Tax havens under attack

As the political pressure mounts around the globe, what does the future hold for tax havens?

by James Taylor
Last Updated: 09 Oct 2013

Governments, cash-strapped as never before, are looking to claw back billions in unpaid tax from offshore regimes that hide away secret fortunes. Public opinion may be in favour, but are they justified in doing so? And is it necessarily in their interests?

So far, 2009 is looking like a bad year to be a tax cheat. On 26 January, former Deutsche Post boss Klaus Zumwinkel was found guilty of dodging EUR966,000 in unpaid taxes - and fined EUR1m. Zumwinkel, and hundreds of other German bigwigs, had been hiding money in LGT, a secretive bank in Liechtenstein. But they hadn't reckoned on the German intelligence service paying an LGT whistleblower a reported EUR4.5m to hand over a computer disk full of client details. To date, this operation has already yielded EUR150m in extra tax revenues - so it's no wonder the British government quickly swallowed its scruples and bought the CD too. The Liechtenstein row has also scuppered the public-service career of banker Glen Moreno, tipped as the permanent chair of the body that manages the UK government's bank investments - until he was found to be an LGT trustee.

Meanwhile, on the other side of the Atlantic, Swiss bank UBS has been accused by the US tax authorities of running a scam that helped wealthy Americans squirrel away up to $18bn in offshore accounts. Raoul Weil, the bank's former head of wealth management, has been declared a 'fugitive from justice'; Bradley Birkenfeld, the private banker whose devotion to his billionaire clients was such that he smuggled diamonds into the country in his toothpaste, is behind bars after agreeing to testify in exchange for a lighter prison sentence. For the bank's wealth business, the scandal has been disastrous. Nervy clients withdrew about $105bn in funds last year, and it could even lose its US banking licence.

With tax issues so high on the international agenda, tax havens have been dragged out of the shadows and into the firing-line. These (often tiny) countries stand accused of oiling the wheels of international tax evasion by helping individuals and companies hide their taxable income and assets away from the relevant authorities. As a result, those of us who can't afford this privilege have to make up the shortfall in tax revenues - which, according to one pressure group, Tax Justice Network, adds up to a whopping $255bn a year worldwide.

A few years ago, this whole issue might have attracted less attention. When times were good, we could, like Peter Mandelson, afford to be 'intensely relaxed about people getting filthy rich'. But now that the financial sector has brought the world economy to its knees, the public mood has changed violently - bankers such as ex-Lehman boss Dick Fuld have become public hate figures, castigated for their avarice and overweening ambition. The wealthy elite will no longer be allowed to get away with flagrant abuse of the rules for their own gain, and tax havens are seen as one of their main instruments. Back in 2006, a Grant Thornton study suggested that they helped Britain's richest people pay just £75m tax on their combined £126bn fortune.

And governments have never needed those tax revenues more. Every big country in the world is spending money like a drunken sailor on shore leave in the fight against recession, and they'll be able to pay off these mounting debts only by ramping up the tax take. Consultancy BCG estimates that there's $6trn of undeclared money sloshing around the world, much of it in tax havens - and cash-strapped politicians are naturally keen to get their hands on it.

'Governments need to raise revenues at a time when they can't raise taxes,' says Philip Marcovici, an international taxation partner at law firm Baker McKenzie. 'So they need to find money from somewhere, and one possible place is the world of undeclared money.'

But this issue hasn't sprung up overnight. 'In the last 10 years we have begun to see this focus on leakage of tax gathering momentum,' says Andrew Watt, a managing director at professional services firm Alvarez & Marsal Taxand. 'Countries are slowly but surely corralling more power to get jurisdictions to open up.' As technology and politics have led to increasing globalisation of the world's markets, big governments have been taking an increasingly hard line - and thanks to initiatives like the US Qualified Intermediary scheme, the John Doe summonses on credit card companies, the EU Savings Directive, and various tax amnesties, they've had some success in getting their hands on juicy offshore financial details.

In the past year, the crusade has also received a massive boost with the election of a new US President. In 2007, Barack Obama sponsored the Stop Tax Haven Abuse Act, a bill designed to identify and penalise US companies that avoid tax through the use of offshore financial centres; since then, he has often spoken out against tax havens. 'Obama's the dream come true for the OECD,' admits Dan Mitchell of the Cato Institute, a libertarian think-tank.

With other world leaders also showing their support, there seems to be an international consensus on this issue for the first time - and a willingness to act in unison. Says Gary Ashford, a director at accountancy Grant Thornton: 'The OECD countries are speaking to each other a lot more, working together rather than acting individually.' Or, as Mitchell puts it: 'It's a tax cartel.'

So where are the nefarious places that attract all this opprobrium? Well, it depends who you ask. The original blacklist of unco-operative tax havens compiled by the OECD's Financial Action Task Force on money laundering mentioned 15 countries; these days, it consists of just three: Monaco, Liechtenstein and Andorra. However, after Obama's bill named about 40 countries, France and Germany are now agitating for a longer blacklist that includes the likes of Switzerland (by far the world's largest offshore centre by fund value). But many of the other centres generally classed as tax havens refute the label - and since there's no widely accepted definition, it's a tough one to argue.

