What’s right, wrong with offshore financial centers?

In a globalized world, offshore financial centers have a role to play, but they need to be transparent. Former Monetary Authority chairman Tim Ridley and John Christensen, executive director of the Tax Justice Network, debated exactly how transparent OFCs should be and the global tax rules they should be subject to at the American Bar Association conference in January.

In the international debate about global tax rules and offshore financial centers, the dichotomy between tax evasion and tax avoidance, secrecy and privacy, and offshore and onshore is increasingly questioned.

One side of the argument highlights the benefits of offshore financial centers in the channeling of investments and the allocation of capital globally; the other side argues the exploitation of different tax rules and regulations to the detriment of countries’ abilities to tax both individual citizens and companies.

One side highlights the benefits of globalization and the other notes that the rules governing the globalization process are broken.

One emphasizes the legitimate right to privacy, while the other points to abusive secrecy under the cloak of privacy.

And offshore financial centers lament their mischaracterization by the international media, as offshore critics claim a legitimate public and media interest in what offshore centers do.

A presidential-style debate organized by the American Bar Association and moderated by Grand Court judge Charles Quin tried to establish where the line between the two camps is drawn.

Labels

Debates about offshore centers are often shrouded in unclear terminology or labels that are either charged with negative connotations or the attempt at a positive rebranding.

The term “tax haven” is popular with journalists because the public understands it, said Christensen. He, however, prefers the term “secrecy jurisdiction“ because it better expresses what these places offer, and there is no mistaking that secrecy jurisdictions are not only confined to small islands. “At the top of our list is Switzerland,” he noted.

Ridley, in turn, argued that labels, like “tax haven” or “secrecy jurisdiction,” don’t help and are only convenient for regulators to draw up lists of countries they don’t like. “Most of these countries use the only resource they have – human resources – because most of the countries don’t have the benefit of hydrocarbons, like some of our harshest critics.”

What is often forgotten in attacks on these small island nations is that they are communities with real people, who have the right to earn a living, he said.

Christensen agreed that “the OECD has consistently targeted smaller jurisdictions whilst ignoring that many of its large members are themselves either tax havens or secrecy jurisdictions.”

Likewise, both panelists concurred that there is currently no level playing field and that everybody should be playing by the same rules. If the U.S. and the U.K. are offering tax rebates and other incentives to attract new business, it is in fact nothing other than the activity they criticize as inappropriate tax competition in offshore financial centers, they agreed.

Globalization and offshore benefits

As the term “offshore” denotes any transaction that takes place outside the country of residence, it is not a negative term per se. Offshore financial centers are unquestionably a response to globalization. The more complex international transactions are, and the more regulatory and tax differences they need to bridge, the more important the role of offshore financial centers becomes.

There are many examples of mutually beneficial transactions involving offshore financial centers because they provide “certainty in terms of their law, the right to privacy as opposed to secrecy and efficient courts that can deal with disputes and can assist generally to the flow of capital throughout the world,” Ridley said. Those can involve, among others, hedge funds, private equity, venture capital and infrastructure funds, as well as catastrophe bonds, captive insurance or global banking transactions.

Christensen does not disagree. “I am not going to say that there is no useful role in the world of globalized transactions for offshore. Quite the opposite, it is imperative that we have offshore financial centers but they need to be transparent.”

And because they are not, in his view, they enable all kinds of activity that tarnishes the role they could play.

Christensen, who has worked in the offshore industry in Jersey, where he grew up said: “The culture of offshore is largely dismissive of democracy and contemptuous of the social contract.”

Christensen does not want to roll back globalization, but he says the promise of globalization is unfulfilled. “Globalization has the potential for massively improving the lot of humanity. But let’s not pretend it has worked that well. It hasn’t,” he said pointing to mounting inequality and regulatory failures.

The fault lines between different tax systems are being exploited and this is wrecking the entire globalization process, he said. As such, tax havens are only the symptom of a much bigger problem. “We have not got the rules right,” he said.

OECD rules

The rules set by the Organization for Economic Cooperation and Development, whether it is tax information exchange or the taxation of transnational corporations, have invited the problems that tax havens have merely exploited.

“So getting the rules right is at the core of our project,” Christensen said and it explains why there is political pressure on the OECD to move away from tax information exchange agreements to multilateral automatic exchange of information, to country by country reporting and toward greater disclosure of beneficial ownership.

