They say in financial circles that “those who know do not talk and those who talk don’t know.” In tax matters, those who know talk, sometimes, but those who do not know talk a lot. The world of tax havens is opaque, confusing, and secretive.


International organizations eschew such popular terms in favor of “offshore financial centers” or even “international financial centers,” implying that tax havens are no different from other financial centers — which as we demonstrate in this book, they are. Those campaigning for reform now call them secrecy jurisdictions.


Tax havens are financial conduits that, in exchange for a fee, use their one principal asset — their sovereignty — to serve a nonresident constituency of accountants and lawyers, bankers and financiers, who bring a demand for the privileges that tax havens can supply.


Our principal contention is that most accepted ideas about tax havens are false. Tax havens are not working on the margins of the world economy, but are an integral part of modern business practice. Furthermore, they exist not in opposition to the state, but in accord with it. Indeed, we take the view that tax havens not only are conduits for tax avoidance and evasion but belong more broadly to the world of finance, to the business of managing the monetary resources of an organization, country, or individuals. They have become one of the most important instruments in the contemporary, globalized financial system, and one of the principal causes of financial instability. Their sovereignty sets them apart, yet it is their sovereignty that gives them the means to integrate themselves into the world on terms they have, at least in part, been able to set for themselves.


The hedge fund industry has discovered the delights of tax havens. The big 4 Caribbean havens — the Caymans Islands, the British Virgin Islands, Bermuda, and the Bahamas — are home to 52% of the world’s hedge fund industry.


What these figures represent can be captured in 1 word — avoidance. They are the abstract expression of the collective efforts of the state, corporate, and business elites of the world to avoid the very laws and regulations that they have collectively designed.


In most cases, entry barriers to the range of benefits offered by tax havens are high, limiting their clientele to a small and extremely wealthy minority. As a result, tax havens benefit the rich and the powerful, while the costs are largely borne by the rest of society.


Individuals and companies just about anywhere in the world have the opportunity to undertake what might be described as “tax planning” within the law of the territory in which they live or operate. For the vast majority of the world’s population, the concept of “tax planning” is largely meaningless: tax is normally deducted at source from earnings, and that is more or less that with regard to the settlement of tax liabilities.


If we add former colonies of the British state such as Singapore and HK, the impact of a political entity long considered defunct — the British Empire — on the contemporary financial system appears decisive, accounting for a 37% share of all international banking liabilities and a 35% share of assets.


The professionals have also been present in each and every redrafting of the laws of offshore and they are the ones who actually set up the offshore facilities that such legislation enables. They also innovate new techniques of evasion and avoidance, which they sell to clients; lobby against changes in the law against tax havens; and argue that tax havens are an entirely legitimate form of business.

The professionals are therefore absolutely irreplaceable, for then ensure that the business of tax havens flourished.


They are simply a legislature for hire, doing what is asked of them. For example, Jersey’s obnoxious Trust Law of 2006 was passed without a vote since no one objected, or as far as we can tell even commented on it, in the island’s State Assembly.


Not only because tax havens are not really home to the vast amount of money that the figures suggest. They are, as we explain in this book, very largely “recording havens” or, to use the jargon, “booking centers” that serve as legal domains for the registration of contractual relationship that take place elsewhere. The staggering statistics belie the fact that at heart, tax havens are largely a fiction, one almighty fictional world that is aimed at one thing: at the avoidance of taxation and regulation in the world in which the transactions they record actually take place or have real impact. Their activity is entirely parasitic, feeding on both the world economy and the system of states.


An estimated 60% of all international trade takes place across frontiers but between different arms of the same company. In an alternative model, many MNEs have chosen the “hollow” route, in which they subcontract out most if not all of their manufacturing, finance and legal services, advertising, sales, and so on.


The financial system is normally divided into 2 branches, retail and wholesale. Retail banking (and other financial services such as insurance) tends to be a highly profitable business, which handles the financial requirements of individual savers and borrowers. Wholesale finance manages specialized, bulk financial transactions, often of unimaginable sums of money, traded between the financial institutions themselves, and it tends to be even more profitable.


The wholesale financial system primarily trades in “incorporeal” properties: currencies, equities (shares), debt instruments (bonds), claims on existing and future earnings, hedging contracts and indices. However obscure and complex some of these instruments may appear, they are all contracts for the exchange of property titles. The existence of a global market simply means that a legal framework that supports such exchanges is global as well. Incorporeal properties have no tangible physical existence; they are represented as contractual agreements that are either printed out or, more commonly now, stored electronically.


Theoretically, the size of a financial center is linked to the size of the economy it services. However, the complexity of financial products and the vast sums of money involved have led to the development of highly skilled groups of workers in the various branches of banking, capital and credit markets, insurance, brokerage, accounting, and of course the law. As a result, financial systems have tended to congregate geographically in the major cities of the world. Profits generated in such centers are taxed by the countries in whose territories these centers are located, and the countries concerned serve as regulatory authorities over these financial centers.


