ifc economic report

ECONOMIC REPORT

In the Chair with Mark Field

Sector ResearchPLUS: Th e Big

DebateIFC Forum

Analysis

AUTUMN 2012

IFC

Good for the Global Economy?

OFFSHORE FINANCE

IFC_Economic_Report_Live_Rev.indd 3 05/11/2012 15:56

2013 EDITION

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Contents

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Welcome to the inaugural edition of the IFC Economic Report.

In many of our past publications a reoccurring theme has been the much maligned reputation of international fi nancial centres (IFCs) and the need for a more balanced debate on the role IFCs play within the international fi nancial architecture.

To this end IFC Review has created the IFC Economic Report to provide a platform for those involved in or whose decisions impact upon the very business of IFCs, to address the issues pertinent to the industry. In this the fi rst edition, we ask the central and seemingly straight forward question - IFCs: Good for the Global Economy?

International fi nance centres need to ensure their voices are heard above the maelstrom of controversy and hype surrounding ‘off shore’ and more importantly that they have infl uence when policy is being made. Th e IFC Forum was established in 2009 to tackle this problem. Sharing this common goal, the IFC Economic Report has collaborated with the IFC Forum in this edition with a special feature that highlights just how IFCs are used in the day to day business of international fi nance.

In this edition, in addition to the IFC Forum special feature, you will fi nd commentary and interviews from EU representatives, the OECD and the IMF; a cross spectrum of opinion in Th e Big Debate; and we are In the Chair with Mark Field MP.

Our aim with the IFC Economic Report is to ensure that the important function of IFCs in the global movement of wealth is understood and to be an industry educator, keeping traditional markets and more importantly emerging markets up to speed with developments in the international fi nance industry.

We welcome any feedback on this edition and suggestions for future issues.

Ciara Fitzpatrickeditor

4 Comment........................................................................................... Marcus Killick

6 In the Chair..................................................................................... Mark Field MP

HEADLINE FEATURE

10 Offshore in Practice: in conjunction with IFC Forum 11 Enhancing Global Prosperity via IFCs............................................ Grant Stein

13 Investments through IFC Companies into the People’s Republic of China...................................................... John Collis, Paul Lim and Teresa Tsai

18 Russia – Cyprus: Case Study on Project M................................. Emily Yolitis

20 Behind the Curve – Brazil Ineffi ciencies Threaten International Investment............................................................................................ Rolf Lindsay

23 A Passage to India......................................................................... Francoise Chan

27 Making a Platform for Business to Africa......................Nikhil Treebhoohun

30 The Big Debate......................................... IFCs: Good for the Global Economy?

34 Sector Research: Global Shell Games: A Mystery Shopping Experiment in Know Your Customer Standards............................................ ............ ...................................... Michael G Findley, Daniel L Nielson and Jason Sharman

37 British Offshore Financial Centres: Prospects in a Changing World............ ............................................................................................................... Richard J Hay

39 Europe: Is the Fiscal and Treasury ‘crisis’ a Short Term Issue or a Symptom of Long Term European Federalisation or ‘Conciliation’?..... ...... .................................................................................................................. Peter Harris

44 Europe: Q&A....................................................................................... Emer Traynor

46 OECD: International Co-operation: The Way Forward with Automatic Exchange......................................................................................... Stephanie Smith

49 OECD: Q&A.............................................................................. Pascal Saint-Amans

52 OECD: How the Peer Review Process is Enhancing Tax Co-operation.... ... Throughout the World...................................................................... Monica Bhatia

54 IMF: Finding the Right Balance.................................................. Alfred Schipke

56 IMF: The Shifting Issues of International Tax........................ Carlo Cottarelli


IFC eConomIC report • Autumn 2012

The banking crash and subsequent economic crisis has led to an increased polarity in beliefs concerning the nature of the services provided by the international financial centres (IFCs). At one end lie the unreconstructed free market advocates. These are groups such as the USA’s Centre for Freedom and Prosperity (CFPs). CFP’s mission is “to educate the public and members of Congress on the benefits of tax competition, financial privacy and fiscal sovereignty”. It is ideologically opposed to everything from the Organisation for Economic Cooperation and Development (OECD) to Foreign Account Tax Compliance Act (FATCA) seeing them as inhibitors to economic growth.

At the other end lie bodies such as the Tax Justice Network (TJN). TJN promotes “transparency in international finance and opposes secrecy” and supports a level playing field on tax.

To the first, IFCs are a cause of prosperity, to the second ‘tax havens’ cause poverty. Each has their political supporters. Without doubt, both groups are earnest, passionate and sincere in their beliefs. Without doubt, both cannot be right.

This economic argument has increasingly, although in some cases unperceptively, entered the dry world of

financial service regulation. Indeed it is through such regulation that many of the battles are now being fought.

Let us begin with the fight against money laundering. Originally this fight, and the early laws designed to support it, were focused, almost exclusively, on money generated in the illegal drugs trade. Indeed many of the first pieces of legislation expressly contained the words drugs in their title. Then, over time, the net was cast wider to include ‘all crimes’ (in reality, all predicate offences). Now tax evasion is firmly on the list of criminal acts covered by the law. Today, the draconian weapons once targeted against gun wielding Colombian drug dealers are now equally aimed against tax evading Belgian dentists.

In another time such a change would be the cause of public uproar, there would be stout defenders, way beyond the CFP, to criticise the use of such powers on otherwise (apart from evading taxes) ‘honest’ citizens.

Yet we live in a different world where even the distinction between tax evasion and tax avoidance is becoming blurred. The attack on those using legal tax avoidance mechanisms, from Jimmy Carr to Starbucks, has been vocal and significant. Public opinion now seems to be that everyone should pay their fair share of tax. IFCs, as the location of many of the structures that enabled

a lower tax to be paid, are themselves subject to criticism. Not because they did anything illegal or facilitated illegality, but because they helped someone commit a legal, but now publicly frowned upon, act.

Let us be clear, this has nothing to do with secrecy. The arrangements may have been private (ie, not public) but they were disclosed to the relevant revenue authority. To that extent the secrecy debate is dead. Indeed, for those who missed the obituary, secrecy itself is ‘a dead parrot’ it has ceased to be.

Of course, if you can find a willing service provider or corrupt local official in some financial sector company, you can undertake your activities with a degree of anonymity (as you can in London, Paris or Rome). However, the concept of a bank account or trust, behind which you can hide, and through which you can perform illegal acts with impunity, now firmly belong in the world of fiction.

Confidentiality remains, but if you are suspected of market abuse, money laundering, tax evasion or a myriad number of other crimes, then your financial details will be disclosed, often without your knowledge and certainly without your consent. Service providers who do not co-operate or who even do not maintain the required records may find themselves subject to

The TideBy Marcus Killick, CEO, Gibraltar Financial Services Commission

Marcus Killick became Chairman and Commissioner of the Gibraltar Financial Services Commission in 2003 and became its first Chief Executive following the introduction of the Financial Services Commission Act 2007. He is an English barrister by training and is also a member of the New York State Bar. From 1998 until 2003 he was a Director in the International Regulatory Services Team of KPMG, based in the UK. He has also previously held positions as Deputy Chief Executive of the Isle of Man Financial Supervision Commission, and Head of Banking, Trusts and Investment Services at the Cayman Islands Monetary Authority.

Comment

4


THE TIDE

criminal penalties.Bank employees stealing and selling

client details to tax authorities may grab the headlines but they are becoming superfluous. Today, you do not need a thief, you simply need an international agreement to gain the information.

There does, however, remain the question as to whether the jurisdiction where the tax evader lives will actually prosecute, but the information is available.

For the legal, but morally frowned upon, tax structures, the IFCs find themselves with an interesting dilemma. They are legal and it is a free market. However, every time one is exposed or its structure publicly challenged, the IFC is named and the image that IFCs are somehow shady and unclean perpetuates. Indeed a number of centres have taken stances against certain activities which, whilst legal, have been regarded as unacceptable. An example of this is the Guernsey government’s recent ban on certain types of vulture funds.

Beyond the privacy issue, the question of tax harmonisation has received greater impetus, not least within the EU and particularly the Euro zone, as a result of the crisis. The issue of the financial transaction tax is but one manifestation. Here, however, the prospects of the TJN achieving their goal are less likely. Tax is merely one element of competition. To equalise tax merely accentuates and distorts other competitive areas (eg, labour costs, infrastructure etc). Nations fiercely defend their sovereignty on tax matters. Fiscal harmonisation may be forced through to save the Euro but its prospects elsewhere are weak at best.

Whilst the fiscal debate remains safely outside the regulatory field, one area, that of the actual benefits of international finance centres to the global economy, is not. Yet, even here, the debate is far wider than the IFCs but, rather concerns the social utility of the finance sector globally.

Before the crisis, the finance industry was generally accepted as being economically beneficial. Working for a bank was seen to be a decent job. The banking crash changed the public’s perception. Some bankers such as Fred Goodwin turned from figures of respect

to figures of hate. As mortgages and commercial lending dried up so people began to ask what use were banks? As the cost of the public bailouts mounted the anger increased. Market abuse such as the Libor scandal and further examples of misselling such as that of Payment Protection Insurance (PPI) broke into the news exacerbated the meltdown of confidence and trust. This was not an IFC problem; it was a globally systemic one.

Whilst the public will accept certain fringe activities which lack genuine social utility, they will not accept mainstream financial institutions that appear to have failed to deliver real social benefits. In correcting this, the IFCs can play a small but vital role.

To acheive this, every centre will need to decide whether they want to be part of a new financial dawn or to continue serving the global financial sector in the same old way.

If a centre does choose to evolve it will, without doubt be taking risks. This is because it will have to work new fields for financial benefits rather than plough old ones. Yet the benefits in terms of reputation and potential growth will be significant.

There are a number of ways individual IFCs can use the current lack of confidence and trust to deliver a new quality reputation of their own.

Firstly, the IFC will need to demonstrate a manifest commitment to the quality of service provided by its financial institutions. Firms will be required to ensure their staff are appropriately trained and effectively monitored. This may be deliverable via professional bodies but the government will need powers to improve those who cannot, and sanction those who will not, deliver quality of service to their clients. Clients must feel safe when dealing with the jurisdiction.

Secondly, the government must decide what activities it does, and those it does not, wish to encourage. Some financial products may be so high in risk and so low in social benefit that they may be considered unacceptable. On the other hand government may wish to encourage beneficial green shoot sectors such as micro finance, working to end financial exclusion and facilitating entrepreneurship financing.

Thirdly, the jurisdiction can work towards a cultural change in the sector by promoting good corporate governance, which includes corporate social responsibility. A government cannot enforce a change in the sector to one of profit by quality of service but it can create an environment in which such a change can blossom. We are already seeing major financial institutions change the way in which they remunerate staff. This is generally by moving from bonuses for volume of sales to bonuses for quality of service. Partially this is in order to facilitate cultural change within the organisation. IFCs by virtue of their size can, in their own way, deliver a similar climate of change.

Finally, the benefits of IFCs have to be explained better and more widely. The public do not understand the distinction between avoidance and evasion. They look at a far simpler argument. Do firms and individuals pay their fair share of tax? The ‘shareholder spring’ on directors pay can easily become a ‘taxpayers autumn’.

Focus has previously been on convincing the decision makers of the benefits of IFCs. However, these decision makers now have louder voices in their ears. Outreach therefore has to be greater, from beyond this group to those that elect them. This requires clearer, simpler messages.

Of course, centres can continue to provide support to those elements of the finance industry that prefer the old approach, those that regard the last few years as a temporary blip. Such a route is easier; it is within the comfort zone. To them there is no reason to believe profits will not return. Many will argue such a path.

But suppose we are at a tipping point, that IFCs, have come to a tide in their affairs, like a tide in the affairs of men, “which taken at the flood, leads on to fortune; Omitted, all the voyage of their life is bound by shallows and in misery”1. If this is true, then there is no fork in the road where a centre can choose one route or the other with equal equanimity.

Maybe, just for once, this time it is going to be different.

1 Shakespeare, Julius Caesar, Act 4, scene 3. 5

IFC



The British Overseas Territories and the Crown Dependencies are listed amongst the top 30 international finance centres – how important do you feel their contribution has been to the global and more specifically the UK economy?MF: The British Overseas Territories and Crown Dependencies play an important role in helping to allocate capital efficiently. To this end they act as important financial intermediaries which match the capital provided by savers in one country with the investment needs of borrowers in another.

Many small IFCs are able to offer a stable, well-regulated and neutral jurisdiction through which to facilitate international and cross-border business. Investment channelled into small IFCs in turn provides much needed liquidity, further investment opportunities, competitiveness and access to capital markets for businesses and investors in both the major developed economies and emerging market countries.

When it comes to the UK, there is a huge mutually beneficial relationship between the City of London and many Crown Dependencies and Overseas Territories, demonstrated not only by the massive capital flows between the two which aid market liquidity and investment in the UK, but also legal and constitutional similarities and the transfer of skilled professionals.

IFCs were used as scapegoats during the financial crisis - what can IFCs do to improve the public perception of them?MF: The trouble IFCs face is that they tend only to make headlines when there are high profile stories of tax avoidance – I recall most recently the Jimmy Carr tax scandal which involved a Jersey-based accountancy arrangement. As a result, the public broadly, and quite understandably, believes that small IFCs are used only by the wealthy for the purposes of avoiding their financial obligations at home. This is a toxic perception in these times of austerity when income disparity is becoming a subject of fierce public debate.

The voice of the Crown Dependencies and British Overseas Territories has largely been absent in these media stories, whether through a timidity to make their case or a lack of interest by journalists in learning about the wider benefits of small IFCs. I think much IFC focus has been on strengthening relations with people and institutions who are already onside. Perhaps there needs to be a much broader campaign which reaches out to sceptics. I would also recommend that those IFCs which, for instance, meet international standards on transparency and co-operate in fighting financial crime take steps vigorously to distinguish themselves from some of their shadier counterparts.

You have been quite vocal in your support of IFCs – how difficult has it been to encourage debate on this subject in the current climate?MF: There is an important public debate at the moment about the societal obligations of the wealthy. Too often the public is being told that they have to accept the terms being dictated by that wealthy portion of the population else they will flee elsewhere and take their money with them. This belligerent and arrogant approach is stoking public anger and making it difficult to talk openly and dispassionately about a variety of issues, particularly taxation. This naturally extends to small IFCs. Mainstream politicians have not the confidence to make the case for lower taxes for all and therefore find it easier instead to argue for punitive taxes on the wealthy and to rail against the reduction of the overall tax burden. In this context, small IFCs are presented as opponents of this orthodoxy, making it difficult to engage people in an objective analysis of what they bring to the financial mix. But that does not mean I shy away from that challenge.

What do you believe is the role or function of an IFC?MF: I have described this broadly above, particularly with regard to small IFCs acting on a hub and spoke basis with mainland UK, the massive capital flows between the two aiding market liquidity

In the ChairIFC Economic Report speaks to Mark Field MP for the Cities of London and Westminster, a vocal proponent of international finance centres.Former solicitor and businessman Mark Field has been MP for the Cities of London and Westminster in the heart of London since 2001.He takes a special interest in economic matters, foreign trade and international development, and is currently Chairman of the All-Party Parliamentary Groups on Venture Capital and Private Equity. Being the Member for the City, Mark naturally has a strong interest in financial matters and has served on the Standing Committees of several important pieces of economic legislation and has raised concerns about European interference in London’s hedge fund industry and the future of the City of London as a world leader in financial services.

6


and overseas investment.Small IFCs often play an important

role in aiding developing countries as well, however, by enabling such nations effectively to ‘rent’ financial expertise from other countries while they develop financial centres of their own. Crucially, they also offer investors greater protection of their property rights against domestic political uncertainty. It is no exaggeration to say that without smaller offshore financial centres many developing countries would not secure key funding for project finance which makes a substantial contribution to the improved lives of the most vulnerable global citizens.

Have IFCs been unfairly discriminated against in their treatment by pan national bodies such as the OECD? MF: I do not think it helpful for IFCs to view themselves as victims. The financial crisis that crashed into global consciousness in 2008 ensured that searching questions were asked of all financial centres, big and small. However it would be fair to say that small IFCs were at a disadvantage in making their case as they at times provided a useful scapegoat for regulatory failure in larger financial centres.

Having been scrutinised closely by the OECD et al over the last 20 years has the time not come for that scrutiny to be turned elsewhere – eg, at the main centres of international finance?MF: The implication of this question is that main centres of international finance are not being closely scrutinised at the moment. I can assure you from representing the City of London that this is not the case!

In terms of global financial standards – what steps should governments be taking to prevent future crises?MF: I think a great deal has been done to make the balance sheets of banks more robust, particularly with regard to capital requirements. I still do not think that the question about the separation of banks’ retail and investment arms has been successfully settled. In the UK we are looking at the Vickers ringfencing idea and we now have the EU examining a similar proposal following the Liikanen report but I remain to be convinced about the practicalities of either. There is a superficial attraction in returning to a Glass Steagall-style formal separation

to reduce systemic risk and any potential burden on the taxpayer. However this would only be practical if applied on a global basis and I suspect we are a long way from that happening. It also contains the implicit complacency that retail banks are somehow risk-free. Never forget that banking is an inherently risky business. Aside from all this, one of my continued concerns is that we are focussing on how we might have prevented the last crisis rather that what might precipitate the next one.

One aspect of the US’ response to the financial crisis has been the enactment of the FATCA legislation, which has been cited as the ‘world’s most wide ranging tax compliance programme’ – do you feel this is an appropriate and effective path for the US to take?MF: Time will tell both if the hype and, more important still, the effectiveness of FATCA are established. Whilst few would argue that tax compliance involving foreign financial assets and offshore accounts should be improved there must be some concern that this will result in yet more tax evasion and an expansion of unregulated financial

IN THE CHAIR

7

IFC

IFCIFC



institutions. This is work in progress, but we should welcome the US authorities/IRS taking their responsibilities over US citizens seriously in the world of globalised finance.

Do you think the regulation and transparency of the small IFCs is comparable with that of central financial centres such as London or New York?MF: As I have said before, there is a danger in lumping all small IFCs into one. I think there is a vast difference between regulation and transparency standards in the Crown Dependencies (Isle of Man, Jersey and Guernsey) than, say, the Cayman Islands and BVI. Many small IFCs have shown willingness to engage with the concerns raised over their tax regime. Guernsey, for example, voluntarily undertook a Corporate Tax Review to act within the spirit of the EU Tax Code of Conduct Group and an IMF review of Jersey’s regulatory standards concluded that Jersey was in the ‘top division’ of financial centres, giving it the highest ranking ever achieved by a financial centre in terms of its compliance with FATF recommendations.

How important is it for jurisdictions to be tax competitive in today’s global market?MF: As it will be increasingly difficult to differentiate on grounds on regulation, tax competition is likely to become an essential USP. Every nation now needs to grasp quickly that we operate within a tough and competitive global economy. The UK cannot expect its tax regime not to have an impact on its economic attractiveness as place in which global businesses and individuals may wish to invest and the same applies to small IFCs. Rather than sniping at small IFCs, the UK and Europe should welcome the case they make for efficient, low tax economies as a welcome warning about continental complacency.

Can and should the UK government be doing anything more to support the financial services sector of the Crown Dependencies and Overseas Territories?

MF: The debate within the UK government has naturally been framed by events surrounding the collapse of Iceland’s banking system. When the Icelandic banks imploded in September 2008, it quickly became apparent that the contagion would spread to British savers and ultimately to the British taxpayer. Furthermore, the role of the Isle of Man as a core financial intermediary between British savers and Icelandic borrowers illustrated the UK’s exposure to offshore centres.

However, the subsequent Treasury Review undertaken by Michael Foot went some way to allaying the two main concerns and has helped the UK government make the case more confidently for small IFCs. In particular, the worries over the fiscal sustainability of UK Crown Dependencies proved to be overstated. Throughout the past years IFCs like Gibraltar, the Isle of Man, Guernsey and Jersey have amassed large budget surpluses while diversifying their tax base as Foot recommended. Indeed the Foot Report commented on the fact that none of the Crown Dependencies have taken on significant levels of borrowing.

The government is committed to working in the international arena to ensure there is no discrimination against well regulated offshore financial centres and has encouraged the same international standards to be applicable to all jurisdictions. That work must continue in order to ensure that, say,

Macau does not get advantages that do not apply to a Crown Dependency like Jersey simply because the Chinese government may have been more robust and confident when it comes to international negotiations.

What role if any can IFCs play in helping the UK out of this current economic slump?MF: The Crown dependencies provide an important platform from which to learn about and access the British economy. For example, the Isle of Man acts as the number one jurisdiction for the incorporation of Indian businesses listed in London, and has been identified by a Chinese Government economic unit as an important link in China’s ‘going out’ strategy in relation to Chinese businesses setting up in the EU.

Similarly, with fledgling satellite, space and film businesses (to name but three), not to mention its shipping and aircraft registration expertise, the Isle of Man brings into a British sphere of influence important strategic global businesses that might otherwise be drawn to a competitor such as Singapore, Hong Kong or the US. The Crown dependencies are keen to continue acting on this hub-and-spoke basis with the UK and adding value to Britain’s international offering in a proper and transparent way and it is here that IFCs can help the UK access precisely the markets in Asia and beyond that we need to, and they us, if we are to get out of this period of stagnation.8


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Europe Jersey

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Brazil

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HEADLINEFEATURE

Offshorein Practice

International fi nancial centres have been subject to intense scrutiny and continuous derogatory media coverage down through the years, so much so that the vital role that the small IFCs play in the world’s economic development has been overlooked by policymakers and the media alike. Th e IFC Forum was created to address the misconceptions surrounding IFCs and to act as the voice for the much maligned ‘off shore’ community. Th e IFC Forum was established to provide ‘authoritative and balanced information about the role of IFCs in the global economy’.

Our headline feature examines the part IFCs play in the global movement of wealth and, in conjunction with the IFC Forum, we examine the ‘vital role’ that IFCs play within the global economy, with practical examples and case studies from IFCs alongside research undertaken in this area.

