Tax Avoidance by the use of Tax Haven Jurisidication: A Corporate Governance Issue - Dissertation Example

? Dissertation Proposal Tax Avoidance by the use of Tax Haven Jurisidication: A Corporate Governance Issue Regardless of the standardof corporate governance, states are powerless to exercise control over the conduct of corporations’ capital flows for taxation purposes when corporations divert funds to tax havens. Therefore, tax avoidance by the use of tax haven jurisdication is problematic for corporate governance constructs under the auspices of agency theory. Agency theory assumes that managers are persuaded to pursue the interests of the corporate owners which increases the risk of using tax avoidance strategies via capital flight to tax havens (Aki and Gregoriou 2006, p. 131). This research dissertation purposes to investigate the significance of the problem and to determine whether and to what extent, corporate governance practices can be strengthened to prevent the diversion of capital to tax havens to avoid taxes. The Research Context The state’s claim to taxes on capital flows makes the state a minority stakeholder in virtually all corporations within its jurisdiction. Even so, the state’s interest does not typically factor into corporate governance constructs (Shleifer and Wolfenzon 2002, p. 3). This oversight facilitates the corporation’s incentive to divert corporate income as a means of avoiding taxes (Desai, Dyck & Zingales 2007, p. 594). Monks and Minow (2008) refer to this as “capital flight to avoid taxation” (p. 364). In this regard, multinational corporations devise frameworks by which transactions and capital are filtered through dummy corporations situated in tax havens. These dummy corporations facilitate a method by which proceeds of legitimate transactions as well as proceeds from illicit practices such as fraud, illegal arms trade, drug trade and embezzlement can be laundered without having to pay taxes. This is possible because of weak corporate constructs implicit in a general failure of transparency among global financial markets (Monks and Minow 2008). Corporate governance usually focuses on investor protection and the protection of outside shareholders (Porta, Lopez-de-Silanes, Shliefer and Vishny 2000, p. 4). It is a state’s method for making corporations accountable for management of corporate capital. However, a state’s control is subject to jurisdiction boundaries in that a state cannot control and regulate corporate governance with respect to funds that are transferred out of the jurisdiction and into the control of dummy corporations located abroad (Monks and Minow 2008, p. 364). Corporate governance can only manage that which can be measured. Tax avoidance by the diversion of capital to tax havens therefore poses a significant difficulty for corporate governance initiatives at home. This is because, tax havens typically have secrecy laws that permit corporations to manipulate income and payables or by “outright diversion” of capital and failing to report these taxable transactions (Schon 2008, p. 15). This dissertation proposes to argue that there is a direct link between taxation and corporate governance effectiveness. It will be argued that since taxation and corporation are both jurisdictional in nature, corporations can avoid both taxation and corporate governance standards and practices by virtue of capital flight to tax havens. In order to test this hypothesis, this dissertation will be investigated and analysed by reference to a primary research question and a number of secondary research questions. The primary research question is: How does tax avoidance by the use of tax havens undermine the effectiveness of corporate governance? This research question is investigated by an exploration and analysis of corporate governance standards and practices and the role of tax havens in facilitating the circumvention of corporate governance controls. The secondary research questions are: What is tax avoidance? This research question calls attention to the distinction between tax avoidance and tax evasion. This distinction is necessary for shedding light on how tax avoidance permits the corporation to escape corporate governance commitments. What is corporate governance? A definition of corporate governance is necessary for understanding how and why corporate accountability is significant. It will also assist in understanding the limits of corporate governance and how those limits can be exploited by capital flight to tax havens. What are tax havens? Understanding what tax havens are, how they operate and how they facilitate avoidance of taxes will be investigated and analysed. What is the connection between tax avoidance by virtue of capital flight to tax havens and corporate governance? This question calls attention to the manner in which tax havens are used for tax avoidance purposes and how corporate governance is ineffective for preventing tax avoidance by capital flight to tax havens. What measures can be taken to improve and strengthen corporate governance to prevent tax avoidance by capital flight to tax havens? This question is investigated by conducting a cost-benefit analysis of the revenue lost as a result of capital flight to tax havens and the revenue lost should the tax enforcement practices and policies be relaxed. Therefore, this question will investigate the possibility of relaxing tax enforcement practices as a means of discouraging the diversion of capital to tax havens. Other possibilities such as the outlawing tax avoidance and/or the harmonization of a global standard of corporate governance for financial markets and multinational corporations are considered. The