Offshore Companies and Tax Havens: A tale of “pirates”

April 2016. The media bring the Panama Papers to light, one of the largest information leaks in history. Confidential documents held by Panamanian law firm Mossack Fonseca reveal a list of offshore companies, registered in tax havens, whose owners and managers include multiple celebrities and political leaders.

In public opinion, the main objective of establishing said companies was tax evasion, that is, the concealment of wealth in order to avoid paying corresponding taxes.

Some listeners heard the term “offshore companies” for the first time and came to the conclusion that it was a synonym for “tax haven”.  This article aims to clarify these terms from a legal perspective, as well as explain how they are interrelated.

Strictly speaking, offshore companies are companies that are incorporated in a foreign jurisdiction where the company does no business. They are very closely associated with tax havens because most of these companies are created in territories where there is no or low taxation for non-residents.

In order to better understand a legal term, it is often helpful to go back to its earliest origins, when the concept first began to be used. Curiously enough, the first offshore operations date back to the 17th century, and were carried out in the port cities of English colonies where protection was offered to pirates. The pirates were allowed to deposit their booty there in exchange for a percentage of the products of their piracy. Later, in the early 20th century, they were started in a formal manner in Switzerland, sheltered by its banking secrecy. In its current form, the term “offshore” first originated in the United States in the thirties, due to islands located beyond its borders being used as financial centers in order to reduce tax burdens.

Currently, when multinational companies plan their international taxation, they have the ability to choose between various jurisdictions for the incorporation of their branches, subsidiaries, establishments, etc. Of course, this choice is aimed at reducing their final costs, and once they have found the ideal territory with the lowest possible tax burden, it’s logical to use an offshore company.

In addition, one of the main consequences of economic globalization has been the creation of tax competition between countries that have reduced taxation for non-residents in order to attract foreign capital.

However, the term “offshore companies” has been exclusively associated with companies that incorporate in so-called tax havens for quite some time. But what exactly is a tax haven? Or what makes a country become a tax haven? First of all, we should clarify the meaning of these words since the term comes from the Saxon phrase tax haven, which has been translated in an unorthodox manner as “tax haven”, when it really means “tax shelter”.

In terms of what criteria should be used to determine whether a jurisdiction can be considered a tax haven, the OECD (Organisation for Economic Co-operation and Development) stated in the nineties that null or low taxation (below 10%) of non-residents’ assets and income was an essential requirement. In addition to that requirement, there should be any of the following: existence of legislative bodies or administrative practices that limit the exchange of information with other countries (their domestic laws provide high protection for banking and financial secrecy with little correlative development in signing international agreements) or the absence of a requirement of real activity, along with the ease and speed of creating companies, including on the basis of bearer securities that allow shareholders to be anonymous.

At a national level, we must highlight the first additional provision of Law 36/2006 of 29 November, on measures for preventing tax fraud, which legally determines tax havens by applying the aforementioned OECD criteria. The original list included nearly 50 countries, and the number has decreased year after year.

Offshore territory and tax haven therefore need not be synonymous. In fact, the country that is now in the media spotlight, Panama, illustrates this statement. Panama signed a double taxation agreement with Spain with an information exchange clause on October 7, 2010 that came into effect on July 25, 2011. Therefore, Panama has been off of Spain’s list of tax havens for years.

So in general, it can be said that unless it is for international tax planning, the purposes for incorporating an offshore company seem spurious at first glance. That’s because offshore companies are normally companies that are registered in a tax haven to evade taxes, with tax evasion considered a breach of tax law through concealment of income and wealth.

At present, and following the news of the Panama Papers, most citizens living in “hells” have become aware that there are “havens” where certain rich people hide their “booty” to avoid paying taxes. And we already knew that lack of tax collection is detrimental to society as a whole since it negatively affects public services and social benefits. In short, the establishment of offshore companies in tax havens, for purposes other than international tax planning, prevents the creation of a better world.

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