Thesis: Use of Offshore Tax Havens by US Companies

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¶ … Companies and Offshore Tax Havens

Many businesses embrace tax havens because they offer unique opportunities to avoid paying taxes and provide other benefits. While the United States currently has weak laws preventing offshore tax havens, many expert that this will change in the near future, especially under the leadership of President-elect Barack Obama.

Why Tax Shelters are Appealing tax haven is a country that has low taxes or, perhaps, no taxes. In some offshore countries, taxes are lowered in an attempt to help companies that are organized in the country but which operate outside the country. These countries do so in an attempt to attract investment.

Individuals and businesses alike can take advantage of the benefits offered by tax havens, but it is mainly beneficial to corporations. Some people or companies take advantage of these benefits by moving to that country and become a resident. Others create a corporation in that country and transfer funds and assets to that location. As soon as they have done this, all new income generated by the company or trust are subject to the tax laws of the tax haven country's jurisdiction.

United States businesses recognize and take advantage of tax haven financial incentives. In 1999, approximately 59% of U.S. multinational companies had affiliates in one of more tax havens (Desai, Foley and Hines, 2006b). A tally of the overall property, plant and equipment held abroad by American firms in 1999 reveals that 8.4% was located in tax havens, which is a lot considering that such small companies would have far less global investment.

In addition, foreign tax havens had unusually high concentrations of foreign employment. About 6.1% of total foreign employee compensation, and 5.7% of total foreign employment, were located in tax haven affiliates. U.S. companies placed 15.7% of their gross foreign assets in the major tax havens in 1999; the major foreign tax havens accounted for 13.4% of their total foreign sales, and 30% of total foreign income in 1999. A great deal of this tax haven income included money from foreign affiliates owned by parent companies indirectly through their tax haven affiliates.

Increasing Popularity of Tax Havens

There are about 45 tax haven countries in the world today, all of which are small, affluent, and have well-run governments (Hines, 2007). Some of the most popular tax haven countries are Ireland, Hong Kong, Luxembourg, and the Cayman Islands. Each of these countries attract disproportionate shares of global foreign direct investment, which has resulted in unusually fast economic growth over the past few decades.

These countries attract U.S. investors by offering lower tax rates. According to Hines (2007), they allow investors to retain most of their locally-earned pretax income, in the hopes that foreign countries will invest heavily in their regions. They also present opportunities for investors to use tax havens to avoid paying taxes to governments of other countries. "For individuals, who are taxed by their home governments on income earned in tax, tax avoidance typically entails willful income misreporting," according to Hines (2007, p. 3). " for businesses, tax avoidance can be accomplished by the use of financial arrangements, such as intrafirm lending, that locate taxable income in low-tax jurisdictions and tax deductions in high-tax jurisdictions."

Furthermore, companies have the option to adjust the prices at which affiliates from different countries buy and sell goods to one another. "Most governments require that firms use arm's length prices, those that would be used by unrelated parties transacting at arm's length, for transactions between related parties, in principle thereby limiting the scope of tax-motivated transfer price adjustments," according to Hines (2007, p. 4). "In practice, however, the indeterminacy of appropriate arm's length prices for many goods and services, particularly those that are intangible, or for which comparable unrelated transactions are difficult to find, leaves room for considerable discretion."

This means that whenever a company completes a transaction with a tax haven affiliate, it can use this transaction to reallocate income from high-tax locations to the tax haven affiliates themselves or possibly to other low-tax foreign locations. This makes it very lucrative for investors to seek out foreign tax havens.

Tax Policy Changes

Tax haven countries are somewhat of a frightening existence to other countries in the world, which rely on high taxes to sustain strong economic activity. "Tax avoidance carries mixed implications for governments of nearby countries, since it may erode tax bases and therefore tax collections, implying that the greater economic activity associated with nearby tax havens might come at a high cost in terms of foregone government revenues," according to (Hines, 2007, p. 7).

In 1998, the Organization for Economic Cooperation and Development (OECD) launched its Harmful Tax Practices initiative, which aimed to discourage OECD member countries and tax haven countries from participating in actions that could potentially harm other countries by unfairly eroding tax bases. The OECD identified what they called Un-Cooperative Tax Havens, naming countries that failed to commit to sufficient exchange of information with foreign tax authorities. Without this exchange of information, countries are unable to accurately tax their resident individuals and businesses on income or assets hidden in foreign tax havens.

OECD Statements

The Organization for Economic Cooperation and Development (OECD) states that global tax competition lowers tax rates and making government expenditure more efficient worldwide (Almeida, 2004). However, in some cases, OECD cautions that the opposite is true. For example, some countries have implemented harmful tax practices that help individuals and business avoid complying with the tax laws of other countries. The OECD says that such harmful tax practices fall into two major categories: preference regimes and tax havens. This paper focuses on tax havens, describing what they are, how they are used by businesses to shelter money, and what the United States government is doing to prevent unfair practices.

Globalization has worked wonders in terms of reducing trade barriers and increasing capital flows among countries around the world (Almeida, 2004). As more and more capital is flowing and available, there are unprecedented opportunities for countries to attract investors. Many countries have adjusted their tax policies in an effort to attract foreign investors. Some do it in such a way that promotes competition and improves economic efficiency, while others implement aggressive tax policies that disrupt other countries.

The OECD has introduced four main arguments when it comes to tax haven' practices (Almeida, 2004):

1. They can erode national tax bases of other countries;

2. They may alter the structure of taxation by shifting part of the tax burden from mobile to relatively immobile factors and from income to consumption;

3. The can discourage compliance by taxpayers and increase the administrative costs of enforcement; and 4. They may hamper the application of progressive tax rates and the achievement of redistributive goals.

Basically, when a tax haven countries applies no or only nominal taxes on income (business or personal), residents of a non-haven country may "divert their investments and be free riders of the public goods available in their home countries," according to Almeida (2004). The non-haven governments are then pressured to shift the tax burden from mobile to immobile factors such as labor, consumption and property. As a result, progressiveness and redistribution are undermined.

Today, it appears that the government and the public are becoming less tolerant of tax havens. Tax havens were recently publicized in a negative light when a major scandal in Europe was exposed, involving secret bank accounts in Liechtenstein (Francis, 2008). A multimillion dollar sum was paid to an informer, who gave up hundreds of names behind tax-dodging accounts held by German business tycoons, about 100 American taxpayers, and tax avoiders from other countries. The IRS recently announced that it is "initiating enforcement action" against the 100 Americans in this case, stating that "combating off-shore tax avoidance and evasion are high priorities."

The Bush administration did little to prevent tax-haven losses. However, it appears that Obama will make changes to laws in the near future. He has described the Ugland House in Grand Cayman, a building that is home to thousands of tax haven corporations, as "the biggest tax scam on record." Many experts expect that he will make an effort to close or limit tax havens.

Opponents of tax havens believe that shutting down tax havens would raise substantial revenues and also reduce the growing income gap in the United States between the wealthy and the middle and lower classes. This is largely because the wealthy are far more likely to use tax havens than the lower classes.

President-elect Barack Obama signed the Tax Haven Abuse Act, a bill introduced in 2007 by Senators (Francis, 2008). According to the Tax Policy Group of Deloitte Tax, Obama is likely to attempt to limit specific international tax planning strategies -- for example, the Obama campaign suggested establishing an international "tax havens watch list."

Carl Levin of Michigan and Norm Coleman of Minnesota. Proponents of the bills argued that offshore tax havens cost the federal government $100 billion in lost tax revenues each… [END OF PREVIEW]

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