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Puzzle of tax havens and shell firms

First published in the Business Daily on April 18, 2016.

The Panama Papers, confidential data leaked from Mossack Fonseca, a Panamanian law firm, have brought to light the appetite for anonymous offshore structures by high net worth individuals and high ranking government officials, including heads of state.

To understand the choice of these structures, one has to understand tax havens and shell companies. In comparison with other jurisdictions, tax havens have lower tax obligations. Shell companies are structured to fairly conceal the identity of the persons with beneficial interest in the companies’ assets.

Combined, the anonymity of a shell company and favourable tax obligations in tax havens make these jurisdictions favourable destinations for large sums of money.

Several former and current government officials and individuals in Kenya have been implicated in various money laundering schemes using shell companies in tax havens such as Jersey Island, Mauritius and Panama Island.

While these structures are vulnerable to money laundering schemes, proper tax planning achieves legitimate results through tax avoidance. Tax avoidance, contrasted with tax evasion, is legal. It aims at settling on the structure that subjects a person to the least amount of taxes.

The OECD, tasked with promotion of global economic policies, noted a trend by multinational corporations to avoid tax obligations by shifting profits to areas with lower or no corporate tax obligation, strategies referred to as Base Erosion and Profit Shifting (BEPS).

Structures

Developing nations suffer the most from BEPS, given their reliance on tax which usually translates to higher corporation tax for these multinationals.

The OECD has developed a tool to address BEPS by providing for charging tax in the jurisdiction where the profit is realised. The Common Reporting Standard developed by the OECD further increases transparency in corporate financial reporting. States are encouraged to obtain information from financial institutions and exchange the information with other states, annually.

From my discussions with Joseph Margéot Jolicoeur, a consultant in global tax efficient structures, the changes in global tax policies and the threat on confidential information impact on the trust in offshore investment vehicles. However, he notes that with proper structures in place, there is no need for clients to panic.

Professional tax planning should be sought to set up tax compliant structures that do not collide with tax requirements in respective countries of residence. For multinationals, while these policy developments may increase reporting obligations and potentially reduce profits, the certainty as to the applicable tax rules is a silver lining.

On their part, tax advisors should be challenged to implement a knowledge management system to ensure the client remains informed about regulation changes in the global tax environment.

As the high net worth individuals and multinationals seek shelter in tax havens, developing nations ought to consider ways of sealing loopholes in their tax law to avoid loss of revenue.

Written by Johnson Kariuki