A tax haven is a country or nation that imposes minimal or no tax liabilities on the bank deposits of foreign corporations and individuals. Tax havens are also called offshore financial centres where non-residents can bypass high taxes. They do not require businesses to operate out of the tax haven jurisdiction or beneficiaries to reside in the said country to avail tax benefits.
According to the Organisation for Economic Cooperation and Development (OECD), the following factors can be used to identify what is a tax haven:
- Zero or nominal tax on relevant income: Different tax havens offer different types of rebates and incentives on a variety of taxes.
- Lack of effective exchange of information: Tax havens have secrecy laws that prevent scrutiny by foreign tax authorities, ensuring that financial information is not shared with outside authorities.
- Non-transparency: There is a lack of transparency, with negotiated tax rates and veiled agreements being common.
- No substantial activity requirement: Tax havens do not require corporations to have a substantial local presence. In other words, most do not require the actual production of goods and services to claim tax benefits.
Companies and high net-worth individuals often use tax havens legally to stash away their earnings abroad to avoid paying high taxes in their resident countries. However, tax havens can also be used illegally to hide money from taxation at home. Many tax haven countries have secrecy laws that protect the information of their depositors from foreign tax authorities, blocking foreign tax fraud inquiries.
Also read: Securities transactions tax
Advantages of tax havens
Now that we have covered the definition of a tax haven, it is time to focus on the advantages and disadvantages of such entities. Here’s a list of some of the advantages tax havens offer:
- The main advantage of a tax haven is that businesses and individuals get to pay lower taxes. Tax rates in such jurisdictions generally range from zero to single-digit rates, allowing businesses to save substantially on the taxation front.
- Tax havens also offer legal protection to individuals and businesses. This can be beneficial to those at risk of losing their assets as a result of legal action.
- Tax haven countries attract capital to their financial institutions and banks, which helps build a thriving financial sector. In other words, the tax haven economy keeps flourishing as more investors are willing to invest in the country.
Also read: Bonus shares
Disadvantages of tax havens
The definition of tax havens makes their disadvantages quite apparent. We have listed the pitfalls of tax havens below:
- Tax havens can be used by the wealthy to avoid paying their fair share of taxes in their home country, resulting in a loss of revenue for the home government.
- Policies of secrecy in tax havens can encourage illegal and criminal activities like money laundering and tax evasion.
- Parking funds in tax havens can tarnish the business’s reputation. Investors and customers can view the enterprise as unethical, resulting in a loss of trust in the company.
Also read: Tax-free bonds
Top tax haven countries list
The largest tax havens of the world are listed below:
- The Cayman Islands: The absence of corporate, income, capital gains, and payroll taxes makes the Cayman Islands a preferred tax haven destination for companies and HNI individuals.
- Bermuda: Bermuda has a zero percent tax rate and imposes no taxes on personal income, corporate income, interest, dividends, and royalties.
- Singapore: Singapore is a prominent tax haven with a low corporate tax rate, zero capital gains taxes, absence of withholding taxes, and lucrative tax incentives.
- Switzerland: Switzerland is a renowned tax haven due to its exceptionally low tax rates (with full or partial tax exemptions) and rock-solid privacy regulations. The country is known to be one of the most reliable and stable global tax havens.
- The Netherlands: The Netherlands remains one of the most popular tax havens among Fortune 500 companies. The country does not extensively tax incoming dividends and royalties and is also one of the most famous conduit countries used to funnel profits from high-tax countries to other tax havens.
- Mauritius: With low corporate tax rates and no tax withholding, Mauritius has become one of the most favoured tax havens, especially for Indian corporations.
- The Bahamas: The absence of personal and corporate income tax and capital gains tax, and a strong historical commitment to financial secrecy have made the Bahamas a top tax haven destination for corporations and individuals.
- Luxembourg: Luxembourg has remained a well-known tax haven for large corporations around the world since the 1960s. Investigative reports suggest that corporations pay an effective tax rate of less than 1% in the country.
- Isle of Man: Situated at the heart of the British Isles, the Isle of Man imposes zero capital gains and inheritance taxes. Income tax rates are also exceptionally low and capped at a maximum of 20%.
Also read: Dividend stocks
Conclusion
Tax havens are jurisdictions that attract corporations and HNI investors with their low and favourable taxation systems. While businesses and affluent individuals can benefit from tax havens, there is a clear risk of them being abused for tax evasion. Their existence has a wide range of ramifications for the global economy. The secrecy laws and lack of transparency in offshore tax havens often cause severe long-term issues for the global financial system, encouraging illegal activities like money laundering and tax fraud.
