WHAT ARE TAX HAVENS?

• They are countries where the tax rates are very low, such that companies from other countries invest in their markets to reduce their tax liability. 

• Tax havens enable giants to avoid tax payment, legally.

For example- say, country X is a large economy while country Y is a small and growing country with almost zero tax rates. Companies from country X will invest in country Y to avoid tax payment and in return it will help country Y attract more and more investments. Country Y here is a tax haven.

• Criteria for a country to become a tax haven- the Organization for Economic Co-operation and Development (OECD) states four factors to be considered in order to state a jurisdiction as a tax haven. These are- low or nil tax rates; transparency; any laws that prevent exchange of information between governments about the benefits these taxpayers are availing; Whether there is an absence of a requirement that the activity be substantial.

HOW DO TAX HAVENS WORK?

• Shell companies- a shell company is a legal entity created in a tax haven. Shell companies typically exist only on paper, with no full-time employees, and no office. They are called shell companies because there is nothing inside. A shell company exists only on paper. 

• Are shell companies illegal? – shell companies are not illegal. It may however, depend upon the use for which the company is being used. Purchasing an expensive asset in company’s name is legal while hiding stolen assets abroad is illegal. 

• What benefits to tax havens bring to companies and governments- Through subsidies in foreign financial centres, companies get to save huge amounts of taxes. For governments, they are beneficial as- firstly, they are not completely tax free. A nominal amount of tax has to be paid by companies. High customs/ import duties usually cover the losses suffered because of low tax rates. Secondly, tax havens may charge for a nominal registration or license fee and renewal charges to be paid every year. 

TAX HAVENS AND THE INDIAN ECONOMY 

• How does it impact the Indian economy? – domestic companies paying taxes elsewhere creates a deficiency in the funds required for development like construction of roads etc.; tax evasion by the usage of tax havens to store black money also dismantles the equity attribute; hindrance in the implementation of the economic policies; tax havens slow down the process and efforts by the Indian government to redistribute wealth and decrease financial margin; it causes an inequitable distribution of tax burden; it encourages base erosion and profit shifting. 

• Regulatory mechanisms adopted by the Indian government- Digital economy (challenges faced due to digitization)

1. Hybrids (Hybrids mismatch arrangements (HMA) are arrangements which exploit differences in the tax treatment of instruments, entities or transfers on cross-border trade and investment and often lead to “double non-taxation”. As an equivalent to the hybrid mismatch effect, changes are made to existing tax laws)

2. Interest deductions (interest rates are reduced to limit base erosion practice)  

3. Prevention of treaty abuse 

4. Transfer pricing  (it is a technique used by multinational corporations to shift profits out of the countries where they operate and into tax havens that involves a multinational selling of goods and services at an artificially high price. The Indian government aims at ensuring the transfer pricing outcomes to be proportional to the value creation of goods/ services)

5. Dispute Resolution (The OECD has shown demur upon the practice of countries to engage in mutual agreement procedures i.e MAPs to resolve treaty-related disputes)    etc. 

• Tax Havens used by Indian entities- the biggest tax havens for Indian companies are countries like Mauritius, British Virgin Islands, Cayman Islands, Luxembourg and Switzerland.

ADVANTAGES AND DISADVANTAGES OF TAX HAVENS - 

The fundamental benefit of holding an offshore corporation or other financial vehicle in a tax haven, as the name implies, is the enormous tax savings it gives. The advantages, however, are not confined to taxation. The following are some of the advantages of offshore tax havens:

1. Reduction of Taxes
   The majority of industrialised Western countries have highly high, progressive tax regimes, in which top incomes and businesses lose a considerable portion of their earnings to taxes. This is why so many people are going to tax havens to lawfully reduce their tax burden. Offshore corporations can expect to pay extremely low or no taxes in prominent tax havens because of their advantageous tax policies. Antigua and the Cayman Islands, for example, levy no corporate income tax, capital gains tax, personal income tax, inheritance tax, or other taxes on offshore corporations. Many other offshore tax havens have tax systems that are comparable to this one, with few or no taxes at all.
   

