Article

Is Midshore the New Offshore?


By By Chris Burton, Managing Director, South East Asia, Vistra, and Joe Cheung, Managing Director and Co-Head, Greater China, Vistra (09/07/2019)

In today’s volatile political and regulatory environment, with global financial transactions subject to ever-increasing scrutiny, the dynamics of offshore financial centres are changing. Establishing and managing ongoing business activities from a traditional offshore location, such as the British Virgin Islands (BVI), the Cayman Islands, or Bermuda, is far from the simple affair it once was. Governments, prodded by political activism and an angry populace and eager to recapture their tax dollars, have gone to extreme efforts to eliminate the traditional ‘tax haven’, causing multinationals to revisit their decisions about where to base subsidiaries.

While it would be a mistake to write traditional offshore jurisdictions off the map, many forward-thinking enterprises are setting their sights on ‘midshore’ locations in Asia. Hong Kong and Singapore, with their sophisticated banking, financial, and legal infrastructure combined with their market expertise, ease of doing business, and proximity to rapidly expanding capital outflows from China, stand to profit in the new environment.

Brewing Discontent

Though the recent slew of regulations may feel like a sudden jolt to those doing business offshore, they are actually the culmination of years of deliberations in the aftermath of the 2008 global financial crisis. In particular, the EU and the US have worked with similar objectives to drive the repatriation of tax money from foreign shores. The OECD has tightened the screw, notably through its Base Erosion and Profit Shifting (BEPS) initiative and has encouraged countries to pass laws preventing structures formed for the purpose of moving income to low-tax or tax-free jurisdictions.

The OECD mandated Common Reporting Standard (CRS), under which participating nations voluntarily agree to exchange financial information with other jurisdictions annually, has been one of the most wide-reaching. So far, 105 countries[i] have signed up, including traditional offshore centres such as Bermuda, the BVI, the Cayman Islands, the Isle of Man, the Channel Islands, and others. So have Canada, France, Germany, the UK and other onshore jurisdictions, providing the impetus for the standard. Conspicuously absent is the US, which already has the one-way Global Intangible Low Tax Income (GILTI) law requiring foreign earnings to be taxed in the US, even if income is not repatriated.

Of all the new regulations facing offshore financial centres, perhaps the most comprehensive and controversial, has been the EU’s Economic Substance requirements. The deadline for countries to have these new rules in place was December 31, 2018, and those that did not comply have been blacklisted by the bloc.

Dealing with the Current Reality

The new rules would seem to indicate that the days of transferring mobile activities to low tax jurisdictions may be numbered.

The substance requirements for tax situs in offshore jurisdictions have become very robust: in fact, more extensive than required in many onshore jurisdictions, including EU member states such as the UK, Luxembourg, Malta and Cyprus. This now mirrors the situation on transparency and regulation, where many offshore centres have implemented tougher regimes than their onshore counterparts. Oddly, rather than midshore becoming the new offshore, there is an argument that offshore is becoming the new onshore. Perhaps the EU will follow through to ensure its member states adopt equivalent regulations to those it expects to be in place in offshore financial centres. 

That said, of course, offshore companies still have their place. They can represent a simple corporate structure to hold assets that are not tax-sensitive and remain popular due to their simple operability and lack of formality around filings, accounting and reporting. This is particularly true of the old favourite, the BVI company. Indeed, not all business activities are deemed ‘mobile’ and many will fall outside the scope of the substance regulations and hence will be unaffected by them.

Companies do appear to be taking the new legislation in their stride. In the latest Vistra 2020 Report, which surveyed 800 executives across the corporate services industry, 74 per cent said they were ramping up investments in compliance, and 78 per cent are confident they will be able to meet new demands in a timely manner. Asked to rank jurisdictions by their importance, the executives still placed the BVI second on the 2018 list.

Looking to Asia

Nevertheless, strict regulations have taken their toll, and many companies are now directing their sights to Asian midshore destinations, specifically Hong Kong and Singapore. Though unscathed by the EU blacklist (Singapore was never cited, and Hong Kong was cleared after completing reforms), both countries are participating in automatic exchange of tax information under the CRS. Companies setting up shop will not escape regulation or taxation, but they may encounter fewer bureaucratic and financial hurdles than they now face in traditional offshore locations in the light of the new substance rules.

However, this is only part of the story. Both jurisdictions also offer strong financial services propositions and robust legal frameworks, not to mention favourable tax treaties. They also provide exposure to the growing economic behemoth of mainland China and a jumping- off point for operations elsewhere in Asia.

Hong Kong Moves Ahead

In our survey, executives rated Hong Kong as the world’s most important financial centre, a spot previously held by the UK. This was principally driven by the continued rapid expansion of the Chinese economy last year.

A longstanding gateway for multinationals to launch an expansion into China, Hong Kong’s role as a facilitator has diminished in recent years as China has become more open to dealing directly with foreign enterprises—albeit not always with the transparency and reliability they would prefer, particularly as it relates to intellectual property. However, Hong Kong’s lost multinational business has been more than replaced by a surge of mainland Chinese companies which are increasingly seeking more sophisticated legal and financial guidance, access to overseas capital markets, and help entering foreign markets. However, in the second half of 2018, Chinese business slowed. This has been mainly due to capital controls the imposed by the mainland in response to heavy outflows over the past few years, many of them facilitated through Hong Kong; as well as the uncertainty of the China–US trade war.

We believe the EU’s substance requirements will only strengthen the position of Hong Kong as a financial hub. The BVI and other offshore financial centres have long been popular destinations for mainland Chinese and Hong Kong-based companies. Our research shows that Chinese firms are responsible for more than 40 percent of the US$1.5 trillion mediated through the BVI, for instance. Large enterprises, including PetroChina, China Netcom, and CNOOC, all have subsidiaries there.

