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by Ronen Palan o o o o o o o o o o o o o o Executive Summary Introduction What are tax havens? The origins of the instruments of tax havens British courts create the non-resident corporation Swiss banking law of 1934 The early development of tax havens The heyday of tax havens, 1960s - 1990s Euromarket and British tax havens Tax havens go global Tax havens under attack Conclusion Further Reading About the author
Executive Summary
o This paper examines the historical development of tax havens. The case for regulating tax havens has become an increasingly prominent issue for policy makers worldwide, especially in light of the current financial crisis. Modern tax havens can be organized into three groups: UK-based or British Empire- based tax havens, European havens, and thirdly new tax havens from the transitional economies in South America and Africa. Tax haven strategy developed piece by piece in different locations, often for reasons which had little to do with their ultimate use. Tax havens are a distinctly modern phenomenon, whose origins lie at the earliest in the late nineteenth century. Only during the second phase of their development, from the end of the First World War, did countries begin to develop comprehensive policies to become a tax haven. Since then, tax havens can be viewed as a distinct developmental state strategy that could have evolved only in the context of a robust international system of statehood, respectful of the sovereign right of states to write their own laws and within an integrated world market. Statistics suggest that tax havens have an extremely prominent role in the global financial system. They have become an important instrument of tax evasion worldwide and constitute the single largest drain on developing countries' economies. Today, the key issue regarding tax havens is their lack of transparency. Tax havens need to be regulated by an internationally agreed code of conduct that ensures the transparency of ownership and traceability of assets to their ultimate owners.
Introduction
Tax havens are increasingly attracting attention today because of the sheer size of the phenomenon. Although reliable data on tax havens is still difficult to come by, the Bank of International Settlement (BIS) quarterly statistics showed that since the early 1980s about half of all international banking assets and liabilities were routed through offshore financial centres (OFCs). About a third of all multinational corporations' Foreign Direct Investment (FDI) go through tax havens. Estimates of gross tax avoidance perpetrated through tax havens are difficult to ascertain. There are no reliable figures on corporate tax avoidance which is presumably the principal reason why so much FDI is routed through tax havens. Individual tax avoidance and evasion is estimated conservatively to be somewhere between $US 800 billion to a trillion a year. Tax havens are also used as the principal route through which laundered money escapes developing countries. Most of the significant tax havens existing today have developed around two principal geo-political poles. One pole has evolved with close links to the City of London. This includes British Crown dependencies such as the Channel Islands, Jersey, Guernsey and the Isle of Man, British Overseas Territories among which the most significant tax havens are the Cayman Islands, Bermuda, British Virgin Islands, Turks and Caicos and Gibraltar, and recently-independent British Imperial colonies such as Hong Kong, Singapore, the Bahamas, Bahrain and Dubai. Less significant in terms of impact, but more numerous, are newly independent British Pacific territories. The other pole developed in Europe and consists of the Benelux countries - Belgium, Netherlands and Luxembourg - Ireland, and of course, Switzerland and Liechtenstein. The only other significant tax havens today which are not part of these two poles are Panama and, to a lesser extent, Uruguay. The history of tax havens is riddled with myths and legends. Tax havens are associated with tax avoidance, which, as far as we can tell, is as old as taxation itself. Tax havens are consequently viewed by some as the latest incarnation of an age-old practice, which in many ways they are. Modern tax havens, however, are sovereign states (or suzerain entities like the Channel Islands with considerable autonomy) that use their sovereign right to write laws in order to attract a certain type of international clientele. Tax havens must be viewed, therefore, as a distinct developmental state strategy that could have evolved only in the context of a robust international system of statehood, respectful of the sovereign right of states to write their own laws. Furthermore, the tax haven strategy is aimed exclusively at an international clientele and hence can be pursued successfully only within an integrated world market. Tax havens, in short, are a distinctly modern phenomenon, whose origins lie at the earliest in the late nineteenth century. The brief overview of the history of tax havens presented here is organized into five sections. Firstly a working definition of tax havens is offered. The second section reviews the historical emergence from the late nineteenth century to the 1930s of the three distinct instruments of tax havens: low or zero taxation for non-residents, easy methods of incorporation, and legally-protected secrecy. The third section follows the initial phase of historic growth in tax havens from World War I through to the early 1970s. During these decades a small number of states, led by Switzerland, began to develop tax haven regimes as an intentional developmental strategy. The fourth section examines the subsequent period from the early 1970s up to the late 1990s when the number of tax havens rose dramatically, as did the scope, planning, and sheer volume of financial assets passing through them. This was the true heyday of the tax haven. Section five
looks at the current phase of tax haven history, which began in 1998 with the publication of an OECD report on harmful tax competition. The same year also witnessed an intensification of the European Union efforts to combat tax havens. The crisis since 2007 has further intensified the pressure on tax havens. The full implications of the current phase of reaction to the enormous expansion of tax haven activity are still to be seen.
