Hay: The case for offshore

Richard Hay

Eye-popping revelations in the Panama Papers have fanned concerns that the so-called “tax havens” lie at the center of a giant web of criminal conduct. Some, including U.K. Leader of the Opposition Jeremy Corbyn, have demanded that these centers be “shut down,” and so disconnected from the global grid. The uproar invites examination of the role played by such centers in the world economy.

Allegations of criminality are easy to make and readily understood by the public. The workings of the international financial system, by contrast, are not easily communicated or grasped. Many of those who benefit from offshore centers – including those receiving workplace pensions – are unaware of the key role played by such centers in their financial affairs.

Asked by a reporter why he robbed banks, Willie Sutton, the famous American crook replied “That’s where the money is.” Money is the lifeblood of criminal enterprise so it is not surprising that tax evasion and other illicit funds are found in financial centers, whether Panama or Canary Wharf.

Unless the plan is to “shut down” the global financial system one should not be alarmed to find that some fraudsters slip through the defenses deployed by most modern finance centers to keep them out. As the recent coverage shows, more important questions turn on the extent to which criminal finance is systemic in any particular center and whether the abuses in cross-border finance outweigh the positive contribution of that activity to the global economic system.

The world is politically segmented but economically integrated. Domestic systems are national fiefdoms, ill-suited to facilitating international transactions. Properly regulated and efficient international financial centers provide the linkages between countries necessary to promote cross-border trade and finance. Globalization has contributed to a doubling of world GDP over the last generation. Much of that benefit has accrued to emerging market countries, where dramatic declines in poverty have followed from connecting local workforces to world consumers.

The economic emancipation of China and the consequent elimination of grinding poverty for some 500 million people has flowed from trade, not aid. China’s growth has been symbiotic with the expansion of the world-leading finance centers in Hong Kong and Singapore. Interestingly, these two centers rely on British-inspired laws and institutions, a characteristic shared by the U.K.’s offshore centers.

Imagine the alternative to the use of well-regulated offshore centers. A lender to a project in China would extend credit to a Chinese company, with contractual arrangements drafted by a Chinese lawyer under local law. Disputes would be adjudicated by Chinese judges. It is easy to see that many international investors may decide the risks outweigh the potential benefits.

Detractors often cite secrecy as the reason for the success of U.K.’s offshore centers. Yet peer reviews conducted by the Financial Action Task Force and the OECD – supported by studies conducted by World Bank and independent academics – show that those centers have robust transparency standards. In fact, U.K. Crown Dependencies Jersey and Guernsey clock the highest scores globally for compliance with FATF requirements. Most other British offshore centers are similarly highly regulated.

Like Singapore and Hong Kong, the true appeal of the U.K. offshore centers resides in their widely trusted British-inspired laws, courts and professionals. The predictability and security offered by British institutions make such jurisdictions magnets for international investors seeking reliable structures for international investment. Many of the users of those centers live in countries with deep institutional deficits, kleptocratic governments and poor control over local criminal elements. Britain enjoys soft power and should take pride from the world’s interest in transacting under its widely respected legal institutions. Thanks to the U.K.’s close financial, political, and legal links to those centers the City of London – and the whole British economy – benefits hugely from them.

U.K. offshore centers support British jobs producing goods or services for export, increase financing available for investment in the country, upstream bank deposits to U.K. financial institutions, elevate the rate of return for savings in the U.K. and increase U.K. tax revenues through their activities. A 2013 survey conducted by Capital Economics, the respected U.K. economic consultancy, shows that Jersey supports over 140,000 British jobs – six times as many as the entire U.K. steel industry.

International investment from diverse sources is pooled in funds in tax-neutral countries like the Cayman Islands, which hosts many of the world’s hedge funds. Cost-efficient facilities afforded by such centers increase investment and pension returns, improving the lives of ordinary workers in retirement and easing the social welfare burden on cash-strapped governments. Such pooled funds are liable to tax in the countries where their income and gains are earned, and again when received by the ultimate investors. Are these arrangements suspect simply because there is not a third level of tax where the funds are pooled?

So, what would the world look like if Jeremy Corbyn got his way and shut down the U.K.’s offshore centers? One might expect the loss of jobs and investment in Britain as well as lower pension returns. One might also anticipate a slowdown in international commerce given the removal of key platforms for intermediating global investment and a resulting impact on growth in both developed and emerging economies. The money would go to other centers which covet the U.K. family’s widely admired franchise in the world financial system.

The author is Head of Tax at Stikeman Elliott (London) LLP and Counsel to the International Financial Centers Forum.