O | a-zofinequality

Offshore tax havens

A vast proportion of the world’s wealth is stored in offshore (i.e., foreign) accounts and companies to avoid or evade taxation. A study by the European Commission estimated that global offshore wealth totalled US$7.8 trillion or 10.4% of global GDP in 2016; the UK’s share of this was €216 billion (approximately £192 billion at current exchange rates) or 8.7% of GDP which resulted in lost tax revenue of €8.5 billion (0.37% of GDP) [1]. A 2017 study by the economist Gabriel Zucman had a slightly higher estimate of $8.7 trillion in global offshore wealth causing about $200 billion in income tax revenues lost globally, while the IMF has estimated that $500-600 billion is lost in worldwide corporate tax revenues [2]. The accountant Richard Murphy puts the loss to the UK’s public revenue at no less than £18.5 billion annually: £8.5 billion due to tax avoidance by high net worth individuals, £3 billion in avoidance by large UK companies, and £7 billion in illegal tax evasion [3].

It is safe enough to say that a huge amount of wealth, likely the equivalent of nearly one-tenth of national income, is held offshore by wealthy individuals and corporations for the sake of exploiting tax advantages causing a loss to the exchequer in the billions. This also means that wealth inequality must in reality be significantly higher than statistics based on domestic holdings would suggest [4]. The use of offshore tax havens by the wealthy offers them a substantial and unfair tax relief while also concealing the extent of their fortunes, forcing workers and people of more modest means to shoulder a greater share of the burden of public expenditure than they should have to.

Where are these offshore tax havens?

The stereotypical image of an offshore tax haven is probably a beautiful Caribbean island but while that picture is not entirely inaccurate, many of the world’s most important tax havens are much closer to home in a couple of senses. In 2013 Apple CEO Tim Cook stated, in response to his company’s tax affairs being questioned in the US Senate, that “We do not stash money on some Caribbean island.” He was technically correct: Apple had instead made extensive use of Ireland’s low rates of corporation tax and, after their arrangements there became subject to an EU investigation, moved much of their cash to Jersey [5].

The Tax Justice Network’s Corporate Tax Haven Index, which attempts to measure the extent to which different jurisdictions are utilised by multinational corporations to reduce their tax liabilities, found that the top 10 included two EU member states (the Netherlands and Luxembourg) and four UK dependencies (the British Virgin Islands, Bermuda and the Cayman Islands making up the top three plus Jersey at number seven), with the UK itself coming in at number 13. Switzerland, Singapore, the Bahamas and Hong Kong rounded out the top ten [6].

Ireland has become a base of operations for many large multinational corporations, especially US tech giants such as Apple, Google, Microsoft, Intel, Facebook and Twitter. This resulted in (literally) incredible GDP growth rates, reaching 25% in 2015, as economic activity was nominally relocated to Ireland’s jurisdiction [7].

Many UK crown dependencies and overseas territories function as tax havens for individuals and companies. The Channel Islands [8, 9], Isle of Man [10], British Virgin Islands [11], and Cayman Islands [12] all offer low or no taxation of personal and corporate income taxes. The Crown Dependencies (Jersey, Guernsey and the Isle of Man) are home to 76,000 companies, about one for every three people actually living there [13]. Trusts based in Jersey alone manage assets totalling about £1 trillion despite the territory being home to just 100,000 people [14], while offshore companies in the British Virgin Islands hold assets of more than $1.5 trillion as of 2017 [15]. The Cayman Islands are particularly attractive for people and firms seeking privacy: they impose no income, corporation, payroll, sales, capital gains or inheritance taxes whatsoever nor any currency controls; as a result there are no reporting requirements (there would be nothing to report) and so offshore companies formed in the Cayman Islands are under no legal or regulatory requirement to publish accounts or submit to auditing [16].

How it works.

Offshore tax avoidance and evasion takes two main forms which could be described as wealth concealment and income shifting.