prefer to include the concept of intentionality in their definition of tax havens. Such a definition of tax havens would be: jurisdictions that deliberately create legislation to ease transactions undertaken by people who are not resident in their domain. Those international transactions are subject to little or no regulation, and the havens usually offer considerable, legally protected secrecy to ensure that such transactions are not linked to those who are undertaking them. Such transactions are 'offshore' - that is, they take place in legal spaces that decouple the real location of the economic transactions from the legal location, and hence remove the tax liability of the transaction from the place where it actually occurred.
While American states came up with the technique of bidding for corporations by liberalizing incorporation laws, we must credit the British courts with the technique of 'virtual' residencies, allowing companies to incorporate in Britain without paying tax - a development that at least one commentator believes is the foundation of the entire tax haven phenomenon. Many trace the origins of the practice to a series of rulings in the British law courts. Most significant among those was the 1929 case of Egyptian Delta Land and Investment Co. Ltd. V. Todd. It was demonstrated that although the company was registered in London it did not have any activities in the UK and hence was not subject to British taxation. This case created, argues Picciotto, "a loophole which, in a sense, made Britain a tax haven". Companies could now incorporate in Britain but avoid paying British tax. The ruling of the British courts proved significant because it laid down the rule not only for the United Kingdom but also for the entire British Empire, a point later exploited by jurisdictions such as Bermuda and the Bahamas and perfected in the 1970s by the Cayman Islands.
Kuenzler suggests that a Zurich-Zug-Liechtenstein triangle emerged as the first true tax haven hub during the 1920s. A few offshore holding companies and trusts existed in Switzerland before the war, but the number of holdings increased relentlessly after 1920. The canton of Zurich was not keen on offering tax privileges to these holding companies, but the city's financial elite used the more amenable and much poorer rural cantons of Glarus and Zug, which redrafted their laws on the advice of lawyers and bankers from Zurich's Bahnhofstrasse. Those same lawyers and bankers advised Liechtenstein. Through these facilities, Zurich became the centre for the Swiss societ anonyme and mailbox companies, eclipsing Basel by the end of the 1920s. Luxembourg as well was among the first countries to introduce the concept of the holding company. Under the law of 31 July 1929, such companies became exempt from income taxes. There is evidence also that Bermuda, the Bahamas and Jersey as well as Panama were all used to a limited extent as tax havens in the interwar years.
The late 1960s also saw Singapore's emergence as a tax haven. With the French IndoChina War having escalated into the Vietnam War, by the mid 1960s there were increased foreign exchange expenditures in the region, but a tightening of credit occurred in 1967 and 1968, contributing to rising interest rates in the Eurodollar market. As a result, dollar balances in the Asia-Pacific region became attractive for many banks. Singapore responded by setting up incentives for branches of international banks to relocate to Singapore. A branch of the Bank of America was the first to establish a special international department to handle transactions for non-residents in what was called the Asian Currency Unit (ACU). As with all other Euromarket operations, the ACU created a separate set of accounts in which to record all transactions with non-residents. Although the ACU is not subject to exchange controls, the banks are required to submit detailed monthly reports of their transactions to the exchange control authority in Singapore. Singapore is currently emerging as the fastest-growing private banking sector in the world. Indeed, the main problem Singapore currently faces in its quest to become the world's largest private banking center is what it describes as a 'talent shortage' - a lack of specialist professional staff, even though the financial center employs about 130,000 people. Asset growth in Singapore has been phenomenal, rising from $150 billion in 1998 to $1.173 trillion by the end of 2007.
havens in other regions of the world such as the Indian Ocean, Africa and now postSoviet republics. By the early 1990s, there were between sixty and one hundred tax havens in the world, depending on the definition one applies to the phenomenon. More worryingly, the BIS statistics showed that about half of international lending was routed through these havens, that at least one third of all international Foreign Direct Investment was routed through them as well, and that they have become an important instrument of tax avoidance worldwide, and have constituted the single largest drain on developing countries' economies. With activity on this scale it appeared that something had to be done.
