The enforcement of tax laws abroad has long posed problems for authorities. However, that enforcement becomes increasingly more problematic when the information necessary for proper enforcement is located within an impenetrable system whose sole purpose is to protect that information from tax authorities in other countries. Although much effort has been expended to remedy the harmful effects of tax havens, few strategies have succeeded. But with the prospects of a record federal deficit and an ever-increasing tax gap, U.S. authorities have begun to look for new ways to strengthen the enforcement of U.S. tax laws abroad. The most prominent of these proposals is the Stop Tax Haven Abuse Act, which invokes the use of a presumption strategy to remedy the lack of information problem. Nevertheless, this Act will most likely fall short of successful regulation. Most importantly, the Act represents a one-sided attempt to regulate a problem that is truly international. Moreover, even if the Act passes, it will provide the Internal Revenue Service few new tools to assist with the collection of taxes. Another issue with the proposed Act is that it invokes a presumption strategy, which may be viewed as an easy runaround for the lack of an automatic exchange provision in the bilateral agreements that currently control the exchange of tax information with foreign authorities. This Note summarizes and analyzes the current regulatory framework and proposes a strategy for the unification of existing regulatory regimes to provide a more effective system for combating the harmful effects of tax havens.
TABLE OF CONTENTS I. INTRODUCTION II. TAX HAVENS AND THE HARM THEY CREATE A. What Is a "Tax Haven"? 1. The OECD Definition 2. Other Characteristics of a Tax Haven 3. The Veil of Secrecy B. Methods of Tax Evasion 1. Individual Tax Evasion 2. Corporate Tax Evasion C. What Are the Harmful Effects of Tax Havens? 1. Loss of Tax Revenue 2. Fraud and Other Abusive Practices III. REGULATION OF TAX HAVENS: NATIONAL AND INTERNATIONAL APPROACHES A. Regulatory Framework in the United States 1. Bilateral Agreements 2. The Stop Tax Haven Abuse Act a. The Use of Presumptions to Circumvent the "Veil of Secrecy" b. Codification of the Economic Substance Doctrine c. Expanding the IRS's Toolbox d. Criticisms of the Stop Tax Haven Abuse Act B. International Regulation 1. OECD 2. The European Union 3. G-20 Countries 4. The Financial Stability Forum and the Financial Action Task Force IV. CREATING A COMPREHENSIVE SOLUTION TO EFFECTIVELY REMEDY THE LACK OF INFORMATION EXCHANGE A. Multinational Approach B. Updating the Tax Information Exchange Agreements to Respond to Past Failures C. Creating a Comprehensive Approach for Regulating Tax Havens V. CONCLUSION I. INTRODUCTION
Commentators have long viewed tax havens as a type of "necessary evil" that facilitate tax competition among nations, leading to increased mobility and efficiency in international capital markets. (1) But in light of the recent economic downturn, many are starting to question whether tax havens should be subject to a stricter regulatory scheme because the harmful consequences significantly outweigh any benefits the tax havens might produce. (2) While tax havens claim to offer potential investors financial privacy, limited regulation, and low tax rates, these jurisdictions have also become sanctuaries for tax evasion, financial fraud, and money laundering. (3)
The issue of tax havens is not solely one of promoting financial integrity and stability, but also one of balancing the federal budget. Facing a record deficit of $1.4 trillion for the 2010 fiscal year, the U.S. government is bound to start looking for alternative ways of increasing revenue and narrowing the federal deficit. (4) Effective regulation of tax havens can facilitate the enforcement of U.S. tax laws abroad and reduce the current annual tax gap of $345 billion. (5) Experts estimate that the total loss from offshore tax evasion alone is close to $100 billion annually, including $70 billion from individuals and $30 billion from corporate tax evasion. (6) Even with such disparaging effects, tax havens have remained relatively untouched from a regulatory perspective. In fact, tax havens are flourishing more than ever. Offshore tax havens hold trillions of dollars in assets--including more than half of all banking assets and a third of foreign investments by multinational corporations. (7) Although tax havens account for only 3 percent of the world's Gross Domestic Product (GDP), more than half of world trade passes through them. (8) Between 1982 and 2003, the economies of these countries grew at an annual average rate of 2.8 percent, more than twice the rate of the rest of the world (1.2 percent) (9) On average, the citizens of these small countries are wealthier than those of most of the Western World, which may incentivize other countries to create their own tax havens. (10)
Despite the failed attempts to regulate tax havens in the past, the U.S. government has launched new initiatives that signal its intent to finally develop an effective solution to remedy the harmful practices made possible by the existence of tax havens. (11) The current administration has already instigated a political crusade aimed at closing loopholes in the U.S. Tax Code, and legislators have advanced several proposals that address international tax issues. (12) In 2009, when President Barack Obama launched a plan to address the problem of tax havens, he described the U.S. tax system as "a broken tax system" that is "full of corporate loopholes that make[ ] it perfectly legal for companies to avoid paying their fair share. (13) In addition to proposals for restructuring parts of the domestic tax laws, legislators have also launched the Stop Tax Haven Abuse Act, which is currently pending in the Senate and the House of Representatives. (14) These new suggestions will be an addition to the bilateral agreements that are currently the primary vehicle employed by the United States in its efforts to facilitate information exchange with tax havens.
