Cold arguments for sunny places

Trouble island

Public anger and shareholder unease threaten tax havens’ tranquillity

UNDER intense international pressure to lift banking secrecy, the first and biggest of the world’s “tax havens”—places that charge low or no taxes to foreigners—is ceding some ground. In a deal signed on October 6th, Switzerland agreed to tax money held in its banks by British residents (it had already done a similar deal with Germany). These customers face a levy of up to 34% as well as, from 2013, a withholding tax.

That could bring the British treasury around £5 billion ($7.8 billion). But Nicholas Shaxson, author of “Treasure Islands”, a book on offshore finance (and a former contributor to this paper), calls it a “Swiss tax swizz”: the country will in effect pay a fat fee to avoid revealing clients’ names. That undermines efforts at the Organisation for Economic Co-operation and Development, a Paris-based club of mostly rich countries, to set international standards on tax evasion.

The fact that Switzerland did a deal at all reflects a changing climate for offshore finance, which has flourished for 50 years. Its defenders still have strong arguments to muster. The most controversial is the Swiss stance, which sees tax as a morally neutral battle of wits against the fiscal authorities: quite different from money-laundering or fraud. From that viewpoint, banking secrecy is a human right and states that try to overturn it are overreaching their powers.

Other less idealistic arguments abound. Some say that companies’ legal duty to shareholders necessitates using offshore finance to reduce and simplify taxes; it is all the more important when regimes and rates differ wildly in the onshore world. Offshore jurisdictions also provide the tax and regulatory competition that keeps grasping governments and officials in check. Even if a company’s profits are higher as a result of using a tax haven, that money will flow out and eventually be taxed, for example as dividends when it reaches shareholders. Offshore financial centres compete by being well run and regulated—with tougher standards (for example on knowing your customer) than some supposedly respectable countries. Rather than cracking down offshore, the need is for simpler, clearer tax regimes onshore, where companies do their real business.

Cold arguments for sunny places

As public faith in the universal benefits of markets and globalisation wobbles, and public coffers empty, such arguments pall. Small firms are angry that clever offshore schemes favour their bigger competitors. Citizens and policymakers are readier to hear a broader case: that offshore finance skews the global distribution of wealth, away from poor countries and those that levy taxes to pay for public goods (including the ones that benefit companies).

Global Financial Integrity, a campaigning group, says poor countries “lose” more than $1 trillion a year to tax havens, around ten times the aid they receive. Two-thirds of this is tax evasion and avoidance, the group says, the rest transfers by criminals and the corrupt. Another outfit of fiscal inquisitors, the Tax Justice Network (TJN), cites research by the Bank for International Settlements, the Boston Consulting Group and McKinsey to calculate that global offshore deposits amount to at least $9 trillion, some $2 trillion more than the total held at home by American banks. ActionAid, a charity, published research this week showing that the companies in the FTSE 100 index had 8,492 offshore subsidiaries.

Legal and rational though this activity may be, the results of the offshore boom can be startling. Mauritius is the largest investor in India, the British Virgin Islands one of the biggest in China. Practical worries are growing too. As blasé attitudes to financial stability give way to concern, tax havens make it harder to gain a true picture of where debt and risk lie, for example in hedge funds trading exotic derivatives. Enron’s finances were obscured by its habit of hiding debt in its hundreds of subsidiaries in the Caribbean.

Tax havens make easy money from registering companies and processing payments—in effect, earning a rent from their sovereign status. Most would otherwise be merely indifferent tourist destinations. But putting pressure on a handful only pushes business elsewhere—from the Channel Islands and Switzerland, say, to Mauritius and Singapore. Rules so far have slowed, not reversed, a race to the bottom.

One avenue for reform is to place a greater duty on companies to explain what profits they make where. That would help prevent the worst abuses of transfer pricing scams, in which tax havens play a handy role. The muddled Dodd-Frank reforms, passed by Congress in America and now being implemented by regulators, supposedly go some way towards this; so does legislation being drafted in the EU.

Campaigners also want to see more countries agree to the automatic exchange of tax information on non-residents. Bilateral tax treaties normally require such exchanges only on request. This works if the government seeking information knows precisely what it is looking for and if the host government can obtain it. As this issue has moved up policymakers’ agendas, some havens have voluntarily become more co-operative. The Isle of Man, for instance, now automatically swaps information (though Jersey refuses to follow suit for fear of losing “competitive advantage”).

Overall, however, resistance to change remains strong, not least in big Western financial centres such as Wall Street and in the City of London, which see the flexibility offered by tax havens as an essential part of their business model. Public discontent may be filling the campaigners’ sails, but political support for reforms is still patchy. France, which holds the presidency of the Group of 20 (a club of the world’s biggest economies) wants to discuss tax havens at next month’s meeting in Cannes. But other countries are less keen, and more urgent items crowd the agenda.

Perhaps the most potent pressure comes from inside the system. Company shareholders, especially ethically minded pension funds, are increasingly asking about the risks (both reputational and other) of using tax havens. Britain’s Barclays bank was publicly embarrassed in January when a British lawmaker quizzing its boss, Bob Diamond, asked him how many subsidiaries it had in the Isle of Man, Jersey and the Caymans. He didn’t know: the answer was 249. Another risk is the effects of a crackdown in home countries. Investors are “starting to calculate how it might affect equity valuations,” says one consultant. Returns, not ranting, may be the tax havens’ biggest woe.

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