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Crucial players in the global economy, small International Financial Centres, or IFCs, act as conduits to the free and effi cient movement of capital.

Enhancing global prosperity and benefi ting both G20 and developing nations alike, small IFCs such as the Cayman Islands, Bermuda, the Channel Islands and the British Virgin Islands have made a signifi cant contribution to raising global standards in recent decades, increasing per capita GDP in the domestic economies of many G20 countries by stimulating investment and creating employment. As stable and effi ciently regulated jurisdictions, highly regarded in terms of transparency, as well as committed and cooperative partners in compliance legislation, these small IFCs are salient participants in the international fi nancial network.

Acting as the ‘plumbing’ in the global fi nancial system, those IFCs perform a range of pivotal functions, essential to economic growth, commerce and the retirement plans of people all over the world.

IFCs provide tax neutral platforms which attract global capital and provide for the smooth passage of fi nancial fl ows where in other circumstances, uncertain or multiple-layered onshore tax rules, investor-unfriendly legal systems and cumbersome banking infrastructures would make a transaction or investment unattractive. Where deals are unattractive, investment into a particular jurisdiction becomes inhibited. Where IFCs are present, they provide effi cient intermediaries for cross-border capital fl ows and corporate transactions, fuelling

global economic growth.Funds established in IFCs act as

effi cient portals for collective investments which maximise returns on pensions and other pooled funds in a manner which does not benefi t one investor over another. Th ese tax neutral platforms are highly appealing to business because not only are they subject to robust legal and regulatory infrastructures, they also have the required fi nancial services expertise to attract capital from various jurisdictions. It should be clearly understood that investors participating in a fund domiciled in an IFC do not avoid paying tax. All investors in off shore hedge funds are still required to make a full tax declaration to their home tax authorities. Tax neutral platforms simply reduce the risk of multiple layers of taxation, which can occur where investments cross borders since onshore tax systems are rarely integrated with foreign regimes.

Confusion also exists surrounding which countries are IFCs, with nations like the UK, Th e Netherlands and modern economies such as Singapore

and Dubai included in the mix with the more traditional off shore jurisdictions. With no real consensus on what really constitutes an ‘IFC’ and more typical commentary tending towards the use of terms such as ‘Tax Haven’ it is perhaps no great surprise that the true economic contribution of IFCs is not fully understood by international policymakers or the mainstream media.

In the years that immediately followed the global fi nancial crisis, many G20 politicians and media commentators had looked to the IFCs to apportion some blame for their own economic problems. While these actions may have been understandable for political reasons, strong evidence exis ts that shows IFCs were not a factor in the economic crisis. For example, in the March 2009 Turner Report, commissioned by the UK Government, Lord Turner concluded: “It is important to recognise that the role of off shore fi nancial centres was not central in the origins of the current crisis”.

In order to ensure that global policymakers fully appreciate the vital role that small IFCs play in terms of economic development and providing liquidity and effi ciencies to the capital markets, the IFC Forum was established in 2009. Th e IFC Forum is a non-profi t organisation aiming to help inform the public debate on small IFCs, as well as to commission research and correct the many misconceptions which surround the activities of IFCs. Its membership comprise private sector organisations in the international fi nancial services sector, operating in fi nancial centres such as London, Dubai, Hong Kong, Singapore, Dublin and Sao

Enhancing Global Prosperity via IFCs

By Grant Stein, Consultant, Walkers, Cayman Islands

‘Acting as the ‘plumbing’ in the global fi nancial system… IFCs perform a range of pivotal functions, essential to economic growth, commerce and the retirement plans of people all over the world.’

IFC FORUM SPECIAL FEATURE

11 11



‘Where IFCs are present, they provide efficient intermediaries for cross-border capital flows and corporate transactions, fuelling global economic growth.’

Paulo as well as many of the UK’s Crown Dependencies and Overseas Territories. Our view was that such misconceptions can be countered to a greater degree through communication and cooperation within the offshore world, which has faced these accusations for many years but only responded in a disparate manner. Traditionally the individual offshore financial centres may have regarded each other as competitors, with the principal centres moving towards their own areas of specialisation.

Today, however, it is clear that the interests of the principal IFCs are aligned at a higher level, while the trend towards more complex multi-jurisdictional transactions has also reinforced the need for greater collaboration. The advantages of this approach are significant. When the IFCs can speak together with one voice, benefits can accrue to all our jurisdictions. Furthermore, by working together, IFCs can ensure that all market participants can see and appreciate the symbiotic relationship IFCs have with both developed and developing countries. One of the primary objectives of the IFC Forum is to facilitate an objective empirical assessment on the economic benefits of IFCs to the wider global economy. Further information on our activities can be found at www.ifcforum.org.

In the context of this debate and calls for so called ‘ tax havens’ to be shuttered, the IFC Forum recognises and shares the legitimate concerns of governments around the world over the potential for tax leakage through tax evasion. We warmly welcome and support any attempts to challenge the illegal use of financial centres – large and small – for tax evasion purposes. Our concern, however, is that many politicians, perhaps confused by some NGO produced facts and figures that do not stand up to proper analysis, have tended to conflate tax evasion – which is illegal anywhere – with the provision of tax neutrality which is essential for pooling funds for international investment.

As mentioned previously, a key part of the IFC Forum’s mission is to demonstrate how small IFCs have a

positive impact on the global economy. In that vein and focusing in particular on the effect on exports, the IFC Forum appointed Europe Economics to conduct an assessment into the impact of capital invested from large EU countries into small IFCs. Europe Economics1 examined patterns of foreign direct investment from the three main EU economies: Germany, France and the UK to some of the more significant IFCs such as the Cayman Islands, Bermuda, the British Virgin Islands, Jersey and Guernsey. They concluded that the argument that money leaving jurisdictions for small IFCs is ‘lost’ to the onshore economy is unfounded. In fact, the research demonstrated that capital flows into small IFCs are invested, resulting in greater benefits for the economy where the investment initially stemmed from, through generation of higher exports. Furthermore, the research showed that when adjusting for the size of economies, FDI into small IFCs is more export promoting than into other countries. Policy makers and NGOs, therefore should re-evaluate their approach to IFCs, because taking Europe’s three largest economies as examples, capital leaving for IFCs like Cayman and Jersey is invested efficiently. Rather than being lost, it generates exports, returning an overall benefit to those European countries. This endorses similar research that already exists in relation to the Canadian and US economies, showing unequivocally that capital flows from the G7 countries through IFCs result in benefits for the domestic economies of those G7 countries. There is no reason to believe that the same would not apply in relation to all developed economies.

In addition to enhancing the

economies of advanced nations, numerous academic studies have highlighted the benefits that IFCs provide to developing nations. A recent study by Professor Jason Sharman of Griffith University in Brisbane, Australia2, found that IFCs help domestic and foreign investors in developing countries access the kind of efficient institutions which are necessary to drive growth but which are often unavailable locally. Typically the local infrastructure in developing countries doesn’t have the critical mass required to seriously drive growth forward. IFC platforms provide an efficient method by which capital from developing nations can access the stable investments in developed nations and at the same time allow investors in larger countries to efficiently invest in the emerging markets. The capital flowing through IFCs also provides alternative sources of liquidity for small and medium sized enterprises, which represent an important driver for jobs and productivity, so badly needed in the developing world.

Further to the improvements associated with growth and employment all around the world, the presence of IFCs in the global economy creates tax competition which has clearly brought its own benefits in keeping tax rates as low as possible. The corporate tax systems of large countries aim to raise funds domestically and were never designed to assist efficient trade, finance and commercial interaction with other complex tax systems. It is the tax neutral platforms of the IFCs that lubricate the interfaces between these systems, facilitating efficient trade and investment, which has underpinned the leap in global living standards in recent decades. Very careful consideration should therefore be given to any policies which threaten to rip out the ‘plumbing’ connecting larger developed countries to smaller IFCs in terms of the impact on jobs, trade and economic growth.

1 www.ifcforum.org/files/Small_International_Financial_Centres_Report___Final.pdf2 www.ifcforum.org/files/Sharman___International_Financial_Centres_and_Developing_Countries.pdf12

IFC


Offshore Financial CentresDespite criticisms by the OECD and G20 heads of state against offshore financial centres with regimes based on tax neutral models, Bermuda, Cayman Islands and the British Virgin Islands continue to lead the way as jurisdictions of choice for corporate investment structures and deal flow in international ‘cross border’ investments and financing transactions in connection with inbound and outbound investments in the PRC.

Opinions on offshore financial centres are often polarised where antagonists would attempt to argue that the form of corporate investment structures used to minimise tax issues in the structuring of international transactions in the global financial system leads to the negative effect of erosion of wealth in developed nations. In fact, these structures have not lead to the erosion of wealth in developed nations and empirical evidence would suggest that the use of these offshore investment corporate structures have instead alleviated and enhanced economic growth in and reduced poverty in the PRC as a case in point.

In a free global economy, jurisdictions both offshore and onshore are free to structure their tax regimes and revenue regulations in any manner that achieves economic success. Although offshore financial centres were initially designed with the aim of creating structures to minimise tax, it is now arguable that tax issues are the least dominant factor or even a factor attributable to the success of offshore financial centres, particularly in terms of international

‘cross border’ investments and financing transactions and should be discarded as a consideration.

Today, offshore financial centres like Bermuda, Cayman Islands and the British Virgin Islands (‘BVI’) are sophisticated, nimble and in sync with the current global transaction deal flow and the use of its available corporate investment structures, namely, the Bermuda, Cayman Islands and the British Virgin Islands special purpose companies in the form of exempted offshore companies, exempted limited partnerships or trusts (the ‘IFC Company’), play a significant, if not major role, in international and global trade and finance. These IFC Companies are commonly used as a ‘cross-border’ special purpose vehicles or investment holding companies through which investors are able to participate in ‘cross border’ merger and acquisition transactions, private equity deals, pre-IPO financings, debt equity capital markets financings, aviation acquisition transactions including international banking financing transactions. They offer a politically stable environment as British Overseas Territories, strong independent legal systems based on English common law, first class infrastructure facilities, professional services and lighter regulatory requirements all of which are seen to be a major determinant factor in using IFC Companies to participate as investment vehicles - rather than the perceived tax benefits.

Against this background, given the

growth of the ever increasing PRC market economy and the PRC’s fear of the prospect of outflow of wealth, more developments in the regulatory and tax aspects of investments into and out of the PRC have been put in place, which have to be taken into account in structuring investments which are compliant with the PRC regulations in particular (Circular, 10, 19 – M&A rules and Circular 698 - Tax), which is beyond the scope of this note.

Nonetheless, we continue to see the use of the IFC Company as the preferred jurisdiction in respect of the use of offshore corporate structures for investments into and out of the PRC as discussed below.

Inbound PRC Investment Structures

Private Equity InvestmentsUntil now, Bermuda, Cayman Islands and the British Virgin Islands IFC Companies remain de rigueur as a platform or conduit from which investments are channelled into the PRC.

In private equity (‘PE’) transactions, investment into a domestic PRC business and its operations are usually effected by restructuring its PRC business operations where the PRC founders will hold its PRC business operations through an IFC Company. The PRC founders will hold shares in the IFC Company through share transfer reorganizations and share swap arrangements and the IFC Company will in turn hold all the shares of the PRC domestic

Investments through IFC Companies into the People’s Republic of China

By John Collis, Paul Lim, and Teresa Tsai, Conyers Dill & Pearman

IFCs → China


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in place, the angel round PE investors will invest through the IFC Companies generally by way of redeemable preference shares (‘RCPS’) with follow on investments, as required, in the form of different classes or series of RCPS with tailor made rights specific to the transaction which generally includes, liquidation rights, protective voting rights, conversion rights, co-sale rights,

drag rights, pre-emptive and trade sale rights and the like.

Once critical valuation is achieved and the target is ripe for exit, the PE investors may exit either by way of a trade sale if there is a potential buyer or by way of an initial public offering (‘IPO’) of shares on a stock exchange (typically The Stock Exchange of Hong Kong or NYSE or NASDAQ exchanges). In practice, a trade sale is generally the preferred choice for an exit as an IPO exit demands the allocation of management resources, is time consuming, will incur further costs, is subject to market appetite for its shares and may involve a lock up of shares for a certain period of time before they can be disposed off.

Block Diagram 1 depicted opposite sets out in a simplistic generic form a typical investment structure into the PRC using IFC Companies. The structure varies depending on the group structure and business requirements of the PRC business operations. PE investors will participate indirectly in the PRC business operations through an IFC Company and when the operations are ready for an IPO, the BVI entity above the proposed Cayman Listco as shown in Block Diagram I is removed through a reorganisation of the structure in preparation for the listing exercise. BVI entities are commonly interposed above and below the proposed Cayman Listco to provide flexibility to the structure in the event further ‘spin off ’ restructuring is required or disposal of shares are made above or below the Cayman Listco.

With respect to the onshore investment structure at the WOFE level, the PRC business and operations are generally held directly by the WOFE if the PRC business operations fall within a business sector that permits foreign investment, subject to compliance with the PRC regulatory requirements. Alternatively, if the PRC business falls within a restricted business sector (eg, media, energy or infrastructure projects), which prohibits foreign investment or is unable to comply with the PRC regulatory requirements, a variable interest structure or ‘VIE’ may be used to indirectly circumvent the restrictions where the WOFE enters into contractual arrangements with the business entities

company normally through intermediate IFC Companies and Hong Kong holding companies as the deal structure necessitates.

For flexibility, there will generally be IFC Companies and a Hong Kong company interposed between the PRC domestic business and the IFC Companies through which the PRC founders hold shares. With this structure

Professor Jason Sharman: IFCs and Developing Countries: Providing Institutions for Growth and Poverty Alleviation“IFCs offer a natural complementarity for developing countries arising from an institutional environment characterised by simple, flexible, modern, sophisticated and impartially-enforced regulations and laws that are specifically tailored for foreigners. Small- and medium- sized enterprises from developing countries, the engines of job and income growth, may be able to access capital much more efficiently in or through IFCs than domestically. For foreign investors, IFCs ease the path of entry into developing countries. An explanation premised on the search for efficient institutions in IFCs sheds light on why, for example, Mauritius is the biggest foreign investor in India, or why the Cayman Islands attracts ten times more capital from China than does the United States.

Funds invested in IFCs are seldom final destinations for capital from the developing world, but rather are commonly brought back to be put to work in the country of origin. Such flows allow investors and private individuals to reconcile their desire for asset protection with the imperative to contribute to national development.

“By far the most successful poverty reduction effort in human history has occurred in China from 1978, during which time hundreds of millions have been lifted out of poverty (Ravallion 2009). Openness to foreign investment is widely regarded as a key driver of Chinese growth during this period. In turn, the World Bank has declared that ‘foreign direct investment remains one of the most important tools in the fight against poverty’ (Klein, Aaron and Hadjimichael 2001: 1). Headly (2007), calculates that the FDI is between three and ten times more effective than foreign aid in boosting growth. Moyo (2009) draws similar conclusions. Less widely appreciated, however, is that flows of foreign investment into China, and increasingly outbound flows of investment from China, have been predominantly routed through tax-neutral IFCs. While Hong Kong has predictably been important, the British Virgin Islands has consistently been the second-largest foreign investor in China, while 10 times more Chinese out-bound investment goes to the Cayman Islands-domiciled structures than to the United States.

The argument is that, by routing investment through IFCs, foreign and domestic investors can utilise institutions that lower transaction costs, in turn resulting in larger capital flows and more efficient use of this capital. The primary beneficiaries of these lower transaction costs in China have been small- and medium-sized enterprises, which have faced severe obstacles in obtaining credit from banks and being listed on local stock markets. Ensuring the adequate flow of capital to such smaller enterprises are crucial, because they make a disproportionate contribution to poverty alleviation.”For full report see: www.ifcforum.org/files/Sharman___International_Financial_Centres_and_Developing_Countries.pdf

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PRC Founders General Partner Limited Partner

PE Fund

Cayman/BVI Company

BVI Company

PRC Domestic Operations

PRC Founders

VIE/PRC Domestic Operations

BVI Company

Cayman Listco

BVI Company

HK Company

WOFE

Block Diagram 1

Offshore

OnshoreSecurity / Call

Options

Contractual arrangements


and the PRC founders, designed to control the PRC business entities and to provide the intended economics of the investment transactions. The contractual arrangements are also supported by share charges and call options to provide some form of investor protection.

Debt Capital MarketsWhere future funding is required by PRC businesses (this assumes a PRC business listed on an exchange in the form structured as discussed above) for general corporate working purposes or expansion of its business operations,

IFC Companies are also commonly used to raise funds by way of investment and non-investment grade high yield notes and bonds including convertible notes from debt capital markets to minimise the amount of regulatory red tape involved in the issue. Typically, for investment grade high yield notes and bond issues through IFC Companies, a BVI special purpose companies (‘BVI SPV’) is used as the issuer with the notes and bonds guaranteed by the parent holding company, generally an offshore Bermuda or Cayman listed company or a PRC listed entity. Under current market practice, no security over assets or shares within the group or a credit rating is generally required for the issue investment grade notes or bonds. Medium Term Notes (‘MTN’) issued through the establishment of MTN Programmes currently follow the form of the investment structures for investment grade bonds and are issued typically through a BVI SPV and guaranteed by the parent holding company. Again, no security over assets or shares within the group or a credit rating is generally required for the issue of MTN Notes.

With regard to issues of non-investment grade high yield notes and bonds, by PRC entities (again, this assumes a PRC business listed on an exchange in the form structured as discussed above), the issuer is generally a listed IFC Company where the issue is secured by assets or shares of the subsidiary companies within the group and where priority over the security is governed by an intercreditor arrangement for further issues. In convertible bond issues, again IFC Companies are normally used as the issuer with the bonds convertible into the shares of the listed IFC Company where no security is generally given except for a guarantee by the parent holding company.

PE FundsLikewise, in the case of PE funds, the investment structures are similar to the IFC Company structures used for private equity investments, except that the offshore investment fund vehicle is generally structured as a limited partnership organised in Bermuda, Cayman Islands or the BVI. 15


Auditor General Partner

Manager

PRC JVPartner


Limited Partner Limited Partner

Block Diagram 2

Offshore

Onshore

PE Fund

BVI SPV

HK SPV

PRC JV(CJV or EJV)



Cayman Islands and BVI limited partnership PE funds are more common in practice and investors are invited to participate as limited partners in the PE Fund operated by the general partner that indirectly holds the PRC domestic target business through intermediate IFC Companies and Hong Kong special purpose companies (‘HK SPVs’). Block Diagram 2 sets out a typical PE fund structure in simplistic generic form where investments are made by the PE fund indirectly into the PRC domestic business. Variations in the forms of funds structures (eg, master, feeder, segregated funds and funds of funds structures) are also used as appropriate depending on the complexity of the business model and scope of investment of the PE fund.

At the intermediate holding level, IFC Companies and Hong Kong SPVs

are interposed to provide flexibility on disposal and exit situations. The Hong Kong SPV will in turn hold interests in the PRC domestic operations and subject to PRC regulatory requirements and the nature of business sector which the PRC business operates, the Hong Kong SPV may either hold the PRC business operation directly or alternatively through the medium of a cooperative joint venture arrangement (‘CJV’) or equity joint venture arrangement (‘EJV’) in partnership with the local PRC partner.

Outbound PRC Investments StructuresSince the liberalisation of the Chinese economy, the Middle Kingdom has continually absorbed capital from foreign investments and not until recent years,

has she begun to embark on seeking investments overseas, in particular in Africa, Australia, Brazil and Indonesia amongst others.

As a result of its growing domestic demand, in particular, for energy and natural resources amongst other capital goods, PRC companies are increasingly looking for more opportunities to invest overseas to satisfy its domestic demands.

Investment vehicles that are being used to bridge such investments are again IFC Companies. The primary sectors of investments are in the oil and gas exploration and mining for natural resources (eg, iron ore, coal etc). The investment structures are less complicated and IFC Companies are normally used to hold overseas investments directly or as financing vehicles to raise capital to fund overseas mining explorations or to participate in joint ventures in respect of overseas business operations.

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In this space, deal flow that we have seen involved the use of IFC Companies to structure the issue of exchangeable notes to PRC entities, investing through IFC Companies to finance mining and exploration activities in Indonesia secured by guarantees and debentures over BVI, Singaporean and Indonesian subsidiaries within the investment structure.

In the case of outbound Chinese PE funds, it has been reported that such funds are beginning to take positions in overseas investment opportunities but this will probably involve a much longer gestation period. However, the stakes are high as these funds will be competing for investment dollars and deal opportunities with their more matured and aggressive Western counterparts like Bain Capital, KKR, and Blackstone etc, and there is moreover the uncertainty of whether Chinese PE funds venturing overseas will be acceptable to western fund investors.

IFC Company StructuresIn practice, we continue to see the use of IFC Companies to structure investments into and out of the PRC as standard fair.They are particularly suited for investments into the PRC given that the PRC’s business and regulatory environment is continually evolving as it moves towards a fully developed nation state. The use of IFC Companies provides investor protection to foreign investors who are comfortable and familiar with the offshore legal systems based on English common law, and investors invariably prefer to use IFC Company structures to effect investments instead of participating directly in investments into the PRC. Moreover, IFC Companies are convenient to use, cheaper to maintain and given their modern up to date and lighter companies legislation, IFC Companies are flexible and may be restructured on short notice to suit the nature and requirements of

any particular transaction for inbound and out bound investments into and out of the PRC. Also, in financing transactions they act as the conduit for aggregating capital from multiple sources to participate in investments.

Overall, notwithstanding the negative rhetoric surrounding offshore financial centres, we continue to see and arguably will continue to see, given its entrenched position, the use of IFC Companies as the investment platform of choice to bridge inbound and outbound investments into and out of the PRC and, more so, if the thought provoking analysis of Martin Jacques in his book When China Rules the World1 proves true.

