Tax Avoidance &Tax Havens Undermining Democracy

Created byAlok(8)

Dinesh(21)Diwakar(23)Naveen(36)Pramod(73)

Introduction

Tax evasion is the general term for efforts by individuals , corporations, trusts and other entities to evade taxes by illegal means.

Tax avoidance is the legal utilization of the tax regime to one's own advantage to reduce the amount of tax that is payable by means that are within the law .

Tax Avoidance Is Legal; Tax Evasion Is Criminal

Corporate Welfare

The term is often used to describe a government's bestowal of money grants, tax breaks, tax holidays or other special favourable treatment on corporation or selected corporations . Example :

• Uttarakhand has had a tax holiday for manufacturers. Companies from elsewhere in India have booked their profits in Uttarakhand-based subsidiaries to lower their tax liability .

• STPI Scheme provides various benefits to the registered units, which includes 100% foreign equity, tax incentives, duty free import, duty free indigenous procurement, etc.

Corporate Crime

• Deliberately under-reporting or omitting income. • Keeping two sets of books and making false

entries in books and records. • Claiming false or overstated deductions on a

return. • Claiming personal expenses as business

expenses. • Hiding or transferring assets or income.• Engaging in a “sham transaction” .

Examples

• A 95-year-old director of south Delhi's Hotel Rajdoot will be put on trial for allegedly not depositing income tax for five consecutive years from 1989.

• Two cases of tax evasion (amounting to Rs 250 crore) by Cadbury India Ltd have been detected during the years 2009-10 to 2012-13, up to October 31, 2012.

• The issuance of 87 crore shares by Shell India to an Shell Gas B.V., in March 2009. The shares were issued at Rs.10/share instead of Rs.180/share instead.

The Scale Of Tax Avoidance

Acc to an article published in Indian Express on Aug 11 2012 :

• The government has detected more than Rs 600 crore in tax evasion from the investigation of information received from Germany and France.

• Undisclosed income of over Rs 32,000 crore from various searches, seizures and surveys during the last three financial years.

• seized undisclosed assets worth over Rs 2,600 crore seized.• The surveys on business premises resulted in detection of

undisclosed income worth Rs 17,325 crore

Tax Avoidance by Fortune 500 companies

Goldman Sachs in 2008 only paid 1.1 percent of its income in taxes in US even though it earned a profit of $2.3.

Citigroup in 2010 made more than $4 billion in US in profits but paid no federal income taxes.

G.E. in 2010, made $14.2 billion in global profits, $5.1 billion inside the United States, paid zero taxes .

Starbucks has paid no corporate tax in the UK in the last three years. It paid only £8.6 million (US$10.8 million) in total tax to the UK government over 14 years .

Amazon, the UK’s biggest online retailer, employs 15,000 in the UK, but drives all of its sales through Luxembourg.

Google paid 0.4 per cent tax rate in the UK, compared with 21 per cent paid globally. Tax charge in Britain was only £3.4 million (US$ 5.4 million) out of declared earnings of £2.5 billion.

Why Is Tax Revenue Important?

Resource Mobilisation Reduction in Inequalities of Income Social Welfare Foreign exchange Regional Development Control of Inflation

Why Don’t Poor Countries Raise Sufficient Tax Revenues?

Tax competition

Trade liberalisation

Tolerance of tax havens

Impacts Of Tax Havens On Poor Countries

Negative effects of tax havens

Damaging tax competition Inefficient allocation of

investment Effects of secrecy Tax havens and the financial

crisis Illegal transfer pricing Unequal division of tax

revenues

Positive effects of tax havens

Beneficial tax competition Increased investment in

high-tax countries Economic development in

the tax havens

Why have tax havens in the first place and who benefits?

A number of reasons including the following:

The main appeal of tax havens come from

their inherently secretive nature.

Tax havens imply low- or no-taxes to be paid.

This makes it easier to avoid paying tax.

Who benefits

Tax havens have allowed multinational

companies, rich individuals, corrupt leaders,

criminals and terrorists to keep their wealth away

from the prying eyes of national tax authorities.

As noted by the Tax Justice Network in a report

titled Tax us if you can , just “ 1% of the

world’s population who hold more than 57 % of

total global wealth use these havens to escape

taxation.”

How much potential tax revenue is lost through off-shoring?

Tax Justice Network reports that $255 billion is lost

each year to governments around the world because of

the no or low taxation of funds in offshore centers .

The Tax Justice Network’s estimates in 2012

approximately $21 – $32 trillion were

being held offshore .

What is profit laundering ?

Profit laundering is the moving of profit from the countries in

which it was earned and where it would incur tax, into tax havens.

