By Frances Emery
“Offshore” is a word for which there are, perhaps, as many varied connotations as there arejurisdictions in the world that consider themselves “offshore financial centers”. And, in the same way that it isn’t as easy as it once was to define exactly what constitutes an “offshore financial center”, the concept of “offshore” itself has changed vastly, and continues to do so at a rapid pace.
One thing that economists and industry experts agree on today is that there is no hard and fast definition for “offshore”. Certainly, most offshore jurisdictions have separate legal systemsthrough which non-resident companies can ease their tax burden and benefit from relaxed regulations and a high degree of privacy protection, as long as they do not trade in the local economy. But the word “offshore” is also often used to describe a country or territory that shares some of the characteristics of “established” – or indisputably recognized – offshore jurisdictions, namely afavorable tax and regulatory regime.
Hong Kong is one example. The territory – unique, too, in its adoption of a “one country, two systems” principle – may be the world’s largest offshore yuan hub, but strictly speaking, it isn’t an offshore jurisdiction because it doesnot distinguish between onshore and offshore companies, as such. But because Hong Kong taxes are relatively low, and no tax is charged on foreign income, it is often treated as an offshore jurisdiction by international investors.
Another factor that adds to the lack of clarity about what the offshore industry is all about is a general lack of knowledge about tax planning practices. In the general public’s eye, offshore financial centers have, to a large extent, become synonymous with tax avoidance in the past few years. Sensationalized mainstream media has a major part to play in that. Unfortunately, in addition to being sensationalist, media of this kind is almost always misinformed, and one reason for this is ignorance or confusion surrounding the differences between tax evasion and tax avoidance.
Tax evasion – as anyone even vaguely clued up about the admittedly complex world of international investment – is illegally failing to pay taxes which are lawfully due, and generally speaking, this is a crime everywhere in the world. In contrast, tax avoidance involves minimizing your exposure to tax by legal means (often referred to as easing your tax burden within investor circles). Although it is perfectly legal, it is frowned upon by politicians – at least in the public sphere – and unsurprisingly, this is where most of the problems arise.
As it was so simply and aptly explained in an article co-written by Brian Garst, Director of Government Affairs for the Center for Freedom and Prosperity,and Dan Mitchell, a Senior Fellow at the Washington-based Cato Institute and Chairman of the Board of the Center for Freedom and Prosperity, “Politicians rarely care about promoting growth, and often are themselves obstacles to its achievement. They care more about raising tax revenues that can then be spent in the quest for the accumulation of personal power and prestige.” Despite the fact that low tax rates are a proven way of rewarding productive behavior by encouraging people to work more, save more, and invest more – and conversely, “bad tax policy”can significantly stunt economic development – politicians the world over favor punitive tax policies.
Mr. Garst and Mr. Mitchell view tax competition as a “mechanism by which the interests of the people in growing the economy can be imposed, at least to some degree, onto the political class”. Tax competition between jurisdictions can make it more difficult for politicians to impose punitive policies and, in fact, it provides them with an incentive to adopt less punitive tax policies instead.
In part, this happens when individuals and businesses relocate (in either the physicalor the financial sense) to jurisdictions with more favorable tax rates, and in doing so apply pressure on their own governments to cut back on excessive taxation. The pressure can prove very effective: countries that refuse to compete suffer economically, while those that embrace competition prosper.
Colin Riegels, a partner and head of the banking and finance global practice group at Harneys law firms offers further explanation of the politics behind this situation. “The public perception is that offshore business is mostly (if not entirely) about tax, and this is a view which is often encouraged by politicians in democratic countries because that way they can promise to raise tax revenue without increasing taxes by catching ‘tax cheats.’ This is what drives legislation like FATCA in the USA. However, most economists recognize that in reality very little additional tax revenue is expected to be raised in this way.”
Not only are methods like targeting so-called “tax cheats” ineffective, but the sheer power of the anti-tax evasion rhetoric itself has a knock-on effect that is felt far beyond the offshore industry. Among the mostdrastic of them comes by way of FATCA legislation, which some consider nothing short of international financial upheaval.
FATCA refers to the Foreign Account Tax Compliance Act, theUnited States’ global tax law. It was enacted somewhat quietly in 2010, but four years later when it came into full effect, the sheer power of its impact began to be felt all over the world. FATCA requires foreign banks to disclose all informationto the US government that is collected about account-holding American citizens with an excess of $50,000 in their possession. Non-compliance on the part of institutions could lead to being forcibly cut off from US markets, which is naturally enough pressure to give nations across the world very little choice but to go along with the bullying legislation, and in excess of 80 nationshave agreed to the law. As Forbes contributor and tax specialist Robert W. Wood explained it, “Cleverly, FATCA’s 30% tax and exclusion from US markets would be so catastrophic that everyone has opted to comply. Foreign financial institutions must withhold a 30% tax if the recipient isn’t providing information about US account holders. The choice is simple, and that’s why everyone is complying.”
