Conduit and Sink OFCs

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Conduit OFC and sink OFC is an empirical quantitative method of classifying corporate tax havens, offshore financial centres (OFCs) and tax havens. [1] [2] [3]

Contents

"Uncovering Offshore Financial Centers": CORPNET's map of connections between countries. Uncovering Offshore Financial Centers Figure 3 Network of ownership flows between countries.jpg
"Uncovering Offshore Financial Centers": CORPNET's map of connections between countries.

Traditional methods for identifying tax havens analyse tax and legal structures for base erosion and profit shifting (BEPS) tools. However, this approach follows a purely quantitative approach, ignoring any taxation or legal concepts, to instead follow a big data analysis of the ownership chains of 98 million global companies. The technique gives both a method of classification and a method of understanding the relative scale – but not absolute scale – of havens/OFCs. [5] [6]

The results were published by the University of Amsterdam's CORPNET Group in 2017, and identified two classifications: [5] [6]

Our findings debunk the myth of tax havens [lower-alpha 3] as exotic far-flung islands that are difficult, if not impossible, to regulate. Many offshore financial centers [lower-alpha 3] are highly developed countries with strong regulatory environments.

Javier Garcia-Bernardo, Jan Fichtner, Frank W. Takes & Eelke M. Heemskerk, CORPNET University of Amsterdam [4]

In 2017, the European Parliament adopted the CORPNET approach into their frameworks for addressing tax havens. [7] In 2018, research by Gabriel Zucman showed that using Orbis database connections specifically underestimates the scale of Ireland, which the Zucman–Tørsløv–Wier 2018 list showed is the largest Conduit OFC in the world. [8] [9] [10] This aside, CORPNET's Conduits and Sinks reconcile closely with the most noted academic top ten tax haven lists.

Background

"Uncovering Offshore Financial Centers": The "Cayman Islands Conundrum". Uncovering Offshore Financial Centers Cayman Conundrum.jpg
"Uncovering Offshore Financial Centers": The "Cayman Islands Conundrum".

The lack of an accepted definition for identifying tax havens (and even offshore financial centres), results in different lists, including:

There are "traditional" tax havens common on all these lists (e.g. some Caribbean and Channel Islands locations), which some global regulators have either blacklisted, or have issued formal warnings/threat of sanctions against, unless transparency is increased. [26] [27]

However, a key difference between the lists regards the major OECD and EU tax havens (or offshore financial centres), such as Switzerland, Ireland the Netherlands and Luxembourg (amongst others). [28] Major regulators like the EU and the OECD don't regard OECD or EU countries as tax havens, and point to their transparency and compliance with international regulations. [29] [30] [31] [32]

Academic leaders in tax haven research, and other non–governmental organizations, point to the role of OECD and EU tax havens in tax avoidance from base erosion and profit shifting (BEPS) schemes, like the Double Irish, the Single Malt and the Dutch Sandwich. [33] [34] [35] [36] They regard them as major tax havens in their definitions of tax havens. [9] [10]

CORPNET Report

"Uncovering Offshore Financial Centers": Example of a corporate global ownership chain. Offshore Financial Centre Chains.png
"Uncovering Offshore Financial Centers": Example of a corporate global ownership chain.

A report published in Nature in 2017 on the analysis of offshore financial centres called: "Uncovering Offshore Financial Centers: Conduits and Sinks in the Global Corporate Ownership Network", [4] provided a quantitative and scientific approach to the classification of tax havens. [37] [38] [1] [3]

The report was the result of a multi-year investigation by political economists and computer scientists in the CORPNET research group at the University of Amsterdam. CORPNET is a European Research Council funded group at the University of Amsterdam investigating networks of corporate control. [2] [39]

The report used the Moody's Orbis corporate database, [40] to examine 98 million global companies and their 71 million ownership connections (using big data computer modelling) to identify 5 global Conduit OFCs (Netherlands, United Kingdom, Ireland, Singapore and Switzerland). These are countries of high financial reputation (i.e. not formally labelled "tax havens" by OECD/EU), but who have "advanced" legal and tax structuring vehicles (and SPVs) that help legally route funds to the 24 tax havens (called Sink OFCs), without incurring tax in the Conduit OFC (or even tax in the source of funds location, where royalty payment schemes can be used). [4] [41] [5]

The work built on methods established in the "Offshore–Intensity Ratio", [42] and in particular the understanding "activity" relative to the "scale" of the domestic economy in a country. [43] At its crudest level, the Offshore-Intensity Ratio explains why the countries at the top of global GDP per capita lists are mostly tax havens.

