A tax haven is essentially an offshore financial institution with low or no taxes known for confidentiality. Individuals can use these financial institutions to set up businesses. Examples of areas that can meet this definition include the state of Delaware, the Cayman Islands, Dubai and the Netherlands.
How do taxpayers use tax havens?
As noted above individuals generally create shell companies in these tax havens. A shell company is one that exists only on paper. It does not have an office. It does not have employees. The sole reason for the shell company’s existence is to manage wealth.
Using a shell company to manage assets can be a valuable financial strategy. It is not illegal. Shell companies are only illegal if used for illegal purposes, like hiding assets and avoiding tax obligations.
How do shell companies legally reduce one’s tax bill?
These companies can legally reduce one’s tax bill by allowing individuals or companies to shift their money to these lower tax locations. The transfer from one business in a high tax location to the shell company must be done legally. One way to accomplish this goal is to have the shell company own intellectual property like trademarks. The business in the high tax location may then need to pay a fee to the shell company for use of the intellectual property. This effectively and legally shifts the money to the lower tax location.
Which brings us back to our initial question: are tax havens illegal? If done correctly, they are not. However, the line between legal and illegal can be a thin one and overstepping can result in allegations of criminal wrongdoing.