NOU 2009: 19

Tax havens and development

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1 Mandat and summary

A government Commission was appointed by Royal Decree on 27 June 2008 with the following mandate:

The Commission shall examine the role of secrecy jurisdictions in relation to capital flight from developing countries. In the context of the aims of Norway’s development policy, the Commission will also consider Norway’s position on the investment of funds via such jurisdictions. The Commission will build on the development policy guidelines embodied in the government’s policy platform, the International Development Minister’s addresses to the Storting (parliament), the fiscal budgets and the Storting’s deliberations regarding such budgets, and on the white paper on development policy when this becomes available.

The Commission will apply the OECD definition of “secrecy jurisdictions” (offshore financial centres/tax havens) and will, as a basis for its assessments and recommendations, utilise studies carried out under the auspices of the World Bank on the effect of illegal capital flows on development and other relevant work carried out under the direction of international organisations and initiatives. The Commission will also, as a basis for its assessments and recommendations, familiarize itself with national legislation and practice in relevant countries and jurisdictions.

The tasks of the Commission are:

  • to improve our insight into and understanding of money flows originating in developing countries and describe both legal and illegal money flows and the consequences thereof

  • to provide a thorough review and description of relevant company and trust configurations that make capital flight possible and of the use made of secrecy jurisdictions in that context

  • to put forward proposals that can help to curb illicit capital flows and money laundering from developing countries via secrecy jurisdictions

  • to propose measures whereby other development partners are invited to share a common approach to the use of secrecy jurisdictions in connection with investments in developing countries

  • to propose measures which can increase the visibility of capital flows to and from developing countries via secrecy jurisdictions

  • to assess whether and to what extent transparent investments channeled via such jurisdictions serve to maintain the structures used to conceal illicit capital flows from developing countries

  • to assess, in the context of the aims of Norwegian development policy, Norway"s stance on the investment of funds via secrecy jurisdictions and to propose a study of possible measures in that connection

  • to provide recommendations that can be included as elements of the operational guidelines for the investment activity of Norfund, the Norwegian Investment Fund for Developing Countries.

The Commission is not mandated to assess the management of the Government Pension Fund – Global. Nor is it mandated to assess the work of the OECD Fiscal Affairs Committee with regard to tax evasion in secrecy jurisdictions or the initiative by the Financial Action Task Force (FATF) to identify non-cooperative countries and territories in the fight against money laundering and terrorist financing, and Norway"s follow-up of this work. However, the Commission will draw on the work done in respect of issues.

The Commission will assess the need to draw on further expertise in the form of, for example, reports and seminars. The Commission"s secretariat function is assigned to Norad, but the secretariat can also draw on additional resource persons from the sectoral ministries. The Commission will present its recommendations to the Minister of the Environment and International Development.

1.1 Composition of the Commission

  • Professor Guttorm Schjelderup (chair) (Norwegian School of Economics and Business Administration)

  • Professor Alexander Cappelen (Norwegian School of Economics and Business Administration)

  • Senior state attorney Morten Eriksen (National Authority for Investigation and Prosecution of Economic and Environmental Crime in Norway)

  • Research Director Odd-Helge Fjeldstad (Chr. Michelsen Institute)

  • Secretary-General Marte Gerhardsen, CARE Norway

  • Special advisor Eva Joly (Norwegian Agency for Development Cooperation – Norad)

  • Investment Manager Lise Lindbäck (Vital)

  • Chief Executive Jon Gunnar Pedersen (Arctic Securities)

  • Local authority executive Anne Fagertun Stenhammer

  • Professor Ragnar Torvik (Norwegian University of Science and Technology)

  • The secretariat was assigned to Norad and headed by Fridtjov Thorkildsen of The Anti-Corruption Project. Senior economist Audun Gleinsvik, hired from Econ Pöyry has had the main responsibility for the writing of the report.