Financial actors can avoid taxation on profits, as well as regulations, by “booking” a contract somewhere other than the place where it was negotiated. In such centers, almost all the bank branches are “shell” operations. In other words, the branches exist but do not actually do any business or have any assets.

It is not only banks and financial institutions that use tax havens for booking purposes. MNEs operate through complex set of subsidiaries, affiliates, and sub-contractors in many countries, and they are supposed to pay tax on profits made in the territory of each of these countries. MNEs therefore have an incentive to book financial transactions in low-tax, lightly regulated countries.


British banks and corporations quickly realized the advantages of tax havens. They established subsidiaries in the Crown Colonies to serve essentially as booking offices for Euromarket transactions in the early 1960s. They were soon followed by NA banks that preferred Caribbean havens. Hence, several tax havens developed their own OFCs but were known primarily as either “booking” centers or funding centers.


Writing in the early 1980s, Irish observed that “typically, these branches in the Caymans are nothing more than a set of ledgers managed and kept by an agent rather than a physical location where business is transacted. While deposits and loans are lodged in these shells, the transactions are physically negotiated elsewhere and the funds many never actually be present in the shell.”


In other words, on average 1 person runs, as well as serves as the employee of 2 banks, insurance companies, or hedge funds in the Cayman Islands.


Most of the largest companies in the world are well installed in Cayman. But what you will not find there is any physical presence of an office completed with logos, staff, and a smile and a hello from a receptionist. No, in Cayman you will find blandly named companies whose names are as purely functional as the companies themselves.


Many of the well known tax havens — such as Jersey, Guernsey, the Isle of Man, Switzerland, and Liechtenstein — impose income tax on the worldwide income of their resident populations, but ensure that tax exiles using their domains do not suffer some or all of these charges.


In sum, the reality of this interdependent world is that when one comes across low- or zero-tax jurisdiction, someone else is paying additional tax elsewhere, thereby permitting that jurisdiction to offer low-tax services.


Trusts and companies are the most prevalent forms of offshore entities. Most companies registered in tax havens are limited by shares, and in contrast to onshore companies, information on governance structure, ownership, and purpose is usually kept secret. Very often, a bearer instrument id used. A bearer instrument is a document that indicates that the bearer of the document has title to property, such as shares or bonds. Bearer instruments differ from normal registered instruments in that no records are kept of either the ownership of the underlying property or transactions involving transfer of ownership. Whoever physically holds the bearer papers owns the property.

Bearer instruments are useful for investors and corporate officers who wish to retain anonymity — although ownership is extremely difficult to recover in the event of loss or theft.


Finally, foundations are also secretive structures. Most commonly associated with Liechtenstein and Panama, foundations might best be described as a form of trust that is recognized as having separate legal existence akin to a limited company.


Among the most significant tax havens of the world, Switzerland, Luxembourg, and Singapore claim that they are not low-tax jurisdictions. Strictly speaking, they are correct: they are certainly not low-tax jurisdictions for their own citizens. Yet through a complex set of loopholes and formal and informal rules they can serve as low-tax jurisdictions to nonresidents. In addition, all 3 offer very strict secrecy provisions and relatively easy and cheap mechanisms to set up nonresident companies.


These havens — Switzerland, NY, and London — developed the resources needed to manage funds deposited by the world’s wealthiest people and can ensure that their clients can get to see their fund manager with relative ease.


In 1957 the BoE created, perhaps unwittingly, the regulatory concept of offshore when it accepted that transactions that took place in London but were undertaken between 2 parties resident outside the UK were not subjects to UK financial regulation. They were deemed to take place “elsewhere” and not London, even though it was obvious to all involved that this was a fiction.


Albeit modified and reduced in scope in April 2008, the UK domicile rule states that any person who immigrates to the UK but declares their wish to return to their country of origin at some point in the future, is not liable to pay local tax on their worldwide earnings. Note that the person need not actually return to their country but only declare that this is their intention. This law is exploited by a horde of Russian oligarchs, Arab sheiks, US corporate raiders, and European magnates, who flock to London, declaring their intention to return home one day, and use the UK as a tax haven.


In the Cayman Islands, the monetary authority does not report dollar amounts on non-bank activity. That leaves Cayman’s huge investment and hedge fund industry off the official radar.


Some tax havens are known for having exaggerated or “massaged” the figures. In the highly competitive marketplace for offshore financial services, puffed-up numbers can heighten a jurisdiction’s perceived prominence. Data are often presented so that offshore financial services appear more significant than they really are.


Half of the global stock of money goes through tax havens. This mind-boggling figure refers not only to the Caymans and Bermudas of this world but also to London, the IBFs in the US, and Tokyo’s JOM.