Low (or even zero) tax rates would seem the obvious characteristic - but, actually, most big economies offer tempting tax rates for certain privileged groups - usually rich foreigners, whose spending power they are keen to attract. 'Over 70 countries offer some kind of preferential tax regime for international capital,' points out Geoff Cook, head of Jersey Finance, a trade body on the island. One notorious example is the UK's non-domicile rules, which the Government has used to attract hordes of top talent (and spendthrift oligarchs) to the City. In the US, certain states also offer particularly business-friendly taxes or regulation - like tiny Delaware, home to 60% of the Fortune 500.

But most definitions tend to involve a general lack of transparency, particularly in the protection of personal financial information. 'The key thing is bank secrecy,' says Professor Willem Buiter, an LSE economist and a former member of the Bank of England's Monetary Policy Committee. 'Wherever you have this, it turns jurisdictions into aiders and abetters and promoters of tax avoidance, tax evasion and money-laundering, and convenient covers for criminal financial activity.'

In places like Switzerland and Liechtenstein, for example, it's actually illegal for bankers to hand over client details to external authorities - handy for shy, retiring criminal types.

Centres without such strict secrecy rules argue that they shouldn't be tarred with the same brush. Indeed, some so-called tax havens claim that they've improved transparency to international standards. 'The IMF and OECD have been very complimentary about our standards of regulation,' says Cook at Jersey Finance. These days, the OECD favours the use of tax information exchange agreements (TIEAs), bilateral deals between a tax authority and an offshore centre that require the latter to pass on information about an individual's finances, as well as sometimes to subtract and remit a withholding tax. Many so-called tax havens have signed a number of these TIEAs with big economies, so they seem to be heading in the right direction.

However, John Christensen of Tax Justice Network insists that this doesn't make them transparent. Unlike the European model, which provides for automatic exchange of information between two countries, the OECD's TIEA model requires centres only to give up account details on request - so countries can only find information they already know is there. 'The approach is so restrictive that it's practically worthless,' he says. Besides, 'sophisticated users of tax havens don't use personal bank accounts, they use trusts and offshore companies'- which aren't covered by any agreement. And since tax havens tend to sign TIEAs only with rich countries, Christensen argues that the model is 'catastrophic' for the developing world, which ends up with no protection at all.

In his FT blog last year, Buiter sparked a row by advocating the forcible annexation of tax havens that refused to play ball. But before we start massing the Royal Navy in the Channel, it's worth remembering a few points. For instance, bankers suggest there are perfectly legitimate reasons for using offshore centres. 'Internationally mobile people need an account that moves with them; that helps them to navigate their commitments and manage their affairs in a tax-efficient way,' says Paul Say, a director at HSBC International in Jersey.

Clients who operate across several different jurisdictions can benefit from a single point of contact, with staff who are used to complex cross-border transactions. So we shouldn't throw the baby out with the bathwater, cautions Mitchell at Cato. 'There are corrupt, sleazy people who use tax havens. But then some people buy cars and use them as getaway vehicles.'

Offshore centres also claim to be a net positive for their neighbours, because they act as a conduit for foreign capital. Academics at the University of Toronto found that it was actually more economically beneficial to Canada if foreign investors channelled money into the country via Barbados rather than directly, because the process was easier and cheaper - leaving more cash to invest in factories and jobs.

Closer to home, the Channel Islands have long argued that they suck international cash into the City of London. 'Tax havens do a wonderful job for the UK,' agrees Kevin Hindley, another MD at Alvarez & Marsal. 'When you have foreign investors who want to come to the UK, the regimes of these places actually help those people bring inward investment into the country.' (Opponents, however, argue that this also creates a huge incentive for countries that rely on big capital inflows - like the UK and the US - to preserve the status quo.)

Then there's the thorny issue of legality. Tax avoidance - 'the only intellectual pursuit that still carries any rewards,' as Keynes once said - isn't illegal, so there's nothing illegal about people using tax havens to minimise their bills. 'People are perfectly entitled to engage in tax planning if they want,' says Hindley. 'You don't have a duty in your tax affairs to maximise the return to the UK Revenue'. Adds Hindley's colleague Watt: 'It's up to the Government to close a loophole if there is one.'

The danger, of course, is that the line between avoidance and evasion - once described by Labour's former chancellor Denis Healey as 'the thickness of a prison wall' - is not always clear.

To the casual observer, the unfeasibly complex tax structures employed by many big corporates - which arrange things so that one brand is owned by a subsidiary in Switzerland and another by a different subsidiary in Holland - might seem to fall on the wrong side of that line. Yet as the laws stand, they have the right to do this.

'Multinationals are entitled to examine their business functions and plan to locate them accordingly to minimise their business costs - of which tax is just one,' says Hindley. In fact, given that directors have a fiduciary duty to maximise returns for shareholders, they're arguably obliged to do so by law.