The EU Parliament's Policy Department on Economic and Scientific Policies included the research in its findings for the EU Committee on Money laundering, tax avoidance and tax evasion (PANA), [44] and by tabulating against existing EU–IMF–FSI list of tax havens, showed material gaps in EU understanding of conduits. [7]

CORPNET's top 5 Conduits and top 5 Sinks are 9 of the 10 largest tax havens identified in 2010 by one of the academic founders of tax haven research, James R. Hines Jr.. Hines' 2010 list of 10 major tax havens only differs in its omission of the U.K., which in 2010, had only just reformed its corporate tax system. [12] CORPNET's top 5 Conduits and top 5 Sinks closely reconcile with the top 10 major corporate tax havens of other major academic and non–governmental organisation tax haven lists. Other tax academics have incorporated the research into their understanding of tax havens. [45]

Conduit OFC

2018 Global Innovation Property Centre (GIPC) Legal Systems League Table: Patents Sub-Category. GIPC Intellectual Property 2018 (Patents Sub-Category).png
2018 Global Innovation Property Centre (GIPC) Legal Systems League Table: Patents Sub-Category.

Conduit OFCs are described as having advanced legal and tax systems designed to enable corporations to route funds from high tax locations (e.g. Germany) to the Sink OFCs (e.g. Bermuda). They tend to have attractive "holding company" regimes (e.g. no withholding taxes, foreign dividends exempt from taxes, capital gains reliefs, full double–tax relief), advanced tax treatment of intellectual property regimes, and large global networks of bilateral tax treaties. [4] [47] [48]

For example, CORPNET's five major Conduit OFCs, all have a top–ten ranking in the 2018 Global Innovation Property Centre (GIPC) IP Index. [46] [49] IP has been described as the "raw materials of corporate tax avoidance", [50] and "the leading corporate tax avoidance vehicle". [51] [52]

Conduit OFCs are shown to be dominated by major law firms and global accounting firms, who create the lawfully constructed special purpose vehicles (SPVs) and BEPS tools that make the connections with the Sink OFCs, by exploiting legislative loopholes such as the Double Irish and Dutch Sandwich. They advise clients on anticipating future changes (e.g. from OECD BEPS processes), that may need new loopholes (e.g. the Single malt arrangement). [53] [4]

Other researchers into tax havens have written that professional service firms in the major OECD and EU tax havens write most of their State's relevant taxation and SPV-related legislation, so that they can create and protect loopholes, and refer to such jurisdictions as being a "captured" by their financial services industry. [54] [55] [56] The legal and tax structuring undertaken by Conduit OFCs is considered beyond the trust–structuring type work of the traditional tax haven "offshore magic circle" law firms. Conduit OFCs need structures that can integrate with bilateral tax treaties involving G20 countries, as well as meeting U.S. GAAP / SEC Regulations that U.S. multinationals, one of the largest users of Conduit OFCs, need to adhere to. [57] [58] [59]

CORPNET's top 5 global Conduit OFCs channel 47% of corporate offshore connections and include the following: [4] [60]

  1. Flag of the Netherlands.svg  Netherlands – the largest global Conduit OFC (by total connections), with dense links from the EU–28 (via the "Dutch Sandwich"), to the EU Sink OFC of Luxembourg, and the Caribbean Sink OFC "triad" of Bermuda/BVI/Cayman. [61] [1] [62]
  2. Flag of the United Kingdom.svg  United Kingdom – 2nd largest Conduit OFC (by total connections), with dense links from Europe to Asia; 18 of the 24 Sink OFCs are current, or past, dependencies of the U.K. (see table on Sink OFCs). [2] [63] [64]
  3. Flag of Switzerland.svg   Switzerland – a major Conduit OFC with a very dense network of connections with Jersey, the 4th largest Sink OFC. [1] [4]
  4. Flag of Singapore.svg  Singapore – the main Conduit OFC for Asia, and densely connected to the two major Asian Sink OFCs of Hong Kong and Taiwan. [4]
  5. Flag of Ireland.svg  Ireland – very dense connections with the US (see Ireland as a tax haven), [1] with very dense connections to Sink OFC Luxembourg, an established "backdoor" out of the Irish tax system. [65] [66]

Sink OFC

"Uncovering Offshore Financial Centers": List of Sink OFCs ordered by value (showing U.K. dependencies). List of sink-OFCs, ordered by sink centrality value.png
"Uncovering Offshore Financial Centers": List of Sink OFCs ordered by value (showing U.K. dependencies).