Conclusion
Tax havens now span the entire world, serving all the major financial and commercial centers. Modern tax havens are still largely organized in three groups. First and still by far the largest is made up of the UK-based or British Empire-based tax havens. Centered on the City of London and fed by the Euromarket, it consists of the Crown Dependencies, Overseas Territories, Pacific atolls, Singapore, and Hong Kong. The second consists of European havens, more specialized as headquarter centers, financial affiliates, and private banking. The third consist of a disparate group of either emulators, such as Panama, Uruguay, or Dubai, or new havens from the transition economies and Africa. By grouping tax havens in this way we begin to appreciate the difficulties, as well as the opportunities, for developing a coordinated international campaign to fight them. The OECD is clearly ill equipped to deal with tax havens, not least as many of its members, including the UK, Switzerland, Ireland and the Benelux countries are themselves considered tax havens. In addition, the financial crisis has weakened the United States and Western Europe, and given greater room for manoeuvre to creditor countries, such as the Gulf States, some of which are emerging as significant tax havens, and Singapore and Hong Kong; the latter protected by China. Nevertheless, the pressure on public finance is intense, and while governments can ill afford to raise taxation, fearing further decline in domestic consumption, recovering any taxes lost through tax havens will be an attractive proposition. The pressure on tax havens, therefore, is likely to continue. The UK is clearly critical to any future international efforts to combat tax havens, not least as half-a-dozen of the most important tax havens are dependencies of the UK. The EU is already clamping down on the Belgian co-ordination centers and other special provisions of this sort. And if the EU, the US and China come to an agreement on tax havens, it is more than likely that Honk Kong and Singapore will succumb as well. The Gulf States, meanwhile, with their commitment to Islamic banking, clearly aim at a specialist, regional market rather than the non-Muslim majority of tax haven users. But what exactly should the struggle against tax havens consist of? Traditionally tax havens differentiated between residents and non-residents; they have tended to tax, sometimes heavily, their own citizens and local businesses, while offering low taxation to non-residents. The EU business directive has put paid to that, with the result that all countries in the EU, as well dependencies of EU countries must treat residents and nonresidents the same way for tax purposes. Once this battle is won, the next great issue is that of opacity. Tax havens have created systems and regulations that help to hide the true owner of assets deposited in their domains. As long as secrecy is maintained, potential tax avoiders and evaders, as well as money launderers are likely to try to take advantage of these countries to hide their assets. The key issue, therefore, is now secrecy, and more generally, opacity. We need an internationally agreed code of conduct that ensures transparency of ownership and traceability of assets to their ultimate owners. October 2009
Further Reading:
Raymond W. Baker, Capitalism's Achilles' Heel: Dirty Money, and How to Renew the Free-Market System, (London: Wiley, 2005) Vincent P. Belotsky, 'The Prevention of Tax Havens via Income Tax Treaties', California Western International Law Journal 17 (1987) 43-62 Dhammika A. Dharmapala & James R. Hines, 'Which Countries Become Tax Havens?' NBER Working Paper No. W12802 (2006) Charles R. Irish, 'Tax Havens', Vanderbildt Journal of Transnational Law (1982) 449-510 Roman Kuenzler, 'Les paradis fiscaux', (University of Genve, Master thesis, 2007) Ronen Palan, Richard Murphy and Christian Chavagneux, Tax Havens: How Globalization Really Works, (Ithaca: Cornell University Press, 2010) Sol Picciotto, International Business Taxation, (London: Weidenfeld and Nicolson, 1992) Jason C. Sharman, 'South Pacific tax havens: From leaders in the race to the bottom to laggards in the race to the top?' Accounting Forum 29 (2005) 311-323 Jason C. Sharman, Havens in a Storm: The Struggle for Global Tax Regulation. (Ithaca: Cornell UP, 2006)