Tax arbitration through offshore centres and tax havens

Introduction

Globalization has produced fundamental changes, blurring the traditional role of borders and trading barriers and creating an international economic system that accommodates some of the national operating mechanisms. [1]. This process of deepening economic interdependence has created a new international order, opened new opportunities for actors involved in cross-border transactions, and has transformed the main facets of the economic life. In the transition from traditional cross-border flows to global economic governance, the international economy has experienced impressive rates of growth, but has also faced ever-increasing obstacles that have stifled its momentum. Increasing the level of interconnection at international level has encouraged not only the mobility of goods and services, but also of production factors, such as technology, labour, and capital. Technological progress in communications and the build-up of infrastructure, state policies geared towards extracting value from globalization, as well as the removal of barriers to trade and foreign exchange flows allowed horizontal and vertical disintegration of production, the outsourcing of production and marketing processes and directing profits to new destinations. The freedom to act where it is most profitable has stimulated the search for advantageous tax solutions as well. For these reasons, the attractiveness of tax havens, which are arbitrageurs of the international financial system, has increased considerably in recent decades, raising concerns regarding whether they play or not a sound role within the world economy.

One of the main features of the world economy in the late 20^th century and the first two decades of the 21^st century was the increase in international capital mobility, a phenomenon that generated the most complex effects. Industrial production, especially highly-intensive in capital, has become increasingly dominated by transnational corporations that create global localization, dislocation and relocation networks with the aim of gaining access to economic areas where they find low wages, friendly-tax systems and permissive environmental regulations. This increase in international mobility has limited the ability of national governments to introduce specific national legislation in areas such as environmental protection or social and technological relationships for fear that such actions may lead to a delocalisation of productive processes to places with lower levels of regulatory rigor, a key-element in this process of accentuating international capital mobility being the growing importance of offshore financial centres, be they "tax havens" or not. In recent years, these novel tax architectures have become an important part of the emerging globalized financial system. The existence of what could be labelled as "offshore interfaces" has fortunately undermined the ability of national governments to impose burdensome taxes on both individuals and companies, but also unfortunately facilitated legally dubious activities or worse (cross-border crime, money laundering and other illegal activities), thus weakening the powers of financial (national, regional or international) supervisory and regulatory bodies, creating an image of global financial anarchy.

Nowadays, a significant part of global financial transactions is being routed through offshore international financial centres. However, there are also many large states that offer preferential tax regimes for certain activities or feature internal jurisdictions with such regimes (states in a federal state). Choosing an appropriate tax hierarchy depends, largely, on two basic criteria, namely: the nature of the company's activity and the characteristics of that territory. In addition to tax issues, there are also non-fiscal considerations that need to be taken into account, such as: political and economic stability, lack of currency restrictions, administrative procedures for setting up legal entities, commercial infrastructure, quality of workforce and of professional assistance, geographic location, etc. Embracing a specific tax haven in order to achieve the most favourable tax position requires the management of risks associated to the established areas and targets. As the legitimacy of the tax collection system is unanimously recognized globally - but also the need to keep it disciplined and in the interest of the taxpayer, irrespective of it being individual or corporate -, the most plausible excuse for striving to evade it is the dissatisfaction of economic agents with the use of taxation system as an instrument for redistribution of income within the society. It remains, therefore, the governments' obligation to improve the tax legislation so that an individual (or a company) should not feel so acutely the need - before blocking the means - to shirk his (its) tax obligations. This article aims to offer a balanced perspective on the problems concerning tax havens.

Someconceptualapproacheswithintheliterature. As the phenomenon of the proliferation of tax havens and the global understanding of the specificity of their problem emerge, it has become imperative to correctly define the term tax haven(or fiscal paradise) in order to delineate the territories that are likely to be classified as such. It has proven very difficult to develop a comprehensive definition of tax havens, because the term refers to activities of a very high complexity. The vast majority of analysts who have studied this thematic area tried to define the concept as elaborately as possible without reaching full consensus.

* "Analytical" yet relatively ambiguous definitions for tax havens

- Palan, Chavagneux, and Murphy [23] believe that state or sub-state entities that host tax havens represent territories that have sufficient autonomy to enforce their own financial and fiscal regulations; they take advantage of this to enact rules designed to help individuals and non-resident companies to evade the regulatory obligations of the territories where such both natural and legal persons de factocarry out their economic activities.

- Adam Starchild [26] focuses on a slightly smaller segment - the tax planningof multinational companies - when he tries to define tax havens, considering that tax havens are a geographical area in which special tax legislation is designed to encourage the establishment of branches and subsidiaries by a non-parent company having its principal place of business inside an industrialized country where an onerous tax treatment is applied.

