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New report calls on Norway to set up fight against tax havens

23 July 2009

In June 2008 the Norwegian government appointed a commission on capital flight from poor countries that would be in charge of presenting proposals to curb illicit flows from developing countries to the Government. One year later, the Commission has released its preliminary report, entitled “Tax havens and development”. The report contains an extensive analysis of the tax havens industry and its impacts on developing countries. It also looks into Norfund investments, a Norwegian investment fund operating in developing countries which uses tax havens in its investment strategies. The report concludes that secrecy and virtually zero tax regimes provided by tax havens have very damaging effects on development and sets out key recommendations to the Norwegian government.

Some of the main impacts are the following:

-Tax havens increase borrowing costs in international financial markets:

The financial crisis has shown that many financial institutions carried off-balance sheet liabilities, registered in tax havens. Therefore, tax havens enhance information asymmetry and risks. They undermine working of international financial markets and contribute to higher borrowing costs for all countries.

-Tax havens undermine the working of the tax system and public finances: by providing secrecy and low or zero tax regimes, tax havens attract capital that should have been taxed in other countries. As a result they help to boost the socio-economic costs of taxation and weaken economic growth in developing countries.

-Tax havens increase the inequitable distribution of tax revenues: the normal approach in bilateral tax treaties is to apply the domiciliary principle (the right to tax remains in the country where the company is registered) rather than the source country (where the company operates). But this principle is not justified in cases where legal entities are merely registered in a jurisdiction, without having a real activity in it.

-Tax havens reduce the efficiency of resource allocation in developing countries: they make it more profitable to pursue tax evasion and planning through instruments that encroach on the sovereignty of other countries. They can also influence the investment criteria (seeking the best return after tax), increasing the gap between private and socio economic investment criteria.

-Tax havens make economic crime more profitable: secrecy legislation provided by tax havens allows players to hide proceeds of economic crime. This problem is all the more serious in developing countries, where tax systems are less developed than in rich nations.

-Tax havens encourage rent seeking and reduce private incomes in developing countries: tax havens influence some private players in choosing tax avoidance as a means to increase their profitability rather than choosing other efficient operations. Such a reorientation of talent away from value creation is particularly problematic in countries with low level of expertise and technological development.

-Tax havens damage institutional quality and growth in developing countries: by making it easier to conceal the proceeds of economic crime, tax havens encourage self interest and create political incentives to demolish, rather than build up institutions, and to weaken rather than strengthen democratic governance processes.

The recommendations addressed to the Norwegian government are the following:

-Development policy: to strengthen and improve tax regimes and anti-corruption efforts in developing countries and to make industrial policy coherent with development assistance policy.

-Advisors and facilitators: to establish a national registry with all operators who facilitate and conduct operations in tax havens.

-Information duty and annual accounts: to require multinational corporations to present in their annual reports key figures of taxable profit and tax payable as a proportion of taxable profit in each of the countries where they operate.

-Transfer pricing: to investigate a set of instruments to determine transfer pricing and promote them at the global level.

-National centre of expertise: to establish a national centre of expertise to conduct research and support authorities on these issues and to enhance expertise in developing countries.

-Cross-ministerial working group: such a working group would be created in order to develop networks with other countries, to cooperate to reduce and eliminate harmful structures in tax havens and to put tax havens on the agenda of international finance and development institutions.

-Tax treaties:  Signing a tax treaty does not lead to the establishment of official company and owner registries with a duty to keep accounting information, or the introduction of genuine audit provisions, nor will a tax treaty prompt a tax haven to change its practice of ring fencing part of its system so that foreigners obtain more favorable tax conditions than locals. Therefore, the report calls for new rules for 1) when a legal entity can be regarded as domiciled in a tax haven (need for economic activity in such jurisdiction) and 2) assigning taxation rights between countries.

-Convention on transparency in international economic activity: to develop a new international convention in order to prevent states to develop secrecy structures which are likely to cause damage to other countries. Such a convention should be general, apply to all countries and be directed against specific damageable structures rather than specific states or states systems.

With the establishment of such a commission and the analysis and recommendations set up in this report, Norway shows a clear leadership on this crucial issue for global economic justice and for development. The Norwegian government must now take action to implement these measures. But we all know that a global response is needed to address these problems. These recommendations provide an excellent basis for action and for other European countries to follow the same direction.