Wealth concealment: this involves individuals and corporations moving their assets to offshore accounts so that they can accumulate and pass on wealth in low- or no-tax jurisdictions. For example, a high net worth individual could move shareholdings to a trust set up in a tax haven free from capital gains tax, inheritance tax and other levies that might take away a fraction of the wealth they accumulate. While this is not always a covert manoeuvre, many tax havens are used specifically to take advantage of lax or non-existent reporting requirements so that people can keep their fortunes hidden and this can help enable criminality.

In any case, this involves people who made their fortune in one country moving it elsewhere to try and keep it away from that country’s tax authorities. Leaks such as the Panama Papers [17] and the Paradise Papers [18] have exposed many secret accounts and shell companies used for this purpose by large corporations and wealthy individuals, including prominent politicians from across the world and even the royal family, with the private estates of the Queen and the Prince of Wales holding investments in the Cayman Islands and Bermuda.

Income shifting: this is primarily the way in which multinational corporations take advantage of offshore tax havens, by artificially shifting revenues and costs between their subsidiaries to exploit the differences between tax regimes in different countries. The OECD refers to this practice as “base erosion and profit shifting” (BEPS) and it works by taking advantage of the fact that corporation tax is typically levied on profits, so if corporations can shift things around on their books so that their profits are superficially being made in tax havens they are taxed less, despite the fact that in reality they are making the vast majority of their money from activities in higher-tax jurisdictions [19].

For example, until 2015 Amazon booked its UK sales as having actually been made by Amazon EU which is based in Luxembourg. Even after agreeing to treat UK sales as a UK income stream, Amazon continues to mostly just account for low profit margin activities such as warehousing and deliveries as having been undertaken by its UK subsidiaries leading to low UK profits and, therefore, a UK corporation tax bill which is a tiny fraction of how much profit it has really generated from its UK business activities [20]. To sweeten the deal further, Amazon deducts the value of Amazon shares allocated to UK managers as part of their remuneration packages from its UK profits, except those shares are not stakes in the nominally low-profit UK subsidiaries that those people manage, but in the lucrative US parent company Amazon Inc. [21]

While income shifting is primarily undertaken by multinational corporations in the form of BEPS, similar activities can also be pursued by some individuals. People with multiple income streams can set up shell companies in tax havens to receive some of their income so that it can nominally be treated as foreign and corporate income despite actually being personal income made in their home country. For example, more than 200 Premier League footballers are currently under investigation by HMRC in relation to dubious image rights arrangements where the income they receive for the use of their image in advertising and publicity is paid to a shell company, often in an offshore tax haven, allowing them to artificially reduce their UK Income Tax liability [22].

Exploiting tax complexity.

Both wealth concealment and income or profit shifting fundamentally involve artificially moving money, be it income streams or wealth, from where it is actually made to the jurisdiction of a tax haven. This requires, in various ways, exploiting legal technicalities, loopholes and outright deficiencies for the sake of gaining an unfair tax advantage. The complexity of tax legislation aids these endeavours by leaving room for dispute over what specific clauses and terms mean or for creative methods to comply with the letter but not the spirit of the law.

Recent attempts to tackle tax avoidance (which occupies legal grey areas, as opposed to straightforwardly illegal tax evasion) have included defining avoidance as actions which technically comply with legislation but act in defiance of the legislature’s intentions; while potentially a fruitful avenue to go down this adds an extra layer of complexity in the need to try and divine what Parliament really intended with any given statute [23]. The complexity of written tax rules imposes unequal costs: effective avoidance schemes are generally expensive and so only available to the rich and wealthy or to large corporations, while those less well off are left spending time and money trying their best to comply with an opaque system. This makes the real burden of taxation more regressive than the written rules say it should be [24].

The issue of tax code complexity is particularly acute for multinational corporations and individuals who hold residencies and interests in multiple jurisdictions. They face not just one tax system but multiple different ones which, on the one hand, makes honest compliance even more difficult and, on the other, offers up even more loopholes and grey areas which can be exploited.

