It cannot be emphasised too strongly that tax haven problems cannot be divorced from the taxation of international transactions in general, or from non-tax policy concerns. It is important to understand the conflicts that arise from these often contradictory policies.
Stated tax policy in the major developed nations is decidedly against tax haven use. However, that policy becomes ambivalent in practice. It reflects an unresolved conflict between the following policy objectives:
- Maintaining the competitive position of the developed country's overseas business investment and export;
- Maintaining tax equity between investment in the developed country and investment abroad;
- The need for fairness in taxing foreign investment;
- Administrative efficiency;
- Foreign policy considerations, and;
- The promotion of investment in the developed country.
The results are policy ambiguities and compromises in legislation that have failed to resolve these conflicts and have left tax law unclear with respect to tax havens. Concern for administrative feasibility has been practically non-existent in the case of US policy. Nowhere is this tension more apparent than when focused on tax haven policy. Nowhere is the failure to resolve the policy issues more obvious. Over the years, Congress has maintained the deferral of taxes on the earnings of foreign corporations controlled by US persons. At the same time, it passed numerous anti-avoidance provisions generally intended to solve perceived tax haven related problems. All have had numerous exceptions, have been complex and difficult to administer, and have had gaps (many intended, some not).
Without the anti-avoidance provisions in the law, corporations can easily be manipulated by shareholders engaged in foreign transactions. Take the simplest case: A person can, in a transaction that qualifies for non-recognition treatment, transfer income-producing assets (such as stock or bonds) to a foreign corporation organised in a zero-tax jurisdiction. The income earned by the foreign corporation is not taxed by the developed country or by the zero-tax jurisdiction. The assets remain under the control of the high-tax nation's resident but the income is not taxed until repatriated. The shareholder would be taxed on the sale of the stock but at favourable capital gains rates.
If the shareholder holds the stock until he dies, it is subject to estate tax but passes to his tiers free of income tax at its value as of the date of his death. His heirs could then liquidate the foreign corporation free of income tax, (because of the step-up in basis by reason of the shareholder's death), and return the property to the developed country to start again, or they could maintain their ownership in the foreign corporation and shelter the income.
Another manipulation could occur if a parent corporation selling goods overseas forms a foreign corporation in a tax haven to make those sales. The parent then sells the goods to the subsidiary at a small or zero profit and the subsidiary sells them to the ultimate customer at a substantial mark-up. The profit on the sale isn't taxed by the developed country and can accumulate free of tax in the tax haven.
In order to curtail so-called abuses, most developed countries have adjusted their systems of taxation and the non-recognition provisions of their laws. Because of those anti-abuse provisions, the simple manipulations described above are not possible under the law. Variations of these techniques, however, do form the basis of international tax planning.
This document was excerpted, modified & otherwise prepared by the 'Lectric Law Library ('LLL) from materials supplied by Baltic Banking Group - www.BalticBankingGroup.com Copyright 1998 - 2002 'LLL & BBG, all rights reserved.