  • Its other members have been

  • Ritha Unneland, Norad

  • Henrik Lunden, Norad

  • Hege Gabrielsen, Ministry of Trade and Industry

  • Geir Karlsen, Ministry of Finance

1.1.1 Work of the Commission

The Commission has based its work on a number of different written documents, as well as on contributions from various experts and other actors who have participated in its meetings. The Commission has also visited Germany, Liechtenstein, the USA and Mauritius, where activities included meetings with representatives of the national governments. The Commission also held meetings in Mauritius with actors from the private sector.

The Commission has had meetings and other communication with Norfund. This institution has been given the opportunity to read the description of its activities in the draft report from the Commission and to comment on the Commission’s recommendations related to Norfund.

The Ministry of Finance has also presented its work on tax treaties to the Commission.

A total of twelve meetings have been held by the Commission, with the last taking place on 25 May 2009.

1.1.2 Observations from Mauritius concerning the commission"s report

The commission"s mandate requires it to make recommendations which can form part of the operational guidelines for investment activity by the Norwegian Investment Fund for Developing Countries (Norfund). Since the latter channels the bulk of its fund investments through Mauritius, it has been important for the commission to investigate legal and tax structures in that country in order to secure the best possible basis for making recommendations on Norfund"s operations. The commission has accordingly devoted particular attention to Mauritius in section 7.5.

The government of Mauritius has read the English version of the report, and made its observations in a letter of 26 June 2009 to the commission. Members of the commission have read this letter, and assessed whether any changes or corrections are required to specific points in the report.

Their conclusion has been that no amendments are required to the report.

1.2 Guidance for readers

The Commission has been asked to assess what damaging effects are caused to developing countries by tax havens, and to document the scale of money flows to tax havens. It has also been asked to make recommendations which can alleviate the problems created by tax havens for developing countries and to propose guidelines for Norfund’s operations. The Commission’s report is structured as follows:

  • Chapters 2 and 3 outline the typical features of tax havens and the way their legal systems and tax legislation affect other countries.

  • Chapters 4 and 5 explain the damage caused by tax havens, both generally (chapter 4) and to developing countries in particular (chapter 5).

  • Chapter 6 outlines the scale of capital flows through tax havens and important characteristics of tax haven economies.

  • Chapter 7 provides an overview of and discussion on Norfund’s investments in tax havens.

  • Chapter 8 provides an overview of international efforts to combat tax havens.

  • Chapter 9 presents the Commission’s recommendations. These include both measures which Norway can implement unilaterally and others which Norway should seek to collaborate on internationally. The Commission also provides recommendations which could be incorporated into the operational guidelines for Norfund.

1.3 Summary and the Commission’s recommendations

1.3.1 Characteristic features of companies in tax havens

Scope . The number of companies and trusts being established in tax havens is much greater per capita than in most industrially and financially developed states. This is despite the fact that most tax havens are geographically remote both from the owners of companies registered there and from the business activities conducted by such companies. No less than 830 000 companies are registered in the British Virgin Islands which, for instance, have only about 19 000 inhabitants. In addition, there are an unknown number of trusts, banks and funds. The scope of such registrations is well illustrated by the fact that a single small office building at George Town in the Cayman Islands serves as the registered address for more than 18 000 companies. 1

Most of the companies registered in tax havens conduct no or very limited genuine local business activity. Legislation in these jurisdictions specify that such enterprises (often called exempted companies or international business companies (IBCs)) should not have local operations or activities over and above the formal activities associated with their registration. Typically, such companies cannot own or rent real property, etc., and their owners cannot reside locally or use the local currency in their business operations. Tax havens in general are characterised by a tax and regulatory regime which distinguishes between investments made by locals and foreigners, with the regulations giving favourable treatment to the latter in all ways. A tax and legal system of this kind is often described as “ring-fenced”.

Exemption rules . Companies governed by ring-fenced legislation direct their activities toward foreigners. Companies operating within this regime can conceal or veil the identities of those who own or control the business, are partly or wholly exempted from paying taxes, have no real obligations relating to accounting or auditing, have no duty to preserve important corporate documents, and are able to move the company to a different jurisdiction with a minimum of formalities.

