“There are only 2 things that are certain in a person’s life – Death and Taxes.” – Benjamin Franklin.
With the recent announcement of Budget 2021-22, on 1st February; the common man as well as the tax practitioners are facing a conundrum of emotions since the income tax rates do not show any variations. Living in the 21st century, going towards modernization and being a future chartered accountant, I frequently ask myself if the current income tax regime has become obsolete or still beneficial.
India is considered to be one of the country having the largest economy in the world, but unexpectedly our country ranks 63rd in World Bank’s ease of doing business whereas small countries like Mauritius, Switzerland, Hong Kong, Singapore attracts huge amount of foreign investments and also ranks way above in index of ease of doing business. These are the countries which follow such type of income tax regimes, in which the respective entities can reduce their income tax liability to almost NIL. This reduction of tax is possible by transferring their income to the related entities in such nations. These nations are termed as Tax Haven.
As the name suggests, Tax haven is a place with very favorable conditions for a company which provides very low or effective rates of taxation for foreign investment. Such countries also share very limited amounts of financial information with foreign tax authorities.
Income tax is the major source of income for any government. And since these so called countries are tax free, the common question which arises in every layman’s mind is “How does the government of these countries earn so that the country can sustain?” All the 30 countries which are right now, tax haven are either blessed with high amount of natural resources or they earn a lot from tourism or the other source of income is that multi-billionaires invest a lot of their money in these countries since the economy is tax free and thus, the government earns via registration fees and other such investing fees.
Another source of major income for these types of countries is that since they are providing freedom from taxation, they are also asking for a huge amount of money to become the citizens of the country. Only citizens of the country avail the benefits of a tax-free country. Eg. An investment of 5 million dirham is necessary to be made which is equivalent to 1.4 million $ to obtain a visa in UAE. In the same way, to obtain citizenship in Monaco, an investment of 1,000,000 euros which is equivalent to 1209580 $. This way the governments of tax free countries earn.
The concept of Tax Haven was introduced in the late 1920s-30s. Switzerland and few other European countries were the early adopters of this principle and classified themselves as a Tax Haven country.
Tax Haven can be classified based on the amount of tax charged by them. For detail understanding, following are the types of Tax haven:
Countries like Bermuda, Bahamas where income taxes are not charged at all. These countries are known as Pure Havens. In such countries, they may impose a small amount of charge on documentation during incorporation. These charges may include annual registration fees as well as charges on corporate shares.
Tax Haven countries where there is an agreement between more than one country to avoid double taxation implements low rate of taxation. Eg; Switzerland, Republic of Ireland
Tax payers in countries like Costa Rica, The Philippines are exempted from paying taxes for cross border transactions. For example in such a haven there is no amount of tax to be paid for exporting domestic/ local manufactured products.
A special tax haven country imposes most of the usual taxes but gives a privilege to special types of companies like shipping and movie production. They have flexibility in their corporate arrangements. This practice is followed in countries like Austria, Luxembourger and Thailand.
Ireland, Madeira in Portugal lies in the category of Tax Havens that offers exemptions to the industries that indulge in development of exports like manufacturing of pharmaceuticals and medical instruments.
Last defined category specifies Tax Haven specifies which provides benefits to financial companies or banking companies which are engaged in off-shore transactions. Jamaica is one of those countries.
How does the Tax Haven encourage foreign direct investment?
As discussed earlier Tax Havens are defined as countries with low tax jurisdictions. Low-tax jurisdictions invite multinational companies to incorporate in their nation by charging very minimal to no amount of tax as compared to the primary place of business. This way Multinational Companies follow the practice of shifting their profit known as Base Erosion and Profit Shifting (BEPS).
What are the major benefits of such tax-free countries?
As the topic suggests, the biggest advantage to any citizen of the country would be the non-payment of income tax. The basic reason why no tax is so beneficial to any individual in a developing economy as India is that if no amount of money is deducted from the total amount earned, it would increase the net income for the individual ultimately leading to more disposable income.
Tax haven protects the personal financial information of investors as well as earners, or shares only a minimal amount of information about the investors and earner.
Negotiated Tax rates, secret ruling and other administrative component are not easily accessible to anyone beyond those who may qualify to put their money into Tax Haven
It is not necessary to own a property in Tax Haven circumstances in order to park your money. You can claim tax benefits even if you don’t conduct commerce or trade from that location.
It takes about as much effort to incorporate a business in a tax haven as it does to balance your personal account in financial institutions or banks.
What are the deleterious effects on such tax-haven countries?
As we know Tax haven contributes substantially to GDP by encouraging new economic activities, but the fact is Tax Haven generates very less investment in tangible assets as the main purpose is tax avoidance which leads to lack of stability and volatile activities.
There is a lot of instability in political and economic atmosphere of Tax Haven. Government can decide to embrace exchange control as a way to control outside investment.
People would be more interested in operating domestically instead of Tax Haven as it costs more to avoid the taxes than it to pay it.
As government interference is minimal it provokes people to get involved in Money Laundry or other illegal activities.
Challenges in the way of India to become a tax haven country
Becoming a Tax haven country requires combining more favorable conditions and implementing sets of rules at a microeconomic level. Low Taxation is not enough for a country to become a "Tax Haven."