1 Martin Jacques - When China Rules The World: The End of the Western World and the Birth of a New Global Order [Second Edition Penguin Books (UK) Ltd. (2012)].

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IFC



CyprusCyprus is a well established international financial centre and a primary gateway for investments into and from Europe, particularly from Eastern Europe and Russia. It has earned this position largely due to a favourable tax regime which is EU neutral and non protectionist, affording equal advantages across the board to EU and non EU investors. In combination with an attractively low corporate tax rate of 10 per cent and a good network of double tax treaties, strategically located investors in treaty partner jurisdictions such as Russia, who choose to structure their holdings and investments through Cyprus can significantly maximise their after tax returns.

Strategic ties to Russia continue to play a major role in the success of the Cyprus tax model and Russia has shown its resolve to stand by Cyprus’ side by extending, in December 2011, a €2.5billion loan to Cyprus on particularly favourable terms. According to informal sources, the Financial Times has reported that Russian deposits in Cypriot banks today amount to more than €10bn. The below case study will demonstrate some of

the principal tax reasons Russian investors use Cyprus to structure their investments.

Case StudyHarneys recently advised a Russian individual (‘RI’), a major investor in the Russian heavy metal manufacturing industry, on a proposed restructuring of his shareholding in an underlying group of Russian companies of which he was the sole direct shareholder (‘RusCo’) with the purpose of maximising the tax efficiency of the corporate structure and with a view to a prospective sale of part of the operations.

The estimated value of this transaction was US$0.5 billion.

The following step plan details the structuring of the transaction, highlighting the tax benefits of using Cyprus.

1. Creating the Cyprus holding companyA Cypriot holding company (the ‘CHC’) was set up by RI. It is important to note that in order to access the double tax treaty network of Cyprus, a company incorporated in Cyprus should also be Cyprus tax resident. This means that the management and control of such

company should take place in Cyprus. In order to secure the tax residence

of the CHC, RI set up an office in Limassol and moved three persons from management from Russia to Cyprus, hiring another two administrative staff. The board of the CHC was comprised of three directors, all residents of Cyprus, ie, spending at least 183 days per calendar year in Cyprus. Board meetings and key management decisions all took place in Cyprus.

2. Contribution of SharesAs shareholder of RusCo, RI then contributed 100 per cent per cent of the shares of RusCo to the CHC in return for further shares in the CHC. The Cyprus Companies Law allows for corporate reorganisations of this type and the Cyprus tax laws incorporate provisions for tax-free corporate reorganisations in line with the EU Mergers Directive. The various forms of permissible reorganisations include exchanges of shares of the type undertaken by RI. Significantly, stamp duty (otherwise applicable at 0.2 per cent per cent of the value of the transaction) is exempted in qualifying reorganisations. Hence the exchange of shares was carried out with no tax implication and no stamp duty levy.

The structure now changed so that RI became the shareholder of an increased number of shares in CHC, and CHC in turn became the shareholder of RusCo.

Cyprus attaches capital duty at a rate of 0.6 per cent per cent on an increase in authorised share capital. This can be avoided by issuing shares at a premium as the duty attaches only to the nominal value of the shares.

Russia – Cyprus: Case Study on Project M

By Emily Yolitis, Partner, Harneys, Cyprus

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3. Dividends from RusCo to CHCProfits derived by the manufacturing operations of RusCo were to be sent as dividends to the sole shareholder, CHC. In accordance with the double tax treaty between Cyprus and Russia (and recently confirmed by the Protocol to the treaty), dividends payable from Russia to Cyprus are subject to five per cent withholding tax in Russia provided the investment exceeds €100,000. In the present case, the investment threshold was met and therefore dividends sent by RusCo to CHC were subject to a five per cent withholding tax in Russia.

4. Incoming Dividends in CyprusThe Cyprus Income Tax law provides for an exemption of dividends received by Cyprus resident corporate taxpayers, irrespective of the holding period or percentage. Dividends are also exempt from 20 per cent levy of Defence Tax if the dividends emanate from a company which is subject to tax in its jurisdiction of residence at a rate which is not substantially lower than the Cyprus tax rate of 10 per cent or failing this, if the company sending the dividend

is not engaged in over 50 per cent of its activities in producing investment income. Investment income has been interpreted to include (portfolio) dividend income, license income, interest income (unless the dividend paying company is a financial institution or a group financing company), rental income from immovable property and certain capital gains.

Since RusCo was engaged in active manufacturing operations, the exemption was applicable and the dividends received in Cyprus by CHC were not subject to any tax in Cyprus.

5. Dividends from CHC to RIBy virtue of the domestic law provisions, Cyprus does not levy any withholding tax on payments of dividends to non-residents wherever they may be situated and regardless of the existence of a double tax treaty. Therefore dividends distributed by CHC to RI who is a non Cyprus resident shareholder were not subject to any withholding tax in Cyprus.

6. Sale of 30 per cent of RusCo by CHCCyprus Income Tax law provides for

a tax exemption from profits realised by Cyprus companies upon the sale of securities (securities being shares, bonds, debentures and other rights and titles on such assets), irrespective of the holding period, number of shares held or trading nature of the gain (capital losses resulting from the sale of securities are not tax deductible). Therefore the sale by CHC of 30 per cent of the shares in RusCo to a purchaser situated in the British Virgin Islands did not attract any income tax in Cyprus as a trading gain.

As far as capital gains are concerned, a gain arising on the sale of the shares held by CHC in RusCo is taxable, in accordance with the double tax treaty between Cyprus and Russia, in the jurisdiction of residence of the seller. As Cyprus does not tax capital gains, (other than on the disposal of immoveable property situated in Cyprus or shares representing immoveable property situated in Cyprus), there was no incidence of capital gains tax in the sale of 30 per cent of RusCo by CHC. The position remains unaltered by the recent Protocol other than in the case of property rich companies where the taxing right will migrate, as from 2017, to the jurisdiction where the immoveable property is situated.

ConclusionBy tapping into the Cyprus tax system and double tax treaty network, RI was able to restructure his holding and sell part of it without incidence of any tax, other than the five per cent withholding tax payable in Russia on distribution of a dividend to CHC. Five per cent is the lowest withholding tax rate on dividends sent from Russia and the treaty with Cyprus features this rate. In fact the withholding tax rates on dividends, interest and royalties were confirmed on all three counts in the recently ratified Protocol to the double tax treaty between the two jurisdictions which allays any fears of an impending increase in the foreseeable future. With the Protocol having provided a secure footing for the tax and business relations of Cyprus and Russia, the former remains the jurisdiction of choice for many Russian investors seeking a reliable route to maximizing their net returns after tax.

Russia -- Cyprus

Walid Hejazi Offshore Financial Centres and the Canadian Economy (Feb 2007)“When a Canadian multinational moves capital through a conduit, be it Barbados or any other, there will be a strong and positive impact on Canadian exports. This is the first evidence to demonstrate this – when Canadian companies use OFCs to access the global economy, there will be increases in Canada’s trade, which have been shown elsewhere to increase Canada’s employment and capital formation.

The use of these conduits reduces the cost of capital for the Canadian multinational. Given the nature of the data, it is not known where the capital is destined – that is, the OFCs, including Barbados, are conduits for these firms to invest in other markets globally. Therefore, we expect that Canadian trade with these other markets should increase whenever Canadian MNEs use conduits. In addition, because of the reduced cost of capital these MNEs are made more competitive in the market they have invested in, as well as globally. As a result, the theory would predict an increase in Canada’s trade with the global economy, with the effects varying by region

…This intuition implies therefore that the use of these conduits to access the global economy have a direct impact on Canada’s exports to the market where the CDIA is destined as well as indirectly to all markets as the competitiveness of Canadian MNEs is improved as a result of the reduction in the cost of capital that comes with the use of the conduit jurisdiction.”For full reports see: www.ifcforum.org/show_article.php?id=8

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19IFC



Against the backdrop of the dramatic rise in fortunes of the emerging markets of Latin America, with growth elsewhere still cramped by the global financial crisis, international investors have zeroed in on investment opportunities across the region in economies such as Brazil and Chile. Latin America has also been a hotspot for numerous international private equity funds, which have focused their portfolios on high growth opportunities, while also reducing exposure to traditional investments.

A 2011 survey from the major secondary market investor Coller Capital highlighted the global shift in sentiment towards Latin America. It revealed that Limited Partner appetite for emerging markets private equity investment stood at an all-time high, with Brazil overtaking China as the most attractive market for dealmaking over the next 12 months. Brazil was also expected to attract the largest influx of new investors, with 14 per cent of Limited Partners planning to start investing there.

This development is extremely welcome for Brazil, not just in order to maintain its economic advance, but with a rash of infrastructure projects underway ahead of its hosting of the football World Cup in 2014 and the Olympic Games in Rio in 2016 the need for international capital has never been greater. In fact, some observers reckon that Brazil needs to spend an additional three per cent of its GDP on infrastructure to meet these

requirements, as well as the growing needs of its own rising middle class.

Competition for international capital, however, is intense and the traditional regulations and mechanisms in Brazil in place to restrict the movement of capital do few favours in this climate. The rules in Brazil regarding the tax regime for the investment entity appear to be less directed towards attracting investment to the country and more in favour of preventing funds being expatriated by Brazilians.

Brazil’s ExperienceIn short, the inability to efficiently access tax neutral platforms from International Financial Centres (IFCs) such as the Cayman Islands for investment into Brazil threatens to constrain international capital flowing to Brazil at the time its economy needs investment the most. It is well accepted – and reinforced by a slew of academic research1 – that global economic growth has been enhanced by the free and efficient movement of international capital through IFCs, which have been essential to economic liberalisation and the improvement in living standards in the developing world.

Brazil’s attitude runs in stark contrast to other key emerging markets currently favoured by investors such as China, which engineered the most dramatic move out of poverty ever seen by being open to foreign investment. Of most significance has been the PRC Government’s moves to gradually relax regulations to allow foreign direct investment in certain industries, while

embracing the many efficiencies and benefits of engaging with IFCs.

In the fight to attract global investment, efficient mechanisms to raise and deploy international capital provide real structural benefits for local economies, and those nations which have embraced these realities have taken a lead over rivals who are unable to see past outdated policies and misplaced suspicion about global capital.

Foreign investment into Brazil typically takes place through the use of Fundo de Investimento em Participações – also known as FIP structures which act like private equity funds providing a whole range of tax and regulatory incentives for foreign investors. The FIP structure is primarily used for private equity investments such as acquisition finance, bridge financing, management buyouts, mezzanine investments and PIPE securities (Private Investment in Public Equity). The incentives mean that foreign holders of the shares can receive an exemption on income tax for up to 40 per cent of the fund’s issued shares. This exemption, however does not apply to investors using vehicles formed in ‘tax havens’ or ‘paraiso fiscal’. Foreign investors in these vehicles are treated in the same manner as domestic investors and subject to the same 15 per cent tax rate, in addition to any tax liability in the investor’s home country.

China’s ApproachIn contrast, China has embraced IFCs and has long been aware of their benefits which have helped power growth and development. Research by

Behind the CurveBrazil Inefficiencies Threaten International Investment

By Rolf Lindsay, Partner, Global Investment Funds Group, Walkers, Cayman Islands

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IFCs → Latin America

The Economic Role of IFCsThere are at least five ways in which IFCs contribute to the operation of economies worldwide.

The first is the important role of IFCs in stimulating foreign direct investment in high-tax parts of the world. Investors are often better able to structure their capital commitments to high tax countries by combining their investments in high-tax places with investments in IFCs, and it appears that levels of foreign direct investment in high-tax countries are sensitive to the availability of financing structures that use IFCs. Evidence of foreign direct investment patterns indicates that firms that are more likely to establish finance affiliates in IFCs exhibit more rapid growth rates of investment and sales in nearby high-tax countries.

The second contribution of IFCs is to discipline financial markets in other parts of the world, limiting the degree to which banks and other large institutions can exploit local monopolies to the disadvantage of individuals and businesses. The ability of investors to channel financial transactions through IFCs reduces interest rate spreads, arbitrary credit allocation, and other problems associated with excessive market power on the part of local financial intermediaries. As a result, IFCs enhance the stability of the world financial architecture.

The third role of IFCs is to promote good government and the benefits that flow from democratic accountability.

The evidence indicates that by far the most successful international financial centers are those whose governments score highly on the World Bank’s indicators of governance quality.

Furthermore, countries and territories without good governance institutions are much less likely to become IFCs than are otherwise similar countries and territories that have high quality governance institutions. As a result, IFCs display the economic benefits available from democratic reforms, hopefully indirectly encouraging such reforms. Moreover, the unwillingness of market actors to devote extensive resources to the few IFCs without high quality governance institutions means that the IFC market is dominated by countries and territories with institutions established by transparent and accountable governments.

The transparency and accountability of IFC governance structures may seem inconsistent with their reputations as locations of choice for money launderers, tax evaders, and others seeking to establish anonymous accounts in which to hide assets from others. Quite apart from the distasteful aspects of assisting in the avoidance activities of others, a country that offers ready availability of anonymous accounts may indirectly contribute to the worsening of governance structures around the world by facilitating the payment of bribes to government officials and others. The most recent evidence indicates, however, that IFCs such as: Bermuda,

the British Virgin Islands, the Bahamas, the Cayman Islands, and Panama in fact adhere rather strictly to international norms requiring ample documentation in order to create corporate entities and bank accounts, making them unattractive locations for money laundering and tax evasion. Instead, the large high-income countries such as the United States, the United Kingdom, and Canada, with their relaxed banking requirements, serve as the easiest locations for the establishment of anonymous accounts.

The fourth role of IFCs is their impact on tax collections and tax competition among large countries. The evidence of the last 30 years is that there has been precious little tax competition among OECD countries, as tax bases have broadened at the same time, and to the same degree, that tax rates have fallen.

Recent economic research suggests that the availability of targeted lowtax opportunities, such as financing structures that use IFCs, permits governments to maintain healthy domestic tax bases without triggering ‘beggar thy neighbour’ tax competition.

Hence far from ushering an era of unbridled tax competition, there is good reason to believe that IFCs permit governments of large countries to implement the domestic tax policies they want and need in the face of international economic pressures.

The fifth role of IFCs is their place in the world economy. IFCs as a group have enjoyed rapid economic growth in the last 25 years, reflecting in part the growing importance of financial sectors of modern economies, and in part the special roles played by IFCs. Greater affluence in this part of the world contributes to economic performance elsewhere, as part of the usual process of economic spillover. Far from drawing down or somehow reducing economic activity elsewhere in the world, the ability of IFCs to contribute to finance and other sectors adds value to economic activity everywhere.See full report at: www.ifcforum.org/files/STEP-International-Financial-Centres-and-the-World-Economy.pdf

James R Hines JrInternational Financial Centres and the World Economy (2009)

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Professor Jason Sharman of Griffith University in Brisbane, Australia, states that the primary conduit for foreign flows of investment in China– both inbound and outbound – has been IFCs, which have afforded cost-effective and efficient capital deployment, providing a major contributor to growth and the reduction in poverty. The two countries, meanwhile, which have consistently provided the greatest level of foreign investment to China, are both IFCs (British Virgin Islands and Hong Kong) and both of them feature on Brazil’s list of tax havens. Also of significance is the fact that 10 times more Chinese outbound investment passes through the Cayman Islands than compared with the US.

China’s success in terms of attracting foreign direct investment has been stunning, which has helped maintain growth of 10 per cent during most of the past 30 years. Additionally, according to a 2010 World Bank report, China received some 20 per cent of all FDI to developing countries over the previous decade. It has been a gradual and prudent approach that has served China well, initially opening up to foreign investment on the manufacturing side before focusing on services around the time of its WTO accession in 2001.

The importance that China places on the IFCs which have so well served its

economic development is clear from how it resisted any interference in Hong Kong as a financial centre when taking control in 1997, while China also went to great lengths to avoid an international crackdown on the activities of Hong Kong and Macau at the G-20 meeting in London in 2009.

China’s double taxation treaty with Hong Kong, which drops the withholding tax to five per cent, has made the Hong Kong vehicle the favoured method of entry into China, with a Cayman Islands exempted company or BVI business company often interposed upstream to allow the company to take advantage of these flexible corporate regimes. Among the benefits of the IFC structures are no requirement for BVI companies established since 2005 to have authorised share capital, no stamp tax on share transfers as well as the speed of incorporation and lower costs. In the private equity context, the Cayman Islands exempted partnership has been the vehicle of choice for attracting foreign capital to be deployed in China. Domestic RMB funds have been in favour for the global private equity houses looking to make inroads in China, while the country is now looking to open its door to capital raising for hedge funds to boost investment into the funds industry.

A Better StateClearly the tax neutrality offered by financial centres such as the Cayman Islands plays an important role in the overall efficiency of a transaction and the presence of a blacklist in Brazil means that additional analysis is required to ensure that the overall structure in play is tax efficient for all participants. Just looking at the infrastructure projects required for Brazil’s development over the medium term, which produce steady rather than spectacular returns, it is critical to eliminate all inefficiencies from the structure if margins are to be maintained.

Just in the last few years, some important progress has been made in removing some of the hindrances to attracting global investment to Brazil, which has been quite encouraging. We have seen a Memorandum of Understanding (MoU) signed between Brazil’s securities regulator (CVM) and the Cayman Islands Monetary Authority, as well as an initiative by AIMA the global investment funds association to forge closer links with the industry in Brazil. In addition, the 2011 cut in tax on foreign investment in private equity funds (to two per cent from six per cent) is another step in the right direction, along with the discussions between Cayman and Brazil on the possible implementation of a Tax Information Exchange Agreement. This important development demonstrates that Brazil is now catching on to the shift in sentiment in the global debate regarding tax evasion which among leading industrialised countries now focuses more on transparency and information exchange.

At such an opportune time, with Brazil squarely in the minds of international investors, it is to be hoped that further policy changes can be introduced which recognise the importance of IFCs and encourage efficiencies into the process of attracting international investment.

1 2009 ‘International Financial Centres and the World Economy’ James R Hines Jr - University of Michigan; and 2007 ‘Offshore Financial Centres and Canadian Economy’ Professor Walid Hajazi - University of Toronto’s Rotman School of Management22

IFC


The offshore financial services sector in Mauritius dates back to 1988 with the amendment of the Banking Act to provide for offshore banking. The objective of Government at that time was to capture regional business and support a forthcoming Freeport for regional trade with neighboring countries such as South Africa and Madagascar, which were undergoing political changes.

However, it was only in 1992, when Mauritius passed the appropriate offshore legislation to enable the setting up of offshore entities and trusts that the sector started to take off.

HistoryThe launch of the Mauritius Offshore Business Sector in 1992 coincided with the liberalisation of the Indian economy when the balance of payment crisis forced India to open her economy for foreign investments. Shortly after, the 1983 Double Taxation Avoidance Agreement (the ‘DTA’) between India and Mauritius was dusted off by international tax practitioners and the island country was quickly put on the map as the preferred jurisdiction for foreign investors investing in India. The aim to make Mauritius a platform for regional business and investments

soon materialised but with the focus shifting to India and the Asian region with the signing of double tax treaties with countries like Malaysia (1993), China (1994), Singapore (1995) and Indonesia (1996).

The DTA has been instrumental in channelling foreign investments into India and in the development of Mauritius as an IFC thereby benefiting both countries. As more and more investors were choosing Mauritius to locate their intermediate holding companies, Mauritius had to gear up. Training from international practitioners was made available

Mauritius → India

By Francoise Chan, Executive Director, Intercontinental Trust, Mauritius

A Passage to India


23



locally and best international practices were being adopted; legislations were passed/amended to enable new products and meet the growing demands of sophisticated investors; communication and internet upgraded and so on. Many job opportunities were created especially in the trust, legal and accounting professions. Many Management Companies (‘MCs’), also known as Trust Companies in other jurisdictions, were set up and licensed by the Financial Services Commission to service the offshore sector (later known as the global business sector).

The rapid growth of the sector in the early years also motivated many international players (banks, fund managers and trust companies) to establish a presence in Mauritius. In this context, international banks such as Standard Bank, Standard Chartered, Deutsche Bank, Investec and the State Bank of India have set-up branches/subsidiaries in Mauritius, joining Barclays and HSBC which were already present in Mauritius prior to the launch of the offshore sector. International law firms such as Conyers, Appleby and Bedell are also present in Mauritius.

Today the financial services sector is one of the main pillars of the Mauritian economy contributing to 13 per cent of GDP and directly employing over 30,000 people. The number of MCs as of August 2012 stood at 160 with most of them forming part of a reputable international consultancy firms’ network.

History of the DTA between India and Mauritius India and Mauritius shared a double tax avoidance treaty during colonial times - under the British Empire. However, Mauritius severed the tax treaty relationship when it became independent in 1968.

Acknowledging the strong ties between the two countries, a comprehensive double tax avoidance treaty was signed on 24 August 1982 and became effective on 1 April 1983. India also wanted to liberalise trade barriers and promote trade relations with neighboring countries, especially Africa via the preferential agreement that Mauritius had with African

countries. Thus, the purpose of the treaty was to encourage mutual trade and investments. In the initial years, the treaty was used mainly for Indian outbound investments into Mauritius and a number of Indian companies set up operations in Mauritius.

A decade after, the situation reversed. By the year 2010, foreign direct investment in India from Mauritius crossed the US$50 billion mark and accounted for 42 per cent of the total FDI, followed by Singapore, USA, UK and Netherlands with nine per cent, seven per cent, five per cent and four per cent respectively. During the same period, India’s foreign exchange reserves grew steadily from a low US$5.8 billion at end of March 1991 to US$38 billion by the end of March 2000 and surged to over US$300 billion in 2008.

The Indian services sector is the highest FDI attracting inflows with 21 per cent of the total inflows, followed by computer software and hardware, telecommunication and housing and real estate with nine per cent, eight per cent, seven per cent and seven per cent inflows respectively.

The Indian Authorities acknowledge the benefits of FDI in the creation of employment in India, corporation taxes collected and development of infrastructure. It is said that some two million jobs have been created in the Indian Telecom industry as a result of Mauritian FDI for example.

