Welcome, here is your free article

Every week, The Week hand-selects the most important news stories and expertly edits them together in one fascinating read. For more excellent, distilled content like this, get your FREE issue today »

The search for “fiscal paradise”

The search for “fiscal paradise”

The Panama Papers have thrown light on the vast but shady world of tax havens

What defines a tax haven?

Quite simply, it’s a state or territory that attracts funds from abroad by offering to foreigners low (or zero) taxes, light regulation and high levels of financial secrecy. US officials often use the term “secrecy jurisdiction”; the French, more poetically, call them “paradis fiscal”. Worldwide, there are more than 60 such offshore financial centres (OFCs). We tend to visualise them as tiny European statelets such as Luxembourg, Monaco or the Swiss canton of Zug; or as islands (of which there’s an archipelago, usually with close British or US connections, stretching from Jersey to the Caribbean, the South Pacific to Hong Kong and Singapore). But many OFCs – the Netherlands and Ireland, the City of London, US states including Delaware, Nevada and Florida – are very much “onshore”. All attract foreign business by offering low tax rates and light regulation.

Are they a significant part of the world financial system?

Very much so. A recent study by the Berkeley economist Gabriel Zucman estimated that about 8% of global wealth, or $7.6trn, is held in OFCs – an informed guess, since these places are so secretive and opaque. Zucman reached it by looking at “holes” and “anomalies” in the world’s balance sheet, and by studying the two large havens, Switzerland and Luxembourg, that actually make public detailed statistics. (In 2015, Switzerland alone held $2.3trn of foreign wealth.) Most respectable studies have reached similar, or higher, ballpark figures. Where multinational firms are concerned, the picture is clearer: use of tax havens is ubiquitous. Oxfam recently crunched the publicly available data to show that the 50 biggest US firms have a total of $1.3trn in OFCs, avoiding some $111bn in taxes per year. Apple alone has $181bn offshore.

Why do people use them?

For many perfectly legitimate reasons. Savers in volatile nations often choose to place their money in a Swiss bank or a British-controlled territory because they provide stability in an uncertain world. Those wanting to invest in an unpredictable market might prefer to base themselves in a well-regulated offshore centre; investing in China via Hong Kong, for instance, or in Africa via Mauritius, where the rules may be clearer and disputes easier to resolve. And OFCs grease the wheels of international trade and investment. For example, if two firms from different nations are merging, they might want to incorporate in a neutral territory. Likewise, investment funds with a range of international clients, such as the one set up by David Cameron’s father, are often domiciled in a zero-tax jurisdiction so clients are not taxed both at home and where the fund is based. And some small territories offer “bespoke” regulation designed to cater for specific sectors: the Cayman Islands are a world centre for hedge funds.

And the less savoury aspects?

Ultimately, people mostly use tax havens to avoid rules, laws and scrutiny in their home jurisdictions. At the extreme end of the scale, there is tax evasion and money laundering, using anonymised accounts and shell companies (which do no real business of their own): the Panama Papers show that OFCs are used by dictators, drug cartels and weapons dealers (see box). Tax havens have thus abetted systemic corruption and theft in nations with weaker legal systems: Zucman estimates that 30% of Africa’s financial wealth is held offshore, and 52% of Russia’s.

And at the less extreme end?

Large multinationals quite legally use offshore companies to move their profits away from higher-tax jurisdictions where they actually make their money. This is part of a process known as transfer pricing, which enables multinationals to achieve huge reductions in their overall tax liabilities, but which deprives both developed and undeveloped economies of a vast amount of tax revenue.

So why do we tolerate such a system?

Ever since the world financial market opened up in the 1970s, independent states have used their tax-setting powers to compete to attract foreign funds. From a free-market perspective, this is desirable, since it lowers tax rates across the board. But in any case, OFCs are now such a fundamental feature of global finance – part of the price of globalisation – that scrapping them would be a colossal shock to the system. Many nations benefit, directly or indirectly, particularly Britain: Jersey alone supports more than 140,000 British jobs in financial, legal and admin services. What’s more, by using firms such as Amazon, Google and Starbucks, which shift profits offshore, and by having pension schemes based in low-tax jurisdictions, we’re all to some extent implicated. Even hard-left shadow chancellor John McDonnell has money offshore: his Westminster Council pension is managed by a Guernsey firm.

What, if anything, can be done?

That is the $7.6trn question. In 2009, the G20 committed itself to a crackdown on tax havens, and a welter of international agreements and regulations followed. But as the Panama Papers show, there’s a long way to go. Transparency is the key. The EU has mooted requiring multinationals to break down all their income flows by country, including tax havens; the better-run OFCs now demand that the beneficial (ultimate) owners of shell companies be disclosed. The most powerful weapon to date is probably the US Foreign Account Tax Compliance Act of 2010, which requires all foreign banks to identify American citizens among their clients and to disclose to the US Internal Revenue Service their assets and earnings: failure to do so results in a 30% withholding tax on all US-sourced payments. Critics of tax havens would love to see such a system imposed more widely. But so far, both the US and Britain have been reluctant to have their own offshore sectors exposed to the light.

Mossfon: shells on the Virgin Islands

Based in Panama City, with offices in all the world’s leading OFCs, the firm at the centre of the recent scandal is the world’s fourth-largest provider of offshore legal services. It’s primarily an incorporation agent, meaning it sets up companies and trusts, mostly in the British Virgin Islands and other havens. Clients can buy a company for as little as $1,000.

Like most offshore law firms, Mossack Fonseca provides complex corporate structures which can be used to disguise assets. Say, for instance, you own a painting but don’t want anyone to know: you can set up an anonymous company in one tax haven to own it, which in turn is owned by another shell company in another jurisdiction. This, in turn, is owned by a trust in a third. More controversially, for an extra fee, Mossack Fonseca’s lawyers can conceal the true owners of their shell companies, by providing sham directors and shareholders to sign on his or her behalf. The Panama Papers reveal that these services were used by an array of shady clients, from notorious Russian oligarchs to Rami Makhlouf, the “bagman” of Syria’s Assad regime. Mossfon, as it styles itself, accepts that some of its services have been “misused” but disputes that it has ever broken the law.

More free articles from
The Week magazine

6 week FREE trial - Try The Week today
Article 50: What happens next?

The agenda for the next two years is vague, but by December 2017 the broad principles of Britain's withdrawal from the EU will be clear

Read the full article here »
Free money for everyone?

The idea that government should scrap welfare payments and give everyone a basic income is becoming increasingly popular

Read the full article here »
China’s steel leviathan

The steel plant at Port Talbot is just the latest casualty of the wave of Chinese steel imports flooding into Europe

Read the full article here »
Bibi Netanyahu: Israel’s divisive saviour

Israel’s ninth prime minister, first elected in 1996, has just won an unprecedented fourth term

Read the full article here »
We hope you enjoyed your free article from The Week magazine.

Try a FREE issue today and enjoy getting to know the whole magazine. Enter your details below.

Try a FREE issue of The Week.

Fill in the form below and a representative will call you to arrange delivery.