TAX AVOIDANCE: MYRIAD PRACTICES WITH DRASTIC CONSEQUENCES FOR THE GENERAL PUBLIC



By Philipp Gerhartinger



[This blog-article published on November 6, 2014, is translated from the German on the Internet, http://blog.arbeit-wirtschaft.at.]



Taxes are the most important foundation of all governmental activities and public services. Tax sovereignty is the heart of nation-state sovereignty. Multinational corporations face many national regulations. Their economic activity and profits cannot be clearly assigned to individual nation-states anymore.



GAPS AND LOOPHOLES



Many gaps and loopholes arose at the interface of national tax laws in the course of time encouraged by the increasing globalization. This enabled economic actors active worldwide to influence, plan, and minimize their global tax liabilities – without regard to the accompanying consequences.



Evading taxes becomes problematic when service and return favor are uncoupled, when for example real value creation and tax payment in a country are no longer plausibly related, when states do not receive any return favor or any proper return favor for providing the infrastructure with all its facets (developed industrial- and commercial areas, transportation connections, trained workers and legal security). Businesses are helped by these public services as a basis for their economic activity. The ones who suffer are the tax-paying workers, small- and medium-size enterprises and consumers who must compensate for the tax shortfall in the countries where the revenue is earned. These sufferers are disproportionately affected by cuts in state spending (and have only marginal possibilities for altering their own tax liability) and must struggle with unfair competitive conditions - in the case of small- and medium-size enterprises.



WHAT IS TAX RESISTANCE?



There is a great multitude of tax optimization practices. Several things are subsumed under the term "tax resistance." Those actions of tax subjects that run counter to the legislators' intentions are essential. All tax-optimizing actions are not illegal. However many that may be legal are not legitimate. In any case, the differentiation of legal "tax avoidance" and illegal "tax evasion" is central.



TAX FRAUD VS. TAX AVOIDANCE



All unlawful forms of tax resistance should be understood as tax evasion. The criminal state of affairs of tax fraud occurs when (financial) authorities are informed incorrectly or incompletely about important fiscal facts or when they are left in ignorance. This mainly concerns private persons or smaller businesses (for example in the case of sales tax fraud).



On the other hand, tax avoidance includes "legally allowed forms of tax resistance through conscious omission of facts or taking advantage of differences between two or more tax systems to lower the tax burden." International corporations have the possibility of shifting their businesses to tax havens through mailbox firms. So corporations redirect their accounting profits to countries where they can pay lower taxes or no taxes and reduce their real profits in the countries where they are gained and would be taxed higher. The simplest way is shifting revenue to low tax countries, for example by awarding credits within corporate structures that increase the revenue from interests in the low tax country. Current regulations on "transfer pricing" between parts of corporations also offer possibilities for shifting profits, particularly when international goods, copyrights, or other goods are involved that are hard to access.



THE FINANCIAL EXTENT



The theme tax avoidance is relatively new on the agendas of the EU and the OECD compared to fighting illegal tax fraud… Tax avoidance is the greater problem although only very meager information exists. Axel Troost (economist with DIE LINKE) says losses through non-taxation of business profits in Germany for example amount to 20-times what the state loses through private tax fraud in tax havens. The data on world trade is also alarming. Two-thirds of border-crossing trade occurs within multinational corporations and more than half of world trade flows – at least on paper – through tax havens.



For a long time, there were only vague estimates on the volume of evaded capital. In 2012, James Henry (ii) presented a robust calculation that financial wealth parked abroad amounted to between and trillion. According to his estimates, the home states of the tax evaders lose up to 0 billion annually in tax revenues.



In his work "Numbers," the economist Gabriel Zucman, a student of the renowned distribution researcher Thomas Piketty, estimated eight percent of private financial wealth (5.8 trillion euros) is in tax havens and 130 billion euros are lost annually in tax revenue. Thus his estimates are lower than those of James Henry. Zucman does not include cash assets, life insurances, and non-financial property assets (for example yachts, works of art, and the like registered offshore). He says these assets are not considerable and his estimate could rise to a maximum of 8 trillion euros.



These two calculations are based on fundamentally different approaches and measure different things. In the calculations of Henry – with foreign bank deposits as his basis -, assets are included that are completely legitimate, for example, business accounts of an Austrian business in Germany necessary for different payments in foreign countries. All of that is not connected with tax fraud. For Zucman, on the other hand, only those parts of foreign wealth are included that actually can be counted as tax fraud – on the basis of the gap between the active and the passive of worldwide asset balances.



Gigantic sums are lost annually through tax fraud. The larger part, business tax avoidance (for example, through profit-shifting), is not even included here although it amounts to many times more. In the European Union, the commissioner Algirdas Semeta said 1 trillion euros are lost annually in the EU through tax fraud and tax avoidance.



HOW THE SYSTEM FUNCTIONS



The offshore world is a "shrewd and coordinated system in which every island and every insignificant small state have its specific partial functions, where every jurisdiction creates the legal framework for very specific services from simple numbered accounts to very complicated interlaced tax structures […]. This is an extreme form of the international division of labor. The offshore world is not a geographical area. Rather it arises in the niches and gaps of colliding legal- and economic zones. So tax- and veiling oases are homes for the multitude of legal constructions for businesses, bank accounts, funds, and foundations. However, these are often only backdrops for the international capital streams. The real businesses take place elsewhere. Capital streams rarely end in shadowy oases. Many smaller states are much too unstable and economically insignificant. The real harbors of money are the great financial centers of the world like the City of London, Switzerland or Frankfurt. The legal constructions in the offshore world are merely roundabout ways of the money stream. As such, tax oases are only "the periphery of a system spanning the world at whose center sit powerful nation states and important world financial centers full of banks, tax experts, and lawyers." The whole offshore system would break down without this core.



The big banks active internationally are the prerequisites for the functioning of the offshore world. Their omnipresence first makes possible the border-crossing transport of money. Add to that an extensive industry of intermediaries. Lawyers, trustees, fiduciaries, property managers and tax consultants worry about the details, provide the know-how and ensure a smooth course. With their help, pseudo-businesses, foundations, and trusts are constructed all over the world. Swiss or Lichtenstein accounts, real estate, and other wealth are put in the ownership of these shell companies. The real owners are veiled and legal obligations circumvented.



Founding offshore partnerships is child's play. Often only a few minutes are needed to establish an offshore company with all the licensing procedures. The costs for that amount to 00 and upwards. For 00, a legal office in Panama can even create a firm through the Internet. A creation can be shifted within 24 hours to another oasis…



Different oases serve as bases for different operations. Oases with legal tax niches are emphasized for businesses while private persons are mainly involved in veiling tax fraud. States described as "tax oases" are useful for aggressive business tax planning. The IKEA example shows businesses do not need to be limited to one or two tax oases… The pressure exerted by tax havens on the corporate taxation of other countries resulted in a tax competition within the EU-27 and led to a drastic decrease of the nominal corporate tax rate between 1995 and 2013 from 35.3% to 23.2%. Austria also stands out in this race to the bottom.



CONCLUSION AND OUTLOOK



International organizations like the OECD have the tax fraud theme on their agendas. Pressure is necessary to enforce far-reaching measures against business tax avoidance practices. This may not end with lip-service. Concrete and effective measures must be carried out. Many European fiscal problems would be solved if business tax avoidance and tax fraud were made difficult or prevented.



Multilateral agreements are necessary. Troost focuses attention on four essential points: 1) specific country reporting by businesses, 2) a common consolidated corporate tax base against business tax avoidance, 3) disclosure of economic authorization and 4) automatic information exchange against tax fraud. All these measures together have the potential of massively reducing the problem.