Exploring the Impact of Tax Havens on Global Economy and the Tactics Used in Crackdowns and Manipulation

1. Introduction

Tax havens refer to jurisdictions with low or no tax rates that are characterized by a lack of transparency, limited information exchange, and high levels of secrecy. Businesses and individuals seeking to evade or avoid taxes are drawn to these jurisdictions, often routing economic activity through them to minimize tax liabilities. This has significant implications for tax revenues, economic development, and inequality, particularly for developing countries reliant on corporate taxation.

The rise of "offshore" financial centers in the late twentieth century spurred concerted efforts by governments to curtail their impact and increase their accountability to global administrations. However, such efforts face challenges since tax rings give countries significant advantages when it comes to attracting businesses and investments. Furthermore, as sophisticated financial instruments and means of communication develop, so too do the strategies to lessen or avoid taxes. As some jurisdictions manage to block or hinder cross-border information exchanges while providing near-total secrecy over their clients’ affairs, recent crackdowns by some countries on these tax jurisdictions and their sanctioned manipulation by some others are just the tip of the iceberg. The key challenge for governments is thus how far they dare go to tame the beasts they have nurtured and, even more concerning, how such beasts could turn on their handlers.

2. Understanding Tax Havens

Tax havens are generally understood as jurisdictions that create opportunities for profit shifting, therefore reducing taxes paid to a high-tax jurisdiction. As a result, tax havens are often described in terms of a “tax haven economy” or a “tax haven sector,” both of which include the legal entities—as defined by legal jurisdiction (e.g. US-owned multinational corporations) as well as type of entity (e.g. US banks)—that file profits in the tax havens, as well as real economic activities captured in the haven. Tax havens provide opportunities to shift profits based on the characteristics of the tax haven (corporate tax rates, secrecy provisions, etc.) and the multinational (e.g. size and geographic reach). Tax havens are often identified based on the characteristics of the jurisdiction itself, such as being small, having certain regulatory provisions (low tax rates, secrecy provisions) and having multinational ownership (FDI in/out). This conceptualization of havens (jurisdictions and their characteristics) is difficult to operationalize because of data limitations. As tax heavens largely exist because of thier secrecy, it typically entails reliance on US or OECD data to create proxies for havens. There is no global data set that defines havens based their jurisdictional characteristics. (Ateş et al., 2020)

A more operational definition of havens is based on the consequences of (or behavior associated with) having certain tax jurisdictions: if a parent multinational corporation has a foreign subsidiary where the effective tax rate is less than a given threshold, the subsidiary is sent to be in a tax haven. This is similar to the idea of a “shadow banking sector,” where an institution is classified as such if it is engaged in activities similar to banking but is not subject to regulation.

2.1. Definition and Characteristics

It is essential to understand what tax havens are and the characteristics that identify them. Generally, tax havens are low or zero tax jurisdictions that provide secrecy to foreign investors. The common characteristics often used to identify tax havens include banking secrecy, very low or no tax, loopholes in the tax code, corporate residency, lack of commercial substance requirement, set-up of insignificant economic activities, a complex corporate structure to benefit from tax treaties, and guidelines against harmful tax practices. These characteristics are mainly used for the classification of the offshore tax havens for the academic purpose and to conduct research. All these characteristics, except banking secrecy, are based on government policies. (Janský et al., 2022)

Country jurisdictions identified as tax havens in the academic literature by researchers include many Caribbean Islands, Malta, Cayman Islands, Bermuda, Luxembourg, the Netherlands, British Virgin Islands, and such Pacific Islands as Vanuatu and Cook Islands. Fishermen and economic critics have referred to such tax havens known jurisdictions as "piranha." In broader terms, tax havens are classified either as offshore centers or low tax economies. Using a largely cited definition of tax havens by the Organization for Economic Cooperation and Development (OECD), an abbreviation of tax haven countries has come into use: "OECD-Haven," this term denotes all the countries that have been targeted for international investigation of their banking laws relating to the confidentiality of offshore funds. Despite recent attempts to further broaden the scope of international cooperation, the countries on that original OECD list, and many additional ones, remain a cause of persistent concern regarding their compliance with international standards. Unfortunately, the campaign against these havens has resulted in little more effectiveness. (Przygoda, 2022)(Lejour, 2021)

In the light of current developments in the global economy, tax havens can be viewed as the defenders of national sovereignty over capital space. Given the radical transformation of the state system, in particular with respect to the autonomy of corporate decision-making, this position appears plausible for justifying the economic and political mindset behind the emergence of tax havens. Nevertheless, the advocates of globalization conventions seem to fail to recognize that the superiority of the states concerned is seriously compromised by the very action of "retreating" from the global economy. It is this form of dependency that is feared by many emerging economies in relation to the global domination of an exclusive "super state" like the United States. (San Juan, 2022)

