The U.S. and European Union, through the Organization for Economic Co-operation and Development (OECD) have taken action to eliminate tax havens - countries that cater to individuals and corporations hiding their identities, assets and business activities from their "home" governments.
Tax havens enact laws permitting foreign individuals and companies to conduct business there without paying taxes or disclosing their ownership or business transactions. Typically, the company maintains a minimal presence in the tax haven jurisdiction through an appointed agent, but – in reality -- has no employees, physical facilities, equipment, inventory or other operating assets actually located in the tax haven and does little or no business in the tax-haven country’s local economy.
How a Tax Haven Works
For a small island country with an economy consisting of fishing or tourism, the lure of becoming a tax haven can be irresistible. After all, the country needs only to pass legislation to create a new and vibrant economic sector. There are stories that for some island countries the revenues generated by the tax-haven economy surpass traditional tourist industries within a few of years of operation.
Here’s how it works: A company desiring to enjoy the tax shelter must pay a fee of approximately $800 per year to the island government, and a bank or trust company must serve as agent for the company and maintain the company records. Bank secrecy laws make it a crime for the agent to disclose any information about the company or its owners. The company pays the annual fee and is never taxed on its earnings or profits; thus, the company can earn income and retain it in the tax haven without paying taxes.
The result: The company and its owners generate income and profits throughout the world without paying taxes. Also, the ownership and business activities are not disclosed, allowing ownership to be shifted easily and anonymously.
Defining a Tax Haven
The OECD considers the following criteria: Does the tax haven jurisdiction:
1. Have no taxation on financial or other service income with respect to the foreign entity?
2. Offer itself as a place where non-residents can escape tax in their country of residence? (In other words, does the jurisdiction market itself as a tax haven?)
3. Have "transparency"? (Are transactions subject to open and public reporting or disclosure?)
4. Have adequate regulatory supervision or financial disclosure of activities?
5. Allow the exchange of information with other countries?
6. Tax the relevant income generated by the foreign enterprise on its geographically mobile financial and service activities?
The Cooperating Six
Under pressure from the OECD, the Cayman Islands, Bermuda, Cyprus, Mauritius, Malta and San Marino have accepted the OECD’s mandate that they abandon their tax haven practices, by making an "advance commitment" to "eliminate harmful tax practices by the end of 2005, embracing international tax standards for transparency, exchange of information and fair tax competition."
The Blacklisted Thirty-Four
Thirty-four counties have been blacklisted, which means they will have one year to develop a plan to eliminate their tax-haven activities by abolishing their bank secrecy rules and their taxing regimes that do not tax capital and services of foreign corporations.
Countries that refuse to cooperate will face an unspecified set of sanctions, which may include:
1. Disallowance of deductions, exemptions, credits and other tax breaks related to transactions with the tax haven;
2. Imposition of withholding taxes on certain payments to residents of tax havens;
3. Denial of deductions for expenses incurred in establishing entities incorporated in tax havens;
4. Imposition of tariffs on certain transactions involving tax havens; and
5. Complex and detailed information reporting requirements for transactions with tax havens, backed by severe penalties for inaccurate reporting or non-reporting of such transactions.
U.S. officials specifically favor withholding taxes on all interest payments made to tax-haven companies, along with additional reporting requirements imposed on taxpayers with accounts in these jurisdictions.
The OECD nations have targeted the tiny rogue nations of the world which are serving as tax havens. Since many of these countries are British protectorates, they are expected to comply with the OECD dictates. For the remaining countries, these sanctions could effectively destroy their tax-haven businesses.