Tax Havens and why they exist?

What are offshore financial centres?

Well, according to an article published in the International Consortium of Investigative Journalists —

There is no universal definition, but tax havens, or offshore financial centres, are generally countries or places with low or no corporate taxes that allow outsiders to easily set up businesses there. Tax havens also typically limit public disclosure about companies and their owners. Because information can be hard to extract, tax havens are sometimes also called secrecy jurisdictions.

And these jurisdictions can be very enticing if you are looking to stash money outside. But not all funds are created equal and not everybody has the same objective.

For starters, you have money held by rich people — Income that’s not taxed and routed to off-shore financial centres. This money could be legal income made through honest work or illicit wealth amassed using criminal activities. And while using an offshore account isn’t illegal per se, most people don’t declare this information to local tax authorities in a bid to save money. And that, believe it or not, is illegal. By some estimates, “the global rich held in 2007 approximately $12 trillion of their wealth in tax havens.”

It’s quite a lot of money.

But there is another category — tax savings of multinational corporations, who use tax havens to pay little or no taxes in countries they operate. Think, Apple and Google who continue to use creative accounting practices to move wealth around. According to one report, countries lose $245 billion each year to corporate tax abuse. And it’s extremely hard to prevent this kind of thing because most of it is actually legal. As one report notes—

The tax avoidance mechanisms of multinationals is even more challenging than recovering the money hidden by individuals. The reason is that unlike the practices of individual tax cheats, what multinationals are doing often is legal. The law as it presently stands in many countries allows them to incorporate offshore in tax havens with no or only low taxes. The result has been trillions of dollars in savings for the companies. Perhaps the most unjust aspect of this practice is that by increasing profits through tax avoidance, multinationals are increasing the value of their stock. This amounts to taxpayers subsidizing, through lost taxes, these companies’ shareholders.

It’s like honest taxpayers lining the pockets of corporations that are already worth trillions of dollars. And while it's true that high-income countries lose more tax revenue in absolute numbers, the brunt of the burden is borne by developing countries who don’t make a lot in tax revenue, to begin with. I mean, look at India. While less than 2% of the country’s population pay income tax, it is still the primary source of revenue for the government.

So it’s imperative to ask — How on earth are companies and individuals still getting away with this?

Well, look. You’re probably thinking about pinning blame on Swiss Banks and secretive laws protecting the identity of some of these individuals and corporations. But in this story, we are not going to talk about them. Instead, we’ll look at another major antagonist —the United Kingdom. Or more specifically, the United Kingdom’s spider web of overseas territories and crown dependencies. Think, Cayman Islands, or the British Virgin Islands. In fact, Britain has 14 overseas territories and seven of them are generally thought of as tax havens.

But why did offshore banking flourish in these areas?

I mean, how did these tiny island states with a combined population of 2,50,000 do this much damage?

Well, that’s a bit of a long story. But let us try and summarize it quickly here.

Right after World War II, the British Empire was on the decline. They had lost their major colonies and they were trying to hold on to the last vestiges of power. And then, the Egyptian president Abdel Nasser landed a body blow by nationalizing the Suez Canal. He assumed full control of the vital trade route and was in a position to choke off a critical supply line. Bear in mind, this canal was owned and operated by Britain and France until the Egyptians took over. And since this was a strategic asset for both countries they couldn’t sit on the sidelines. So when Israel invaded Egypt in 1956, Britain and France saw an opportunity to overthrow the president and take control of the canal. In fact, they had planned this all along. However, after pressure from the US and the UN began to mount, all three invaders were forced to call off the invasion and retreat. For Britain, this meant losing control of the Suez permanently and investors were contemplating if the country was headed towards financial ruin.

Some investors who bet on this eventuality started exchanging British currency for something they thought was valuable. And as the Pound lost its sheen, Britain’s central bank was forced into action. They immediately halted domestic banks from lending money to overseas borrowers. The hope was that they could stem the flow of currency out of the country and keep a leash on the value of the Pound. However, bankers were upset about losing business and a compromise was sought. But the compromise was… quite ridiculous.

The central bank stipulated that foreign lending could continue so long as the transactions transpired in non-sterling currency. Meaning, a currency that wasn’t the British Pound. Second, the central bank mandated that both lenders and borrowers had to reside somewhere other than the UK. Where else would they be based you ask? Well, anywhere.

Or as one report in the BBC notes —

“They [meaning the central bank] simply deemed certain transactions as not taking place in the UK. Where did the transactions take place for regulatory purposes? Nowhere.”

But since the banks needed an address, they simply chose British overseas territories for the job. And while at it, they figured out that this was an excellent way to circumvent key regulations and to borrow/lend billions without any oversight from the government. Also, local authorities in these areas deliberately designed regulations to make the process more seamless. And offshore banking took off in a massive way. Today these territories are responsible for tax losses of some $160 billion each year. And while the British government continues to maintain innocence by declaring that these territories are individual self-governing states, that isn’t a very sustainable proposition. Key government officials here are appointed by the British Crown and even their laws are approved in London. So the state holds significant influence in these territories and there’s no other way to put it.

Bottom line — Unless Britain does something about this matter, beyond issuing hollow statements, we will continue to see the rich getting richer and the poor getting fleeced.

And tax havens?

Well, they’ll just continue to thrive.

Credits: Finshots