The July 1997 amendments to income tax laws imposed income tax on all kinds of payments to offshores. This measure, its advocates claimed, was designed to clip the wings of tax evaders.
The fact that Lithuanian papers are crammed with offers of opportunities to launch a company or to open an account in an offshore is a meaningful one. It suggests that there is something wrong with the country’s tax system. Something is forcing businesses to migrate in search of a more peaceful shelter. That enigmatic something is high and complicated taxes, obscure tax rules and unbearable penalties for violations, which are impossible to avoid in the existing maze of taxes. In a nutshell, the problem is with the unbearable burden of taxes and regulations. Sadly, the government seems to be getting a different message: People are evading taxes. True, the word evasion is ill-suited here, as tax returns are being reduced by legitimate means.
The authorities have set to crack down on those who treasure and protect their own wealth, wealth created by the sweat of their brow. The officialdom refuse to admit that the problem has its origins in faulty taxes and infinite regulation. Instead of addressing this problem, they are using the most vicious and short-sighted ways to handle tax avoidance. Intent on doing away with “massive tax evasion once and for all,” they have imposed taxes on all financial transactions with offshores.
What are Offshores About?
Every individual and every nation search for their place on earth. Lucky are those countries which are endowed with abundant natural resources, perfect climates or lovely sceneries. Those which are devoid of such advantages have relied on their reason or lack thereof in others. Tax havens (offshores) would never have emerged if it weren’t for countries with high taxes. Offshores offered an opportunity to lower production costs and taxes and to protect one’s wealth. Later on, similar services were proposed not only by exotic islands but also by such European countries as Luxembourg, Liechtenstein, Ireland, and Hungary. Ranking among tax havens are also members of the European Union and candidates for accession. Offshores conclude agreements on double taxation avoidance with countries around the world. The only thing that distinguishes them from other countries is that they apply low taxes to companies that perform no economic or commercial activities there.
The appeal and potential of tax havens have been growing of late due to continuous tax increases in other countries, political and economic instability as well as technical progress that has opened up new opportunities for international business. Every year roughly 130,000 companies are registered in offshores. The most renowned and reputable companies around the world, such as Merrill Lynch, Lloyds, City Bank and many others, have their subsidiaries or branches there. The securities of offshore companies are quoted on the world’s stock exchanges, and information on their prices is available in every issue of Financial Times.
Tax havens are recognized all over the world, and there is no reason why they should not be. Contrary to what people in Lithuania are told, offshores do not hide criminals nor pursue aggressive policies. Often as not, they are faced with unjustified accusations due to our own errors and inability to tell good from bad, legal from criminal, honest from crooked. All offshores do is let a world’s citizen maximize his profits, lower taxes and, what is more important, do it by legal means.
Taxes Against Tax Avoidance
Lithuania’s efforts to outlaw offshores is not unique. Other countries have ventured to do it as well. Luckily, their efforts have proved futile. But the lessons have been valuable. They have shown that fighting tax evasion with new taxes is both meaningless and worthless, as new and higher taxes only encourage more ingenious tax avoidance.
Short as it is, Lithuania’s experience too has confirmed this. A year had hardly passed since the adoption of the income tax amendments, and newcomers swelled the ranks of businesses that use legal ways to lower their tax returns. Those who were dealing with tax havens for tax purposes continue to rely on them to lift the tax burden. Government Decree No 888 cost them establishing intermediaries in a jurisdiction that is off the government’s blacklist and that boasts low taxes or imposes no “extra taxes” on them.
The newcomers previously had nothing to do with offshores. They used to perform normal business operations (e.g. tourism, commerce) with tax havens. Today, they must withhold, or, to be more precise, pay themselves, a 29 (24)-percent turnover tax on the value of each contract with an offshore. They can reduce the tax burden by effecting payments through natural persons (individuals), since notorious Decree No 888 is not applicable to natural persons. Instead of organising a civilised holiday, say, in Cyprus, a travel agency may suggest that the customer pay his hotel bills and tour fares himself upon arrival in the country of destination.
It is not difficult to guess how a Lithuanian tourist feels and looks when he carriers all the money in his wallet and pays his bills in cash. Thanks to bureaucrats, Lithuanians will long fail to discard the “Russian tourist’s” label. Tourism is but one, and the most simple, example. Many companies have already devised, and still more will devise, ways to circumvent the decree hanging like a sword of Damocles over them.
All this leads to an unequivocal conclusion that taxation of transfers to offshores will generate neither more revenues nor more order. Just the opposite. It will result in a more complicated tax avoidance and other inconveniences at the cost of quality and prices. If the rigours of the regulations do not allow the taxpayers to lower the tax burden to an acceptable level, the consequences will be even graver. The taxpayers will simply abandon the country, together with their capital and brains.
