Taxpayers, corporations, and mutual funds may choose to work through tax havens—often through subsidiaries—or hold their bank accounts there. This allows these individuals and groups to avoid paying taxes in their home country. That’s because income earned by a U.S.-based corporation’s foreign subsidiaries is not subject to federal income tax. It is only taxed once the income is repatriated to the United States via a dividend to the parent corporation. This means that corporations based in the United States can form subsidiaries in tax havens. As the profits earned in these subsidiaries remain in the tax haven, the corporations can avoid paying U.S. income taxes on them.
Example of a Tax Haven
For example, the Cayman Islands imposes no income tax on individuals or corporations. It is considered one of the most financially secretive nations in the world. As a result, the Cayman Islands is a popular tax haven used by many U.S.-based corporations. The profits these corporations report that they earn through their Cayman Islands subsidiaries are equal to 20 times the Cayman Islands’ own gross domestic product. Delaware is also seen as a tax haven for many companies and organizations. More than 1 million corporations have made Delaware their legal home, according to the Delaware Division of Corporations. Avoiding taxes by keeping subsidiaries’ profits overseas is legal. But some taxpayers may attempt to hide assets and even income overseas. This is more likely to happen in tax havens that don’t often share information with foreign taxpayers’ home countries. This type of fraud could be as simple as putting undisclosed cash in a bank account in a tax haven. Or it could be as complex as setting up a web of domestic trusts formed in the United States and foreign trusts formed in a tax haven to hide your business income.
Rules Preventing Tax Evasion Via Tax Havens
To combat taxpayers evading taxes by operating in tax havens, the IRS has imposed certain disclosure requirements on taxpayers with assets or income abroad. Examples of these disclosures include:
Report of Foreign Bank and Financial Accounts (FBAR) using FinCEN Form 114 Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts Form 8938, Statement of Specified Foreign Financial Assets
This law required United States corporations with profits in overseas subsidiaries to pay a one-time 15.5% tax on profits held in cash and a one-time 8% tax on profits held in liquid assets. Corporations were given the option to pay the tax all at once or in parts over eight years. Combating tax evasion through the use of tax havens is not only an issue in the United States. In fact, in 2009 the Organization for Economic Cooperation and Development (OECD) founded the Global Forum on Transparency and Exchange of Information for Tax Purposes. The forum’s goal is to increase cross-border transparency and end cross-border tax evasion. Much of this work involves tax havens.
