What is a Tax Haven

A tax haven is a country or a semi-independent territory which charges no tax, or very little tax, and therefore attracts money from large corporations or wealthy individuals hoping to escape paying taxes in their home countries. Because offshore holdings generally involve storing or transferring money rather than labour-intensive activities, very small countries often find that charging a negligible tax is useful in drawing in large numbers of clients and contributing a meaningful component of government revenue with very little effort. Tax havens may also be abused by money launderers, organized crime, and terrorist organizations, which is why they have come under increasing scrutiny since 2001.

Moving between jurisdictions in search of regulation and tax advantages is a common practice and hardly new – the regulatory advantages are why, for instance, so many American corporations are based in the small state of Delaware. For a very long time, banks in Switzerland, and to some extent Liechtenstein, served as leaders in the tax haven field, since it was relatively easy to store money at these banks without requiring one’s name to appear on a comprehensive paper trail. However, Bermuda has also been a tax haven for most of the twentieth century, and several islands in the British Isles, like the Channel Islands, also pay no government taxes and have paid none for centuries.

There are several basic ways in which most tax havens operate. First, people can simply move to a low-tax country where they can live off their savings or their investments. If they are escaping tax bills in their home country, these individuals are known as tax exiles, since they can maintain non-resident status only by being in their home country for less than a specified time per year. (Different countries have different residency requirements.) Second, they – or a corporation – can simply create a holding company in an offshore tax haven. To escape tax laws which have increasingly caught up with such activities, corporations may also utilize much more complex financial relationships. For example, one scheme is to “invest” money in a subsidiary or otherwise related fund in a tax haven, and then receive a “loan” or a reinsurance product back from that company in return. The result is that the home company is essentially purchasing services for itself at extremely high cost, and the “profits” from this are then transferred to the tax haven, to escape taxes in the home country.

Tax havens first came under criticism from tax authorities in developed countries which were not tax havens, and from international organizations dominated by these countries like the Organization for Economic Cooperation and Development (OECD), because of the fact that they were being used (albeit legally) to avoid paying taxes. Tax havens typically charge little or no taxes, and disclose little or no financial information about clients at banks there (they thus combine very low taxes with very high privacy protection). For this reason developed countries’ tax agencies have attempted to reduce the apparent incentives of investing savings in tax havens, usually by passing new legislation under which some or all of the revenue held in or moved to a tax haven is assessed as though it were still present in the home country.

Tax havens were caught up in the generally increased suspicion of secretive offshore and transnational financial activity following 9/11, so that the international Financial Action Task Force now maintains a list of suspect tax havens which refuse to provide information about residents or clients, and therefore might be used by terrorists and organized crime. However, many other tax havens are not necessarily suspected of such manipulative criminal activity.

Current major tax havens include Bermuda, Andorra, Aruba, the Bahamas, Naurua, the Virgin Islands, and the Cayman Islands.