According to Merriam-Webster, the word “haven” is defined as:
- A harbor, or port
- A place of safety
- A place offering favorable conditions or opportunities
If you add “tax” in front of “haven,” you get another definition. Specifically, a tax haven is defined as an offshore country that allows high net-worth individuals and business owners to place their funds and assets with that country’s local institutions. The appeal of such countries is that they offer low or no taxes and are relatively easy to set up.
The goal of a tax haven? To avoid paying home country taxes on profits of any kind. This means that wealthy individuals and corporations end up paying less in taxes. Furthermore, many tax havens have an opaque reporting structure, meaning it’s uncertain how much money might be flowing through various banks, institutions, and coffers.
How a Tax Haven Operates
One of the more infamous examples of how tax havens operate was uncovered with the revelation of the Panama Papers. In 2016, an anonymous source leaked 11.5 million files from Mossack Fonseca, an offshore law firm. The documents outlined how the wealthy made use of opaque offshore tax regimes and havens.
Five years later (and a few more leaks from the International Consortium of Investigative Journalists), tax havens still exist. It’s relatively simple to open one. All that is needed is a shell company, or a legal entity, created in a tax haven. Shell companies, or offshore companies, only exist on paper, have no full-time employees, and no offices.
Where Tax Havens Are Located
Many tax havens are located “off shore.” The Corporate Tax Haven Index listed the following top-ranked tax havens in 2021:
- British Virgin Islands
- Cayman Islands
- Bermuda
- Netherlands
- Switzerland
- Luxembourg
- Hong Kong
- Jersey (in the Channel Islands)
- Singapore
- United Arab Emirates
While tax havens are considered offshore, here in the United States, Delaware is considered a domestic tax haven. This is because the state doesn’t tax “intangible assets,” which encourages wealthy individuals and corporations to relocate parts of their business to Delaware. This, in turn, helps them avoid taxes in other states.
Are Tax Havens Bad?
This is a difficult question to answer. On the one hand, funneling dollars to locations that require fewer, or no, taxes can decrease tax revenues in home countries. A decrease in revenue can be problematic for the home country.
However, academic research indicated that high-tax jurisdictions could indirectly benefit from tax havens.
For example, Juan Carlos Suárez Serrato’s 2019 paper, “Unintended Consequences of Eliminating Tax Havens” points out that limited profit shifting by U.S. multinationals tends to reduce investment and domestic employment.
Serrato, Duke University Associate Professor of Economics and Faculty Associate with the National Bureau of Economic Research, based his research on the repeal of Section §936, which eliminated Puerto Rico as a tax haven. The elimination spelled trouble for the Puerto Rican economy. Additionally, Serrato also noted that businesses impacted by the repeal reduced U.S. investment by 38% and employment by one million jobs.
To conclude, tax havens aren’t inherently “bad” or “good.” When handled correctly, these havens can be a method to reduce certain taxes on profits and capital gains.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor.
