What is a Tax Haven?
A tax haven or offshore financial center is any country or jurisdiction that offers minimal tax liability to foreign individuals and businesses. Tax havens do not require businesses to operate out of their country or the individuals to reside in their country to receive tax benefits.
Criteria for Tax Havens
In 1998, the Organization for Economic Cooperation and Development (OECD) gave a number of factors to identify tax havens. Some of the most common factors are given below:
- No or nominal tax on relevant income
- Lack of effective exchange of information
- Lack of transparency
- No substantial activities
How Governments Earn Money from Tax Havens
- Tax havens are not completely tax-free. They charge a lower tax rate than other countries. Low tax jurisdictions generally charge high customs or import duties to cover the losses in tax revenues.
- Tax havens may charge a fee for new registration of companies and renewal charges to be paid every year. Additional fees may also be charged such as license fees. Such fees and charges would add up to a recurring fixed income for the tax havens.
- By attracting foreign individuals or businesses, even if they are only charged a nominal tax rate, the country may earn substantially more in tax revenues than it would otherwise. Also, the country may benefit from corporate investments in business operations that offer jobs to the country’s residents.
Benefits to a Tax Haven
- To Tax Haven Countries – The countries benefit by way of attracting capital to their banks and financial institutions, which can then be used to build a thriving financial sector.
- To Individuals or Businesses – The individuals and businesses benefit by saving tax, which in tax haven countries may range from zero to low single digits compared to high taxes in their country of citizenship or domicile.
Top Tax Havens in the World
- Bermuda – Declared the world’s worst (or best if you’re looking to avoid taxation) corporate tax haven in 2016 by Oxfam with zero percent tax rate and no personal income tax.
- Netherlands – Most popular tax haven among the world’s Fortune 500. The government uses tax incentives to attract businesses to invest in their country. One such tax incentive cost an estimated 1.2 billion euros in 2016 to Netherlands.
- Luxembourg – It gives benefits such as tax incentives and zero percent withholding taxes.
- Cayman Islands – No personal income taxes, no capital gains taxes, no payroll taxes, no corporate taxes, and the country does not withhold taxes on foreign entities.
- Singapore – Charges reasonable nominal corporate taxes. Reasonable corporate tax rates are provided through tax incentives, lack of withholding taxes, and what appears to be substantial profit shifting.
- The Channel Islands – No capital gains taxes, no council taxes, and no value added taxes.
- Isle of Man – No capital gains tax, turnover tax. or capital transfer tax. It also imposes a low income tax, with the highest rates at 20%.
- Mauritius – Low corporate tax rate and no withholding tax.
- Switzerland – Full or partial tax exemptions depending on the bank used.
- Ireland – Referred to as a tax haven despite officials asserting that it is not. Apple discovered that two of the company’s Irish subsidiaries were not classified as tax residents in the United States or Ireland, despite being incorporated in the latter country.
Top Companies that Benefit from Tax Havens
- Apple – Amount booked offshore is $214.9 billion. It uses Ireland as a tax haven. Would have owed the U.S. government $65.4 billion in taxes if tax haven benefits were not used.
- Nike – It holds $10.7 billion offshore. It uses Bermuda as a tax haven. It would have paid $3.6 billion for taxes if tax havens benefits were not used. This implies Nike pays a mere 1.4% tax rate to foreign governments on those offshore profits, indicating that nearly all of the money is officially held by subsidiaries in tax havens.
- Goldman Sachs – It holds $28.6 billion offshore and uses Bermuda as a tax haven.
- Some of the 50 biggest U.S. companies that have stashed approximately $1.6 trillion offshore include Microsoft, IBM, General Electric, Pfizer, Exxon Mobil, Chevron, Walmart
These 50 companies earned over $4.2 trillion in profits globally but they used offshore tax havens to lower their effective overall tax rate to just 25.9%, which was well below the U.S. statutory rate of 35% and even lower than the average levels paid in other developed countries.
The Panama Papers
- The leak of 11.5 million files from the database of world’s fourth-biggest offshore law firm, Mossack Fonseca.
- The Panama Papers revealed the ways in which the rich could exploit secretive offshore tax regimes.
- The following are the type of files contained in Panama Papers:
- Owning an offshore company is not illegal but Panama Papers revealed that concealing the identities of the true company owners was the primary aim of the majority of the offshore companies.
- Panama Papers revealed the names of various well known international banks that helped their clients establish a business in offshore jurisdictions as a part of wealth management services.
Tax implications in valuation and financial modeling
When performing a company valuation, the calculation of taxes can have a material impact on cash flow. A financial analyst is tasked with building a forecast of what they expect revenue, expenses (including taxes), and other financial items to be in the future. This process of forecasting items into the future is known as financial modeling and is performed in Excel.
To learn more about financial models, see our complete library of financial modeling resources.
Thank you for reading the CFI guide to tax havens. For further reading on taxes and accounting, see the following resources.