The law has fallen behind the economic reality of financial globalization, Christensen argued. While it has the potential to be a good thing, there is no cooperation between national tax authorities and there are too many loopholes for wealth holders to exploit this lack of cooperation.
Ridley responded that he does not have conceptual objections to exchange of information on any basis, provided its agreed template is clear and capable of application in a meaningful way. “Where I get concerned is the cost of implementation. We are building a compliance nightmare,” he said, referring in particular to the U.S. Foreign Account Tax Compliance Act. “In terms of adding value, the compliance burden is probably the biggest issue that we have to worry about.”

Christensen acknowledged that cost is an important factor in getting the rules right, but he is also critical of the U.S. law because it does not serve the wider global community. While initiatives like FATCA have brought success with regard to Switzerland, which in his view has been the major stumbling block in the exchange of tax information, he is critical of the U.S. not using its political power to bring developing countries to the table and to tailor a system that is flexible, cheap and also serves the needs of the developing world. “It only serves U.S. and European interests.”

Privacy vs secrecy

How far transparency rules should go is not at all clear. Ridley noted that offshore centers that provide a legitimate base for global financial transactions should not be immediately criticized as secrecy jurisdictions only because they provide privacy and the rule of law. “Every jurisdictions falls into some kind of secrecy,” he said.

Ridley said he does not know where the right line is to be drawn between the appropriate level of regulation, law enforcement, access to information and the right to privacy backed up by the rule of law.

“The same people who criticize what they perceive as secrecy at the same time are lobbying heavily for improved data protection laws,” he said.
“They are actually part of the same debate. And we need to get the balance right.”

He agreed that transparency in financial centers should be improved in “controlled circumstances,” but transparency should not equate to full transparency of people’s private and business affairs to the media.

Christensen said he does not think that anyone is seriously pushing for that. Yet a distinction must be made between privacy, confidentiality and secrecy.

“I am delighted that David Cameron as part of his presidency of the G8 agreed with us on three key areas: automatic exchange, multilateral information exchange, disclosure of beneficial ownership information,” he said.

This is not revolutionary nor a high bar to set, Christensen stated. “Whoever benefits from the privileges of incorporation of trusts or other entities should at least have to disclose who they are.”

Ridley disagreed that the ground rules for privilege could suddenly change, in terms of disclosing beneficial ownership, “whatever that may mean,” in addition to legal ownership. “The implications of having this information in a public register need a lot more discussion that would include issues how companies are supposed to operate.”

Tax competition

Ridley and Christensen also have different views on tax competition.

While Ridley does not think that this kind of tax policy will change and that tax competition is alive and well, Christensen claims it will lead to a race to the bottom and negative tax rates. In his view, tax competition is a misnomer for what, in fact, is a tax war. Rather than attracting productive activity, it simply attracts what economists call rent seeking activity, which distorts the economy, he said. “The idea that countries compete through their tax systems is as disastrous and insensible as the currency wars in the 1930s.”

Ridley retorted that regulatory competition is acceptable, because it is not clear what the right tax system should be. First, one needs to know the right level of government and the right level of spending and only then can be decided what the appropriate tax regime should look like. But the notion one could establish one common tax rate and one common tax system would create a system “more monumentally wrong” than the current one, despite its problems, he said.

Christensen in turn clarified it is not a common tax system that is required, or wanted by the Tax Justice Network, but a system of global rules. “Otherwise, we end up undermining democracy elsewhere and the ability of other countries to set their tax rates.”

Tax as a moral obligation

Christensen said the Tax Justice Network is not pushing for higher levels of tax for companies. “We are saying the companies should pay the tax that is due. Tax avoidance is not acceptable. Company directors do not have a fiduciary duty to avoid tax.”

Not avoiding taxation would improve a company’s operating margins in the long term and ensure sustainability as companies maintain access “to the right infrastructure, trained people, laws and the ability to enforce those laws,” he said.

Ridley responded that the debate between tax evasion and tax avoidance, where avoidance is technically still legal but in some way morally offensive, “is a very dangerous road to go down.”

“You must have a legal system that is capable of interpreting what your tax law says,” he said.
For Christensen, in turn, the outcome of tax evasion and tax avoidance is exactly the same. “The outcome is higher levels of inequality, the erosion of public revenues, higher levels of debt. None of this is sustainable. Now we need to have a debate about how far we can go,” he said. “We have allowed tax avoidance to become respectable.”

He suggested the move forward could be general anti-avoidance rules as a principle, covering actions primarily driven by an attempt to avoid tax, upon which courts can rely.

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Tim Ridley

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John Christensen

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