Tax havens: How do tax havens work?

Concealment | Resident or non-resident |  Tax haven jurisdictions |  The risks

Tax havens are countries that the Tax Office sees as having less-than-transparent tax or financial systems, and that by dint of such systems may encourage tax evasion or out-and-out fraud.  Tax havens also have minimal or no taxes for taxpayers (either people or businesses) who are not tax residents of the country.

Australia and the Organisation for Economic Co-operation and Development (OECD) use two yardsticks to assess whether a country is a tax haven – a lack of transparency, and a lack of effective information exchange.

The Tax Office's main worry is that the financial systems in tax havens make concealment of assets too easy, in particular the schemes that make good use of a tax haven's secrecy laws to hide assets and income that would otherwise be subject to Australian tax.

The Tax Office's Project Wickenby, for example, while targeting a range of tax avoidance schemes, has a central interest in offshore tax havens. The Tax Office's e-magazine Targeting Tax Crime reveals that Wickenby has recovered more than $1 billion in tax liabilities since 2007 (although not all of it was from offshore activities). The latest issue of Targeting Tax Crime is available at this link.

Concealment
A straightforward example of concealing assets and income would be an Australian taxpayer who sets up a bank account in a tax haven country. As that country does not have an agreement to exchange information with Australia, or has a strict banking secrecy policy, the Australian Tax Office has no way to get any information about this offshore bank account.

The most common form of the more complex tax haven structure used to conceal ownership is the 'international business company'. In these cases, an 'international promoter' may use trusts or companies as the shareholders, using their own companies as trustees or nominees.

The directors of the offshore company could also be companies associated with the international promoter. Arrangements are also put in place to ensure that the 'owner' is still able to influence or control the offshore trust or company.

These complex arrangements aim to conceal the true ownership of assets and so avoid declaring any offshore income or gains.

Under Australian law, broadly speaking, a resident is subject to tax on income from all sources, within or outside of Australia. A non-resident is subject to tax generally on income that is only derived from Australian sources (see information on residency and non-residency here).

Tax havens usually have much lower tax rates than Australia (sometimes zero), so even if someone pays local tax on their investment income in the tax haven, it would probably be nowhere near how much tax they would have to pay on that same income under Australian law. Therefore, a resident has incentive to locate their offshore assets and income in tax haven jurisdictions outside the reach of the Australian authorities in order to avoid being taxed at Australian rates.

Resident or non-resident
Residency for tax purposes is a central concept in our tax laws, and is important on the wider worldwide stage. A company, for example, that is not incorporated here can still be deemed as 'resident' and have to pay its fair share of Australian taxes on its worldwide income if it carries on business in Australia and either has its management and control or its majority voting power here.

In the case of individuals, the tax law contains four alternative tests for Australian residency – you have to pass only one of them to be considered an Australian tax resident. Be aware that you can be a resident even if you aren't currently living in Australia or don't have Australian citizenship or permanent residency. And people across all taxpaying groups have increasingly become involved in global investment and business dealings.

Tax haven jurisdictions

The status of a country as being considered to be a tax haven or not can change depending upon the perspective from which it is viewed and analysed. The number is gradually shrinking, and many countries previously considered to be tax havens are now in fact coming to agreements with other countries.

In Australia, the list of countries that have a "tax information exchange agreement" (TIEA) in place, or have agreed to one, is growing. Check this Tax Office page for what a TIEA is, and for the latest developments. As this list expands, the number of countries that are no longer considered to be tax havens grows with it.

It is not illegal to have dealings with a tax haven, and in fact there can be very legitimate reasons to conduct business there. An Australian for example may work overseas as a non-resident and build up savings in a tax haven's bank.

Some tax havens, including those that have large value dealings with Australian taxpayers, have developed particular niche markets. Others are regarded as offshore financial centres, and can be attractive to international businesses involved in portfolio management, such as insurance companies, self-insurers, hedge and mutual funds and offshore investment funds.

The risks
But it's a fact that some people try to exploit the confidential nature of tax havens to conceal assets and income to avoid paying their fair share of tax in Australia. The Tax Office says there can be risks in dealing with tax havens, and points out that the 'confidentiality' that may have been so appealing in one circumstance could work against you in another circumstance. The Tax Office contends that if a scheme's promoter is willing to dodge Australia's tax laws, why wouldn't they also dodge responsibilities to you?

A giveaway can be secrecy and concealment. Any arrangement that involves disguised ownership or hidden accounts should trigger anyone's alert button.

Updated August 8, 2012

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