2.2. Historical Evolution

The alluring siren of tax havens has enchanted the rich and powerful since the 16th century. By taking advantage of secretive jurisdictions with lower taxes, the elite could conceal wealth and chase investments away from prying hands. As the rich deserted London for the tax-free shores of the Bahama Islands, they unwittingly set off a domino effect, with other nations scrambling to attract the newly mobile taxes. Nations bereft of income became desperate for cheap accommodations. The system became known as the race to the bottom. Untethered by import tariffs and trade barriers, companies flocked to nations with few resources or regulations. Here, firms could import raw materials tax-free, manufacture goods on the cheap, and sail them off into the open sea. As profits mounted, so did outrage from the once-wealthy countries the firms had left behind. Reckless vaudeville in the Bahamas unearthed fortunes that led Parliament to pass England's Income Tax Act in 1853, followed by the German Kaiser Heinrich VIII amendment to "police these free port swindlers." At the same time, empire-builders such as Cecil Rhodes scoured the globe for hideouts amid uncontrollable empires. The anti-gravity shelf escaped the long arms of the laws protecting corporate decision-making from corruption. It was here—on the very crest of empire—that the blueprints for the modern-day offshore world were conceived. (Liu et al.2020)(Hill, 2022)

It had taken only a few short years for the race to the bottom to spiral out of control. What began as a simple attempt to contain a few wayward taxpayers had escalated into a full-blown arms race, with nation after nation hustling to enlarge the prize by offering deeper and deeper tax evasion discounts. Nations with no local wealth to protect quickly got into the act. The United Kingdom’s North Borneo Company in 1881 was followed by the newly created colony of Labuan in 1886. By 1900, Panama and Zanzibar were both taking steps to attract foreign investors with tantalizingly cheap package deals. The controlling requirements? Turn off the Amber Alert, open the pages of a British-liberal Constitution, and close the books. For European and American businesses, the appeal was obvious. The latter could stage an interlude of sober business respectability—conducting matters elsewhere and severing connections with the few reliable chambers of commerce left on the surface. In due course, the gifts would be gently returned to the seeded country's banks—salted abroad in the Florida Keys via Florida courts covering up Hassan, Giannini, and Davis's adventures in Latin America, where they were bailed out as well by Rothschild banknotes. In the era of great sea-roaming business magnates, such blind trust in the perfidious and maturing common-law would have been unthinkable. (Tan, 2020)(Tan, 2024)

2.3. Types of Tax Havens

Tax havens can be divided into four groups based on their characteristics. The first group consists of the oldest offshore centers. For example, the British Channel Islands and the Isle of Man are well-known offshore centers that provide services to non-residents for more than half a century. Until recently, most of these jurisdictions were closely tied to a certain country providing them with an identity (tax neutrality and a certain banking secrecy) and competitive advantages. The service industry of these jurisdictions, however, is well-developed and provides many options for wealth holders and wealth creators from other countries to circumvent their domestic (mostly European) regulations. These offshore centers are relatively large in terms of their defendant populations compared to other offshore jurisdictions. They are mostly located in Europe and the area of jurisdiction is from 5,000 square kilometers in case of Guernsey to 15,220 square kilometers in case of Jersey. The tax levels of the jurisdictions are low or non-existent. Wealth and wealth transactions are well protected by strict legislation. The language used in wealth transactions is mostly that of the home country or an international language, mostly English, which makes transactions less risky. (Hebous & Johannesen, 2021)

The second group consists of locations where offshore centers came into being as a political or economic response to certain countries’ regulations. For example, Iceland, Luxembourg, and Monaco are the best-known European jurisdictions. Due to their proximity to the Scandinavian countries, Iceland’s development was similar to that of other Nordic countries. The primary aim of the legislation was to build an international banks’ market. In the mid-1990s, Iceland was involved in privatizating the state banks. The banks had to find possibilities to expand beyond the Icelandic market, and offshore services were one of the alternatives. This was the starting point of Iceland becoming a tax haven-like jurisdiction. The regulatory arbitrage opportunity was attacked by amending anti-avoidance provisions in the Icelandic taxation act. The amendments came into force in 1997, and offshore services to non-residents were illegal unless accounted for in the jurisdiction. (Yeoh, 2021)

