Article on the future for OFCs by Colin Powell OBE, Chairman Jersey Financial Services Commission and
OFCs are frequently portrayed as jurisdictions which allow individuals and corporate bodies to evade tax and engage in criminal activities behind the cloak of bank secrecy. Increasingly, however, it is recognised that many OFCs fully comply with international standards for financial regulation and anti money laundering measures.
The G7 Finance Ministers in reporting to the Head of States and Government at the Okinawa Summit in July of last year under the title ‘Actions Against Abuse of the Global Financial System’ still singled out OFCs for special mention. However, they did at the same time recognise that not all OFCs could be tarred with the same brush. The statement in the Report that ‘efforts to impede financial crime and to prevent tax evasion and avoidance are being undermined by those so called offshore financial centres that do not comply with international standards’, clearly implies that there are OFCs that do comply with international standards.
There is growing recognition that what is at issue is not OFCs per se but how to ensure that all jurisdictions including OFCs adhere to the standards agreed by the international bodies concerned with financial regulation, money laundering, and harmful tax competition.
These sentiments were given particularly clear expression in a statement made by a United Kingdom Treasury Minister in March 2000 when congratulating Jersey, Guernsey and the Isle of Man for the way they had responded to the recommendations in the report on the review undertaken of financial regulation in the Crown Dependencies (The Edwards Report). To quote -
‘The policy of the United Kingdom Government on Offshore Centres can be summed up as follows:
- we have no problem, in principle, with centres who earn their living from providing financial services to non residents. This activity is not confined to offshore centres. Many onshore centres, including London and New York, do substantial non resident business;
· It is important that all financial centres comply with world standards, regardless of whether onshore or offshore;
- we support the initiatives under way in various international bodies to encourage all jurisdictions to improve standards;
- we consider that the true distinction is not between onshore or offshore centres, but between centres which comply with international standards and those which do not’.
The Financial Action Task Force’s NCCT (non co-operative countries and territories) exercise also has not limited its attention to OFCs, and its initial list of NCCTs published in June 2000 included Russia and Israel.
The G7 Financial Stability Forum (FSF) reported on OFCs, found no evidence that they had contributed to date to financial instability, and placed them in three groups according to their standards of financial regulation and international co-operation. At the request of the FSF, the IMF has agreed to undertake a programme of assessments of OFCs over a three year period. The initial emphasis will be on the OFCs in groups 2 and 3 and there is little pressure to assess those in the top group (i.e. Hong Kong, Singapore, Luxembourg, Switzerland, Dublin, Jersey, Guernsey and the Isle of Man) although some of the centres in that group have indicated that they would be happy to be assessed. The United Nations also took an interest in OFCs following its 1998 report on ‘Financial Havens, Banking Secrecy and Money Laundering’, and the United Nations Office of Drug Control and Crime Prevention set up the UN Offshore Forum. However, it was quickly realised that the issues being addressed were not restricted to OFCs and as a result the Forum has been translated into a Global Programme on Money Laundering.
The OECD has produced a list of so called ‘tax havens’ but its concern for eradicating harmful tax practices is not limited to such jurisdictions and extends to OECD member countries and non OECD countries. The OECD has made clear that it is not seeking to dictate to jurisdictions what their fiscal policies should be, and has accepted the zero tax regimes of Cayman Islands and Bermuda. The OECD is concerned to promote three broad principles - transparency, non-discrimination and effective information exchange. What is accepted is that these principles will have to apply to countries world-wide, and not just to OFCs or tax havens, if they are to be effective in their application.
The OECD is currently engaged in finding a mutually acceptable political process by which its three principles can be turned into commitments.
It is recognised that those on the list of so called ‘tax havens’ will not be persuaded to co-operate in implementing these principles unless OECD members take steps to eliminate their own harmful tax practices. For example, Jersey can see no reason why it should be out of step with, or be treated differently from non OECD jurisdictions such as Singapore and Hong Kong, or OECD members such as Luxembourg and Switzerland, with whom it is in direct competition in the provision of cross border financial services.
The Threat of ‘sanctions’
One of the difficulties faced by the international organisations that have focused on OFCs has been to come up with a clear definition of an OFC. Sometimes the definition appears to be limited to small islands, mainly in the Caribbean and the Pacific; sometimes it embraces jurisdictions such as Switzerland and Luxembourg; and sometimes it extends to all locations, including London and New York, that provide cross border financial services to non- residents. The difficulty in defining an OFC is another reason why attention is increasingly being focused on which jurisdictions are compliant or non compliant with international standards rather than whether a jurisdiction is offshore or onshore.
Notwithstanding these difficulties there is still talk about the possible use of sanctions - sometimes described as defensive measures or negative incentives - to bring OFCs into line. G7 Finance Ministers have stated that, where OFCs demonstrate a failure to meet certain standards and are not committed to enhancing their level of compliance with international standards, steps would be taken to encourage the jurisdictions to take the necessary action, and measures will be taken to protect the international financial system against the effect of these failures. These measures it is suggested could include -
· market incentives - expecting financial institutions to take account of the standing of individual OFCs when conducting a risk assessment of business to be undertaken.
- official incentives - restricting membership of organisations, or withdrawing financial assistance, such as that provided by the World Bank.
- counter measures designed to protect the international financial system including
- specific requirements for financial institutions to pay special attention to all financial transactions with non co-operative jurisdictions;
· requirements to report certain financial transactions conducted with individuals or legal entities operating from non co-operative jurisdictions; and
- measures designed to restrict, condition or even prohibit financial transactions with these jurisdictions.
These possible actions are reflected in the FSF report on the OFCs, the FATF NCCT report, and the OECD report on Harmful Tax Practices.
In assessing the likely impact of these measures, should they be promoted, the following comments can be made.
