Rising to New Challenges

“Offshore” is a word for which there are, perhaps, as many varied connotations as there are jurisdictions in the world that consider themselves “offshore financial centers”. And, in the same way that it isn’t as easy as it once was to define exactly what constitutes an “offshore financial center”, the concept of “offshore” itself has changed vastly, and continues to do so at a rapid pace.

One thing that economists and industry experts agree on today is that there is no hard and fast definition for “offshore”. Certainly, most offshore jurisdictions have separate legal systemsthrough which non-resident companies can ease their tax burden and benefit from relaxed regulations and a high degree of privacy protection, as long as they do not trade in the local economy. But the word “offshore” is also often used to describe a country or territory that shares some of the characteristics of “established” – or indisputably recognized – offshore jurisdictions, namely a favorable tax and regulatory regime.

Mr. Sanjeev K. Lutchumun

MBA FCCA, TEP – Director of Premier Financial Services Limited

Hong Kong is one example. The territory – unique, too, in its adoption of a “one country, two systems” principle – may be the world’s largest offshore yuan hub, but strictly speaking, it isn’t an offshore jurisdiction because it doesnot distinguish between onshore and offshore companies, as such. But because Hong Kong taxes are relatively low, and no tax is charged on foreign income, it is often treated as an offshore jurisdiction by international investors.

Another factor that adds to the lack of clarity about what the offshore industry is all about is a general lack of knowledge about tax planning practices. In the general public’s eye, offshore financial centers have, to a large extent, become synonymous with tax avoidance in the past few years. Sensationalized mainstream media has a major part to play in that. Unfortunately, in addition to being sensationalist, media of this kind is almost always misinformed, and one reason for this is ignorance or confusion surrounding the differences between tax evasion and tax avoidance.

Tax evasion – as anyone even vaguely clued up about the admittedly complex world of international investment – is illegally failing to pay taxes which are lawfully due, and generally speaking, this is a crime everywhere in the world. In contrast, tax avoidance involves minimizing your exposure to tax by legal means (often referred to as easing your tax burden within investor circles). Although it is perfectly legal, it is frowned upon by politicians – at least in the public sphere – and unsurprisingly, this is where most of the problems arise.

As it was so simply and aptly explained in an article co-written by Brian Garst, Director of Government Affairs for the Center for Freedom and Prosperity,and Dan Mitchell, a Senior Fellow at the Washington-based Cato Institute and Chairman of the Board of the Center for Freedom and Prosperity, “Politicians rarely care about promoting growth, and often are themselves obstacles to its achievement. They care more about raising tax revenues that can then be spent in the quest for the accumulation of personal power and prestige.” Despite the fact that low tax rates are a proven way of rewarding productive behavior by encouraging people to work more, save more, and invest more – and conversely, “bad tax policy”can significantly stunt economic development – politicians the world over favor punitive tax policies.

Mr. Garst and Mr. Mitchell view tax competition as a “mechanism by which the interests of the people in growing the economy can be imposed, at least to some degree, onto the political class”. Tax competition between jurisdictions can make it more difficult for politicians to impose punitive policies and, in fact, it provides them with an incentive to adopt less punitive tax policies instead.

In part, this happens when individuals and businesses relocate (in either the physicalor the financial sense) to jurisdictions with more favorable tax rates, and in doing so apply pressure on their own governments to cut back on excessive taxation. The pressure can prove very effective: countries that refuse to compete suffer economically, while those that embrace competition prosper.

Colin Riegels, a partner and head of the banking and finance global practice group at Harneys law firms offers further explanation of the politics behind this situation. “The public perception is that offshore business is mostly (if not entirely) about tax, and this is a view which is often encouraged by politicians in democratic countries because that way they can promise to raise tax revenue without increasing taxes by catching ‘tax cheats.’ This is what drives legislation like FATCA in the USA. However, most economists recognize that in reality very little additional tax revenue is expected to be raised in this way.”

Not only are methods like targeting so-called “tax cheats” ineffective, but the sheer power of the anti-tax evasion rhetoric itself has a knock-on effect that is felt far beyond the offshore industry. Among the most drastic of them comes by way of FATCA legislation, which some consider nothing short of international financial upheaval.

FATCA refers to the Foreign Account Tax Compliance Act, theUnited States’ global tax law. It was enacted somewhat quietly in 2010, but four years later when it came into full effect, the sheer power of its impact began to be felt all over the world. FATCA requires foreign banks to disclose all informationto the US government that is collected about account-holding American citizens with an excess of $50,000 in their possession. Non-compliance on the part of institutions could lead to being forcibly cut off from US markets, which is naturally enough pressure to give nations across the world very little choice but to go along with the bullying legislation, and in excess of 80 nationshave agreed to the law. As Forbes contributor and tax specialist Robert W. Wood explained it, “Cleverly, FATCA’s 30% tax and exclusion from US markets would be so catastrophic that everyone has opted to comply. Foreign financial institutions must withhold a 30% tax if the recipient isn’t providing information about US account holders. The choice is simple, and that’s why everyone is complying.”

In Mr. Garst and Mr. Mitchell’s view, the United States is using FATCA to assert its universal rightto enforce domestic tax laws on the entire world. “FATCA purports to combat tax evasion, using a dragnet-style spying regime that threatens to cost the world far more than it will raise in new revenue for the US government.”
Legislation such as FATCA has posed major challenges to the offshore industry, for which banking privacy used to be one of the central draws to domiciling one’s wealth offshore. But rather than seeing these heightened restrictions and regulations – of which FATCA is just one example – as an impediment to its success in the future, the offshore industry is rising to the challenge and adapting both to changes in the global financial landscape market and changes in clients’ requirements.

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