The Securities and Exchange Board of India (Sebi) said that despite tightening norms of foreign portfolio investors (FPIs), the regulator has faced global challenges in handling tax havens.
What is a tax haven?
A tax haven is a country or jurisdiction that offers minimal tax liability to foreign individuals and businesses. Such countries do not require businesses to operate out of their country or individuals to reside in their country to receive tax benefits.
Tax haven provides financial and economic stability as well as financial secrecy from tax authorities.
Tax haven countries play a very prominent role in the global financial system.
Introduced to develop the broken economy of countries after World War II, the tax haven system now plays a prominent role in the world's financial system. It has now become a vital tool for big corporations and wealthy individuals to evade taxes.
In 2016, a report by Citizen for Tax Justice, a US-based think-tank and advocacy group, stated that more than 370 companies out of Fortune 500 operate subsidiaries in such countries.
Criteria for tax havens
In 1998, the Organisation for Economic Cooperation and Development (OECD) gave a list of factors that can determine the process of identifying tax havens.
Some of the factors are:
Nominal tax on relevant income
It offers negligible taxes for earnings made under the jurisdiction of the tax haven nation, though it may vary with different countries. A nominal charge is levied against the services offered by such nations.
Secrecy of information
One of the most important features of tax haven nations is that they protect their clients' personal and financial information with high credibility. Such nations do not share information with foreign tax authorities without the individual's consent.
Lack of transparency
Offshore financial centres usually keep their functioning as entirely opaque. Financial information is not disclosed to national governments. Thus, the system is manipulated for tax evasion and money laundering.
No substantial activities
Tax haven nations do not require outside entities to produce goods or services within their jurisdiction. Entities can bypass their earnings created in tax-paying countries to be taxable under their jurisdiction by opening head offices in such havens or transferring significant financial transactions of the company to shell companies located in tax haven nations.
How do governments earn money from tax havens?
Tax havens charge a lower tax rate than other countries. Low-tax jurisdictions usually charge high customs or import duties to cover the losses in tax revenues. However, tax havens mostly charge a fee for new registration of companies, and individuals have to pay renewal charges every year.
Additional fees may also be charged, such as licence fees. Such charges would add up to a recurring fixed income for the tax haven nations. By attracting foreign individuals or businesses, even if they pay a nominal tax rate, the nation may earn substantially more in tax revenues than it would otherwise. The country also benefits from corporate investments in business operations as they offer jobs to the country's residents.
Tax haven nations offer zero tax incentives to those who transfer their profits and jobs to such countries, and such individuals may only have to pay taxes which may even be as low as single digits compared to high taxes in their countries. However, low- and middle-income families and individuals struggle to meet their tax obligations, and big corporations and rich individuals evade taxes using offshore financial centres.
Tax havens work towards identifying and minimising loopholes in offshore taxation policies. They benefit by attracting capital to their banks and financial institutions, which can then be used to build a thriving financial sector.
However, tax evasion can be drastic for the country's economy as taxes are the only source of revenue for the government.
Top tax havens in the world
Bermuda - In 2016, Oxfam, a UK-founded organisation working to end the injustice of poverty, declared Bermuda as the best corporate tax haven with a zero per cent tax rate and no personal income tax.
Netherlands - Netherlands is the most popular tax haven among the world's Fortune 500. The Netherlands government uses tax incentives to attract businesses to invest in their country.
Luxembourg - It provides benefits to foreign individuals and businesses, such as tax incentives and zero per cent withholding taxes.
Cayman Islands - It gives a number of benefits to foreign individuals, such as no personal income taxes, no capital gains taxes, no payroll taxes, and no corporate taxes. The country does not withhold taxes on foreign entities.
Singapore - It charges nominal corporate taxes through tax incentives, lack of withholding taxes, and substantial profit shifting.
Switzerland - It gives individuals full or partial tax exemptions, depending on the bank used.
Top international companies that benefit from tax havens:
The company uses Ireland as a tax haven, and the amount booked offshore is $214.9 billion. The American multinational technology company would have owed the US government $65.4 billion in taxes if tax haven benefits were not used.
The company uses Bermuda as its tax haven and holds $10.7 billion offshore. If tax haven benefits were not used by Nike, it would have paid $3.6 billion in taxes. Nike pays a mere 1.4 per cent tax rate to foreign governments on offshore profits, indicating that subsidiaries in tax havens officially hold nearly all of the money.
It holds $28.6 billion offshore and uses Bermuda as a tax haven.
The Panama Papers
The Panama Papers refers to a leak of 11.5 million confidential documents related to Mossack Fonseca, the world's fourth-largest offshore law firm in Panama. The documents, released in 2016, exposed over 2,14,000 shell companies in various tax havens. The leaked documents revealed various famous individuals' identities and financial information, including world leaders, politicians, and celebrities from 200 countries.
The leaked documents included emails, database formats, PDFs, images, and text documents.