· Are there clear international standards against which to measure compliance? Unlike financial regulation and money laundering there are few clearly defined standards for harmful tax practices. Questions such as what is a harmful tax practice, or what is a ‘civil tax matter’ for the purposes of information exchange, remain to be answered.
· Are there precedents? Many jurisdictions already apply different regimes to financial transactions with low tax jurisdictions (e.g. through controlled foreign corporation legislation, or exclusion from double taxation agreements of specific favourable tax arrangements such as the international business company). Other jurisdictions have ‘blacklists’ of countries, transactions with which are subject to particular scrutiny or on which specific penalties are imposed (e.g. withholding taxes).
- Could the measures proposed be readily applied? In many cases jurisdictions will need to introduce legislation or amend international agreements and this will take time. The prioritisation of new legislation may be questioned if it is to bring little real benefit to the legislating jurisdiction.
· What is the likelihood of the measures being introduced at the same time by all countries? International bodies such as the OECD do not have any teeth in themselves. Their task is to produce by consensus recommendations which member countries are expected to implement, but it will be the individual countries who decide which of the recommendations to adopt, according to their own assessment of their economic and political interests. No jurisdiction will want to act against their best interests (for example, the City of London, and United Kingdom financial institutions, would be damaged if their competitive position were to be adversely affected by action taken by the United Kingdom which was not also taken by other countries);
- What is the potential impact of the measures? Some OFCs would be affected more than others. For example, a failure to enter into a double taxation agreement, or the termination of an existing double taxation agreement, will have less significance for a jurisdiction which does not have double taxation agreements than a jurisdiction which presently depends on such agreements as a basis for the type of business which is undertaken.
The OECD can be expected to continue to strive to obtain an agreed response to harmful tax practices that has global application. However, in the future as in the past, it is to be expected that individual countries will act independently, either ahead of or beyond what might be the subject of international agreement, in pursuit of their own economic interests.
The US withholding tax proposal is a good example of this. What is of interest is that it is not directed at OFCs alone, and OFCs such as Jersey, Guernsey and the Isle of Man have obtained qualified intermediary status in common with other jurisdictions.
Acting independently, however, will become more difficult with increasing globalisation of financial markets, and increasing use of electronic communication. This will reinforce the importance of getting world wide applicaton of international standards. Any attempt by the OECD members to impose their will on non-member jurisdictions can be expected to fail. What will need to be engendered is a general spirit of co-operation through a multilateral approach which establishes an international level playing field.
What Of The Future
International initiatives that are perceived to be directed at OFCs have given rise to some uncertainty about their future. Action taken by individual countries (for example, the ‘advisorie’ applied to jurisdictions listed by the FATF as non co-operative) has added to this uncertainty.
However, there is growing recognition of those offshore jurisdictions that are complying with international standards The market place can be expected to reinforce the attitudes and actions of governments in this respect. Quality business will be attracted to quality financial centres. Those centres that do not warrant the appropriate status will find it increasingly difficult to attract good business and their long term future must be in greater doubt.
There is no reason why quality OFCs cannot continue to exploit niche market opportunities and continue to have an appeal in the world financial market place. Many of the reasons for the success of quality OFCs, such as Jersey, will be unaffected by the international initiatives -
· relatively low rates of taxation - the acceptance by the OECD of zero tax regimes, providing they are non-discriminatory, is as good an indication as one could hope for that there is a future for tax differentials;
- more responsive to market needs - the greater speed with which OFCs can enact legislation which meets the needs of the international financial market place will remain;
- their record of political and fiscal stability - of particular importance for those living in politically unstable areas;
- the confidentiality offered to those engaged in legitimate business and who have legitimate reasons for protecting that privacy;
- the greater flexibility of small jurisdictions;
- the quality of the services provided and the expertise available.
No one would suggest that the financial centres of London, Zurich, Geneva, Luxembourg, Dublin, Singapore or Hong Kong - centres that provide the same cross border financial services for the benefit of non resident individuals and corporate investors that are provided by quality OFCs generally - are at risk of disappearing.
The OECD is keen to dismantle discriminatory preferential tax regimes. This can be done, however, without affecting the essential attractions of an OFC. One example is the replacing of a preferential regime by a non discriminatory corporate tax at a low rate, as the Irish Republic are to do, thereby maintaining the attractions of the Dublin International Financial Centre.
What is important for the future is the existence of a level playing field. There is little prospect of obtaining an effective response to the international initiatives, particularly in the area of taxation, unless all countries engaged in the provision of cross border financial services act in unison.
There will always be room in the market place for a quality niche market operator. With the continued advantages of OFCs referred to above, the continued growth in wealth world-wide, and the globalisation of the financial market place there is every reason to expect both small and large financial centres engaged in cross border financial services, working to international standards, to find a place in the sun. This view is supported by the expectation that financial institutions of stature will want to avoid reputational risk and reinforce their own image by operating only from jurisdictions of stature.
The prospects for a continued long and successful partnership between companies and individual investors engaged in legitimate activities and quality OFCs are extremely good in my view. There will be more international co-operation in the pursuit of those engaged in fiscal fraud and other criminal activities and this will manifest itself in requests for more exchange of information in support of criminal investigations and prosecutions. However, there is no reason why companies engaged in legitimate business should face fewer opportunities to take advantage of international tax differentials, nor should investors engaged in legitimate activities fear for any loss of the privacy they have a right to enjoy, and which they will be able to call upon human rights legislation to defend.
When addressing the international initiatives on financial regulation, money laundering and harmful tax practices, there is in my view no cause for the pessimism expressed by some observers concerning the future of OFCs. There is every reason for optimism about their future, if they are committed to and comply with international standards, whether their use is being considered by corporate bodies or individual investors.
020 7235 9381
March 2001 by