A third group of jurisdictions went through a tax haven-like transformation as a result of political changes, primarily from communism to democracy and from the centrally planned economy to a market economy. Cases include a number of post-communist countries, primarily in Eastern and Central Europe. For example, as a consequence of the privatization program, a financial services industry developed in Hungary, which could be an intermediary between the western investors, eastern privatization funds, and state-run public companies. Recently, a new wave of regulations stimulating foreign direct investments came into existence in the Czech Republic, Poland, Slovenia, and largely in the last decade, in all post-communist countries. The recent EU enlargement opened a new window of opportunity for offshoring wealth creation in new jurisdictions. (Cockfield, 2023)

As a fourth group, in addition to already existing offshore centers, a number of countries decided to try to attract global players from finance and wealth creation. For example, the establishment of an offshore center in Malta was considered in the mid-1990s. Only few had any questions about whether Malta had the ability to construct a successful offshore industry. Those who took the project seriously wondered about Malta’s options and the type of offshore industry this small Mediterranean island had to develop in order to be competitive. Questions relating to the problems Malta was likely to encounter were also raised. One of the conclusions was that Malta would no longer be a veritable paradise for overseas banks and other financial institutions, and bank secrecy as understood in the Caribbean or other established havens would cease to exist. (Jónsson, 2024)

3. The Economic Impact of Tax Havens

The nature of tax havens and their economic activity has sparked significant interest among researchers and organizations alike. These advocates do not dismiss the use of tax havens, but stress a balanced perspective that takes their positive as well as the negative effects into consideration. They assert that tax havens cannot be broadly judged as good or bad, emphasizing the need for policymaking to focus on a clear definition and a deeper understanding of tax havens’ characteristics.

A basic definition of tax havens must be broad enough to include the complex characteristics of countries like Singapore. Areas designated as tax havens should meet at least three criteria, namely: 1. No, or very minimal, appreciable taxes on relevant income; 2. Laws or administrative practices which act to prevent the effective exchange of information with foreign tax authorities; and 3. An established, government-sanctioned, and sustained level of secrecy so as to encourage the use of that jurisdiction for the establishment of mass repositories of the moneys and wealth of non-residents. Further, the assessment of tax haven activity should include its impact on individuals and corporations. (Dharmapala2021)

First, it is argued that tax havens can be beneficial to developing countries. To this end, it matters how base countries or source countries react in the wake of a capital flight. If strong countermeasures are taken by improving regulations, monitoring transfers and stricter enforcement of regulations, the results of tax havens might be positive as they induce better cooperation among states. At least in terms of increasing economic activity, the alleged doom scenarios concerning massive capital flight seems to be exaggerated. This is in line with the increasingly positive tone on tax havens by governmental bodies like the OECD or IMF. There is hope that developing nations might benefit in terms of tax revenues, reduction of capital flight and competition between nations for investments.

Alternatively, it can also be claimed that tax havens might be positive for a broad class of countries particularly with respect to preventing rich bees and unprofitable companies from leaving them. Such an outcome would be desirable given the importance of persistent policies and outcomes. The number of states with regulatory climate harmonizing regulations may thus be stable at a non-zero number, and even though capital flight occurs, developing countries would nevertheless have a wide range of policy choices available. However, this perspective of global welfare implies states not maximizing the welfare of their constituencies, which seems unrealistic in the context of a growing inequality worldwide. Moreover, the theory is highly sensitive to the strength of the consideration against tax havens.

On the other hand, the evidence is probably more in line with the perspective of tax havens being harmful to developing countries. The impact of tax havens and money transfers to them is most devastating for developing countries unable to attract business, investment and taxation equivalently. The initial aggregate beneficial results set off underestimations of eventual negative net advantages. It has been pointed out that, years after tax haven regulation was first liberalized, serious counter-measures have yet to be taken.

3.1. Positive Effects

While tax havens have often been blamed for negative developments in the global economy, recent research has also highlighted their positive effects. Analysis of countries, including several tax havens, found that tax havens are on average richer, grow faster, are less indebted, invest more, experience more FDI income, invest more outwards, experience higher profits and broader capital market access, and have larger net interest payments. In the case of tax havens being typically small countries with a specific geography and economy, sensitivity analyses excluding them did not affect the conclusions. (Laffitte, 2024)(Sovičová, 2020)

However, policy implications were less straightforward. On the one hand, accounting would have to be adjusted. On the other hand, the positive effects of tax havens may hint at options for less competitive countries eager to attract more MNEs. Similarly, it has been noted that the recurrent conduct of international organizations that combat harmful tax competition by encouraging countries to increase tax burdens on mobile tax bases would be of little help to low-tax jurisdictions wishing to develop their economy, particularly as larger markets also tend to have a stronger influence on the decision to headquarter in these countries.