The benefits afforded by the DTA between India and Mauritius have weighted in the investors’ decision making process. We will now see in detail the advantages of the DTA.

Typical Structures and Highlights of the Mauritius India DTAUsually a special purpose vehicle (SPV) or a Collective Investment Scheme (CIS) / Fund will be set up in Mauritius for Indian direct investment and portfolio investment respectively. These vehicles will hold a Category One Global Business Licence and apply for a Tax Residence

Certificate (TRC) in order to take benefits of the DTA.

Capital Gains TaxThe DTA transfers the taxing rights on capital gains to the country of residence of the seller, ie Mauritius. Mauritius having no capital gains tax, a complete exemption of capital gains tax is obtained on sale of shares of Indian companies by a Mauritius entity.

Dividend Withholding TaxThe Tax Treaty caps the dividend withholding tax for substantial shareholdings to five per cent. Although India has abolished dividend withholding tax, it should be noted that the Indian tax authorities have done so twice in the past decade and had re-introduced dividend withholding tax after a certain period.

By structuring investments through Mauritius, the maximum dividend withholding tax for substantial shareholdings will be capped at five per cent in the event dividend withholding tax is re-introduced.

Currently, in India there is a dividend distribution tax (DDT), which ranges between 15 per cent and 25 per cent. DDT is a tax on the company distributing the dividend and not on the recipient. Under the Mauritian tax laws, a Mauritius company can claim underlying tax credit on the DDT if the Mauritius Company holds directly or indirectly at least five per cent in the Indian company.

‘It is a fact that Mauritius has played a central role in fuelling India’s economy over the last two decades.’

InVEStORS

Equity

Equity

0% WHT on Dividends

No CGT

MAuRItIuSCOMPAny

INDIA24



make an abuse of the Treaty by investing funds derived from India back into the country only to take benefits of the Treaty. In fact, there has been no proven case of round-tripping.

Commercial SubstanceIt is easy for a company to demonstrate commercial substance in Mauritius. The good repute of its IFC, the legal, regulatory, financial and technological facilities and expertise; the cost and ease of doing business and Mauritius as an ideal gateway to other markets namely Africa. A GBC1 can furthermore deal with Mauritius residents and the island’s

diversified and open economy provides numerous investment opportunities in the country.

More recently, the proposed introduction of General Anti Avoidance Rules (GAAR) in India has motivated many companies to enhance substance in Mauritius by doing more than just meeting the statutory requirements for tax residence.Mauritius has been very prompt in addressing the various concerns. Measures taken include:• Stringent licensing conditions have

been introduced to ensure that Indian sourced funds are not re-

Mauritius Remains Best Route for India Inbound InvestmentsThe use of the DTA, however, has not been without controversy. The Authority for Advance Ruling (AAR) in India had, in the case of Natwest, denied treaty benefits on the grounds that the investment was routed through Mauritius prima facie for the avoidance of income tax advance rulings. However, the ruling was overturned in another case (commonly referred to as the AIG ruling) where the AAR upheld the availability of treaty benefits on the ground that structuring investment through Mauritius was based on genuine commercial reasons and not only as a means of avoiding taxes. In early 2000, the Indian Revenue Authorities once again sought to deny treaty benefits to some Mauritius entities and the response to this controversy, the Central Board of Direct Taxes in India issued a circular No 789 on 13 April 2000 to Tax Officers stating that a Tax Residence Certificate issued by the Mauritian tax authorities would be considered as prima facie evidence that the Mauritius company was a Mauritius tax resident and entitled to claim treaty benefits.

A company can apply for a Tax Residence Certificate (TRC) from the Mauritius tax authorities if certain conditions are satisfied namely, the company has a minimum of two directors resident in Mauritius; it maintains its principal bank account in Mauritius; all statutory and accounting records are maintained at its registered office in Mauritius; financial statements are audited in Mauritius and the board meetings must include at least two resident directors.

Mauritius as a Route for Indian FDIOver the years there have been negative comments about the Mauritius route for Indian FDI. The main concerns as reported in the Indian press are set out below.

Allegations of Round Tripping and lack of Exchange of information Press allegations against Mauritius are that the Mauritius IFC is a haven for Indian residents wishing to route gains made outside of India back into India by using shell structures in Mauritius or

Professor Jason Sharman: International Financial Centres and Developing Countries: Providing Institutions for Growth and Poverty Alleviation“…Third country nationals investing in India have chosen to go through Mauritius to take advantage of the skills and institutions available from the internationally-oriented Mauritian financial sector. This is certainly so relative to the more heavily regulated and parochial Indian finance sector. The large and growing tax treaty network that Mauritius is building provides a rough equivalent to the tax-neutrality afforded in other IFCs. Added to this are the same sorts of transaction-cost-reducing geographical proximity and cultural affinities that Hong Kong enjoys with China. These last may explain why, despite having a very similar tax treaty with India, Cyprus is much less often used by foreign investors in India.

“Further evidence for the beneficial nature of the Indo-Mauritius economic relationship, and the tax treaty more generally, is provided by the attitude of the Indian government. Both under the BJP and Congress parties, the government has been broadly supportive of the tax treaty, and indeed has consistently defended it from various court challenges. A former Indian Commissioner of Income Tax mounted a challenge to the decision (Circular 789) of the Central Board of Direct Taxes mandating that Indian authorities accept Mauritian certificates of tax residency. The goal of the action was to invalidate the use of GBC1s as a conduit for foreign investors into India by disqualifying them from the concessions available under the double tax treaty. Although initially successful, this challenge elicited a strong challenge from the Indian government, which appealed the decision in the Supreme Court, winning the case in October 2003. In defending the double tax agreement so strongly, the government seemingly indicated it was aware of the value of this arrangement in fostering foreign investment in India, and thus the development of the country more generally. On the other side of the ledger, the Vodafone India case dealing with capital gains tax liability (see http://www.theworldlawgroup.com/docs%5CIndia%20-%20Vodafone.pdf for details) may limit the ability of local and foreign firms to access efficiency-enhancing institutions in IFCs when investing in India.”For full report see: www.ifcforum.org/files/Sharman___International_Financial_Centres_and_Developing_Countries.pdf

RESEARCH

ExTRACT

25



invested in India through Mauritius;• Indian auditors have been allowed to

practice in Mauritius – Global Business Companies investing in India may use the services of Indian auditors to have their accounts audited for Mauritian regulatory purposes;

• Mauritius law has been amended to provide for wider Exchange of Information with Indian authorities. A Mutual Assistance in Criminal and Related Matters Act has been introduced and provides for requests for judicial assistance;

• The entering into an MOU with the Securities and Exchange Board of India (SEBI) providing for exchange of information. Mauritius has further agreed to the stationing of an officer from the Revenue Department of India at the High Commission of India in Port Louis for better exchange of information; and

• Issuance of TRCs on an annual basis, upon the recommendation of the Financial Services Commission which will supervise full compliance with the undertakings provided by applicants for the TRC.Amidst concerns and in view of

increasing revenue collection, India publicly announced its intention to renegotiate the DTA with Mauritius. It has been observed that each time there has been talks of renegotiations of the DTA in India and loss of taxing rights by Mauritius, the Bombay Stock Exchange has experienced panic selling.

It is a fact that Mauritius has played a central role in fuelling India’s economy over the last two decades. The Indian Finance Ministry stated that India needs approximately US$1 trillion of new FDI up 2020 to finance its infrastructure development plans. The Mauritius IFC can help India in increasing the inbound investments and meet its objective.

India Outbound InvestmentsCurrent trends in foreign exchange movements in India show that capital outflows now exceed capital inflows. Indeed, in order to sustain India’s economic growth and meet the demand for raw materials, energy

and commodities, India is investing outbound and particularly in Africa.

There is today a trend of Indian multinational companies using Mauritius as a platform for its outbound investments in Africa - leveraging on the regional membership of Mauritius

(member of SADC, COMESA) and the fact that Mauritius has signed DTAs with a given number of African countries rich in natural resources.

Mauritius is now being called upon to play a critical role in facilitating Indian outbound investments.26 IFC



Its development model was based on a foundation that was made up of economic diplomacy on the international front, and continuous public-private sector dialogue domestically with a clear understanding that there will be a social welfare net for the vulnerable groups in terms of free education, healthcare, and old age pensions amongst others.

Economic diplomacy was directed towards ensuring market access for products and services from the island: the Sugar Protocol, which provided a guaranteed price and quantum to the European market, the Lome Convention, which gave access to exports and which catalysed the take-off

of the Export Processing Zone (EPZ), the African Growth and Opportunity Act for access to the US market, and 36 Double Taxation Avoidance Treaties to support the development of a financial services industry.

From independence in 1968, however, Mauritius positioned itself squarely in Africa. It leveraged its colonial past and bilingualism to become a member of the now defunct OCAMM (Organisation Commune Africaine, Malgache et Mauricienne), which held a Heads of States Summit on the island in 1973. It also joined the Organisation of African Unity (OAU), which held its Heads of States summit here in 1975.

When Mauritius achieved independence some four and a half decades ago its main industry was sugar, which accounted for some 98 per cent of foreign earnings. Today it represents less than four per cent of GDP, while manufacturing (mainly textile and clothing) accounts for 18 per cent, tourism nine per cent, and financial services 15 per cent (of which global business is five per cent).

Its economy has grown in spite of the handicaps arising from its small size, its relative geographic remoteness from its main markets and sources of supplies, and despite having no natural resources.

Mauritius → Africa

Making a Platform for Business to Africa1

By Nikhil Treebhoohun, CEO, Global Finance, Mauritius

27



Later it was part of the East African Preferential Trade Area, which became the COMESA (Common Market for Eastern and Southern Africa) and in the 1990s it joined SADC (Southern African Development Community).

In 1995 Mauritius was also one of the seven founder members of the Indian Ocean Rim Initiative, which became the Indian Ocean Rim Association for Regional Cooperation (IOR-ARC) and now has 19 member states. The secretariat is in Mauritius. Interestingly, the coat of arms of the republic of Mauritius still has the motto: Stella clavisque maris indici (the Star and Key of the Indian Ocean) -this is the main reason it was first colonised. With the opening of the Suez Canal, it lost some of its strategic importance. However, with the advent of new technology and improved communications, its position in the international time zone (GMT+ 4) that allows it to straddle part of business hours in the East and the West, Mauritius has the ambition to be once more the star and key of the Indian Ocean.

The drive to be part of groupings emanates from the recognition that the continued growth and development of

the island depends crucially on access to markets. Africa has always been considered as its natural hinterland. But the unstable political situation in Southern Africa, which delayed the economic take-off of the region did not provide the expected pull for the Mauritian economy. In fact, there was a belief that ‘the flying geese model of development’ of the Asian tigers, which had Japan as the lead goose would be replicated in this part of the world; unfortunately this has not materialised – so far! Now, as Africa becomes the centre of attention of the developed world and emerging countries because of its wealth of natural resources, Mauritius is in a strategic position to facilitate cross-border investment into Africa. Why?

Definitely the network of DTAs (the two latest signed with Kenya and Nigeria) and IPPAs does help. More important is the fact that Mauritius can offer integrated services as the ITES/BPO sector is well developed and is servicing global business ( Mauritius was ranked fourth in Africa in The AT Kearney Global Services Location Index, 2011 ). In addition, it ranks well in most competitiveness and doing business

indices. The ease of doing business is borne out by the fact that there are 13 international banks in Mauritius today and some 10,000 global business companies, many of them facilitating business into Africa - as the two case studies below demonstrate.

Mauritius as a Headquarter Location for Pan-African Firms As a new era dawns on the African continent, African entrepreneurs with international know-how and expertise are beginning to bring in tailored solutions to real African problems. One such solution has been the introduction of an innovative pre-paid payment solution in seven West African countries to address the needs of a stratum of the population that does not have access to banking facilities. Indeed, the charges imposed to maintain a bank account in a number of African countries by practically all retail banks have made access to banking facilities a reserved of the elite. The solution proposed by the operator enables the transfer of money or payment of utility bills electronically - even if the payee does not have a bank account or bank card or not even a mobile phone. The operation occurs through accredited agents such as the local post-office or shopkeepers which utilise a pre-paid card to enable transactions on behalf of clients. A commission is paid by the client for each transaction, which is shared amongst the agent and the operator.

The operator established its headquarters in Mauritius in February 2011, whilst maintaining operational subsidiaries in most of the countries in which it is operating. The choice of Mauritius has been motivated by the fact that the island nation provides an eco-system conducive for business structuring, professional services and technology-enabled development and deployment. As one of the most prominent International Financial Centres of Africa, Mauritius offers tax-efficiency coupled with access to international banks, law firms and accounting and audit practices. As one of the leading outsourcing destination in Africa, Mauritius enables the provision of shared services in a cost effective, process

Case Study:

Funding for African Agriculture GrowthThis case shows how the presence of an international bank (Barclays) in the Mauritius IFC has facilitated the raising of capital for and the financing of an agricultural project that has a funding requirement of over US$1.0bn on a yearly basis.

Barclays’ (BB) client is Africa’s leading entity engaged in the agriculture sector. The customer has benefited from Barclays ‘ONE AFRICA’ strategy, where Barclays Ghana and Barclays Mauritius partnered in providing a solution through a consortium of banks where Barclays Ghana plays a leading role with support from Barclays Mauritius. Each bank has leveraged on its strength showcasing an excellent team work and the capacities of Barclays ‘ONE AFRICA’ network. This co-operation was made possible for two reasons.

The first has to do with country strength. Mauritius being a reputable IFC attracts investors which helps build in the liquidity/treasury base of banks. This muscle (obviously foreign currency – US$ in here) allows the banks to assist in providing financial assistance to such big corporates. The same scenario is applied with various other multinational corporates banking within Barclays’ network.

The second reason is Barclays specific. BB Mauritius is a branch of BB Plc, UK whereas BB Ghana is a subsidiary. Hence, the ‘single borrower’s limit – SBL’ (which is a cap on lending capacity) does not apply here while BB Ghana is limited in its lending capability as it is a subsidiary. BB Mauritius muscle is equivalent to BB Plc London given the branch status. There is an internal arrangement in Barclays whereby BBM and BBG can use their strength to assist customers and keep these same customers within the Barclays network.

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optimised manner by bilingual (French / English) professionals.

The operator headquarters is organised as a group of companies engaged in the following activities in Mauritius:

Server HostingMauritius is well connected to Africa through the SAFE , LION and EaSSy Cables. The operator has decided to take advantage of this and to further enhancing its operations in Mauritius through hosting of its main servers in a data centre in Mauritius. All point of sale terminals are connected to these central servers, thus ensuring accessibility, reliability, security and stability of operations.

Shared Services The group runs its back-office and reconciliation activities in Mauritius. This enables invoicing and billing of clients in a timely manner. The availability of bilingual professionals is a major advantage which allows the group to manage a central billing centre for both English and French speaking Africa.

Treasury ManagementMauritius offers a good platform for central treasury management. First and foremost, there is no exchange control on foreign exchange on both entry and exit. Banks offer the ability to effectively manage sub-accounts in practically all hard currencies from a single main account. This allows the group to maintain its revenue in dollars and euros thus considerably reducing the risk of exchange rate fluctuations.

Relocation of Key PersonnelMauritius allows professionals to be work and reside on the island through a single occupational permit. This is delivered in an expeditious manner with minimum administrative burden. The group has relocated its key personnel for the development and maintenance of its technology platform in Mauritius.

IT Applications DevelopmentThe group has an office in Mauritius which acts as a development centre for the technology platform. The latter is structured in a separate global business

company such that it can effectively be marketed as a product in its own right.

Holding of the Intellectual Property RightsMauritius currently has the appropriate legal framework, which allows a business idea and concept to be protected. The model adopted is a central registration of the Intellectual Property which could be effectively licensed as royalties to other operators in Africa.

Employment of Staff and Wealth ManagementGiven that the group operates in many countries at once and employs staff who have to roam from one country to for operational and marketing purposes, all employment contracts are emitted by the holding company in Mauritius. A split contract arrangement allows salaries to be paid in the countries of operation as well as the bank accounts of the employees in Mauritius. The staff therefore have sophisticated instruments in the financial centre of Mauritius to manage their wealth. The payroll is run centrally in Mauritius avoiding single granular operations in each country of operations.

Signing of PartnersThe group recently signed a contract with a leading Point of Sale (PoS) manufacturer. The contract enables the deployment of PoS in many more markets in Africa without capital investment from the group and with a revenue sharing mechanism thereafter. By signing the contract from the Mauritius companies, the group ensures that the laws of Mauritius become applicable. The hybrid legal framework of

British Common Law and French Code Civile in force in Mauritius, ensures that the contract will be valid in all African countries. Furthermore, Mauritius is now a place for international arbitration with a dedicated international arbitration centre. Any dispute during the course of the engagement of the two parties can be effectively resolved in Mauritius in a very cost efficient manner.

Sales and Contract ExecutionThe group signs its contracts with its accredited agents through a global business company in Mauritius. By doing so, the group effectively is liable to a maximum corporate tax rate of three per cent. The fact that the operations are in several countries means that the contracts need to be managed in a central location. Centralisation of the sales, marketing, and contracts management operation in Mauritius enables the group to recognise its revenue in Mauritius and thus benefit from very efficient taxation. The retained earnings resulting from this consolidation process allows the group to envisage expansion in other African countries.

Corporate and Project FinancingAs part of its vision to become a pan-African operator, the group is constantly looking for additional financing and investors. Private equity investors find it proper to enter at the Mauritius holding level. The company law in Mauritius enables easy allocation of different types of shares to additional investors. The financial operating system in Mauritius also enables efficient and tax free exit of the investors whenever the time is proper.

Investment StructuringThe operator has structured its investment in various subsidiaries through Global Business Companies in Mauritius. This provides a number of fiscal advantages in view of the fact that there is no capital gains tax and no taxes on dividend distribution in Mauritius. Thus at the time of partial or full exit of the shareholder(s) from the company, there will be full exemption on capital gains irrespective of the value created in the company.1 This article has benefited from the input of Barclays Bank International and Abax Services.

‘Now, as Africa becomes the centre of attention of the developed world and emerging countries because of its wealth of natural resources, Mauritius is in a strategic position to facilitate cross-border investment into Africa.’

29 29

IFC



The Big DebateWe asked leading commentators from across the international finance industry – opponents and proponents alike the same question – IFCs: Good for the Global Economy?

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THE BIG DEBATE

31

Is it in the interests of Western countries such as the UK and the US to pursue an agenda of maligning the small finance centres which surround them? The reputation of

the British offshore centres for probity, professional skills and financial sophistication enables them to attract capital

from around the world.

The leading British Offshore Centres and other small international financial centres (IFCs) have played a key role as lubricants in globalisation. That many such centres are clustered near major financial markets such as the City of London and New York is no coincidence. Their tax neutral platforms have made them essential symbiots supporting the depth and success of such ‘onshore’ markets over the last 30 years.IFCs do the following:• pool monies for pension and other

institutional investors to enhance investment returns and spur growth

• provide insurance (and reinsurance) for business and other users

• provide sophisticated legal and professional infrastructure to facilitate financial intermediation, trade and investment support for emerging markets (eg China)

Globalisation is regarded with suspicion by many Western politicians as it introduces competition, including on taxes. Despite formally welcoming such competition, most producers (including governments) prefer monopolies, or at least manageable cartels. Tax competition fostered by international finance centres is often considered unwelcome, even while (or perhaps because) economists recognise it as prompting greater efficiency in utilisation of onshore government expenditure.

A possible underlying motivation for the challenge to small financial centres

may be the desire of the larger countries to flex control over mobile capital. In a globalising world, is there any more important sovereign prerogative than controlling where mobile money alights?

Big countries may also seek to control financial services business for sound commercial reasons. Financial services jobs are lucrative, and coveted. US government statistics appearing in the CIA fact book show that the top 20 economies in the world (measured by GDP per capita) are dominated by countries with either oil or financial services. It would be unseemly to overtly demand surrender of profitable markets from competitors, but calls for heavy regulation on smaller market participants facilitates that same goal.

Is it in the interests of Western countries such as the UK and the US to pursue an agenda of maligning the small finance centres which surround them? The reputation of the British offshore centres for probity, professional skills and financial sophistication enables them to attract capital from around the world. Such capital is then substantially directed into the UK, European and US capital, banking and securities markets. Capital goes where it is welcome, of course, so the erection of US or EU barriers to trade with international financial centres could steer their allegiances towards Asian, Middle Eastern or Latin American markets. Who will suffer most if UK or US relations with these complementary financial centres are damaged?

Richard HayPartner, Stikeman Elliott London



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Most of the economies of wealthy countries consist of services, and that is because services of all kind,

particularly legal and financial services, provide enormous value in the modern world. Indeed, if one asks why countries such as the United States enjoy such high standards of living,

the answer is not, as it once was, the abundance of natural resources, since natural resources represent rather a small

proportion of gross domestic product. Instead, countries such as the United States thrive simply because they operate

capitalism so well.

THE BIG DEBATE

James R Hines JrUniversity of Michigan and NBER

European Network on Debt and Development (Eurodad)

International financial centers (IFCs) play an important and growing role in the world economy, serving as financial intermediaries, fostering competition among firms and industries, and generally facilitating the operation of modern capitalism. IFCs contribute to economic growth by reducing the cost of financial transactions and thereby making it possible to provide cost-effective financial, legal, and accounting services, in the process lowering the cost of investment in other countries. Just as capitalism can itself be controversial, so too IFCs, for all their contributions to wealth creation, are the subjects of various concerns. The concerns include that the availability of IFC-based transactions somehow damages the world economy, eroding tax bases, diverting economic activity from other parts of the world, facilitating

undesirable activities, undermining financial regulation, and contributing to undesirable tax competition. There is something, it seems, distasteful in the purely financial, or legal, or what might be called service-oriented, aspect of much of the economic activity in IFCs.

