In recent years, the issue of comprehensive tax reform has caused quite a heated debate among politicians and members of different economic classes throughout several developed nations such as the United States, the United Kingdom, and Australia. In these countries, both companies and the top income earners have complained in vain about being burdened by very high-income tax rates and extremely tedious tax compliance requirements. According to the Tax Foundation, a nonpartisan tax research organization, the U.S. ranks number three in the world among nations with the highest top marginal tax corporate income tax rate. It is also important to note that it can be very expensive for businesses, especially small businesses, to simply stay fully compliant with the Internal Revenue Service (IRS). That is because the complexity of America's more than 70,000-page tax code will often require the need to get counsel from lawyers and accountants who not only studied the intricacies of tax law but also keep abreast with regular updates to the tax code. It is no wonder why Dr. Laura D’Andrea Tyson, an economics professor at University of California, Berkeley, described the country's current tax system as, "Not an attraction to the U.S. as a place to do business, either for U.S. companies or for foreign companies."

The broken tax system in America has forced many wealthy individuals, their families and companies to make use of offshore financial centers to significantly minimize, and even eliminate, their total income and capital gains tax liabilities. These centers are commonly referred to as tax havens because they are often low tax jurisdictions that have strict bank and corporate secrecy laws. The Cayman Islands, the British Virgin Islands, Panama, Nevis and Bermuda are some of the most popular tax havens. As a result of their relatively minimal income tax revenues, some might wonder how exactly do tax haven governments raise enough money to pay for things like healthcare, education and law enforcement. Below we will take a look at the different ways that governments of tax havens can make money with very low, and in some cases no, corporate and personal income taxes.

Customs and Import Duties

Despite what their name might imply, tax havens are not completely tax-free. Low-income tax jurisdictions normally supplement lost government revenues with taxes on most goods imported into the country, known as customs and import duties. These are a form of indirect taxes and can make the cost of living high because they are applied to the price of items before being sold locally. In Britain’s Trillion Pound Paradise, a 2016 BBC documentary on the Cayman Islands, the presenter was shocked to find out that the island’s high import duties caused a pack of fish fingers to retail for as much as £8.50. ($12) (You might also like: Why Is Panama Considered a Tax Haven?)

Corporate Registration and Renewal Fees

As already mentioned, there are a lot of companies that find the legal and business environment in tax havens to be very attractive. A research paper published by the International Monetary Fund (IMF) in 2011 entitled Republic of San Marino: Selected Issues for the 2010 Article IV Consultation revealed that there were more than 600,000 offshore companies registered in the British Virgin Islands alone. Furthermore, earlier this year the Guardian reported that there were more than 100,000 companies domiciled in the Cayman Islands. To put that into perspective, that’s roughly two companies for every resident on the island.

Although most offshore financial centers impose no corporate income tax, their governments still financially benefit from having thousands of companies registered in their jurisdiction. That is because tax haven governments typically impose a registration fee on all newly incorporated business entities like companies and partnerships. Also, companies are required to pay a renewal fee each year to still be recognized as an operating company.

There are also additional fees that are imposed on the companies depending on the type of business activity that they engage in. For example, banks, mutual funds and other companies in the financial services business usually need to pay for an annual license to operate in that industry. All of these various fees add up to create a strong source of recurring revenue for tax haven governments.  It is estimated that the British Virgin Islands collects over $200 million each year in the form of corporate fees. (For related reading, see: Panama Papers Reveal The Secrets Of Dirty Money.)

Departure Taxes

Quite a few tax havens have a very vibrant tourism industry, welcoming hundreds of thousands and even millions of visitors each year. This high level of tourism creates an extra revenue source for some of these countries in the form of departure taxes. A departure tax is essentially a fee that is levied on a person upon their exit of a country. (Also, see: Switzerland's Declining Tax Haven Appeal.)

The Bottom Line

Income taxes are a major source of government revenue for most countries. According to the Tax Policy Center, individual income tax has been the U.S. government’s largest source of revenue since the year 1950. There are a handful of countries, known as tax havens, that impose very low-income taxes on their citizens and domiciled companies. Some of the ways that their governments make up for the loss of potential income tax revenue include collecting annual license fees from incorporated entities and levying a customs duty on the majority of imports brought into the country.