This article was first published in the June 2013 International edition of Accounting and Business magazine.
American politicians – like other politicians and pressure groups around the world – have long condemned tax havens as a global menace that need to be stamped out. Offshore centres, the case goes, enable companies and wealthy individuals to dodge tax and provide hiding places for criminal money. President Barack Obama is particularly fond of satirising the Cayman Islands, where a single office block – Ugland House – contains 18,000 offshore corporations.
So the US has been at the forefront of global efforts to force such rogue jurisdictions to clean up their act. But how far are countries looking at their own back yards? America, it can be argued, has made one notable exception – for itself. ‘Much of the US attack on offshore financial centres is highly dubious given that it is the world’s best-known destination for setting up low-tax light-touch corporate structures,’ says Chas Roy-Chowdhury, head of taxation at ACCA.
‘The US is arguably the world’s largest tax haven,’ says Dan Mitchell, a fellow at the Cato Institute in Washington. ‘If you define an offshore centre as a place where you can easily and anonymously set up a corporation and minimise taxes, America can be hard to beat.’
Delaware, America’s chief financial refuge, is home to 945,000 companies, more than the number of citizens living in the state. Nevada has been trying to catch up, while Miami is a favourite destination for rich foreigners hoping to keep their assets hidden from their home governments. Ironically, US-led efforts to tighten standards elsewhere have increased the relative appeal of the US as an offshore centre.
This has laid the US open to the charge of hypocrisy. In April, the Austrian finance minister Maria Fekter, who has been resisting pressure to share private financial information with other nations, insisted that ‘Delaware and Nevada are tax havens and money-laundering centres that have to be laid bare just as much’.
Birthplace of offshore
Indeed, some financial historians view the US as the birthplace of the offshore centre. As early as the 1880s the state of New Jersey pioneered certain strategies that later became hallmarks of financial centres like the Cayman Islands. The most notable was easy incorporation – the ability to set up a shell company quickly and cheaply. ‘Corporate headquarters were attracted to New Jersey primarily due to its liberal incorporation laws, and to some extent by its relatively low rate of corporate taxation,’ Ronen Palan, a professor at City University London wrote in a paper on the history of offshore finance. Noting this, Delaware emulated this approach when drafting its laws of incorporation in 1898.
Similarities to Cayman
The tiny east coast state has never looked back. Now it is almost impossible to distinguish from the foreign tax shelters that Obama often criticises. The state’s capital Wilmington – just 100 miles from Washington DC – even has its own answer to the Cayman’s Ugland House. The single-story 1209 North Orange Street houses a remarkable 285,000 companies – four companies for each of the town’s 70,000 inhabitants. These absentee tenants include such august corporations as Apple, American Airlines and Warren Buffett’s Berkshire Hathaway.
What makes Delaware such an attractive destination is the ease with which a legal company can be formed, even with no staff, assets or operations.
One of the big advantages the state offers is anonymity, says Bruce Zagaris, a partner at Washington law firm Berliner, Corcoran & Rowe. ‘In Delaware you don’t even need to disclose who actually owns the business,’ he says. ‘The true beneficiary can hire a local attorney to act as an agent.’ Such tactics have been used by upstanding companies, such as Walt Disney, which set up phantom Delaware corporations to amass in secret vast areas of land in Florida that would later become Disney World. Others value the anonymity for other reasons. Viktor Bout, the Russian arms dealer recently sentenced to 25 years in prison, had two addresses in Delaware.
As a result Delaware can offer many clients greater confidentiality than more famous offshore centres, like the Caymans, Isle of Man or Jersey – all of which compel greater disclosure. As recently as 2009 the US ranked number one in the Financial Secrecy Index, published by the pressure group Tax Justice Network. It has since fallen to fifth. But this is still a very high ranking out of 72 countries. Austria came 17th, for example. ‘The way the rules are set up in Delaware makes it extremely difficult to discriminate between criminals or legitimate investors,’ Zagaris says. ‘I could have five fraud convictions and still set up a company. By contrast the Channel Islands has to make sure that you are a fit and proper person to form a company.’
Discretion is just one of the perks offered by Delaware. There is an almost complete absence of red tape and a single person can set up their own limited liability company.
Too big to be pushed
These advantages become ever more valuable as other offshore centres are forced to add extra layers of administration, says Dan Mitchell. Various initiatives by the rich nation OECD club and the Financial Action Task Force have insisted on ever tighter procedures to prevent money laundering. ‘Small jurisdictions can be forced to make concessions,’ says Mitchell. ‘But there is no way the OECD is going to try to push around the US.’
Worryingly for critics of tax havens, Delaware’s success has attracted imitators. The state collected US$860m in taxes and fees in 2011 from its absentee corporations, accounting for a quarter of the state’s budget. Wyoming and Nevada, eager for a share of this bounty, have instituted similar corporate regimes.
To a degree it is the neighbours of such states that pay the price. One other convenience that Delaware offers is that it does not tax income from intellectual property or interest. ‘As a result companies can save a lot of state tax by setting up subsidiaries in Delaware that own much of their patents or trademarks,’ says Scott Dyreng, a professor at Duke University. ‘A company can sell goods in high-tax states but much of the profit is registered in Delaware, where royalty payments are sent.’ This Delaware loophole alone has cost fellow states around US$9.5bn in lost tax revenue over the past decade, according to a recent estimate published in The New York Times.
Even aside from such obvious havens as Delaware, the US as a whole has often been a favoured location for those looking to minimise tax liabilities. One aspect that lures foreigners is that the country does not tax the interest or capital gains of non-resident aliens, Mitchell says, and does not report such earnings. ‘The US might not have very explicit policies to support financial privacy,’ says Mitchell. ‘But if you are the citizen of a despotic government you can use the US as a haven with a high level of confidence,’ says Mitchell.
A strong case can be made that offshore financial centres offer valuable service. ‘Places like Delaware make it harder for politicians to impose high tax rates,’ says Mitchell. ‘They also perform a valuable role in human rights, making it easier for politically oppressed groups to keep their assets safe,’ Mitchell adds.
But as one of the world’s largest tax havens, it could be argued that the US is in a weak moral position to castigate rival offshore jurisdictions.
Christopher Alkan, journalist based in New York