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HOW DO TAX HAVENS AFFECT DEVELOPING COUNTRIES? IN SPECIFIC CONTEXT OF MALAYSIA
Table of Contents
Introduction    3
Analytical Framework    4
Tax Havens - Boon or Bane    4
Rational for Companies Preferring Tax Havens    5
Case Study    7
Taxation System of Malaysia    7
Benefits to Off-Shore Companies in Malaysia    8
Discussion    10
Impact of Tax Haven on Local Malaysian Companies    10
Comparative Effect of Tax Haven on Economy of Malaysia    11
Conclusion    13
Bibliography    14
Introduction
Taxation system varies across the globe depending on the economy of a country. Few countries offer benefits to foreign companies whereas few do not. Tax haven refers to a country that offers foreign companies or individuals no tax liability of limited liability in an economically and politically static environment. With the advent of globalisation, companies are going global to increase the volume of their business and thus profits. Companies prefer to invest in countries that offer a large market shares along with healthy tax benefits. Individuals and companies try to minimise their cost to ensure a healthy return on investment. Tax forms a major expense of the profits and thus tax haven are preferred by foreign nationals and companies for investment purpose.
There is a significant impact of such taxation system on the local as well as national companies. Some nations allow tax advantage whereas some do not. The secrecy maintained by such countries also attracts the foreign investors for investing their excess wealth or just storing the same. Switzerland, Luxembourg, Hong Kong and others are among the most preferred tax haven across the globe. Tax haven may impose certain conditions for providing the tax incentive. Malaysia also offers certain benefits to the investors in the form of tax incentive to attract foreign incentive. In spite of rapid economic developments, Malaysia is not considered as a developing country. The impact of tax haven on economy of Malaysia and local Malaysian companies has been discussed in detail.
Analytical Framework
Figure 1: Diagrammatic Representation of the Analytical Framework
(Source: Learner)
Tax Havens - Boon or Bane
Tax havens have modified their laws over the course of time to attract investments from foreign countries. According to Keightley and Sherlock (2014), there are more than 70 tax havens across the globe. More than 70% of the global stock of money is located in or goes through the tax havens. The per capita income of tax haven is among the highest across the globe. According to Harrington (2016), the tax advantages help the country in attracting investments from foreign countries. This helps the counties in regulating the money supply in the economy. In case of developing countries, unemployment, money supply and few other issues are prominent. As commented by Graham (2003), tax haven leads to a significant gap between the economically established and the poor. The rich does not have to pay any tax as they invest in tax havens. On the other hand, the low-income group people have to pay tax that reduces their disposable income.
The developing economies require large quantum of money for supporting the developing infrastructure. The money invested by foreign companies and individuals can be used for supporting such infrastructure. In addition to that, such companies provide employment to a large quantum of people that solves the problems of unemployment up to a large extent. The money supply in the economy is also balanced due to large volume of transaction of such companies. The foreign investment and large volume of transaction supports the foreign exchange reserves of the country. This helps in managing the import payments and the balance of payments. As stated by Tanzi (2012), investors prefer investing large amount in infrastructure to ensure that the operation is smooth. This reduces the burden of the government to invest heavily on infrastructure as the multination do it themselves. The technology advancement is also fast due to presence of such multinationals. The same seems to be a win-win situation for both the parties that are the company and the economy. There is a development of innovative culture in the economy thereby leading to rapid technological advancement.
However, the same affects the business of local companies. As per the views of Graham and Tucker (2006), due to presence of multinationals, the market share of local companies has to face the heat of the competition. The profits of the local companies seem to be affected due to presence of such companies. The local companies are unable to capture the require market share. In addition to that, the small business ceases to operate, as they are unable to compete with large companies. The small business do not have the advantage of economies of scale thereby the cost of production is high. On the other hand, multinationals operate at a large scale thereby enjoying the benefits of economies of scale. Therefore, the small business cease to operate that curbs the entrepreneurial spirit among the local entrepreneurs. Thus, tax havens have advantages as well as disadvantages. It seems to be a boon for the multinationals, who route their funds through such economies. On the other hand, it is a bane for the local companies, who have to compete with such multinationals.
Rational for Companies Preferring Tax Havens
Companies shave to pay a significant part of their profits as tax to the government. The same hurts the managers as the same funds can be used for increasing the wealth of the shareholders. As commented by Burn (1999), tax is a type of compulsory expense for the company. However, the expense is not fixed and the same depends on the income of the company. It is highly similar to any variable expenditure incurred by the company. Operating in tax havens provides an individual or a company the advantage on tax expense. Either the government charges no tax or minimal tax is charged. In addition to that, high level of secrecy is maintained by such economies. This helps the foreign individuals in hiding the excess money from various regulatory authorities.
As stated by Loretz et al. (2017), the foreign companies operate from their home countries and have to pay a heavy portion of their income as tax. In addition to that, companies shave to follow the rules of the land, in which they operate. Multinationals operate across the globe and hence have to follow the tax laws of various countries. As stated by Palan and Nesvetailova (2014), operating from tax havens provides the opportunity to the multinationals to save the tax that is required to be paid for operating in countries that do not provide such advantage. The companies have the tax advantage that reduces their cost of operation and ultimately increases their profits. The investors demand profit, which is increased due to operations in tax havens. IN addition to that, there is high level of secrecy, which attracts the individuals and companies, who try to evade taxes from their home country. The excess money or the black money is invested or deposited in tax havens, which helps them in managing their funds along with reducing the tax amount to be paid. Companies and individuals route funds to tax havens to reduce the amount of tax to be paid.
As stated by Nesvetailova and Palan (2014), operating from tax havens also becomes easy for the multinationals as there are no issues of taxation and the ease of doing business is very high. Economies like that of Saudi Arabia, Luxemburg, Malaysia offer heavy tax incentives for investing in their countries. Developing economies like that of Malaysia offer heavy tax incentive to those investing in their economy. The multinationals operate from such economies and thus are able to increase their volume of business without increasing the quantum of tax payments. The tax savings from tax havens positively affects the wealth of the shareholders.
Operating in a country that does not provide tax incentive seems to be costly for the company. Tax is an expense and if there is a reduction in such expense, it leads to savings on the part of the company. As noted by Haberly and Wojcik (2014), companies tend to identify areas, from which tax can be saved. It is the nature of managers to avoid tax and reduce the tax payment to the minimum amount possible. Therefore, companies prefer to operate in tax havens to ensure that they can reduce their tax burden. In case of Malaysia, the tax expense can be reduced to minimal. In addition to that,...