Dr.

SHAKUNTALA MISRA NATIONAL REHABILITATION

UNIVERSITY LUCKNOW

Faculty of Law

PROJECT ON

Tax haven in india

Tax havens: An Indian Perspective
1. INTRODUCTION: This paper will attempt to achieve the following four objectives:
(a) To compile a list of various tax havens in the Indian context
(b) To analyse the effects of these tax havens on non-tax haven countries
(c) To analyse the effects from the Indian point of view
(d) List some measures which can be taken by India to control them

Tax havens are countries with low tax regimes which provide individuals and businesses
opportunities of tax avoidance or tax evasion. There are roughly 45 tax havens in the world today.
These tax havens are generally small and affluent, comprising about 0.8 percent of the world
population and accounting for about 2.3 percent of the world income (Hines, 2005). These
disproportionate figures justify the global attention which the tax havens have been receiving
lately. The OECD which has been working on the harmful trade practices for nearly a decade now
has recently become more aggressive. The 2008 Liechtenstein affair was an eye opener for the
whole world. In the Indian context, these tax havens not only hit the tax base but are also
detrimental to the national security as their opaque system of information exchange help in the
financing of many anti national activities. Due to these and many other concerns discussed later in
the paper, there is an imminent need to take measures to control their menace. Though tax havens
have been highly written about, this term paper looks at them from the point of view of india.
2. REVIEW OF LITERATURE: Extensive work has been done on the determinants of tax
havens. A fact which is well documented in literature is that tax havens tend to be small
countries, generally more affluent than other countries, with low level of taxes and secrecy
jurisdictions. Also, countries with economic stability, good financial markets and big
concentrations of wealthy individuals are more likely to become tax havens (Jhons, 1983;
Palan, 2002; Hansen and Kessler, 2001 and hines, 2007). According to Dharmapala and Hines
(2006) countries with good quality of governance is one of the more prominent but ignored
determinant of tax havens.
There are both positive and negative effects of tax havens and the literature has explored
both the facets of their existence. The fact that tax havens flourish economically is commonly
accepted. But also acknowledged is the point that tax havens erode the tax base in high tax
countries. The effects of tax havens on economic welfare in high tax countries are unclear,
though the availability of tax havens stimulates economic activity in nearby tax haven countries
(Hines, 2007).

3. WHAT IS A TAX HAVEN?: Organizations like OECD, TJN etc. have come out with list
of tax havens from time to time. The basic criteria used by these organizations for listing the
tax havens can be summed up in the following four points :
3.1. Very low or no capital tax on income: The primary aim of tax havens is to attract foreign
investment and hence they have to give the foreign investors incentives to do so. But the
existence of low or zero tax regimes is not by any means a sufficient condition though it
is a necessary one. In fact, the OECD recognizes that every jurisdiction has a right to
determine whether to impose direct taxes and, if so, to determine the appropriate tax rate.
The following three criteria have to satisfied for a country to be classified as tax haven.
3.2. A very special tax regime for shell companies (ring fencing): A shell corporation is a
company which serves as a vehicle for business transactions without itself having any
significant assets or operations (definition taken from www.wikipedia.org). The number
of companies in these countries (tax havens) per capita is much greater than in many
industrially and financially developed countries. British Virginia Island which has a
population of 19000 has 830 000 companies registered. This is apart from the unknown
number of trust, banks etc. registered there. The scope of such registrations is best gauged
 by the fact that a small office building in George Town (in Cayman Islands) serves as the
registered address for more than 18 000 companies.
The truth is that these companies are shell companies with no or very limited local
business activity. Typically such companies are denied privileges such as they cannot own
or rent real property, their owners cannot reside locally or transact in local currency etc.
Tax havens are generally characterized by tax and regulatory regimes that distinguishes
between locals and these shell companies (foreign investors) with regulations being
favorable to the latter in many ways. Such a regime is known as ring-fenced. Companies
governed under such a regime are wholly or partially exempted from paying taxes, have
no obligation regarding accounting and auditing, have no duty to preserve important
corporate documents, and they can shift to other jurisdictions with minimum of
formalities. In fact, these companies have only one obligation as far as the tax haven in
which they are registered is concerned- pay the required registration or administration fees
and this is how these countries earn their revenues from them.
3.3. A lack of transparency concerning the ownership and no effective exchange of information
on tax issues with other countries and jurisdictions: the legal framework in tax havens is
designed to conceal the identity of the owner, the company’s actual activity and
transactions form the authorities in the country in which business transaction really takes
place. Secrecy is reinforced by the absence of public registries particularly of those
companies which intend to do business in other countries. Whatever information is present
is also difficult to access. Considering the above points, it is clear that those countries
which are affected by the operation of these companies and have claims against their
owners have no way of knowing what is actually happening
Dharmapala and Hines gave the following criterion to judge whether a country is tax haven
or not
a) The tax haven countries are generally small in size, commonly below 1 million in
population. This is so because small countries are price takers in the world scenario. As a
result they can’t transfer their tax burden to the foreigners. Moreover, the high rate of
corporate taxes may well lead to reduction in wage rates, land prices and deadweight losses
due to inefficient taxation which further harm the domestic factors. Dharmapala and Hines
(2006) used the Hines-Rice definition and compiled summary statistic of the size of a
country (in terms of population and area) for tax havens and non-tax havens separately
and confirmed the fact stated here. They found the average population of tax havens to be
1145.69 thousand while for non-tax havens this figure was 126475.9 thousand.
b) Those countries which are affluent tend to be tax havens. Affluence of a country is
measured in terms of its GDP per capita. Countries with greater affluence (i.e. higher gdp
per capita) are more likely to be tax havens than other countries with lesser affluence other
parameters remaining same. This is again confirmed in Dharmapala and Hines (2006)
which found out the average GDP per capita (US $ in PPP terms) of tax haven countries
to be 18.51 thousand and 9.55 thousand for non-tax havens.
c) Countries with good governance are more likely to be tax havens. Tax haven countries
have a mean government index of 0.73 which is quite higher than that of the non-tax haven
countries (.13) (Dharmapala and Hines, 2006). This is because the returns of becoming
tax havens are more for countries with good governance. The high foreign investment and
the economic growth which it brings with it result in lowering of taxes in well governed
countries, one if the most basic conditions to be satisfied by a tax haven country.