The tax haven business model . Jurisdictions which offer exemptions like those described above derive their revenues from the registration and management fees paid by the companies. The total effect of these payments is insignificant for the companies, but they represent an important source of income for the tax havens, which are often very small jurisdictions. This makes it important for tax havens to attract many foreign registrations. These may amount to 95-98 per cent of the total number of registered companies in the jurisdiction; the remainder being ordinary companies with local activities.

Secrecy . The lack of access into tax relevant information and the absence of public registries in tax havens differ from corresponding regulatory regimes in states based on the rule of law because the actual purpose is to conceal activities which take place in other jurisdictions. The legal framework in tax havens has, unlike in other countries, no balance between the interests of the owners (the clients of tax havens) and the interests of the company’s creditors, employees, or other social interests. Such aspects affect third countries because the companies and the owners of the registered companies are neither active nor domiciled in the tax haven. The geographical division between the formal domicile of the companies and the location of their economic activities means that those with legitimate claims against companies in tax havens have no or very limited opportunity to protect their interests. As a result of the secrecy rules, those affected by the operation and development of the companies or those who have claims against the owners have very few opportunities to discover what is actually happening in these companies or who operates and owns them. If the owners themselves wish to provide accurate information to the outside world, they are at liberty to do so. But they can also conceal their identity or present misleading or opaque information about ownership and the company’s real position and operations.

Tax treaties . An unfortunate effect of tax treaties as they are normally drafted is that they reduce tax revenues in the country where the income is earned (the source country). Combined with the use of secrecy rules and fictional domiciles, this makes the access to tax-relevant information conferred by such treaties illusory. Paradoxically, tax treaties help to make tax havens a more favourable location than if such agreements did not exist. The tax treaties will not affect the harmful structures that exist in tax havens. Accordingly, the Commission has noted that tax treaties can do more harm than good unless they are followed by measures that reduce the harmful structures identified by the Commission. It is important to ensure that in this connection the tax treaties do not constrain further action against tax havens.

1.3.2 Damaging effects of tax havens

Tax havens increase the risk premium in international financial markets . The financial crisis has revealed that many financial institutions carried off-balance-sheet liabilities where part of the liability was registered in tax havens and thereby protected from insight. Examples include underwriting structured investment vehicles and structured investment products registered in tax havens. Tax havens enhance counterparty risk and information asymmetry between different players, which undermines the working of the international financial market and contributes to higher borrowing costs and risk premiums for all countries.

Tax havens undermine the working of the tax system and public finances . Tax havens offer secrecy rules and fictional domiciles combined with “zero tax” regimes in order to attract capital and revenues that should have been taxed in other countries. This increases competition over mobile capital, but not tax-related competition in the normal sense since tax havens offer harmful legal structures which encroach heavily on the sovereignty of other countries. This has made it difficult for other countries to maintain their capital taxes, and has thereby contributed to lower taxes on capital. Developing countries have a narrower tax base than rich countries, and also obtain the largest portion of their tax receipts from capital. Accordingly, lower capital taxes mean either a decline in revenue and/or higher taxes on a narrower base. Moderate tax rates on a relatively broad base are preferable to high taxes on few tax objects, because tax efficiency declines more than proportionately with the tax rate. As a result, tax havens help to boost the socio-economic costs of taxation and weaken economic growth in developing countries.

Tax havens increase the inequitable distribution of tax revenues . The use of tax havens affects which country has the right to tax income from capital and can lead to a more inequitable distribution of tax revenues. This problem relates particularly to taxation of capital gains by companies registered in tax havens. The normal approach in bilateral treaties regulating which country has the right to tax international revenues is to apply the domiciliary principle – in other words, the primary right to tax rests with the country in which the owner is domiciled or registered rather than the source country. This method of assigning the right to tax has traditionally been justified by reference to the strong link which typically exists between the country of domicile and the taxpayer. The justification for this principle of taxation disappears in cases where legal entities are merely registered in a jurisdiction, without pursuing real activity of any kind. A characteristic of tax havens is precisely that the link between the tax subject and the jurisdiction exists only at the formal level. In such cases, considerations of fairness suggest that the source country should have the right to tax.