There are significant other factors that decide the "Status" of a country as a "Tax Haven." Below are the few factors that are lacking, and such factors can become challenges in India's way to become Tax haven Country.
1. India ranks quite below in “Ease of Doing Business Index”
Countries implement Tax Haven Regimes to attract a lot of foreign investments. Countries with Tax Haven regimes encourage foreign companies to invest in their countries.
Most of these countries with 'Low tax Regimes' rank higher than India in the Index of "Ease of Doing Business." To get foreign direct investments, India has to overcome the challenges that are stopping India's growth and development.
According to the World Bank’s evaluation, "Starting a Business."
"Registering for a Property" and "Paying Taxes" are significant challenges India faces.
The Indian government needs to focus on how these processes can become smooth and foreign ventures can think over-investing in Indian Markets.
2. "Virtual Residence"
The concept of "Virtual" Residence is an integral part of Tax Haven Country. If a company is registered in a Tax Haven country even though it doesn't have any activity, it’ll come not to be charged any sort of Taxation.
In India, It is essential to determine a person's resident status or a company. It is very important during the tax filing season. It decides the person or a company's tax liability.
If a company is registered in India, It'll be an Indian Resident, and it has to pay the imposed taxes.
3. Security and Secrecy
In 1934, Switzerland, implemented a law that would protect all the financial information from the authorities regarding bank accounts. There is even punishment of imprisonment if there is any disclosure of information.
To achieve a status of 'Tax Haven Country,' India would have to implement such laws to provide financial secrecy. If there is such secrecy with current taxation regimes, there could be a severe threat of "Black Money Holding”
4. A Large Population
It is not a new thing that Population is the root cause of many problems. To achieve significant growth, Population is always going to be a hindrance. In making India a "Tax Haven", the population will play a vital role and the way it is going, it is safe to assume that the population will play a vital “negative” role.
"Tax Havens" charge a significantly low rate of tax. Hence, "Tax Havens" depend upon other countries' economies. A Framework developed by Slemrod and Wilson in 2009 shows that Tax Havens are small countries and rely on foreign investments.
The study also concluded that To encourage more foreign investments, Such "Tax Havens" have to rely on other government income sources like, Imposing taxes on wage income in their model, and cutting public expenditure.
Considering such a large population of India, Imposing such norms and taxation regimes can be impactful in a very negative way, and thus, this huge Population can be a massive challenge for India to achieve the status of "Tax Haven."
5. Percentage of Service Sector in GDP
The probability variable (in becoming a Tax Haven) of a country highly depends upon the percentage of the service sector in the country's GDP. "Tax Havens" are small countries that heavily depend upon their service sector in GDP.
In countries like Switzerland, Cayman Islands, and The Bahamas, the Service sector makes up more than 72% of its GDP. What is the condition of INDIA?
What do we determine from the above article?
Tax Haven is that country that does not impose any sort of taxation. Either the tax-rate is nil, or it's the bare minimum. The Tax rate in such "Tax Havens" ranges around 0.2% to 2%. Such countries are spread across the globe.
Maximum countries in the list of Tax Haven are either small countries surrounded by ocean or countries with maximum natural resources.
The astonishing fact here is that such countries have spotlights on them regarding financial centres in the world. They have a significant amount of role in maintaining global financial stability.
Indian Economy is in the limelight as it is one of the fastest-growing Economies in the world. Being a nation of the "Youth," can India take a leap over its competitors by achieving the status of "Tax Haven?"
In this study, I have started some of the advantages and disadvantages of being a "Tax Haven" country. There are few advantages like; it attracts an enormous amount of "Foreign Investments”. Whereas there are also disadvantages like illegal activities
When Indian's skilled but cheap labor shakes hands with reforms and laws that will create a favorable environment for foreign direct investments, the Indian Economy can take a leap against its competitors.
On paper, it seems like a good step, and the Indian Economy can become a skyrocket within a quick succession but there, as the famous proverb says, "Short cuts make long delays."
Being a "Tax Haven" and luring numerous foreign investments is a different story while becoming a strong economy on its "own" is another. "Tax Havens" are not strong economies. They're just financial stabilizers for the Global Economy.
The 30 countries across the globe having the status of "Tax Havens" are small countries. The population is significantly less, and they have an abundance of natural resources. These types of countries rely on other big economies and Indian Economy is one of those.
Tax Haven countries rely on Base Erosion and Profit Shifting (BEPS) of Multinational Corporations (MNCs). Such countries work as an arena for MNCs in reducing their tax liability.
India is a strongly growing economy, and it doesn't need such practices of eroding the tax bases. Moreover, there are many other fundamental differences in Indian Economy and Tax Havens.
For Instance, Such countries have more than 75% of the Service sector in their GDP; While India has only about 52%. The service sector and population play an essential role in making a country Tax Haven.
India's Economy has a lot of potential, and it has started to show its real capability. India is standing beside some economic world leaders like the USA and China. Indian Economy will boost eventually, and India doesn't need any particular reforms specially designed to hide wealth and become an escape point for companies looking for Tax Evasion but with legal accountability.