With financial innovation and expanding networks of interdependencies causing multinational enterprises (MNEs) to possess roughly half of the world’s capital stock and three-quarters of its commerce, one of the critical skills bordering on secrecy is tax planning. Using competitive, innovative arrangements, many of them funnel their profits through tax havens to avoid taxes. However, tax havens are often blamed for economic developments from increasing income inequality and a financial crisis to the current woes of the euro. At the same time, recent analyses of the offshore economy curbed the perception of tax havens as economic wastelands. (Wallace, 2021)

3.2. Negative Effects

With the introduction of tax havens in the 1920s, there was a sudden increase in tax evasion, the disruption of markets, avoidances of legislative efforts to promote transparency, and evenly the indirect suggestion of corruption. Take the case of Denmark, with sales taxes of 25 percent, foreign airlines reportedly charged fees through their Dutch operations, and several multinational firms setting up subsidiaries in tax havens. Denmark was inviting those companies to harm the requested change or make a move to another country. There were also concerns that shadow banking would take place in these havens. On the other hand, a wealthy man would have to think twice before laundering moneys in some offshore island because banks charged enormous rates for this kind of service. Noncooperate banks and institutions were often dragged into lawsuits. The G20 countries were concerned about the role of Bermudalike islands in the dollarbond market and voted in 1989 to apply an automatic withholding tax on certain dollarbonds issues. (Guex & Buclin, 2023)(Guex2023)

However, many places found it very hard to give up the pack even for the purpose of ending (or mitigating) the pack in other countries. For example, there were states in the United States very well aware of the harmful nature of gambling devened their treaty conversations with other states. They said that it would be absurd to give up such a massive source of income. In the early afternoon hours of a bar exam, candidates would be bombarded with advertisements for Las Vegas casinos.

During the mid-1990s, concern over the manipulation of the euro began to emerge in the political agenda. Many European governments were uncertain how to calculate their euro-entry expenditures. In consequence, pressure increased to make long-term interest rates converge and for mutual cooperation in the management of currencies in the vague transition period. The maintenance of currency bands was part of this, as was the attempt to curtail speculation against weaker currencies. In these efforts states tried to counter the cache on the players by means of greater transparency. In the UK, the treasury opened a special inquiry into the currency markets, and in Germany a parliamentary committee investigated the manipulation of the Deutsche Mark. In the US, some politicians labeled hedge fund managers as “criminals” and from there, the political agenda turned to the blunter notion of “need for regulation”. (Lysandrou & Stassinopoulos, 2020)

Another important concern became whether the heavily bloated euro-crisis “shadow banking” sector, with its so-called “money market funds” would be at the core of a currency crises. After the euro was instituted in 2002, there had been massive transnational shifts of capital from banks to euro-denominated money market funds which generated a development similar to the growth of offshore euro-dollar banking in the first wave of financial deregulation during the 1960s. In several nation-states mutual fund companies, large banks, and securities corporations transformed into money market fund providers. After the eurozone collapse and the bailouts the literature also turned to a concern over the political economy of control and dominance, basically in the wake of concerns born with the so-called “Latin American crisis”. One gesture was to turn to the disciplines of the so-called “new” political economy traditions. Basically, these are not driven by whether one is for or against globalization as is the case with a number of economic nationalist accounts.

4. Regulatory Frameworks and International Efforts

Discussions about tax havens usually come down to the absence of serious regulations or ineffective rules that are also easy to exploit. For states where tax evasion is common, it is often said they lack havens to which their wealthy citizens can escape. The financial conditions of tax evasion are therefore significant influences on the political economy of global finance, including, importantly, the regulation of the global financial industry. Countries with national tax benefits must weigh public interest against capital flight. On the one hand, tax systems with no havens are prone to collapse, aligning their tax rates with those of the havens. In other cases, wealthy states can cooperate to close tax havens in other jurisdictions, which may benefit metropolitan states. At the same time, the hope persists that simply improving poor states’ regulations will be enough to mitigate regulatory arbitrage. Unfortunately, regulatory convergence does not always win. (Temouri et al.2022)

The Organisation for Economic Co-operation and Development (OECD) holds a pivotal position in international policy discussions about tax havens. Formed in 1961, it is based on principles of participatory democracy and free-market economics. The OECD has become the most respected authority on the conduct of economic policy among officials in wealth-generating states. It has examined tax competition and offshore money laundering, issuing reports, statements, and guidelines, and has led efforts to regulate offshore tax havens. Following the release of substantial reports by the OECD about the conduct of tax havens, many hopeful declarations on regulating expensive jurisdiction followed. In the earlier, celebratory stage, OECD states called for new regulations. They claimed to have the knowledge and tools to control capital from small wi-fi seashore locales. But these efforts bore little fruit outside of real offshore money directing states, weakening hope in the process.

