Offshore Tax Havens by U.S.

¶ … offshore tax havens by U.S. companies

Tax Haven can be defined as a country/province/city where certain taxes are either not applied at all or applied with very little force or are levied at extremely low rates. Governments all over the world have been busy attracting global investors through these tax havens. Corporations, on the other hand, have been actively shifting their operations to such parts of the world where government regulations are minimal and can be overlooked easily. This in turn has pressurized the governments of the developed world to lower their tax rates, as well as, lower their standard protocols. In this paper we will review why U.S. companies are locating their activities or businesses in those tax haven countries? And what could change in the U.S. tax law from a tax policy perspective to make this less attractive tax shelter.

Financial Savings:

One of the primary reasons that the U.S. companies locate their business in other tax haven countries is the percentage of savings that the can make on their finances. The developing countries throughout the world have one of the cheapest labor rates and the cost savings that companies can make by launching businesses in these countries is up to 90% with the individual costs of hiring being 4 times less then what they have to pay in internally. This difference in salaries alone can save up to 75% of the finance for these companies. OXFAM (2000) writes, "Tax havens, and tax competition in general, can provide big business and wealthy individuals with opportunities to escape their tax obligations. This limits the capacity of countries to raise revenue through taxation on both their own residents and foreign owned capital. Tax competition and the implied threat of relocation has forced developing countries to progressively lower corporate tax rates on foreign investors. Ten years ago, these rates were typically in the range of 30 to 35 per cent - broadly equivalent to the prevailing rate in most OECD countries' Today, few developing countries apply corporate tax rates in excess of 20 per cent. Tax competition also extends to efforts to attract foreign portfolio investment. Earlier this year, India was forced to reverse efforts to clamp down on the use of tax havens by foreign institutional investors for channelling funds into the country for fear that future foreign investment would stay away."

The reason behind such a vast presence of cheap labor in such countries is because of the abundant and rising level of population of these countries. Furthermore, high poverty levels result in a decreased standard of living. This decreased standard of living allows the U.S.-based companies to have lower salary rates for all of the labor that they employ in their outsourced franchises and use the percentage of costs saved on resources and infrastructure. It is important to note here that the costs savings are different as per country and as per vocation (the Economist, 2004). This simply means that the costs for hiring an accountant in, let's say India, will be different from hiring an engineer in India. Similarly, the costs for hiring an accountant in India will be different from hiring an accountant in Pakistan.

There is of course one downside when outsourcing businesses in the developing countries: semantics. The communication barrier is a major one as the laborers in the developing countries have little to no command on the English language medium. Even though, this problem is a major one, it can be solved if a little more investment is done by the companies. This decreases the overall costs saving by at least 30%, hence considering that, the overall savings made are not as significant but are still enough to attract companies to invest in these tax haven countries (the Economist, 2004).

Tactical Outsourcing:

One of the major reasons that companies invest in these tax-haven or developing countries is because of the age-old tactic of having different sources and suppliers. This simply means that companies believe that it is always better to have suppliers who provide one with the resources and the infrastructure that they need instead of building the infrastructure themselves. This was mainly done so that the company could direct all the internal focus on the strategies that would help them move forward and upward within the market structure. However, this is not always true in all the cases, as Duncan (2007) writes "Billions of pounds, enough to pay for the entire primary health and education needs of the world's developing countries, are being siphoned off through offshore companies and tax havens, according to a body formed to expose the offenders. Aid organizations are alarmed that money which should be used for building the infrastructure of the poorest countries is being hidden in havens by corrupt politicians and multinationals exploiting tax loopholes. Offshore companies are being formed at the rate of about 150,000 a year. While in the 70s there were just 25 tax havens, there are at least 63 now, about half of them British protectorates or former colonies. Tax avoidance in Britain alone is estimated at between £25bn and £85bn."

In addition, there are multiple reasons behind the use of tactical outsourcing that differ form one country or industry to another. For example, the automation industries outsource their suppliers because they are secure in the fact that most of their suppliers are smaller companies and won't be able to pose any market threat to their manufactured product. For other industries, it was more important to increase the overall quality of the production so the outsourcing was an effort to increase eth overall competition amongst the smaller companies (Mark, 2004).