It can be seen clearly that the ratio of FDI to GDP increases tremendously when a well
governed country reduces tax while there is almost a negligible and unfavorable change
for a poorly governed country. Moreover these countries generally have tax treaties with
foreign countries which facilitate tax avoidance for foreign investors thereby bringing in
more foreign investment. Tax avoidance is again one of the major factors why foreign
firms invest in these countries. On the other hand, the poorly governed small countries
tend to have high tax rate because it is one of the major sources of their income. Also,
these countries have corrupt government and bureaucratic officials. The high level of
corporate taxes increase their bargaining power while negotiating bribes.
One more reason is that while all small countries may like to become tax havens but only
the better governed of those can credibly commit to not expropriating foreign investors in
the long run (either directly or through high tax rates).

It can be seen that even though the tax havens tend to have a relatively high GDP per
capita, yet they are predominantly clustered above the fitting line showing better
 governance quality for tax havens as compared to other countries at all levels of GDP.
Thus tax havens appear to be better governed than would be expected given their
affluence.

4. Specifying the model: Now one has to develop a model to find the tax havens in
the Indian context. Keeping in mind the findings of Dharmapala and Hines (2006),
it can be said that any country which is (a) small, (b) affluent, (c) has good quality
of governance, (d) is internationally open and (e) has considerable amount of
investment in India will be a tax haven for India. Since one can’t quantify the first
four determinants at this level, an alternative approach is being used to check if the
country being considered satisfies the first four conditions. This criterion is: presence
in OECD (2009) and TJN (2007) tax haven list. Using these criteria is totally justified
because presence in both the lists guarantees that a country will satisfy these 4
conditions (as proved by Dharmapala and Hines, 2006). So presence in both the lists
means that a country is tax haven for sure. All that remains to be checked now is
whether it is a tax haven in the Indian context. For this, it has to be considered if the
country is channeling considerable funds into India. But since the top 20 contributors
to Indian FDI are taken in the sample to be analyzed here, this problem is taken care
of. A table of the analysis has been provided in the appendix (TABLE 1).
5. NEGATIVE EFFECTS OF TAX HAVENS
5.1. Used for tax avoidance by MNC’s: In residency international taxation systems (like the
one in USA), the taxation of foreign income is deferred until the income repatriates to the
company based in the home country. In such cases, MNC’s instead of repatriating the
foreign income prefer to hold it in their tax haven affiliates or invest it through these
affiliates thus escaping from taxation in the home country. The taxes in the tax havens are
either negligible or altogether zero.
Another way to achieve this is the strategic use of transfer pricing. One of the
mostly used examples is intellectual property. Affiliates of the same MNC can choose
where to locate their research and development operations such that royalty payments flow
towards low tax jurisdictions. Desai, Foley and Hines (2006a) find that US MNC’s with
higher focus on research and development are likely to establish base in tax haven
 countries. Another strategy that MNC’s follow is the strategic use of debt among affiliates.
They locate their debts in the high tax jurisdictions, thus directing interest payments to
low tax jurisdictions. In this way, they generate tax deductions in high tax countries. Desai,
Foley and Hines (2004a) find that US MNC’s tend to locate debt in high tax countries.
(Also can use fig 2a and 2b in what are the opportunities and problems of tax havens). The
brief discussion above shows that MNC’s have enough incentives to use tax havens for
tax planning and tax avoidance.
5.2. Used for tax evasion by individuals: In February 2008. An international scandal
involving tax evasion unfolded after German authorities purchased information from a
former employee of a Liechtenstein bank. This information led to the persecution of many
German individuals for tax evasion by holding money in secret accounts in that bank. This
scandal emphasizes the use of tax havens by individuals to evade home country taxes.
These countries offer superior legal protection from creditors and potential litigants who
might try to seize an individual’s wealth. Switzerland and Liechtenstein banks are
notorious for this
5.3. Unhealthy tax competition: Due to the increased capital mobility, it has become possible
to lure foreign capital by reducing tax rates. Tax havens have reinforced tax competition
by offering secrecy laws and fictitious domiciliary positions.
Countries generally try to overcome the problem of taxation by assigning the right
to tax mobile capital in the country of domicile or origin. But this depends on the home
country obtaining information from the source country which becomes extremely difficult
considering the secrecy jurisdictions of the tax havens. This not only amounts to erosion
of tax base for the home country but is a direct threat to their sovereignty.