Some of these companies are reconsidering whether it makes sense to continue those entities or to return closer to home and consider Hong Kong. Certainly, Hong Kong offers significant advantages. The World Bank ranks it fourth among 180 countries for ease of doing business[ii], and the World Economic Forum’s Global Competitiveness Index 2018 ranks it ninth[iii]. Its financial sector is highly developed and stable, its transportation and infrastructure outstanding, and its labour market among the world’s most flexible and efficient.

We predict that outbound investment from China could reach US$2.5 trillion over the next decade. If Hong Kong captures even a fraction of that business, its economy could easily continue its upward trajectory.

 Greater Bay Area Initiative

Hong Kong’s destiny is clearly intertwined with mainland China's, and the Greater Bay Area Initiative provides some clues as to how things might play out. The plan is a blueprint for the development of an area that includes not only Hong Kong and Macau, but nine southern Chinese cities, including Chinese tech hub Shenzhen, which is home to tech giants such as Tencent, DJI and Huawei. The plan calls for a merging of these cities’ economies and legal systems, and an improvement of technology and infrastructure, to develop the area into the next Silicon Valley.

Even if China only partially succeeds in its ambition, the effect on Hong Kong could be substantial. We believe it will be a positive one. The Greater Bay Area already produces 37 per cent of the country's exports and 12 per cent of its gross domestic product. Closer integration with Hong Kong’s business expertise could boost that output further.

Chinese and foreign companies that want to expand into Shenzhen, or elsewhere in southern China, will find it easier to tap into capital markets through Hong Kong. Corporate service providers in Hong Kong, where commercial property is among the world’s most expensive, may decide to open new locations on the mainland to serve burgeoning enterprise needs. If Hong Kong’s ties to the mainland are strengthened, multinational companies may once again be swayed to headquarter themselves in a place with a familiar and reliable legal system and fewer rules and restrictions than mainland China. The Greater Bay Area Initiative allows financial services firms in Hong Kong access to the mainland market.

The Greater Bay Area initiative shows that China is intent on economic expansion and is willing to liberalise its laws to bring Hong Kong into the fold. It also made an exception for Shenzhen, whose status as a special economic zone enabled it to develop into the industrial powerhouse it is today.

Mainland China and Hong Kong have always had a symbiotic relationship. Hong Kong has long played an important role for both Chinese and multinational corporations, and China continues to allow it to do so today. We expect this role to expand until at least 2047, and very possibly beyond.

Singapore: On the Fast Track

Another midshore location that businesses are considering as a desirable alternative for structuring is Singapore.

Multinationals are attracted by the country’s relatively low 17 per cent corporate tax rate, as well as the ease of opening bank accounts for local companies compared with offshore entities and locations. A stable political environment and a predictable English-based legal system are also important factors.

In addition, Singapore has 60 comprehensive double tax agreements and seven more limited agreements in force, making it an ideal location for holding companies of enterprises that wish to do business in Vietnam, Thailand, Indonesia, and other countries in Southeast Asia. Under local tax regulations, dividends from these and other locations can be repatriated without having to pay withholding taxes.

World famous for its business-friendly stance, the country ranks second in the World Bank’s 2019 Ease of Doing Business report[iv], two slots above Hong Kong. The World Economic Forum’s Global Competitiveness Index 2018 also ranks it second[v], giving it high marks for openness and infrastructure, as well as for its efficient legal system. It is rated as the top performer for corporate governance and property rights, including intellectual property protection, and described as the world’s “most future-ready” economy.

Companies looking for a culture where they can find skilled, reliable workers will find what they need in the island nation, which is known for its well-educated and flexible workforce. The World Bank Human Capital Index ranks it the best country in the world for human capital development[vi].

A New Landscape

The profusion of financial regulations in recent years has changed the landscape for offshore financial centres, and we do not expect the tide to turn back any time soon. However, many companies that have traditionally used these as an easy route to minimise tax are about to find this a lot more problematic. They are weighing up the advantages of building substance in far away, offshore islands, versus creating entities in more traditional, established midshore jurisdictions. Hong Kong and Singapore offer real advantages for such companies, particularly where investments are oriented towards Asia. Whilst we continue to see that offshore companies have their place, especially for non-tax driven structuring, we expect to see Hong Kong and Singapore companies featuring more and more prominently in the organisational structures of multinational corporations.



[i] "Signatories of The Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information and Intended First Information Exchange Date.", Oecd.Org, 2019 <https://www.oecd.org/tax/exchange-of-tax-information/MCAA-Signatories.pdf> [As of May 2019].

[ii] "Ease Of Doing Business In Hong Kong | 2019 | Data | Chart | Calendar", Tradingeconomics.Com, 2019 <https://tradingeconomics.com/hong-kong/ease-of-doing-business> [As of May 2019].

[iii] "These Are The World's Most Competitive Economies", World Economic Forum, 2019 <https://www.weforum.org/agenda/2018/10/most-competitive-economies-global-competitiveness-report-2018/> [As of May 2019].

[iv] Doing Business 2019 (World Bank, 2019) <http://www.worldbank.org/content/dam/doingBusiness/media/Annual-Reports/English/DB2019-report_web-version.pdf> [As of May 2019].

[v]These Are The World's Most Competitive Economies", World Economic Forum, 2019.

[vi] "Human Capital", World Bank, 2019 <http://www.worldbank.org/en/publication/human-capital> [As of May 2019].

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