Where are the tax havens?
What is a Tax Haven?
A tax haven is simply a country that allows you to reduce the amount of tax you pay.
This is a tax haven at its most basic and, although pretty obvious, it's worth bearing in mind what their purpose is without getting bogged down in the details. Let's state at the beginning that there is nothing wrong with using tax havens provided you are careful not to break any rules in your country of residence.
Many people use tax havens to hide their money from the tax authorities in their home countries. This is not only illegal, it's foolish because one day you probably will get caught and could end up with substantial fines or even a jail sentence.
However, if you have the legal right to use a tax haven you would be foolish not to take advantage of all the opportunities you can to maximise your wealth.
There are three main types of tax haven:
• Nil-tax havens
• Foreign source exempt havens
• Low-tax havens
Nil-Tax Havens
These are simply countries that do not have any of the three main direct taxes:
• No income tax or corporation tax
• No capital gains tax, and
• No inheritance tax
Many of the nil tax havens you've probably heard of or read about in novels. You may even have holidayed in some of them. They include:
• The Cayman Islands
• St Kitts and Nevis
• Dubai
• Monaco
• The Bahamas
• Bermuda
• Vanuatu
• The Turks & Caicos Islands
• Anguilla
Although there are no taxes in these jurisdictions, the tax haven governments still need to generate some revenue to provide public services. They may therefore impose small fees for company incorporation documents or annual registration fees for companies. However, these charges are fixed and usually small. If you're looking at living in one of these jurisdictions, most of these charges won't apply and you may able to live with little state involvement in your affairs. The only tax charges that would then affect you would be import duties or local sales taxes.
Foreign Source Exempt Havens
These countries do levy taxes and sometimes they can be pretty high. However, what makes them tax havens is the fact they only tax you on locally derived income.
In other words, if all your income is derived outside the tax haven you will not pay any tax. Good examples of foreign source exempt tax havens are:
• Panama
• Costa Rica
• Hong Kong
• Seychelles
• Singapore
This type of tax haven exempts from tax any income earned from foreign sources, provided (and this is crucial) the foreign income source does not involve any local business activity.
For example, you couldn't set up a consultancy business that was run from Panama and claim that the income generated shouldn't be subject to tax there.
Some of the other tax havens don't even allow a company to conduct business internally if any tax advantages are to be claimed.
Jurisdictions such as Panama and Gibraltar would require a company to decide at the time of incorporation whether it was allowed to do local business (and therefore taxed on its worldwide profits), or only foreign business and therefore free from taxation.
Low-Tax Havens
The final group of tax havens are countries that do have a system of taxation and impose taxes on residents' worldwide income. You may be wondering why these are still classed as tax havens. There are two main reasons:
• Some countries may have special concessions that offer considerable tax advantages in special situations (such as for capital gains tax avoidance).
• Clever use of double tax treaties that countries enter into with each other may allow you to lower your tax bill.
The problem with the well-known nil-tax havens is most developed countries do not have treaties with them. When planning your tax affairs it may be more tax efficient to use a low-tax haven, combined with a double tax treaty, than simply rely on a nil-tax haven.
Example
Let's say you own shares in a company listed on the New York Stock Exchange. For commercial reasons (in other words, non-tax reasons) you want to set up a holding company to own the shares. You could use one of the traditional tax havens such as the Bahamas or the Cayman Islands. The problem with using these countries is that US withholding tax will be deducted from dividends at rates of up to 30%.
However, if you use one of the recognised holding company jurisdictions, such as Belgium or Denmark, there may be very little tax deducted in the US. Good examples of low-tax havens are:
• Cyprus
• The United Kingdom
• Barbados
• Switzerland
• Denmark
• Belgium
• The Netherlands
• Austria
Other Important Factors to Consider
When looking at tax havens, although the amount of tax they levy is obviously crucial, this is not the only important factor.
You wouldn't, for example, want to invest your cash in an offshore account in a politically unstable country, particularly if there is a risk that your assets could be expropriated.
Therefore tax planning is only one consideration. Other important factors include:
• Privacy. What level of disclosure is there. Will your financial affairs be kept private from prying eyes?
• Ease of residence. How easy is it to obtain permission to live in the tax haven?
• Political stability. Is there a risk your cash could end up in the government's coffers?
• Communications. How good is telephone and broadband internet access and how easy is it to travel to the country?
• Lifestyle factors. If you want to live there, how good is schooling, the climate, and how high is the cost of living?
It's therefore a question of what you want from your tax haven: are you only concerned with the tax position or are other factors equally important?