In evaluating the economic impact of IFCs it is important to dispel older notions of what kinds of activity contribute to prosperity. Most of the economies of wealthy countries consist of services, and that is because services of all kind, particularly legal and financial services, provide enormous value in the modern world. Indeed, if one asks why countries such as the United States enjoy such high standards of living, the answer is not, as it once

The concept of a global economy refers to how companies and markets operate and relate to each other, but says little about how the impact is distributed. Research conducted by Eurodad and other CSOs conclude that the load is often unequally shared and offshore financial centres are being used to tip the balance in favour of a few wealthier economic actors. This is particularly true in the case of developing countries, where complex tax planning structures are no match for under-resourced tax administrations.

Irresponsible companies often create subsidiaries in offshore financial centres in order to manipulate prices and to minimise

tax payments. Take major banana importers, for instance. Research unveiled by the Guardian showed that bananas imported into the EU nominally travel across several subsidiaries in different offshore financial centres. Some subsidiaries provided insurance or other services, but others did not perform any real economic activity. Upon arrival in the EU around 80 per cent of the bananas’ price has been recorded offshore, and only 20 per cent ends up in the producing countries.

Sometimes, subsidiaries’ activities can also be questioned. A Chilean mine bought in 1979 for €64 million was sold for €1.04 billion in 2002. Despite the 16 fold increase in price, the mine consistently reported losses and accumulated €460 million in tax credits. A Chilean Parliamentary commission later concluded that, among other practices, the profits generated in Chile were effectively transferred to a subsidiary in an offshore financial centre. In addition, many offshore financial centres fail to prevent the laundering of illegally acquired profits. Weak transparency regulations and the absence of proper ownership

was, the abundance of natural resources, since natural resources represent rather a small proportion of gross domestic product. Instead, countries such as the United States thrive simply because they operate capitalism so well. A critical aspect of this operation is the financial and legal infrastructure, of which IFCs, and the industries they support, are an important part. Other countries can share in this affluence by embracing market capitalism. Far from there being a presumption that IFCs undermine national objectives, they encourage and reward well designed economic policies and sound tax systems, ultimately contributing to the economic growth that makes it possible to achieve national goals.


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Now, more than ever, the global economy needs to efficiently re-cycle savings and capital from the rapidly growing

economies to the struggling economies in the West. It would be bizarre while many central

banks are busy injecting liquidity into the system via quantitative easing to do anything

to hamper the flow of funds through the IFCs.The positive role IFCs play in the global

economy is confirmed by many rigorous studies. The UK government-commissioned Foot Review, for example, highlighted the

‘significant contribution’ to liquidity of the British offshore centres.

THE BIG DEBATE

registries make it difficult to identify illegal money. This is how corrupt officials like Teodorin Obiang managed to invest hundreds of millions of dollars in real estate and other goods in Western counties since the early 2000s.

Whether illegal or not, these practices are ethically questionable when used to undermine the tax policies of developing countries. Global Financial Integrity has estimated that illicit flows from developing countries amounted to US$1.3 trillion in 2009 and over 50 per cent of this figure is related to trade manipulation. This is several times greater than total global development assistance.

Some of these practices also fool developed countries, as illustrated by the legal dispute between a major telecommunications company and the UK. The damage is proportionately less severe for developed countries, however, they remain the world’s economic engine and the main recipients of foreign direct investment, totalling US$748 trillion in 2011, therefore the impact is vast.

Meanwhile, offshore financial centres’ dodgy activities create few benefits for host jurisdictions. The UNCTAD World Investment Report 2012 concludes that offshore financial centres generate very little value added or employment.

Offshore financial centres may perform a role in the global economy, but it is hard to see this as beneficial when reckless companies and individuals can so easily use them to undermine the policies of the countries where they actually generate most of their value.

George HodgsonDeputy Chief Executive, Society of Trust and Estate Practitioners (STEP)

The aftermath of the 2008 banking crisis has seen a vociferous campaign to put extra firewalls in to the global financial system. For example, many major banks are now under pressure to break themselves up. Recent events are seen as highlighting that institutions that are ‘too big to fail’ are very dangerous in situations when they very nearly do fail.

It is important, however, to look also at the potential damage caused by changing the current system. Thus, the chairman of one highly successful major global bank has explicitly laid out the costs of ‘Balkanising’ the banking system. After all, big banks got big because they were typically more efficient.

Similarly it is alleged that IFCs represent a weak spot in the international regulatory structure because they impede transparency. If Balkanising the banking sector is a bad idea, however, Balkanising the international financial system would be even worse.

Now, more than ever, the global economy needs to efficiently re-cycle savings and capital from the rapidly growing economies to the struggling economies in the West. It would be bizarre while many central banks are busy injecting

Whether illegal or not, these practices are ethically questionable when used

to undermine the tax policies of developing countries. Global Financial Integrity has

estimated that illicit flows from developing countries amounted to US$1.3 trillion in 2009

and over 50 per cent of this figure is related to trade manipulation.

liquidity into the system via quantitative easing to do anything to hamper the flow of funds through the IFCs.

The positive role IFCs play in the global economy is confirmed by many rigorous studies. The UK government-commissioned Foot Review, for example, highlighted the “significant contribution” to liquidity of the British offshore centres. More broadly, in a major report commissioned by STEP, Professor James Hines concluded: “The evidence indicates that IFCs contribute to financial developments and stability in neighbouring countries, encourage investment, employment and other aspects of business development…This evidence appears to be quite robust.” Perhaps, therefore, rather than criticising IFCs, those keen to restore the western economies to health should look at how we can better use the advantages IFCs bring to the global economy.

THE BIG DEBATE



Organised crime and the financing of terrorism depend on financial secrecy. Untraceable shell companies are widely regarded as one of the most important means of providing such financial secrecy. Recognising this danger, international organisations and national governments have responded by mandating Know Your Customer (KYC) standards to enable authorities to ‘look through’ shell companies to find the real individuals in control. Yet as important as these KYC rules are, no one has really known how effective these policy measures have been in achieving their aims. While proponents trumpet the need for corporate KYC standards, critics allege that the standards are an expensive failure.

In response to this fundamental uncertainty, we designed an experiment based on impersonating 21 fictitious low- and high-risk customers and soliciting offers for shell companies from thousands of Corporate Service Providers in 182 countries to test whether and how KYC standards are actually applied in practice. Here we provide a brief summary of the design of the global mystery shopping experiment, as well as the some of the main results.

The exercise was based on creating a variety of fictitious customers who exhibited various types and levels of risk, particularly to do with corruption and the financing of terrorism. Using email approaches, we then

had researchers impersonating these customers make 7466 requests for shell companies to 3773 providers. The standard email explained the customer was a consultant looking for tax savings, limited liability and confidentiality, and asked how much a company would cost, and, crucially, what identity documents were required. If providers fail to collect KYC documentation on customers forming shell companies, it is very difficult for the authorities to establish the identity of the beneficial owner further down the track, making the company effectively untraceable.

The risk profile of the customer was manipulated in several ways. The baseline approach came from a customer in one of eight small OECD countries with low levels of corruption and terrorist financing. The corruption risk profile instead had the customer come from West Africa or Central Asia, and work in government procurement, features that in combination with the standard shell company solicitation should have constituted an obvious red flag. Similarly, the terrorism financing risk had the customer being a citizen of one of four countries perceived as having a high terrorism risk, and working for an Islamic charity in Saudi Arabia. Other variations included providing more information about international KYC standards, and suggesting various penalties or inducements for breaking these rules.

Having contacted the provider with

a request for a shell company, one of five things could happen. Most simply, the provider could decline to reply, either as a product of commercial logic, inattention or risk aversion. Similar reasoning might lie behind the second outcome, when the provider replied to refuse service. Third, the provider could offer to form a company, but insist on certified identification documents for KYC purposes, a response which we coded as compliant with international standards. If the response asked for some identity documents, but did not specify they had to be certified, this was classified in partially compliant. Finally, if the provider offered a company without asking for any identity documents, this was coded as non-compliant.

Given that the project was based on impersonating fictitious characters and pretending to be interested in buying shell companies, it was based on deception. Indeed, this deception gives us confidence that we did receive genuine answers from providers. But deception must be ethically justified. In line with general principles governing such research, deception can only be justified where (1) the costs are low, (2) subjects are not exposed to any physical or emotional pain, (3) there is no other way to do the research, and (4) there are significant benefits resulting from the research.

By randomly matching customers of varying risk profiles with the providers, it is possible to see how different risks influenced providers’ willingness to

Global Shell Games: A Mystery Shopping Experiment in Know Your Customer Standards

By Michael G Findley, Assistant Professor, Government, University of Texas at Austin; Daniel L Nielson, Director, Political Economy and Development Lab, Political Science, Brigham Young University; and Jason Sharman, Centre for Governance and Public Policy, Griffith University

seCtor researCh

34


SECTOR RESEARCH

reply, and to comply with or violate international KYC standards on the beneficial owners of shell companies. Relative to the low-risk baseline profile, high-risk profiles like those from the corruption and terrorist financing email approaches should have decreased the proportion of providers replying and failing to perform KYC checks, while increasing the proportion insisting on certified identity documents. To what extent were these expectations fulfilled, and what evidence is there as to whether or not KYC rules are effective?

Overall, international rules that those forming shell companies must collect proof of customers’ identity are relatively ineffective. Nearly half (48 per cent) of all replies received did not ask for certified identity documentation, and 22 per cent of all replies received did not ask for any identity documents at all to form a shell company.

We explain many of the results below with reference to a ‘Dodgy Shopping Count’, which measures the average number of providers a particular type of customer would have to approach to receive a non-compliant response, ie, be offered a shell company with no need to supply any identity documents. A five per cent non-compliance rate would thus equal a Dodgy Shopping Count of 20. The lower the Dodgy Shopping Count, the easier it is to get an anonymous shell corporation.

Thus at the broadest level, of the 7,466 inquiries sent, the non-compliance level is 8.4 per cent, for an overall Dodgy Shopping Count of 12. The 8.4 per cent includes non-responses in the denominator, since conceivably some providers may fail to reply in response to risk and thus may be complying with international law in a ‘soft’ way. As a simplified measure, it is important to note that very high Dodgy Shopping Counts (ie, very low rates of non-compliance) in some cases exist alongside very high rates of compliance (eg, the Cayman Islands), very high rates of partial compliance (eg, Denmark), very high rates of refusal and non-response (eg, US law firms), or some combination of these. Thus, jurisdictions may have highly positive Dodgy Shopping Counts with very different patterns in the other categories.

Against the conventional policy wisdom, those selling shell companies from tax havens like the Cayman Islands, the Bahamas and Jersey were significantly more likely to comply with the rules than providers in OECD countries like Britain, Australia, Canada and especially the United States, which was one of the worst

performers (see Tables 1 and 2). In the United States sample, the noncompliance level is 9.2 per cent and the Dodgy Shopping Count was 10.9, which was almost 10 per cent lower than the average in the international sample. Obtaining an anonymous shell company is therefore easier in the

Dodgy Shopping Count0 20 40 60 80 100

United Arab EmiratesSeychelles

JordanJerseyIsrael

DenmarkCayman Islands

BahamasMalaysia

IndiaIsle of Man

SpainUruguayAlbaniaTurkey

US Law FirmsHong Kong

St. Kitts and NevisLiechstenstein

British Virgin IslandsDominica

BelizeMaurtiiusLebanon

BrazilMacauSerbia

SwitzerlandSingaporeIndonesiaRomania

MaltaBulgariaCyprus

JamaicaChina

BermudaGibraltar

MexicoThailand

ArgentinaAustria

PanamaColombiaVietnam

USBahrain

BarbadosUkraine

UKChilePeru

PolandLithuaniaAustralia

IrelandPhilippines

GhanaCzech Republic

CanadaUS Inc. Services

Kenya

table 1: Dodgy shopping Count by Country for nations with at least 25 approaches. all Firms in none of the top eight countries were ever found

noncompliant. Because there is no natural upper bound on the Dodgy shopping Count, we set it to 100 for these.

35



US than in the rest of the world. However, two factors worsen the gap

between the US and other countries. First, the US number is elevated by the much higher non-response rate from firms in US sample, which was 77.3 per cent in the US compared to 49.3 per cent in the international sample. The proportion of providers in the US sample who replied to our inquiries and required no identity documents whatsoever was 41.5 per cent, which is roughly two-and-a-half times the average of 16.5 per cent in the international sample. We followed up with firms failing to reply to any of our emails with an innocuous inquiry basically asking if the firm was still in business and assisting customers but making no mention of confidentiality, taxes, or liability. We learned that the vast majority of non-responses are not soft refusals: they failed to respond to any inquiry, even the most innocuous that we could design. Only a tiny proportion of US providers of any kind met the international standard by requiring notarized identity documents (10 of 1722 in the US sample, less than one per cent). Thus our Dodgy Shopping Count measure tends to flatter the US by equating non-response with a form of compliance.

Another surprise was that providers in poorer, developing countries were at least as compliant with global corporate KYC standards as those in rich, developed nations. For developing countries the

Dodgy Shopping Count is 12, while for developed countries it is 7.8. The significance of this finding is that it does not seem to be particularly expensive to enforce the rules on shell companies, given that poor nations do better than rich countries. This suggests that the relatively lacklustre performance in rich countries reflects a simple unwillingness to enforce the rules, rather than any incapacity. These results lend support to the results of a similar study by the World Bank, The Puppet Masters, which similarly concluded that rich, developed countries are generally the worst offenders in failing to meet corporate KYC standards.

Defying the international guidelines of a ‘risk-based approach’, shell company providers were often remarkably insensitive to even obvious criminal risks. Thus, although providers were less likely to reply to clear corruption risks than to approaches for low-risk profiles, those providers that did respond were also less likely to require certified identity documents of potential customers from high-corruption countries who claim to work in government procurement, a notoriously corruption-prone area.

Corporate service providers were significantly less likely to reply to potential terrorists and were also significantly less likely to offer anonymous shell companies to customers who are possibly linked to terror.

However, compared to the low-risk baseline profile, a significantly lower share of firms replying to the terrorist profile refused service.

In some ways the biggest surprise was how little difference there was between the relatively innocuous low-corruption risk email and the obviously high-risk corruption approach, despite the international guidelines specifying that these customers should be subject to enhanced scrutiny. Excluding the US, the Dodgy Shopping Count was 11.5 for the low risk email, 11.3 for corruption, and 18.5 for terrorism financing risk. The results for the United States are nine for the low risk email, 9.9 for corruption, and 17.4 for terrorism financing.

Varying the email approach to inform providers of the KYC rules they should be following made them no more likely to do so in the US or internationally, even when penalties for non-compliance were mentioned. The exception was in the US, where telling providers that the IRS enforced Know Your Customer standards reduced non-compliance (and thus increased the Dodgy Shopping Count from 9.5 to 13.2). In contrast, when customers offered to pay providers a premium to flout international rules, the rate of demand for certified identity documentation fell compared to the low-risk customer profiles.

These results represent by far the most detailed, extensive and reliable test of KYC rules in relation to shell companies ever performed, and the pattern that emerges as a result is worrying. Given the patchy overall level of compliance, the easy availability of formally prohibited untraceable shell companies, and the willingness of hundreds of businesses to supply obvious criminal risks with the corporate anonymity, the existing system seems to be very compromised. Many of these failings can be laid at the door of large, rich countries, especially the English-speaking OECD members and the United States above all, who conspicuously fail to apply standards that they have so energetically imposed on others.

For full results of the study, please contact Jason Sharman at [email protected]

Figure 2: Dodgy shopping Count by type of Country Internationally and by type of Firm in the United states

36

IFC


BRITISH OFFSHORE FINANCIAL CENTRES

In the modern world grand ideologies tend to move in 30 year cycles. Investor confidence ultimately overshoots and crashes, just as it does in stock markets.

Western thinking from the middle of the last century was dominated by the Cold War. Communist containment was the central organising principle. A new era launched in the 1970s, characterised by exuberant confidence in the private sector. The global economy experienced dazzling growth, unprecedented in world history.

The extraordinary growth fuelled unsustainable bubbles, triggering a financial crash in 2007-2009 and signalling another radical shift in Western thought. Freewheeling capitalism and the financial services industry which serves it are now in the dock. Governments are back in the ascendant.

The British offshore centres are the best of their breed and they were remarkably successful in the last era. They are now under unremitting scrutiny. What are the implications of the new grand narrative for such centres?

This article reviews three key developments by way of response: 1. The remarkable rise of ‘civil society’

(non-governmental organisation) influence in global financial services policy.

2. The recent United Kingdom review of its Overseas Territories.

3. The advent of the US Foreign Account Tax Compliance Act (FATCA), the world’s most ambitious tax compliance program.

The Rise of Civil SocietyNon-governmental organisations

(NGOs) campaign on ‘tax fairness’. Their agenda items include close scrutiny of the small financial centres. The NGOs are networked, ideologically committed and integrated into G20 - the principal forum for coordination of global economic policy. Civil society was invited inside the cordon at the 2011 Cannes Heads of State Summit during the French Presidency. NGOs continued their prominent role at the Los Cabos Heads of State summit meeting in Mexico in June 2012. They are active again in their preparations for G20 under the 2013 Russian Presidency.

All voters want more public spending than they are prepared to pay for in taxes. Darwinian survival for politicians requires them to deliver on this voter demand, however fiscally reckless. Politicians seek reasons to delay spending reform, ideally to the time that the next lot are in power. A fictional NGO narrative that the spending gap can be closed by more and particularly better enforced taxation has appeal. NGOs offer an (imagined) alternative to the gloomy reality that Western government spending is unsustainable.

In the UK, HMRC has suggested that estimates of tax evasion advanced by NGO ‘experts’ to support their narrative are a multiple of the correct number1. The Tax Justice Network estimates tax evasion at £120bn; UK HMRC’s calculations, provided in evidence in a direct response at the Public Accounts Committee for this, are £4bn. Despite such authoritative challenges to NGO facts and conclusions, their work is routinely profiled in the mainstream press with little critical analysis.

The rising influence of NGOs has been

largely ignored by the British offshore centres - at their peril. What should they be saying in response?

British offshore centres have adopted financial services regulation at the leading edge of global standards, routinely assessed and confirmed in peer reviews organised by the OECD, The Financial Action Task Force (FATF) and the IMF. A recent empirical study by three independent academics, including Professor Jason Sharman from Griffith University, tested compliance with anti-money laundering regulatory standards in 182 countries and concluded as follows:

“The overwhelming policy consensus, strongly articulated in G20 communiqués and by many NGOs, is that tax havens provide strict secrecy and lax regulation, especially when it comes to shell companies. This consensus is wrong. Some of the top-ranked countries in the world [showing compliance with international standards] are tax havens such as Jersey, the Cayman Islands and the Bahamas, while some developed countries like the United Kingdom, Australia and Canada and the United States rank near the bottom of the list.”2

Most of the work in financial centres - large and small - is mundane support for the transaction ease, stability and neutrality that business requires in capital raising and commercial dealings. Such services play a crucial role in easing the jagged interfaces between the complex and inflexible tax systems of the large economies they serve. Financial intermediation facilitates trade, economic growth and jobs.

British Offshore Financial Centres: Prospects in a Changing World

By Richard J Hay, Stikeman Elliott, London

37



An offshore rock needs much more than secrecy and a teller’s window to succeed in the ultra-competitive world of offshore finance. British offshore centres are successful because clients value their stability, probity and world class professional services.

UK Views on its Overseas TerritoriesA recent White Paper on the future of the United Kingdom’s Overseas Territories3, published by the Foreign and Commonwealth Office, provides encouraging UK government support for the financial services industries in its Overseas Territories. On its terms the Paper is confined to the Overseas Territories - essentially the Caribbean territories and Bermuda - but it might also be seen as an indication of attitudes towards the UK Crown Dependencies (Jersey, Guernsey and the Isle of Man).

The report describes the financial services industry of Bermuda, the British Virgin Islands and Cayman as “key contributors to local economies” and “success stories [with] important niche positions in international financial markets”. Self-interest is always a good companion in taking any supporter along, so it is particularly promising that the report recognises the international business centres in the Overseas Territories are positioned to “play a complementary role to the UK-based financial services industry”.

The White Paper records a UK commitment to “work in the international area to ensure no discrimination against such centres”. Encouragingly, the report also acknowledges that “UK government respects the right of Overseas Territory governments to compete on tax”, acknowledging the importance and legitimacy of tax neutrality in their financial centre offerings.

The UK government is the key spokesman (and, when minded, protector) for the British offshore centres in the intergovernmental dialogues over financial services regulation. More concrete UK action supporting Overseas Territories’ involvement in international rulemaking and standard setting processes is still required. However, the

report is a welcome expression of support for such centres, signalling a recognition of UK government interest in the success of its offshore symbiots.

Global Information Exchange – FATCA

The main work stream affecting small financial centres pertains to information gathering and exchange for tax enforcement purposes. The US FATCA juggernaut signals a massive acceleration in information collection and exchange with eye watering costs.

In 1998 OECD launched a program to promote financial transparency and information exchange. The US often leads world innovation, including in its regulatory environment. Yet lax US incorporation requirements have undermined a central pillar of the OECD project, globally comprehensive identification of beneficial owners of companies.

As the OECD’s peer review process was gathering momentum in 2008, the US announced a change of tack, unveiling unilateral measures in FATCA for collection and provision of financial information to the US. Draconian consequences loom for those who decline to participate. Compliance costs borne by foreign financial institutions and governments (and so ultimately their clientele and taxpayers) will likely exceed US taxes collected. Costs borne by the small financial centres may be eased marginally if they conclude inter-governmental information exchange agreements with the US along the lines of those negotiated by the so-called G5 countries in Europe.

The most striking feature of the FATCA story is that the world environment has changed so much that a system like it can be operationalised. Had the United States proposed FATCA a few years earlier, the goals would not have been unachievable. Global information on beneficial ownership was simply not available and the US could not have insisted on access to a massive reservoir of information which did not exist. OECD built out transparency to support a moderate system of information exchange on request. Now any country with leverage can oblige others to provide wholesale

supply of data on the financial affairs of its citizens and residents.