idea is to determine whether or not there are other means for preventing or minimizing the risk of capital flight for tax avoidance by the use of tax havens. Research Aims and Objectives The aims and objectives of this research is to identify the ineffectiveness of corporate governance constructs to circumvent the avoidance of taxes by the use of tax havens. This research aims to measure this hypothesis by presenting material that demonstrates how tax havens operate and how they are able to facilitate corporate manipulation of taxable income. This research will aim to prove the hypothesis by presenting data that reflects the loss in tax revenue will be reported to support the hypothesis. This research also has as its aims and objectives the presentation of a solution by offering recommendations for strengthening global corporate governance and cooperation among financial institutions and multinational corporations relative to tax avoidance. A Review of Key Research Relevant Literature The purpose of the literature review is to establish an empirical and conceptual basis for investigating the significant impact that tax avoidance by the use of tax havens has on corporate governance locally and internationally. The literature review establishes the conceptualization that tax havens contribute to the loss in government revenue and exposes the weaknesses in corporate governance (Gravelle 2009, p. 1). There are also arguments in the literature review that tax havens can actually improve corporate governance (Dharmapala and Hines Jr. 2009, 1058). Both arguments are exposed in the literature review as a means for providing a basis for further research and investigation. Tax Avoidance vs Tax Evasion The distinction between tax evasion and tax avoidance is significant for defining the correct responses to tax avoidance within the confines of corporate governance constructs. Hoffman, Smith and Willis 2009) explains that tax avoidance is a legitimate method of minimizing taxes whereas tax evasion is an illegal method of achieving the same end (pp. 2-35 – 2-36). In other words, individuals and corporations wishing to minimize tax liabilities have an alternative to tax evasion (Webley, Robben, Elffers and Hessing 2010, p. 135). Regardless of the legal distinction between tax avoidance and tax evasion, both methods of tax planning have virtually the same consequences. The both result in a loss in state revenue and are “based on the same desire to reduce the tax burden” (Kirchler, Maciejovsky and Schneider 2003, p. 535). Regardless of the legal differences and the moral similarities, tax avoidance is generally perceived in a positive way. Kirchler, Maciejovsky and Schneider (2003) conducted a survey of 252 business students, lawyer, small business proprietors and fiscal officers. The respondents were asked to rate their perception of tax flight, tax avoidance and tax evasion as either positive, neutral or negative. The survey results reflected that a vast majority of the respondents viewed tax evasion as negative, tax flight from a neutral perspective and tax avoidance positively (Kirchler, Maciejovsky and Schneider 2003, p. 535). The legal nature of tax avoidance therefore makes it an acceptable practice and an acceptable method of reducing or eliminating tax obligations. It would therefore follow that if tax avoidance was an illegal method of minimizing or eliminating tax obligations, perceptions of tax avoidance would change. The rationale is, if tax avoidance was perceived negatively by corporations, they might be less inclined to use this method of tax planning. This research will therefore investigate the possibility of making tax avoidance unlawful and the likely consequences this might have on corporate governance. As Christensen and Murphy (2004) inform that “tax revenues are the lifeblood of democratic governments” (p. 37). Even so, corporations have “structured” their businesses “so as to enable tax avoidance in every jurisdiction in which they operate” (Christensen and Murphy 2004, p. 37). Tax Havens and Tax Avoidance The publicized accounts of corporate scandals have placed corporations and the issue of corporate governance under intense scrutiny in recent times. This makes the issue of tax avoidance all the more significant. Tax avoidance conduct has been described as the among the “most serious compliance issue” threatening the enforcement of tax commitments (Desai 2005, p. 171). The impact of tax havens on corporate governance has attracted two opposing arguments. On the one hand it is argued that tax havens result in “laissez-faire standards of corporate governance that gives tremendous power to corporate managers” (Shaxson 2011, p. 123). Dharmapala (2008) argues however, that increasingly researchers are finding evidence that corporate governance constructs in tax havens is much more efficient than in “non-haven” countries (p. 661). Regardless of which side of the argument is adapted, it is largely agreed that tax havens which facilitate capital flight result in state loss of revenue. The Tax Justice Network (2011) report that more than US$11.5 trillion are diverted to tax havens resulting in the loss of US$250 billion in state revenue each year. The loss in revenue for governments is exemplified by the fact that in 1999 Microsoft reportedly earned US$12.3 billion in profits but did not pay taxes on that amount. The avoidance of taxes was facilitated by the use of tax havens (Benatar and Brock 2011, p. 177). Both sides of the argument will be analysed. This research study will review and analyse the literature relative to whether or not tax havens contribute to good corporate governance as argued by some