Globally, tax havens and offshore jurisdictions are attracting huge amounts of foreign direct investment (FDI) when many developing countries are not receiving their required FDI even providing a lot of incentives. Again, outward FDI from the offshore secret jurisdictions are also quite high for many developing countries. Thus, a big question is already there on what actually is happening in these tax havens.
In its latest Global Investment Trend Monitor, released in the first week of this month, United Nations Conference on Trade and Development (UNCTAD) presented a brief overview of the state of affairs. According to UNCTAD: "In 2015, the volatility of investment flows to offshore financial hubs - including those to offshore financial centres and special purpose entities (SPEs) - rose significantly. These flows, which are excluded from UNCTAD's FDI statistics, declined but remain sizable." The most important thing that has emerged from this statement is that investments in the offshore jurisdictions are volatile by nature.
GLOBAL SCENARIO: Despite some differences, tax havens and offshore jurisdictions are generally considered similar. While developed countries like Switzerland and Luxemburg are considered as tax havens, these are not necessarily offshore jurisdictions like British Virgin Island or Cayman Island. These are the countries or territories providing secrecy in parking financial assets, negligible or zero taxations and facilities to transfer assets to other territories. The basic feature is simple: less regulation and high secrecy on invested or parked assets flowed out from other countries.
The flows of assets from developing or even developed countries are generally considered as investments in these offshore jurisdictions. Though this is true, most of these investments take place, in reality, as illegal or secret transfers of financial assets from the home countries to avoid or evade tax. Thus, a significant portion of FDI in tax havens is another form of capital flight or illicit transfer of assets or outflow of black money from other countries.
UNCTAD mentioned two major channels of such investment flows. One is offshore financial centre (OFC); the other is special purpose entities (SPEs). An OFC is any financial centre where offshore financial activities take place. These include: banking, fund management, insurance, trust business and tax planning. To be more accurate, as pointed by the International Monetary Fund (IMF), OFC is a jurisdiction where most financial activities are linked with overseas borrowers and lenders. OECD, however, defined all the tax havens as OFC. So, grey area on defining the OFC is still there. Again, an SPE is a legal structure, separately created by a firm to provide liquidity or obtain easy external funding.
UNCTAD's Global Investment Trend Monitor report showed that investment flows to offshore financial centres stood at $72 billion. Though the amount is almost half of the amount worth $132 billion in 2013, it is still high. The UN body explained the latest trend of FDI in OFC as follows: "Investment to these jurisdictions, which hit an estimated US$72 billion in 2015, had risen in recent years by the growing flows from multinational enterprises (MNEs) located in developing and transition economies, sometimes in the form of investment round-tripping." Amount of investment in SPEs is higher than OFCs. In 2015, it stood at $221 billion. (Table-1) Thus, total foreign investments in the offshore jurisdictions closed to $300 billion last year while global FDI stood at $1.7 trillion, as per UNCTD's primary estimation.
These figures suggest that tax-avoiding investment across the world is still a matter of concern. Some caution, however, needs to be applied in this regard to draw any conclusion.
TAXATION MATTERS: A driving factor to invest in the tax havens is to avoid high tax in the home country. Moreover, after availing lower or zero tax, some of the investors reinvest the money in their home countries to avail tax benefits and other incentives applicable for foreign investors. It is very easy to form a shell company in any of the tax havens. But this company is considered as foreign company in other countries and so qualifies for tax incentives. A good example of such a case is India and Mauritius.
India and Mauritius have double taxation avoidance agreement (DDTA) meaning that tax is applicable in any of the countries. But, tax regime in Mauritius is very relaxed and tax rate is very low. So, Indian and other investors initially register their entities in Mauritius. Then they invest in India to take advantage of the DDTA showing payment or settlement of their taxes in the island and so they are not required to pay any taxes in India.
Last week, India has signed a protocol with Mauritius to amend the existing DDTA. As a result, India can impose tax on capital gains arising from sale or transfer of shares of an Indian company acquired by a Mauritian resident or entity. The amendment will be effective from April, 2019, and capital gains will be taxed at 15 per cent to 40 per cent in India.
In fact, multinational corporations (MNCs) or multinational entities (MNEs) are using the technique for long. Taking benefit of double taxation avoidance treaties among the countries, the MNCs also tap the incentives for foreign investors. So, they can book higher profit margins.
Last year, UNCTAD in its World Investment Report highlighted the issue. It said: "Tax avoidance practices by MNEs are a global issue relevant to all countries: the exposure to investments from offshore hubs is broadly similar for developing and developed countries. However, profit shifting out of developing countries can have a significant negative impact on their sustainable development prospects. Developing countries are often less equipped to deal with highly complex tax avoidance practices because of resource constraints and/or lack of technical expertise." (World Investment Report 2015: Reforming International Investment Governance; P-198).
BANGLADESH CONNECTION: Illegal transfer of financial assets from Bangladesh is now well known. But, the re-routing of a portion of such assets or siphoned money is a new phenomenon in this country. For the last few years, FDI from several tax havens (table-2) in Bangladesh is rising slowly although the total amount is still small.
According to the central bank statistics, total FDI from offshore jurisdictions stood at around $100 million in 2015. The amount is around 4.5 per cent of total inflow of FDI worth $ 2.23 billion in the country last year.
Global Financial Integrity (GFI), a Washington-based organisation, estimated that illicit financial flows (IFF) from Bangladesh stood at $9.66 billion (Tk 740 billion) in 2013. Its latest report, released in December last, also showed that in last 10 years (2004-2013), dirty or black money worth $55.87 billion flew out of the country to different tax havens like Mauritius, British Virgin Island and Dubai.
There is a popular notion that siphoned money doesn't come back to its origin as it was drained off for parking in safe place. But, in real world, many developing countries have witnessed return of a significant portion of stashed money in the form of fresh investment. Here again India is a good example. Mauritius and Singapore are sources of about 60 per cent of FDI in India. But origins of these FDI are actually in the United States or India-related investors many of whom earlier transferred funds to these islands. Mauritius is generally used for availing tax benefits and for ensuring anonymity of Indian businessmen.
Thus, it is not surprising that a negligible amount of the siphoned money returned to Bangladesh to take advantage of incentives applicable to foreign investments. These incentives include no resection or limitation on the amount of foreign investment. Moreover, Bangladesh has DTAA with more than 50 countries which include tax havens like Mauritius.
Though there are no detailed data to detect sectors where FDI from tax havens are entering, statistics on 2015 revealed that most of the FDI is going to the country's textile sector. For instance, last year, net inflow of FDI from British Virgin Island stood at $40.12 million of which $35.13 million went to textile and apparel sector. In a similar vein, FDI from Mauritius stood at $16.31 million of which $13.69 million went to textile sector.
Moreover, the latest leak of Panama Papers shows that Bangladeshi businesses have some links with the tax havens and offshore jurisdictions. May be the unveiled data is just a tip of the iceberg. Thus, more investigation and research are needed to find and understand the trends of FDI from tax havens.