Again the overall costs decrease considerably when outsourcing, domestic or international, is conducted. The concept of specialization aids this decrease in costs on outsourcing. This is so because a specialized company would probably do a certain task at a much lower level as opposed to a team of employees that is hired to do the same task for the company internally. Furthermore, another reason behind using outsourcing as a strategy is to decrease the overall level of staff employed within the company. Many advertising agencies today do so because they feel that it decreases their overall costs significantly and increases the competition between the smaller companies. One of the most popular and obvious examples of outsourcing is the sector of government or civil jobs. The government outsources some of the common and district tasks to companies and civil servants who enjoy the added-advantages of pensions, medical and health insurances, government grants, etc. offered by the government to them under the umbrella of working in government-owned company (Mark, 2004).

The spectrum of overseas talent:

One of the biggest motivators for the U.S.-based companies to outsource overseas is the lack of technically proficient domestic laborers. It is believed that most of the local labor force is more interested in the management sector as opposed to the technical side of the business. Even though, the it sector has increased the overall ratio of the laborers tremendously within a span of 5 years, there are still many companies who seek employees in the tax haven countries because there the technically proficient labor force is present in much higher numbers then within the U.S. (Paul, 2003).

Countries like India and China are the main targets of the U.S.-based companies when they want to outsource or establish franchises that need technical assistance. This is so because of the high number of graduates that both countries have annually in the industrial and technical sectors. Furthermore, engineers and it professionals in these countries prefer working in the U.S. based companies because most of the time they feel that they are being under-utilized and un-appreciated by their own domestic companies. This of course makes the hiring process smoother for the U.S.-based companies. Plus the hard work that the workers from the developing countries put into doing their jobs is no where near matched by the domestic workers (Paul, 2003).

Rights of the U.S. employers:

The rights of the employers within the U.S. is that the employees hired can be disposed at the will of the employers. This can allow the employers to hire and fire the employees for whatever reason they see fit. Of course, the reasoning for firing the employees has to be valid and logical. But with the passage of time, the U.S.-based companies have been able to design and structure their policies in such a way that the have been able to reduce their domestic company size, in term of the employees working within the company, and have managed to outsource most of their work (Paul, 2004).

This has allowed the companies to manipulate their power and authority on the hiring and firing polices and has allowed them to increase the costs benefits that they are able to retain. As aforementioned, the costs of laborers in tax haven counties is far less then the domestic workers which has been the main incentive for the American employers to exploit the right of firing (Paul, 2004).

The other side of this is that the companies have to spend finances in areas of language training or job training when they outsource. However, over the years, many U.S.-based companies haven't been discouraged by these additional costs because the overall costs of outsourcing with the job training session and language teaching and outplacement requirements are still far less when compared to the costs that they would have to endure when they don't outsource. If the overall costs of outsourcing was even marginally close to the costs on domestic hiring then there is a high probability that the overall right of firing of the employers would not be employed as much as it ahs been in the past. Of the negative perception of using the firing right at such an extensive level does create negative images which the company has to spend money to correct and rebuild into positive images at a constant rate (Ryan, 2004).

The U.S. Tax Inducements:

One of the facts of outsourcing is the use of the tax-free off-shore accounts that allows the transfer of money from one country to another under the radar. This is one of the biggest loopholes in the U.S. policy because it allows a majority of the wealthy groups and individuals to avoid paying their rightful taxes. Also, many of the rich corporations have avoided paying taxes under the right issued by the Congress that the profits that are earned overseas can have no taxes levied on them. There would however be a 35% tax levied on the deferrals that they bring back to the U.S. This of course was again rallied by the corporations and currently they only have to pay a total of 5.25% of taxes on the deferrals that they bring in to the United States. Jeffrey (2007) writes, "Increasingly, tax evasion is facilitated by governments that lack transparency and are not prepared to counter tax abuse. With the increasing prevalence of offshore accounts in havens like the Bahamas and the Cayman Islands, the OECD's Jeffrey Owens warns of the threat that these practices pose to sovereign governments."

This particular break and loophole has also been one of the biggest reasons why many of the U.S.-based companies have chosen to outsource overseas. The decreased level and percentage of taxes allows the companies to keep almost all of the profit that they make as well as retain a majority of the revenue earned because of the decrease costs and financial investment needed in the overseas companies. Jeffrey (2007) argues that this practice has grown because: "Offshore tax evasion is not about small islands that do not impose income taxes: It is about all countries that lack transparency and that are not prepared to cooperate to counter tax abuse. These practices make it difficult for other countries to enforce their own tax laws. With globally integrated financial markets and modern communication techniques, the creation of offshore financial accounts, shell companies and the like are just a click of a mouse away."