- Nicholas Shaxson [25] offers a definition of tax havens that one may find quite vague, arguing that the term refers to places that try to attract money by providing politically stable facilities to help people and entities circumvent rules, laws and regulations of other jurisdictions. He conveys that it is perfectly normal for some jurisdictions to exercise their sovereign right to become richer via undermining the sovereign laws of other places.

- Of course, there are various "rule of thumb" definitions. Mark Hampton [11] considers tax havens are jurisdictions that do not have or, at best, have low tax rates compared to other jurisdictions.

Because there is no general agreement on the definition of tax havens, international bodies and the academic world have tried to determine the criteria by which a geographic area can be recognized as belonging to this domain. Differences in the qualifications of tax havens by various international bodies and by numerous experts constitute proof of the opacity of the phenomenon, despite the concern of (inter)national fora.

- In 1998, the Organization for Economic Cooperation and Development (OECD), the most important intergovernmental "crusader" against tax havens, found four keyfactors for identifying them: the absence of a nominal income tax or its existence at a very low rate; the absence of exchange of information with foreign tax administrations; the lack of transparency of banking activities; the absence of "material" activities [32].

- At its turn, the International Monetary Fund (IMF) has set the following criteria for recognizing tax havens: jurisdictions that have a relatively large number of financial institutions engaged in business in general with nonresidents (hypertrophied financial systems); financial systems in which mainly foreign assets and liabilities are traded; centres offering nominal or zero taxation, poor or moderate financialregulations, banking secrecy as well as anonymity [31].

• De-homogenizing offshore financial centres from tax havens

Unlike the relatively more "judgmental" treatment of tax havens coming from the OECD [33], the IMF provides a more practical definition of an offshore financial centre, considering it to be the centre where most of the financial sector activity is offshore on both sides of the balance sheet (i.e., the majority assets of financial institutions are formed by non-resident activities), where transactions are initiated elsewhere, and where most of the institutions involved are controlled by non-residents. It is important to know the meanings of the terms used, while noting that it is difficult to make a clear-cut analytical distinction between a tax haven and an offshore financial centre. An offshore financial centre is a structure in which complex financial techniques could be used to provide customers in international financial markets with a comparative advantage in fiscal matters.

Offshore financial centres are usually established in tax havens and benefit from their favourable tax laws. Branches or subsidiaries of major international banks and financial service providers (fund managers, trusts, company directors, accountants, law firms) are set up in offshore financial centres which are usually tax havens, although not all tax havens are concurrently offshore financial centres.

Ahmed Zoromй [27] finds the offshore financial centre as representing "a territory or a country providing financial services to non-residents on a scale that is disproportionate to the size and level of financing flows of its domestic economy", Mark Hampton [11] portrays offshore financial centres as "places hosting separate financial activities either legally or geographically by the major regulatory units", while Palan &Chavagneux [21] identify ten criteria that a territory should meet in order to fall into the category of tax havens, be they offshore financial centres as well or not: a reduced or non-existent taxation of non-residents; banking secrecy; professional secrecy; easy registration procedures; high capital mobility; quick deployment; support from an important financial group; economic and political stability; good reputation; a net of bilateral tax avoidance agreements.

It is noted that in virtually all attempts to define or delimitate tax havens, the principle of residence is invoked as essential. The concept of fiscal residence becomes crucial in an internationally-based fiscal system. While the registration of a company can be compared with the acquisition of citizenship by individuals, in many countries the corporate equivalent is the venue where the firm is actually run.

The place of effective management does not tell the whole story though. Typically, tax systems use a combination of these criteria to determine whether a company is resident in their territory. Conversely, nonresidents are usually identified as all those not resident in that jurisdiction. Applying different criteria by states can lead to a situation where a company is resident in several states for tax purposes: e.g., a company incorporated in a state which uses the registration criterion to determine its tax residence but which is actually managed from another state using effective tax management as a tax residence criterion will be seen as resident in both states for tax purposes. This may trigger adverse tax consequences on companies that are usually resolved through double taxation avoidance treaties. Also, dual tax residence can have beneficial effect on firms' tax expenditures.

• The "synthetical" path of avoiding biased analytical definitions

Because of the divergence of views on the criteria that delimit the territories that can be considered tax havens or similar structures, there is no unanimously accepted list of them. In 2017, the European Union first published a so- called "blacklist" of tax havens comprising 17 jurisdictions and a list of 47 supervised territories that agreed to make changes to national tax regulations. The overall purpose of the EU list was to improve good global tax governance and ensure that EU partners comply with the same standards as EU member states. Among the 17 states there are: American Samoa, Bahamas, Barbados, Grenada, Guam, Republic of Korea, Macao, Marshall Islands, Mongolia, Namibia, Palau Republic, Panama, Saint Lucia, Samoa Integral State, Trinidad and Tobago, Tunisia, the United Arab Emirates [30].