The UK government estimates that between 50 % - 60% of world

trade is accounted for by transactions between different parts of

the same company.

This creates an ample scope for mispricing and, as a result the

laundering of profits.

How much profit laundering is there?(Christian Aid reported in 2005)

Amount siphoned from the developing world - $500

billion

Amount of profit laundered by MNCs - $200

billion

Amount of profit laundered by individuals - $250

billion

and criminals Amount lost through corruption - $50

billion

In sum approx. $1.1 trillion flowed into the EU and US from

mispricing from non-EU countries alone .

This would amount to $365 billion in lost tax for developing

countries (or almost $122 billion a year).

What is Tax competition and why is it bad?

Tax competition is about countries out-

competing each other to offer the lowest

taxes

The Tax Competition has negative impact on

developing countries

Faced with the threat that companies will

relocate unless given concessions on lower

regulation and lower taxes governments

engage in tax competition.

Governments are forced to cut tax rates on

corporate profits to zero and subsidize those

companies choosing to invest in their countries.

This results in underinvestment in infrastructure,

education and health services thus hindering the

social and economic development of a country.

How did tax avoidance come about in the first place

This whole idea probably started with the US and the

British Empire

In the 1920s a UK court ruled that a company

incorporated in the UK was not subject to UK tax if its

board of directors met in another country .

At a stroke, the concept of the separation of the place

of incorporation of a company and its obligation to pay

tax had been created. This concept became the basis

for the operation of most tax haven corporations

throughout the world.”.

The major Swiss contribution to tax injustice is

banking secrecy

Tax avoidance undermines capitalism

The ability of multinationals to take advantage of tax havens to

avoid tax and launder profits distorts markets thus undermining

capitalism

It gives them an edge over nationally based competitors, which

has nothing to do with the quality or price of the goods they are

selling

Research suggests that

Atleast 75 % of UK-quoted companies do not pay tax at the

notional rate of 30 % that applies to them.

In the US, 60 % of corporations with at least $250 million in

assets reported no federal tax liability for between 1996 and 2000.

Tax avoidance undermines democracy

Major casualties of the tax avoidance industry

are ordinary people, who are forced to pay higher

taxes while corporations and the rich avoid

theirs.

Corporate tax payments now account for just

2.5% of national income, the smallest share ever.

We can be persuaded to vote for governments

that promise to invest public revenues in

education, healthcare or public transport. But the

tax avoidance industry exercises the final veto

by shrinking the tax base and eroding tax

revenues.

Main actors of Tax Avoidance

The main players who promote what they call “tax injustice” are: Accountants Lawyers Banks Transnational corporations Tax haven governments Tax avoiders and tax evaders

The big four accounting firms and other tax shelter promoters came under fire from the IRS, the Treasury Department and Congress for their roles in developing and marketing questionable tax shelters during the 1990s. 

“the tax shelter industry had moved from providing one-on-one tax advice in response to tax inquiries to also initiating, designing, and mass marketing tax shelter products”

• The report focuses on generic tax products developed and promoted by KPMG, PricewaterhouseCoopers, and Ernst & Young, auditors and tax experts

• During the 1990s, in response in part to the stock market boom and the proliferation of stock options, these firms and others designed and developed tax products used to generate large paper losses that could be used to offset or shelter gains from taxation.

• Tax products examined by the Subcommittee include: • KPMG’s Bond Linked Issue Premium Structure (BLIPS), Foreign

Leveraged Investment Program (FLIP), and Offshore Portfolio Investment Strategy (OPIS);

• PricewaterhouseCooper’s Bond and Option Sales Strategy (BOSS)

• Ernst & Young’s Contingent Deferred Swap (CDS) tax product. • All of these tax products have been “listed” by the IRS(Internal

Revenue Service) as potentially abusive tax shelters

COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

(2005)

Methods of Corporate Tax Avoidance

Transfer Pricing

One way that firms can shift profits from high-tax to low-tax jurisdictions is through the pricing of goods and services sold between affiliates.

To properly reflect income, prices of goods and services sold by related companies should be the same as the prices that would be paid by unrelated parties. By lowering the price of goods and services sold by parents and affiliates in high-tax jurisdictions and raising the price of purchases, income can be shifted.

If a firm can shift profits to a low-tax jurisdiction from a high-tax one, its taxes will be reduced without affecting other aspects of the company.

CompuGlobalHyperMegaNet UK Ltd's profit statementTotal sales revenues £100m

- Cost of parts from China

£50m

- Labour costs and UK overheads

£25m

- Royalty fee paid to CompuGlobal Corp*

£15m

- Interest on loan from CompuGlobal Corp

£5m

Total costs £95m

Taxable profit (revenues minus costs)

£5m

What is Transfer Pricing?• CompuGlobal UK Ltd is a

subsidiary of the imaginary US company CompuGlobal Corp.

