]

Bonddad,

Thanks for the clear explanation.

It seems to me that there's quite a lot of hypocrisy in the tough words of our french president who is very loud about tax havens.

Obviously french people, who pay many taxes (I think the figures are 68 % in France, 62 % in Germany, compared to 28 % in the USA, though I'm not sure) would all love to settle in a tax haven !

But governments use tax havens too.

When money must be transfered to a dictator's pocket, so that the ressources of his country can be exploited, I guess this money transits between tax havens. See Niger where our uranium comes from, and think about 85 % of the french electricity being produced in nuclear plants.

When business deals are made between corporations and governments, and fighting planes or war helicopters are bought, money transits from the industrial military corporations to the buying deciders' pockets through tax havens.

When our president and his wife go on vacations in their rich buddies' private jet, on their rich buddies' yatchs, or in a Mexican drug producer's 5 stars hotel, don't they enjoy some wealth accumulated thanks to tax havens ?

I wonder whether all those tough words against tax havens are a comedy played to quiet the average citizen.

[Hdaryl01]

Francoise: What do you pay the 68% tax on in France? Exclusively earned income through wages, right? The US federal rates are 36% max. PLUS up to +/-10% state on worldwide income from whatever source. Plus property taxes, fees, etc. In the final analysis, when you add it all up, for the top earners, we're paying virtually the same rate you are, and we DON'T get the services you do. We don't get free cradle to grave health care. Nor do we get real retirement pensions. Nor do we get free education.­......etc.

[02bmw76]

Thanks Bonddad... Youe see where we're headed. Thanks...

[clarryr]

Very informative, thank you.
By what mechanisms does a person move money into and out of a tax haven or any foreign bank without it being monitored and accounted for? Similarly, what about multi-national corporations being able to move money between their holdings within foreign countries and tax havens?

[francoise]

Some mechanisms are not secret, and not fraudulent.

I know of a wealthy parisian couple who used to pay 750 000 euros taxes per year. Yes, I did say they were wealthy. No, they're not my Mom and Dad, unfortunately !

They went to Switzerland, found a house near the Geneva lake, got an appointment with the guy in charge of the Swiss residency. They agreed with 250 000 euros taxes per year. They have to spend 6 months a year in Switzerland (but the checkpoints at the borders have been suppressed, so who knows ?).

Now they're Swiss residents. And they've got a good 2/3 bargain on their taxes.

All the french tennis players are Swiss residents (even their current coach is), next to all of our soccer players are (or else they're Belgium residents), and the richest french singer is now in California.

Global competition in the bargains that tax havens offer, it seems.

[schatsie]

Yes and that is why BONO lives in MONACO so he can avoid the taxes...

[schatsie]

I feel so sorry for the RICH, NOT....

[Rule Of Law]

Hale, you address the issue of individuals here, but how does it work for corporations? And does incorporating in some tax haven--while doing business out of New York, let's say, change anything?

[francoise]

All big corporations have secondary corporations in tax havens throughout the world. Instead of realizing the profits in the heavily taxed country of origin, the benefits are made in the secondary offices in Macao, Costa Rica, or Luxembourg.

Even very small businesses do that. I work with an entrepreneur who has a very very little company that sells and lays floor tiles. The guy used to kneel to lay tiles for a little money (after the taxes). One day he and his wife went to spend some time in Luxembourg. They bought a garage there. They transfered their business' address there. They're now making the profits in Luxembourg, and paying the taxes there according to the Luxembourg laws.

He's driving a Porsche, she's driving a big SUV.

And my point is not to demonstrate that they're smart when it comes on what they spend their money on ;-)