Part II of this Note explores the detrimental economic effects that result from the existence of tax havens and examines common characteristics of tax havens. This background section also emphasizes some current methods being used for tax evasion to provide an understanding of how these can best be addressed. Part III provides an overview of the current regulatory scheme aimed at reducing the total number of tax havens and analyzes the strengths and weaknesses of the different approaches. It also explains how the current regulatory framework is inadequate and sets forth reasons why the Stop Tax Haven Abuse Act will do little to remedy these shortcomings. This Act employs a novel approach in the fight against tax havens, however, as this Note demonstrates, it also suffers significant shortcomings that prevent it from embodying a complete and effective solution. This Note argues that there are inherent deficiencies in the previous efforts to reduce the harmful effects of tax havens and that the Stop Tax Haven Abuse Act is only a part of the solution to a problem that requires multinational effort. Moreover, the Act's use of presumptions to remedy the lack of efficient information exchange could conceivably harm U.S. multinational corporations. Finally, Part IV proposes improvements designed to increase the effectiveness of the existing regulation and elaborates on how the bilateral agreements and the Stop Tax Haven Abuse Act will fit into a multinational regulatory system. This section suggests that the primary tool for regulating information exchange with tax havens should be bilateral agreements with automatic exchange provisions that cover a broader scope than the current agreements in force. This Part also explores alternative multinational solutions where the United States and other governments could reduce the use of tax havens to shelter income and, accordingly, substantially limit the use of tax havens.
TAX HAVENS AND THE HARM THEY CREATE
What Is a "Tax Haven'?
The OECD Definition
Depending on the choice of definition, between thirty and seventy tax havens exist; however, both the terminology, as well as the precise definition, varies between regulatory authorities. (15) The most widely used definition is the one created by the Organisation for Economic Co-operation and Development (OECD). The OECD lists four principal requirements for a country to be classified as a tax haven. (16) The first factor requires that the jurisdiction have no, or only nominal, tax rates, (17) However, a low taxation level by itself is not conclusive evidence, especially since many "high-tax" countries have passed legislation providing low taxes for certain industries, (18) The principal difference is that tax havens use low tax rates as the primary means of attracting foreign capital, whereas in other countries, these arrangements are typically limited to a small subset of the economy to allow that sector to remain competitive. (19) The second requirement to qualify as a tax haven is the "ring-fencing" of regimes, (20) that is, the regime must have a two-part tax system where residents are subject to one tax and legal system, while foreign investors or companies are subject to a separate system. (21) Many tax havens also impose a requirement that a foreign investor cannot be domiciled, or that a company cannot have any business within the jurisdiction. (22) Additionally, some ring-fencing laws prohibit qualifying investors and companies from using local currency to avoid unnecessary fluctuations in the price of the currency. (23) The result of ring-fencing is to separate economic cause and effect, thereby insulating the tax haven's economy from adverse consequences from its tax policies. (24) For example, many tax havens impose income tax on foreign income of their residents, while...