Tax havens reduce the efficiency of resource allocation in developing countries . Tax havens make it more profitable to pursue tax evasion and planning through instruments which encroach on the sovereignty of other countries. These activities are not profitable for society as a whole because they make no contribution to value creation. Tax havens can also influence which investments are the most profitable after tax, and thereby increase the gap between private and socio-economic investment criteria. This can lead to a redistribution of resources by the private sector away from activities which yield the highest pre-tax return to ones which give the best return after tax. Such behaviour reduces overall value creation.

Tax havens make economic crime more profitable . A common feature of many developing countries is that they lack resources, expertise and capacity to build up and develop an efficient bureaucracy, and that the quality of the tax collection system is less well developed than in rich nations. The probability that economic crime will be discovered by the authorities is accordingly lower in developing countries. Secrecy legislation in tax havens provides a hiding place for players who want to conceal the proceeds of economic crime. Tax havens thereby lower the threshold for such criminal behaviour.

Tax havens can encourage rent-seeking and reduce private incomes in developing countries . Countries rich in natural resources have averaged lower growth than other nations over the past 40 years. This phenomenon is often termed the paradox of plenty. The most important lesson it teaches is that revenues which fall naturally into the lap of the political and economic players in a country can have unfavourable economic consequences in nations with weak institutions (such as a weak government bureaucracy and weakened democratic processes). This is because resources are wasted on redistributing existing revenues in one’s own favour rather than on creating new income (known as rent-seeking).

Rent-seeking leads to the reorientation of society’s resources away from productive value creation. A particularly important effect of this reorientation is that tax havens influence how some private entrepreneurs choose to use their talents. Tax havens make it relatively more profitable for them to devote their abilities to increasing the profitability of their own business through tax avoidance rather than through efficient operation. A private-sector distortion of talent along these lines is not balanced by a socio-economic gain, because the socio-economic calculation must reflect the fact that tax saved for the private entrepreneur represents a reduction in government revenue. Tax havens thereby enhance the profitability of being a rent-seeker, which prompts more people to opt for rent-seeking and fewer to choose productive activities. The more people who opt for rent-seeking, the fewer who participate in productive activity. In fact, rent-seeking activity can become so great that private income actually falls. Such a redirection of talent away from value creation is a particular problem in countries with a low level of expertise and technological development.

Tax havens damage institutional quality and growth in developing countries . Potentially the most serious consequences of tax havens are that they can contribute to weakening the quality of institutions and the political system in developing countries. This is because tax havens encourage the self-interest that politicians and bureaucrats in such countries have in weakening these institutions. The lack of effective enforcement organisations mean that politicians can to a greater extent exploit the opportunities which tax havens offer for concealing proceeds from economic crime and rent-seeking. These proceeds can be derived from corruption and other illegal activities, or be income which politicians have dishonestly obtained from development assistance, natural resources and the public purse. By making it easier to conceal the proceeds of economic crime, tax havens create political incentives to demolish rather than build up institutions, and to weaken rather than strengthen democratic governance processes.

Over the past decade, it has become clear that institutional quality represents perhaps the most important driver for economic prosperity and growth. Acemoglu, Johnson and Robinson (2001) is the best-known study that looks at the impact of institutions on national income. It estimates that if countries which scored low for institutional quality could have improved their institutions, national income would have increased up to sevenfold. Few factors have such a strong influence on growth as improving institutions. This is precisely why the damaging effects of tax havens can be so substantial for developing countries – they contribute not only to preserving poor institutions but also to weakening them.

1.3.3 Capital flows and tax havens

The scale of illicit money flows from developing countries to tax havens cannot be determined precisely, but it unquestionably far exceeds development assistance, for instance, or direct investment in these countries. In 2006 the total registered money flows into these countries (including China and India) is estimated at USD 206 billion (IMF World Economic Outlook database). Total development assistance was USD 106 billion (OECD). Donor aid accounted for USD 70 billion of this figure. The most qualified estimate (Kar & Cartwright-Smith (2008)) for illegal money flows from developing countries indicates that illegal capital flows totalled USD 641-979 billion. The illegal outflow corresponds roughly to ten times donor aid given to developing countries.