In order to offset the losses incurred due to the lost capital gains tax, countries
generally increase taxes on the immobile items. This has to secondary effects. First, it
affects the way the tax burden is distributed in society. For example, the lowering of capital
tax rates means that owner of the capital pay smaller portion of the total tax and the wage
earners pay a higher portion. Second, this kind of a tax regime directs allocation of
resources (both by companies and employees) away from what is socially optimal. For
example, a higher tax on earned income may give incentives to workers to work less and
 thus reduces the overall efficiency in relation to the position in which the earned income
is not taxed or taxed at lower rates.
The costs of tax competition are born by all countries but are particularly high for
developing countries. This is because developing countries derive most of their revenues
by taxing capital. As a result they have to reduce investments in the public sector thereby
forfeiting their development.
5.4. Inefficient allocation of investment: Investments should be made where they yield
highest pre-tax return i.e. where socio-economic returns are best. But private investors are
interested in post-tax returns. As a result if given the opportunity private investors would
like to route their investments through tax havens which offer low and sometimes zero tax
rates. Tax havens are thus capable of changing investors’ behavior and thereby decrease
the difference between socio-economic and private returns. As a result of this tax havens
lower the overall value creation of society.
5.5. Effects of secrecy: The tax havens have two major characteristics. First, they offer tax
affiliation without the company or investor engaging in any real activity and second, they
hinder the flow of information and provide anonymity to their foreign investors from their
home country as well as possible creditors. In return for this, they charge a fee. Therefore
it is clear that tax havens offer low tax as baits to sell tax evasion technology. In other
words, they reduce the costs of committing crime (of tax evasion) by concealing the
criminal activity as well as its gains.
5.6. More inequalities division of tax revenues: The use of tax havens also affects which
countries have the right to tax capital income which can lead to a more unequal distribution
of tax revenues.
Under the international law, both the domicile as well as the source country has the
right to impose taxes on capital gains. In order to prevent this nuisance of double taxation
to the investors, bilateral treaties are signed by countries all over the world. These treaties
usually apply the domiciliary principle i.e. the country in which the investor is registers or
domiciled retains the right to tax capital gains and not the source country. The justification
given for this is that if a taxpayer pays tax in the country in which he is domiciled then he
benefits from the public services financed by that tax. This justification disappears in case
of foreign entities merely registered in the tax havens. One major characteristic of tax
 havens is that only minimal link exits between the registered entity and the jurisdiction. In
such a case, principle of fairness suggests that right to tax should lie with the source
country.
5.7. Effects on the international financial market: Registering companies or funds in the tax
havens creates uncertainty because third parties are denies information about the actual
commitments of the counterparties. Because of lack of confidence in the government (of
a tax haven) to support companies in the eventuality of a crisis, market players start to
mitigate counterparty risk with companies which transact substantial business using tax
havens. Hence companies operating in tax havens pose an additional risk for the
international financial market. This is well illustrated by the fact that in the run up to the
recent financial crisis, many companies were found to have off-balance-sheet liabilities in
their accounts such as SPV’s (special-purpose vehicles) which were registered in tax
havens.
All in all tax havens have resulted in information asymmetry between the players in
the financial market leading to lack of confidence and uncertainty. As a result, the risk
premiums have increased on financial transactions in the international financial market.
At the same time, they have led to big stock market fluctuations as players sought to
mitigate counterparty risk.
6. POSITIVE EFFECTS OF TAX HAVEN- The economic literature suggests that tax
havens could have positive impacts on development and prosperity in tax haven countries as
well as those which are not. Though the benefits of being a tax haven are numerous to the tax
haven country itself (political stability, a well-functioning legal system, absence of corruption,
economic benefits etc.), but keeping in mind my objective in this paper I limit myself to
enlisting benefits for countries like India which are not tax havens. As it turns out, in case of
non-tax haven countries the only positive effect which can be thought of is the following-
6.1. Increased level of investment in non-tax haven countries: tax haven can positively
affect the amount of foreign investment in a country if the investors can route their money
through the tax havens. This is because routing through tax havens can increase the returns
on the investments in the source country and thereby making them attractive for further
