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«1-15-2015 Tax Havens: International Tax Avoidance and Evasion Jane G. Gravelle Congressional Research Service Follow this and additional works at: ...»

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1-15-2015

Tax Havens: International Tax Avoidance and

Evasion

Jane G. Gravelle

Congressional Research Service

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Tax Havens: International Tax Avoidance and Evasion Abstract Addressing tax evasion and avoidance through use of tax havens has been the subject of a number of proposals in Congress and by the President. Actions by the Organization for Economic Cooperation and Development (OECD) and the G-20 industrialized nations also have addressed this issue. In the 111th Congress, the HIRE Act (P.L. 111-147) included several anti-evasion provisions, and P.L. 111-226 included foreign tax credit provisions directed at perceived abuses by U.S. multinationals. Numerous legislative proposals to address both individual tax evasion and corporate tax avoidance have been advanced.

Multinational firms can artificially shift profits from high-tax to low-tax jurisdictions using a variety of techniques, such as shifting debt to high-tax jurisdictions. Because tax on the income of foreign subsidiaries (except for certain passive income) is deferred until income is repatriated (paid to the U.S. parent as a dividend), this income can avoid current U.S. taxes, perhaps indefinitely. The taxation of passive income (called Subpart F income) has been reduced, perhaps significantly, through the use of hybrid entities that are treated differently in different jurisdictions. The use of hybrid entities was greatly expanded by a new regulation (termed check-the-box) introduced in the late 1990s that had unintended consequences for foreign firms. In addition, earnings from income that is taxed often can be shielded by foreign tax credits on other income. On average, very little tax is paid on the foreign source income of U.S. firms. Ample evidence of a significant amount of profit shifting exists, but the revenue cost estimates vary substantially. Evidence also indicates a significant increase in corporate profit shifting over the past several years. Recent estimates suggest losses that may approach, or even exceed, $100 billion per year.

Individuals can evade taxes on passive income, such as interest, dividends, and capital gains, by not reporting income earned abroad. In addition, because interest paid to foreign recipients is not taxed, individuals can evade taxes on U.S. source income by setting up shell corporations and trusts in foreign haven countries to channel funds into foreign jurisdictions. There is no general third-party reporting of income as is the case for ordinary passive income earned domestically; the Internal Revenue Service (IRS) relies on qualified intermediaries (QIs). In the past, these institutions certified nationality without revealing the beneficial owners. Estimates of the cost of individual evasion have ranged from $40 billion to $70 billion. The Foreign Account Tax Compliance Act (FATCA; included in the HIRE Act, P.L. 111-147) introduced required information reporting by foreign financial intermediaries and withholding of tax if information is not provided. These provisions became effective only recently, and their consequences are not yet known.

Most provisions to address profit shifting by multinational firms would involve changing the tax law: repealing or limiting deferral, limiting the ability of the foreign tax credit to offset income, addressing check-the-box, or even formula apportionment. President Obama’s proposals include a proposal to disallow overall deductions and foreign tax credits for deferred income, along with a number of other restrictions. Changes in the law or anti-abuse provisions have also been introduced in broader tax reform proposals. Provisions to address individual evasion include increased information reporting and provisions to increase enforcement, such as shifting the burden of proof to the taxpayer, increased penalties, and increased resources. Individual tax evasion is the main target of the HIRE Act, the proposed Stop Tax Haven Abuse Act, and some other proposals.

Keywordstax evasion, tax havens, Congress

This article is available at DigitalCommons@ILR: http://digitalcommons.ilr.cornell.edu/key_workplace/1378 Comments Suggested Citation Gravelle, J. G. (2015). Tax havens: International tax avoidance and evasion. Washington, DC: Congressional Research Service.

This article is available at DigitalCommons@ILR: http://digitalcommons.ilr.cornell.edu/key_workplace/1378 Tax Havens: International Tax Avoidance and Evasion Jane G. Gravelle Senior Specialist in Economic Policy January 15, 2015

–  –  –

Summary Addressing tax evasion and avoidance through use of tax havens has been the subject of a number of proposals in Congress and by the President. Actions by the Organization for Economic Cooperation and Development (OECD) and the G-20 industrialized nations also have addressed this issue. In the 111th Congress, the HIRE Act (P.L. 111-147) included several anti-evasion provisions, and P.L. 111-226 included foreign tax credit provisions directed at perceived abuses by U.S. multinationals. Numerous legislative proposals to address both individual tax evasion and corporate tax avoidance have been advanced.





