Is there a future for tax havens in view of recent developments?

Tuesday May 12, 2009

Tax Insights - A column by Kang Beng Hoe

THE meeting of heads of state of the G20 countries in London in early April 2009 reached agreement on initiatives against tax havens on the issues of lack of transparency and lack of exchange of information.

The upshot was that the Organisation for Economic Cooperation and Development (OECD) issued a “blacklist” of jurisdictions considered to be tax havens and deemed not cooperative in exchanging tax information. Labuan’s initial listing has now been removed in view of the timely positive response by the government.

This latest effort represents a second “bite of the apple” as slightly over 10 years ago, the OECD issued the 1998 report, “Harmful tax competition: an emerging global issue”, which called for the elimination of harmful tax practices through the use of offshore tax havens.

This initiative met with considerable resistance and in some ways has fallen short of its aims.

The current economic downturn means that governments have suffered from the loss of tax revenues.

This coupled with the recent large-scale tax evasion scandals involving UBS, the Swiss bank which fell foul of the US tax authority, and Liechtenstein whose private bank LGT was used by clients in some 13 countries to evade taxes, have galvanised action by these large economies to crack down hard on tax evasion involving tax havens.

They recognise that exchange of information is essential if their national tax authorities are to confront their nationals who have evaded taxes.

Thus the thrust of the message is that bank secrecy and other confidentiality laws are no longer considered appropriate as they are not in line with non-tax laws such as those against money laundering, terrorism financing and corruption.

Countries, which do not commit to changing such laws to comply with the “internationally agreed standard” of information exchange for tax purposes could be subject to sanctions.

So how will all this affect the operations of the global community of tax havens?

The OECD views a tax haven, also known as offshore financial centre, to have the following features:

·Nominal or no taxes,

·Lack of effective exchange of information,

·Lack of transparency,

·No substantial activities.

They also say that “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.”

Users of tax havens fall into two broad groups. One group is made up of taxpayers intent on evading taxes of their home country. They use the secrecy available in the tax havens to hide part of their income transactions.

They also rely on the fact that their tax officials cannot extend their investigative reach to the offshore location where if all the facts are known, the transactions would be set aside.

The other group of taxpayers are those who wish to remain within the law but would be prepared to argue their position if challenged by their tax authority.

They are involved in legal tax avoidance and hope to take advantage of the varying laws of different countries plus loopholes in their own tax law to minimise their taxes.

The most common vehicle used by both groups of taxpayers is the offshore company. The following features make them popular:

·Tax free or nominal amount;

·Anonymous ownership – no public register of shareholders and in many instances bearer shares are allowed;

·Flexibility – broad objects are allowed and so any business activity can be carried out with some exceptions;

·Ease of use – less administrative requirements but an annual fee payment is required; and

·Quick incorporation.

The first group of taxpayers is the prime target of the OECD initiatives.

Tax evasion is a crime and governments are right to pursue those they suspect of committing it.

The insistence on transparency and information disclosure will not only make their task easier but serve to deter others from doing it.

The second group of taxpayers would find the new landscape particularly challenging.

Tax authorities of the industrialised nations dislike offshore centres and this is evident from the undue and continuous pressure they have experienced in the last few years.

The removal of secrecy and anonymity would likely reduce incentives for using offshore companies for legitimate tax avoidance.

Developments in a number of countries have further served as dampeners on the use of tax havens.

In the US a bill has been proposed to allow its tax authority to have more time to review tax returns where “offshore secrecy jurisdictions” are involved.

Mainland China’s tax authorities are seen to be revamping their domestic tax rules to counteract the abusive use of tax treaties, which often requires using offshore structures.

Despite all this, going offshore will remain possible but it will require detailed knowledge and careful planning. The days of easy and quick use of offshore centres are over.

Kang Beng Hoe is an executive director of TAXAND MALAYSIA Sdn Bhd, a member firm of the TAXAND Network of independent tax firms worldwide.

The views expressed do not necessarily represent those of the firm. Readers should seek specific professional advice before acting on the views.