Treaty-shopping has become a controversial issue around the globe. It is described as the practice of some investors of “shopping” between countries having a more favorable tax treaty by forming an entity (usually a special purpose company) in that country. Generally, tax havens describe countries or areas that give tax favors such as no withholding for corporate tax or income tax as well as very low tax rate in case of levying tax. It can be possible when there are special treatments in terms of taxation, deregulation of foreign trading rules and the corporate law, and any obstacles to the business administration. Some multinational companies establish their subsidiaries on those tax haven territories which include the Caribbean Sea Coast or Central and South America as means of evading tax burdens or concentrate and operate capital.
In terms of the current global financial crisis, tax havens increase the risk premium in international financial markets. Also tax is originally supposed to go into the social part, but the money instead went to the pockets of individuals or corporations which are already wealthy. As result, tax havens may cause poverty and undermine welfare states. Therefore, this treaty shopping using tax havens must be rooted out. In order to dig deeper to root out tax havens, The IRS(Internal Revenue Service) seeks to uncover the dubious use of low-tax or no-tax shelters and more and more global efforts are highlighted.
Categorization of Tax Haven
Tax havens are sorted into four groups.
① Tax Paradise: Countries that have no tax treaty regime with other countries and do not impose any income tax at all. It includes the Bahama islands, Bermuda, and the Cayman islands.
② Low Tax Havens: Countries that signed tax treaties with many other countries and impose very low tax rates. Also, there is no withholding tax on the dividends. Virgin islands, Jersey islands, Bahrain, Monaco, and Singapore are the typical low tax havens.
③ Tax Shelters: Countries that levy very low tax rate or do not impose on the foreign income. Hong Kong, Liberia, Panama, Costa Rica, and Malaysia are categorized into the tax shelters.
④ Tax Resort: Tax resorts provide simple procedures for a company to be established and tax preference to a certain type of corporate or business activities. Thus tax resorts usually attract multinational companies or international hot money who want to avoid taxation or collect and operate money. Crime organizations also use tax resort for money laundering. Switzerland, Netherlands, Greece, Ireland, and Luxembourg are classified in this category.
How to Reduce the Possibility of Tax Evasion
Since this issue has become a global issue, many governments and international organizations started to show their moves to tackle tax avoidance done by wealthy individuals, big companies, or crime organizations Starting with that the OECD announced the lists of tax havens mentioned above, some progress has been made to address tax evasion issues.
First, National Tax Service became a member of Joint International Tax Shelter Information Center (JITSIC). This center was created in 2004 for efficient exchange of information of intelligent international treaty shopping. Korea’s National Tax Service had promoted building exchange channel of taxation information among main countries for regulation of tax avoidance using tax havens. Finally South Korea joined JITSIC in January, 2009 at the ‘Leeds Castle Group.’
Second, In the U.S., the IRS requires Americans who own a foreign financial account to report the account yearly. The FBAR is a tool to help the US government identify persons who may be using foreign financial accounts to circumvent U.S. law. In Korea, the national assembly exerts efforts for adopting the FBAR used in developed-countries in order to back up ex post facto management as well as grasp of foreign financial assets from institutional view.
Global efforts to root out those harmful activities have appeared for the blockade of tax evasion. It cannot only be solved with one nation’s efforts but also with the global cooperation. South Korea also needs to actively participate in the global effort.