The big offshore debate

Are offshore financial centres engaged in “economic warfare” and tax evasion enablers or are they facilitators of foreign direct investment and efficient capital allocators? Apparently all of the above, according to a panel discussion at this year’s Offshore Alert conference in Miami, which pitted three offshore representatives against three anti-offshore proponents.  

Tax havens are at the heart of the global economy, they enabled uncontrolled growth of the financial industry and thereby significantly contributed to the financial crisis, said Nicholas Shaxson, reiterating one of the arguments of his book ‘Treasure Islands: Tax havens and the men who stole the world’. Tax havens, according to Shaxson, include not only small islands but also places like Switzerland, the US and the UK.  

It is this misconception that makes it difficult to understand the role of offshore financial centres in the global financial crisis, but the mere fact that centres like London and New York were also involved does not absolve smaller OFCs from any blame, he stated. 

Small financial centres were the leaders in the race toward deregulation precisely because they are so small and they marketed themselves as flexible, Shaxson said.  

“We can do it quickly, we can bash it through fast, we can give you what you whatever you want. We don’t care who gets affected, you can have it,” he said. 

Additionally, small OFCs use regulatory and tax arbitrage to attract capital from larger centres, thereby hurting the ability to collect taxes in these countries and lowering the level of transparency in the financial industry, Shaxson noted. The structures used in financial centres have the sole purpose of transferring wealth away from taxpayers to corporations and shareholders, he said. 

Barbadian Avinash Persaud, senior fellow at the London Business School, agreed with Shaxson that the US and UK are in fact offshore centres, but he pointed out, they are also the worst perpetrators when it comes to the regulatory arbitrage they accuse small OFCs of. 

“For ten years London boasted that it was the place for light touch regulation. Come here and escape from regulation,” Persaud noted. “Why is London the world’s largest financial centre? Why is the Eurobond industry in London? Because they took it from New York through a tax arbitrage. Why is the world’s hedge fund industry in London? Because of the non-dom tax arrangements that London and the UK have,” Persaud said. 

“So to say we are going to deal with these regulatory arbitragers, when you have got much larger, much more substantive financial centres benefitting from these things and then you gear the guns on tiny small states that’s just bullying,” he argued.  

Bob Roach, senior investigator with the US Senate’s Permanent Subcommittee on Investigations, disagreed with Persaud, saying that for years the argument has been: ‘You are just picking on us because we are small. You are bigger, you are worse. Leave us alone.’ 

“Well that does not sell either,” Roach said. “I could go on for 10 minutes and list for you the findings of our subcommittee and what has occurred in a number of these jurisdictions.”  

The fact is “they are not small when you talk about the financial world,” he said, adding that as a result OFCs have the same responsibilities as large countries. 

Roach stated that there are gaps in international standards that are applied in different ways and with different degrees of diligence. But he underlined that his boss, Senator Levin, has always said the finger points both ways. The issue is that of responsible regulation, said Roach. “That is what we need to have here. Not leave us alone.”  

Persaud, in contrast, emphasised that many of the small offshore financial centres “have far better regulation, far better compliance, far better anti-money laundering, far better anti-corruption practices than many of the developed, large financial centres.” 


The right to self-determine one’s tax system  

As far as competing tax systems are concerned, former Cayman Islands Monetary Authority Chairman and Maples Partner Tim Ridley noted that most successful OFCs all started from the fundamental principal that each jurisdiction has the right to determine what its tax system should be.  

“And for good or bad reasons, which we usually bury deep in history, many of these places elected to have a system that relied on indirect revenue to their governments, not direct revenue in the form of income or corporation taxes.” 

For the most part this was not created in order to attract foreigners, Ridley stated. 

Shaxson, however, called the tax systems of offshore financial centres “economic warfare”, and a significant reason for a declining tax intake onshore. 

He retorted that “countries that are the victims of other countries’ tax aggression have the sovereign right to defend themselves and to put in place aggressive defences against what is done by offshore financial centres”.  

