In this era of globalised economies, the flow of capital across borders is perhaps the most talked about topic. It is commonly understood that capital from the developed countries flows into less developing countries to facilitate economic activities. The inflow of FDI in India is perhaps one of the biggest examples of this. However, if one were to go by official records, the biggest source of FDI inflow in India is not some big economy from the West, but the small island nation of Mauritius, which accounts for almost 40% of all FDI coming to India! Compared to it, the USA accounts for only 6%, Japan around for 8%, and the UAE for just 1%. So does that mean that Mauritius is one of the richest economies in the world? The answer to this riddle is what has been plaguing all major economies in the world- tax havens.
As finance flows from one country to another, the question of the origin or owner of such capital becomes very important, as only the owner can be legally taxed for the incomes earned. In today’s world, most investments are covered under double taxation avoidance treaties between countries, which ensure that any economic activity like investments should not be double taxed. Thus, any investor from Country A investing in Country B and thereby earning a profit cannot be taxed at both countries. A double taxation treaty between A and B will chalk out proper guidelines that ensure both have some share of the taxes without putting additional burden on the investor. While such agreements are morally justified and are essential to ensure flow of capital across borders, there are loopholes that are being exploited by certain agents for malicious practices. One of the biggest issues here is the emergence of tax havens.
Tax havens are countries that have very
lenient tax rules in order to encourage MNCs to register themselves in those countries. Additionally, these countries have laws and regulations that allow individuals or corporations to conceal financial information (either from domestic authorities or even international authorities or foreign countries), have a high degree of opacity in the legislative or administrative operations designed deliberately to prevent any such investigations, and actively encourage foreign entities to operate from their shores. Thus any company from Country A can register a subsidiary in a tax haven B, and channelise its investments through the subsidiary to Country C, such that it avoids paying taxes in both A and C, with tax rates in B being ridiculously low, perhaps even 0%! Since all investments are being done by the subsidiary company, neither Country A nor C can claim taxes for the activity, as double taxation treaties between the
countries A, B, and C prevent it.
The concept of tax havens is
nothing new by itself. Even in ancient Greece, traders would utilise other Greek islands as bases for importing items to avoid the taxes imposed on imported goods by the city-state of Athens. Swiss banks gained a reputation for parking funds post-World War 1, not only because of their secrecy, but also because of the fact that Switzerland imposed very low tax rates on incomes compared to other European countries, which had to raise taxes to cover for the war expenses. However, with the increase of globalisation, and especially with the development of finance capital, the problem of tax havens has severely multiplied. The advent of information technology and digitalisation of the banking system has further accentuated the problem. It is very easy today to register a company in some tax haven, wire money transfer to a bank account in that country, and then transfer it to some investment destination. All it takes is a simple laptop, an Internet connection, and registered accounts. Subsidiaries registered in tax havens often do not have even an office, with just one employee operating out of some hotel room, transferring billions across the world.
CATCH THEM IF YOU CAN
While it is quite apparent why MNCs love tax havens, it needs to be understood why countries opt to be tax havens. In today’s world of finance capital, all developing countries have to provide some kind of tax incentives to woo foreign investors. Tax holidays in SEZs are such examples which even India had to resort to. We have experts who are always suggesting that corporate taxes should be reduced or relaxed to ensure investments, economic growth, etc. The smaller a country is, the more incentives it has to offer to foreign entities to woo them. There is a very thin line between providing tax incentives, and ultimately, becoming a tax haven to be exploited by MNCs.
Island nations like Mauritius or Singapore have historically survived as being major ports for trading. Their geographical locations are perhaps the only resource they have to offer, wooing overseas traders to use their ports to transfer goods inland; they have historically offered lower port taxes to encourage the same. In an age when capital is the most traded commodity, it is not surprising that both these examples have emerged as major tax havens.
For small countries with very little natural resource or scope of industrialisation, becoming a financial hub is the easiest and often only route to ensure existence. Despite very low tax rates, the income they earn out of it is greater that what its GDP would be otherwise. Often, countries become tax havens to encourage actual relocation of the production chain to their countries, which is essentially forming a SEZ to have MNCS set up productions base for exports. This provides some employment to the inhabitants, which compensates for the loss of tax revenues.
Instead of demonising such countries - as the media usually does - it needs to be understood that the global economy dictated by finance capital itself has actively encouraged the emergence of tax havens to serve its interests. As MNCs become larger entities than nations themselves, some nations will always succumb to being tax havens while others will have to face the consequences of losing out on revenue.
It is not just small nations that run the risk of becoming tax havens. India itself runs the risk of becoming one, as the finance minister recently said in the context of the State of India versus Vodafone battle over taxation. Sovereign rights to determine one’s tax structure is being severely undermined by the plethora of international treaties and investment incentives, with the threat of FDI outflow looming if the country does not act according to the diktats of the MNCS. In the meantime, we are struggling to review India’s treaties with Mauritius (which is one of the nine tax havens officially recognised by the Indian State) and make amends in our own tax laws to recover the loss of tax revenues to tax havens like Mauritius and Singapore - which are the top two sources of all FDI being channelised to our economy.
Thus, the issue of tax havens is a
double-edged sword in today’s world of finance capital, and both developing and developed nations are trying desperately to find a solution to the problem.
—Amitayu Sen Gupta has a PhD in
economics from Jawaharlal Nehru University and works at the Economic Research Foundation