Targeting tax havens

For global companies who use tax havens to route investments, the era of a tax-free ride may soon be over. Tax havens mostly cater to two kinds of clients: Businesses, who set up subsidiaries in order to legally benefit from a tax-free status; and individuals, who illegally stash cash here in order to evade taxes in their home countries.

The assault on tax havens is two-pronged: First, the Organisation for Economic Cooperation and Development (OECD), hell-bent on eliminating fraud and enhancing banking transparency, has begun to slot countries into ‘black,’ ‘grey’ or ‘white’ categories based on how clean and open their banking systems are. Even Switzerland—legendary for its elite banks that kept mum about client identities even if they happened to be wealthy ex-Nazis—has been forced to play ball.

The US President Barack Obama—faced with decreasing tax revenues during a severe recession—has also begun to push for legislation that will prevent American firms from using offshore havens. On May 5th, Obama referred to one building in the Cayman Islands that housed more than 18,000 companies as either the largest building in the world or the world’s largest tax scam. Obama’s initiatives are hardly surprising.

Tax havens like Mauritius—with which India has a tax treaty—or Bermuda, shield a staggering $225 billion in unpaid taxes a year, according to Girish Vanvari, Executive Director at KPMG for M&A Tax. The US alone loses $60 billion a year. By contrast, India loses a paltry $500 million to $1.5 billion, mainly due to individuals trying to dodge taxes at home. Still, in an effort to gain pre-election currency amongst voters, parties like the BJP have clamoured for foreign banks to reveal the identities of Indian tax dodgers.

Top destinations for outgoing investments Switzerland Why: High tech hub The Netherlands Why: Pharma hub/ European gateway UAE Why: Oil industry hub/ zero tax Singapore Why: Easy to set up base Ireland Why: Entry to Europe/ low tax

So, will these European and American initiatives throttle investment flows into India? “Not likely,” says Vaibhav Manek, Partner at tax and audit firm KNAV. Reason is, countries like Mauritius and Cyprus—which cater to routing investments into India—have amended their secrecy laws and graduated to the OECD ‘white’ list.

In the long run, however, Manek says that companies may find that investing directly in a country makes more sense for them. Overseas tax havens simply pile on administrative, legal and transaction costs. Plus, “FDI flows into India improved when we withdrew the tax on short- term capital gains and introduced just the securities transaction tax,” says N.C. Hegde, Partner at Deloitte India.

At the end of the day, all this hand-wringing about tax havens could simply be irrelevant for a country like India. “Tax havens or no-tax havens, global companies will have to invest in India for growth,” says Hegde. What is important, however, is for India to remain competitive with other growth destinations, he adds. This means sensible investment policies that render tax havens ultimately irrelevant.

You can’t move my Swiss cheese The attraction of Switzerland is more than just its banking secrecy laws. The ease of doing business in this country and the moderate tax rates are major draws. Anyone who wants to set up a company, with adequate preparation, can actually fly in, get all the permissions, lease an office, set up a bank account, appoint a local CEO and fly out the same evening. They even get the benefit of a singlewindow transaction with a professional escort firm assisting at every step. The country now allows a peek into bank accounts only if there is an official request through government channels—but there has to be proof of money laundering or tax evasion in the hands of the authorities for the account holder.