2. Convenience
   Offshore tax havens are meant to entice rich people, corporations, and investors to set up offshore financial structures. They create favourable financial conditions and, as a result, gain from the economic inflow brought by offshore investors. This also implies that most tax havens make incorporating or establishing any type of financial instrument relatively straightforward, simple, and quick.
   

3. Privacy
   Offshore tax havens provide far more secrecy and non-disclosure. There are usually limited reporting or auditing obligations, and information about the corporation and its beneficial owners is not visible to the general public. Tax havens are perfect for shielding one's money and assets from unwanted attention and inquisitive eyes, and so assist in protecting assets against confiscation, litigation, and divorce, among other things.
   

4. Protection of Assets
   Offshore tax havens are suitable locations for asset protection. This is due to the fact that they operate outside of the regulatory and legal frameworks of the United States, the European Union, and other industrialised Western nations. This makes it exceedingly difficult for local court decisions to have any impact on your efforts to recover your offshore assets and/or taxes. 

There are certainly several advantages to utilising offshore tax havens intelligently. There are, however, some possible downsides. These are mostly attributable to public perceptions of offshore tax havens as being untrustworthy. Whether or not these assertions are correct, the unfavourable publicity that these tax havens have received has undoubtedly resulted in some of the following disadvantages:

1. Issues with Corporate Bank Accounts 

Many respectable banks consider corporations based in tax havens to be higher-risk clients. This is likely to lead to more stringent due diligence procedures and a decreased likelihood of getting approved for a corporate account.

2. Outside Investors tend to refuse the Investments 

Outside investors may be hesitant to participate in a firm that operates through an offshore tax haven due to the same reasons as previously noted (whether valid or not). This isn't a problem for offshore tax haven vehicles that are just employed as holding corporations or for individual asset protection, but it can have serious implications for active firms. 

3. Additional Scrutiny

Businesses that use tax havens may be exposed to greater scrutiny from their local regulatory authorities in the form of tax audits and other investigative actions as a result of some of the rising unfavourable views about them. Some consumers and suppliers may be wary of doing business with you and hence avoid doing so.

KEY TAKEAWAY

Tax havens are countries that allow foreign investments at very low rates of interest. The aim behind this is to increase foreign direct investment in the country’s market. For the companies, it is a big advantage to the fact that they evade tax, legally. In context to the Indian economy, while tax havens bring a plus side to the companies, the government struggles to manage hybrids, interest rates, distribution of wealth etc. The biggest tax havens for Indian investors are Cayman Islands, Luxembourg and Switzerland. For any country to become a tax haven, there are certain criteria to be fulfilled. This criterion has been mentioned by the Organization for Economic Co-operation and Development (OECD). Shell companies are established for the purpose of this legal tax evasion. 

References - 

1. https://www.icij.org/investigations/panama-papers/what-is-a-tax-haven-offshore-finance-explained/

2. http://www.igidr.ac.in/conf/money/mfc-11/Manish_Shashank.pdf 

3. https://www.icij.org/investigations/panama-papers/what-is-a-tax-haven-offshore-finance-explained/ 

4. https://corporatefinanceinstitute.com/resources/knowledge/other/what-is-tax-haven/#:~:text=A%20tax%20haven%2C%20or%20offshore,to%20foreign%20individuals%20and%20businesses

5. https://taxguru.in/income-tax/tax-havens-impact-indian-tax-economy.html 

6. https://prepp.in/news/e-492-tax-haven-indian-economy-notes 

7. https://taxguru.in/income-tax/tax-havens-impact-indian-tax-economy.html 

8. https://blog.ipleaders.in/how-tax-havens-are-regulated-in-india/#What_are_tax_havens 

9. https://www.businesstoday.in/latest/economy-politics/story/taxing-the-untaxed-income-tax-havens-india-black-money-fdi-inflows-outflows-money-laundering-252541-2020-03-19

10. https://taxjustice.net/faq/what-is-transfer-pricing/

11. https://www.thehindu.com/news/cities/mumbai/whats-base-erosion-and-profit-shifting/article8404293.ece