I mention some of these other factors elsewhere in the book, although obviously many of these are subjective and would therefore need to be addressed by you personally. We'll therefore mainly be focusing on the tax issues.
How Tax Havens Can Help You
In this section we'll take a brief look at how tax havens can be used to cut your tax bill. The chapters that follow contain much more detailed information but I think it's worth explaining some of the tax planning techniques briefly before we look at some of the individual tax havens.
Most countries will tax you in one of three different ways, based on:
• The source of your income or capital gains. If your income is derived locally the local tax authorities will tax you on it.
• Your country of residence. If you are resident in a country, that country may have the right to tax you on your worldwide income or gains. The United Kingdom does this.
• Your country of nationality. This is rare, but is very important if it applies. Some countries such as the United States tax you if you are a national or citizen. Even if you leave the country you will still have to pay tax.
Most developed countries apply the first two rules, although the US applies all three in certain situations. It's easy to see how two countries could easily decide to tax the same income.
Example
Steve, a UK resident, has an offshore bank account in Spain. As a resident of the UK he will be liable to UK tax on his worldwide income, including his Spanish interest.
However as the interest has a Spanish source, Spain will also want to tax it. In this case the double tax treaty between the two countries would come to the rescue. Any Spanish tax paid would be allowed as a credit against Steve's UK tax liability. What if Steve used a bank in a nil-tax haven such as the Bahamas or the Cayman Islands?
In this case there would be no overseas tax as these countries do not levy tax. However, there would still be UK taxes to pay because individuals who are UK resident and domiciled are subject to UK tax on their worldwide income.
This is crucial to understand because it dispels the myth that tax havens can be used to automatically escape taxes. Unless you are careful how you use them you will not enjoy any tax savings.
Some books hint at keeping your income private and therefore hint at tax evasion. In many countries this is the fastest way to land in jail (or at the very least end up paying substantial penalties) and I would never advise this.
You should always disclose as much information as the tax authorities in your home country require.
Every country has different disclosure requirements. For example, the US requires separate disclosure of foreign bank accounts of which you are a signatory. Other countries such as the UK do not.
It's the secrecy that European and North American tax departments don't like and this has led to growth in tax information agreements between countries and, for example, the advent of the EU Savings Tax Directive and the proposals at the April 2009 G20 summit to crack down on tax havens -- we'll look at these in more detail shortly.
In terms of the EU Savings Tax Directive this is an agreement between members of the EU (and various overseas dependencies) to automatically share information with each other about customers who earn savings income in one country but live in another.
Provided you stick to these simple rules you should be able to sleep peacefully at night. And that's far more important than escaping tax!
Tax havens are useful in lots of different ways, including:
Emigration
If you fancy living abroad, one option is to live in a tax haven. Fortunately many tax havens have extremely high living standards and are beautiful places to stay. If you choose the country wisely, you may be able to completely avoid income tax and other taxes.
Emigrating to one of the nil-tax havens such as the Bahamas, St Kitts and Nevis, the Cayman Islands or the British Virgin Islands would be ideal for this purpose. US citizens cannot do this, however, because they are subject to US tax wherever they live (although there are limited tax exemptions for US citizens living abroad that can exempt the first $95,100 of earned income).
Another option may be to establish yourself in one of the foreign source exempt havens and put your money in an offshore bank account. In this way you will also not pay one penny in tax.
Finally, you could go and live in a low-tax haven if it offers concessions that suit your particular circumstances. For example, you could go and live in South Africa or New Zealand if you have a big property investment portfolio and want to escape or reduce capital gains tax.
Diverting Profits
Tax havens are often used to divert profits from a country with high tax rates to a country with low tax rates. They're also used to divert interest, royalties and management charges.
Unfortunately this is not very easy to do in practice -- the country where the income is sourced is likely to have rules preventing you from doing this. However, it is possible in certain circumstances.
Example
Patrick owns a company called Compco that manufactures and sells computers. His company is located in a country with a corporation tax of 30%. Patrick decides to become non-resident and live in a tax haven, while still doing work for the company. The advantage is that there will be no income tax to pay in the tax haven. Furthermore, provided the cost of his services is set at a reasonable commercial rate, Compco may be allowed a tax deduction for the full amount paid to Patrick. This means there will be no corporation tax on the money paid to Patrick.
Diverting income from a high-tax country to a low-tax country is one of the key benefits of using offshore tax havens.