G20 actions have so far been at the level of attempting to regulate a situation before such regulation is possible. The calls for eighteen offshore locations to automatically exchange financial data with the ‘homeland’ states of expatriated wealth proved a useless carrot-over-stick approach. Places like the Cayman Islands, Bahamas, and the British Virgin Islands are each home to half a trillion in global assets. Codifying an international legal framework prohibiting states providing secrecy for fees of any description would be a stick to wield. Attempts to make sovereign state secrecy a violation of international law or at least subject to foreign tax access would fully thwart international competition in the market for money laundering laws, if such a competitive scenario were intelligible in the first place, given that the compliant states mentioned above belong to the United Kingdom, a member of the G20. (MacDonald, 2020)

4.1. OECD Initiatives

Tax havens remain at the forefront of national and international economic policy and, depending on the definition used, tax havens can be found among both developed and developing economies. “Haven” countries set their tax rates at zero or at levels well below income rates in “source” countries. In 1998, the OECD published a report entitled “Harmful Tax Competition.” This discussed the problems caused by a trend in some countries and territories to compete for mobile investment by offering very low or no tax rates and other special privileges to non-residents. The report focused on international financial services, but similar concerns were raised in other policy spheres. In June 1998, in response, the G7 summit at Birmingham called for the OECD to lead an initiative to combat tax competition (OECD 2006).

A series of initiatives was launched to combat what was seen as harmful competition: the Forum on Harmful Tax Practices to tackle banking secrecy and “ring-fencing.” This refers to deliberately excluding local economies from competition, for example, by restricting access to onshore markets to local banks or currency. Three types of countries were identified as reassuringly robust: the “onshore” (low and no tax but not secrecy), “neutral” (less than ten percent tax and secrecy) and “far” (high tax, little penetration). Of 13 country lists, Ireland, Luxembourg, the Netherlands, and the UK were on the “far” list. (Wójcik et al.2022)

In 2000, the OECD produced a Blacklist of 35 “tax havens” — now called “harmful preferences” countries — which were then pressured to abandon the tax regimes. This was thought politically plausible to achieve given that many of the countries were small, general revenue dependent, lacked any market power, and used tax incentives to draw investment and develop the financial services sector. In 2001, a wave of commitments to remove economic citizenship, bank secrecy, and zero tax regimes was secured. However, the political terms of compliance were increasingly resisted by countries with extensive legal networks; many resorted to withdrawal from OECD processes.

In January 2002, the new OECD Secretary-General announced a change in strategy. “Rather than attack the problem on many fronts — seven initiatives in total — we recommend a concentrated approach focused on the harmful tax competition initiative” (OECD 2006). Thus, ahead of the March meeting of G7 finance ministers, a new round of pledges to comply with the terms of the OECD initiative was secured from Bermuda, Guernsey, and the Isle of Man. However, onshore countries similarly appeared increasingly unprepared to actually remove their own harmful regimes. Further, after meeting with a delegation of Caribbean representatives in Antigua in June 2002, it seemed possible that a collective resistance would emerge.

In the face of this challenge, OECD efforts to mobilize forces into the political arena intensify. Some onshore governments openly signaled their readiness to maintain the current positions and accept ongoing losses in terms of tax revenue. Obvious compensatory mitigation strategies were reopening cases of market abuse, online gambling, etc. Further reforms were proposed to the WTO services negotiations including a new “request-offer” system for onshore countries to gradually secure countries with substantial binding commitments.

4.2. G20 Actions

The G20's engagement on the issue of tax havens was catalyzed by the 2008 global financial crisis. The associated issues of tax revenue losses and weakened public confidence in the ability of governments to act against the crisis were high on the agenda of the individual G20 countries and on the G20 agenda (G20 2009-2016). In April 2009, the G20 countries committed to a broad range of measures to tackle tax avoidance and evasion by means of secrecy jurisdictions in development and growth-enhancing ways. Later in 2009, the G20 countries also decided to act decisively on the OECD’s 2004 mandate to eradicate harmful tax practices. Due to the G20's political weight and its Great Repositioning of Power narrative’s spotlight on the developing world, the OECD’s work became the leading global initiatives in the fight against tax havens. Progress in implementing the G20’s commitments and in stopping the veritable bonanza of bank secrecy taxes in OECD countries must include a global anti-secrecy framework and also extend far beyond the confines of the tax and banking areas (OECD 2019).