Concerns posed by government intrusion into private affairs are largely ignored by a public still in the grip of hysteria over terrorism. The wider implications of systematising comprehensive government collection of financial data may come to be seen as disconcerting in due course. Those readers born closer to 1945 than 2012 need no further elaboration on the potential dangers.

Despite their travails the British offshore centres are hardly properly regarded as victims of the world order. They have transformed in a generation from small rocks, with barely viable economies, to the commanding heights of the global economy. The remarkable success of those centres crucially turns on a shortened distance from the countries which surround them. Vexing it may be for those who long for a quiet life, but scrutiny by the countries which supply those financial centres with their clients and markets comes with the territory.

Governments, institutions and professional firms in small financial centres have collective responsibility to foster informed international policy on their operations. The small British offshore centres now regulate at the leading edge of global standards, yet this is not enough. Broader public support for their activities will follow only if they can also effectively articulate their constructive contribution to the larger economies they serve. On this task, the work has only just begun.

1 Closing the tax gap: HMRC’s record at ensuring tax compliance: Government Response to the Committee’s Twenty-ninth Report of Session 2010–12, House of Commons, Treasury Committee, 15th May 2012

2 Michael Findley, Daniel Nielson and Jason Sharman, ‘Global Shell Games: Testing Money Launderers’ and Terrorist Financiers’ Access to Shell Companies’, Centre for Governance and Public Policy, September 2012

3 The Overseas Territories Security, Success and Sustainability, Foreign Commonwealth Office, June 201238

IFC


EUROPE

The European Treaty structure, using the term in a lay sense, can either be seen as an incoherent set of treaties involving different organisations, or a pragmatic case by case resolution of specifi c diplomatic issues in a treaty context devoted to the diplomatic position in the defi ned sector addressed. Here I am placing the European Union institutions and the various treaty extensions within the European wide context of the other treaty networks and structures such as the Council of Europe and NATO, insofar as its functions extend to Europe.

Th e following outline is best read in the light of the formation and the ensuing work of the EU Code of Conduct Group, a non-institutional extension

of ECOFIN1. Th is Group was in fact working outside the strict borders of treaty and EU institutional competence, as the last paragraph of the preamble to the Resolution of 1 December 1997 makes perfectly clear. Th is is confi rmed by a more detailed study of the various ‘informal’ extra-institutional meetings leading up to it, enumerated in the ECOFIN “Conclusion” 98/C 2/01 to which it is annexed. None of these documents have ‘legal’ or enforceable status, under the treaties. However, the actions of the institutions acting under its political infl uence, rather than under legal structural obligation, are subject to certain general procedural constraints.

I would like to explore here the development of that body of diplomatic function, known loosely as the Congress of Vienna of 1815, through its development and partial attachment to

what has now become the Consilium2, as the diplomatic behaviour patterns in relation to smaller foreign jurisdictions such as international fi nance centres remain largely unchanged from that historical perspective. What is signifi cant about the Vienna Congress was that it rarely met in plenary session and the main diplomatic strategy was to ensure that you were in the right session at the right time in order not to be left out of the developing process and its implementation. From that strategic perspective, little has changed. Th e ECOFIN fi scal Code of Business Conduct3 in eff ect was an entirely and admittedly ‘unlawful’ or ‘extra-legal’ statement, which was given political mass and weight by the Member States and the Consilium, as it now is. Th at initial statement of policy has since gained political, but not legal mass.

Europe: Is the Fiscal and Treasury ‘crisis’ a Short Term Issue or a Symptom of Long Term European Federalisation or ‘Conciliation’?

By Peter Harris, Barrister, Overseas Chambers, Jersey

39



However, the European Commission and the Consilium have adopted methodology, which reverts back to the ‘procedures’ of the Congress of Vienna rather than to the core legal treaty concepts upon which they rely for their existence, competence and jurisdiction, ie, their raison d’être.

The development of the various Common Market, European Community, and now European Union treaties towards the idealised goal of a Union or Federalisation has led to a change in the balance of rights and powers as between economic actors and the various States concerned.

This is exacerbated by the political use of the macro-economic notion of fiscal ‘discipline’, and the inevitable distortion and incursion into the legal aspects of the definition of the taxpayer’s tax liability, its declaration, collection and enforcement, which remain within the microcosmic sector of analysis. There is an overreaching tendency of economists to assume that their science takes precedence over the law giving effect to it.

A deliberately non contentious example: In the negotiations of the 2004 Tax Treaty between France and the United Kingdom, the previous article 164C4 ‘strong’ exemption was excluded from the renegotiated Treaty on the basis of a French assertion that the tax in question could not be recovered from an EU citizen. The French stated that it was understood that income tax was an issue which was indirectly covered by the EU Treaty in the context of the freedoms involved. In fact, the French tax administration was preparing to defend the contrary thesis before the CJEU and succeeded in front of that court in stating there that income tax was not covered by the EU Treaties, and that it could therefore discriminate. In other words the Member States, as between them, are not loyal, if scarcely honest, as to their assertions in bilateral treaty negotiation. The result was that HMRC gave up the treaty exemption, which now enables the French administration to assert taxing rights on deemed income arising on properties owned by United Kingdom residents and citizens. Spain retained the strong exemption in its treaty, and its citizens are not taxed.

What is curious here is that HMRC made no attempt to defend its treasury ‘outflow’ as it was more concerned with defending the taxation of partnerships that it was proposing. What is serious is that, as between themselves and their taxpayers, Member States are being less than loyal in relation to prior established and legally superior European principles.

The point of this example is that the treaty concepts such as the freedom of movement of capital and payments are being rewritten by reference to the tax exception to that principle5, and by reference to newer structural concepts such as subsidiarity. In other words the Consilium is being incoherent in its defence of the written treaty, but coherent in relation to other, opaque diplomatic issues beyond the EU treaty structure.

This is important to bear in mind, as the degree of resistance to non-EU corporation tax regimes, such as the ‘Zero-Ten’ debate was conducted on entirely non-EU legal principles, with the result that most of the eastern Europe Union has managed to base its tax revenues on flat rate taxation, at a lower level that that, for example of France, the United Kingdom and, incidentally, Jersey, Guernsey or the Isle of Man6.

Provided that the European Union is not seen as the sole decider but rather as a consensus of the political inhabitants of the diplomatic space, which has for the moment attached itself to the Consilium in this area, the policies to be adopted by the EU in relation to, for example, alternative investment funds become more understandable. These decisions are in fact no longer taken by the Commission in Brussels as a principal instigator and ‘policeman’, but rather as an agent for the Consilium and for those influencing that remodelled institution’s decision making process.

So What for the Future? The long term build up to the creation of a European central bank structure as an effective economic fore has been stimulated by the crises, or rather the bumps in the process of financial globalisation from 2004 through to 2008 and until now. That globalisation encouraged by the USA is now reverting back to a set of regulatory barriers to

freedom of movement at a participating state level. In short, it is only by the creation of a fully functional European Central Bank, in the eyes of the Federalists, that the momentum towards a unified market can be achieved.

Those studying the development of the treaty jurisdiction of the European Central Bank7 and its adjunct, the ESCB8 will have seen that, next to article 103 TFEU, the conceptual structure of these institutions has been taking the direction of a federalisation and that it will, in fact take very little more in the way of remodelling the Treaty to render the actual federalisation of the assets backing Euro a legal and constitutional fact. That has been one underlying current in the diplomatic space to which I have referred. That renders the issue of the fiscal ‘let out’ for Member States from the requirement that there be no obstacles to freedom of capital and payments, whether within the EU or to or from the outside world a legal strategic issue.

It is that area of semi-licensed discrimination that should concern the IFCs at this present moment.

The Court of Justice of the European Union may be the next port of call, were the license to tax under Article 65 (1) (a) TFEU be abused, as it is at present. It is going to be difficult for a Member State levying taxes as against other Union or third States’ corporate or citizens on the basis of its own legislation, to apply the information exchange requirements for taxes otherwise outside the formal Treaty scope, without admitting that these same taxes can constitute an infringement of Article 65 (1)(a). The subsidiarity ‘let out’ does not stretch that far.

What is also clear is that the Member States have asserted their claims to subsidiarity, and have strengthened their taxation of assets outside their inherent jurisdiction, on the basis that these are considered to be their citizenry’s or resident’s, whether corporate or individual, and if not, part of their national asset base when situated within their jurisdiction. They use what was no more than a mere fiscal exception to the principle of freedom of movement to enable such an arrogation to strengthen this miss-appropriation, which is not particularly ‘European’ in the true sense 40


EUROPE

of the term. The current change in ethos from the

now rare exemption principle to avoid double taxation, to double taxation with credit, is being thwarted by double taxation without exemption and credit merely by asserting different legal bases of taxation on the same issue. A comparison of the HMRC taxation of a French usufruit dismemberment on the false basis that is a ‘settlement’ or a trust is but one example; as is confirmed by the recently introduction by France of a ‘tit for tat’ treatment of trusts as remaining within the foreign settlor’s estate for wealth tax, gift and estate duty purposes9.

The original European ethos was severely compromised in the Lisbon Treaty, and the Revenue authorities of Member States have used their treasury crises as an excuse to arrogate assets and income to their own budgets which in the absolute legal sense were not theirs.

The financial centres outside the EU where to a greater or lesser extent alternative investment funds are administered, need to be prepared for more European institutional issues. The European Parliament should not be seen as operating as a parliament in the

sense that it will defend business or its electorate, but rather as a staging post allowing for amendments negotiated elsewhere, involving the Consilium and the Commission, and being influenced by what are now described as ‘stakeholders’ throughout the decision making process. What is worse is that the European Parliament is seeking powers to initiate legislation, rather than debate matters proposed to it.

Where does this leave Financial Services?The financial service sector in the wide sense is not the most popular congregation within the economic religions or economic castes represented in Europe. However, the main emotional complaint being directed against lending institutions in general is that the ‘money’ put back into the system by differing means to replace the writing down involved in recovering the stock exchanges fluidity after the 2008 crisis is not reappearing in the money supply but is reinforcing capital, and therefore not consumption. This may in part be caused by the slowness of the American legal system in correlating collateral to the

defaulting paper, botched by its reliance on interest from defaulting sub-prime loans. As part of its quantitative easing process the US Fed is currently proposing to buy back mortgage backed paper, a percentage of which were comprised in part of the additional interest kickers from sub-prime or Ninja loans consolidated with less risky security to render their revenue apparently more attractive.

It is here that the financial centres have to rise to the occasion with an objective clarification of their role in the supply of money at all stages of its creation and circulation. There will be less difficulty within the financial markets within which they presently play a role, as their presence is regulated and process understood.

The difficulty will be faced where there are the following four factors, at work:

Where there are business opportunities within an EU jurisdiction within the Eurozone, the currency defences being built up by Eurozone central banks and the fiscal authorities to protect their own markets, and ability to raise finance, both against other central banks and against private capital influence;

The political / legal implications of fiscal discrimination implicit both in 1. and generally, and attempts at capturing foreign liquid capital within the capital markets of the home state: cf FATCA;

The intentional use of differing economic definitions in the domestic establishment of financial transactions taxation between Member States, and third jurisdictions;

The ramifications of the false proposal that money ‘offshore’ is ‘dead’, when in fact it is reinvested onshore: it has to be, as otherwise, it has no value.

This also needs to be seen in the context of private capital being in a sense ‘nationalised’ in order to provide part of the host central bank’s money issuing process, in a disturbingly similar manner to the warring Italian City States in Renaissance Italy. Against what does a Central Bank effectively borrow and re-lend? The future prospect of tax revenue and capital within its own purview: the efforts and capital of its residents, in the case of the United States, its citizens and residents. However, the disturbing change in the flow is that the 41



United States have effectively realised that their economy had functioned as a form of Ponzi scheme in that foreign liquid capital had to be poured into their stock markets in order to maintain some semblance of balance sheet and asset value, when in fact there was then none which could be adequately defined. FATCA is no more and no less than a fiscal trap for that foreign capital, posing as an attempt to isolate and tax non-compliant American citizens abroad.

The main issue now is that certain of the EU Member States have aligned their fiscal policy along FATCA principles, and are negotiating FATCA relaxations with the US in exchange for information, in both directions.

The main issue is therefore the need for a clear intervention in the legislative process, both in, and within, the European Union and outside, to prevent the meaning of ‘money’ and risk investment becoming distorted into a state monopoly.

However, there is a need for ‘regulation’ in the wide sense, in that the American sub-prime issue turned into a systemic crisis as a result of the over commercialisation of ‘ninja’ type investments as an ‘add on’ to render more conservative loans look attractive on the higher paper at several levels removed.

It is therefore essential that the financial centres act to provide liquid capital to sponsor investment, which will lead to future capital creation and investment, rather than being perceived, wrongly, even at the level of such institutions as the OECD, as being the main source of systemic ‘risk’. That was simply the American economic sub-prime model becoming extended beyond its rational scope, for domestic political expediency, enabling Americans to ‘own’ their own home whilst in effect leasing it from the capital markets. The legal system in the US has still not yet managed to match collateral to the loans written down, nor thereby to release the rescue liquidity poured in from abroad: a significant failure of a so called ‘regulated’ economy. Hence FATCA capital imprisonment and the tax ‘exception’ justification currently being deployed by certain European States.

It is clear that the perception of the

Tobin Tax in Europe is that it in some manner discourages the excesses in the derivative markets, despite the OECD not giving it a clean bill of health in 2003. The EU version of FTT10 currently under consideration is, for some reason being raised to the level of an EU own resource. That will mean that the Commission will be able to treat the FTT as an institutional matter in the same manner as it has VAT in the past.

This will lead to increased legal pressures on financial centres to concentrate on areas within which their investments are not at risk, as the European Parliament has indicated that it wishes to render FTT “unstamped” transactions “unenforceable”. The systemic risk involved in such a step is to all extents and purposes infinite in a global economy, but less so in an insularized one. The FTT definition of the ‘taxpayer’ has also been modified so as to render it possible for a European situated bank not to honour its quasi-derivative contracts, thereby offering a further systemic risk in the world-wide currency markets. All this on the basis that ‘index betting’ does not represent a category of derivative of a positive nature, which unwind themselves at the end of their investment cycle, generally agricultural or industrial. It is therefore not by offering vehicles apparently promoting perceived ‘greed’, rather than protection models, that the former will be acceptable entrance ‘gifts’ to gain access into the EU market.

However, European risk appetite is generally limited, as the European models generally insist on lower loan against collateral ratios. It is at that point that the financial centres can continue to provide private capital to fund investment, which is after all what the European and British markets are crying out for.

This has to be seen in an overall context where the internal weaknesses and inadequacies of the Euro work to the benefit of certain, not least the unified Germany, but act as a increment to the strong’s creditworthiness, reducing certain otherwise sustainable economies to the status of sub-prime. Were capital to have been available to Greece and Spain at lower interest rates, rather than flowing through to Germany and other

strong economies, would there now be as large a problem? The ERM would have served as a vehicle to export German recession following unification, which happened anyway, and that issue appears to have been forgotten.

London and Dublin will doubtless need to decide to what extent they are prepared to remain a conduit for live capital from the Crown Dependencies and from Associated Territories; rendering these attractive legal platforms for ‘non-domiciled’ investment from the BRICS or elsewhere. Otherwise, the Tax Justice Forum’s fallacy as to ‘dead’ offshore capital may become reality, for the wrong reasons, and serve only to further republicanise the concept of ‘money’ and its creeping fiscalisation onshore, towards the left.

The question is whether there is a sufficient perceived need to reduce withholding and tax discrimination relating to these international flows and investments. Most Member States have a ‘back-door’ funds arrangement to assist capital risk investment, and it is a question of whether these particular advantages can be tolerated in the current political and emotional context.

The Court of Justice of the European Union has recently required France to remove its 15 per cent withholding taxes on certain fund distributions paid both to foreign EU funds and also to those in tax compliant third countries. This is on the basis of the wording of the freedom of movement of capital provisions, which are designed to avoid deflection of capital coming into and out of Europe. Here there are both potential entrances and exits for foreign fund capital.

In short, there is much to be done if financial services from abroad into Europe are not going to be taxed on their full monetary value, rather than the income or capital gains that the capital produces. In other words to prevent the FATCA developments in the USA being indirectly implemented within Europe between Member States. Hence the prior reference to the Italian Renaissance City States that stood or fell on the basis of their citizen’s ability to continue to guarantee their own bonds and therefore currencies, and their reliance upon hiring foreign mercenaries – at that time from 42


EUROPE

Essex 11-, amongst others - to appropriate other City States capital. That is still happening at the Member State level and the conceptualisation of ‘subsidiarity’ within the Union framework is but one tool employed.

However, there is no doubt that the diplomatic corpus appearing regularly in one shape or form throughout recent European history, certainly since the Napoleonic wars, was in a sense the vehicle for Europe’s stability, barring the odd war or three. It is therefore necessary to treat the Consilium as an emanation of a political and diplomatic continuum, and not necessarily as a final arbiter. It is towards that amorphous body that the finance centres should be directing their influence and energy, a little like the German printers at the Vienna Conference , to ensure the survival of their intellectual property. Certainly as such batons of ‘unlearned’ political influence such as the TJF as wielded by their NGO and union sponsors have penetrated the institutional framework, it may need a different approach from IFCs which are after all quasi-sovereign micro-states.

The fact that no significant European premier ego has been elected to the Consilium’s head is a sign of its stability as an emanation of that continuum. None of Mssrs. Giscard, Kohl or Blair have made it to that seat. The current geographical area covered by the Consilium renders it very similar to the Congress of Vienna, and its geographical scope is now sufficiently towards the

East of Europe and Russia to render reference to its historical development pertinent. All the financial services sector lacks is a less crippled but more vociferous organisational Talleyrand, before it is reduced to a mere satellite such as the German printing industry represented at Vienna, in their attempt to counter Mettenech’s attempts to curtail their ‘business’. That ‘business’ was the flow of ‘republican’ ideals within the then nascent pseudo-monarchic order by the then sole means available to communicate ideas without travel.

It is essential therefore that the finance centres do not allow their worth to be miss-defined and thereby effectively sidelined, otherwise their business, the flow of money, will also be curtailed within a new order, which will become politically hostile to their contribution, unless informed and, in a sense, placated.

Talleyrand’s main expertise at the Council of Vienna was reformulating the notion of ‘statehood’ behind a form of constitutional monarchy, which could be dismissed, of a non-republican nature, whilst permitting the increasingly potent democratic forces some freedom. At that stage Europe had had enough violent ‘republicanism’, and even Napoleon had started to formulate a notion of constitutional leadership. The same ideas are required now in the field of international money flows, as the European Central Banks in the ECSB start erecting barriers within an increasingly ‘federal’ Europe to maintain their ‘ideal’, the Euro. With that will surely come fiscal pressure on non-resident non-voters, with each Member State asserting its own sovereignty in its time-hallowed traditions, with the added injustice of double taxation at penal rates on non-residents who use legitimate methods other than those tolerated by the tax administration.

It is therefore of the essence to encourage the use of such historic institutions of influence as the Foreign and Commonwealth Secretariat to further the interests of the Commonwealth in general and the Crown Dependencies and the Associated Territories in particular, in conjunction with the larger Commonwealth states; to the extent that their interests are not

contradictory. However, the main issue is to avoid being relegated to the status of a mere ‘stakeholder’, but retaining their influence as jurisdictions within the current post-Westphalian context12.

NB I stress that this is no more than a conceptual argument from an international tax lawyer’s perspective. It is certainly not intended to be an absolute or a scientific analysis of any merit.

1 ECOFIN: The Economic and Financial Affairs Council is, together with the Agriculture Council and the General Affairs Council, one of the oldest configurations of the Council of the European Union. It is commonly known as the ECOFIN Council, or simply ‘ECOFIN’ and is composed of the Economics and Finance Ministers of the Member States, as well as Budget Ministers when budgetary issues are discussed. It meets once a month.2 By Consilium, I am referring to the institution also styled the Council of the European Union.3 See Resolution 98/C/2/01, above.4 Article 164C code general des impôts taxes non-resident individuals on a deemed income arising from their ownership of property in France equivalent to three times the annual rental value of the property, irrespective of whether it is let out or not. The French assume that an individual owning property in France has to have that level of income to be able to upkeep it. That is double taxation of a deemed income, taxed elsewhere, without credit and the previous exemption.5 Article 65(1)(A) TFEU.6 Generally the rate of income tax in these Crown Dependencies is 20%.7 European Central Bank.8 European System of Central Banks.9 Articles 792 -0 bis, 885G and 990J Code général des impôts. 10 Financial Transactions Tax11 or what were the Iceni, in a previous inversion of roles.12 The Treaty of Westphalia commenced the notion of a nation state, subsequently taken up more or less in the Congress of Vienna: that concept of nationhood has been eroded since the Second World War. That now provides an opportunity for smaller micro-jurisdictions to assert their position, as they are doing at several international levels such as the OECD Global Forums.

‘The wider implications of systematising comprehensive government collection of financial data may come to be seen as disconcerting in due course. Those readers born closer to 1945 than 2012 need no further elaboration on the potential dangers.’

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IFC



Can tax competition benefi t the economies of EU states? At what point does tax

competition become ‘harmful’? Th e issue of corporate tax competition and coordination has gained importance in the

European Union. In a world where economies are increasingly integrated and capital increasingly mobile, the current trend of declining statutory corporate tax rates has led to fears of a race to the bottom. Tax competition is, however, a complex phenomenon that can materialise through multiple channels and the eff ects on real economic activity and on governments’ tax revenues of which are oft en ambiguous.

Th e economic literature is divided on tax competition. On the one hand, tax competition for mobile tax bases leads to a ‘race to the bottom’ in tax rates and leaves the competing jurisdictions with too little revenue to be able to provide public services at a socially optimal level. On the other hand, other models fi nd a useful role for tax competition in curbing the tendency of governments to overextend the size of the public sector.