That's why some offshore supporters argue that the big countries are looking at this the wrong way. Rather than trying to suppress tax competition or impose fiscal rules on other sovereign nations, large economies should instead concentrate on making their regimes more competitive. If taxes are low, red tape is minimal and compliance is easy, there's far less incentive for firms to get into tax planning in the first place. Hindley believes the UK (where the tax code now runs to more than 10,000 pages) is not doing enough to stay competitive. 'If you make your tax regime progressively less attractive for investment, it's perhaps not surprising when companies choose not to invest in it.'

A recent poll found that the proportion of UK-based companies looking to relocate, as WPP and Shire did recently, has doubled in the past year. Like it or not, squeezing the tax base is not necessarily the best way to increase the tax take. And if nothing else, at least simplification would trim down the avoidance industry, Buiter points out. 'Hundreds of thousands of corporate lawyers and accountants and financial advisers across the world could be redeployed to more socially productive labour.'

However, it's hard to see this happening in 2009, when governments will be a bit tied up making sure the global economy doesn't fall over. Besides, tax havens are a much easier target: they're small, they don't vote, and they tend to serve a relatively tiny number of very rich people - which means there's no political downside to attacking them. So much more international pressure is likely to be brought on these centres this year to improve transparency - particularly after April's G20 summit, which will be chaired by the UK.

New Labour came to power promising a harder line - but since the 1997 Edwards review of the financial regulation of UK offshore jurisdictions, it has been reluctant to crack the whip. Now it's coming under increasing pressure from the OECD and disgruntled voters to play a more visible role in the fight against tax evasion - which might explain the recent launch of the Crown Dependency review (see box, p45).

But it's still not obvious where all this is going. Cracking down on global tax fraud is a costly and resource-intensive business, and most tax authorities face an uphill struggle against the serried ranks of accountants and lawyers massed against them. In the UK, there's a suspicion that HM Revenue & Customs is taking a less aggressive line on corporate tax dodgers, shying away from full-scale investigations in favour of the civil route, where firms agree to waive any criminal charges in exchange for full co-operation and possible fines. Given the Revenue's ever-decreasing headcount, the thinking is understandable. Yet the potential returns from following a harder line could more than recoup the costs - and even pay for some more of those terrible Adam Hart-Davis tax-return ads.

So perhaps a more likely outcome is an increase in TIEAs, for all their flaws, along with more amnesty-style deals like the UK's Offshore Disclosure Facility of 2007, aimed at the UK's big banks (another is expected this year for the smaller private banks). Baker McKenzie's Marcovici believes in a 'more sympathetic approach', and is working with the OECD to this end. He thinks that, rather than big governments bullying banks and tax havens into submission, institutions and offshore centres should be incentivised to participate in the process - because, ultimately, that's the best way of getting money out of the shadows and into state coffers.

Clearly, the world is changing rapidly for tax havens. The days of rich people stashing their cash in secret offshore bank accounts with complete impunity are surely numbered, even if progress is slower than many campaigners would like. 'The reality is that the wealthy have only two options: play by the rules of the country they live in, or get out of it,' says Marcovici. 'Hiding money is simply not a choice they have any more.'

As international pressure mounts, some offshore centres will be small and nimble enough to adapt their offering to the demands of the new world order. The rest could quickly find themselves out in the cold.

WHEN IS A TAX HAVEN NOT A TAX HAVEN?

None of the Channel Islands likes to be called a tax haven. These tiny crown dependencies claim to funnel billions of pounds into the City every year, and don't like being classed alongside places such as Liechtenstein, which have strict bank secrecy laws. They point out, too, that they've been praised for their efforts in moving towards greater transparency. 'In the last 15 to 20 years, we've made massive strides to clean up the business,' says Guernsey Finance boss Peter Niven.

Dodgy dealings are a 'myth of yesteryear', in the words of Paul Say, head of HSBC International in Jersey. Adds Geoff Cook, CEO of Jersey Finance: 'Independent experts have all found that we meet the highest standards of corporate governance.'

But this just shows how low the bar is set globally, retorts John Christensen, a former economic adviser to the Jersey government and now a director of pressure group Tax Justice Network. Jersey's information-exchange agreements are largely worthless, he says, because they don't cover trusts and give up specific information only on request. Jersey opts to pay a withholding tax rather than sign up to the EU Savings Directive, and has passed a new law legalising sham trusts, showing that it is 'leading the pack in trying to undermine attempts to tackle tax evasion.'

But says Cook: 'There's lots of evidence that we want to be a responsible part of the international community; we want to be good neighbours and a tax-transparent jurisdiction.'

The mainland Treasury also seems to have its doubts. Last year, Alistair Darling launched a review of the British offshore financial centres in the pre-Budget report, hinting at further scrutiny of their regulation, taxation and challenges after the onset of the financial crisis. With the IMF also mid-way through a review, it'll be a big year for these islands.

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