Also, in 2017, following the G20 Summit in Hamburg, the OECD published a list of so-called "non-cooperative tax jurisdictions", noting, in the same time, that "great progress has been made" in the fight against tax evasion. The global standard to which jurisdictions that do not want to appear on the OECD blacklist adhere is cooperation through the automatic, multilateral exchange of tax information between tax authorities. The OECD blacklist contains surprisingly one country: Trinidad and Tobago [34]. Researchers [19] believe that there are 45 to 60 tax havens worldwide, differences among analysts coming from the subjective perception on cooperation propensity of tax haven-like states.

Regarding the value of wealth held in tax havens, there is again a variety of opinions. This is due to the incomplete data available and the different calculation methods. James Henry [12], former chief economist at McKinsey, concludes that the value of offshore wealth falls somewhere between $2 and $21 trillion. A French economist [28] estimates "that it would be a three to four times lower sum - $7,500 billion". Therefore, it can be concluded that the successes in the research of tax havens are faltering and there is no consensus and consistency in terms of opinions in the literature. It is certain that tax havens are an element of the world economy whose existence has tangible negative (and positive) effects.

"Supplyside" and "demandside" oftaxhavens. One of the distinctive features of tax havens on which experts have reached some consensus is the low level of taxation or even the absence of any tax burden on companies and nonresidents. Tax havens distinguish between resident and non-resident taxpayers in order to apply a more favourable treatment to non-residents, in particular an exemption from taxes on residents. It should not be understood from this that non-residents would benefit from full and absolute gratuity. Although they benefit from consistent tax-related facilities, they will have to bear quite a lot of costs, which may take various forms, such as: royalties if they resort to licensing, rental or other forms of transfer of usage rights; payments for hiring (sometimes even fictitious) local experts or managers; the costs incurred by the operation of nonresident entities. Amounts earned for the maintenance of small local offices, property taxes, employing fictional residents contribute to the compensation of public authorities' "revenue loss". It is nevertheless difficult to assess the contribution of such "indirect"/"collateral" taxes to national revenues.

A way to maintain low tax rates on non-residents comes from the magnitude of transfers from developed countries or from the corporate environment to tax havens, thus allowing for significant revenue collection and the creation and maintenance of taxpayers' dependence on these derogatory areas. Noteworthy, there is a complementary group of actors operating in a financial offshore "ecosystem", adding to its fluent functionality: the service providers associated with tax havens, including banking institutions, mutual funds and other similar categories. For instance, most international banks have subsidiaries in tax havens. What keeps all these actors together, apart from the obvious motive of the diminished fiscal costs, is the strict confidentiality of all operations. Opacity in obtaining information on the nature, scale and identity of business people is one of their jurisdictional attractions, besides the nominal level of taxation. Another equally appealing feature of a tax haven is the ease and anonymity with which the entities can be recorded. This means that most tax havens do not even require corporations registered in their territory to be "physically" present [22].

Broadly speaking, there are three principal reasons for choosing to act in a tax haven:

- avoiding or reducing taxes and duties in the state of residence;

- the confidentiality enjoyed by clients of offshore financial structures (regardless of the nature of the business);

- the circumvention of national regulations (the IMF adds a basic sense of legality into the picture, distinguishing tax havens with legal coverage from those that are placed at or beyond the limit of legality).

As can be seen in the literature, among legitimate reasons we can find, in a detailed enumeration: lower explicit taxation and, consequently, the increase in profit after tax; regulatory frameworks that reduce implied taxation; simple registration procedures; the existence of adequate legal frameworks to protect the integrity of relations between service providers and customers; proximity to major economic powers; the reputation of certain financial centres and specialized services provided; making currency exchange without restrictions; means of protecting assets from the impact of litigation; the instability of the political and economic environment in the jurisdiction of residence [8].

Offshore financial structures can also be used for illicit purposes, such as pure tax evasion and laundering money from criminal (even terrorism-related) activities. This type of motivation derives from the advantages of tax havens - mainly the opacity of the operating environment and the confidentiality that prevents the exchange of information with the authorities of the real beneficiary's home. A great challenge when wanting to capture the amplitude of the phenomenon is the access to continuous and relevant statistical series. There are no comprehensive international databases, most information coming from information leaks (e.g., produced in 2015 as part of the Panama Papers scandal) [20].

Corporatetaxplanning - whyoptfor a taxhaven. Through an effective international tax strategy and a global approach to the interaction between fiscal and financial functions, companies can maximize profits seen globally and at the same time minimize certain types of risk across the entire group.