The important question would therefore be whether tax competition could be stopped, Shaxson said, adding that “it is extremely harmful”. 

“Progressive tax systems become less and less an option and the sovereign right of countries is eroded and attacked from outside,” he added. 

Jack Blum, chairman of the Tax Justice Network in the US, concurred, saying “we have seen how offshore jurisdictions have managed to hammer onshore jurisdictions and force them to play around with their own tax rate to the detriment of providing social services to their citizenry.” 

Bob Roach weighed in that Senator Levin always said that offshore financial centres can do what they want with regard to taxation or the regulatory regime. “It is their business, but when our citizens and our businesses begin to take advantage of what is being offered over there to avoid and evade legal obligations in the US, that is our business,” Roach said.  

The US will continue to refine its own laws to ensure that “that kind of exploitation stops”. 

In his view, there is either going to be a more consistent international regime and cross-border set of standards and cooperation “or you are going to find nations more and more going it alone and making sure that the bleeding stops”. 

One example for the “bleeding” was given by Blum, who referred to the very low tax liability of General Electric.  

Ridley conceded that the US has the sovereign rights to pass whatever tax laws it wants.  

“It has the right to stop all air flights to offshore financial centres, it has the right to pull visas and deny entry for people coming from those OFCs. Those are all threats that were made in the good old days,” he said.  

But “for the US to unilaterally develop some of these approaches has fundamental implications for global trade and that is something the US has to think very carefully about,” Ridley added. 

Ridley said he did not want to debate General Electric one way or another, but as a lawyer he believes in the rule of law and one cannot collect taxes based on moral obligations. 

“If you shut all these places down physically, which is possible if you stop all flights and visas etc, that is your prerogative but you are actually not going to solve the problem that you are worried about,” he said. 


The role of OFCs  

Blum maintained that what we have developed is “an industry that works on arbitraging the regulation and the tax laws of multiple jurisdictions to minimise both regulation and taxes.” 

He believes most OFCs are designed to “provide arrangements so that great wealth can be passed inter-generationally without any kind of levelling effect” or to reduce corporation tax through complex schemes. 

Offshore financial centres provide a “Chinese menu of places that have a variety of laws, and there are real experts in knowing who won’t cooperate with whom on which level, and where to have the data and where to have everything placed so that the rest of you in the room who follow the trail cannot possibly follow it,” he said. 

He mentioned the case of a London law firm, which on its intranet had “a mapping of how to set up different corporations in different places, so when they were creating financial instruments for different investment houses that were selling them the tax implications would be minimised. And it is how you route the payment of dividends using different tax treaties to bring them to a place where there would be no tax at all,” Blum said. 

On the issue of tax evasion, Roach spoke about the 2008 hearings on the activities of banks in Liechtenstein and Switzerland. 

“The people in those banks were actively soliciting and aiding and abetting individuals who wanted to set up structures and set up accounts to avoid paying taxes not only in the United States but also in other nations in Europe,” Roach said.  

Approached by the IRS, Switzerland referred to the regulatory treaty process established for the exchange of information. When the IRS followed the treaty process to gain information on the 52,000 US persons with accounts at UBS, it only received information on 12 accounts. “Twelve. It’s a joke,” Roach said. 

“That is why I am talking about diligent enforcement and the idea that you cannot allow enablers and facilitators, the law firms and the trust formation agents, … [and the] banks to arbitrage those gaps to facilitate nothing but tax dodging and criminal activity,” he said. “It distorts the actual true flow of capital, people are sending capital to all sorts of agents not because that is the place where they want to invest but because they can set up some weird tax structure to avoid paying taxes.” 

“You want to talk about efficient allocation of capital, when someone designs a transaction that looks like the schematic of a nuclear power plant?“ Roach asked. 

“Often OFCs provide nothing but a weigh station to perpetrate that kind of activity, which actually adds no value,” he claimed. 

Ridley replied the existence of “global capital flows that are routed through OFCs does not mean they are criminal or necessarily counterproductive”.  

