What Is a Tax Haven?
A tax haven is a country that offers foreign businesses and individuals minimal or no tax liability for their bank deposits in a politically and economically stable environment. They have tax advantages for corporations and for the very wealthy, and obvious potential for misuse in illegal tax avoidance schemes.
Companies and wealthy individuals may use tax havens legally as a means of stashing money earned abroad while avoiding higher taxes in the U.S. and other nations.
Tax havens may also be used illegally to hide money from tax authorities at home. The tax haven can make this work by being uncooperative with foreign tax authorities. In recent times, tax havens are under increasing international political pressure to cooperate with foreign tax fraud inquiries.
Key Takeaways
- Tax havens encourage foreign depositors by offering tax advantages to corporations and the wealthy.
- Many have secrecy laws that block information on their deposits from foreign tax authorities.
- Depositing money in a tax haven is legal as long as the depositor pays the taxes required by the home jurisdiction.
Understanding Tax Havens
Broadly speaking, tax havens are jurisdictions that have low taxes and low residency requirements for foreign entities and individuals willing to park money in their financial institutions.
A combination of lax regulation and financial privacy laws enables corporations and individuals to screen some of their income from tax authorities in other nations.
The Tax Justice Network maintains a Corporate Tax Haven Index that tracks the jurisdictions that it says are "most complicit" in helping multinational corporations evade taxes. As of 2021, the worst offenders were the British Virgin Islands, the Cayman Islands, and Bermuda.
Tax havens may be found in another country or merely in a separate jurisdiction:
Intranational Tax Havens
Some U.S. states have no income tax. That simple fact makes them attractive to corporations looking to pay less overall in taxes, although it doesn't help them avoid federal taxes.
For example, in the United States, Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming require no state income tax.
Delaware is the state of choice for corporate incorporation. It does not impose a corporate tax on corporations that incorporate in Delaware but do business elsewhere.
Offshore Tax Havens
From the viewpoint of an American, "offshore" is anywhere outside U.S. jurisdiction.
Offshore tax havens benefit from the capital their countries draw into their economies. The funds flow in from individuals and businesses with accounts at banks and other financial institutions.
Individuals and corporations benefit from low or no taxes charged on income in foreign countries where loopholes, credits, or other special tax considerations may be allowed.
Characteristics of tax haven countries generally include no or low taxes, minimal reporting of information, lack of transparency obligations, lack of local presence requirements, and marketing of tax haven vehicles.
Worldwide there is not a comprehensively defined standard for the classification of a tax haven country, but several regulatory bodies monitor tax haven countries, including the Organization of Economic Cooperation and Development (OCED) and the U.S. Government Accountability Office (GAO).
U.S. Government Response to Tax Havens
The Tax Cuts and Jobs Act (TJCA), which passed in December 2017, set the effective corporate rate of U.S. taxes at 21%. It also added provisions intended to discourage foreign investments.
Systematically, the TCJA is known for being more territorial in nature than previous international tax laws. The international tax system under the TCJA exempts foreign profits from domestic taxation but has certain provisions for high-return foreign profits.
Some companies that have historically been known for offshore tax haven holdings include Apple, Microsoft, Alphabet, Cisco, and Oracle. Overall, tax havens may also offer advantages in the area of credit, since it may be less expensive for U.S.-based companies to borrow funds internationally. This type of lending, which can potentially fund acquisitions and other corporate activities, is also subject to reporting within the guidelines of U.S. tax law, generally accepted accounting principles (GAAP), and guidelines under International Financial Reporting Standards (IFRS).
Individual U.S. Taxpayers
The U.S. has special rules in place for the reporting of foreign income by U.S. citizens and non-U.S. citizens. These rules are generally governed under the Foreign Account Tax Compliance Act (FATCA).
FATCA requires the filing of a Schedule B and/or Form 8938, which provides disclosure of foreign account holdings when investments exceed $50,000. Separately, foreign account holders may also be required to file Form 114, Report of Foreign Bank and Financial Accounts.
In general, there can potentially be exemptions and foreign tax credits for investment in all types of overseas vehicles but it is important to consult a tax advisor for individual situations to ensure proper reporting.
Regulatory Oversight of Tax Havens
Tax havens create opportunities for illegal activities that go well beyond tax evasion. They are popular stops in the elaborate process of money laundering, which involves transferring illegally obtained cash through a series of shell companies until it can't be traced.
As such, there is some regulatory oversight of tax havens.
To maximize tax receipts, many foreign governments maintain relatively constant pressure on tax havens to release information regarding offshore investment accounts. However, because of the monetary burdens, regulatory oversight may not always be a top national priority.
Worldwide, some programs are in place to increase the enforcement of offshore investment reporting. The Automatic Exchange of Financial Information is one example, overseen by the Organisation for Economic Co-Operation and Development (OECD).
The program requires participating countries to automatically transmit tax-related banking information of non-citizen depositors to the countries in which they are citizens.
Sometimes it takes a crisis to force change. For example, Cyprus’s financial sector, built on the country’s tax haven status, collapsed in 2013. The European Commission, European Central Bank, and the International Monetary Fund predicated an $11.8 billion bailout on the country's agreement to comply with more robust tax participation.
What Are the Top 10 Overseas Tax Havens?
The top tax havens currently are the British Virgin Islands, Cayman Islands, Bermuda, The Netherlands, Switzerland, Luxembourg, Hong Kong, Jersey, Singapore, and the United Arab Emirates.
How Much Money Do Corporations Put in Tax Havens?
In 2022, U.S. companies shifted a collective $800 billion in profits to overseas jurisdictions, $369 billion of that to countries considered tax havens. Worldwide, multinational corporations shifted nearly a trillion dollars of profits to tax havens.
What Are the Advantages of a Tax Haven?
Corporations and wealthy individuals benefit primarily from low or no taxes on their income in foreign countries where loopholes, credits, or other special tax considerations may be lawful.
Tax havens may also offer advantages in the area of credit, since it may be less expensive for U.S.-based companies to borrow funds internationally.
Some tax havens also have strong privacy protections and share limited or no financial information with foreign tax authorities.
How Does a Nation Benefit From Being a Tax Haven?
The tax havens benefit when their financial institutions bring in a vast amount of money. That money is then invested for profit.
Plus, even the very low fees charged for offshore accounts add up nicely. According to a study by the Internal Revenue Service, U.S. households hold about $4 trillion in overseas accounts, about half of it in countries normally considered tax havens.
The Bottom Line
Tax havens are jurisdictions that attract foreign investors with comparatively low tax burdens or bank reporting requirements. These countries and territories have become attractive destinations for foreign capital. While they are not inherently illegal, a person who banks or invests in a tax haven may be violating the laws of their home country.
