Tax Havens - What are they?

Offshore tax havens are places where corporations and individuals can reduce their tax burden. This is done by parking assets, profits, or even intellectual property. These jurisdictions offer low or zero taxes, confidentiality, and limited regulatory oversight.

When discussing tax havens, most people think of the Cayman Islands, Bermuda, Luxembourg, or Switzerland. Those are tax havens, but this depends on your perspective or home country. For example, the United States would is a tax haven for a business that is operating in the UK or somewhere like France.

Today, we’ll talk about these from a U.S. perspective.

From a CFO’s standpoint tax havens are incredibly appealing. Why pay the U.S. corporate tax rate of 21% when you can park your profits in a tax haven and pay nothing? The appeal is obvious.

Just because this is legal, doesn’t mean it’s without risk though. Significantly more expertise is required if you’re going to operate in this complex game. In the world of tax havens, there’s a fine line between tax avoidance and tax evasion. And once you cross it the penalties are severe.

Tax Avoidance vs. Tax Evasion

Let’s be clear. Tax avoidance is legal, but tax evasion is not. Avoidance is legal because it involves exploiting loopholes and using strategies to cut tax burdens within the boundaries of the law. Evasion is when you outright lie, exclude income, or use fraudulent methods to avoid paying taxes. As we’ll show later, there are grey areas that come into play with offshore tax havens where it isn’t always clear what is avoidance vs. evasion.

World’s Top 10 Tax Havens

Tax havens are not just for companies. They also can offer individuals minimal or no tax liability. Good ones also provide a politically and economically stable environment.

Below are the top 10:

1. Hong Kong

2. Switzerland

3. Singapore

4. Luxembourg

5. Jersey

6. Bahrain

7. Cayman Islands

8. Panama

9. Macao

10. Isle of Man

Hong Kong tops the list with almost $3 trillion in offshore wealth. The concern is that China might tighten its controls on this special administrative region at any time. The main attraction is the banking infrastructure and its Offshore Profit Tax Claim allows offshore owners to pay 0% tax on income outside its borders.

Each of these countries has its pros and cons. Depending on your type of business and where you operate, any of these might be worth considering. There are quite a few others not on this list though that should also be considered.

Some Strategies and Methods

There are an almost endless number of strategies for a company to use in various tax havens. Changes in the laws create new areas for exploitation.

Any CFO who is exploring this will want to work with a reputable tax attorney. We’d say you’ll want two types of attorneys involved.

Your corporate attorneys that are familiar with your structure and operations. And international/local tax attorneys in the domain you are looking at. This isn’t an area to be cheap. Great legal advice can save you millions and keep you out of jail.

Here are some strategies that have been widely used.

The Double Irish with a Dutch Sandwich

The Double Irish with a Dutch Sandwich is probably something you heard about in business school or if you follow financial news. It’s infamous among tech giants like Google and Facebook. At least until regulators began cracking down. Although no longer a valid strategy, it was once one of the craftiest methods to funnel profits through offshore tax havens.

Here’s how it worked:

1. A U.S. based company sets up two Irish subsidiaries.

2. The 1st subsidiary owns the company’s IP (intellectual property).

3. The 2nd subsidiary operates as the company’s sales hub.

4. The 1st subsidiary licenses the IP to the 2nd subsidiary, which creates huge tax deductions in Ireland.

5. Shuffle the profits through the Dutch since there are favorable tax treaties between the Netherlands and Ireland.

6. Transfer the funds to a tax haven such as Bermuda where the tax rate is zero.

By following this strategy companies were able to park billions of almost tax-free profits in various tax havens…and it was completely legal.

That is until regulators decided to start clamping down. They eventually came up with some initiatives such as the Base Erosion and Profit Shifting reforms that were implemented to close this loophole.

Transfer Pricing

Another technique CFOs use involves the strategic setting of the price of goods and services sold between subsidiaries.

Suppose a U.S. subsidiary buys consulting services from a Cayman Islands subsidiary. The price at which they “sell” the service can be what they want within certain parameters. That price directly dictates how much profit is shown in each subsidiary.

When CFOs do this aggressively it could cross into potentially illegal territory. It all depends on the actual market rate of those services and how well they’ve documented and supported that pricing with market research.

We once worked with a multinational corporation whose CFO was a master of this game. Using various transfer pricing strategies, he moved profits from high-tax countries to tax havens. This trimmed millions off the company's tax bill. But regulators started noticing. And soon the company was facing an IRS audit.

He then had to make a choice. Unwind the aggressive pricing or face potential legal battles and fines.

He chose the latter option after consulting with the legal team. They thought it would hold up under scrutiny.

Unfortunately, it didn’t, and the company was hit with back taxes and penalties. Even though he had worked with lawyers to confirm the strategy, he was quietly asked to resign. It was a lesson learned the hard way—just because a strategy is legal doesn’t mean it’s bulletproof.

Why Perception Might be as Dangerous as Regulation

In the world of offshore tax havens, the legal risks are one thing. But there’s another dangerous aspect that CFOs need to keep in mind and that is public perception.

For a cautionary tale, look no further than the Panama Papers. In 2016, over 11 million documents were leaked from a Panamanian law firm called Mossack Fonseca. These papers revealed the financial secrets of many world leaders, celebrities, and corporations.

They also showed that many were using offshore havens to hide money and avoid taxes.

In the end, most of the actions exposed by the leak were legal, but the public didn’t care. The ethical questions and reputational damage that followed were enormous. The loopholes might have been legal, but the court of public opinion wasn’t as forgiving.

For us, we’d look at this two different ways depending on if you work for a publicly traded company or a private company.

If you work for a public company, then consider this. Your company legally avoids millions in taxes by funneling profits through the British Virgin Islands. You save money, your shareholders are happy, and you earn fat bonuses. But then the media gets wind of it and suddenly, you're the face of corporate greed. The stock price dips and even though you didn’t break the law, the board decides they need someone to throw under the bus to relieve the pressure. That person is going to be you.

If you’re with a private company though, the public perception is often not as big an issue. For one thing, you aren’t a target by the media because random company XYZ doesn’t usually generate any public interest. Also, the amount of investigative work it takes for the media to out you isn’t worth it.

They want the name brand company or celebrity for their article. The tax savings are still more valuable to this company and so they will congratulate the CFO for a job well done.

As a CFO, it’s not only about playing the game well. It’s about knowing when to walk away when you can't win the game.

Conclusion

Using offshore tax havens can be an important tool in a CFOs toolbox. But they come with some serious risks. Here are some things to keep in mind:

1. Don’t be Greedy - It’s easy to get seduced by the idea of paying 0% tax on millions of dollars, but the more aggressive your strategy, the greater the risk. Weigh the short-term financial benefits against the long-term risks, both legal and reputational.

2. Know the regulations - the global tax environment is changing fast and what’s legal today might be illegal tomorrow. Expert legal advice is mandatory.

Next Week

Stay tuned for our article next week about how CFOs can use AI to make themselves more efficient, learn complicated subjects on the fly, and raise the performance level of their companies.