Tax havens - a big challenge
Salaried class contributed Rs69.4 billion or 7.8% of the total income tax collection in the first half, which was higher by 20% when compared with the same period of last year. PHOTO: FILE
The Panama Papers, Luxembourg Leaks and Paradise Leaks clearly reveal how tax evasion and money laundering are being carried out on a massive scale through tax havens across the globe.
The ill-gotten and tax-evaded money channeled/ laundered through tax havens has become a global issue for the developing and the developed economies alike.
International tax policy experts have estimated the global tax revenue lost as a result of abuse of tax havens at $200 billion per year. For example, a multinational entity (MNE) pays around 20-30% tax on its income in non-tax havens whereas the said income is taxed at 0% in the tax haven of Bermuda.
Tax haven may be defined as a tax jurisdiction levying very low or no tax on offshore entities apparently with the main objective of encouraging foreign investment. The loss of revenue suffered by the tax haven is compensated by exploiting other sources of revenues.
The Tax Justice Network’s Corporate Tax Haven Index ranks Bermuda, the British Virgin Islands and the Cayman Islands – all British overseas territories – as the top three tax havens. The organisation’s Financial Secrecy Index ranks Switzerland, the United States and the Cayman Islands as the top three jurisdictions for private wealth.
About $650 billion or 40% of MNEs’ profits are shifted to these tax havens every year. About 98% of this profit shifting is done by 10% of the world’s largest MNEs.
Some famous multinationals involved in this profit shifting are Amazon, Google, IKEA, Nike, etc. These MNEs are more profitable in tax havens when compared with their financial results declared in non-tax havens.
These foreign firms are declaring around 1,500% pre-tax profits of their expenses under the head of “salaries and wages” in Ireland, 1,100% in Puerto Rico, 500% in Luxembourg and Singapore and 300% in Switzerland while for countries like the US, the UK, Australia, Spain, France, Japan, Italy, Germany, etc, this ratio ranges between 30% and 40%. The resultant corporate tax losses suffered by the countries are also huge. Just to quote a few examples: Germany loses 29% of its corporate tax revenue every year, France 24% and the US 17%.
According to a report of the Congressional Research Service published in January 2013, the US corporate tax losses from domestic operations were estimated at $90 billion per year while the offshore corporate tax profits from the tax haven of Bermuda reported by US-based companies grew five times over the last decade.
Corporate entities are not the only beneficiaries, the wealth of individuals stashed in tax havens has also been estimated at $8.7 trillion, according to the estimates of Gabriel Zucman (2017), an economist of the University of California at Berkeley.
Nicholas Shaxson, a famous economist, has estimated the lost global individual income tax at around $200 billion a year.
According to a Reuters’ report published on December 3, 2016, Starbucks, a US-based coffeehouse, reported losses over the last 13 years on its offshore operations in the UK. On the other hand, all along these years, it has been propagating to its investors about its high financial performance.
Leaked record of January 2014, obtained by the International Consortium of Investigative Journalists (ICIJ) pertaining to China’s offshore companies, reveals that close relatives of China’s top Communist leadership hold offshore companies.
Revenues of non-tax havens
Tax havens are posing so many challenges to the domestic economies. Tax havens are thriving at the cost of domestic tax revenues of non-tax havens.
It is a major source of money laundering and tax evasion. It is creating economic imbalances among countries. It is leading the world economy towards the race to the bottom. International tax policy experts are trying to tackle the issue of domestic tax revenues lost by countries as a result of declaration of high tax profits by the MNEs from their operations in tax havens.
The average global corporate tax rate has fallen by 50% over the last 50 years in non-tax havens. The US government passed the Foreign Accounts Tax Compliance Act (FATCA) in 2010, which binds all non-US foreign financial institutions in the world to pass on all the requisite information about their clients having any connection with the US.
Furthermore, since the last decade, especially after the 2008 global financial crisis, it has become the main agenda item of discussions of OECD/ G20 countries and other international fora.
In order to discourage various harmful tax practices, the Organisation of Economic Cooperation and Development (OECD) has already taken various initiatives like the Multilateral Convention for Mutual Administrative Assistance in Tax Matters, Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information, OECD Common Reporting Standards (CRS) & Base Erosion and Profit Shifting (BEPS) Action Plan. In July 2019, the OECD estimated that as a result of the Multilateral Convention on Automatic Exchange of Information, 90 countries exchanged information about 47 million accounts worth €4.9 trillion and resultantly, bank deposits in tax havens fell by 20-25% and that voluntary disclosures generated an additional tax revenue of €95 billion for non-tax havens.
However, the Base Erosion and Profit Shifting Action Plan, based on the “economic substance” and “arm’s length” method, is seen as “not a success story” for OECD countries, especially after the emergence of a digitalised economy.
In March 2019, Christine Lagarde, the then managing director of the International Monetary Fund (IMF), termed it outdated and urged for a fundamental rethink for devising formula-based approaches for the allocation of taxable income.
Solutions
As a way forward, at present, two possible solutions are being floated by the international tax policy experts. One is corporate tax harmonisation, ie a minimum benchmark for corporate tax rate all across the globe and the second is unitary tax with formula-based apportionment of income, reflecting true economic activities based on sales, employment and tangible assets.
The disclosure of beneficial ownership of all types of assets (especially financial and intangible) can also be made part of country-by-country reports.
As a final word, it can be said that international tax negotiations are like international relations where nothing is permanent but the individual interests of countries.
The most feasible solution lies in the combination of some or all of them: capital outflow control with special focus on modes of economic transaction settlement, economic substance, arm’s length principle, automatic exchange of financial information, disclosure of beneficial ownership of all types of assets, country-by-country reporting and unitary tax with formula-based apportionment of net earnings.
The writer is the Chief Inland Revenue in FBR headquarters
Published in The Express Tribune, March 15th, 2021.
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