A few specific UK tax rules make the use of offshore tax havens easier. Non-domiciled (“non-dom”) status allows individuals living and working in the UK who have a permanent residence abroad to avoid paying UK taxes on income and assets made or held overseas so long as they are not remitted to the UK. Achieving non-dom status does not really require that an individual has their primary home abroad, individuals can claim their parent’s permanent home as their domicile or superficially make themselves the resident of a tax haven for the sake of claiming non-dom status while, for all intents and purposes, still being a UK resident except in their tax arrangements. HMRC estimated that 78,000 individuals claimed non-dom taxpayer status as of 2018-19 with the number having fallen sharply since 2016 [25]. While there many legitimate uses for this status – it is right, for example, that someone living temporarily in the UK should not have to pay UK taxes on assets they keep in their home country – but it is easily exploitable by people with the means to do so, offering another avenue to avoid taxes on money that is artificially moved offshore [26].

As mentioned above, corporate tax avoidance in the form of BEPS is facilitated by the fact that multinational corporations are primarily taxed via a charge on their recorded profits in each jurisdiction they operate in. This allows companies to move around the nominally profitable parts of their enterprise – their headquarters, intellectual property, management, etc. --- to low-tax countries even as most actual revenue is generated elsewhere. In this respect, big multinationals exploit not just the complexity of a single country’s tax code, but the even greater murkiness of multiple interacting tax regimes as well as their own ability to complicate their own balance sheets. Taxing profits according to where they are accounted for is a common method of taxing corporations, but not a necessary one, and its persistence has enabled tax avoidance.

Tackling offshore tax avoidance.

There are four key avenues by which governments could make a sustained effort to combat avoidance and evasion via offshore tax havens:

Transparency: the opacity of the tax arrangements of high net worth individuals and corporations serves to frustrate enforcement efforts and hinders public understanding of the true scale of wealth inequality and the tax advantages the wealthiest enjoy. Greater transparency would make the job of tax authorities easier and could also bring public pressure to bear upon those who are obviously flouting their social responsibilities. HMRC could take further steps to tighten accounting and disclosure requirements such that offshore holdings and income sources are at least well known; it has already made some progress towards this by introducing the Common Reporting Standard which requires banks, trusts and other financial service providers to provide annual reports about offshore accounts and investments [27]. The Corporate Interest Restriction, which limits the extent to which large companies can deduct interest costs from their taxable profits, takes the global costs of multinational groups into account [28]. These are positive steps and the principle should be carried further.

Besides opening up the affairs of UK residents and companies, the UK government could play an especially important role in shedding more light on activities in some of the world’s top tax havens – many are British dependencies and so, while they have their own laws and autonomy, it should be possible for the UK government to exert some influence and persuade these territories to adopt better tax standards. In recent years co-operation agreements have already been reached with Crown Dependencies and British Overseas Territories and, again, this cause should be pursued further. The scope of information-sharing agreements could be expanded and corporate reporting standards improved and the UK government publicly demanding such actions be taken would put a lot of pressure on the governments of its dependencies to comply [29].

Cooperation: many offshore tax avoidance schemes by individuals and corporations exploit differences between the laws and regulations of different countries. While the UK can take some unilateral actions to lessen the impact these schemes have on the UK, truly solving this problem will require substantial international cooperation. The OECD’s measures to tackle BEPS and international tax treaties to standardise certain rules to reduce the scope for exploitation have been promising developments [30]. The UK ought to pursue bilateral and multilateral information-sharing, rule alignment, and dispute resolution mechanisms as far as reasonably possible so that there are measures in place to frustrate those seeking to gain an advantage from any differences between the UK and foreign tax codes.

Reform: the UK tax code could be reformed in a few ways to close gaps that facilitate avoidance. Non-dom status is largely a privilege for the wealthy, with the vast majority of people who would be eligible to claim it gaining no advantage from it compared to their treatment under regular UK tax laws, and abolishing it would help to counteract many offshore tax avoidance attempts. Since 2017 the rules have already been tightened so that people who have been a UK resident for at least 15 of the previous 20 years cannot claim non-dom status [31]. It has been Labour Party policy to completely abolish non-dom status since 2015 [32].