• It assembles widgets from parts manufactured at CGHMN Corp factories in China, and then sells them in the UK.

• "Transfer pricing" rules apply to the cost of parts, the fee payment and the interest on the loan.

• If CompuGlobal Corp overcharged for any of these, it would reduce CompuGlobal UK Ltd's corporation tax bill in the UK, while increasing CompuGlobal Corp's taxable profits in another country.

Double Irish, Dutch Sandwich

One problem with shifting profits to some tax haven jurisdictions is that, if real activity is necessary to produce the intangible these countries may not have labor and other resources to undertake the activity.

However, firms have developed techniques to take advantage of tax laws in other countries to achieve both a productive operation while shifting profits to no-tax jurisdictions. One such technique is the “double Irish, Dutch sandwich”

This type of methodology has been used by Google and came to light in the year 2010 when it was reported that Google uses techniques to reduce its corporate income tax to 2.4%, by funneling its corporate income through Ireland and from there to a shell in the Netherlands where it can be transferred to Bermuda, which has no corporate income tax

Apple Inc.Eli Lilly and CompanyFacebookForest LaboratoriesGoogle

MicrosoftOracle Corp.Pfizer Inc.Adobe Systems

It can collect all the income, and be taxed by Ireland at a relatively low rate of 12.5 percent. But the royalties it's paying to 1st subsidiary can be deducted from its income.  In the end, it doesn't have to pay that much in taxes, and the "royalties" that make their way to 1st Sub. are tax-free.

Why would anyone opt for the Double Irish over the Single Bermudan? Because of tax treaties. When you transfer money within the EU, the government doesn't take a cut in the form of a withholding tax. When money goes directly to an unregulated country like Bermuda, however, it gets taxed at the origin country's normal rate.

Why are two Irish subsidiaries better than one? Because now S1 can license the parent company's products to S2 in exchange for a stream of hefty royalty checks. This means that S2 can collect all the income, and be taxed by Ireland at a relatively low rate of 12.5 percent (compared to 35 percent in the United States). But the royalties it's paying to S1 can be deducted from its income.  In the end, S2 doesn't have to pay that much in taxes, and the "royalties" that make their way to S1 are tax-free.

Why Irish ?Irish tax law provides that a company is tax resident where its central management and control is located, not where it is incorporated, so that it is possible for the first Irish company not to be tax resident in Ireland. 

Google avoided about $2 billion in worldwide income taxes in 2011 by shifting $9.8 billion in revenues into a Bermuda shell company, almost double the total from three years before.

In 2012 Google India was slapped with a fine of INR 760 million (US$13.8 million) by the country's income-tax authorities. The penalty order, states the following:

The entire activity of (Google's) AdWords Programme and the revenue earned thereon has happened in India with both the advertisers as well people making use of the advertisements situated in India. To this extent, the income of M/s Google Ireland Ltd was held to be accrued as well as arisen in India itself.

Tax Shelters And Avoidance In The United States

• Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments.

• A legal method of minimizing or decreasing an investor's taxable income and, therefore, his or her tax liability.

Contd.

Two types of Tax shelters 1. Legitimate tax sheltersMany people take advantage of legitimate tax shelters, such as Roth IRA accounts, deductions for home mortgage interest or small business R&D investments. These are deductions sanctioned by Congress, often for social purposes.

2. Illegitimate tax sheltersIllegitimate tax shelters, however, often arise when sections of the tax code, or multiple sections of the code, are used for purposes not originally intended by Congress or the IRS

A 1999 Treasury Department white paper identified common characteristics of illegitimate tax shelters as:

The participation of "tax-indifferent parties," such as foreign or tax-exempt entities that receive a substantial fee to enter into the shelter transaction.

A fee structure based on the tax savings of the client.

High transaction costs.

The Scale Of The Problem

Some estimate the cost is in the tens of billions every year and a few deem it as high as $50 billion a year. 

In October 2003, the General Accounting Office (GAO) released a report, "Challenges Remain in Combating Abusive Tax Shelters" that notes, "Although they do not have a reliable measure of the size of the abusive shelter problem, Treasury and IRS believe that tens of billions of dollars of taxes are being improperly avoided and the potential for proliferation of abusive shelters is strong.“

Whatever the actual cost, former IRS Commissioner Rossotti says that abusive tax shelters are the "biggest single source" of a larger problem -- the gap between taxes owed and taxes collected. 