Sink OFCs cover a broad range of locations from very small countries (e.g. the Marshall Islands), to major global financial centres (e.g. Hong Kong). [4]

Just because funds reach a Sink OFC, does not mean that they remain dormant. Quite the contrary, the funds can be invested in assets all over the world, but their legal ownership and future gains remain in the Sink OFC. For example, the circa US$1 trillion of US company offshore cash is held in Sink OFCs (esp. the Caribbean). [67] [68]

The report highlighted some interesting aspects of the 24 Sink OFCs: [4]

  1. British Virgin Islands – in terms of connections, the BVI was the "Netherlands of Sink OFCs" and heavily linked with the Conduit OFC United Kingdom.
  2. Luxembourg and Hong Kong – could have been considered Conduit OFCs, but CORPNET's research showed they are even bigger Sink OFCs (e.g. long-term homes for funds), Luxembourg (for routing funds from high-tax EU countries), and Hong Kong (for routing funds out of China).
  3. Jersey – remains a unique link with major Conduit OFC, Switzerland (because the study could not capture individual "Jersey trusts", it noted that the scale of Jersey could still be understated).
  4. Bermuda, British Virgin Islands, Cayman Triad – these three traditional tax havens are heavily interlinked and starting to present as one large Sink OFC.
  5. Taiwan – has been a controversial entrant on several tax haven lists (the Tax Justice Network calls Taiwan the "Switzerland of Asia", [69] however, Taiwan is not on any EU/OECD/IMF tax-haven list), and is identified as the 2nd largest Asian Sink OFC.
  6. Cayman Islands – the Cayman Islands are becoming the biggest financial centre for Central and Latin America. [70]
  7. Malta – the report highlights the rise of Sink OFC Malta as an emerging tax haven "inside" the EU, [71] [72] which has been a source of wider media scrutiny. [73]
  8. Mauritius – has become a major Sink OFC for both SE Asia (especially India), and African economies, and now ranking 8th overall. [74]

OECD failings

Of the wider tax environment, O'Rourke thinks the OECD base–erosion and profit–shifting (BEPS) process is "very good" for Ireland. "If BEPS sees itself to a conclusion, it will be good for Ireland".

Feargal O'Rourke CEO PwC (Ireland)
Cited "architect" of the Double Irish BEPS tool [75] [76]
Irish Times, 2015 [77]

CORPNET highlighted the lack of progress the OECD's Base erosion and profit shifting (BEPS) project was making, and that the OECD's support of transparent intellectual property–based tax structuring (or "patent boxes" and "knowledge boxes"), is incompatible with the emerging position of intellectual property as the leading BEPS tool in conduit OFCs. [78] The reasons for this failure are discussed in failure of OECD BEPS Project.

An example of an IP–based BEPS tool is Ireland's Capital Allowances for Intangible Assets (CAIA) tool, also known as the "Green Jersey", which has an effective tax rate of 0–2.5%. Apple used the CAIA (or Green Jersey) BEPS tool in Q1 2015, resulting in the "leprechaun economics" restatement of Irish GDP by 34.4 percent. Ireland has other IP–based BEPS tools (Ireland as the first OECD nexus-compliant KDB), [79] and is a supporter of the OECD BEPS project (see box). [77]

Isle of Man omitted

The Isle of Man (the "IOM") was absent from the list of top Sink OFCs. The IOM appears on tax–haven lists and ranks 42 on the 2018 Financial Secrecy Index. [80] [81]

The Chief Minister of the IOM, Howard Quayle, announced that the CORPNET report proved that the IOM is not a tax haven. [82] [83] However, CORPNET researchers from the University of Amsterdam directly replied to Howard Quayle's article [84] clarifying that while the IOM does not appear as a leading Sink OFC for corporate tax avoidance, it does not mean that individuals (personal bank accounts and trusts) do not use the IOM to avoid taxes, and particularly United Kingdom VAT.

