Deja-vu all over again - Panama Papers a few years back, and now the Paradise Papers. The recent leak of 13.4 million documents belonging to an offshore law firm Appleby exposes individuals, multinational corporations and institutional endowment funds who are engaged with offshore tax havens for tax avoidance purposes. These revelations have once again sparked attention toward the usage of offshore finance; rankling politicians, anti-corruption bureaus, and tax justice campaigners. They have reignited the debate on the benefits or harms caused by the offshore financial services industry.
Unlike Panama papers revelations earlier, Paradise papers do not show overt criminality. The newly leaked documents do show aggressive tax avoidance techniques used by individuals and multinationals. Even though these tax avoidance schemes may be legal, they are clearly designed to reduce the taxes which otherwise may be considered due. Professor Richard Harvey from Villanova University, an ex-senior tax policy advisor to the IRS commissioner states,” companies generally intend to stay within the law, but sometimes (i) the law may not be clear or (ii) the companies get too aggressive/greedy.”
The voluminous flow of capital and goods across borders has in the aggregate brought global economic growth. However, this trend has also created opportunities for aggressive accounting, outright tax evasion, money laundering and illicit financing.
Tax relief are government endorsed deductions, credits provisioned by the existing tax code which seek to elicit certain economic behavior out of individuals and entities. Whereas, tax avoidance refers to legal methods used to reduce taxes by shifting taxable profits to offshore tax havens. Tax avoidance is within the law but has bad optics, especially when exposure happens via these episodically leaked events. On the other hand, tax evasion involves eschewing taxes by illegal methods such as deliberately misreporting to the tax authorities.
As per the Organization for Economic Co-operation and Development (OECD), tax havens have low or non-existent tax rates on some types of income. These tax-friendly jurisdictions usually require little or no economic activity for an entity to obtain offshore legal status. Additionally, they provide attractive features such as anonymity for the principles and beneficiaries and operational opacity. OECD states, such tax avoidance strategies, albeit legal, cost the US treasury over 100 billion dollars a year. These companies use various cross-border corporate structures and methods to minimize their overall tax liability.
A Cornell University, ILR School study on International Tax Avoidance and Evasion states, “most of the international tax reduction of individuals reflect evasion, and this amount has been estimated at $40 to $70 billion each year.” It further states that individual taxpayers who are channeling their investments through foreign entities, either do not report or misreport their holdings or incomes from overseas assets on their U.S. tax returns, thereby evading tax payments required by the code.
Many economists and government officials denounce these off-shore tax havens, stating that, they have no economic purpose other than offering illicit opportunities to corrupt officials, money launderers, and criminals. On the other hand, the proponents state that these entities facilitate global commerce, avoid double taxation and provide other conveniences.
The over-arching strategy that facilitates tax avoidance is: Multinationals are not taxed on income earned by foreign affiliates until repatriated to the U.S. To reduce their taxes, without affecting other operating aspects, such firms strategically architect the generation of profits in low-tax jurisdictions instead of in high-tax jurisdictions. Company executives of such firms, under the advice of their internal and external international tax planners, devise a multitude of dynamic strategies to avoid tax liabilities.
A simple example of tax avoidance is a multinational firm having an operational facility incorporated in a low-tax jurisdiction and choosing not to repatriate the profits to a relatively higher tax jurisdiction of the parent.
Another way firms shift profits from high-tax to low-tax jurisdictions is through the transfer pricing of goods and services transacted between affiliates. By raising the transfer price of purchases from affiliated entities (cost loading), profits can be shifted to the low tax jurisdictions.
Another technique for shifting profits to low-tax jurisdictions is through the check-the-box provisions in the present tax code. The check-the-box rules allow multinationals to create hybrid entities that are treated one way in a foreign jurisdiction and another way in the U.S. jurisdiction.
Yet another practice used is called, an inversion, wherein an operating entity in a high tax jurisdiction is acquired or merged into a foreign entity incorporated in a low tax jurisdiction while retaining its material operations intact.
Many of these tax avoidance strategies highlight the complex nature of global tax regimes. Tax jurisdictions around the globe are continually evolving their tax codes to minimize tax avoidance and evasion, while new tax havens are stepping forward to fulfill the void and meet the demand for tax avoidance.
The U.S. administration’s current plan to lower the corporate tax rate is conjectured to reduce the tax advantage differential between domestic and offshore tax jurisdictions, thereby potentially act as a disincentive to engage in elaborate tax avoidance schemes. Additionally, the administration could address the “check-the-box” rule in the current tax code that helps U.S. multinationals shift the taxes from high-tax to low-tax jurisdictions.
Although, the Paradise papers have made interesting headlines, yet they have not shown glaring instances of criminal behavior. The perennial cat and mouse game between the taxpayers and the tax collectors are here to stay. Historically, the rulebook of tax collection has lagged behind the frontiers of the modern economy. Legislators need to address the tax avoidance issue and yet not stifle commerce.
