Tax: Avoidance, Evasion and the Corporate Loopholes

Faith Clarke examines the growing global issue of tax avoidance, and what the world’s governments are – or aren’t – doing to put a stop to it
Commercial awareness
Politics and economics

Denis Healey, a former Labour party politician and ex-Chancellor of the Exchequer, once famously stated that the difference between tax avoidance and tax evasion is ‘the thickness of a prison wall.’ 

In other words, tax avoidance is legal but tax evasion is not; tax avoidance is a manipulation of the rules in order to minimise tax, whereas tax evasion is deliberately not paying tax that should otherwise be paid.

With sensationalised stories such as Lewis Hamilton’s tax-dodging jet coming to light after the unveiling of the Paradise Papers – a leak of 13.4 million files relating to offshore tax havens – investigative journalists worldwide have exposed high-earning individuals who are dodging tax, as well as the usual suspects – multinationals such as Apple and Facebook.  

But perhaps the most scandalous case of all is that of the Queen. Our nation’s sovereign allegedly has millions of pounds from her private estate invested offshore in a Cayman Islands fund, which is supposedly linked to the high street brand BrightHouse – notorious for its exploitation of low-income earners. 

What are tax havens, and how did they come to be in the first place?

‘Tax haven’ is usually used to describe a jurisdiction that offers favourable tax conditions, perhaps offering low-tax incentives to residents or overseas investors, or even a no-tax policy on certain incomes such as inheritance. 

‘Haven’ is also a nod towards the hush-hush nature of such places, where investors can rest assured that their financial documents will remain in safe hands – unless leaked, that is. 

A multinational company might avoid paying tax by basing their headquarters in an off-shore, low-tax jurisdiction, booking profits and transactions through the location in question as opposed to the country in which the sales are made. 

Likewise, individuals might keep their assets in an offshore trust, enabling them to live in a high-tax country but avoid paying large amounts of tax because their money is kept elsewhere.

By putting assets ‘in trust’, an individual allows their finances to be managed by a third party. The third party then pays the money out to chosen beneficiaries. Conveniently, this can include the person who invested the money in the first place –thus the nature of offshore tax havens is to deceive and manipulate. 

This is all perfectly legal, but the fact that a person has gone out of their way to knowingly avoid paying tax usually raises a few eyebrows, particularly if they happen to be in the public eye. 

According to a spokesperson for Her Majesty’s Revenues and Customs (HMRC), ‘Tax avoidance is bending the rules of the tax system to gain a tax advantage that Parliament never intended… It often involves contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage. It involves operating within the letter – but not the spirit – of the law.’

In his article History of Tax Havens, Ronen Palin suggests that tax avoidance dates as far back as the very concept of taxation itself. As long as there have been regulations in place, people have found ways to manipulate and cheat the system.

An interesting piece published on Vice.com highlights how tax avoidance can be traced back to the Roman Empire, and Tax Havens to the Slave Trade. The authors also write about how Switzerland was granted status as a ‘neutral’ country in 1815 by the Congress of Vienna, and essentially became the first ‘offshore’ territory. 

A safe haven for money as well as people, many Europeans fled to Switzerland during World War I to protect their funds from hiked tax rates to help with the war effort. World War II saw another surge of wealth to Switzerland, with the Nazis looking to protect looted goods. Despite public outrage, many banks welcomed these ill-gotten gains with open arms.

According to Palin, modern tax havens are ‘sovereign states that use their sovereign right to write laws in order to attract a certain type of international clientele.’ Ireland’s low corporation tax of just 12.5%, for example, makes the Emerald Isle financially attractive to large multinational businesses such as Google. 

Palin proposes three different types of tax havens, the largest being those that surround the City of London – UK-based or British Empire-related jurisdictions including the Crown Dependencies, Overseas Territories, Pacific atolls, Singapore, and Hong Kong. 

The second are those centred around certain European countries, usually disguised as hubs for private banking and business headquarters – Luxembourg, Switzerland, Malta and Ireland are just a few examples. 

The third group comprises a handful of standalone havens scattered throughout the rest of the world – they include Panama, Uruguay, and Dubai.

