TAX NEWS - JUNE 2010

Offshore Tax: International Offshore Financial Centers Taxation Regimes

by Alain Megias -- Many e-businesses are considering moving offshore because of the advantages related to offshore jurisdictions' tax regimes. Although International Offshore Financial Centers ("IOFC") have been under pressure from part of Western high-tax countries these last few years, they managed to preserve their attractive tax regimes.

Tax issues are often the main motivation for e-businesses operating in high tax countries, and clearly, the financial incentives available offshore may be rewarding. International Offshore Financial Centers no-tax or low-tax environment offers legal ways for e-businesses to reduce their tax bills. However, since September 11, Western governments have become aware of the existence of international money laundering schemes used to finance terrorism, as well as the existence of massive tax evasion through offshore schemes, notably in the US. As a result, companies operating from International Offshore Financial Centers (IOFCs) are closely watched.
 
 
What is a tax haven / International Offshore Financial Center (IOFC)?
 
A tax haven has been defined by the IRS as a country that provides a no-tax or low-tax environment. The term "tax haven" is sometimes used interchangeably with "International Offshore Financial Center" and consequently these terms are hard to distinguish. Some authors define tax havens as territories offering very low local tax exposures for foreigners, and offshore financial centers as territories with specific tax advantages designed to operate across a wide range of offshore financial service industry activities and which have infrastructure and legislative support for such activities.
 
 
What are the characteristics of offshore financial centers tax regimes?
 
Although tax legislation varies among International Offshore Financial Centers (IOFCs), there are some characteristics that are common to most of them. The common characteristics of tax havens are:

- Virtual absence of tax on personal, corporate income or capital;
- Bank secrecy and strict privacy laws;
- Nil or low withholding taxes on remittances from the tax haven;
- No exchange control restrictions on foreign capital;
- Wide range of local professional services, notably legal and tax advisers.

 
Can these tax regimes be expected to remain untouched?
 
International organizations such as the OECD and the European Union have long been concerned with "harmful tax competition" and "unfair tax practices" that they associate with offshore jurisdictions. As a result, in 1998, the OECD issued a report entitled "Harmful Tax Competition: An Emerging Global Issue." This report identified factors that could undermine the integrity and fairness of tax systems and it listed four criteria to determine the harmful aspects of a particular jurisdiction and identify it as a so-called tax haven. These criteria are (i) no, or nominal, taxes and no, or low, effective tax rates; (ii) lack of effective exchange of information; (iii) lack of transparency; and (iv) no substantial activities. Under the OECD initiative, tax havens were blacklisted, and had to bring themselves into compliance with requirements or risk being subject to sanctions. Many tax havens had to seek an agreement with the OECD in order to get out of/stay off the black list. These agreements took the form of letters of commitment, under which tax havens accepted to share bank account information with foreign governments conducting criminal tax evasion investigations in certain circumstances. Many tax havens made concessions in order to maintain their tax characteristics and remain free of income tax, corporation tax, capital gains tax, etc. Running alongside the OECD initiative is the Financial Action Task Force ("FATF"), which role is to promote coordinated action on money laundering. FATF has its own blacklist, and pressures offshore jurisdictions to establish effective mechanisms for locating financial crime. These mechanisms include monitoring agencies and exchange of information.