researchers. This dissertation will also investigate the claim that tax havens contribute to poverty and the evidence documenting that tax havens are responsible for losses in government revenue. Corporate Governance, Tax Havens and Tax Avoidance Cohen and Boyd (2000) argue that there are two dimensions at work in the proliferation of tax havens as a tool for tax avoidance. First there is the international call for improved corporate governance and cooperation among international financial markets operates on the one hand to discourage tax avoidance initiatives and the diversion of capital to tax havens. However, on the other hand, improvements in technology facilitating the proliferation of “sophisticated financial instruments” and the exploitation of tax havens together with competition in tax policies among the industrialized world, “is making the problem of tax avoidance more intractable” (Cohen and Boyd 2000, p. 367). The problem for corporate governance is amplified by the fact that accounting firms play an important role in compiling strategies for tax avoidance practices. For example, KPMG is an international accounting firm that has under its employ more than 100,000 experts with 6, 5000 partners located in approximately 148 countries. KPMG also has offices in 18 tax havens where it advices individuals and corporations on how to avoid taxes (Christensen 2005, p. 2). Thus, with the help of accounting experts and the diversion of capital to tax havens, the lack of corporate governance via transparency and corporate accountability is essentially legalized, motivated and facilitated. Cheuvreaux (2009) conducted an overview of corporate governance in European banks. The focus was on the role of corporate governance in the recent and on-going global financial crisis. One of the concerns for Cheuvreaux (2009)was the corporate governance issue relative to tax havens. In this regard, the Cheuvreaux research team proposed that in compliance with the latest G20 recommendations, its group of banks “take action against tax haven jurisdictions with often have lower regulatory standards and lack transparency” (Cheuvreaux 2009, p. 13). Cheuvreaux (2009) also noted that there were two main corporate governance concerns relative to tax havens. First there was the control risk since tax havens typically do not have tight regulatory regimes. The second concern was the pressure that governments were under to minimize practices that permit corporations to avoid taxes (Cheuvreaux 2009, p. 14). The G20 Communique reporting on its summit in London in 2009 resolved: To take action against non-cooperative jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over (p. 4). The Organization for Economic Cooperation and Development (OECD) has also pursued a similar initiative for the promotion of corporate governance standards that undermine the ability of tax havens to facilitate capital flight (Jackson 2010, p. 1). Angel Burria (2008) Secretary-General of the OECD reported at the Paris, France OECD Conference on the Fight Against International Tax Evasion and Avoidance: Improving Transparency and Stepping up Exchange of Information in Tax Matters reported that there are over 40 tax havens globally. Even so, the OECD has obtained commitments from 35 of those tax havens to comply with the OECD’s corporate governance standards relative to “transparency and exchange of information” (OECD 2008). The significance of the OECD’s initiative on tax havens is the impact it will have on corporate governance. The standards developed by the OECD by virtue of the OECD’s Global Forum on Taxation was subscribed to by the G20 Finance Ministers and the UN Committee of Experts on International Co-Operation in Tax Matters. These standards impose upon all member states including tax havens to cooperate in exchanging information relative to requests by other states for the purpose of administering and enforcing taxes regardless of bank secrecy laws (OECD 2009). As of 2005, empirical research efforts by Becker and Fuest (2007) indicated that cooperation by tax havens was weak. The research compiled data from sixteen German states between 1970 and 2005 (Becker and Feust 2007, p. 2). With the more recent initiatives by the OECD and the UN Committee of Experts on International Cooperation in Tax Matters, Great Britain’s Parliament House of Commons International Development Committee raised a concern about whether or not these efforts will correspond effectively with the urgent problems associated with capital flight to tax havens (Great Britain Parliament 2009, p. 109). Research Design, Methods and Techniques In the investigation of a hypothesis that is not effective answered by either a qualitative research method or a quantitative research method, a mixed research method is desirable (Creswell 2009, p. 138). The hypothesis that tax avoidance by the use of tax havens is linked to corporate governance is not answered by either a qualitative or quantitative research analysis, but rather by a combination of both methods. Therefore this research will be conducted by virtue of a mixed research method. Qualitative Research Methods The qualitative research methods is designed around the collection of data in the literature. This data is comprised of empirical research studies and theories and assumptions relative to the link between tax avoidance via tax havens and corporate governance. Thus the data is comprised of primary and secondary resources. Primary resources include government and inter-governmental publications documenting corporate governance, taxation policies and practices and policies and practices toward tax havens. This includes documents released by the