Corporation Tax being levied on a company’s accounted UK profits is problematic for a few reasons, the fact that it enables multinationals to engage in BEPS and avoid tax being just one of them. Corporation Tax liabilities really ought to be based on the gains a corporation really makes from its activities and sales in the UK rather than the technical details of their own accounts. One alternative would be to base corporate taxation on where customers are, calculating liabilities based on where a company makes its sales which is the point least subject to manipulation. A destination-based assessment of production chains is already used to calculate Value-Added Tax and a similar mechanism could be used to determine Corporation Tax [33].

Simplification: fundamentally, a great deal of tax avoidance is enabled by the complexity of written tax laws. A simpler tax code would make compliance easier and avoidance harder, ensuring a more equitable distribution of tax burdens, but simplifying the tax code is far from a simple proposition and would likely involve many controversies and costs. In the UK there is a possible route to achieving simpler and more just legal outcomes without rewriting the entire tax code which would involve establishing a greater preference for trying and judging complex tax affairs according to common law principles rather than obsessing over differences in interpretations of statutes.

HMRC has arguably made a move in this direction since the introduction of the General Anti-Abuse Rule (GAAR) in 2013 which enables it to counteract clearly “unreasonable” arrangements which have been principally set up to enable tax avoidance [34]. This is part of the broader definition of tax avoidance as actions which seek to technically comply with tax laws but in a way not intended by the legislator – this allows for arrangements which are technically compliant with statute law but clearly abusive to be identified as illegitimate. The use of the GAAR mostly concerns counteracting abusive tax advantages and making them ineffective by making “just and reasonable” tax adjustments [35]. A bolder anti-avoidance provision, making it an offence subject to penalties in excess of just recouping owed taxes to avoid tax liabilities in any way not intended by legislation, has been considered in the past and implemented in other common law countries such as Canada, Australia and New Zealand [36].

While most tax offences are created by statute, the common law offence of “cheating the public revenue” has been preserved. This offence is largely reserved for the most serious cases in which false statements or falsified documents are made with the intend of defrauding the tax authority; it is a “conduct offence” meaning no actual loss needs to proven to secure a conviction, the prosecution only needs to establish that the defendant acted dishonestly with the intent to defraud [37]. While this specific offence would not be applicable to tax avoidance cases which generally involve exploitation of rules rather than explicit fraudulence, the principles underlying it could perhaps be applied more broadly to complex tax affairs such that courts are empowered to judge whether an individual’s or company’s tax affairs constitute an honest attempt to pay what they owe or an abusive exploitation of statutory complexities and differences between jurisdictions.

1https://ec.europa.eu/taxation_customs/sites/taxation/files/2019-taxation-papers-76.pdf

2https://www.imf.org/external/pubs/ft/fandd/2019/09/tackling-global-tax-havens-shaxon.htm

3http://www.taxresearch.org.uk/Documents/TaxHavenCostTRLLP.pdf

4https://www.nber.org/system/files/working_papers/w23805/w23805.pdf

5https://www.bbc.co.uk/news/world-us-canada-41889787

6https://www.corporatetaxhavenindex.org/en/introduction/cthi-2019-results

7http://www.oecd.org/sdd/na/Irish-GDP-up-in-2015-OECD.pdf

8https://www.gov.je/LifeEvents/MovingToJersey/LivingInJersey/Pages/MoneyTax.aspx#anchor-2

9https://www.careyolsen.com/briefings/summary-guernsey-taxation

10https://www.isleofman.com/about-the-isle-of-man/taxation/

11https://www.wis-international.com/british-virgin-islands-tax-haven.html

12https://home.kpmg/xx/en/home/insights/2011/12/cayman-islands-overview-introduction.html