Offshores as Shock-Absorbers
Every company and individual agree to pay in taxes only as much as they deem bearable. A “bearable” tax burden is specific for each individual. Yet, some general level may be figured out. If the tax burden is too heavy, people start looking for ways to ease it. If they fail, they either opt out from business or leave the country, as the price and risk are too high to continue working under the established conditions.
So, it is not the state who decides how much will be paid in taxes. In the final analysis, it is the taxpayers who determine how much of their wealth they hand over to the state. Foreign companies use legitimate ways to lower taxes, a practice labelled as “tax planning.” Tax planning services are offered by the largest foreign banks, and businesses use them on a wide scale. Tax inspectors, in turn, refrain from taking imprudent actions, as these may lead to a complete loss of a taxpayer.
Tax avoidance through an offshore is like a shock-absorber which lessens the negative impact of taxes. It allows one to reduce the tax burden to an acceptable level, to stay in business and not to migrate completely. A possibility to use services provided by offshores eases tension. Obviously, dealing with offshores involves extra risks and costs too, and only those who carry an excessive burden of taxes resort to them. Offshores will never entice those who deem their personal tax burdens “bearable.” Yet, an increasing interest in their services suggests that more and more people are suffocating under the tax burden imposed by the state.
Investment Hunters Fail
Lithuania’s attempts to attract investors, especially large ones, cannot go unnoticed. The government has approved a foreign investment promotion programme. A draft law on investment is underway. In short, the officialdom are falling over themselves to attract investment. The left hand, however, does not know, or appraise, what the right hand is doing. Undoubtedly, imposing taxes on normal business operations with offshores looks weird, to say the least, to foreign investors. The instability of tax rules alone, not to mention other factors, may frustrate all attempts to attract investment
Foreign or domestic, investors are no altruists and do not intend to save Lithuania. They come to make money. If they decide that Lithuania, with its political and economic order, is unfavourable to profit seeking, they will choose another country. There are dozens and dozens of states in the world, and investors can afford to be picky.
Foreign investors are benevolent to countries which are consistent and predictable in their policies and which create even playing fields for all investors and treat all incomes the same. This means applying no special favours, exemptions or represiveness. Foreign investors are experienced enough to know that in a country where blacklists are used one can never dismiss the possibility of being blacklisted.
For investors, equally important are law enforcement procedures and legal traditions. The most appealing conditions fail to entice investors if stability, predictability and respect for entrepreneurship are lacking. In this respect, Lithuania does not deserve a praise either. The tax on payments to offshores was introduced on July 1. The tax rules and the list of offshores were adopted by Decree No 888 in August. The rules which stipulate tax-exempt base prices of goods were not passed until six months later. Despite that, the law was effective. The money timer was ticking, and confidence in Lithuania was declining. Not surprisingly, investments are now flanking Lithuania, and even Lithuanians themselves are retreating.
Investment hunters should remember that money and property avoid entering places which are hard to get out from. Obviously, if offshores are required to pay a 29 (24)-percent tax on the revenues from the sale of property (real estate or financial assets), not a single one of them will invest in Lithuania. And it’s a fact that the bulk of investments usually comes from offshores. Foreign companies make investments through intermediaries registered in tax havens, almost never directly. They do so because they plan their taxes.
Who is Who
Offshores are often labelled as the bad guys. This opinion stems from idiosyncratic perception of morals. Suffering a tax at its full rate is, according to this ideology, a manifestation of high morals, like over-fulfillment of a five-year plan. Rent-seeking is considered to be a norm, while the use of tax loopholes and other legal ways to lower taxes is deemed a crime, at least a moral one.
Such attitudes reflect at best ignorance of economic processes and at worst a propensity to live at the expense of others. All wealth, including pensions and salaries of officials, teachers and doctors, comes not from the government nor from political parties but from the private sector. Those who recognise this fundamental truth should realize that lining up for government largesse is a greater sin than clutching at something you have created or earned. Governments can dispense favours, guarantees or other handouts only at the expense of others, creators. Any intentions and attempts to expropriate wealth is an offense against property. It is not the use of offshore services but rent-seeking that is detrimental and immoral.
Much has been said and written about the economic effects of special favours and exemptions. Let me mention the moral aspect, which is in most cases obscured. We in Lithuania have reverse morals. Moral discomfort oppresses not him who demands that the state takes from someone else and gives to him. A sense of guilt is felt by those who give in to the natural and wholesome pursuit of profit; by those who strive to maximize profits and minimize costs, taxes including. Such morals and economics will sooner or later have to be reappraised. The later it happens, the greater the costs.
In Lieu of an Epilogue
One day Lithuania will learn the “offshore lesson” and realise that international relationships are guided by the rule of “a happy marriage.” If you want to be happy, you must change and adjust. You can’t change your partner. It means that the only way to keep businesses at home and to outrival offshores is by being a country of clear, simple and low taxes as well as limited regulation. Sadly, Lithuania’s officialdom are not ripe for that. They haven’t tried out the art of war. They have not grasped the cost of ill-judged decisions. Not yet.