Other commentators have added that the IOM is "failing as a tax haven", and is now too small to appear in major studies like the CORPNET research. [85]

Ireland underestimated

The CORPNET report used legal corporate connections on the Orbis database, rather than the actual "quantum" of money, as its primary metric of analysis. In theory, the authors felt that this does not impede the goal of classification, and of making relative rankings. However, it does mean the "monetary amount" of potential tax avoidance was not calculated. [4]

The tax haven academic and author of The Hidden Wealth of Nations , Gabriel Zucman, used a different quantitative approach. Zucman focused on macro–data of national statistical accounts. In theory, the total assets in a system should equal the total liabilities. By aggregating national account data, Zucman identified an excess of liabilities over assets, implying that the missing assets (to balance the equation), are hidden in tax–havens. On this basis, in 2015, he estimated that 8% of the world's wealth (or US$7.6 trillion) was "missing" in offshore tax–havens. [86] [87]

Zucman's analysis highlighted the special case of Ireland and why the Orbis database underestimates Ireland's scale as one of the world's largest corporate tax avoidance, or BEPS, hubs. [88] In 2018, Zucman (et alia) showed that many of Ireland's U.S. multinationals don't appear on Orbis (e.g. Facebook), or only have a small fraction of their data on Orbis (e.g. Google and Apple). Analysed using "quantum of funds" (not "Orbis connections"), Zucman showed Ireland is one of the largest corporate tax shelters in the world, and a route for Zucman's estimated loss of 20% in EU corporate tax revenues annually. [8] [9] [10]

See also

Notes

  1. See the table below for the list of the sinks.
  2. The conduits are: Netherlands, United Kingdom, Switzerland, Singapore, and Ireland.
  3. 1 2 As discussed in the Definitions sections of tax havens, and of offshore financial centres, most tax academics consider the terms as being synonymous and use them inter–changeably

Related Research Articles

A corporate haven, corporate tax haven, or multinational tax haven, was used to describe a jurisdiction that multinational corporations find attractive for establishing subsidiaries or incorporation of regional or main company headquarters, mostly due to favourable tax regimes, and/or favourable secrecy laws, and/or favourable regulatory regimes.

International Financial Services Centre Financial centre in Dublin, Ireland

The International Financial Services Centre (IFSC) is an area of central Dublin and part of the CBD established in the 1980s as an urban regeneration area and special economic zone (SEZ) on the derelict state owned former port authority lands of the reclaimed North Wall and George's Dock areas of the Dublin Docklands. The term has now morphed into use as a metonym for the Irish financial services industry as well as being used as an address and still being classified as an SEZ.

Corporation tax in the Republic of Ireland Irish corporate tax regime

Ireland's Corporate Tax System is a central component of Ireland's economy. In 2016–17, foreign firms paid 80% of Irish corporate tax, employed 25% of the Irish labour force, and created 57% of Irish OECD non-farm value-add. As of 2017, 25 of the top 50 Irish firms were U.S.–controlled businesses, representing 70% of the revenue of the top 50 Irish firms. By 2018, Ireland had received the most U.S. § Corporate tax inversions in history, and Apple was over one–fifth of Irish GDP. Academics rank Ireland as the largest tax haven; larger than the Caribbean tax haven system.

Financial centre Locations which are centres of financial activity

A financial centre, financial center, or financial hub is a location with a concentration of participants in banking, asset management, insurance or financial markets with venues and supporting services for these activities to take place. Participants can include financial intermediaries, institutional investors, and issuers. Trading activity can take place on venues such as exchanges and involve clearing houses, although many transactions take place over-the-counter (OTC), that is directly between participants. Financial centres usually host companies that offer a wide range of financial services, for example relating to mergers and acquisitions, public offerings, or corporate actions; or which participate in other areas of finance, such as private equity and reinsurance. Ancillary financial services include rating agencies, as well as provision of related professional services, particularly legal advice and accounting services.

