Tax havens and sovereignty

Topics Taxation | MNCs | OECD

What is proposed in this article is that there is a definitive link between tax sovereignty and tax havens. Nation states protect their fiscal policy and tax sovereignty in particular. One can view it from the beginning of time as a source of war finance. In the last millennia, the association of tax with war became unmistakable in medieval Europe, Asia and, later, the United States. When sovereignty had to be protected, the instrument was war, and an easy way to finance war was through taxes. There was a quid pro quo in that the sovereign state was responsible, in turn, for protecting its citizens and enhancing their welfare. 

Over the last century, with a well-established practice of the sovereignty of nations to tax, countries found that a business might, and sometimes did, have to pay tax on the same income in more than one country.  Thus, bilateral (a set of two countries) Double Taxation Avoidance Agreements (DTAAs) emerged as a preferred device to minimise cross-border double taxation of the taxpayer operating in both those countries.

The ramifications of DTAAs were not entirely clean, however. For one, some multi-national company (MNC) taxpayers could now shop around among different DTAAs to locate the management of their company in a country to derive maximum tax benefit, delinked from the extent of value added being generated there. Two, the DTAAs themselves revealed the underlying respective bargaining powers of countries — closely linked to their economic strengths and political power—thus, in a way exacerbating the inequity already prevalent among sovereign nations. And, three, some countries, often with the tacit understanding — if not encouragement of selected advanced countries — reduced their tax rates to a low enough level to be called tax havens, thus making it attractive for MNCs to locate their management, however questionably defined, there. 

MNC tax avoidance was recognised as a heavy burden on nation states — advanced and emerging alike — with the appearance of the 2008-09 global economic crisis. The world’s interest in multilateralism in tax conventions took a sharp favourable turn at that point. And so the Base Erosion and Profit Shifting (BEPS) project was born as a G-20 sponsored concept materialised by the OECD. 

By and large, advanced economies had not taken steps to eradicate tax havens — that were linked to themselves though perhaps from a distance — used by MNCs to avoid global taxation. This behaviour reveals that some of them want an escape route from the likely severity of any international tax burdens on their own MNCs or individuals. The OECD cannot be said to be indifferent to the existence or deleterious ramifications of tax havens but does not directly address the prevalence, control or dilution of tax havens. It has focused, rather, on marginal disincentives from double taxation on cross-border investment and, subsequently, taken up MNC tax avoidance through its elaborate BEPS Actions —15 in number—with aplomb.

However, the European Union (EU) has taken up the tax havens issue directly over 2016-19 by issuing a code of conduct, drawing up a blacklist and a grey list of offenders. Yet, not surprisingly, Oxfam, an NGO that fiercely tracks MNC misbehaviour, has given their view on it, raising issue with the EU as to why some countries were in the latter list and not the former, and why some had not been included in either list. Nevertheless it has to be recognised that the EU is at least addressing the issue. 

Oxfam names 18 jurisdictions that are likely to comprise EU’s updated blacklist totalling 23. They are worth identifying, namely, American Samoa, Bahrain, Cape Verde, Cook Islands, Dominica, Fiji, Grenada, Guam, Marshall Islands Morocco, Nauru, New Caledonia, Niue, Oman, Palau, Saint Kitts and Nevis, Samoa, Trinidad and Tobago, Turkey, Turks and Caicos Islands, the UAE, the US Virgin Islands, Vanuatu. 

Nothing could be more apparent in the list than the overwhelming presence of small island nations that are hardly self-sustainable and continue to be economically dependent on their erstwhile colonial connections. In a quid pro quo, they offer tax protection to the latter’s MNCs whose management is strategically anchored in the former. This comfortable arrangement has continued in the guise of tax sovereignty of nation states that falls under the Westphalian philosophy of sovereign state entities possessing the monopoly of force within their mutually recognised territories.

Illustration by Binay Sinha

Along those lines, western scholars continue to question the merit of any sacrifice in tax sovereignty. By and large, they pursue both the merits of tax sovereignty as a philosophy to be protected and tax havens as a practice to be confronted. They appear to want both, bypassing the built-in contradiction between the two. Some have feared that multilateralism will deplete the rights of countries to say “no” when needed to safeguard or preserve their sovereignty. They do not emphasise sufficiently that sheer adherence to sovereignty without modifying it to fit the needs of a modern global society has led to contradictions through DTAAs, mushrooming of tax havens, and strategic MNC location there, detrimental to the Pareto-optimal1 progress of a global society.

It is not that academicians and scholars have not recognised the in-built conflict. To quote a comprehensive observation of scholar Ronen Palan2 on the issue: “Tax havens cannot simply be legislated away, because they are not perversions of the principle of sovereignty as much as they are a direct outcome of the conflicting principles of national sovereignty in the age of mobile capital. Consequently, any serious attempt to combat the tax haven phenomenon would have to be conducted at a multilateral level, and would have great implications for the modern doctrine of sovereignty. The abolition of tax havens would require a degree of cooperation among industrialised countries and a limit on the sovereign rights of states, which would effectively spell the end of the so-called Westphalian system.”

The ink dries before one can infer what the final normative stand is of the author — as of some others — on multilateral sovereignty pooling.
1. A condition whereby anyone can gain but no one can be worse-off
2. Ronen Palan, “ Tax Havens and Commercialization of State Sovereignty,” City University of London, 2014



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