We should be clear from the outset that the technical meaning of FDI can be misleading. Economists distinguish broadly between 2 types of cross-border investments. Portfolio investment was traditionally the passive holding of foreign securities such as stocks, bonds, and financial assets; whereas FDI involve “real” facilities in foreign lands, including factories, offices, distribution networks, subsidiaries, and so on. Since the mid-1970s, however, the OECD has adopted a new definition of FDI: “an incorporated or unincorporated enterprise in which a foreign investor owns 10% or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise.”


82 of the 275 top US corporations paid no taxes between 2001 and 2003, although they declared $102B in pre-tax profits. 46 companies with a combined profit of $42.6B paid no federal income taxes in 2003 alone. Instead, they received rebates totaling $5.4B.


All the evidence suggests that the main vehicle of tax avoidance/evasion and capital flight through tax havens is the mundane practice of transfer pricing. Transfer pricing is the price companies charge for intra-group, cross-border sales of goods and services. About 70% of all capital flight is conducted by means of transfer pricing. Multinationals placed transfer pricing at the heart of their tax strategy.


Transfer pricing is a legitimate practice so long as it is undertaken under what is called an “arm’s length principle” — that is, companies charge for their goods and services at prices equivalent to those that unrelated entities would charge in an open market.

In practice prices based on the arm’s length principle are often difficult to establish within highly complex international production networks, where companies use trademarks, patents, brands, logos, and a variety of company-specific intangible assets. The technique, therefore, is open to abuse.


They were able to identify flagrant anomalies such as water plastic seals from Czech Republic quoted to the parent company at an astronomical price of $972 per unit; gloves from China quoted at $4K a kilo. Meanwhile US missiles were exported to Israel for the modest sum of $52 each, diamonds were exported to India at $13 per carat, cameras went to Colombia at $7 per unit.


Money laundering and capital flight are not the same thing, although capital flight often involves laundered money.


Why has Switzerland changed its tune? Switzerland, it seems, has had enough of being singled out and wanted to demonstrate that it was only a minor player in the international dirty money game, in effect a mere servant to the City of London. Of the $4B diverted to Switzerland, 59% came from London and 42% subsequently returned to London.


Yet even such rough estimates lead us to the unavoidable conclusion that tax havens are not marginal. They must be understood as a core component of modern, globalized economy.


Commons argued that economic transactions take place within 2 spheres simultaneously — the “physical” sphere of exchanges of goods, services, and financial products, and the legal sphere where the exchange of property titles takes place. Conventional economics tended to study the first sphere in isolation, whereas lawyers and accountants focus on the second.


Mobile items such as vehicles, airplanes, and ships must have a license issued by a national authority and must display that license wherever they go. In theory, every single item exchanged, including services and financial products, must also have a sovereign home. Goods are marked as “made in” this or that country. Indeed, every valid contract must specify the sovereign location that governs its conduct — even though in many cases, the sovereign state may be entirely unaware that its laws have been chosen to adjudicate disputes.

The marking of legal personalities, goods, and services by territorial states places the marked individuals, goods, and services under the tax rules of these territories. As individuals, goods, and services are becoming increasingly mobile, the question which territory is entitled to which portion of taxation becomes acute. Simply stated, international economic activities generate overlapping tax claims, and taxation becomes a barrier to the internationalization of economic activities.

This problem of overlap has obvious solutions. Either income or profits that result from international activities can be taxed where the income is earned, in other words in the source country, or where the recipient is normally based, that is the country of residence. There are problems associated with each solution, for each offers opportunities for avoidance and evasion. Not surprising, there is considerable discussion of the 2 principles among tax haven experts. At heart, however, the tax haven strategy hinges on neither one.


Not only can knowledgable practitioners exploit uncertainty within one state as to the meaning of tax law, but they can also exploit the uncertainty that the interaction of the law of 2 or more countries provides. International tax planning has emerged as an extreme lucrative business run by some of the best-paid professionals in the world.

More problematic, some states create rules establishing a relationship to taxable events that are aimed, or so it appears, at luring taxpayers and taxable events to their domains from wherever the real events actually occur. Some countries have even innovated legal conditions under which taxable events can be represented or registered as if they take place there, while they simultaneously deem those events as taking place elsewhere (the beauty of the invention being that the “elsewhere” is never specified and as we will see, it is often nowhere). In such cases, the taxpayer ends up in the paradoxical but highly lucrative position of being in a no-man’s-land in tax terms, which means paying no tax at all.


We can now refine our definition of tax havens. The tax haven boils down to a very simple idea: the state creates legal instruments by which individuals land companies can reduce, or completely sever, their “connecting factor” to their country of origin. They do so knowing that individuals and companies have an incentive to sever their connecting factor: to avoid taxation.


Relocation to tax haven may be a drastic move for an individual to undertake, but companies can relocate by the simple expedient of creating new subsidiaries in tax havens. Their presence is easily disguised, first by the secrecy to which we have referred elsewhere, and second because corporations are allowed to present one set of accounts. These accounts are, however, prepared on a consolidated basis. “Consolidated” means that all transactions between different parts of the corporation are eliminated from the accounts. There may be hundreds or even thousands of such constituent companies, which can be hidden from the public eye because of this accounting convention.

