Panama Papers: Tax Havens Should Not Be Banned

Panama Papers Scandal
View of buildings in the financial center of Panama City, April 4, 2016. The fallout of the data leak from the law firm Mossack Fonesca has now resulted in the U.S. launching an investigation into tax avoidance. RODRIGO ARANGUA/AFP/Getty Images

The revelations of what looks like massive tax evasion and money laundering, from the hacked Panamanian law firm, Mossack Fonseca's computer, with links to many other tax havens, have once again called into question the justification for the existence of these offshore finance centres, that often also act as tax havens with low or zero tax rates.

A number of countries have signed up to greater information exchange and transparency and appear on lists compiled by global watchdogs and pressure groups that indicate how far they are meeting these requirements. A new OECD rule book for international taxation laws might add more scrutiny. It wants to reduce what it terms "base erosion and profit shifting" which involves moving business into other lower tax territories and hence saving on the tax a firm pays. Such tax avoidance is calculated by the OECD to cost some 4 to 10 percent of global tax each year. Individuals keeping their money offshore in trusts or filtering money out of the country, in a way which takes advantage of bank secrecy, all add to this loss of tax revenues.

This is a real problem for the country that loses potential tax revenue. But there is nothing illegal in tax avoidance per se—as distinct from tax evasion. The tax havens involved could argue that the problem lies with high rates of tax elsewhere which encourage firms to legitimately seek out lower tax jurisdictions. And if they keep a greater share of profits they can reinvest them and hire more people in the countries where they operate—who in turn pay taxes, national insurance contributions and VAT on the goods and services they consume.

Tax havens and offshore finance centres, by providing the ability for firms to be set up and/or hold assets in a jurisdiction other than the ones they operate in, offer security against volatile regimes. They also enable companies and individuals to have access to British or other laws operating in offshore finance centres such as Cyprus and the British Virgin Islands that could shield them from volatile regimes back home. They allow territories with little other industry to become reasonably wealthy and also use those revenues to diversify and develop.

The existence of these havens has encouraged a rethink on tax which has resulted in many developed countries, such as arguably the U.K., reducing their own corporate tax rates while closing many of their tax loopholes. And the governments of tax havens can legitimately claim that their main competition comes from places such as the City of London, Ireland, and Luxembourg as well as U.S. states such as Delaware which is a Mecca for U.S. firms due to its low corporate tax rates. They can also point to some of the biggest European banks being implicated themselves, perhaps unwittingly, in some of the secrecy and sanction busting scandals that are emerging.

That is of course all true. But in the minds of the public things are changing. The thin line between tax avoidance and tax evasion is increasingly blurred. Revelation of the tiny amount of tax paid in the U.K. by large multinationals such as Google has shifted attitudes. SMEs (small and medium-sized entreprises) worry that big firms paying a smaller percentage of their profits in tax enjoy a competitive advantage. The perception is reinforced that there is one rule for the big and powerful and another for the smaller players. The revelations contained in thePanama Papers of the ways in which the tax system can be exploited by corrupt nations and officials will have far-reaching implications.

According to GoodCorporation, a firm involved in advising companies on corporate social responsibility: "The appetite for aggressive tax avoidance schemes is certainly on the wane. The FTSE Group has said it is looking into excluding companies with overly aggressive tax reduction practices." A big change in global tax regulation is coming—the pace of which is certain to accelerate after recent events.