So why is tax avoidance legal?

From opening an ISA account, duty-free shopping, paying into a pension scheme, or donating to charity through Gift Aid, there are many legitimate forms of tax avoidance out there.

As citizens, we are all entitled to make use of these transparent and agreed-up forms of tax avoidance. What the government does not allow is purposely striving to deceive the taxman. And even if the means of tax avoidance do not strictly breach regulation, the question of morality often arises. 

Avoidance quickly morphs into evasion when the truth is knowingly concealed or distorted. An individual found doing so could be deemed to be breaking the law by a tribunal. 

What are the loopholes used by big business?

According to Americans for Tax Fairness, US corporations dodge a combined $90 billion in income taxes every year. 

There are several loopholes multinationals use to avoid high tax rates and shift profits to offshore subsidiaries. Some – such as the ‘Double Irish’ – have been shut down by governments; a number of others, particularly in the US, have yet to be sealed off. 

Popular among US corporations, the ‘Check-the-box’ loophole is when a business checks a box to confirm that their subsidiaries are offshore. Provided the profits don’t touch an American bank account, the firm can avoid paying corporation taxes locally. 

The sister to this loophole is the ‘Look-through’ method. According to Business Insider, the ‘Look-through’ (US) loophole ‘was passed by Congress in 2006 and works as a companion policy to the check-the-box loophole’. 

Reuters reported that the law was passed with very little debate. As a result, it strengthened the ‘Check-the-box’ loophole by ‘giving corporations more latitude to move some types of income from one foreign unit to another without paying a tax.’ 

A third loophole is the ‘Double Luxembourg’, which is pretty much the same as the ‘Double Irish’ in that payments are shifted from high-tax jurisdictions to low-tax jurisdictions. 

Economist Sean Coffey summarises Amazon’s tax strategy like so: 

‘We have a trading company operating in Luxembourg that records the sales made by Amazon from across the EU – these number in the millions and thus accumulate a large profit. But then the trading company makes a royalty payment to another Luxembourg-registered company but one that is not subject to tax in Luxembourg.  Thus the payments to the holding company are not taxable in Luxembourg.’

Why haven’t these loopholes been closed?

Governments are stuck between wanting to entice large employment-generating corporations to their shores and trying to reduce the massive cost of tax avoidance. While Ireland sealed off the ‘Double Irish’ in January 2015, in America many loopholes remain open thanks to lobbying and pressure from corporations. 

The new Republican tax plan is supposed to be so simple that a standard income tax filing can be filled out in the space of a postcard. But according to The Week, the ‘complex latticework of loopholes will remain in place.’ 

The Week claims that the code was written largely by corporate lobbyists working in the tax-free or tax-reduction interests of their corporate clients. Counter Punch makes the point that while America’s 35% official corporate tax rate is higher than that of many countries, the US taxation system provides far more loopholes than most other jurisdictions. 

Because of this, it is estimated that US-based corporations only contribute around one-tenth of total federal revenues.

The accountancy and law firms at the centre of the Paradise Papers will simply argue that they are doing their job – maximising shareholder value. Moreover, they operate within the parameters of the law. Appleby’s website states that it offers ‘intelligent and insightful offshore legal advice and services, delivered with perspective.’ 

In terms of ethics, can it really be immoral if a firm or corporation is operating within the law? I would argue ‘yes’, because the means-to-the-end matter. But still, global citizens should surely be directing their anger at those who pass such laws in the first place. 

What are we supposed to do about it? 

Exposés such as The Paradise Papers usually see a crescendo of public uproar until another scandal occupies the front pages. While it is difficult to condemn an individual, particularly if their actions are legal, we could do more to hold corporations to account. They rely on our demand as consumers, after all. 

But boycotting a company’s products can only have an impact if done on a mass, long-term scale. Despite the initial public reaction to tax avoidance, do the majority of people really care as long as they can still buy a product at rock-bottom price, and order it for one-click, free, next-day delivery? 

Just like the Panama Papers, the Paradise Papers will be old news by the time it comes to ordering this year’s Christmas presents.