Should Offshore Financial Centres be Discouraged?

Get the answer of: Should Offshore Financial Centres be Discouraged.

The views on tax havens as offshore financial centres are deeply divided. Those in favour argue that they play a legitimate role in international finance and trade. Its critics believe that they encourage illegal global tax evasion and endanger the world through illicit practices involving money laundering and now terrorist financing using poorly regulated small financial centres.

Some of the comments for and against offshore financial centres are listed below:

Supporters:

(i) Tax havens as OFCs help to minimize tax liabilities in a competitive world. They reduce the effective marginal tax rate on capital and provide incentive for saving and investment. They help low-tax jurisdictions grow faster than other countries.

Tax havens also help nearby onshore economies to greater competitiveness and growth. They boost economic activity in non-havens. They make high tax centres more attractive to foreign investors.

(ii) Tax havens permit tax avoidance and not tax evasion. Tax evasion is a crime while tax avoidance is not. Avoidance simply means paying less tax than the government intended you to pay when it wrote the tax rules. However, tax is what the law says it is, and simply defining avoidance as paying less tax than government intended is not enough.

(iii) Tax havens cut the size of government and improve efficiency. They encourage reduction in tax rates through tax competition. They have smaller government budgets. Tax competition is not harmful to the taxpayer. It is only harmful to high tax countries that do not receive enough of it. Tax competition is a healthy disciplining force. It is the only competition governments have.

(iv) Many OFCs are specialist financial centres and offer more than low taxes. They are often tax neutral and provide value-added services. Recent international pressures (See Section 6.2) have abolished ring fencing in most jurisdictions, while many jurisdictions have moved to zero tax regimes. Most of them do not encourage tax evasion.

(v) There are no reasons why “offshore” should be more vulnerable to abuse than the “onshore” environment. Onshore jurisdictions potentially pose greater risks to international financial stability.

Offshore centres are in many cases better regulated than onshore centres. They have light but effective regulations; they only regulate high-risk business activities. Offshore centres also ensure confidentiality and protect privacy.

Critics:

i. Tax havens as OFCs are often used for illegal tax evasion schemes by residents of onshore jurisdictions. These schemes are encouraged by the high level of confidentiality. The concern with tax havens today does not relate to low or nil tax but to the lack of transparency and problems relating to exchange of tax information.

ii. Tax havens encourage tax competition that undermines fair competition and public confidence in the national tax systems. They shift taxation from capital to labour and to indirect taxes. They create financial problems for high-taxed regimes with public financing obligations for ageing populations and high social security costs.

iii. Offshore centres are vulnerable to abuse and organized crime. With the use of electronic fund transfer, ease of company formation and inadequate regulation, and secrecy over beneficial ownership, they assist money laundering, terrorist financing and other illegal activities. Bank secrecy and confidentiality is often a cover for such activities.

iv. In recent years, there have been several cases where OFCs have been used for financial manipulation with fictitious transactions using anonymous offshore structures (Examples: BCCI, Enron, Parmalat, etc.).

v. Poor countries cannot compete on taxes in the “race to the bottom” due to tax competition. Oxfam Great Britain (2000) estimated that developing countries lose as much as US$50 billion per year in tax revenues due to tax avoidance and inter-jurisdictional tax competition.

Comment:

The Business and Industry Advisory Committee of the OECD justified the use of tax havens in international tax planning, as follows:

“The minimization of costs and taxes is a legitimate concern of each business; much of the use of tax havens is not motivated by a desire to pay little or no tax, so much as an economic necessity to reduce costs, including taxes, to a bearable level in circumstances where the laws of countries are uncoordinated and even the laws of individual countries are inconsistent, insofar as they relate to the treatment of international business”.

There is considerable controversy over the impact of tax havens. Some commentators argue that they divert investment from high-tax jurisdictions. Others believe that tax havens encourage economic activity with a positive spillover, and thereby contribute to economic prosperity elsewhere.

Recent studies suggest that tax havens do encourage investment in other countries. They offer empirical evidence that tax haven activity and economic activity outside them influence each other. The ability to relocate taxable income into offshore centres improves the desirability of investing in high-tax locations.

The various supranational initiatives over the past decade have helped significantly to improve financial regulations and supervision in traditional offshore financial centres. Several recent IMF reports have mentioned that many of them today have better financial controls than in onshore jurisdictions.

Offshore financial centres have also realized that investors prefer better regulated jurisdictions. Poorly-regulated OFCs have a limited future, while well-regulated tax havens attract greater foreign investment than other countries of similar size.

The volume of offshore business is large and growing. According to the OECD, over USD 1 trillion are invested in offshore funds alone (an increase of 1400% in 15 years).Many OFCs are growing because they are not just tax havens but sophisticated financial service centres.

They offer services in niche markets and products not available in onshore markets. They provide these services under tax neutrality, and are often involved in wholesale rather than retail financial service activities.

Tax havens stimulate greater investment activity, and permit onshore governments to tax more mobile international capital less heavily. By providing a low-tax alternative they have also forced them to cut taxes and keep the size of their budgets down.

In brief, like onshore jurisdictions, offshore structures and jurisdictions can be abused but that does not justify that they should be discouraged. They fulfill a meaningful role in the global financial markets.

According to a 2007 survey “…although international initiatives aimed at reducing financial crime are welcome, the broader concern over OFCs is overblown. Well-run jurisdictions of all sorts, whether onshore or offshore, are good for the global financial system”.