In the current economic crisis context, at macroeconomic level, tax competition could be considered harmful if it was formally identifi ed as a driver for Member States’ budget defi cits.

At microeconomic level, for the last 15 years the Code of Conduct group on has applied a set of criteria to identify potential harmful tax practices which are then rolled back by the respective Member State. Broadly speaking these are the following: • an eff ective level of taxation which is

signifi cantly lower than the general level of taxation in the country concerned;

• tax benefi ts reserved for non-residents; • tax incentives for activities which are

isolated from the domestic economy and therefore have no impact on the national tax base;

• granting of tax advantages even in the absence of any real economic activity;

• the basis of profi t determination for companies in a multinational group departs from internationally accepted rules, in particular those approved by the OECD;

• lack of transparency.

Can the EU clampdown on harmful tax practices thus far be considered a success? Over a period of 15 years the Code of Conduct group has reviewed more than 500

measures, more than 100 of which have been found harmful and rolled back. Th is is a success, looking at the context of the EU as it is now and taking into account the Commission’s competencies according to the EU Treaties. Of course the Commission still faces challenges ahead such as extending the application of the code principle to neighbouring countries and trading partners.

Has the line between tax evasion and tax planning become blurred with the EU

now trying to put an end to so called ‘aggressive’ tax planning?

All those interested in this subject will recognise that the distinction has never been

clear cut. Aggressive tax planning is not a new concept even though the degree of aggression is oft en subjective. For example, some Member States are very familiar with the concept of abuse of law

while others are less familiar. In view of the scale of tax evasion and avoidance in the EU and globally there is a need for clarifi cation on this issue. Th is is one of the reasons why the Commission will be coming forward with ideas to tackle aggressive tax planning in the EU before the end of the year.

Again, greater coordination is essential to prevent loopholes between national tax systems from being intentionally exploited. In fact, the Commission has already taken the fi rst steps in this direction, with its work on double non-taxation. It is also working on strengthening the Code of Conduct on business taxation, and discussions have taken off with Switzerland and Liechtenstein as part of the Commission’s work to have the principles of the Code applied more widely.

Promotion of good governance, including transparency, exchange of

information and fair tax competition, is part of the EU strategy – how many EU states have now signed up to the exchange of information? Is an automatic exchange of information for EU member states the way forward?

Exchange of information on request on tax fraud is a standard accepted by all 27

EU Member States. It derives directly from the Directive on administrative cooperation in taxation adopted by the Council in 2011. Th is Directive goes as far as saying that bank secrecy cannot be opposed to a request for information. In many areas of taxation, such as taxation of savings or VAT, automatic exchange of information is taking place at a large scale. For the Commission this is 44

The EU on Offshore Th e IFC Economic Report spoke to EU Commission representative Emer Traynor about the EU response to tax competition and international fi nance centres.

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THE EU ON OFFSHORE

definitely the way forward.

The Initiative’s objective is to protect the EU against the challenges of uncooperative

jurisdictions including so called ‘tax havens’ – what constitutes a tax haven?

That’s what the Commission is working on and the planned December Communication will

help to clarify this.

Could you expand on the ‘carrot and stick’ approach by the EU towards ‘tax

havens’ and third countries? To effectively address tax havens, two things are necessary.

Firstly, a coordinated EU approach. This is essential if the Commission’s measures against uncooperative jurisdictions are to have any effect. One unified stance has much more weight than 27 different and possibly contradictory approaches. The Commission has seen that collective pressure works. The OECD’s work since 2009, to which the Commission is closely aligned, has already brought about considerable changes, both in the international attitude to tax havens, and the behaviour of these countries themselves. Now the Commission will push that further, by setting down a stronger EU position. The Commission must also use its shared instruments, such as trade agreements, to ensure that European good governance principles are respected by those who we do business with.

Secondly, a ‘Stick and Carrot’ approach to the havens themselves. While the Commission is still in the process of considering what the best and most effective measures could be, there are all sorts of possibilities eg, making agreements with the EU conditional on being on a ‘white’ list or conditional on respecting our standards of good governance.

How important is the automatic exchange of information between

member states? The Savings Directive is proof of the benefits of intra-EU cooperation. Around four

million records are exchanged between

Member States each year, representing on average €20 billion worth of savings information. This Directive creates an information exchange system for tax authorities to help identify individuals that receive savings income in a Member State other than their own. The core principle is that of automatic exchange of information. This means that Member States can collect data on the savings of non-resident individuals, and automatically provide this data to the authorities where the individual resides.

Is the aim to achieve a level tax playing field? Is this considered the most

economically beneficial way forward for EU member states?

Since the Treaty of Rome and more specifically during the last 15 years the Commission

has been working hard at ensuring that tax competition between Member States would take place on a level playing field. Taxation is a domain where the Commission is very active at monitoring national legislation and carrying out infringements where necessary. To give just one example, the VAT reduced rate applied by FR and LU on e-books is a striking case of harmful tax competition. The infringement process enables the Commission to actively pursue Member States that don’t apply their tax regimes in conformity with the fundamental freedoms and principle of non-

discrimination, without undermining national sovereignty.

The success of the Code Group’s work is illustrated by the abolition of over 100 harmful tax regimes in the 27 Member States and their overseas territories. Some Member States may still need to amend certain legislation – which takes time – but overall, the Code has produced very positive results. What the Commission regards as a very positive and important development, is that the Group in the past years has also taken on board more horizontal issues such as coordinating a minimum level of anti-abuse provisions for specific areas and addressing losses of tax revenues which are not caused by one single predatory regime but by a failure in the interaction between two tax systems.

Alternatives such as more fiscal integration could be envisaged, but it would require changing the Treaty.

What is your response to those who feel the EU is not going far enough to combat

so called harmful tax practices? Under the existing EU Treaties, the Commission does all it can to combat harmful practices

and to encourage Member states to combat these practices. It is a joint responsibility to tackle these issues and the Commission will use all its influence to ensure that the EU and its Member States put an end to these practices together. 45IFC

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International Co-operation: The Way Forward with Automatic Exchange

by Stephanie Smith1, Head of the OECD’s Tax Information Exchange Unit

The OECD has been pursuing the goal of tax transparency and automatic exchange of information for almost 20 years, those who are at the front line of the OECD’s battle speak about its success and the impact the OECD’s work has had on the industry. -

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As the world becomes increasingly globalised it is easier for taxpayers of all incomes to make, hold and manage investments through foreign financial institutions; something that not long ago was accessible only to wealthy taxpayers. Vast amounts of money are kept offshore and go untaxed when taxpayers fail to comply with their tax obligations in their home jurisdiction. Offshore tax evasion is a serious problem for countries all over the world, not just developed countries. In fact, it can pose a significant threat to the government revenues of developing and emerging economies as they typically have fewer resources, both financial and legal, to attack the problem.

While tax rules and tax rates will inevitably vary from jurisdiction to jurisdiction, secrecy and a lack of cooperation should not be allowed to impede a jurisdiction’s right to collect their legitimate tax revenues. International cooperation is essential to ensure that governments have the information required to enforce their own domestic taxation laws.

Countering offshore tax evasion has featured prominently on the political agenda of the past couple of years, in general focusing on transparency and

exchange of information on request. In this respect a great deal of progress has been made with well over 100 jurisdictions having committed to the international standard of transparency and exchange of information on request, something that was unthinkable just three years ago. The Global Forum on Transparency and Exchange of Information for Tax Purposes, which was substantially restructured in 2009, plays a key role in ensuring that jurisdictions implement the standards through a rigorous peer review process.

Tax administrations use a range of tools to ensure that taxpayers pay the right amount of tax to the right jurisdiction including: strictly domestic rules requiring taxpayers to report their income and assets from abroad; exchange of information on request; spontaneous exchange of information; tax examinations abroad; and the automatic exchange of information. In many ways all of these tools complement each other. In fact, the most successful use may be when two or more of them are used in combination.

The following provides a brief overview on the work of the OECD on automatic exchange of information and how recent developments around FATCA2 may facilitate the use of automatic exchange and help to provide a platform for multilateral cooperation.

Automatic Exchange of InformationAutomatic exchange of information involves the systematic and periodic transmission of ‘bulk’ taxpayer information by the source country to the residence country concerning various categories of income (eg, dividends, interest, royalties, salaries, pensions, etc).

Interest by governments in automatic exchange of information is growing and this is demonstrated at the international level, including at the EU, the OECD and the G20 where automatic exchange is high on the agenda3. In addition NGOs have argued for many years that automatic exchange is required to effectively combat tax evasion, especially if developing countries are going to be in a position to benefit from the new transparent environment.

The OECD has been active in facilitating automatic exchange for many years to support those interested in this form of exchange. The work has ranged from creating the legal framework for such exchanges4 to developing technical standards and seeking to improve automatic exchange at a practical level. From a technical perspective the standardisation of formats is crucial so that information can be captured, exchanged and processed quickly and efficiently in a cost effective manner by


THE OECD

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the receiving country. OECD work on standardisation has taken advantage of technological developments starting with a paper standard format, then moving to the standard magnetic format (‘SMF’), and finally to a more advanced standard using XML language (‘STF’5). Investment by governments in IT and related back office functions is critical to enable them to enjoy the maximum benefits of automatic exchange.

The European Union (EU) Council has adopted standard formats for the implementation of the EU Savings Directive which are largely based on the OECD STF (into FISC 153 format). In addition to the adaptation of the STF format, the EU has also developed specifications to ensure a good quality of data and monitors the functioning of the format. To develop the formats the EU works in close collaboration with the OECD with the common objective to have one technical standard for the automatic exchange of information with schemas being released as much as possible at the same time by both the OECD and the EU.

Results of a recent survey on automatic exchange conducted by the OECD show widespread use of automatic exchange of

information regarding country coverage and income types, transaction values and records exchanged. Automatic exchange as a tool to counter offshore non-compliance has a number of benefits. It can provide timely information on non-compliance where tax has been evaded either on investment return or the underlying capital sum. It can help detect cases of non-compliance even where tax administrations have had no previous indications of non-compliance. Other benefits include its deterrent effect, increasing voluntary compliance and encouraging taxpayers to report all relevant information6. While the survey on automatic exchange of information demonstrated the widespread use of automatic exchange and highlighted many of its benefits it also showed that work needs to be done to improve automatic exchange on a practical level, including the development of common standards on capturing information.

Work on automatic exchange is also being done by other organisations. The EU is engaged in revising its Savings Directive and recently adopted its Mutual Assistance Directive which also contains provisions on automatic exchange. The OECD and the Council of Europe

recently revised the Convention on Mutual Administrative Assistance in Tax Matters (Multilateral Convention) which provides a basis for automatic exchange. It is now open to all countries and the Multilateral Convention will soon have over 50 countries that have either signed the Convention or signed a letter of intention to sign the Convention. As the number of signatories to the Multilateral Convention increases this instrument provides a platform for widespread adoption and use of automatic exchange for those countries that wish to take advantage of automatic exchange. Further, the Multilateral Convention provides a good opportunity for developing countries to benefit from the new transparent environment without having to incur the significant costs of negotiating bilateral agreements with many countries.

FATCA and Other Residence Reporting RegimesWhile the most well known residence country reporting regime is probably FATCA, other regional residence reporting regimes exist. The FATCA rules were enacted by the US Congress in 2010, with the objective of combating the use of offshore accounts and entities to evade US tax. On 26 July 2012, the US Treasury Department released a ‘Model Agreement for Improving Tax Compliance and Implementing FATCA”, developed in consultation with five other OECD member countries7. The FATCA Model Agreement provides for the implementation of FATCA through reporting by financial institutions to their local tax authorities, which would exchange the information on an automatic basis with the IRS.

In Europe there is the EU Savings Directive, which is an agreement among the member states of the EU to automatically exchange information with each other about customers who earn savings income in one EU member State but reside in another. Other regional agreements exist, for example, among the Nordic countries where a large amount of information is required to be exchanged automatically with the country of residence.



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Common Model for Residence Country Reporting The trend of requiring residence country reporting is likely to continue as governments continue to seek to improve existing tools to ensure compliance with their domestic taxation laws. Financial institutions seem to have generally accepted their role as cross-border tax intermediaries but have a strong interest in the standardisation of approaches to avoid unnecessary costs. As a result, the development of a common model for automatic exchange, including the development of reporting and due diligence standards for financial institutions, is supported by governments and business alike. A common approach will avoid a proliferation of different models and reduce the costs for both governments and business.

To develop a common model governments need to engage with financial institutions around the globe to develop a model that is both effective, capturing the information required by governments to ensure compliance with their domestic legislation, while at the same time not being overly burdensome and costly. To achieve these objectives, it is important to leverage off work being

done by other organisations. Important and relevant work is being done by FATF8, which has strict requirements for identifying customers and beneficial owners. The OECD’s work in connection with the ‘Oslo Dialogue’ is also relevant as it supports a ‘whole of government’ approach in combating tax crimes and other crimes.

The OECD acknowledges the importance of common standards and stands ready to support the efforts of governments wishing to develop a common model of reporting and due diligence standards. Improving tax compliance is in the best interests of governments, businesses, and taxpayers and supports fairness and equity for everyone by working towards ensuring that no one is able to hide their income and assets and avoid their responsibility to pay the taxes that are legitimately due.

ConclusionMuch is happening in the area of international tax co-operation, and especially automatic exchange of information, as this brief overview has shown. These developments will benefit not only governments but also business and will help promote

equity and fairness ensuring that all taxpayers pay their fair share of taxes. Governments will better be able to enforce their own domestic tax laws and the standardisation of formats, common reporting and due diligence standards will reduce the cost of compliance for both business and governments.

As work in this area continues governments and tax administrations will continue to focus on protecting the confidentiality of taxpayer information both in law and in practice9. While confidentiality has always been of upmost importance to tax administrations it is especially pronounced in automatic exchange. In times of austerity, and with governments determined as ever to crack down on offshore tax evasion, work in this area is bound to continue as the potential for domestic reporting coupled with automatic exchange continues to develop along with the potential offered by multilateral cooperation in this area. 1 The views expressed in this article are those of the author and do not necessarily reflect those of the OECD or its member countries.2 Foreign Account Tax Compliance Act.3 The June 2012 Los Cabos G20 Communiqué stated: “We welcome the OECD report on the practice of automatic exchange, where we will continue to lead by example in implementing this practice. We call on countries to join this practice as appropriate and strongly encourage all jurisdictions to sign the Multilateral Convention on Mutual Administrative Assistance.”4 Article 26 of the OECD Model Tax Convention is commonly relied on as the basis for the automatic exchange of information. The OECD has also developed a model memorandum of understanding regarding the automatic exchange of information.5 Standard Transmission Format.6 See the OECD Report ‘Automatic Exchange of Information: What it is, How it Works, Benefits, What Remains to be Done’.7 France, Germany, Italy, Spain and the United Kingdom.8 Financial Action Task Force.9 See the guide recently published by the OECD, ‘Keeping it Safe: The OECD Guide on the Protection of Confidentiality of Information Exchanged for Tax Purposes’.

IFC


THE OECD

The OECD began its campaign for transparency in the late 1990s – how

successful in your opinion has that campaign been?

After years of stalling, this campaign has been highly successful in recent years

following what we all know as the Liechtenstein scandal in 2008. In the context of the financial crisis, the G20 has made transparency one of its key priorities and the London Summit in 2009 led to a new momentum. Following the London Summit, the Global Forum on Transparency and Exchange of Information for Tax purposes was restructured with all its members, now over 115 jurisdictions, on an equal footing and committed to international standards of tax transparency and subject to a rigorous peer review process. Over 800 tax information exchange agreements have been concluded in the last few years. The Multilateral Convention on Mutual Assistance was opened to signature to non OECD, non Council of Europe countries. It has now been signed by more than 40 countries and many have expressed interest in signing. Banking secrecy is no longer acceptable as grounds to refuse to share information with tax authorities. We are creating a new compliance culture within a cooperative international tax environment.

How important is a level tax playing field?A level playing field is very important as it is fundamentally about fairness – equity and fair competition. The broad

membership of the Global Forum is a good illustration of how seriously we take it! All Global forum members are

on an equal footing and the peer review mechanism precisely relies on peers’ inputs. Whether small or big, financial centres or not, high tax jurisdictions or no tax jurisdictions, all countries are treated equally. This is of critical importance because jurisdictions that meet the high standards of transparency and exchange of information should not be disadvantaged by jurisdictions that are not part of the process and the latter should not be permitted to profit from the promotion of their position of being on the outside.

How important do you believe the black, grey and white ‘listing’ of jurisdictions

has been in encouraging tax transparency and regulation in former tax havens?

In 2009, at the request of the G20, the OECD was asked to report on progress towards

transparency made by jurisdictions. Leveraging on the work of the sub-group on the level playing field (made of eight former ‘tax havens’ and eight OECD countries), the OECD was in a position to identify (i) the countries which had not committed to implementing the standard and (ii) those which

had committed to but had not made significant progress. The sub-group had agreed that signing 12 agreements to the standard was a fair benchmark of progress. It is important to note that the ‘list’ provided to the G20 and issued on 2 April 2009 covered all countries, OECD and non OECD! There is no doubt that it played its part in pushing some major financial centres to adopt the standard (four OECD countries did so on 13 March 2008). More importantly, beyond committing, all countries have made major progress in signing agreements. However, this ‘list’ is now outdated and has been replaced by the peer review mechanism which has its own, much more in-depth criteria: (i) having a good legal framework and (ii) exchanging information in practice. This is a more sophisticated process that objectively assesses jurisdictions against clear criteria and makes recommendations for improvements to meet the standards. All the evidence shows that jurisdictions act on those recommendations and the result is greater transparency and better tax compliance. What matters now for a jurisdiction is to be part of the process (unlike Lebanon which has refused to join the Global forum)

OECD Q&A

‘Whether small or big, financial centres or not, high tax jurisdictions or no tax jurisdictions, all countries are treated equally. This is of critical importance because jurisdictions that meet the high standards of transparency and exchange of information should not be disadvantaged by jurisdictions that are not part of the process and the latter should not be permitted to profit from the promotion of their position of being on the outside.’

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IFC Economic Report speaks to Pascal Saint-Amans, Director for the Centre of Tax Policy and Admistration about the progress and objectives of the OECD’s policies

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and then to have its legal framework in place to be able to move to the phase 2 (assessment of the actual information exchange). At the end of the phase 2, countries will receive an overall rating on their performance.

What is the OECD’s long term objective with regard to IFCs?The goal of the OECD and now of all Global Forum members is to promote transparency and

level the playing field.

How successful has the tax treaty programme been?The treaty programme has been very successful. There has been widespread adoption of the standard of exchange

of information set out in Article 26 of the OECD Model Tax Convention (the standard is contained in the UN Model, TIEA and the Multilateral Convention and is incorporated in the Global Forum terms of reference).

An update to Article 26 was approved by the OECD Council in July 2012, which provides for group requests. The Global forum will have to decide whether this improved standard will be incorporated in its own terms of reference.

How important is the automatic exchange of information?Automatic exchange as a tool to counter offshore non-compliance has a number of benefits. It

can provide timely information on non-compliance where tax has been evaded either on investment return or the underlying capital sum. It can help detect cases of non-compliance even where tax administrations have had no previous indications of non-compliance. Other benefits include its deterrent effect, increasing voluntary compliance and encouraging taxpayers to report all relevant information. G20 has also recognised its importance encouraging countries to consider exchanging information automatically on a voluntary basis under the Multilateral Convention. We can see automatic exchange of information becoming a growing practice, though not being a standard.

What is the objective behind the peer review process – is it proving successful?The aim of the peer review process is to ensure that international standards

of transparency and exchange of information, to which all members have

made a commitment, are implemented by all jurisdictions across the globe so that the free movement of capital is complemented by exchange of information to ensure that tax is paid in the place where it is due and it is no longer possible to hide income or assets from the relevant tax authorities. The peer review process has benefitted from the active involvement of all its members including IFCs and has delivered fair, transparent results. The success of the process is reflected in the wide sweeping changes that have been brought about in the regulatory environment across the globe. As the process moves to evaluating exchange of information practices, there will be increased pressure to make sure promises are delivered and there is real change on the ground.

In what way do you feel the business of international tax has changed since the OECD began its campaign against harmful tax competition?There is a greater awareness that

tax cooperation goes hand in hand with globalisation, both by governments and business as well as the general public. It is recognised that while countries may have different tax rates, which play a part in economic competitiveness, this cannot 50

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be seen in isolation. There is also a need for countries to be able to collect their legitimate tax revenues. This applies to OECD countries and also to developing countries. There is now a much greater recognition of these inter-relationships and the need for common standards to ensure fairness and effectiveness in global taxation. There is increased realisation that there is no longer a place for businesses that rely on secrecy and that the new environment is here to stay. In fact, many countries are moving to automatic exchange of information and that will result in more cooperation. FATCA is another game changer. Businesses which can adapt themselves to the new environment based on transparency will be the ones which will survive.

What impact will FATCA have?As said earlier, FATCA is a game changer. Model 1 and Model 2 intergovernmental agreements (IGA) are likely to foster the dynamic towards

transparency. FATCA Development of a common model for automatic exchange, including the development of reporting and due diligence standards for financial institutions, would avoid a proliferation of different models and reduce costs for both governments and business. On the one hand, FATCA, being a unilateral, extraterritorial legislation, raises a number of serious concerns. On the other hand, the fact that bilateral agreements can be concluded and then articulated through a multilateral platform to operate the information exchange makes it much more acceptable by all players. The OECD, in particular with its Global forum, can help in that sense and direction.

Should we be considering a future with no financial privacy?It is important to distinguish between taxpayer confidentiality and banking secrecy. The former

is a legitimate expectation of compliant taxpayers. Indeed the international standards require it. Transparency and exchange of information is about cooperation between tax authorities who have a duty to protect the confidentiality of the information they receive. Our aim is

to promote transparency for tax purposes, which means that countries and financial institutions must share information with tax authorities, which is different from public disclosure of private information. Interestingly, the OECD, followed by the Global Forum, has adopted a manual on taxpayers’ confidentiality. The ability to protect confidentiality is also a condition to access the multilateral convention. We take this very seriously. The more progress towards transparency, the more we need to protect taxpayers confidentiality.