In India for example there was the need for foreign capital to develop as a country, because it was not available locally, Ridley said. To encourage foreign direct investment, however, there was no political consensus on how to change the domestic tax system.  

But India’s double taxation treaty with Mauritius, which reduced the tax burden for foreign investment in India, enabled foreign direct investments to be routed through Mauritius. 

Although the dynamic is changing now, Ridley said, it would be an astounding statement to say that a country could not participate in the facilitation of the movement of capital into a country like India or China or in fact to say that Mauritius added nothing at all.  

To the interjection that the Mauritius treaty is now used for tax evasion by wealthy Indians, Ridley retorted, “we all know that there is abuse of tax treaties, we all know that there is round-tripping.” 

“The Indian point is absolutely correct. The Indians should nail the Indians who abuse the India Mauritius treaty, but it would not be very sensible to say, sorry legitimate capital from outside won’t come to India,” Ridley said and added that despite the round-tripping, there is a massive amount of capital augmentation.  

Kevin Higgins, managing director at the Turks & Caicos Islands Financial Services Commission, noted that despite all the talk about tax, the statistics for cross-border assets and liabilities of offshore financial centres show that 70 to 75 per cent of those are interbank transactions and not individuals trying to hide money from tax authorities. 

“My view as an economist is that this is about competition,” said Higgins. “How do you structure your deals to maximise your profits? Where can you get increased efficiency? Should you be looking at investing in China from New York or Hong Kong? Which one is the more efficient from a business point of view?”  

Ridley named the Mini as another example, saying the car was not built in the UK, but all over the world, with the engine coming from Brazil for instance.  

“BMW decided that logistically it is the most efficient way to build what is a hugely successful car. That I assume is alright. For GE to construct something that is not about building a car in the most efficient way but about building a corporate structure in the most efficient way, apparently that is reprehensible,” Ridley said. 

Yet these structures create wealth for pension funds and tax payers.  


Financial crisis  

As for the financial crisis Persaud said that New York’s and London’s regulatory failures cost $1.6 trillion of tax payers money. Roach’s argument that many of the CDO’s that contributed to the crisis were issued in offshore centres, is disingenuous, Persaud said. 

“Take Northern Rock the trigger of the financial crisis. What is Northern Rock doing? Is it an offshore bank, is operating offshore?” Persaud asked. “It is selling 120 per cent mortgages using borrowed money market funds. That is a fundamental regulatory failing. So when the regulators say they problem is offshore when the problem was basic bad bank regulation they are simply trying to find a scapegoat to escape the fact that they have been at the centre of the biggest calamity ever and they are not getting their house in order.” 

Ridley, who at Maples and Calder worked on a number of off-balance sheet transactions, quoted a study from Oxford University, which found that “the location of off-balance sheet vehicles in offshore jurisdictions certainly does not contribute to the transparency of the system, but the problems experienced by SIVs during the financial crisis were not due to their offshore location but due to their off balance sheet status, leading to information failures and low capital ratios and because their business model was flawed, ie they borrowed short and lent long.” 

“You should be talking to Mr Bernanke and talking to politicians in the UK and saying to them, why do they allow a financial system to be built in their onshore economies that produced this meltdown?” Ridley suggested. “The meltdown didn’t take place in Bermuda, it did not take place in Cayman. I accept some of the criticisms you make about these structures but fundamentally the asset underlying the problem was firmly fixed in the US and the UK,” he said. 


No middle ground  

Rarely did during the two hour debate find a middle ground, as even the issues of international corruption, organised crime and North African dictators were linked to the existence of offshore financial centres, by Blum and Shaxson.  

Ridley remarked that to suggest “the small OFCs are a critical part of the problem that can be dealt with by getting rid of them is a bit like saying if you never have any transactions globally, you will never have any problems”.  

His statement also made clear that much of the criticism of OFCs by Blum and Shaxson was in fact criticism of globalisation and the financial industry per se. 


Tim Ridley (centre) argues his point during the Offshore Alert panel discussion on offshore financial centres, with Jack Blum (left) and Avinash Persaud (right). – Photo: Offshore Alert