Why A Rise In Tax Shelters In The 1990s?

 According to Harold Handler, former chair of the Tax Section of the New York State Bar, "What changed in the '90s was that the tax line of the financial statement became a profit center for many corporations.“

Reasons 1. as the bull market exploded, companies came under increasing

pressure to keep their profits and stock prices up. One favored means was to drive down the tax line of their corporate returns.

2. The other big change was in how tax shelters were marketed. Tax firms that previously responded to client needs, (i.e., reviewing business transactions to help minimize the tax implications) turned to pushing tax products that had no connection with the client's business needs.

How has sheltering affected corporate tax revenues?

Corporate tax shelters reduce the corporate tax base, raising the tax burden on other taxpayers.

In October 2000, Robert McIntyre, director of the Institute on Taxation and Economic Policy, released a study that looked at the tax rates of 250 large U.S. corporations between 1996 and 1998. The study found that in 1998, the average effective tax rate companies were paying was 20 percent -- in contrast to the corporate tax rate of 35 percent. "Lately, we think the rate is down to about 15 [percent]," McIntyre says. "In other words, companies are paying less than half of what they're supposed to."

What is the IRS doing about the problem of abusive tax shelters?

The IRS tries to discourage the use of illegitimate tax shelters by identifying and publishing transactions that it believes are "abusive." The process, called "listing," is intended to put taxpayers on notice that the IRS will not recognize, or allow, certain types of transactions. 

In addition, the IRS is going after tax shelter promoters, trying to enforce requirements that promoters register all shelter products and maintain lists of clients who use these products. The Department of Justice, on behalf of the IRS, has brought several cases against promoters -- including KPMG -- for failing to register their products and/or provide client lists when requested. Some promoters have settled with the government.

The IRS also offers periodic amnesties to investors to try and get them to come forward with information about shelter promoters and transactions. In these cases, the IRS will lessen the penalties on the investors to induce them to come forward.

According to IRS Commissioner Mark Everson, the agency currently has 100 active investigations of tax shelter promoters underway.

Tackling The Problem, Or Pretending To Do So?

Now after knowing so much about the various ways and implications of tax avoidance and tax evasion via tax havens, lets see how world perceives to this problem. Different countries have different approach towards this menace.

The poor countries are the greatest sufferers followed by the developing countries and to the very recent times developed countries were not much bothered about it, until it started effecting their economy.

Media is another important factor which greatly influences the magnitude of problem in hand, under reporting of events, curtailing the loopholes in the system and targeting some CEOs like scapegoats are some of the practices being undertaken by media throughout the world. There are very less reports on off shore tax evasion and tax havens either in developing or developed world.

Tackling The Problem, Or Pretending To Do So?

Now after knowing so much about the various ways and implications of tax avoidance and tax evasion via tax havens, lets see how world perceives to this problem. Different countries have different approach towards this menace.

The poor countries are the greatest sufferers followed by the developing countries and to the very recent times developed countries were not much bothered about it, until it started effecting their economy.

Media is another important factor which greatly influences the magnitude of problem in hand, under reporting of events, curtailing the loopholes in the system and targeting some CEOs like scapegoats are some of the practices being undertaken by media throughout the world. There are very less reports on off shore tax evasion and tax havens either in developing or developed world.

Now we'll have a look on different factors leading to tax avoidance by the firms or individuals-

In some countries, the business community shouts a lot about government interference (in their profits) and recommends that the government be reduced in bureaucracy.

Some argue that minimizing tax is one of the various parts of a company’s responsibility to maximize shareholder wealth. As such, tax is seen as a “cost” to be minimized.

Black money is the major contributor to tax havens, this money gets unnoticed by the parent country.

Rich Country Governments Finally Acting Because It Now Affects Them?

For many years, various organizations have attempted to highlight these problems and its effects on poor countries.

If anyone can help sort this out, it would be rich country governments as they would have the clout to do something. Poor countries simply don’t have the resources to deal with this.

And it is at such a time that we see some rich countries potentially pressuring tax havens to become more transparent.

The current global financial crises has hit nations like the US and UK very hard. As such, one of the causes of the problem, tax havens, has come into the fore.

Countries such as the US (with its Stop Tax Haven Abuse Act), the UK, France and Germany, are all showing signs of acting by demanding more transparency.

If individual nations such as UK or US try to deal with this alone, they might find their companies looking for other ways around any new measures and regulations by going elsewhere, or that companies will fight hard to resist measures by saying other countries are not doing it and they will therefore be at a competitive disadvantage.