The convention has some other benefits. The accounts presented to a stock exchange and to shareholders might make it look as if there is a single multinational entity but in reality, when it comes to taxation, there is no such thing as an MNE. Companies can legally maintain economic ties between their subsidiaries, but every single subsidiary is deemed a separate entity when it comes to taxation. Consequently, multinational corporation is an economic but not a legal concept. A parent company usually owns all or most of the other entities in a group, and controls them all because ownership of a company’s shares provides that right under company law. However, the companies remain legally distinct and entirely separate for tax purposes.


The company is actually run by a director or board of directors, and its legal affairs are managed by the company secretary. Most countries have introduced regulations that are intended to protect shareholders and traders from abuse. Such safeguards require: maintaining a public register of companies, listing all those in existence; having a registered place of business at which a company may be contacted; making known details of a company’s issued share capital and the names and addresses of those owning and providing that capital; placing on record full information on its directors and secretary; and filing annual accounts for public inspection. Tax havens provide almost none of these safeguards.


Limited Liability Partnership (LLP) is another limited liability entity developed in the last decade to promote secrecy and to protect tax-haven-registered companies from claims. LLPs add another layer of confusion regarding ownership of assets. Yet the Big4 accountancy firms have lobbied hard for and promoted legislation to create such entitles in Jersey, and even threatened to leave the UK if it did not provide similar opportunities. These entities, or variations upon them, are now widely available in tax havens.

LLPs have a particular role in the tax planning of major corporations because they are considered “tax transparent.” Although they legally exist in a tax haven, they have no tax residence in those havens. Instead, members of these entities are taxed as if they undertook the transactions of a LLP. This allows the separation of legal ownership of assets from the location of income arising from them. Tax is divided between countries — an opportunity, of course, for complex tax planning schemes. Much of the recent anti-avoidance legislation in the UK, including some in the Finance Act 2008 with regard to both stamp duty avoidance and the loss of corporation tax, is aimed at combating these abuses.


Trusts can be dated as far back as the Crusaders: when English knights left on long expedition to the Holy Land, they left others to manage their affairs under what became known as trust arrangements. Such arrangements remain peculiar to Anglo-Saxon law.

In trusts a person or entity (the trustee) holds legal title to certain property (the trust property) but has a fiduciary duty to exercise legal control for the benefit of one or more individuals or organizations (the beneficiary), who hold “beneficial” or “equitable” title. To put it another way, a trust arises when “there is a gift by a person (known as a settlor) or property to trustees for them to manage for the benefit of others (known as beneficiaries).”

Trusts are contractual agreements between 2 private individuals that create a barrier between the legal owner of an asset and its beneficiary. The instrument enables the transfer of legal ownership of property or financial assets to another person on behalf of third parties. Trusts provide secrecy because they do not require any form of registration in most jurisdictions, and even where registration is required, it is not placed on public record. Nor is the trust deed that regulates management of the trust a matter of public record — in fact, it is still possible for a valid trust to be created verbally.


IBCs can be set up by individuals. People with very high incomes, such as professional athletes, inventors, and top corporate management, set up an IBC in a tax haven into which their salaries are paid. They become, in turn, employees of their companies but receive only nominal renumeration from these companies when they repatriate income and bring it onshore.

Individuals use IBCs for other purposes as well. IBCs and offshore trusts allow taxpayers to recategorize income as having a different form and hence subject to a different tax or to no tax at all. Income can be recategorized as capital gains, for capital gains tax is usually charged at a lower rate than income tax. Alternatively, income derived from labor is recategorized as investment income by way of payment of dividends to owners instead of the payment of wages to the same people. Social security charges can be either avoided or evaded by such schemes.


It is important to note that trusts are not set up only for tax reasons. Individuals may wish to hide assets from their spouses; family or business partners may use the trust facility as well. Trusts may also be used to avoid inheritance laws. Some users may be seeking to avoid regulation, for example on controlling too large a part of an industry. Tax is, however, a common motivation. In all cases, the trust is likely a charade or sham, especially when instructions to trustees given in side letters are taken into account.


Foundations are another method to conceal assets. Foundations are a form of trust that is recognized as having separate legal existence akin to a limited company. The foundation’s success arises from its combination of secrecy with a legal existence separating it from the lawyer who manages it and from the settlor and its non-taxable status.

Foundations have no owners or shareholders. They are set up to manage assets whose income must serve a specific goal. Many tax havens demand only minimal disclosure from foundations. In one extreme case, Panama, no approval is needed to create a foundation.


Tax havens are used by 3 types of financial institutions. First, the majority of tax-haven banks are empty shells. They have either no or minimal physical presence in the jurisdiction. These institutions are overwhelmingly involved in criminal financial activities, particularly those registered in countries that fail to cooperate with the FATF and the FSF. Some experts believe that 40% of all the financial activities of such institutions are of criminal or at the very least illegal nature. There have been serious attempts to close this type of banks, so far with only partial success.