Double Tax Treaty (DTT) Manipulation
As mentioned earlier, low-tax havens are often used to take advantage of double tax treaties. Using double tax treaties to avoid taxes can result in big savings and this makes some of the low tax destinations that have lots of double tax treaties very popular.
Example
Pedro conducts business in the United States but through an offshore company located in Cyprus.
Provided Pedro does not actually have a fixed place of business in the United States or act via an agent (the treaty defines this as having a 'permanent establishment' in the US -- more on this later in the book!) the income from the business will pass to that company with little or no US tax being paid because of the tax treaty between the two countries, provided the Cyprus company is a resident of Cyprus.
If income is paid to a person or company in a jurisdiction with no tax treaty with the US, the profits will be subject to US tax, at a rate as high as 35%.
Now that the money is sitting in the Cyprus company, it could be extracted free of Cypriot taxes to a non-resident.
This example illustrates how complex offshore tax planning with tax havens can be. Everyone's situation is different, hence the need for professional advice.
Capital Gains Tax (CGT) Planning
In recent years many individuals have moved abroad to escape capital gains tax. Most are property investors who have made huge profits during the global real estate boom of recent years.
If they sold their properties without moving they'd see a large chunk of their profits going to the taxman in their country of residence or the country where the property is located.
Avoiding a big tax bill is particularly important where properties have been heavily remortgaged to enable the investor to withdraw the equity (paper profits).
Investors with large debts over some properties may actually end up with insufficient cash to cover their capital gains tax bills. Therefore they look for any opportunity, including moving overseas, to escape paying tax.
Tax havens are also used to escape CGT by entrepreneurs who've had enough of the rat race and want to sell their companies.
Using offshore company arrangements or emigrating to countries that don't charge CGT on overseas disposals can drastically reduce the tax liability.
Example
Tony, a UK resident, has a big property portfolio with profits in excess of £1 million.
He wants to sell the properties and minimize the tax payable by moving offshore.
The UK doesn't usually impose capital gains tax on non-residents (unless they're conducting a trade from the UK) and Tony therefore decides to move to the Bahamas, sell his property portfolio and avoid paying UK capital gains tax.
The downside to this is that he would need to stay overseas for five complete UK tax years to avoid the gains being taxed if he returns. Five years is too long for many people. It used to be possible to get around this by emigrating to a country with a suitable tax treaty with the UK (Greece was one such country).
Unfortunately the UK closed this loophole in the 2004 Pre Budget Report and UK emigrants are therefore usually tied in to a five year absence.
(Having said that, they could still spend a couple of months per tax year in the UK without bringing the gain back within the scope of UK taxes. The key issue here is showing that they have established their new life and home overseas.)
Inheritance Tax (IHT) Planning
If there's one tax people resent above all others it's inheritance tax. In the UK the rate of inheritance tax is 40%. Paying 40% tax on your assets is much worse than paying 40% tax on your profits. Furthermore, your assets will, for the most part, have been built up out of after-tax income -- meaning that they are effectively taxed twice.
The good news is there are ways that tax havens can help you reduce your inheritance tax bill. By transferring some of your wealth into an offshore trust or company you can escape the tax in certain circumstances because the trust/company becomes the new owner of the assets. Your estate will then have fewer assets to tax.
Many countries don't subject offshore trusts and companies to IHT and, if they do, it's usually an amended form of tax. Hence the correct use of offshore entities can maximize your wealth and minimize your taxes.
Once again it's important to stress that offshore tax planning is a complicated area and you should always obtain detailed professional advice from a qualified tax adviser in your country of residence. In particular, there will probably be anti-avoidance rules (most high-tax countries have them) that may apply and careful 'navigation' in these circumstances is essential.
Asset Protection
Tax havens aren't just used by people who want to pay less tax. They're also very important for the purposes of asset protection. You'll notice that the subtitle of this book says 'Safeguard Your Financial Freedom'.
We're not referring to saving tax here but to the importance of protecting your wealth from anyone else who may try to get their hands on it.
In recent years the UK has gone much the same way as the US and become litigation crazy.
Doctors and other professionals feel extremely vulnerable but anyone could fall victim to a frivolous lawsuit.
Others who may try to target you include ex-employees, spouses or business partners, fraudsters and other crooks, disgruntled family members or clients, ambulance-chasing lawyers and virtually anyone who knows you have money and thinks you are easy prey.
The idea of asset protection is to make your assets extremely difficult to trace and, if they are traced, extremely difficult to get hold of. For example, many tax havens have strict banking secrecy laws and as long as you are not involved in any criminal activity or money laundering your details will not be made available to third parties.
