By Yu Hong Zhi, Sherman
In January 9, 2015, Cheung Kong Holdings Limited announced the restructuring arrangement of combining Cheung Kong Holdings and Hutchison Whampoa to form a new listed company: “CK Hutchison Holdings Limited”. This newly established company is incorporated at Cayman Islands (SCMP, 2015) which has been commonly known as “tax haven”. As the name implies, tax haven is a place where levy taxes at a very low rate or even not at all to companies registered there. It has been an interesting phenomenon that most of the largest corporations in the world, they are not registered at the place where they operate their major business or make most of the profits. Indeed, how is this mechanism works? How could the multi-national corporations in the world transfer their profits made all over the world to these tax havens to avoid tax?
Advantages of tax havens
If we look at the figures provided by HKEX in 2013, 724 out of 1602 companies listed in Hong Kong Stock Exchange market are incorporated in Cayman Islands (881903, 2015). This has indicated that it has already been a common practice for listed companies to be registered in these offshore financial centre. Take Cayman Islands as an example, being one of the most popular tax havens in the world, not only it has a no profit tax levied, but also it comes with much looser company law and other financial regulations. For the investors who want to register a company in Cayman Islands, there is no foreign exchange control, nor any restriction on the nationality of registrants. Moreover, Cayman Islands has never signed any tax treaty with other jurisdictions, which means shareholders’ information are always kept classified, hardly could the tax authority from other countries to trace the capital flow of the company through these tax havens.
All the above advantages have enabled the opportunity for the multi-national corporations to avoid tax legally as well as to protect the privacy of their shareholders.
How it works?
The most common practice to avoid tax is called the “transfer pricing”. As the definition of taxable income in different jurisdictions varies, a set of complicated procedures are conducted by the corporation to transfer its profit to tax haven by making use of different tax systems in different jurisdictions. The most well-known practice is called the “Double Irish and Dutch sandwich arrangement”.
Take the tax avoidance practice of Apple Inc. as an example, according to laws in the U.S.A., the U.S.A government only taxes on the revenue earned in America or when the profit earned overseas is transferred to U.S.A. (Joseph, 2007). However, the law in Ireland states that the income earned is not taxable by Irish Government if the company is not operating in Ireland (Joseph, 2007). Hence, Apple make use of that to set up two subsidiaries in Ireland. Both are incorporated in Ireland but one of them has its head quarter in tax havens (Bermuda), namely Sub1. The other one is incorporated in Ireland and thus taxable by Irish authority, namely Sub2. These two companies shall find a “thing” to transact for transferring the profit earned. Apple along with lots of other tech companies use “intellectual property” as the exchange medium because it is intangible but very much valuable. Apple in US then transfer the overseas use rights of certain intellectual property to Sub1. While all the major business operations take place in Sub2, Sub2 need to “pay” royalty for the use rights of those intellectual properties to Sub1. Nevertheless, one more subsidiary is opened in Nederland to make use of the tax deduction of inter-EU transactions. Sub2 therefore pays the royalty to the Dutch subsidiary to get the tax deduction from Irish government, and then the Dutch subsidiary transfer the payment received from Sub2 to Sub1 by paying minimal amount of Dutch transaction tax. Sub1 can eventually transfer a huge amount of profit (as royalty in nature) with negligible cost to Bermuda where the company enact central management and control over there. Once the capital has been transferred into these tax havens, due to the privacy protection of money flow and shareholders’ information, it is almost impossible to trace how the money is used afterwards.
Legal but ethical?
Straightly speaking, the above tax avoidance method is completely legal but unethical in terms of business ethics. A company should be taxed for its revenue earned in that jurisdictions. The tax revenues collected can be used to invest in public welfare and social development, but now they all become privately owned the big companies. By the use of tax havens, the NPR (2011) estimated that the U.S.A. government is losing US$90 billion a year in federal tax revenue.
In order to tackle the problem of tax havens, the victim countries such as U.S.A and Britain have pressurized the Irish government to amend its law. Finally, the Irish government announced that every company registered in Ireland shall be taxable regardless of where the company is truly operated in 2013 (Henry, 2015). Tax havens like Bermuda and Cayman Islands also signed the Tax Information Exchange Agreements to provide related information for civil tax investigation purpose to the contracting parties upon request. In addition to efforts done by tax havens, the so-called tax victims also hold some “tax holiday” to attract their companies to transfer capital back to the country by offering a temporary low tax rate (Drucker, 2011). This is a compromise to the big companies as they are not required to pay the normal tax rate but less is better than nothing.
Conclusion
Although the problem of tax havens has been discussed for decades and many measures have been adopted to minimize the amount of tax avoided, the problem still perpetuate as low tax rate is often adopted by many developed countries or self-autonomous region (Even Hong Kong is being recognized as tax haven!). Once if a tax haven is agreed to increase its tax rate, companies will register themselves in other tax havens, repeating this game endlessly.
To conclude, the problem of tax havens can only be effectively eliminated under the consensus of the whole world. Every country in the world should enforce the same tax regulations; at least should disclose the shareholders’ information of the companies registered. Transparency is the key to mitigate the problem, and because tax havens are only enjoyed by multi-national corporations in the world, they indeed shifted the tax burden to medium-size local companies which seriously exacerbates the taxation fairness within the country. Unfortunately, considering the uncooperative attitudes from the tax havens, this problem is not going to come to an end in foreseeable future.
Reference
881903 (2015, January 12). 長和系重組 點解要去開曼群島？. Commercial Radio HK. Retrieved from: http://www.881903.com/Page/ZH-TW/thefactdetail.aspx?itemid=772590&csid=941_3781
Drucker, J and Rubin, R (2011, September 29). Lobbying for a Trillion-Dollar Tax Holiday. Bloomberg Business. Retrieved from: http://www.bloomberg.com/bw/magazine/lobbying-for-a-trilliondollar-tax-holiday-09292011-gfx.html
Henry M. (2015, July 9). Ireland to abolish controversial ‘double Irish’ tax arrangement. the Guardian. Retrieved from: http://www.theguardian.com/world/2014/oct/14/ireland-abolish-double-irish-tax-scheme-apple
Joseph B. (2007, May 15). International “Tax Planning: Double Irish More than Doubles the Tax Saving”, Practical US/International Tax Strategies 11(9).
NPR (2011, March 17). How Offshore Tax Havens Save Companies Billions. Nation Public Radio. Retrieved from: http://www.npr.org/2011/03/17/134619750/how-offshore-tax-havens-save-companies-billions
Sitz, P. (2015, September 17). In latest Li Ka-shing shake-up, Cheung Kong Infrastructure plans merger with Power Assets. SCMP. Retrieved from http://www.scmp.com/business/companies/article/1856352/latest-li-ka-shing-shake-cheung-kong-infrastructure-plans-merger
Filed under: Academic Year 2015 - 2016 