A tax haven is a country or place with very low "effective" rates of taxation for foreign investors. In some traditional definitions, a tax haven also offers financial secrecy. However, while countries with high levels of secrecy but also high rates of taxation, most notably the United States and Germany in the Financial Secrecy Index ("FSI") rankings, can be featured in some tax haven lists, they are not universally considered as tax havens. In contrast, countries with lower levels of secrecy but also low "effective" rates of taxation, most notably Ireland in the FSI rankings, appear in most § Tax haven lists. The consensus around effective tax rates has led academics to note that the term "tax haven" and "offshore financial centre" are almost synonymous.

Offshore financial centre Corporate-focused tax havens

An offshore financial centre or OFC is defined as a "country or jurisdiction that provides financial services to nonresidents on a scale that is incommensurate with the size and the financing of its domestic economy."

Double Irish arrangement Irish corporate tax avoidance tool

The Double Irish was a base erosion and profit shifting (BEPS) corporate tax tool used mostly by US multinationals since the late 1980s to avoid corporate taxation on non-U.S. profits. It was the largest tax avoidance tool in history and by 2010 was shielding US$100 billion annually in US multinational foreign profits from taxation, and was the main tool by which US multinationals built up untaxed offshore reserves of US$1 trillion from 2004 to 2018. Traditionally, it was also used with the Dutch Sandwich BEPS tool; however, changes to Irish tax law in 2010 dispensed with this requirement.

Institute on Taxation and Economic Policy Washington non-profit non-partisan tax think tank

The Institute on Taxation and Economic Policy (ITEP) is a non-profit, non-partisan think tank that works on state and federal tax policy issues. ITEP was founded in 1980, and is a 501(c)(3) tax-exempt organization. ITEP describes its mission as striving to “keep policymakers and the public informed of the effects of current and proposed tax policies on tax fairness, government budgets and sound economic policy.”

Financial Secrecy Index qualitative ranking of secrecy jurisdictions

The Financial Secrecy Index (FSI) is a report published by the advocacy organization Tax Justice Network which ranks countries by financial secrecy indicators, weighted by the economic flows of each country.

Base erosion and profit shifting Multinational tax avoidance tools

Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to "shift" profits from higher-tax jurisdictions to lower-tax jurisdictions, thus "eroding" the "tax-base" of the higher-tax jurisdictions. The Organisation for Economic Co-operation and Development (OECD) define BEPS strategies as "exploiting gaps and mismatches in tax rules".

Dutch Sandwich Dutch withholding tax avoidance tool

Dutch Sandwich is a base erosion and profit shifting (BEPS) corporate tax tool, used mostly by U.S. multinationals to avoid incurring EU withholding taxes on untaxed profits as they were being moved to non-EU tax havens. These untaxed profits could have originated from within the EU, or from outside the EU, but in most cases were routed to major EU corporate-focused tax havens, such as Ireland and Luxembourg, by the use of other BEPS tools. The Dutch Sandwich was often used with Irish BEPS tools such as the Double Irish, the Single Malt and the Capital Allowances for Intangible Assets ("CAIA") tools. In 2010, Ireland changed its tax-code to enable Irish BEPS tools to avoid such withholding taxes without needing a Dutch Sandwich.

Bermuda Black Hole Corporate tax avoidance strategy

Bermuda black hole was an historical term given to the final destination for untaxed global profits of corporate base erosion and profit shifting (BEPS) tax avoidance schemes which ended up in Bermuda, which is considered a tax haven. The term was most associated with US technology multinationals such as Apple and Google who used Bermuda as the "terminus" for their Double Irish arrangement tax structure.

Gabriel Zucman French tax economist

Gabriel Zucman is a French economist known for his research on tax havens and corporate tax havens from his 2015 book The Hidden Wealth of Nations: The Scourge of Tax Havens. Zucman is also known for his work on the quantification of the financial scale of base erosion and profit shifting (BEPS) tax avoidance techniques employed by multinationals in corporate tax havens, through which he identified Ireland as the world's largest corporate tax haven in 2018. Zucman showed that the leading corporate tax havens are all OECD–compliant, and that tax disputes between high–tax locations and havens are very rare. Zucman's papers are some of the most cited papers on research into tax havens. In 2018, Zucman was the recipient of the Prize for the Best Young Economist in France, awarded by the Cercle des économistes and Le Monde in recognition of his research on tax evasion and avoidance and their economic consequences. He is currently an Associate Professor of Public Policy and Economics at the University of California, Berkeley‘s Goldman School of Public Policy.