Not all the illegal money flows go to tax havens, but it is well documented that placements in these jurisdictions are very large and that a substantial proportion of the capital placed there is not declared for tax. The Tax Justice Network has estimated (2005) that placements by high net-worth individuals in tax havens totalled USD 11-12 000 billion in 2004. Official statistics suggest that the scale of such placements increased sharply in subsequent years, while the financial crisis has led to a decline over the past year. Revelations in the USA and the UK indicate that only about five per cent of those placing assets in tax havens declare these for taxation in their home country (confer the UBS case in the USA, US Senate (2008) and Sullivan (2007) in the UK).

1.3.4 Other conditions

The Commission has determined that the problem related to the use of tax havens primarily represents a combination of (a) a ring-fenced tax system offered to players who do not pursue real business operations in these jurisdictions, but in other states, and (b) secrecy legislation which conceals the identity of the owner, the company’s actual activity, transactions and so forth from the countries in which the business is actually conducted. These factors are reinforced by bilateral treaties to avoid double taxation, which often assign the right of taxation to tax havens. Many countries that in a number of areas are not perceived as tax havens possess elements of the types of structures typically found in tax havens. A case in point is the Norwegian international ship register. The Commission believes that the goal must be to eliminate such structures regardless of where they are established, but tax havens have gone much further than other countries in consistently developing such harmful structures.

The Commission has not demarcated tax havens in the form of a list, and believes that existing lists are inadequate for determining which jurisdictions possess harmful structures. Any list must be based on a detailed assessment of regulations and regulatory regimes in various jurisdictions. This has not been possible within the time allowed for the Commission’s work.

A number of recommendations are made by the Commission, aimed partly at reducing the scope of the types of harmful structures described above and partly at reducing their damaging effect on developing countries. What Norway can achieve on its own is limited. Generally speaking, problems associated with tax havens must be combated through international collaboration. The most important of the Commission’s recommendations are briefly presented below. The recommendations and the reasons for making them are described more fully in chapter 9.

1.4 Recommendations by the Commission

Development policy . The Commission has noted that the Norwegian authorities should increase their commitment to strengthening and improving tax regimes and anti-corruption efforts in developing countries. Working to strengthen democratic processes in developing countries is also important, including support for organisations and institutions working for greater transparency, democratisation and accountable government (including freedom of the press and civil society). Norwegian industrial policies should also more strongly reflect the goals of Norwegian development assistance, so that the two conflict as little as possible.

Advisors and facilitators . The Commission wants the Norwegian actors who facilitate and establish operations in tax havens to record their activities in a dedicated Norwegian registry, where establishments from 2004 and onwards would be registered. A special domestic law Commission should be established in Norway to formulate the legal basis for such registration and the jurisdictions it should include. The Commission would also study a number of issues related to the tax status of companies that do not have local operations in tax havens.

Information duty and annual accounts . The Commission takes the view that the Norwegian authorities should study whether multinational companies in Norway could be required to present in their annual reports key figures relating to such aspects as taxable profit and tax payable as a proportion of taxable profit in each of the countries in which they have operations. Such information is important not only for investors but also for society, because most multinational companies have expressed support for corporate social responsibility.

Transfer pricing . The Commission takes the view that incorrect pricing of intra-group transactions with the aim of transferring profits to low-tax jurisdictions is a major problem for both rich and poor countries. Even in a country like Norway with relatively good tax controls, data from Norwegian enterprises indicate that multinational companies transfer a substantial share of their profits to low-tax jurisdictions. The loss of potential tax revenue from foreign multinational enterprises is estimated as being in the order of 30 per cent. On that basis, the Commission accordingly requests the Norwegian authorities to investigate a set of instruments which can be used to determine transfer pricing that are broader than those currently provided by Norway’s domestic legislation, and that Norway also promotes such instruments in international fora.

National centre of expertise . The Commission has noted a lack of social investment related to transfer pricing and international constructions for avoiding tax. A general problem for all countries, but particularly for developing countries, is that expertise related to tax evasion techniques and transfer pricing exists primarily in the private sector. The public sector, including higher education institutions, have limited incentives for developing such expertise – partly because the financial incentives are not as strong and partly because this type of expertise is not concentrated in one place in the public sector. Accordingly, the Commission recommends the establishment of a centre of expertise which can conduct research into and support the Norwegian authorities on such issues, and which can simultaneously contribute to enhancing expertise on such issues in developing countries.