In order to accommodate for G20 interest in the broader range of secrecy jurisdiction issues and in fast-moving developing countries' globalizing citizens, the OECD revived its earlier informal work on non-OECD members and de facto development cooperation. In particular, through the outwardly open but G7-dominated so-called Global Forum, in which a non-participation dialogue would use World Bank Group and International Monetary Fund (IMF) leverage to bring in the most lessees well-developed developing countries. To this end, the OECD established a dual track with a twofold process for promoting and examining compliance with the new G20 standards: on the one hand, the 55 now member strong Global Forum's peer review process on a "comply or explain" basis that would closely shadow the OECD's own members, and on the other hand, the FATF's "name and shame" process for heavily non-member jurisdictions (OECD 2015, 2016). (Larionova, 2022)(Lips & Mosquera2020)

5. Tactics in Cracking Down on Tax Havens

This section explores the mechanisms employed in the Journal’s initiatives and the analysis of tax havens and abusive tax practices. The four mechanisms include scrutinizing new laws or regulations, examining proposals for new ones, investigating allegations of abusive practices, and monitoring the implementation of recommendations.

Legislative Measures Regulatory initiatives initially focused on the legislative measures during the AFL-CIO/PSI survey. To date, twenty-three countries have adopted regulatory measures designed to expose or curb tax haven and abusive tax practices. A summary of these measures, including the legal and regulatory references where the full contents of the Legislative Measures can be located, is Appendix 1. Each measure is categorized in the following format: General Provisions, which includes measures that generally require or enable incidental actions; Specific Provisions, which includes measures that specifically require or enable prescribed actions; and Institutions, which indicates the greatest power, authority, or discretion institutions have under a measure. Institutions include governments, legal and regulatory authorities, ministries, public agencies, legislative bodies, international organizations, and accountants. (Cockfield, 2023)

Enforcement Actions The ethical core principles of accountants did not explicitly prohibit or exempt making and implementing aggressive tax avoidance plans. In general terms, accountants are required to act “with integrity, objectivity, professional competence and due care, confidentiality and professional behavior.” This could not be construed to exempt accounting advice from liability under tax abuse circumstances. Unabated, tax avoidance schemes fuelling delinquencies and abuses were now widely regarded as a scandal. An example is the 2009 HSBC scandal, during which it was reported that the bank had aided thousands of wealthy clients in shifting $100 billion in assets and avoiding $4.1 billion in taxes through 15,000 secret accounts. At the same time, thousands of poor people were being sentenced to jail across the United States for inability to pay the punitive tax penalties. The state attorney generals of fifty states combined forces to negotiate with the bank, and in 2012 HSBC agreed to pay a $1.9 billion settlement, which represented only a 5 percent penalty of the taxes unpaid.

5.1. Legislative Measures

Tax havens are not only a concern for governments but also for international organizations. International organizations and state associations have actively sought to combat tax avoidance strategies based on tax havens. To this end, they have often prepared lists of countries considered harmful tax havens. Currently, there are more than a dozen such lists elaborated by various organizations and states, including FATF, OECD, EU, WTO, IMF, and the US. The majority are based on the OECD “List of Uncooperative Tax Havens”, prepared in response to the 1998 request of the G7 (“Group of Seven”) wealthy states. Later this list was supported by the EU “List of Non-Compliant Tax Havens” and the US “List of Jurisdictions whose Laws or Practices are not sufficient to ensure the Fiscal Transparency of Foreign Based Subsidiaries”. In parallel, after the G7 started to focus on tax havens, several initiatives aimed at harmonizing rules concerning bank secrecy and combating fiscal fraud were prepared by the whole Enhanced Financial Accountability and Transparency (E FAT) initiative or on the bases of the Bilateral Tax Information Agreements (BTIA). (Miyandazi et al., 2021)

The OCED lists state countries that failed to agree to the OECD tax convention and cooperate with the OCED forum on tax harmonization and transparency. Moreover, the OECD country-specific recommendations went further, listing actions to be taken against certain tax havens and stipulating deadlines for compliance with these recommendations. An EU report elaborated by the relevant working group enumerates 28 states having “uncooperative” tax practices, including Caribbean islands, Swiss cantons, Monaco, and other European non-EU countries. The G7 lists of tax havens have become the basis for similar initiatives by banks, financial institutions, and regulatory agencies (in the UK).

In addition, the EU conducts a continuous screening of the EU member states tax policies ability to cope with racial abuse. Such screening has revealed that Irish and Dutch policies aimed at attracting foreign investments through tax incentives do not comply with the EU legislation on fiscal state aids. This prompted the EU to notify these countries about further investigations on the compliance of taxpayer’s state aids with the competition rules. Increasingly, provisions on independent protection from tax discriminatory practices and environmental legislation emerged in the trade agreements with Western countries (particularly American) and the European Treaty of Amsterdam. These were subsequently mirrored in negotiations within the OECD.

