The world will lose $4.7 trillion of revenue in the next decade to tax havens. How did we get here?

Countries around the world are about to lose, collectively, an estimated $4.7 trillion in revenue over the next decade unless reforms are made to global tax rules, according to a recent report released on 25 July by a London-based international tax fairness advocacy group, Tax Justice Network (TJN), in its State of Tax Justice 2023. 

The majority (64%) of the lost revenue is attributed to multinational corporations, that engage in profit-shifting. This is a strategic tactic which is choosing jurisdictions that have low tax (ie tax havens) to assign a disproportionate share of a corporation's profits while they were primarily generated by a company's economic activities in higher-tax areas. 

The remaining 36% of the $4.7 trillion shortfall is attributable to wealthy individuals who benefit from financial secrecy rules, making it easy to hide assets in offshore havens from tax authorities. The TJN authors of the paper believe that $4.7 trillion is roughly equivalent to a year's worth of global public health spending.

And Bangladesh has a couple of wealthy individuals also playing in this field. 

The report says Bangladesh is losing a staggering $361 million annually due to shifting profits through offshore shell companies by multinational corporations into tax havens abroad. Additionally, the country is losing $26 million each year due to tax evasion by private individuals. 

The combined tax loss of $387 million represents 1.5% of Bangladesh's tax revenue, which is higher than the regional average. 

The TJN's report sheds light on the gravity of the problem – revealing multinational companies shifting $1.4 billion in profit out of Bangladesh each year through cross-border tax abuse and individuals hiding wealth offshore.

In the face of staggering inflation and a dried-out dollar stock, can we really afford to lose this much money? 

How did we get here?

The roots of the concept of going under the radar to avoid paying taxes date back to ancient Greece. During the Classical Age, some 4,000 years ago, Greek merchant ships would avoid docking in ports that would charge them a trade tax or customs duties. The traders tried to do business outside the ports. 

Other studies trace tax havens back to the Roman Empire or the age of colonialism when the Caribbean Sea gave refuge to pirates seeking to hide ill-gotten gold.

The first modern-day tax havens date back to 1880, when the US states of New Jersey and Delaware decided to provide reduced taxes to enterprises willing to set up shop in their territory. It was the first time a sovereign government imposed a tax exemption on its whole area. 

The practice became increasingly widespread in the 1920s, and other countries such as the Bahamas and Switzerland adopted it. The Swiss bank secrecy law, which criminalised the revelation of banking data, went into effect in 1930 and was tightened in 1934. 

According to the report How we got here: A historical perspective on tax fraud and tax evasion by Miguel Viegas for the European Parliament, "between 1920 and 1938, offshore fortunes, ie those of non-residents in Switzerland, jumped from 10 billion to 125 billion Swiss Francs!  However, it was mainly after World War II that a number of territories began specialising in favourable tax treatments to huge fortunes and strict banking secrecy rules." 

Miguel further stated in his report that the major financial markets themselves actively promoted the establishment of tax havens in the 1960s, and later with the emergence of petrodollars. This gradually emerged as a fundamental link in international financial practices. With globalisation and the free movement of capital, as well as a series of legal innovations, companies gradually changed. 

Today there are numerous tax haven lists - all share OECD's known criteria for defining a tax haven (low or non-existent rates of taxation, an opaque tax system and no exchange of tax information with other jurisdictions).

What does profit sharing or tax evasion mean and why is it dangerous

Profit shifting refers to the practice of multinational companies artificially moving their profits from higher-tax jurisdictions to lower-tax or tax-haven countries. This strategy is often employed through complex corporate structures, transfer pricing manipulation and the exploitation of loopholes in tax regulations. 

Well, it can work like this – you have a bank of your own. Now you set up a company and enlist it with the stock market and a bank of your country. Then you set up an offshore company (which is basically a shell company or a fake company) and take loans from your own bank. After that, you transfer the money to the publicly-listed company and declare a hefty dividend for your investors. 

This way you take out the bank money in the form of a dividend. 

Now, you set up another shell company and take another loan. With this money, you adjust the loan of the previous shell company. And then you keep on setting up fake companies and keep shifting the loan burden from one company to another.

You have to keep a few people, among the regulators, blind to your misdoings. For example, the central bank, the auditors and so on. This is how the bank money will be swindled in the form of loans by setting up one fake company after another.

Once you have made money, you fly to your dream country – the United States.