There are, of course, things you can do in your home country to protect your wealth, for example setting up a limited company or limited liability partnership.
However, many argue that nothing quite beats the privacy of setting up an offshore structure, especially if you choose a tax haven with strong privacy laws. Your creditors first have to find your offshore company, trust or bank account before they can get their hands on your money!
It's important to bear this point in mind as you read the book. You may not be able to use a tax haven to legally avoid tax... but you may be able to use one to protect your money from everyone else.
Forum Shopping
English courts have become known as a 'wives' paradise' as they favour the less wealthy spouse (still typically the wife), and it's not just wealth acquired during marriage that's at stake. English courts can also take into account wealth a spouse brought into the marriage as well as inheritances.
This is one of the reasons why 'forum shopping' is becoming so popular. Essentially it involves starting divorce proceedings in an overseas country so that the divorce is based on overseas laws. As other countries take a different view on the treatment of pre-nuptial agreements or on assets that were inherited by one of the spouses, it can lead to a reduction in the settlement.
The other reason why forum shopping is becoming important is that more and more people are marrying overseas residents or living overseas.
The G20 Crackdown on 'Tax Havens'
The G20 summit in April 2009 resulted in a number of agreements and commitments to clamp down on cross-border tax evasion. In the press it was widely reported that one of the key proposals was a clamp down on using tax havens.
This, however, does not paint the full picture. The actual report stated:
"...We call on countries to adopt the international standard for information exchange endorsed by the G20 in 2004 and reflected in the UN Model Tax Convention. We note that the OECD has today published a list of countries assessed by the Global Forum against the international standard for exchange of information.
We welcome the new commitments made by a number of jurisdictions and encourage them to proceed swiftly with implementation.
We stand ready to take agreed action against those jurisdictions which do not meet international standards in relation to tax transparency. To this end we have agreed to develop a toolbox of effective counter measures for countries to consider, such as:
• increased disclosure requirements on the part of taxpayers and financial institutions to report transactions involving non-cooperative jurisdictions;
• withholding taxes in respect of a wide variety of payments;
• denying deductions in respect of expense payments to payees resident in a non cooperative jurisdiction;
• reviewing tax treaty policy;
• asking international institutions and regional development banks to review their investment policies; and,
• giving extra weight to the principles of tax transparency and information exchange when designing bilateral aid programs..."
What was agreed at the G20 summit is, therefore, closely tied in with the OECD Exchange of Information Treaty. The issue clearly isn't whether a country is a nil or low-tax regime -- it's more an issue concerning the disclosure and exchange of information provisions countries adopt.
The OECD report referred to in the G20 proposals can be found here:
www.oecd.org/dataoecd/38/14/42497950.pdf
Essentially this report is split into three parts:
• The first list contains jurisdictions which are deemed to have 'substantially implemented' the agreed tax cooperation standard (known as the 'white list').
• The second contains the names of jurisdictions which have committed to, but have not yet implemented the standard (known as the 'grey list').
• The last list names those jurisdictions which have not committed to the standard (known as the 'black list').
Only four jurisdictions were on the 'black list' (Costa Rica, Labuan, the Philippines and Uruguay). However, since the publication of the report in 2009, these countries have all agreed to implement the proposals and are all on the 'white list'. Since the London G20 meeting in April 2009 there has been a flurry of activity with numerous new tax information exchange agreements and double taxation conventions.
Most of the countries on the 'grey list' in 2009 (such as the Bahamas, Gibraltar and the Cayman Islands) have now moved up to the 'white list'.
The countries on the 'grey list' as of May 2012 are:
• Guatemala
• Nauru
This treaty requires exchange of information on request between the signatory countries. Any provisions on banking secrecy can be overridden and the country providing the information doesn't have to require the information for its own tax purposes.
It's important, however, to remember exactly what the G20 and the OECD are trying to achieve. There's nothing in all this that attempts to prevent you using a low or nil tax haven to reduce your taxes.
In fact, many of the larger developed countries that belong to the OECD and G20 themselves have tax regimes that can be used to achieve low or zero taxes. For example, in the US you have the Delaware LLC, in the UK there are special rules for non-domiciled individuals, and Spain has favourable rules for holding companies.
It's the secrecy that the OECD and G20 countries don't like and as such they're trying to ensure that there is good exchange of information between jurisdictions. It's true to a certain extent that this will affect the 'tax havens' more than other countries as they have traditionally been more reluctant to pass on information than many of the 'higher-tax' jurisdictions. It's worthwhile bearing in mind, however, that if you were looking at using tax havens to avoid disclosing your overseas income or assets to the tax authorities in your home country, you were on very shaky ground anyway.