The second type of offshore bank serves as a subsidiary of large onshore banks. Many of these subsidiaries are owned by well-known retail banks, are managed by them, and may share their names. Yet legally, they are separate entities. Banks use their tax haven subsidiaries for both legal and illegal activities. Multinational corporations set up offshore banks for the same purpose, to finance their own activities.

Finally, there are genuine offshore banks located in properly regulated jurisdictions. Of course, it is exceptionally difficult to tell which bank is in which category, because of the secretive nature of offshore and of corporate reporting.


The British Isles, including the Isle of Man, have developed another segment of the insurance market: the laundering of drug money through life insurance contracts. Many insurance companies have been involved in laundering circuits. Other tax havens have learned to establish insurance companies for the sole purpose of avoidance, a US law tax-exempts those insurance companies that collect less than $350K in premiums exploited for this purpose. A small insurance company may be created with little income, not even enough to pay one employee, but it will put aside extremely high reserves to cope with a future crisis — and the reserves will be placed where they are not taxed. Very often, such companies have only 1 or 2 “clients.”


Consider the complexity and variety of techniques, and the fact that many of the techniques we have described are at best on the very margins of the law, if not outright illegal. They have to be designed by specialized professionals. Dubious tax shelter sales are no longer the province of shady, fly by night companies with limited resources. They have become big business, assigned to talented professionals and drawing on the vast resources and high reputations of the largest accounting firms, law firms, investment advisory firms, and banks.

Many MNEs have created specialized departments to deal with their tax affairs. These departments are considered profit centers and value creators, and staff are remunerated on their ability to produce tax savings for the company.


The law in any country is built out of words, and words are always open to interpretation. Tax avoidance seeks to exploit this uncertainty of interpretation. No matter what legislation is in place, the accountants and lawyers will find a way around it. Rules are rules, but rules are meant to be broken.


Corporations were few and far between, requiring a Royal Charter, Act of Congress, or Act of Parliament. Corporation law evolved slowly and hesitantly in the 19th century, with the US taking the lead. The first general corporations law is credited to the State of NY in 1823, although that law was applicable only to manufacturing corporations.


Soon another US state suffering from budgetary problems, Delaware, decided to emulate New Jersey’s example. Again, a group of lawyers in NY played a vital role behind the scenes in drafting an even more liberal law. Delaware law of 1898 set the standard to be followed by tax havens worldwide, by allowing corporations to write their own rules of governance. New Jersey’s law sparked what was seen at the time as a “race to the bottom,” with states all over the country gutting corporate law to become more business-friendly.


In 1862, income tax was introduced again to fund the Civil War, only to be repealed a few years later by the courts as unconstitutional. It was, therefore, only in 1913 that the 16th Amendment to the Constitution made the income tax a permanent fixture in the US tax system.


Swiss bankers have long established a reputation for pragmatism. Voltaire is reputed to have quipped, “if you see a Swiss banker jumping from a window, jump behind him, there should be some money to be won.”


The principle of bank secrecy was the norm in Switzerland by 1912. As Europe underwent profound changes, Switzerland attracted considerable French, German, Italian, and Austrian capital and became the European “haven for capital.”


The Anstalt is a “reverse corporation” designed to obtain all the advantages of incorporation for an individual physical person. It is thus a one-man corporation endowed with legal personality for the apparent purpose of concealing the identity of its owner in the carrying out of business which he would not be likely to conduct openly under his own name. Glos cannot think of uses for the Anstalt other than the concealment of property and income subject to taxation.


Swiss lawyers are allowed to set up entities in Liechtenstein, and in effect, it is used by Swiss banks and financial institutional to by-pass Swiss laws, most of which were introduced in response to international pressure.


Swiss law demands “absolute silence in respect to a professional secret,” that is, absolute silence in respect to any accounts held in Swiss banks — “absolute” here means protection from any government, including the Swiss. The law labels inquiry or research into the “trade secrets” of banks and other organizations a criminal offence. Not surprisingly, ver few academics and journalists have been prepared to risk jail for their research. The law ensured that once past the borders, capital entered an inviolable legal sanctuary guaranteed by the criminal code and back by the might of the Swiss state.


In 1966 Swiss bankers invented a legend about the protection of Jewish assets in response to the grilling they had faced in the US Congress. The myth has been perpetuated ever since by apologists of Swiss banking secrecy. The irony, of course, is that Swiss bankers used precisely the same bank secrecy laws to justify their unwillingness to return Jewish money to Holocaust survivors.


The emergence of tax havens appears to modern eyes as a perhaps regrettable but unavoidable response to rising taxation. The history of tax havens demonstrates, however, that neither governments nor individuals understood fully the potential for pecuniary gains in the tax haven strategy. In fact, no one state or jurisdiction developed the strategy fully; each appears to have responded to very specific circumstances and only much later, perhaps not before the 1950s, would a fully articulated strategy emerge, based on a wholesale rewriting of tax and regulatory laws with the sole aim of attracting nonresident capital.


