The Case for Offshore

Eye-popping revelations in the Panama Papers have fanned concerns that the so-called ‘tax havens’ lie at the centre of a giant web of criminal conduct.  Some, including UK Leader of the Opposition Jeremy Corbyn, have demanded that these centres be “shut down”, and so disconnected from the global grid.  The uproar invites examination of the role played by such centres 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 centres- including those receiving workplace pensions- are unaware of the key role played by such centres 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 centres, 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 defences deployed by most modern finance centres 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 centre 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 centres provide the linkages between countries necessary to promote cross-border trade and finance.  Globalisation 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 five hundred million people has flowed from trade, not aid.  China’s growth has been symbiotic with the expansion of the world-leading finance centres in Hong Kong and Singapore.  Interestingly, these two centres rely on British inspired laws and institutions, a characteristic shared by the UK’s offshore centres.

Imagine the alternative to the use of well-regulated offshore centres.  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 UK’s offshore centres. 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 centres have robust transparency standards.  In fact, UK Crown Dependencies Jersey and Guernsey clock the highest scores globally for compliance with FATF requirements.  Most other British offshore centres are similarly highly regulated.

Like Singapore and Hong Kong, the true appeal of the UK offshore centres 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 centres 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 UK’s close financial, political, and legal links to those centres the City of London– and the whole British economy– benefits hugely from them.

UK offshore centres support British jobs producing goods or services for export, increase financing available for investment in the country, upstream bank deposits to UK financial institutions, elevate the rate of return for savings in the UK and increase UK tax revenues through their activities.  A 2013 survey conducted by Capital Economics, the respected UK economic consultancy, shows that Jersey supports over 140,000 British jobs- six times as many as the entire UK 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 centres 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 UK’s offshore centres?  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 centres which covet the UK family’s widely admired franchise in the world financial system.

Richard Hay
Richard Hay is a Stikeman Elliott London partner specializing in international tax law, and head of the London office's International Private Banking and Financial Regulation Group. Mr. Hay advises financial institutions and private clients on tax, regulatory and political risk aspects of cross-border estate planning structures for high net worth families, including those in Canada, Latin America, Asia and Europe. Mr. Hay also advises IFC Forum (www.ifcforum.org), banks and private clients on financial regulation and the information exchange initiatives conducted by the G-20, the OECD, the EU, FATF and the IMF. Mr. Hay is also Co-chairman of the London based International Committee of the Society of Trust and Estate Practitioners, a member of the International Bar Association and the International Tax Planning Association.