Offshore Financial Centres - Dogs May Bark But the Caravan Moves On

Dec 122017

Tax Optimisation & Offshore Financial Centres: Dogs May Bark, But the Caravan Moves On, Part 2[1]

One of the interesting aspects in the current discussion about multinational corporations and wealthy individuals who use Offshore Financial Centres (OFCs) to reduce their tax bill is that despite rising levels of public indignation, there appears to be a lack of consensus and political will to do something about it. This phenomenon deserves to be analysed more closely. Firstly, and to avoid a misunderstanding, this essay only addresses legally perfected tax optimisation structures. Tax evasion, the illegal sibling, is generally rigorously prosecuted by civilised societies.

The practice of these mobile high-earners to minimise their tax bill, whilst perfectly logical from a micro-economic perspective has well documented detrimental effects on societies. As Tax Justice Network has highlighted, especially resource-rich developing countries suffer as their tax base is eroded and their ability to raise the standard of living of their population is compromised. Developed economies also suffer. As tax revenues drop due to these structures the burden shifts to less mobile tax payers, undermining social solidarity and cohesion, cornerstones of a civil society. Moreover, tax avoidance provides an unfair competitive advantage to multinationals over small and medium sized companies.

Everybody always talks about the weather, but nobody does anything about it.

Two main obstacles are put forward to explain the lack of progress in dealing with the problem.

  1. The topic has become highly politicised and contentious. Partly due to the significant bargaining power of global multi-national corporations, governments perceive tax optimisation policies to be a zero-sum game - if we don’t do it, someone else will and we will lose out. This argument may hold true for countries who would otherwise struggle to maintain economic viability, but can hardly justify the detrimental effects when it concerns well developed economies.
  2. There is a stubborn lack of clarity on what constitutes an OFC. The definitions and identities vary greatly, which I suspect suits the parties involved just fine. The cynical motto seems to be that if you can’t convince, you should try your level best to confuse. Developed economy OFCs are particularly adept at dodging transparency in the debate.

The first obstacle is symptomatic for a divided and suspicious country-centric international global order and unfortunately difficult to overcome in the short term. Hopefully, over time, this attitude will soften, though the title chosen for this essay reveals this author’s low expectation of this happening any time soon. The efforts of NGOs such as Tax Justice Network, the International Consortium of Investigative Journalists and others to keep the topic in the public arena are to be encouraged in this respect. Keep those Panama and Paradise Papers coming!

It is more productive in the short term to tackle the second obstacle: creating clarity in the OFC discussion. As said, identification of OFC jurisdictions has become a politicized and contested issue. The EU, IMF, OECD and other organisations have published lists of OFCs based on a qualitative assessment of the jurisdictional regulations and taxation frameworks. However, this approach says little about the real-world relevance of specific jurisdictions as OFCs and is vulnerable to political influence. The just updated EU list OFCs list is a perfect example of such selective reporting.

To improve the transparency, it is helpful firstly to distinguish two types of OFCs, namely ‘Conduit’ OFCs and ‘Sink’ OFCs and, equally, to understand that these are Siamese twins, joined at the hip. It is difficult to conceive one surviving without the other.

A Conduit OFC’s role is to act as a financial ‘way station’ through which capital passes but does not remain. These jurisdictions typically have low or zero tax imposed on the transfer of capital to other countries, either via interest payments, royalties, dividends or profit repatriation. A Sink OFC is where the capital’s legal entitlement ultimately resides, attracting low or zero local corporate tax. (Ironically, the actual funds are mostly held in safe custody with Western banks.) Countries may be OFC Conduits, OFC Sinks, a combination of both or neither.

A study[2] by CORPNET published in July 2017 uses a novel way to identify the different types of OFCs. Their analysis is not based on tracking capital flows but on a country’s position in the network of corporate ownership through global ownership chains. Whilst still not perfect as some jurisdictions (such as Delaware) publish no or unreliable corporate information and High Net Worth Individuals are excluded, this approach has the advantage that it relies on fine-grained, verifiable data of firm-level corporate ownership, not aggregated macroeconomic indicators.

CORPNET identifies 24 Sink OFCs and five major Conduit OFCs. As can be seen below, many OFCs are not exotic small islands that cannot be regulated, but highly developed countries.

Sink OFCs

Conduit OFCs

 

Rank

Country

Rank

Country

Rank

Country

1

British Virgin Islands

13

Nauru

1

The Netherlands

2

Taiwan

14

Cyprus

2

United Kingdom

3

Jersey

15

Seychelles

3

Switzerland

4

Bermuda

16

Bahamas

4

Singapore

5

Cayman Islands

17

Belize

5

Ireland

6

Western Samoa

18

Gibraltar

 

 

7

Liechtenstein

19

Anguilla

 

 

8

Curaçao

20

Liberia

 

 

9

Marshall Islands

21

St Vincent & the Grenadines

 

 

10

Malta

22

Guyana

 

 

11

Mauritius

23

Hong Kong

 

 

12

Luxembourg

24

Monaco

 

 

             

Telling in CORPNET’s study is that in relative terms, The Netherlands is by far the most significant Conduit OFC with about 20 times more value channelled in and out of the country than the size of its economy justifies. Ranked second, the UK channels approximately three times more than its economy justifies. For a country that prides itself for a tradition of international solidarity, this observation should lead to some serious introspection behind the dykes.

Let the debate begin in earnest.

Pieter van den Akker (Pieter@i-kyc.com), December 2017.



[1] Part 1 was published in i-KYC’s Q2, 2016 Trend Letter

[2] doi: 10.1038/s41598-017-06322-9, www.nature.com/articles/s41598-017-06322-9#Sec2

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