Multinational firms can artificially shift profits from high-tax to low-tax jurisdictions using a variety of techniques, such as shifting debt to high-tax jurisdictions. Because tax on the income of foreign subsidiaries (except for certain passive income) is deferred until income is repatriated (paid to the U.S. parent as a dividend), this income can avoid current U.S. taxes, perhaps indefinitely. The taxation of passive income (called Subpart F income) has been reduced, perhaps significantly, through the use of hybrid entities that are treated differently in different jurisdictions. The use of hybrid entities was greatly expanded by a new regulation (termed checkthe-box) introduced in the late 1990s that had unintended consequences for foreign firms. In addition, earnings from income that is taxed often can be shielded by foreign tax credits on other income. On average, very little tax is paid on the foreign source income of U.S. firms. Ample evidence of a significant amount of profit shifting exists, but the revenue cost estimates vary substantially. Evidence also indicates a significant increase in corporate profit shifting over the past several years. Recent estimates suggest losses that may approach, or even exceed, $100 billion per year.

Individuals can evade taxes on passive income, such as interest, dividends, and capital gains, by not reporting income earned abroad. In addition, because interest paid to foreign recipients is not taxed, individuals can evade taxes on U.S. source income by setting up shell corporations and trusts in foreign haven countries to channel funds into foreign jurisdictions. There is no general third-party reporting of income as is the case for ordinary passive income earned domestically;

the Internal Revenue Service (IRS) relies on qualified intermediaries (QIs). In the past, these institutions certified nationality without revealing the beneficial owners. Estimates of the cost of individual evasion have ranged from $40 billion to $70 billion. The Foreign Account Tax Compliance Act (FATCA; included in the HIRE Act, P.L. 111-147) introduced required information reporting by foreign financial intermediaries and withholding of tax if information is not provided. These provisions became effective only recently, and their consequences are not yet known.

Most provisions to address profit shifting by multinational firms would involve changing the tax law: repealing or limiting deferral, limiting the ability of the foreign tax credit to offset income, addressing check-the-box, or even formula apportionment. President Obama’s proposals include a proposal to disallow overall deductions and foreign tax credits for deferred income, along with a number of other restrictions. Changes in the law or anti-abuse provisions have also been introduced in broader tax reform proposals. Provisions to address individual evasion include increased information reporting and provisions to increase enforcement, such as shifting the burden of proof to the taxpayer, increased penalties, and increased resources. Individual tax evasion is the main target of the HIRE Act, the proposed Stop Tax Haven Abuse Act, and some other proposals.

Congressional Research Service Tax Havens: International Tax Avoidance and Evasion Contents Introduction

Where Are the Tax Havens?

Formal Lists of Tax Havens

Developments in the OECD Tax Haven List

Other Jurisdictions with Tax Haven Characteristics

Methods of Corporate Tax Avoidance

Allocation of Debt and Earnings Stripping

Transfer Pricing

Contract Manufacturing

Check-the-Box, Hybrid Entities, and Hybrid Instruments

Cross Crediting and Sourcing Rules for Foreign Tax Credits

The Magnitude of Corporate Profit Shifting

Evidence on the Scope of Profit Shifting

Estimates of the Cost and Sources of Corporate Tax Avoidance

Importance of Different Profit Shifting Techniques

Methods of Avoidance and Evasion by Individuals

Tax Provisions Affecting the Treatment of Income by Individuals

Limited Information Reporting Between Jurisdictions

U.S. Collection of Information on U.S. Income and Qualified Intermediaries

European Union Savings Directive

Estimates of the Revenue Cost of Individual Tax Evasion

Alternative Policy Options to Address Corporate Profit Shifting

Broad Changes to International Tax Rules

Repeal Deferral

Targeted or Partial Elimination of Deferral

Allocation of Deductions and Credits with Respect to Deferred Income/Restrictions on Cross Crediting

