What is tax evasion and what does it actually mean to call somewhere a tax haven?

This year, Code for South Africa launched a project that interrogates transparency within the private sector, “Transparent Corporates” (Trace). Our mission is to make corporate data freely and publicly available, and to empower everyone living in South Africa to hold the right people in the private sector accountable when they do things that affect everyday life. Over the next few weeks, we’ll be publishing a series of pieces that highlight some of the work we do, from looking at international shareholding to tax evasion, Trump to “paid Twitter” and much, much more. In the second article of our series, we look at tax evasion; what is it and what does it actually mean to call somewhere a tax haven?

Forget Panama, Bermuda or the Cayman islands, it’s easier to hide your money in parts of the US than most better known tax havens. The state of Delaware has in recent years been nicknamed “an onshore tax haven” because of how popular a place it is to form shell companies.

Delaware, known as the First State, is one of a few tax havens in the country, along with Wyoming and Nevada. In Wilmington, Delaware, there are nearly 30,000 companies listed in one particular building, 1209 North Orange, which overshadows the nearly 20,000 listed at the Cayman Islands’ Ugland House. More than 50% of all US publicly traded companies are incorporated in Delaware and with very good reason.

As you would expect, some of the biggest names in the corporate world have incorporated entities in Delaware, including US President Donald Trump. When he announced that he was running for president, he had to disclose a full list of entities where he is the named executive. The list includes over 500 different entities, mainly registered in Delaware, which, as we’ll explain, guarantees almost 100% privacy.

What makes somewhere a tax haven?

There are a few things that make somewhere a tax haven. Namely, minimal or no taxes on specific types of income, financial secrecy laws, a lack of transparency and zero requirements for substantial activities. In other words, all you really need to do is form your entity, pay the minimum fees in upkeep and voilà, you can safely store your money, move it around and avoid losing parts of it to the taxman.

And what about this particular tax haven? Well, it has extremely advanced and flexible business formation laws, and much of US corporation law was written by the Delaware Court of Chancery. This makes for more predictable litigation, as all Chancery judges have a background in corporate law, and they decide on the outcome of a case without the help of a jury. Delaware Corporation Privacy allows the incorporation of an entity to take place without listing shareholders, directors or officers on public record. And when it comes to taxes, corporations aren’t taxed a thing if business is conducted outside of the state. It also takes less than an hour to incorporate a company, making for a quick and painless process.

Although Delaware isn’t a typical zero-tax jurisdiction, it does have what’s called the “Delaware Loophole” which works as follows: A company sets up a subsidiary in Delaware and transfers its intangible assets (such as a trademark) there. Its other locations pay the subsidiary (in Delaware) to utilise those assets, where they are not taxed at all. The company can then deduct these as a business expense in its home state, reducing the tax burden. Of course, this means the state where these corporations are actually operating will lose millions in tax revenue; naturally, there’s a good dose of antagonism between other states and Delaware. A well-known example of this is the case of Toys “R” Us and Geoffrey the Giraffe. In short, the outlet’s trademark, Geoffrey, became the face of the “Delaware Loophole”, allowing Toys “R” Us to move money from other states to Delaware, significantly lowering their tax burdens.

So, how do you incorporate an entity there? Well, it’s really easy and as the director, you can remain entirely anonymous.

Choose the type of business entity that best suits your needs.choose a name for your entity. Note: it can’t include the words “bank”, “university”, “college”, “insurance” or “trust”. If you don’t live in-state, select a registered agent to maintain your incorporation. File a Certificate of Formation (or Incorporation) with the Secretary of State, listing the name of your corporation, its purpose, the number of authorised shares of stock, the name and address of your registered agent, and the names and addresses of the incorporators.

Okay, so why is all of this such a big deal? Because of its almost 100% guaranteed anonymity, Delaware corporations are a good vehicle for tax evasion and money laundering from illegal activities. No state in the US requires disclosure of beneficial ownership information when it comes to formation but Delaware is one of the easier jurisdictions in which to remain untraceable. It’s almost impossible to follow the money in Delaware.

There’s been an attempt to increase transparency, and in 2014, the state passed legislation that requires a registered agent to identify a person at the company that has a list of the entity’s legal owners. But the only way this can be accessed is through a subpoena, meaning that it would never be made publicly accessible. In Global Shell Games, an experiment in attempting to unveil shell corporation trade secrets, it was found that it’s easier to set up an anonymous company in the US than in most of the well-known tax havens.

Some tax havens are more equal than others

But, as has become clear, not all tax havens are created equal. According to the Financial Secrecy Index (FSI), a tool launched by the Tax Justice Network in 2015, South Africa ranked significantly low as a secretive financial jurisdiction (at 61), which, in comparison to the Cayman Islands and the US, indicates that it isn’t much of a tax haven at all. The index looked at tax efficiency, company ownership, banking secrecy and international cooperation. In South Africa, the biggest red flag was a lack of compliance in corporate transparency regulation. We don’t require company ownership details or company accounts to be made publicly available online and despite the FSI identifying us as performing well in terms of tax financial regulation, we fell R11.6-billion short in tax revenue, according to last year’s (2016/17) budget. This doesn’t necessarily point to tax evasion, but it doesn’t rule it out either.

When the Panama Papers were released last year, the government, clearly embarrassed by the nearly 2,000 South Africans who were named and shamed, attempted to bring an end to over-investing in offshore assets its citizens. They introduced the voluntary disclosure programme (VDP) which, as its name suggests, allows for anyone with offshore assets to voluntarily disclose them, or face future scrutiny and possible investigation. At the moment, South Africans are free to invest within the exchange control limits, but, as part of the global move towards tax-related transparency, the days of carefree money movement back and forth between tax havens are slowly coming to an end. Now, if you invest in a jurisdiction that may allow you to do so without disclosing your assets, the South African Revenue Service (SARS) could come after you for tax avoidance. If you’re found guilty of making an arrangement that resulted in tax benefits within a business context, you could get up to five years in jail and SARS could deal you a hefty fine.

Now, we aren’t out to expose tax evasion schemes; the government, with support from multiple nonprofits is already doing that. What we’re interested in is the extent to which companies are complying and more importantly, how transparent they are about their financial management. A large part of our research involves political beneficial ownership and how tax evasion enables this in different places around the world. Delaware is one such example.

In our next piece, we’re going back to the beginning and will look at why we’re doing all of this. What is open data? Is there such a thing as closed data and what do we have here in South Africa? Why is corporate transparency so important and how is it connected to making data open? And if you haven’t read our first piece in this series, you can find it here.

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