OECD, the United Nations, the World Bank and the UK government as well as the European Union. Legislative provisions and cases relative to tax avoidance will also be used to explore the significant link between corporate governance and tax avoidance by virtue of the use of tax havens. Secondary sources will include textbooks, articles/journals and internet publications. The secondary sources provide empirical studies demonstrating the manner in which tax havens facilitate the erosion of corporate governance constructs and states’ ability to measure and control capital flows across borders. The empirical research studies such as the Tax Justice Network also provide evidence of the revenue losses that states experience as a result of the diversion of capital to tax havens. Quantitative Research Methods The qualitative research methods are comprised of the analysis of secondary and primary data. The secondary data will be comprised of informal interviews conducted among corporate management. Candidates are selected from a random population of companies with subsidiaries in tax havens. The aim is to interview as much as 20 corporate managers, but no less than 10 managers. The questions will be formulated in advance and notes relative to responses will be recorded contemporaneously. The questions will be designed to explore the extent to which corporations save in terms of income taxes and how much they lose in terms of corporate fees for the formulation of corporate advice and instruments to facilitate capital flight to tax havens. Other questions will be asked about the difference in terms of corporate governance in tax havens and domestic corporate governance structures and the degree of cooperation between tax havens and local tax administrators. The primary data analysis will be comprised of two survey distributed among up two groups. One group is comprised 50 legal and actual persons. The random sample will be persons either legal or actual that use tax avoidance strategies by the use of tax havens. The questionnaire will be categorically scaled from 1-6 with 1-6 representing indicators such as Agree, Mildly Agree, Strongly Agree, Disagree, Mildly Disagree and Strongly Disagree. The idea is to rate the degree to which the morality and legality of tax avoidance is viewed. Other questions relate to how amenable the respondents are to alternatives to tax avoidance such as the relaxation of tax administration at home, the lowering of income taxes, the risk of criminalizing tax avoidance prospects and concepts of corporate social responsibility. A second group is comprised of 50 random members of the public. The questions are categorically scaled from 1-6 as explained above. The idea it to assess and rate the attitudes and perceptions of the public (stakeholders) in corporate and individual practices designed to avoid taxes by the use of tax havens. The questionnaires will be blind items in that respondents will be apprised of their privacy and the right to refuse to participate in the questionnaire. More over the questionnaire is completed anonymously and distributed manually and returned by virtue of mail. As an ethical responsibility, respondents will be informed that the questionnaire is relevant to an academic dissertation and can be used to aid in the improvement of corporate governance and to make tax havens more transparent and accountable. Likely Research Findings, Recommendations and Policy Considerations The quantitative research methods expect to find that those who subscribe to tax avoidance by virtue of tax havens are unlikely to perceive that it is morally or legally wrong. As Hong (2007) informs, individuals in countries with high taxes perceive that tax avoidance strategies are beneficial to them. The likely research findings are expected to expose a gap between corporate social responsibility, corporate governance and initiatives to avoid taxes via the use of tax havens. Such a gap was revealed by Sikka (2010) in a series of examples provided in terms of how corporations promise to act responsibly yet practice tax avoidance strategies via the use of tax havens at social and welfare costs to governments and citizens. The research findings are also expected to find that some corporations do gain in terms of earnings as a result of tax avoidance by virtue of tax havens. As Harrison (2010) argues, the fact that tax havens have been used for decades is a reflection that they do provide benefits to corporations and individuals. The research also expects to find that despite the perceived savings of using tax avoidance by virtue of tax havens, corporations suffer losses in terms of fees and a loss in reputation as they become engaged in what may be perceived by members of the public as immoral and illegal practices. We also expect to find hypocrisy among members of the public who believe it is alright to underestimate income for tax purposes but do not agree with corporations using tax avoidance strategies. Bemmell, Morrissey and Pinar (2004) conducted a survey which reveals that the participants have a tendency to underestimate income and over-estimate expenses for tax avoidance strategies. This research expects to recommend that the obvious solution might be to either reduce tax obligations and to relax administration policies and practices or to tighten corporate governance constructs to minimize the risk of capital flight to tax havens. However as a matter of policy, this might lead to greater welfare and poverty concerns at home as corporations might simply take physical flight to tax havens. Therefore some middle ground will have to be taken into account. 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