You should always ensure that you declare overseas income and gains to the tax authorities in your country of residence. Provided you do this, the G20 clamp down will have little impact on you.
So Who Does the Clamp Down Affect?
Anyone who holds assets or generates income in an overseas jurisdiction will potentially be affected. For example:
• Anyone with an offshore savings account
• Anyone with an offshore company
• Anyone who can benefit from an offshore trust or foundation
The G20 changes will ensure that the authorities in your home country can be passed details such as:
• Overseas account balances
• Interest earned
• Income sources and where they're generated
• Details of signatories on offshore accounts
• Company shareholders
• Beneficiaries of offshore trusts/foundations
• Settlors of offshore trusts/jurisdictions
• Company income and gains
• Trust income and gains
So long as you have accounted for these in accordance with the tax rules in your country of residence you should be OK.
Here are two examples where the G20 changes will have no impact at all:
Example 1
Jack is a UK resident and holds an interest in an offshore 'tax haven' company. The company is controlled from overseas and generates all of its income overseas. Jack isn't caught by the anti-avoidance rules because, in this case, there is no tax avoidance motive for the use of the company. In addition he has always declared this position in his self assessment tax returns. Jack is not taxed on any of the profits of the offshore company.
Example 2
Pedro is a non UK domiciliary who has been in the UK for five years. He has earned interest on an offshore savings account (located in a tax haven) and has retained the interest abroad. He has not declared the offshore interest but has declared his non UK domiciled status and now claims the remittance basis.
Because both individuals have fully complied with their UK tax obligations there will be no negative impact even if the overseas jurisdiction passes on details to the UK tax authorities.
Privacy Shopping
It's likely that most countries will implement exchange of information treaties in accordance with the OECD's recommendations. This appears to be high up on the political agenda and it's unlikely that it will lose momentum over the next year or two.
To satisfy OECD requirements (in other words to get onto the white list) a country needs to implement 12 exchange of information treaties. In Britain, the Prime Minister has however already stated that he expects British dependencies to exceed the OECD's minimum requirements.
Nevertheless, there could still be opportunities for 'privacy shopping', to avoid exchange of information requirements by choosing countries which don't have reciprocal exchange of information treaties. As stated above, however, if you are disclosing what is required this should not be necessary. In summary, the main aim of the G20 and OECD proposals is to ensure that information is disclosed between countries. Providing you declare your overseas income and gains in accordance with the tax regime in your country of residence, these proposals should have limited impact.
They also do not prevent you from emigrating and establishing residence yourself in a low or nil tax haven.
With the UK Government getting tough on offshore evasion, as from April 2011 there will be a new penalty regime where there is a loss of tax connected with offshore activities.
The penalty regime is widely drawn up to include any loss of tax relating to income tax and capital gains tax, and is obviously aimed at UK residents avoiding UK tax by keeping quiet about overseas income or capital gains.
As from April 2011, the penalty regime has been modified so that penalties will be increased by a factor of 1.5 if the tax loss is connected to a jurisdiction which does not exchange information with the UK automatically (as opposed to on request) and by a factor of 2 where there is no exchange of information whatsoever.
So if there is an income tax or CGT loss from a country with which the UK does not have any exchange of information treaty the penalty will be doubled.
If there is an exchange of information treaty but it only applies to specific requests by HMRC you're looking at a penalty of 150%.
This shows the problems HMRC has in identifying taxpayers with untaxed overseas assets or income in countries where there is no automatic exchange of information.
These are, of course, maximum penalties, and can be reduced if an individual makes a prompted or unprompted disclosure.
HMRC has published a list of the countries in Category 1 and Category 3. It has not published Category 2, but says that those countries not in Category 1 or 3 will fall into Category 2. Category 1 consists mainly of countries with automatic exchange of information with the UK. These include the Cayman Islands, Guernsey and the Isle of Man. It also includes all the EU countries, except Austria and Luxembourg.
Category 2 includes countries that exchange information with the UK on request. This includes many offshore jurisdictions.
Category 3 is mainly the territories that do not exchange information with the UK. These are listed and include Belize, Monaco and Panama.
About the Author
The Author of this article is our site Editor, Lee Hadnum. Lee is a rarity among tax advisers having both legal and chartered accountant qualifications. After qualifying a prize winner in the Institute of Chartered Accountants exams, he also went on to become a chartered tax adviser (CTA).
He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.
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