Between 1970 and 2008, British tax legislation alone has grown from 1,297 to 4,580 pages of primary legislation and from 171 to 1,444 pages of secondary legislation — a compound rate of growth of 6% per annum since 1970, over 8% since 1988, and over 12% since 1992. These figures are in stark contrast to the 450 pages French tax codes, and Germany’s 450 pages of tax legislation. The longer and more complex the rules, the more opportunities are created for avoidance and evasion.


The principles that has guided British courts ever since is an emphasis on the words of the legislation, not on their meaning or purpose. The principle was restated in the House of Lords in 1980: “A subject is only to be taxed upon clear words, not upon ‘intendment’ or upon the equity of an Act. Any taxing Act of Parliament is to be construed in accordance with this principle.”


Wherever British colonists settled, they brought with them the common law. However, “subsequent statuses passed by the Parliament at Westminster do not apply to the new colony unless distinctly made applicable by their provisions or by natural inference.” The result was lags and delays in the introduction of British law throughout the Empire, resulting in loopholes useful for tax avoidance.


Decolonization also played its part. The breakdown of the British, French, and Dutch empires had a huge impact on the geo-economic map of the world. Simply put, there were many more states around. Each was sovereign, each claimed a right of self-determination, and each was looking for ways to survive in the harsher economic climate of the 1970s. Consequently, each wave of decolonization brought new entrants to the tax haven game. The Caribbean havens developed in the 1960s, the Pacific atolls in the 1980s, and the transition economies (former communist countries) in the 1990s.


In 2001, Lee Hsien Loong, then DPM, finance minister, and chairman of the MAS all rolled into one, met with international bankers to discuss how Singapore could tailor its laws to gain primacy. Following these consultations, he introduced amendments to the Banking Act to revise the secrecy provisions, including stringent laws that are far more robust than Switzerland’s. The penalty for breaking Singapore’s bank secrecy laws were raised: a fine of up to $125K or 3 years in jail, or both. Swiss banks are now moving much of their client business to Singapore to exploit this fact given that banking secrecy in Switzerland has now proved to be permeable.

There are 2 other reasons why Singapore is considered a tax haven. First, as an English common law country, Singapore still permits nonresidents to form limited companies but manage them from elsewhere. Neither the UK nor Ireland do so, and Singapore has emerged as the leader in this field. Despite a notional tax rate of 22% on income originating in Singapore, foreign corporate income is not taxed at all. Second, due to a complex arrangement of subsidies and deferred payments, Singapore is considered a low-tax country. Sullivan puts effective tax rates of US subsidiaries in Singapore at 11%, which is at the high end of taxation among intermediate tax havens.


Employing may be 1K people, more than enough to establish a physical presence in Ireland, the subsidiary was used by Microsoft to license the sale of all its products outside the US. As a result, license income was taxed only at the lower effective rates charged by Ireland and not at the much higher rates charged in the countries in which many of the end consumers of these products were located. When WSJ reported the arrangement in 2005, Microsoft re-registered its Irish subsidiary as an unlimited company, meaning that it no longer had to place its accounts on public record, and it thereby avoided future scrutiny of its activity.


All these havens introduced familiar legislation modeled on the successful havens, including provision for zero or near zero taxation for exempt companies and nonresidential companies, Swiss-style bank secrecy laws, trust companies laws, offshore insurance laws, flags of convenience for shipping fleets and aircraft leasing, and since the early 21st century establishing advantageous laws aimed at facilitating e-commerce and online gambling.

In the case of the British and Australian dependencies, the offshore sector was developed in a deliberate policy to reduce the cost of maintaining the islands.


Since the early 1990s, the statutory tax rate for corporate taxation has declined almost everywhere in the world. In the EU as a whole, average nominal corporate taxation declined by an average of 10 points, from 35% to 25%, between 1995 and 2007.


The positive perspective on international tax competition derives from 2 bodies of ideas: an interpretation of mainstream economic theory, which claims that tax havens are harmless, combined with normative considerations attached to neoclassically derived political science, purporting to show that tax competition increases efficiency.

Nor surprising, perhaps, we find that mainstream economists, schooled in the “dismal science,” generally come out in favor of tax havens. Their hypothesis is that international tax competition limits the naturally expansionist tendencies of bureaucratic governments.


Tiebout’s theory is often advanced in favor of international tax competition by modern-day politicians, particularly Bush 43’s administration. In a nutshell, the argument holds that international tax competition forces otherwise idle governments to think long and hard about the balance between taxation and public services, and hence to respond to consumer need. Based on this view, tax havens push governments to enhance their “efficiency.”

