A Tax Lawyer Explains Tax Havens

The banking secrecy issue is incredibly important to the G-20 nations. What they need is a way to obtain compliance with their domestic anti-avoidance laws -- laws meant to prevent tax evasion.
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Offshore Tax Havens have been in the news a great deal lately. Stanford Financial utilized an offshore jurisdiction for their banking needs and now we've learned the AIG utilized certain offshore jurisdiction's secrecy laws to avoid oversight. However, none of these stories has placed any of these actions in context. The fact is offshore secrecy has been under assault and will be going away for the remainder of our lifetimes.

First, let me add this disclaimer. I am a tax lawyer who has a masters in domestic (US) and international taxation. Offshore jurisdictions can be used legitimately and legally in a variety of ways -- in ways which I have advocated and implemented for clients.

That being said, let's start with a definition: what is a tax haven? The following definition from the OECD is perhaps the most often cited definition:

"The absence of tax or a low effective tax rate on the relevant income is the starting point of any evaluation. No or only nominal taxation combined with the fact that a country offers itself as a place, or is perceived to be a place, to be used by non-residents to escape tax in their country of residence may be sufficient to classify that jurisdiction as a tax haven. Similarly, no or only nominal taxation combined with serious limitations on the ability of other countries to obtain information from that country for tax purposes would typically identify a tax haven."

So what we have is a combination low/no tax along with banking secrecy. Let's take these one at a time.

Why do tax havens have no taxation? The primary answer is the vast majority are small geographically. Consider most of the island jurisdictions in the Caribbean -- most are at the most 500 square miles with far smaller populations than the US/OECD countries. In other words, they don't have the need to pay for the physical infrastructure that a country like the US has.

As for secrecy, this is a long-standing tradition most famously practiced by the Swiss but later by most tax havens. Secrecy ties into the fact that most OECD/G-20 countries have a "self-reporting" tax system, meaning individual taxpayers tell the tax authority how much they make with the tax authority auditing suspicious transactions and/or reports. Fraud is a bit easier in such a system which dovetails into offshore secrecy's attraction. Therefore, the secrecy issue is incredibly important to the G-20 nations. What they need is a way to obtain compliance with their domestic anti-avoidance laws -- laws meant to prevent tax evasion.

Now let's go to a bit of history. Starting in the late 1990s, the OECD (Organisation for Economic Co-operation and Development) engaged in a very serious campaign to limit the impact and availability of offshore jurisdictions. The OECD reframed the debate claiming these jurisdictions engaged in "unfair tax competition." The reason is large industrialized countries were seeing their tax base move offshore and they needed to do something to stop it. The primary document is titled "Harmful Tax Competition" and is available from the OECD here.

With the terrorist attacks of 9/11 the OECD countries now had a very strong argument to use against these tax havens. Bank secrecy laws aided terrorists. Therefore, the veil of bank secrecy had to be lifted to prevent these jurisdictions from attracting illegal funds. This argument worked. Offshore jurisdictions are now signing "mutual assistance treaties". These essentially prevent an individual or company from hiding money offshore to evade taxation. While the ground rules of each jurisdiction vary, the bottom line is clear: the age of banking secrecy is over. For more information on mutual assistance treaties, see the Model agreement on exchange of information on tax matters. In addition, there are three model tax treaties -- the OECD, the US and the UN -- all of which have a "mutual assistance" provision.

In addition, US taxpayers are allowed by law to plan their affairs in a manner that provides for the lowest possible tax. This was sanctioned in the 1936 Supreme Court case Gregory v. Helvering which stated, " The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted." This is in contrast to tax evasion which is "a willful and esp. criminal attempt to evade the imposition or payment of a tax". In other words, tax evasion is a specific intent crime, which requires a specific state of mind.

Finally, US tax law has numerous "anti-avoidance" provisions. For example, the US has en entire set of foreign tax laws titled "controlled foreign corporation" laws which attribute international income to US corporate owners. Similar laws exist for foreign trusts, foreign personal holding companies and foreign partnerships. In other words, US taxpayers who comply with the law face numerous hurdles in hiding assets.

Let's wrap all this up.

1.) Bank secrecy has been under assault since September 11, 2001. It will continue to be under assault for our lifetimes. More and more jurisdictions are signing mutual assistance treaties which allow one jurisdiction to obtain confidential information from another jurisdiction in certain situations and cases.

2.) US taxpayers are allowed to plan their affairs to minimize taxation and have been allowed to do so since 1936. They are not allowed to deliberately evade taxation, which is criminal.

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