A tax haven is any country or jurisdiction that offers overseas individuals and businesses the opportunity to avoid their tax liabilities in order to preserve their wealth. A country that is a tax haven will typically have no tax or extremely low tax rates and strict banking privacy provisions. In addition, their tax operation systems lack transparency and there is very little exchange in financial information with other countries.
These jurisdictions can be used to launder money that is earned through illegal means such as drug trafficking. However, they are also frequently used by large banks, multinational corporations and very wealthy individuals.
One method in which they operate is to move money from one point to another, so that debts or profits are shifted from a high-tax jurisdiction to a low-tax one. This is an effective strategy for companies because they can borrow more money in a high-tax jurisdiction and move the profits to a low tax jurisdiction. Also, a large multinational company with operations in multiple jurisdictions may sell goods or services to a related entity at a lower cost than market value, allowing the corporation to shift its income around.
Businesses that use these operations may also influence the local market. For instance, a company that owns trademarks or patents can set up the business and transfer the patents or intellectual property rights to a related company in a tax haven jurisdiction. This company then charges the parent company fees at a very high rate, making it difficult to establish a fair market value for these rights. It can be very difficult for the authorities to curb these types of arrangements.
Tax havens are aided greatly by their banking secrecy because of their strict confidentiality laws which make it very easy to transfer large amounts of money into offshore accounts. In most cases, tax authorities that attempt to research these transfers discover very little information, such as who the owner of an account is and whether the money has been earned legitimately. If the money cannot be traced to an owner, there is virtually no hope of recovering taxes on it.