The opposing view maintains that international tax competition resembles only superficially the neoclassical model of market competition. According to this view, the application of neoclassical methods to tax competition conflates micro-economic theory of the firm with political economic theory of the state — a fallacious notion, say opponents, because tax havens affect income distribution rather than efficiency or optimality. International tax competition is a double zero sum game: the tax receipts earned by some territories are tax receipts lost by others; but also, the diminished fiscal burden for some translates into an increased burden on others. Consequently, the neoclassical rhetoric of competition advances the parochial interests of particular groups and sections in society. It is not simply an analytical tool through which to understand the impact of tax havens on world economy.

Take the tax havens themselves. The idea that tax havens have pioneered or have contributed to a reduction in tax rates is misleading. The tax rates for ordinary people who live in Switzerland or Luxembourg are not particularly low when compared to the taxes imposed on the middle classes elsewhere. Some tax havens, such as Jersey, have robust laws to make sure that their residents cannot take advantage of the services of other tax havens.


If tax havens were meant to reduce tax rates for all, then they must be considered failures. The overall rate of taxation has risen in the past 3 decades, even in the US and the UK. Tax havens are used only by a small portion of the population, the wealthy and multinational businesses. Clearly, if the burden of taxation has not declined, and wealthy individuals and corporations are reducing their tax bills because of their use of tax havens, then someone else has had to bear the costs. The big losers from the tax haven games are the salaried middle classes.

A decline in nominal and real corporate tax in OECD countries contrasts with a rise not only income tax rates but in other forms of taxation as well, such as consumer taxes (VAT and the like) and social security contribution, both of which have disproportionate effects on the middle classes and the poor. The ratio of consumption spending to income is, inevitably, higher for the poorest members of the community. Social security contributions, for instance, apply to income derived from labor and hence affect the rich only marginally. In addition, most social security systems have earning caps above which further contributions are not made.

In addition, and despite the claims of its advocates, tax competition exerts little meaningful pressure on governments to be more efficient. Governments are not profit-maximizers and not to collude with one another to raise tax levels in the way that businesses do to raise price levels. The purported “innovations” generated by tax competition have led to no discernible improvement in the provision of public services at lower costs. On the political side, democratic governments are accountable to their electorates, who are keenly aware of tax levels. The aim of an artificial competition between states to reduce taxation is a direct attempt to undermine the ability of electorates to choose between otherwise viable tax alternatives.


Some of the most extreme unregulated and untaxed havens, the Pacific atolls, are also some of the least successful tax havens. They have succeeded in attracting money laundering flows but rarely serve as booking centers for larger financial and industrial institutions. Respectable MNEs, banks, and hedge funds are not too keen to attract attention to themselves by associating with disreputable havens. There is a premium for those tax havens with a reputation for solidity and at least the appearance of a regulatory environment. Tax havens compete in the business of appearing not to exist.


The argument is that opacity benefits the one who is, as one Enron director reputedly quipped, “the smartest man in the room.” The small investor, if not the dumbest in the room, is the one least equipped to handle complex and rapidly changing information.


Enron’s fraud was organized through 3K SPVs with over 800 registered in well known offshore jurisdictions, and about 600 using the same post office box in the Cayman Islands.


Most developing countries do not possess sophisticated tax systems. Typically, they are characterized by large and undertaxed informal economies, and in some of the extreme cases economies that are not taxed at all. An effective tax system is a critical factor in development. Not only does a functioning tax system raise the necessary revenues for development; it also builds the institutional capacity necessary for long-term development, and it encourages consensus and political conversation between private and public actors.


Tax evasion and avoidance, however, are more of a future than a current worry. Individual and corporate tax rates are much lower in developing countries, and enforcement is at best patchy. The biggest issue is not the use of sophisticated tax avoidance schemes or even tax evasion, but rather capital flight from developing to developed countries.


What is of greater concern is that illicit capital flight considerably exceeds current overseas aid to developing countries — about $100B. At best, overseas aid replace 20% of illicit capital flight.


Companies can decide whether they want this outcome, although we must stress that it is not always as straightforward as it may appear. There may be great difficulties in determining the “third party” price for some products transferred across international borders, for example the price of a part of a finished component that will never be sold on the open market.


Exxon succeeded by use of some of the techniques we have already described. The principal technique used to expatriate funds from Chile was through the payment of interest on loans from Exxon financial affiliates in offshore havens.


Other high-value commodities such as art, antiques, and rare coins also serve as means to take wealth out of poor countries.


Both involve elites avoiding and evading their responsibilities to the societies that sustain them. This “Revolt of the Elites” has 2 main components: first, elites remove themselves from carrying the costs involved in maintaining healthy societies; second, they remain actively involved in democratic (or other) process of government, notably through lobbying. Tax evasion and corruption both worsen poverty, and both corrode faith in the integrity of the political and economic structures of governance. Both involve the abuse of the public interest by narrow sectional interests.


Not all the capital that flees developing countries stays out. Some of it comes back disguised as FDI. This process is called “round tripping.” Preferential treatment accorded to many foreign investors provides an incentive to engage in this process. In the case of China, foreign investors typically enjoy lower tax rates, favorable land use rights, convenient administrative supports, and even favorable financial services. They also enjoy superior protection of their property rights.