5.2. Enforcement Actions

Enforcement actions have traditionally been central to crackdowns on tax havens. Unlike in legislative measures where action is usually taken through multilateral organisations or coordination between countries, enforcement actions are individual initiatives taken by countries. These measures typically take the form of investigations or information requests towards specific individuals or firms, often but not always who are suspected of wrongdoing, to encourage individuals to pay back taxes or settle penalties.

Countries often cooperate together to coordinate their participation in the enforcement action. The Organisation for Economic Co-operation and Development (OECD) has also facilitated enhanced tax information exchange between tax authorities through the Convention on Mutual Administrative Assistance in Tax Matters but this is not part of the strict investigation measures. The focus here is on the latter, strict investigation measures. Previous enforcement actions that were analysed are the US 2009-2020 tax investigation into Credit Suisse, the Bahamas ICIJ and the Panama Papers investigation, the 2011-2022 investigation into Kreab Group and the 2020 Swedish investigation into tax advisors. (Maryudi et al.2020)

Generally, either a large part of a country’s income is lost due to it being actively kept out of reach from tax authorities in other countries or a small part of income is hidden with the use of tax schemes that comply with the laws but interprets them in a way that is against their spirit. When it comes to tax haven related illegal revenue streams businesses are often set up in offshore havens although not necessarily reporting the business income there. The areas of income covering most enforcement actions are financial assets in connection to addressees in a tax haven and tax advisory services in connection to arranging involvement in a tax haven. The client base that is typically targeted in these arrangements are wealthy individuals, firms and funds operating cross-border, opting for a withholding tax on request or undertaking financial transactions potentially outside reach of tax authorities.

6. Manipulation and Evasion Strategies

The tactics employed by corporations and ultra-wealthy individuals to evade taxes are often crafted with a ruthlessly meticulous design. The manipulation of transfer pricing systems and the establishment of shell companies represents some of the most sophisticated tactics deployed in a collective effort to eschew taxes.

Transfer pricing is a pricing strategy utilized by multinational corporations to artificially shift revenue (in the form of payments for goods and services) from high-tax jurisdictions to low-tax jurisdictions. By manipulating transfer prices, multinational firms are able to fabricate tax deductions that offset taxable revenue in high-tax jurisdictions. Such reductions in tax liability can then be recognized in a jurisdiction with lower taxes. However, transfer pricing is a difficult practice to monitor as it does not require illicit actions, such as the submission of falsified documents or the bribing of public officials. On the contrary, the entire process is recorded and documented, and prices are modified algorithmically to comply with the “arm's-length principle,” a principle endorsed by the Organisation for Economic Co-operation and Development (OECD). (Kalra & Afzal)(Korol et al.2022)

The OECD states that “a transfer price will be considered to be an arm's length price if such price is consistent with the prices which would be agreed upon by unrelated parties in comparable transactions.” In order to comply with the criteria of the arm's-length principle, companies need to establish an exhaustive dataset of such prices across numerous jurisdictions, which is frequently financially unfeasible under current legislative frameworks. In addition, different laws regarding transfer pricing regulations across jurisdictions complicate such undertakings.

Tax compliance audits of transfer pricing contracts are often conducted by examining the rationale behind the transfer pricing modes and determining whether it follows an arm's-length principle. Auctioning of tax contracts or “Mexican standoffs” between independent tax authorities of two jurisdictions are additional proposals meant to combat transfer pricing. However, these measures are premature and require considerably more research prior to implementation. In general, the delegation of transfer prices to the marketplace, the complete repeal of the OECD guidelines, and the coordination of price regulations are viewed as the optimum solutions to the transfer pricing issue. Regardless, careful consideration must be taken in order to mitigate negative externalities. (Kraievskyi & Muravskyi, 2024)

The establishment of shell companies is a tactic that lays at the intersection of manipulation and evasion, as it requires the establishment of companies abroad in low or no tax jurisdictions. Such companies then fabricate contracts with legitimate firms and fake economic activity in order to route the amassed income through this sophisticated structure, which is in the essence of tax avoidance and illicit under the OECD's definition. Shell companies are often criticized as a mere legislative loophole. However, the OECD determines the establishment of shell companies in jurisdictions with lower tax liabilities to be entirely legal. Such companies have been subject to various crackdowns in the past, yet the development of equivalent tactics has allowed the process to continue.