Or it can also be done how the tech giant Apple did profit sharing through its subsidiaries in Ireland a decade ago. Most of Apple's research and development (R&D) was done in the US, but some of its R&D costs were generated by its Irish subsidiaries under a cost-sharing agreement. 

From 2009 to 2012, one of those Irish subsidiaries contributed $4.9 billion to Apple's R&D but booked pre-tax profits of 15 times that amount. The tax experts suggested that there might have been a 'sweetheart deal' on their R&D investment — the kind of deal that Apple wouldn't give to an outside entity. 

It's the absence of stringent regulations and inadequate enforcement mechanisms which make it easier for multinational companies to exploit loopholes and engage in aggressive tax planning strategies. And differences in tax rates between countries encourage companies to shift profits to jurisdictions with lower tax burdens, allowing them to maximise profits and minimise tax liabilities. 

This not only causes a direct loss of tax revenue but also creates an uneven playing field for local businesses, hindering economic growth and job creation. 

In March 2023, in a pre-budget discussion meeting, National Board of Revenue (NBR) Chairman Abu Hena Md Rahmatul Muneem said that it will not be possible to continue tax support after 2026 to local industries and others that enjoy the benefits. In that meeting, he said that there is pressure from local and international parties to increase the tax-GDP ratio (revenue contribution to GDP).

This will eventually impact the small and medium enterprises the most. 

The TJN report also emphasises that Bangladesh's annual tax loss of $387 million amounts to 0.1% of its gross domestic product (GDP), a significant sum that could be channelled towards essential public services and infrastructure development.

For example, the $361 million annual tax loss represents nearly one-third of Bangladesh's health budget or 6.19% of its education spending. Insufficient funding for these vital sectors can lead to compromised healthcare facilities, limited access to education and a diminished overall quality of life for the population. 

And in effect, socio-economic inequalities may widen, hindering the country's progress toward achieving sustainable development goals.

The funds lost to profit shifting and tax evasion could have been invested in developing infrastructure, boosting industrial growth and supporting small and medium-sized enterprises (SMEs). 

Addressing the issue of tax justice

Faced with this massive loss of wealth and tax revenue as a result of tax haven schemes, the world's nations have launched a counter-strike against these practices. To thwart tax havens, blacklists have been created and various legislations have been adopted during the last few decades. 

The global scope of this initiative is very bright. On that account, as part of its Base Erosion and Profit Shifting (BEPS) project, the Organisation for Economic Cooperation and Development (OECD) developed a 15-point action plan to help governments prevent the artificial transfer of profits to jurisdictions of convenience. 

In the US, pursuing the line of the Hiring Incentives to Restore Employment Act (HIRE), Congress also enacted the Foreign Account Tax Compliance Act (FATCA) in 2010, which provides for an automatic exchange and transfer of information about US citizens and taxpayers holding financial assets abroad. This is considered one of the strongest anti-tax-avoidance measures taken to date by any government, and its effectiveness was secured by the signing of over 100 intergovernmental agreements between the US and other jurisdictions.

More recently, the European Union passed EU Directive 2016/1164, which enshrines many of the OECD's suggestions into law.

Meanwhile, mechanisms like the Common Reporting Standard (CRS), the Automatic Exchange of Financial Account Information, Transfer Pricing, requirements for financial institutions, controls on beneficial owners, along other related party transactions, have also heightened the pressure on both individual and corporate tax evaders.

From a local perspective, Spain – and most EU countries – grew as a pioneer in the fight against tax avoidance, following the mentioned OECD's suggestions (those policies were incorporated by several EU Directives). Some of the main recommendations of the BEPs were incorporated into the Spanish Corporate Tax Law of 2014 (Law 27/2014) and other co-standards.

To combat the challenges posed by profit shifting and tax evasion, Bangladesh needs a multi-faceted approach that involves both domestic and international efforts. The government must enact stringent tax laws, improve tax administration and close existing loopholes that allow corporations to exploit the system. 

Strengthening transparency in corporate financial reporting and establishing international cooperation for information exchange are essential steps to track and curb tax evasion, which will eventually help in developing a just and equal world for everyone. 

By actively participating in initiatives, such as the Base Erosion and Profit Shifting (BEPS) project by the Organisation for Economic Co-operation and Development (OECD), Bangladesh can strengthen its position in promoting a fairer international tax system.