The OECD G20 Base Erosion and Profit Shifting Project is an OECD/G20 project to set up an international framework to combat tax avoidance by multinational enterprises ("MNEs") using base erosion and profit shifting tools. The project, led by the OECD's Committee on Fiscal Affairs, began in 2013 with OECD and G20 countries, in a context of financial crisis and tax affairs. Currently, after the BEPS report has been delivered in 2015, the project is now in its implementation phase, 116 countries are involved including a majority of developing countries. During two years, the package was developed by participating members on an equal footing, as well as widespread consultations with jurisdictions and stakeholders, including business, academics and civil society. And since 2016, the OECD/G20 Inclusive Framework on BEPS provides for its 137 members a platform to work on an equal footing to tackle BEPS, including through peer review of the BEPS minimum standards, and monitoring of implementation of the BEPS package as a whole.

Irish Section 110 Special Purpose Vehicle (SPV) Irish zero-tax legal structure

An Irish Section 110 special purpose vehicle (SPV) or section 110 company, is an Irish tax resident company, which qualifies under Section 110 of the Irish Taxes Consolidation Act 1997 (TCA) for a special tax regime that enables the SPV to attain "tax neutrality": i.e. the SPV pays no Irish taxes, VAT, or duties.

Modified gross national income Metric to replace distorted Irish GDP

Modified gross national income, Modified GNI or GNI* was created by the Central Bank of Ireland in February 2017 as a new way to measure the Irish economy, and Irish indebtedness, due to the increasing distortion that the base erosion and profit shifting ("BEPS") tools of US multinational tax schemes were having on Irish GNP and Irish GDP; the climax being the July 2016 leprechaun economics affair with Apple Inc.

Feargal ORourke Managing Partner of PwC, Dublin

Feargal O'Rourke is an Irish accountant and corporate tax expert, who is the managing partner of PwC in Ireland. He is considered the architect of the famous Double Irish tax scheme used by U.S. firms such as Apple, Google and Facebook in Ireland, and a leader in the development of corporate tax planning tools, and tax legislation, for U.S. multinationals in Ireland.

Ireland as a tax haven The notion that the Republic of Ireland is a tax haven

The Republic of Ireland has been labelled as a tax haven or corporate tax haven by multiple financial reports, an assertion which the state denies. Ireland's base erosion and profit shifting (BEPS) tools give some foreign corporates § Effective tax rates of 0% to 2.5% on global profits re-routed to Ireland via their tax treaty network. Ireland's aggregate § Effective tax rates for foreign corporates is 2.2–4.5%. Ireland's BEPS tools are the world's largest BEPS flows, exceed the entire Caribbean system, and artificially inflate the US–EU trade deficit. Ireland's tax-free QIAIF & L–QIAIF regimes, and Section 110 SPVs, enable foreign investors to avoid Irish taxes on Irish assets, and can be combined with Irish BEPS tools to create confidential routes out of the Irish corporate tax system. As these structures are OECD–whitelisted, Ireland's laws and regulations allow the use of data protection and data privacy provisions, and opt-outs from filing of public accounts, to obscure their effects. There is arguable evidence that Ireland acts as a § Captured state, fostering tax strategies.

Qualifying investor alternative investment fund Irish zero-tax legal structure

Qualifying Investor Alternative Investment Fund or QIAIF is a Central Bank of Ireland regulatory classification established in 2013 for Ireland's five tax-free legal structures for holding assets. The Irish Collective Asset-management Vehicle or ICAV is the most popular of the five Irish QIAIF structures, and was designed in 2014 to rival the Cayman Island SPC; it is the main tax-free structure for foreign investors holding Irish assets.

James R. Hines Jr. is an American economist and a founder of academic research into corporate-focused tax havens, and the effect of U.S. corporate tax policy on the behaviors of U.S. multinationals. His papers were some of the first to analyse profit shifting, and to establish quantitative features of tax havens. Hines showed that being a tax haven could be a prosperous strategy for a jurisdiction, and controversially, that tax havens can promote economic growth. Hines showed that use of tax havens by U.S. multinationals had maximized long-term U.S. exchequer tax receipts, at the expense of other jurisdictions. Hines is the most cited author on the research of tax havens, and his work on tax havens was relied upon by the CEA when drafting the Tax Cuts and Jobs Act of 2017.

References

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