Now the measures taken by countries doesn’t seem to be that effective-

For Example- The G20 decided to endorse the OECD(organization for economic co-operation and Development) approach of exchanging information about companies and individuals suspected of evading taxes on request, rather than the more stringent automatic exchange of information called for by the Tax Justice Network and others.

US Stand with respect to Tax avoidance through tax havens with special ref. to Swiss Banks

The United States of America and Switzerland seek to build on their existing relationship with respect to mutual assistance in tax matters and desire to conclude an agreement to improve their cooperation in combating international Tax evasion.

The Name of Agreement is FATCA(Foreign Account Tax Compliance Act) enacted in 2010.

The objectives of this Agreement are to:

a) Implement FATCA with respect to all Swiss financial institutions.

b) Ensure that all required information about identified U.S. Accounts will be reported to the IRS(Internal Revenue Service).

c) Remove legal impediments to compliance.

d) Increase legal certainty by clarifying which Swiss financial institutions are subject to FATCA implementation.

e) Simplify the necessary due diligence procedures.

FATCA imposes steep penalties beginning in 2014 on financial institutions that do not comply with the its demands. Banks and other financial institutions failing to comply with the law would be frozen out of US financial markets.

Switzerland is one of seven countries which have so far agreed to comply with FATCA, which aims to ensure that all US citizens can be taxed by the Internal Revenue Service on their income and assets worldwide.

FATCA meanwhile requires foreign financial institutions to report all assets in accounts held by US citizens to the IRS.

In light of this problem and to avoid trampling on Switzerland’s cherished banking secrecy rules, a number of exceptions have meanwhile been negotiated under the deal signed.

Social security funds, private pension funds and property and casualty insurers have been excluded from the Swiss FATCA filing requirements and bank compliance has been simplified.

The new deal also ensures that information will not be transferred automatically without the client’s consent, although FATCA then requires banks to charge a 30-percent withholding tax on the US client’s assets.

Major Impacts by FATCA

The US, unlike the rest of the world, taxes its citizens no matter where they live. You would have to surrender your US citizenship and pay the exit tax of 30-35%, then you wouldn't have to pay us taxes any more.(money.cnn.com).

Switzerland’s oldest private bank, Wegelin & Co., has announced it would “cease to operate as a bank,” following its admission to tax-law violations in the US.

The Swiss bank agreed to pay $57.8 million in fines after admitting to conspiracy charges of helping at least 100 US clients conceal large sums of money from the federal tax collection agency in overseas accounts.

Indian Stand with respect to Tax avoidance through tax havens with special ref. to Swiss Banks

India has comprehensive Double Taxation Avoidance Agreements (DTAA ) with 84 countries. This means that there are agreed rates of tax and jurisdiction on specified types of income arising in a country to a tax resident of another country. Under the Income Tax Act 1961 of India, there are two provisions, Section 90 and Section 91, which provide specific relief to taxpayers to save them from double taxation. Section 90 is for taxpayers who have paid the tax to a country with which India has signed DTAA, while Section 91 provides relief to tax payers who have paid tax to a country with which India has not signed a DTAA. Thus, India gives relief to both kind of taxpayers.

A large number of foreign institutional investors who trade on the Indian stock markets operate from Mauritius and the second being Singapore. According to the tax treaty between India and Mauritius, capital gains arising from the sale of shares are taxable in the country of residence of the shareholder and not in the country of residence of the company whose shares have been sold. Therefore, a company resident in Mauritius selling shares of an Indian company will not pay tax in India. Since there is no capital gain tax in Mauritius, the gain will escape tax altogether.

New provisions in DTAA with special ref to black money stashed in Swiss Banks

The new provisions of the Double Taxation Avoidance Agreement (DTAA) between India and Switzerland have now come into effect.

The conditions will enable India to get information even if we have only limited details about the person with bank accounts in Switzerland.

EARLIER VERSIONS HAD COME UNDER FIRE

The India-Switzerland DTAA had come under fire in India because earlier versions did not make it easy for sleuths to get information on tax offenders and account holders in Swiss banks.

Under the rules, India had to provide details of the person being investigated and also the name of the foreign holder who can provide this information as part of the identity requirement without which Swiss authorities would not share information. (ET Bureau May 1, 2012)

Major Impacts

Much have been said and large number of steps are proclaimed to be undertaken, but the matter of fact is not a single penny have been brought back. The government’s stand is that they are studying on the details provided by the Swiss banks and would act accordingly.

“Rudolf Elmer, a rare whistleblower who has brought out much information on secret Swiss banks accounts, has accused the Indian government of not being serious enough in getting details of black money stashed away in Swiss banks.”

Its not we can’t do it, its just we don’t want to do it.

Thank you