This particular policy has lasted as long as it has because there is the fear for the American government that unless these companies are give these tax benefits then the possibility of these outsourcing companies to create job opportunities and increase investment within the U.S. could decrease considerably which could pose serious hurdles for the economic growth of the country. He concludes, "Growing demand in recent years, the demand for offshore facilities has expanded considerably, owing to the high growth rates of cross-border investment and to the increased number of wealthy and not-so-wealthy individuals who are prepared to use the new technological and communication infrastructures to go offshore. There is also a growing use of multiple layers of transactions to structure offshore operations through vehicles located in different countries. The gradual relaxation of reserve requirements, interest rate controls and capital controls in the main "onshore" markets and the creation of offshore banking facilities in some of the main industrial countries (the United States and Japan) have reduced the regulatory advantages of offshore financial centers, making them less attractive for conventional banking."

Technological Change:

The introduction of Internet and simultaneous growth of the it industry have allowed outsourcing to be a much easier task then it has ever been before. The internet has removed all time and space barriers that previously posed hurdles for outsourcing to be conducted on a large scale. The practicability of overseas outsourcing is far more financially beneficial for the companies then domestic outsourcing or hiring. Perhaps the biggest exploiter of this technological change was Enron. David (2002) writes, "Enron Corp. paid no income taxes in four of the last five years, using almost 900 subsidiaries in tax-haven countries and other techniques, an analysis of its financial reports to shareholders shows. It was also eligible for $382 million in tax refunds from the Treasury." He further writes, "The company used strategies common among U.S. businesses to avoid taxes. It also used some unusual methods, including the creation of 881 subsidiaries abroad, including 692 in the Cayman Islands, 119 in the Turks and Caicos, 43 in Mauritius and eight in Bermuda. Two Enron subsidiaries have been accused by a group of insurers of engaging in sham transactions in a tax haven, according to court papers in a New York lawsuit. Enron is by no means alone in not paying income taxes. A small but growing percentage of large U.S. companies pay no income taxes, a study by Citizens for Tax Justice showed in October 2000. The study of half the Fortune 500 companies found that 24 owed no tax in 1998, up from 13 in 1997 and 16 in 1996."

The geographic or topographic hindrances are no longer an issue because of the transfer of cooperative technical information or infrastructure through the software available on the Internet. Furthermore, the high level of dependency on the it tools and the internet has forced all of the companies in this world to invest in this sector and expand it in order to compete effectively. This dependence and investment has allowed the companies to advance to such an extent that the overseas outsourcing has become a very real option for most of the wealthy multinational corporations (Ron and Anil, 2005).

Both the private and public sectors have incorporated the use of Internet in their structures which has allowed the flow and ebb of businesses over the Internet a lot more common and popular. This has been a great advocate of the division of work and hence allowing the companies to outsource on a much larger spectrum then before. This is so because the incorporation and dependence on Internet on such a large basis has promoted the concept of modularization of the overall work (Ron and Anil, 2005).

Furthermore, the high level of technological advancements have made it easier for companies to settle down in areas where the weather or the topography might not have suited them before. For example, companies are now building industries and opening franchises in the deserts of UAE because now they have the infrastructure to do so and control the internal environment of the company with the high-tech modern machineries and tools that are available to them (Ron and Anil, 2005).

The forms of taxation

In much of the developing world, the tax burden is primarily shared by individuals. Corporation's share in the total taxes is minimal. This provides shareholders of large corporations a great inventive to shift all kinds of business operations to these countries. The developed world, in order to offset this change has begun to follow this trend as well. As David (2003) writes, "Investigations and prosecutions of suspected tax criminals have fallen by half over the last decade, even as cheating has grown. New data also show a continuing shift of tax burdens away from businesses and onto individuals. Last year, corporations paid 10.5% of all the taxes collected by the Internal Revenue Service, down from 16.4% in 1973. "

While the share of corporate profits has increased in the last three and a half decades, their share in the national tax has witnessed a steep decline. Similarly individuals have been sharing the burden of the taxes. Since 1973, corporate income taxes have risen 75% as fast as corporate profits. As David (2003) writes, "By contrast, individuals' income taxes rose 21% faster than adjusted gross incomes. Social Security taxes, which apply to the first $87,000 of pay, together with Medicare taxes, grew 82% faster than incomes."