Cross-ministerial working group . The Commission recommends that the Ministry of Foreign Affairs appoint a cross-ministerial working group to develop networks with other countries which might cooperate with Norway to reduce and to eliminate harmful structures in tax havens. This group will also work to put tax havens on the agenda in international finance and development institutions.

Tax treaties . Tax treaties contain provisions on assigning taxation rights between two jurisdictions. They also provide for information exchange upon request. In the Commission’s view, the use of tax treaties does not eliminate the damaging effects caused by tax havens. Signing a tax treaty with such jurisdictions does not lead to the establishment of official company and owner registries with a duty to keep accounting information, or the introduction of substantial genuine audit provisions. Nor will a tax treaty prompt a tax haven to change its practice of ring-fencing parts of its tax system so that foreigners secure better tax terms than nationals. Practice shows that issues related to re-domiciling of funds (in other words, transferring funds from one tax haven to another) will persist. Since none of these issues is affected by tax treaties, tax havens will have no incentive to exercise control over the extensive opportunities for misuse offered by the exemption system. The Commission accordingly recommends that Norway take both national and international initiatives to create new rules for (i) when a legal entity can be regarded as domiciled in a tax haven (including requirements for real economic activity in such jurisdictions) and (ii) assigning taxation rights between countries.

Convention on transparency in international economic activity . Norway should take the initiative to develop an international convention to prevent states from developing secrecy structures which are likely to cause loss and damage to other jurisdictions. This initiative should be taken together with other countries that take the same view on such issues. The Commission would emphasise that, even though a number of countries are unlikely to sign to such a convention, experiences with other conventions which many countries have refused to sign are positive. Examples include the conventions banning the use of anti-personnel mines and cluster munitions. These have established norms, and even countries which have not signed up have applied them in various contexts and in a constructive manner. Such a convention should be general, apply to all countries and be directed against specific damaging structures rather than specific states or state systems.

Guidelines for Norfund . The Commission presents a number of detailed recommendations concerning Norfund, which include the preparation of ethical guidelines on the choice of investment location and how Norfund should report its operations. In the Commission’s view, Norfund should gradually cease to make new fund investments via tax havens over a three-year period from the approval of the Commission’s report. The Commission has noted that the consequence of this will probably be that Norfund increases its direct investments in companies in developing countries, without that necessarily having a negative effect on the profitability of the institution’s investments. Furthermore, the Commission takes the view that, since Norfund has goals related to contributing to value creation and tax revenues in developing countries, the pre-tax return on its investments should be the most important investment parameter. Managing in accordance with the post-tax return means that Norfund would devote resources to minimising its tax payments in developing countries. This is not reconcilable with the institution’s objective of contributing to development in poor countries. The Commission has not found it appropriate to recommend that the government ask Norfund to withdraw from funds existing in tax havens.

The Commission takes the view that risk capital is essential for sustainable development. Norfund’s investment activities make an important contribution in that respect. When framing transitional arrangements, the owner must take into account the possibility that new rules could impose additional costs on Norfund and limit its investment opportunities.

On the other hand, account must be taken of the damaging effects of maintaining structures used to conceal illegal capital flows from developing countries. The Commission has established that tax havens represent an important hindrance to growth and development in poor countries, and that they make it opportune for the political and economic elites in developing countries to harm the development prospects of their own countries. Putting a stop to the damaging activities of tax havens is accordingly important. The Commission takes the view that a short transitional period for Norfund will send an important signal as to the significance of not using tax havens. Against the background of ongoing processes in other countries, other actors are expected to adopt similar restrictions. Therefore, Norway has an opportunity to take a leading role in this work. In the longer term, the new guidelines for Norfund could also contribute to the creation of more venues for locating funds in African countries without harmful structures.



Ugland House in George Town, Cayman Islands, which takes its name from a Norwegian ship owning family.

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