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Offshore Financial Centers: A Necessary Evil?

Benjamin Franklin once noted that ‘nothing in this world is certain except death and taxes’. For rich and well-advised individuals and corporations, only a meeting with the grim reaper is certain. Or is it?

Bankers and armies of lawyers often advise corporations and wealthy individuals on ways to structure transactions to reduce or eliminate their tax liability by moving them ‘offshore’ and enter offshore financial centers (OFC). The IMF defines an OFC as ‘a country or jurisdiction that provides financial services to non-residents on a scale that is incommensurate with the size and the financing of its domestic economy’.

Offshore financial centers (OFC) are often portrayed as parasites that survive by diverting tax and other revenues from “real” economies, offering a haven for tax cheats and money-launderers. Some of this undoubtedly happens, but it happens in big ‘onshore’ economies as well.

A common image that comes to mind when one mentions OFCs would undoubtedly be of sandy beaches and rum in the Caribbean. Indeed while Ugland House, a five storey building in the Cayman Islands, is officially home to more than 18,000 companies, it pales in comparison to the number of companies registered in the U.S. state of Delaware alone (950,000). Another U.S. state, Miami, is a popular destination for Central and South American businessmen to deposit their money safe and away from nosy tax officials back home. The City of London, a pioneer of offshore currency trading post World War II, still advises non-residents on ‘tax matters’ and ‘estate planning’. ‘Shell’ companies incorporated in the United Kingdom and the Crown Dependencies of Jersey, Guernsey and the Isle of Man are often named defendants in financial crime cases. Other European Union countries are known globally for ‘off-shoring’ services and low tax rates: Luxembourg, the Netherlands and Ireland.

In the United Kingdom, Amazon and Starbucks were threatened by consumer boycotts for routing profits through tax havens while paying little tax in the jurisdiction they were conducting business in. During the 2012 United States Presidential Election, Republican candidate Mitt Romney was vilified by political opponents for having maintained offshore bank accounts in the Cayman Islands. More recently, the leak of the ‘Panama Papers’ forced political resignations and caused embarrassment to many political leaders. The question begs: are OFCs really ‘bad’ or ‘evil’ as the public makes them out to be?

Offshore investment is among the murkiest sectors of the financial world. Keeping money offshore can help shield it from tax authorities, obscure its origin and conceal the genuine owners. Opponents of OFCs often list money laundering, tax evasion and opacity as the ‘problems’ of OFCs. Often, shady special purpose vehicles and off balance sheet entities make the monitoring of financial stability troublesome. When financial institutions concealed risks through creative accounting methods, it misrepresented the underlying riskiness of their business which contributed directly or indirectly to the financial crisis.

However, OFCs can and do play a legitimate role in the world economy. Proponents of OFCs argue that in a fiercely competitive global economy where tax laws across jurisdictions vary, minimizing tax payments are a competitive necessity for international businesses. For example, if a firm formed with partners from Germany, Brazil and Canada were registered in one of those countries, tax officials might seek to tax the company as well as the partners’ gains, even though a partner may not even be a tax resident in the country where firm is registered. By domiciling offshore, they are able to pool profits generated into a single entity before repatriating the money back home where they will still be taxed (albeit lesser). Doing this reduces compliance and tax costs therefore encouraging businesses to grow.

For individuals, there are other non-nefarious reasons for opening a bank account offshore, for example to better manage investment portfolios or to protect assets from unstable or capricious governments. Offshore accounts, while helping individuals pay less tax in certain cases (legally), is not evading taxes (illegal) but avoiding (legal) an extra layer of tax.

Despite decades of scrutiny, why are OFC still thriving? OFC watchers and analysts put down the resilience of these countries to their legitimate uses such as being a mediator in facilitating international financial flows and the protection against unlawful or unfair seizure of assets. OFC serves the need created by the hamstringing nature of complex national tax codes.

Besides, OFC do generate a societal benefits. Because OFC generally encourage tax competition in its geographic locality and abroad, this serves to discourage irresponsible governments from trying to tax their way out of financial woes. In some OFC where tourism is seasonal and domestic tax pickings slim, taxes collected from the offshore industry would expand and create a more resilient tax base.

Indeed, while there remains a lot to be done to rein in money laundering, terrorism finance and tax evasion, OFC must continue to be allowed to operate with complementary and symbiotic relationships to the global financial system.




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