investment.
7. EFFECTS FROM INDIAN PERSPECTIVE: The magnitude of the tax haven menace
in India can be gauged from the fact that Mauritius- a small country with economy 1/100th the
size of the Indian economy has been the major exporter of foreign capital to India (it roughly
accounts for 43% of the Indian FDI). In section 5, the harmful effects of tax havens have been
looked at from a world perspective i.e. how the tax havens affect the world socially and
economically. This section, on the other hand, explains why the tax havens are a greater threat
to India than other developed countries. It also looks at a couple of threats which are
particularly relevant to India and other developing countries than to the other developed
countries.
7.1. The amount of money stashed away from India between 2002- 2006 is estimated to be US
$ 27.3 billion annually. For these five years the total sum would be (27.3 *5) US $136.5
billion. The important fact is that this is only for five years. The figure for the amount lost
from 1991 (when India liberalized and foreign investment started pouring in) till date
would be several times this figure. But this loss in tax revenue is far more serious for India
than other rich countries. This is because, when such a phenomenon occurs in developed
countries, they retaliate by increasing the tax on immobile items and reducing the tax on
mobile capital. This is not possible in case of India because due to the inefficient and weak
tax collection system, taxes on immobile tax items (mostly wage earners) are difficult to
identify and collect. Hence loss of capital gains tax in case of India and other developing
countries means a reduction in the economic activity by the public sector which in turn
hinders the growth process.
7.2. A growing cause of concern for India is the use of tax havens for undercover financing of
terrorist activities. Indian NSA Mr. MK Naraynan raised this concern during his speech
‘link between the world of finance and terrorism’ in berlin in 2007. As a result, the secrecy
laws in tax haven countries pose a direct threat to our security.
7.3. Another major consequence of tax havens for India is that they contribute to the
weakening of the quality of institutions, bureaucracy and political system. This is because
tax havens give the politicians self interest in weakening the quality of existing
institutions. The lack of effective law enforcement agencies means that politicians can
take advantage of opportunities provided by tax havens to conceal money earned from
economic crime and through rent seeking. A very good example of this is the oil rich
 countries which in spite of being resource rich tend to be undemocratic, have great
inequalities in distribution of wealth and officials there are highly corrupt (Ross 2001b).
Since institutional development is one of the main pre-requisites of national growth, it can
be said that tax havens in this way are hampering growth in India.
8. STEPS TO BE TAKEN BY INDIA- Tax havens are heightening inequality and poverty,
corroding democracy, reducing the efficiency of financial markets, undermining regulation,
reducing tax base and curbing economic growth, and promoting corruption and crime not only
in India but throughout the world. On the other hand, their positive effects are much too less
and in no way can offset the losses which the countries around the world face on their account.
A list of various measures which can be taken by India are:
8.1. First, India must maintained disaggregated and robust databases that measure and record
financial flows to different centers in the country, including by financial institutions such
as hedge funds and SWFs. This will provide a firmer foundation for monitoring illegal or
harmful flows.
8.2. Second, there is a need to reform financing rules for the political parties and for elections;
and tighten disclosure requirements for NGOs and for religious and charitable
organizations. This along with more persistent and effective use of the Right to
Information Act can help mitigate the flow of illegal money abroad, strengthening India's
fiscal base.
8.3. Third, India must review its DTAAs, and monitor their use, particularly with countries
such as Mauritius, which account for disproportionate share of FDI in India. It should also
monitor stringently the activities of countries aggressively using "fiscal dumping" such as
Singapore and Dubai. It is also imperative that Mumbai is developed as an international
financial center, minimizing the need for importing financial services.
8.4. Fourth, India must reform its own tax policies and administration to ensure that they are
internationally competitive and compatible. Frequent changes in tax policies, excessive
use of cesses and surcharges, and use of such dysfunctional tax such as the fringe benefit
tax must be avoided.
8.5. Finally, the term "black money" used by the media and in policy debates reflects
colonisation of the mind, where "black" is associated with something undesirable, and
 "white", with something that is desirable. This subconscious devaluation of own sense of
worth must be explicitly discarded.
8.6. We should push for harmonization or coordination of national taxes in the international
agencies.
8.7. India must include provisions in tax treaties with tax havens to have the right to impose a
withholding tax up to a certain limit so that at least a share of revenues is retained.
 CONCLUSION:

A country which appears in the tax haven list composed by OECD and TJN and is a significant
contributor to foreign investment in India despite it small size has been taken to be a tax haven in
the Indian context. According to these criteria the five biggest and most harmful tax havens for
India are Mauritius, Singapore, Cyprus, Switzerland, Cayman Islands.

The available evidence indicates that tax havens are a real threat to India since they
undermine our national security, erode our tax base and weaken our institutional and political
set up. They also reduce the overall efficiency of financial markets and reduce the cost of
committing crimes such as tax evasion. In short, the positive effects of tax havens are too less
as compare to the threats posed by them. Moreover, most of the positive effects of tax havens
are on their economies while they affect the world economy in general negatively. Hence these
countries have to be dealt with strong measures. The countries around the world have to join
hands to curb the menace posed by them. The most important thing is to compel these tax
havens to exchange information and to keep better record of the business activity going inside
their boundaries. On the other hand, we also have to keep a better track of the finances of the
various political parties, rich businessmen and NGO’s.

TABLE 1

Ranking w.r.t country Whether Whether Tax

Contribution included included Haven
to Indian FDI in OECD in TJN (in the
tax haven tax haven Indian
list (2009) list context)
(2007) (Y/N)
1 Mauritius ● Y Y
2 Singapore ● Y Y
3 U.S.A (New ● Y Y
York)
 4 U.K ● Y Y
(London)
5 Netherlands ● Y Y
6 Cyprus ● Y Y
7 Japan ● N N
8 Germany(Fra ● Y Y
nkfurt)
9 U.A.E ● Y Y
10 France ● N N
11 Switzerland ○ Y Y
12 Italy ● Y Y
(Campione
d'Italia)
13 Sweden ● N N
14 Cayman ○ Y Y
Island
15 Indonesia ◊ N N
16 South Korea ● Y Y
17 Spain ● Y Y
(Mellila)
18 British ○ Y Y
Virginia
19 Hong Kong ● Y Y
20 Bermuda ○ Y Y

“●” represents jurisdictions that have substantially implemented the internationally

agreed standard of tax: Mauritius, Cyprus, U.S.A, U.K, Netherlands, Japan, Germany,
U.A.E, Italy, South Korea, Spain, Hong Kong
“○” represents Jurisdictions that have committed to the internationally agreed standard
of tax but have not substantially implemented: Switzerland, Cayman Islands, British
Virgin Islands, Bermuda

“◊” represents countries which are do not appear on the OECD List
List of OECD tax havens as of 2009- taken from the official OECD site- www.oecd.org
List of TJN tax havens as of 2007 –taken from “identifying tax havens and offshore
centres” (briefing paper, TJN)
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