By Neil Mohindra, From Financial Post

Higher-tax countries don’t like the competition

With all the hype over the Panama Papers, “tax havens” are again under fire from a barrage of misinformation.

The term “tax haven” is routinely applied to small jurisdictions that facilitate the offshoring of capital and profits. While the term comes with a history of tax secrecy, which may have been true in the past, it’s not so fitting anymore, outside of a few holdouts. Nowadays, U.S. states, including Delaware, Nevada, Wyoming, Alabama and Montana are more reluctant to co-operate with inquiries from other tax authorities than the exotic countries that normally come to mind.

Countries like the Cayman Islands, Singapore, Mauritius and the Channel Islands of Jersey and Guernsey actually specialize in providing vital global pipelines through which foreign investment flows. They typically comply with reasonable inquiries from other tax authorities. But who cares about that when they can so easily be trotted out as scapegoats for tax-hungry governments and left-wing NGOs?

Understanding what these jurisdictions actually do requires understanding double-taxation-avoidance agreements. DTAAs are tax treaties that allow businesses to operate in the two signatory countries without the same profits being taxed by both. Since bilateral tax treaties between every country in the world would be impractical, some small jurisdictions have specialized in negotiating networks of DTAA agreements that they then market to other countries.

These countries also encourage companies to park their profits with them through low corporate tax rates. While higher-tax countries may not like that competition, every sovereign jurisdiction can legitimately set its own rate.

Most importantly, many of these jurisdictions strive to meet international standards for co-operation between tax authorities. The Global Forum on Transparency and Exchange of Information for Tax Purposes, an OECD Forum addressing the risks to tax compliance posed by non-co-operative jurisdictions, ranks many of the countries accused of being tax havens as “largely compliant.” This is the second-highest ranking possible, the same as for Germany, the U.S., Italy and the U.K.

A few years ago, Jason Sharman, an Australian professor researching money laundering and global tax regulation, contacted thousands of firms that set up shell companies across 182 countries to see how each would respond to increasingly dodgy requests for anonymous shell companies. His requests included red flags that signal money laundering, terrorist funding or corrupt officials. The results were not what you’d assume.

In Canada, the U.S. and Japan, Sharman found compliance rates with international rules below 50 per cent. In the U.S., five states scored under 20 per cent. Jurisdictions that scored above 90 per cent included the Cayman Islands, Jersey, the Isle of Man and St. Kitts and Nevis. Cayman Islands and Jersey actually scored 100 per cent.

Some prominent progressive economists like Jeffrey Sachs and Thomas Piketty claim these so-called havens “serve no useful economic purpose” but to deny government’s tax revenue, particularly to developing countries where companies will do business, but offshore profits to lower-taxed jurisdictions. But they actually play a vital role in facilitating investment to higher-risk countries, helping economic growth. Where political risk is high, as in some African countries, investors can only justify their risk with higher after-tax returns, which are often attainable when they can minimize taxes offshore. Development agencies including the African Development Bank and the development arm of the World Bank use places like the Cayman Islands and Mauritius to help facilitate investment into developing countries. 

Many jurisdictions specializing in tax treaties are now seeking ways to move up the value chain of international finance. The Channel Islands are developing niches in becoming leaders in intellectual property protection. Others are negotiating business investment treaties to allow them to become centres of dispute arbitration. Given that they’ve become easy political targets, they’re wise to diversify.

But it’s clear that tax-hungry governments will continue to use them as scapegoats. To keep profits, and taxes, from leaking to more competitive jurisdictions, Western governments are hurrying to create as many regulations as possible, such as the OECD’s Automatic Exchange of Information initiative in which countries will blast reams of taxpayer files at one another without any need for an official request. (The U.S. is refusing to go along, despite pioneering a similar concept with its Foreign Account Tax Compliance Act that requires foreign banks to turn over information about clients who are U.S. citizens.)

It should come as little surprise that the Canadian government is increasingly front and centre in the global blame game against tax havens. The minister of revenue has lately been vowing action against tax avoidance, which is legal, in addition to tax evasion, which is not. Already spending beyond its means on the dubious assurance that it will lead to more growth, Ottawa will soon need scapegoats to blame when its promises prove false.

Neil Mohindra is a public policy analyst based in Toronto and a former senior manager of the Financial Services Commission of Mauritius.

IMAGE: Countries like the Cayman Islands, Singapore, Mauritius and the Channel Islands of Jersey and Guernsey actually specialize in providing vital global pipelines through which foreign investment flows.

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