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Corporate tax avoidance by multinational corporations is not too different from alchemy. The latter claims to transform metals into gold. The former aims to transform operating profits made in one country—say, by selling coffee—into financial profits in an offshore financial center—such as royalties received for the right to use the image of a mermaid on a coffee cup. These financial profits are then taxed at an extremely low rate in the offshore financial center. In his dissertation,  Javier Garcia-Bernardo analyses these jurisdictions. Garcia-Bernardo shows that small islands known to be tax havens only constitute a small part of international tax avoidance, and regulation should rather focus on a radical transformation of the entire international tax system.

The alchemists of today are tax professionals, who advise governments on the creation of tax legislation, and at the same time advise corporations how to organize their structure and operations to take advantage of such legislation. And they are very successful. Nowadays 40% of all foreign profits of corporations, amounting to a staggering 600-1,000 billion dollar follow this transmutation and are shifted towards offshore financial centers.

Corporate tax avoidance deprives governments of tax revenues, privileges large corporations over small and medium-sized enterprises, and contributes to rising inequality. While the relevance of tax avoidance has been recognized since the late 20th century, quantitative research on tax avoidance has been hampered by a lack of data.

Using novel datasets and algorithms, Garcia-Bernardo analyzes which jurisdictions can be considered offshore financial centers and the extent to which they contribute to corporate tax avoidance, revealing a clear pattern of specialization. There are two main types of offshore financial centers. 

  1. The first, the profit center, resembles the conventional idea of the tax haven—a small island state with no taxation and high secrecy that attracts large amounts of profit. Profit centers play a role in the organization of multinational corporations through holding companies. The profit per employee in these jurisdictions is usually above $500,000/employee, which reflects the lack of real activity in these jurisdictions.
    Among these, Bermuda, the British Virgin Islands, and the Cayman Islands are the largest profit centers.
  2. The second type of offshore financial center, the coordination center, is a jurisdiction that provides the opportunities for widespread corporate tax avoidance. They are important not only for profit shifting through holding companies, but also for regional management, financing operations, and high value-adding activities such as procurement, marketing, sales and distribution.
    The main such examples are the Netherlands, Switzerland, Luxembourg, Ireland, the United Kingdom, and Singapore.

Garcia-Bernardo finds that coordination centers play an increasingly large role in relation to corporate tax avoidance in two ways. Firstly, these are the places where tax professionals (and with them the coordination of tax avoidance) are situated. Secondly, Garcia-Bernardo shows that an increasing amount of profits are shifted to these jurisdictions. In the last decade, 14.2% of all profits from US multinational corporations have been shifted to four coordination centers: the Netherlands, Switzerland, Ireland and Luxembourg. This is because they offer very low tax rates on financial profits--- such as those arising from trademarks, intellectual property, or loans. Multinational corporations in these jurisdictions pay a similar effective tax rate to the one in Bermuda.

Garcia-Bernardo’s dissertation employs new methodological approaches from network science and machine learning to open the black box of corporate tax avoidance, uncovering the emergence of coordination centers. By doing so, it exposes potential avenues for regulation. Instead of shaming small-island jurisdictions into compliance, a radical transformation of the international tax system, limiting the potential harmful effects of coordination centers, should be the focus for policy efforts towards stopping corporate tax avoidance.

More information

Javier Garcia-Bernardo will defend his dissertation on the 9th of June. The defense is open for interested public (through a YouTube livestream).