The Paris Agreement’s tax loophole crackdown is one of the most well-known anti-shell company legislative frameworks. However, the efforts of countries to institute the regulations of the Paris Agreement would hinder smaller emerging economies while rapidly industrialized economies, such as Ireland and the Netherlands, would remain undeterred, as compliance with the Paris Agreement would allow jurisdictions highly constrained by the regulations to decide which other jurisdictions would be subject to regulations. Furthermore, the shadow of overreaching retaliation of countries deemed in violation of the Paris Agreement looms large.

6.1. Transfer Pricing

One of the most prevalent techniques used by multinational corporations to manipulate economies is transfer pricing. Transfer pricing refers to the pricing of goods, services, and intangibles between related entities within the same multinational enterprise. While theoretically, the transfer price of a good or service would reflect an Arm’s length price, i.e., the price a third-party would pay, this is often difficult to determine given the wide disparity of the markets in which multinational corporations operate. Transfer pricing mechanisms can manipulate profits and move them out of high tax jurisdictions, and across borders into low tax jurisdictions. Broadly there are two approaches used to manipulate transfer prices; the market approach and the cost approach. The market approach refers to determining arm’s length gross profit margins using prices from, or comparable gross profits on, third-party transactions. Under the cost approach, the arm’s length transfer price is determined using costs entered into the transaction, plus adjustments (markups) relative to those costs. (Rathke et al.2021)

Manipulating the situation where the buyer side has a majority share in the multinational corporation and is bundled into the cross-border transactions, under the cost-plus method, would mean determining the cost plus markup transfer prices on a unilateral basis (that can be done at costs that meet arm’s length standards and without consideration of the local standards set in the local jurisdiction).27 As opposed to the purchase price method where either by transfer pricing or comparison with simple cost-effective product sales comparisons would ensure that the transfer prices that would have been charged to the undistorted transaction had been fixed, better transfer prices mean ensuring sales losses had been fixed as if sales to unrelated companies had taken place instead.

Under the market approach, cooperation, for the determination of arm’s length transfer prices based on prices between independents for similar goods, i.e., prices adopted in uncontrolled transactions, would provide access to important and accurate information that other subsidiaries are likely to have. However, checking the veracity of the multinational corporation’s data necessarily limits monitoring due to the many tax jurisdictions in which multinationals create subsidiaries and the spread of the information provided. Furthermore, by the multinational adopting the market method and the local companies not having access to the same competitor data as the buyer side has or the less than normal risk attributed to that side in ascribing the position of related party companies i.e., normally risk lagging that of other companies implies that trade rapport is employed but that rapport may limit complaints, the selection of comparables might have a sustained impact on the local subsidiary; as basing on the buyer side’s cuts would lower the operating profit of the local subsidiary the more competitors have been included in the selection, the local company’s dispute position can be limited if it has been taken over by multinationals and the cut was under the acceptable say European Monetary System band, or by selecting the queries unrelated companies supplied by unrelated companies outside the tax jurisdiction.

6.2. Shell Companies

An intriguing tactic allowed by tax laws of high tax regimes was the establishment of a shell (or phantom) company in tax havens. Such company has no business other than to hold shares in other companies and it is operated entirely on paper, creating the illusion that both parties are independently existing and not artificially created for tax minimization. This is considered a form of aggressive tax planning and has recently been fought against by the OECD. Despite its crude form, it is surprisingly effective. Namely, while the transfer pricing method requires settling for "fair" royalties, here the royalty is simply set to 0 and the payment is made to a company, whose entire activity is just a facade. Between 2008 and 2016, there were 157 subsidiaries of Fortune 500 firms "domiciled" in Bermuda that fit the description “Incorporated after 1998, with no employees and no assets, whose only financial transaction is the receipt of a royalty from a foreign parent”. About 85% of royalties received by these companies were paid to other tax havens. Innovativeness in tax avoidance is of particular interest because it tends to produce further innovations over time, resulting in complex webs of intricate regulations. Brazil is a good example in that sense, as the complexity of regulation has added up rapidly and become exorbitant. Conducting due diligence on foreign companies reveals unforeseen twists and turns, such as ownership by man of straw based in Alaska and an onerous but mandatory annual public report on which auditors can be held criminally liable and suffer $10,000 fines per day if not completed. That said, regulations still allow for predictions concerning tax avoidance tactics. Each country enacts its own regulations on tax havens and not all havens are equal. Popular countries for tax planning are those whose legislation is particularly favorable in regard to specific treatment. For instance, Luxembourg offers tax incentives for financial services firms and Pequot Capital Management used this and other havens to create a web with 65 companies claiming to be firms in such jurisdictions. In effect, Pequot paid only 3% taxes in 1992 while its revenues grew fourfold, a 12-fold increase in profitability.

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