Agglomeration theory makes sense, but lacking good systemic comparative research, we are left with assertions and presumptions and not facts.


The theory is founded on the premise that whereas large, heavily populated states have a great many instruments of competition at their disposal, the smallest states cannot realistically compete for large-scale production or manufacturing facilities, nor can they compete in high-value sectors. Besides locational advantages, such as splendid sandy beaches and beautiful mountains that attract tourists, their only “competitive advantage” is their smallness and their sovereign right to write their law. Due to their small size they have no need for a costly army, and indeed they have no choice but to rely on international law and norms for their security. They also have relatively low infrastructure costs, as many of them have few roads and no universities or big hospitals to maintain. Dependencies under the protection of the UK government receive subsidies for basic infrastructure costs even when their nominal income per head is higher than that of the UK. The cost of maintaining the state and government is, therefore, relatively small.


Although they are known as tax havens, the 2 islands relied heavily on the 20% corporate tax on local businesses and were, as a result, in danger of running a substantial budget deficit. They sought to recover taxes by creating a complex but ultimately futile system of voluntary contributions from local businesses.

In fact, serving as satellites to financial centers such as London and NY, many tax havens are extremely vulnerable to changes in these centers. Changes in British or US law and practices may have a fast and brutal impact on a satellite.


Although they claim their sovereign rights, these states have an independence that is more apparent than real, for their developmental and social goals are subject to the whim of foreign capital. As a rule, tax havens do not lack transparency only in financial matters — opacity pervades the entire state. The majority are controlled by a small, often invisible, oligarchy.


Transfer pricing is both normal and legal. It happens whenever 2 entities under common control trade with each other across an international boundary. As a result, however, they can set prices that allocate profits in a way not determined by the market. It can constitute tax evasion if it breaches the regulations enacted to control this activity.


In addition, some goods and services are made available only on an intra-group basis, and in such cases no market comparison is available to help determine an appropriate price. This happens, for example, with components traded in a half-finished state and when IP or management services are traded.


A US firm wanting to invest in China might route its investment through a subsidiary incorporated in an intermediate territory such as BVI. The technique raised the significance of locations such as Switzerland and the Netherlands, which had extensive networks of double tax treaties but which also operated favorable regimes for the taxation of dividends, royalties, and other investment income.


When the offshore branch refused to hand over the documents, citing Bahamian confidentiality laws, the bank was fined $50K a day for contempt of court, later increased to $100K. In effect, the Miami agency was held to ransom. 18 months and $1.8M later, the bank relented. In this and other cases, the US demonstrated its willingness to pressure the small Caribbean havens to a greater extent than international law seemed to permit.


A perception among Pacific offshore centers that they were disproportionately stigmatized because they lacked powerful allies.


The CIA used tax havens for its clandestine operations for many years.


Under the Bush administration, the US abandoned multilateralism and reverted, at least for tax havens, to its traditional policy of aggressive unilateralism.


The concept of the level playing field is ambiguous; it has an ethical ring to it, but the OECD primarily intends it in macroeconomic terms, to ensure markets free of political distortion. FDI and relocation decisions shoudl be driven by economic goals. Here we agree with critics of the OECD. The OECD perhaps should have learned from the long experience of the EU, which never succeeded in converting the theory of market distortion and fiscal competition to tangible policy.


Tax havens are defined by the OECD along the lines of the “pure” tax havens, while PTRs are more complex. PTR countries offer a great variety of preferential treatment to foreign investors not available to domestic investors.


The response of tax havens was highly uneven. The British and Dutch dependencies have tended to comply, or make all the right noises suggesting that they have complied, whereas the more independent and perhaps less savvy Pacific islands put up stiffer resistance. A few tax havens with small offshore centers lost the will to fight and surrendered to the OECD demands.


This gave credence to the argument that the OECD initiative attempted to protect the privileged positions of its own financial centers (e.g., Paris, Frankfurt, NY) against incursions from other centers with comparative tax advantages in a period of growing financial deregulation and mobility.


Last but not least, some tax havens claimed, correctly, that they had been advised by institutions like the IMF and the WB, as well as their home countries, to specialize in financial centers. Now the mood had changed, and they were left high and dry.


The US, he declared, “does not support efforts to dictate to any country what its own tax rates or tax system should be, and will not participate in any initiative to harmonize the world tax systems.”


Tax havens have also learned to cooperate. As they mobilized against the OECD, they understood that they are not only competitors but have common interests to defend. They employ the expertise of professionals, the big law and accounting firms, and PR firms to help them plan and coordinate their responses. They also established what are from their perspective very useful links with conservative US think tanks, which serves as a powerful lobbyist in the halls of Congress.


Obama may have underestimated when he remarked: “You’ve got a building in the Cayman Islands that supposedly houses 12K corporations. That’s either the biggest building or the biggest tax scam on record.”