Do you feel that the traditional offshore jurisdictions have been

treated fairly by supra national bodies when compared to treatment of more traditional ‘onshore’ finance centres?

The Global Forum members participate in its working on an equal footing and have

been involved actively. The process is designed to ensure fair and equal treatment for all members. All financial centres are playing their part in the new cooperative tax environment. Financial centres contribute assessors to the peer review process and work closely with other Global Forum members to ensure that standards are applied fairly and consistently across all jurisdictions. This inclusive process means that traditional offshore centres are now much more part of mainstream tax cooperation and are themselves helping to ensure the process works fairly.

The Tax Justice Network feels that the OECD and other international bodies

are not doing enough to track offshore wealth – what is your

response to such accusations?I think the changes we have seen over the last few years in the international cooperation

environment are nothing short of revolutionary. What has been achieved was unthinkable a few years ago. We are creating an environment where countries and tax authorities are much better placed than before to trace off shore wealth and collect tax revenues. Over the last few years the framework for tax cooperation has been transformed. However the process is far from over and there is still much to do.

Should we dispel with differentiating between offshore and onshore / tax

havens and financial centres and acknowledge that tax evasion and its unsavoury companions can be found throughout the financial system as a whole and not just in IFCs?

The OECD and Global Forum aim to combat tax evasion wherever it occurs. We promote

tax cooperation by all jurisdictions based on common standards. The international standard for transparency and exchange of information does not distinguish between different types of jurisdiction in the standard that must be applied. It recognises the different characteristics and economic circumstances of the wide range of Global Forum members. This is one of its greatest strengths, that large and small financial centres, non-financial centres, emerging markets, developed and developing countries, have been able to come together in pursuit of common standards. The Global Forum has done much to break down barriers between different jurisdictions and will continue in that vein.

‘There is increased realisation that there is no longer a place for businesses that rely on secrecy and that the new environment is here to stay. In fact, many countries are moving to automatic exchange of information and that will result in more cooperation. FATCA is another game changer. Businesses which can adapt themselves to the new environment based on transparency will be the ones which will survive.’

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Reflecting the decision taken by the Global Forum at its meeting in Mexico on 1-2 September 2009, the OECD Council adopted a decision formally establishing the Global Forum on Transparency and Exchange of Information for Tax Purposes (the Global Forum) as a Part II programme of the budget of the Organisation on 17 September 2009.

All of the activities of the Global Forum are carried out with the aim of ensuring the effective worldwide implementation of the international standard of transparency and exchange of information for tax purposes (‘the international standard’). This standard is based largely on the OECD Model Tax Convention and its Commentary, as updated in 2004, and the 2002 Model Tax Information Exchange Agreement and its Commentary. The standards have also been incorporated into the UN Model Tax Convention and the G20 has called on all countries to implement them. Further, a number of international organisations have incorporated them into their tax cooperation frameworks [and policies].

The principal mechanism used by the Global Forum to achieve its objectives is the ‘peer review’ process. The Global Forum developed the peer review mechanism during the first six months after its Mexico meeting. During this period its Peer Review Group (PRG), which is tasked with conducting the

reviews, developed detailed Terms of Reference, a methodology for undertaking the reviews, as well as assessment criteria and a comprehensive schedule of reviews. These were adopted by the Global Forum in February 2010.

The peer review process developed by the Global Forum comprises two phases. Phase 1 reviews assess the quality of a jurisdiction’s legal and regulatory framework for the effective exchange of information, while Phase 2 reviews look at the application of the international standard in practice. The methodology also provides for Combined – Phase 1 and Phase 2 – reviews. To date the Global Forum has adopted 79 Phase 1 reviews and 20 Combined reviews. A total of 555 recommendations have been made in these reviews, following which 17 jurisdictions could not move to Phase 2 and three could progress to Phase 2 subject to meeting certain conditions. Another nine peer reviews, including two combined reviews, are under consideration by the Global Forum.

The Global Forum has also completed a number of supplementary reviews. The supplementary review process, adopted by the Global Forum in 2009, is so designed that the progress made by a jurisdiction in implementing the recommendations is reflected in a published document. The methodology also provides for a situation where a jurisdiction back-steps on its regulatory framework or stops exchanging information, in which case the Chair

of the Peer Review Group may ask the jurisdiction to present the changes and the Peer Review Group may then decide to launch a follow-up procedure. Thus far, 17 jurisdictions have made requests for supplementary reviews. As many as 60 recommendations have been removed as a result of the supplementary reviews completed because it was found that the jurisdictions had taken sufficient steps to comply with the international standard.

The supplementary reports provide a measure of the effectiveness of the Global Forum and the impact that its work has had on policy development. The Global Forum has now entered the next phase of its task with the launch of the stand-alone Phase 2 reviews, which will assess the application of the international standard in practice. The Global Forum has drawn up its schedule of reviews and the first set of stand-alone Phase 2 reviews will be considered by the Peer Review Group in early 2013. By the September 2013 meeting of the Peer Review Group, we should have completed about 27 standalone Phase 2 reviews.

Recommendations made during the peer review process are one measure of output from the process. However, the Global Forum has been charged with encouraging countries to implement the standards and its recommendations are only a means to that end. The real proof of the success of the work done by the Global Forum is evident from the fact that jurisdictions have begun to make changes in their laws and legal structures

Global Forum on Transparency and Exchange of Information for Tax PurposesHow the Peer Review Process is Enhancing Tax Co-operation Throughout the World

By Monica Bhatia, Head of the Global Forum on Transparency and Exchange of Information for Tax Purposes, OECD

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to accept the recommendations that have been made. So far 50 jurisdictions have provided follow up reports describing actions they have taken to implement recommendations - 17 jurisdictions have allowed or improved access to bank information for tax purposes, in addition to this, 17 jurisdictions have introduced, or are introducing, measures to abolish, immobilise or otherwise identify the owners of bearer shares, 42 jurisdictions have improved their legislation to ensure the availability of accounting and ownership information and six jurisdictions have eliminated domestic tax interest requirements to access information for EOI purposes.

These statistics indicate quite clearly that the work of the Global Forum has found acceptance even among those countries that did not receive favourable reports. This is testimony to the principles of fairness, equity, and consensus upon which the Global Forum is operating.

Apart from making changes in their laws, jurisdictions around the globe are entering into new agreements. Agreements that were not in keeping with the internationally accepted standards are being updated to reflect the norm. More than 800 new bilateral agreements have been signed that allow for the exchange of information in accordance with the international standard. Multilateral Tax Information Exchange Agreements (TIEA) negotiations have resulted in the signing of more than 100 bilateral Tax Information Exchange Agreements. Thirty-eight jurisdictions including 35 Global Forum members have now signed the multilateral Convention on Mutual Administrative Assistance in Tax Matters, an innovative and wide-ranging instrument that meets the Global Forum standards, and more have indicated their intention to do so.

As important as it is to make some real efforts to set up legal systems that are based on principles of transparency, it is equally important to ensure that these systems operate effectively and efficiently. In fact, the Phase 2 peer reviews are designed to do just this. It can be seen the world over that countries now recognise the importance of having human resources dedicated to the task of managing exchange of information

(EOI) mechanisms. Many countries have increased the number of staff directly involved in EOI, others have established new EOI Sections, drafted EOI Manuals outlining procedures to be followed in handling requests, or have amended procedures in their case management systems to include sending regular updates to EOI partners. Many countries have reported shortened times for responding to an EOI request. All these changes indicate that countries are moving towards more and more transparency and more effective exchange of information meaning that tax evaders have fewer and fewer places to hide.

The Global Forum does not simply publish its reports and then leave the jurisdictions to fend for themselves. The Global Forum has taken upon itself the task of helping member jurisdictions to enhance their capacity for exchange of information by teaming up with international organisations like the World Bank, IMF and others. Among the various mechanisms that the Global Forum has adopted, is the holding of various regional training seminars that focus on transparency and exchange of information for creating awareness of the international standard and help prepare countries for their peer reviews. Five regional seminars have been held (in Jamaica, Australia, South Africa, Ghana and the Philippines), attended by 248 participants from 77 jurisdictions and seven international organisations. Two pilot projects have taken off, funded by the UK Department for International Development (DFID), to provide assistance to Ghana and Kenya to help them build capacity. In order to match demand and supply of assistance, the Global Forum also hosts a coordination platform which contains details of jurisdictions needing assistance and helps link them with the Global Forum’s partner organisations and donor agencies that are in a position to provide it.

The effectiveness of the Global Forum is also demonstrated in its growing membership. From a membership of 95 in 2009, it has grown to 113 today. All the jurisdictions that have come on board are fully aware that along with membership of the Global Forum, come some attendant responsibilities.

These include a commitment to the internationally accepted standards of transparency but also the need to make efforts to put in place and maintain a legal system that is in keeping with these standards. This is not an easy task. Yet, an impressive number of countries have joined the Forum and many more have evinced keen interest to join. This only shows that despite the responsibilities that membership of the Global Forum casts upon the jurisdictions, all countries realise the significance of this endeavour and the need to come together to address the problem of tax evasion.

In the years that it has been functioning, the Global Forum has become the legitimate voice of countries who are interested in setting up systems that are based on transparency and cooperation. The Global Forum has been able to bring the point home to countries around that world that transparency is not something that is just associated with exchange of information but that legal systems based on transparency have a direct correlation with the increasing of domestic tax revenues.

The Global Forum has set and operated a truly inclusive system that has worked with International Financial Centres and other low tax/ no tax jurisdictions. Their commitment to the international standard and the move towards greater transparency reflects the realisation that an economic model based on secrecy can no longer survive. They have actively worked as Global Forum members on equal footing to take the transparency agenda forward and will remain at the forefront of its future work.

As the Global Forum stands on the threshold of a new phase of its work with the launch of the Phase 2 reviews, it is clear that even though it has made giant strides so far, its work is far from done. Ultimately the real test of whether the Global Forum has achieved its goal is whether it has improved transparency and made exchange of information more effective in practice. This can only be determined at the end of the Phase 2 reviews. The challenge now is to build on the success that has already been achieved to enhance tax cooperation in practice throughout the world. 53IFC



Offshore financial centres are again the focus of many countries in the world. Some are looking to increase the size of the sector; others are trying to tighten the rules and regulations under which they operate. For both sets of countries, the increased interest is directly related to the fallout from the 2008–09 global economic and financial crisis.

On the one hand, faced with lower growth and high rates of unemployment, countries are searching for new sources of growth, and some of them—including smaller ones—are looking toward offshore financial centres (OFCs) as one potential source of future growth.

On the other hand, the fallout from the global crisis has accelerated efforts by a number of global bodies to target OFCs and the tax and regulatory environment in which they operate. A number of national regulators and supervisors, in turn, are concerned about the potential spillover from weakly regulated and supervised offshore financial banks into the onshore sector, which can undermine the health and stability of entire financial systems and result in high fiscal costs and economic hardship or disruptions. Therefore, balancing these competing objectives is paramount for countries that are considered OFCs or are pursuing expansion of the sector.

What Are OFCs and What Are Their Benefits?Although no single definition encompasses all OFCs, these entities share a number of characteristics—the primary

orientation of the business in OFCs is toward nonresidents, and OFCs take advantage of existing loopholes in onshore legal frameworks and the presence of low or zero taxation structures. OFCs specialise in supplying financial services to nonresidents far in excess of the size of their host economies (Rose and Spiegel, 2007; and Zoromé, 2007).

Offshore financial centres provide a large range of financial services, including international banking, headquarter services, foreign direct investment, structured finance, insurance, collective investment schemes, and so forth. Benefiting from relatively low start-up costs, they often provide attractive tax regimes, as well as privacy and secrecy rules. For example, by providing international banking services, they allow corporations and individuals residing in politically or economically unstable countries to protect their assets by placing them overseas and to avoid scrutiny by doing so. OFCs also play an important role in the internal organisation of multinational firms. For instance, the financial management and treasury operations of multinationals typically include offshore affiliates that support certain transactions, such as new acquisitions or mergers, or that permit foreign direct investment to be financed with debt rather than equity. In addition, companies benefit from a number of legal and tax advantages when headquarters services are provided from the OFC. According to the US Government Accountability Office (GAO, 2008), more than 730 companies trading on US stock exchanges, including Coca-Cola, Oracle, and Seagate Technology, reported to the

US Securities and Exchange Commission that they are incorporated in the Cayman Islands. Also, some firms opt to locate their head office in an OFC, with onshore activities being conducted by affiliates of offshore headquarters.

From the point of view of the host country, OFCs provide a number of direct benefits such as direct employment, spillovers to other sectors in the economy (tourism, infrastructure, telecommunications, and transportation), and government revenue from taxes and fees. For example, in both The Bahamas and Barbados, revenue was estimated at about eight per cent of GDP in 2008. The empirical evidence also suggests that higher OFC-related capital inflows have a positive impact on economic growth. The positive impact of OFCs and growth are also supported by Hines (2010). And these results hold true irrespective of whether a country or jurisdiction is classified as a ‘tax haven’.

Stylised FactsAccording to the IMF’s Coordinated Portfolio Investment Survey database, inflows into OFCs increased significantly before the 2008–09 global financial crisis, and the share of OFCs in the global financial system remained fairly stable during the crisis period. At the end of 2009, some 40 OFCs accounted for about eight per cent of worldwide cross-border portfolio liabilities and assets.

The Caribbean accounted for a disproportionately large share of OFCs, representing about five per cent of worldwide cross-border liabilities. Within the Caribbean, the Cayman

The IMF: Finding the Right Balance

By Alfred Schipke1, Advisor in the Asia and Pacific Department of the International Monetary Fund and Adjunct Lecturer in Public Policy at the Kennedy School of Government, Harvard University

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Islands accounted for close to three-quarters of the sector (see Figure 2). In aggregate, OFCs have generally maintained balanced participation in the debt and equity markets.

Increased Vigilance is WarrantedGlobal Oversight InitiativesHarbouring OFCs, however, is becoming increasingly challenging and potentially very costly. Policymakers in advanced economies have stepped up their efforts to increase fiscal revenue by closing loopholes and going after so-called tax havens. At the global level, as a result of the fallout from the global financial crisis, efforts are increasing to strengthen global financial systems, including by increasing pressure on OFC host countries and jurisdictions to intensify their adherence to financial standards and information sharing.

These efforts are being led by a number of international bodies that have launched or reinvigorated initiatives to strengthen the tax and financial regulatory policies that apply to OFCs. The key bodies are the Global Forum on Transparency and Exchange of Information (OECD/Global Forum), the Financial Stability Board (FSB), the Financial Action Task Force (FATF), and the G-20 (see Figure 1). These global initiatives share many of the same objectives and, most important, have similar implications for OFCs because of

the possibility of ‘naming and shaming’ or so-called gray/black lists.

After being put on a grey/black list, for example, many large international financial institutions exited from OFCs in 2008–09. Also, empirical evidence indicates that grey/black-listed OFCs experienced a decline in their share of global capital flows relative to their white-listed competitors. Conversely, signing the tax information and exchange agreements (TIEAs) required to be put on the Global Forum/OECD’s white list had a positive impact on portfolio capital flows to OFCs2.

In addition to the direct impact of being grey/black listed, potentially severe reputational risks could apply not only to the offshore sector itself, but to the country overall. Countries that intend to target high-value services such as tourism to foreigners could see their reputations tarnished. Apart from any reputational risks, the global community could apply outright sanctions. Hence, a good understanding of these global and toughening initiatives is critical to minimising any adverse implications.

National Regulation and SupervisionAmong all types of OFC activities,

offshore banks pose the most significant risk as revealed by a number of high-profile cases in which offshore banks were allegedly related to Ponzi schemes (Carvajal and others, 2009). Problems in offshore banks can also threaten

the stability of the domestic financial system when such banks are associated with onshore commercial banks. The existence of multiple regulators and supervisors, and the possibility that they do not share information, might limit their ability to detect outright fraud and prevent spillovers to the onshore sector. These experiences highlight the need to strengthen regulation and supervision, including by moving toward consolidated supervision of commercial banks that include offshore bank affiliates.

What Are the Key Takeaways?OFCs have become an important part of the global financial system

Offshore Financial Centers(OFCs)

Fiscal/Tax Financial/Regulatory

Global Forum/ OECD

OECD/Individual countries

Financial Stability Board

Financial Action Task Force/IMF

A Taxonomy of Global Initiatives

Tax EvasionInformation exchange and transparency

Regulatory StandardsCompliance with international cooperation and information sharing standards

Money Laundering and Financing of TerrorismRevised compliance review process

Tax Minimization ArrangementsElimination of unacceptable tax arrangements

Source: Authors' illustration.

Figure 1. Offshore Financial Centers

Figure 1

Figure 2. Portfolio Liabilties of OFCs in the Caribbean, 2009

Source: IMF Coordinated Portfolio Investment Survey (CPIS) Database. 55

The Bahamas 0.68%

Barbados 0.09%

Belize 0.01%

Netherlands Antilles 6.77%

Bermuda 17.30%

Cayman Islands 72.60%

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THE IMF

and are again at the centre of attention of policymakers across the globe. This rekindled awareness is directly related to the fallout from the 2008–09 global financial crisis, a number of high-profile scandals involving OFC-related Ponzi schemes, and the spillover of offshore financial sector problems to the onshore banking sector.

For some countries or jurisdictions, OFCs are a legitimate source of potential growth, employment, and fiscal revenue at a time when they are faced with more headwinds from the global economy. Indeed, some empirical evidence shows that activities of large OFCs positively contribute to growth. At the same time, OFCs are also faced with more, and more-complex, global oversight initiatives, ranging from the Global Forum/OECD, FSB, and FATF, to individual G-20 members. Failure to comply with these global initiatives has potentially severe consequences for the host OFC, including the risk of naming and shaming; adverse implications for the reputation not only of the OFC sector, but possibly the entire country; and even outright sanctions.

Striking the right balance is therefore crucial for countries that intend to continue to operate, or even increase the size of, OFCs. Host countries and jurisdictions will have to evaluate carefully the costs and benefits of their OFCs. They must proactively meet the requirements of global oversight initiatives to maximize benefits and improve the regulation and supervision of the OFCs, including through consolidated supervision. These steps, however, require that OFC host countries devote sufficient resources and human capital to staying up to date on developments.

1 The opinions expressed in this chapter are solely those of its author. This article draws from ‘Offshore Financial Centres: To Be or Not to Be?’ María González and others, in Eastern Caribbean Economic and Currency Union—Macroeconomics and Financial Systems, ed. by Alfred Schipke, Aliona Cebotari, and Nita Thacker, (Washington, DC: IMF), Forthcoming.2 The Caribbean, for example, has demonstrated its commitment to meet

international standards. Although many countries initially found themselves on a black/grey list, of them signed the necessary Tax Information and Exchange Agreement and are now on the white list. The Caribbean is also making efforts to increase compliance with Financial Action Task Force.

ReferencesCarvajal, A., H. Monroe, C. Pattillo, and B. Wynter, 2009, ‘Ponzi Schemes in the Caribbean,’ IMF Working Paper 09/95 (Washington).María González and others, ‘Offshore Financial Centres: To Be or Not to Be?’, in Eastern Caribbean Economic and Currency Union—Macroeconomics and Financial Systems, ed. by Alfred Schipke, Aliona Cebotari, and Nita Thacker,

(Washington, DC: IMF), Forthcoming.Hines, James R., Jr, 2010, ‘Treasure Islands,’ Journal of Economic Perspectives, Vol. 24, No. 4, pp. 103–26.Rose, Andrew K., and Mark M. Spiegel, 2007, ‘Offshore Financial Centres: Parasites or Symbionts?’ Economic Journal, Vol. 117, No. 523, pp. 1310–35.Schipke, Alfred, Aliona Cebotari, and Nita Thacker (Eds.), Forthcoming, Eastern Caribbean Economic and Currency Union—Macroeconomics and Financial Systems (Washington, D.C.: IMF), Forthcoming.Zoromé, A., 2007, ‘Concept of Offshore Financial Centres: In Search of an Operational Definition,’ IMF Working Paper 07/87 (Washington: International Monetary Fund).

International tax issues, including continuing pressures from tax competition, are increasingly center stage, not only in advanced and emerging economies, but in developing countries too. Indeed for them tax issues are potentially even more important, since they raise more of their overall revenues from corporate taxation.

The issues are many and complex. Profit-shifting, though transfer pricing and financing arrangements with similar effect, has attracted particular attention. But there are others too. A concern in many developing countries, for instance - not least those with large natural resource discoveries - is that disadvantageous treaty agreements, with very low withholding rates on some outward payments, may leave them less able to secure revenue than they would have been with no treaty at all.

Low tax jurisdictions play a central role in all this. Some see them as mitigating the adverse impact of high taxes elsewhere; some, perhaps most, as simply undermining tax systems elsewhere. There are sensitive issues

of national sovereignty here. But there seems at least to be increasing acceptance that countries should provide enough information to allow others to implement their own residence-based tax systems. And it needs to be remembered that many forms of international tax avoidance are possible only because of provisions adopted by large advanced countries themselves.

With such strong international interdependencies of policies, it is likely that all can benefit from some degree of cooperation. Ultimately, information exchange alone is not enough: it achieves little if tax rates are competed to zero. The idea of a World Tax Organisation with wide powers to shape the international tax regime is, for the moment, chimerical. And regional efforts at some form of coordination have yet to bear much fruit. The challenge remains to develop forms of cooperation that have broad enough participation to be effective, are targeted enough to be realistic in their objectives, and offer enough demonstrable benefit to all to be feasible. The urgent revenue needs of many countries makes the case for this stronger now than ever.

The Shifting Issues of International TaxBy Carlo Cottarelli, Director, Fiscal Affairs Department, International Monetary Fund

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