What are Offshore Tax Havens and their Uses and Misuses ?

What are Offshore Tax Havens ?

In recent years, there has been a lot of media interest in Offshore Tax Havens or countries where the global companies can base their offices as well as route their investments into emerging markets from offshore subsidiaries. To define offshore tax havens, they are countries where there is no tax on the profits earned by the companies based in their jurisdiction.

For instance, if a company is located in the Cayman Islands, Luxembourg, or the Isle of Mann apart from Mauritius, it need not pay any taxes on its profits earned by it. Hence, the term offshore tax haven because it is located away from traditional centers of business and because the tax breaks offered to the companies are like a haven for them. This means that if a multinational wants to setup its headquarters in one of the many tax havens, it not only gets its profits without taxes but it can also invest in mainland countries where it can claim that since it is headquartered in an offshore tax haven, it need not pay tax in the mainland as well.

The Misuse of Tax Havens

It has been estimated that the global economy foregoes more than a Trillion Dollars in taxes every year because of the tax havens. Further, there are agreements between the offshore tax havens and the mainland countries on double tax avoidance, which means that both countries sign an agreement that declares that if a company is being taxed in one country, it need not pay the same tax in the other country.

However, in practice the double tax avoidance works to the advantage of the companies as more often than not the offshore tax havens levy a negligible tax on the company is leading to these companies avoiding paying taxes in the mainland country. Of course, disputes arise because of these provisions as was seen in the case involving Vodafone and the Government of India.

The Income Tax department in India held that Vodafone was avoiding taxes on its acquisitions in India because it claimed that the investments were routed through Mauritius. On the other hand, Vodafone contested the tax bill strongly and the case went to the Supreme Court that ruled in the IT department’s favor. It is another matter that the dispute is now being arbitrated at different levels and a final decision is still pending.

Strong Opposition to Tax Havens

The reason why many activists and experts voice concern over the offshore tax havens is that thought they promote globalization and free trade; they skew the incentives in favor of tax avoidance rather than productive contributions. Considering the fact that the governments of the world need taxes to actualize social welfare, offshore tax havens indeed work against social justice.

The situation in the UK is more alarming as it has been found that most British and Multinational companies in the UK take advantage of the offshore tax havens and avoid paying tax altogether. Moreover, they also resort to what is known as transfer pricing, which means that they quote different prices in the target country and different prices in the tax havens to exploit the loopholes in the system. This again leads to a situation where even the meager amounts of tax on the operations of the firms in the UK are largely avoided.

Further, social activists also point to the scope for criminal activities and money laundering that these tax havens offer to their clients. This is the reason that there has been a concerted effort by activists in recent times to force governments to act tough against tax havens.

Concluding Remarks

Finally, corporates have a duty towards society and this is the reason that they must not exploit the system to their advantage. This is also the reason why governments of the world must come together to plug the loopholes and the lacunae in the laws to ensure that corporates pay taxes like anybody else.