One way to streamline the financial results of multinational companies is to appeal to international tax arbitration. Unlike avoiding tax payments by registering companies in tax havens or engaging in non-economic transactions, international tax arbitrage is a result of legal differences and inconsistencies between two or more solid tax systems, whilst the law is not violated. Even though the concept of tax arbitrage is present in specialized papers dealing with taxation or with the structure of capital, there are very few empirical studies showing how companies use tax arbitrage as an integral part of the long-term financial strategy. At the same time, a number of authors point out that asset prices only partly reflect the effects of fiscal differences across countries. For instance, Engel, Erickson and Maydew [5] found that the tax benefits generated by debt are approaching the maximum, thus contradicting Miller's [17] research which argues that there is no tax benefit in the case of indebtedness. Furthermore, as tax systems evolved and diversified, companies began to invest in countries where the concept of withholding tax is missing, as well as in tax havens from some developing countries. In the same vein, Clausing [3] documents the fact that governmental revenues sourced from US companies' profits were about 35% lower, due to a change in the source of those profits.

In order to achieve the highest degree of profitability for a company, its financial and fiscal functions need to be linked to each other, and taxes and fees must also be taken into account when choosing a company financing option. Fama and French [7] studied how taxation of dividends and debts affects the value of the company, while Mackie-Mason

[16] and Graham [9] found that companies facing high marginal tax rates are more inclined to choose loans. Graham [10] presents the effects of taxes and duties on the organization form and company restructuring, on the risk management policy, and also on various decisions on financing or granting compensation / benefits to its managers. From further literature analysis, it also transpires that some researchers are wondering what are the reasons for companies and managers to engage in exclusive transactions to minimize taxes and fees. An extensive literature analysis shows how the managers' benefits determine their behaviour and the company's activity, especially in terms of tax arbitrage. The spectacular increase of managers' compensations and bonuses during the 1990s coincides with an increase in the mismatch between the returns on capital markets and the profits reported by tax authorities [4].

Bypassingbarriersviataxarbitrationpractices. The level of globalization has generated an unprecedented deepening of interdependencies between national economies. Players participating in the current economic game operate at the confluence of several national tax territories and must take a proactive attitude to the challenges attached to this. The continued maintenance of rather different national regulations on the cross-border financial and trade flows forces firms to resort to complex tax arbitrage schemes [24] in order to achieve predictability and consolidate the earnings derived from the transactions carried out globally. However, it is virtually impossible to take into account all the possible risks and to keep up with the developments in the increasingly complex and turbulent business picture.

Arbitration, including in the field of taxation, is related to commercial law and contract practices. As stipulated in the Article II (I) of the New York Convention [29] - "Each Contracting State shall recognize an agreement in writing under which the parties undertake to submit to arbitration all or any differences which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not, concerning a subject matter capable of ettlement by arbitration". As such, arbitration [2,

6] is a legitimate exercise of contractual freedom to establish a private form of justice and adjudication. At international level, there have been great successes both in terms of the regulatory and institutional framework (as exemplified by the French and American legislation in this domain).

Multinational companies' businesses face a whole series of barriers, restrictions and imperfections (Table 1). As a result, companies seek to bypass these obstacles and try to diminish their impact by resorting to arbitrage operations (Table 2).

Table1.Obstacles and imperfections within (inter)national markets

Source: Own synthesis from the literature.

Table 2.Bypassing barriers in the way of international transactions

Source: Own synthesis from the literature.

Emerging economies are in great need to explore and exploit these possibilities in a smart and sustainable manner, in order to reconcile own development goals (where, among other things, fiscal competitiveness as well as fiscal fairness are important) with the need of international credibility and reliability (as an originator and destination of financial transaction and a valuable piece in the gear of the worldwide economic order).

The case of the European Union member state, yet still maturing as a functional economy, Romania is illustrative in this respect. The debates in the Romanian society, at the level of business environment and policymaking authorities, assisted by Academia and civil society opinions - despite doctrinal differences between liberals and socialists -, converge to pointing out the need for actions on a number of levels, namely:

-at a macro-economic level- to adopt as soon as possible a modern, flexible and easily applicable legislation on the basis of which to regulate the principle of arbitration, create arbitration tribunals that are accessible to economic actors and consolidate a business culture to effectively handle these problems;

- at a micro-economic level- to develop new organizational cultures based on another attitude towards transactional risks, a new managerial ethos towards business internationalization and another way of conforming to the transformations that are taking place at national / European / global business levels;

- at a meta-economic, civil society level- to promote the principle of proactivity, militancy towards a healthy business environment and corporate sustainability, "morally and materially".

The controversial practice of "treaty shopping".