Formula Apportionment

Narrower Provisions Affecting Multinational Profit Shifting

Eliminate Check-the-Box, Hybrid Entities, and Hybrid Instruments

Tighten Earnings Stripping Rules; Limit Interest Deductions

Foreign Tax Credits: Source Royalties as Domestic Income for Purposes of the Foreign Tax Credit Limit or Create Separate Basket; Eliminate Title Passage Rule; Restrict Credits for Taxes Producing an Economic Benefit

Transfer Pricing

Other Provisions

Options to Address Individual Evasion

Information Reporting

Multilateral Information Sharing or Withholding; International Cooperation.................. 34 Expanding Bilateral Information Exchange

Unilateral Approaches: Withholding/Refund Approach; Increased Information Reporting Requirements

Other Measures That Might Improve Compliance

Incentives/Sanctions for Tax Havens

Congressional Research Service Tax Havens: International Tax Avoidance and Evasion Revise and Strengthen the Qualified Intermediary Program

Place the Burden of Proof on the Taxpayer

Treat Shell Corporations as U.S. Firms

Extend the Statute of Limitations

Greater Resources for the Internal Revenue Service to Focus on Offshore

Make Civil Cases Public as a Deterrent

John Doe Summons

Strengthening of Penalties

Address Tax Shelters

Regulate the Rules Used by States to Permit Incorporation

Make Suspicious Activity Reports Available to Civil Side of IRS

Summary of Enacted Legislation in 2011

The Hiring Incentives to Restore Employment (HIRE) Act (P.L. 111-147): FATCA............ 38 Reporting on Foreign Accounts

Deduction of Interest for Bearer (Nonregistered) Bonds

Additional Information Reported on Tax Returns

Penalties

Statute of Limitations

Reporting on Foreign Passive Investment Companies

Electronic Filing

Trusts

Treat Equity Swaps as Dividends

Economic Substance Doctrine: The Patient Protection and Affordable Care Act, P.L.

111-148.

P.L. 111-226

Preventing Splitting Foreign Tax Credits from Income

Denial of Foreign Tax credits for Covered Asset Acquisitions

Separate Foreign Tax Credit Limit for Items Resourced Under Treaties

Limitation on the Use of Section 956 (the “Hopscotch” Rule)

Special Rule for Certain Redemptions by Foreign Subsidiaries

Modification of Affiliation Rules for Allocating Interest Expense

Repeal of 80/20 Rules

Technical Correction to the HIRE Act

Summary of Legislative Proposals

American Jobs and Closing Loopholes Act (H.R. 4213, 111th Congress)

Source Rules on Guarantees

Boot-Within-Gain Revisions

President Obama’s International Tax Proposals

Provisions Affecting Multinational Corporations and Other Tax Law Changes............... 45 Provisions Relating to Individual Tax Evasion, Not Enacted in the HIRE Act................. 49 The Wyden-Gregg and Wyden-Coats Tax Reform Bills

Chairman Camp’s Territorial Tax Proposal (Included in H.R. 1, 113th Congress) and Senator Enzi’s Bill (S. 2091, 112th Congress)

Stop Tax Haven Abuse Act

111th Congress (S. 506 and H.R. 1245)

112th Congress (S. 1346 and H.R. 2669)

113th Congress (H.R. 1554, S. 1533, and H.R. 3666)

114th Congress

Finance Committee Proposal, 111th Congress

Congressional Research Service Tax Havens: International Tax Avoidance and Evasion Fraud Enforcement and Recovery Act, S. 386, 111th Congress

Incorporation Transparency and Law Enforcement Assistance Act, S. 1483, H.R.

3416, 112th Congress

Additional Proposals in the 113th Congress

Tables Table 1. Countries Listed on Various Tax Haven Lists

Table 2. U.

S. Company Foreign Profits Relative to Gross Domestic Product (GDP), G-7........... 17 Table 3. U.S. Foreign Company Profits Relative to GDP, Larger Countries (GDP at Least $15 billion) on Tax Haven Lists and the Netherlands

Table 4. U.

S. Foreign Company Profits Relative to GDP, Small Countries on Tax Haven Lists



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