What Is a Tax Haven?

A tax haven is generally an offshore country that offers foreign individuals and businesses little or no tax liability in a politically and economically static environment. Tax havens also share limited or no financial information with foreign tax authorities. Tax havens do not typically require residency or business presence for individuals and businesses to benefit from their tax policies.

In some cases, intranational locations may also be identified as tax havens if they have special tax laws. For example, in the United States, Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming require no state income tax.

Key Takeaways

  • Tax havens provide the advantage of little or no tax liability.
  • Offshore countries with little or no tax liabilities for foreign individuals and businesses are generally some of the most popular tax havens.
  • Investors and businesses may be able to lower their taxes by taking advantage of tax-advantaged opportunities offered by tax havens, however, entities should ensure they are compliant with all relevant tax laws.

Understanding a Tax Haven

Offshore tax havens benefit from the capital their countries draw into the economy. Funds can flow in from individuals and businesses with accounts setup at banks, financial institutions, and other investment vehicles. Individuals and corporations can potentially benefit from low or no taxes charged on income in foreign countries where loopholes, credits, or other special tax considerations may be allowed.

A list of some of the most popular tax haven countries includes Andorra, the Bahamas, Belize, Bermuda, the British Virgin Islands, the Cayman Islands, the Channel Islands, the Cook Islands, The Island of Jersey, Hong Kong, The Isle of Man, Mauritius, Lichtenstein, Monaco, Panama, St. Kitts, and Nevis.

Worldwide there is not a comprehensively defined standard for the classification of a tax haven country. However, there are several regulatory bodies that monitor tax haven countries, including the Organization of Economic Cooperation and Development (OECD) and the U.S. Government Accountability Office.

Characteristics of tax haven countries generally include no or low-income taxes, minimal reporting of information, lack of transparency obligations, lack of local presence requirements, and marketing of tax haven vehicles.

U.S. Corporations

The Tax Cuts and Jobs Act (TCJA), which passed in December 2017, set the effective corporate rate of U.S. taxes at 21%. It also added several other provisions that discouraged foreign investments.

Systematically, the TCJA is known for being more territorial in nature than previous international tax law. The international tax system under the TCJA exempts foreign profits from domestic taxation but has certain provisions for high return foreign profits. 

In general, this and other provisions, particularly for reinvestments, provide allowances for businesses to benefit from low or no tax rates offered in foreign countries but businesses should closely monitor and accurately report foreign income as it pertains to U.S. tax law, generally accepted accounting principles (GAAP), and the guidelines under International Financial Reporting Standards (IFRS).

Some companies that have historically been known for offshore, tax haven holdings include Apple, Microsoft, Alphabet, Cisco, and Oracle. Overall, tax havens may also offer advantages in the area of credit, since it may be less expensive for U.S.-based companies to borrow funds internationally.

This type of lending, which can potentially fund acquisitions and other corporate activities, is also subject to reporting within the guidelines of U.S. tax law, GAAP, and guidelines under IFRS.

Individual Taxpayers

The United States has special rules in place for the reporting of foreign income by U.S. citizens and non-U.S. citizens. These rules are generally governed under the Foreign Account Tax Compliance Act (FATCA).

FATCA requires the filing of a Schedule B and/or Form 8938, which provides disclosure of foreign account holdings when investments exceed $50,000. Separately, foreign account holders may also be required to file Form 114, Report of Foreign Bank and Financial Accounts. 

In general, there can potentially be exemptions and foreign tax credits for investment in all types of overseas vehicles but it is important to consult a tax advisor for individual situations to ensure proper reporting.

Regulatory Pressure

All income earned by U.S. individuals and businesses is subject to taxation. There can be exemptions, credits, and special situations that can apply for foreign investments. Offshore investing can also create a lot of opportunities for illegal activities. As such, there can be a great deal of regulatory oversight.

To maximize tax receipts, many foreign governments maintain relatively constant pressure on tax havens to release information regarding offshore investment accounts. However, because of the monetary burdens, regulatory oversight may not always be a top national priority.

Worldwide, there are some programs in place to increase the enforcement of offshore investment reporting. The Automatic Exchange of Financial Information is one example, overseen by OECD.

The program requires participating countries to automatically transmit tax-related banking information of non-citizen depositors for use by countries of citizens in the facilitation of taxes on income, earnings, interest, dividends, and royalties.

Certain countries may be targets for offshore activities. For example, Cyprus’s financial sector built on the country’s tax haven status collapsed in 2013. The European Commission, European Central Bank, and International Monetary Fund predicted the $11.8 billion bailout on the country’s agreement for compliance with more robust tax reporting and participation with the Automatic Exchange of Financial Information in Tax Matters program.