Tax Havens: International Tax Avoidance and Evasion

Table of Contents

Introduction....................................................................................................1

Meaning of Tax Havens and How They Work.......................................................................1

Alarming Growth in Tax Haven Abuse......................................................................3

Google's Tax Avoidance.....................................................................................4

Policy Solutions................................................................................................5

Conclusion......................................................................................................7

Endnotes........................................................................................................8

Bibliography...................................................................................................9

Introduction

Over the last two decades, there has been a marked increase in the use of international tax havens for the principal purpose of tax avoidance. Several hundred U.S. multinational banks and corporations utilize tax havens as a way to reduce or eliminate their taxes and shift tax responsibilities onto the backs of domestic businesses and individual taxpayers. Our economy and domestic business sector is undermined when large companies are rewarded for financial manipulation rather than productive investment, innovation and job creation.

It is conservatively estimated that U.S. multinational corporations and banks are using tax havens to avoid at least $37 billion in U.S. taxes per year. This $37 billion could be used to fund initiatives to support America's small businesses, the nation's biggest job creators, by increasing their access to capital, increasing their opportunities to invest, and rewarding entrepreneurship through provisions like those found in the Small Business Jobs Act.

There is no justification for tax avoidance and evasion through tax havens. Offshore tax havens provide cover for banks, hedge funds and corporations to shift taxable income from the United States to tax havens to escape taxation. They provide the secrecy that helps companies cook their books and allows wealthy Americans to hide assets.

Meaning of Tax Havens and How They Work?

The top marginal corporate tax rate has stood at 35 percent since 1993, which is the highest rate in the world (§11)1. Companies often pay a lower effective tax rate, after taking advantage of tax credits and deductions and keeping overseas earnings reinvested indefinitely. In fact, companies pay an average effective tax rate of about 25 percent. The U.S. is among a handful of countries that tax profits earned in other countries, though only when the money is brought home, or repatriated.

Governments regularly lose corporate income tax revenues due to a variety of methods involving low-tax countries or territories known as tax havens, tax avoidance and tax evasion. A tax haven is a low-tax country or territory where individuals or corporations shift their income to avoid the taxes of their home location. Tax avoidance is the act of taking advantage of legally available tax-planning opportunities in order to minimize one's tax liability. Tax evasion, on the other hand, is the willful attempt to defeat or circumvent the tax law in order to illegally reduce one's tax liability. Depending on who you ask, some people may say that tax avoidance is either smart business or it's immoral. But, if done correctly, there's one thing it's not...it's not illegal.

By channeling investments or passive income (e.g. interest) through foreign entities, some individuals evade taxes illegally by not reporting these assets or income on their tax returns. According to the OECD, the world's most common tax havens are located in Caribbean, Europe, and Pacific in locations near large developed countries (Hanna). Up to 50 countries are considered on a regular basis to have characteristics of tax havens.

Common methods for corporations avoiding tax and shifting profits artificially to low-tax countries have included:

* Allocating debt to tax havens: borrowing more in high-tax countries than low-tax ones using subsidiaries or foreign entities.

* Transfer pricing: changing the prices of goods and services sold to company affiliates to shift income from high-tax jurisdictions. Similarly, companies have transferred intellectual property or intangible assets to tax havens.

* Contract manufacturing: using another company as a contractor to manufacture goods to avoid high tax rates.

* Check-the-box provisions: these provisions allow corporations to be considered entities in one country and not in another. For example, a corporation can be recognized as a hybrid entity together with a subsidiary from a low-tax country and thus avoid paying taxes.

* Cross crediting: using excess foreign taxes paid in another country to offset U.S. taxes through foreign tax credits. Since companies can defer the process of repatriation of income to their benefit, the Government Accountability Office estimates that American multinational corporations pay virtually zero tax to the U.S. government on foreign source income2.

Impart from corporations, individuals commonly avoid and evade taxes through use of the Internet, which facilitates online transactions. Tax avoidance is typically undertaken by individuals using U.S. rules that do not impose withholding taxes on certain types of income, including interest and capital gains. This is further advanced by limited tax reporting between countries on income, interest, and corporations registered in tax havens.

By purchasing investments directly from foreign countries (e.g. stocks, bonds) or placing money in foreign banks accounts and not reporting income, some individuals evade tax. Some individuals also set up shell corporations or trusts in foreign countries to evade tax on investments by taking advantage of exemptions on interest income and capital gains for non-residents in the U.S.

Alarming Growth in Tax Haven Abuse

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