In Mr. Garst and Mr. Mitchell’s view, the United States is using FATCA to assert its universal rightto enforce domestic tax laws on the entire world. “FATCA purports to combat tax evasion, using a dragnet-style spying regime that threatens to cost the world far more than it will raise in new revenue for the US government.”
Legislation such as FATCA has posed major challenges to the offshore industry, for which banking privacy used to be one of the central draws to domiciling one’s wealth offshore. But rather than seeing these heightened restrictions and regulations – of which FATCA is just one example – as an impediment to its success in the future, the offshore industry is rising to the challenge and adapting both to changes in the global financial landscape market and changes in clients’ requirements.
“It is important to remember that the offshore industry is a continuously evolving and highly fluid industry,” explains Harneys partner, Colin Riegels. “People talk about an ‘offshore company’ as though it is a static unitary concept, but the ways in which such companies are used evolve rapidly and often.”
Tax planning certainly still features as one of the goals laid out by clients when setting up an offshore company, but as Mr. Riegels points out, “Ironically, most people familiar with the offshore industry will tell you that offshore structures are used less and less for tax planning purposes today.” The irony is clearly lost on FATCA advocates, who are insistent on eliminating what they presumably imagine to be copious loopholes in the global system of taxation. “Modern tax codes simply don’t contain the sort of loopholes that enabled cross border tax mitigation in the way that was possible ten years ago,” explains Mr. Riegels. “However, whatever the true position is in reality, the public perception is that offshore business is mostly (if not entirely) about tax”. Unsurprisingly, politicians take this perception and run with it.
A 2014 Global Incorporation Guide published the very unembellished statement: “While it is true that (legal) tax avoidance can be achieved by placing income and assets in an offshore company, and that tax minimization is a major reason for creating an offshore company, it is by no means the only reason why so many are formed”.
But if tax planning is no longer the most popular reason for forming an offshore company, or for banking offshore, what motivates millions of people around the world who do so? Mr. Riegels explains: “People set up offshore companies for a large number of different reasons, and those reasons tend to shift and evolve over time – sometimes rapidly.” As a partner at one of the largest and oldest offshore law firms, Harneys, who practices BVI, Cayman and Anguillan law, he is well-placed to describe the changes the industry has undergone. “When I first started practicing offshore in the 1990s most structures were heavily tax driven. Now much less of what we do tends to be tax focused, but is increasingly geared towards either regulatory arbitrage or structural flexibility.”
He mentions three jurisdictions that currently relate to his practice: the British Virgin Islands (BVI), the Cayman Islands, and Anguilla. “If you took a snapshot of typical offshore company use for [these] jurisdictions, it would probably look something like this: BVI – holding company structures, joint ventures, private wealth holding vehicles and conduit financing vehicles; Cayman – investment funds, private equity, listing vehicles and also joint ventures; Anguilla – mostly private wealth holding vehicles and conduit financing vehicles, but typically characterized by people looking for a lower profile jurisdiction.”
Increased demand for lower profile jurisdictions is another relatively new change within the offshore industry. In describing the effects of an increasing number of anti-tax evasion campaigns, Mr. Riegels says, “Within the global industry itself this has led to something of a shift, pushing work away from better known jurisdictions towards the lower profile jurisdictions.”
Generally speaking – and Mr. Riegels emphasizes the difficulty in making generalizations about such an enormous country – Chinese clients still tend to see higher profile jurisdictions as more appealing. “Chinese clients seem particularly attracted to BVI and Cayman companies in terms of their offshore structuring requirements. The two features of those jurisdictions which seem to appeal most to clients are the protection of the privacy of their financial affairs, and the higher reputation which those two jurisdictions enjoy as the two premier offshore jurisdictions.”
Offshore companies are used across a broad spread of the market, so generalizations about the most popular types of offshore vehicles used among mainland Chinese clients are tricky, but Mr. Riegels notes, “A lot of the more interesting offshore structures which we see in relation to PRC clients involve cross-border equity investments; either US or other foreign funds investing into China, or (increasingly) Chinese investors seeking opportunities in developing economies.” It isn’t an offshore company per se, but “in relation to the private equity space the Cayman exempted limited partnership has also proved to be an extremely popular and flexible vehicle,” he adds.
Another jurisdiction that benefits from a favorable reputation – both internationally and within China –is Mauritius. Sanjeev K Lutchumun, Director of Premier Financial Services (a fast growing Management and Trust Company which is licensed and regulated by the Mauritius Financial Services Commission) describes the Indian Ocean island’s appeal to investors. “Mauritius, as an International Financial Centre of substance and repute, offers high quality services to investors through its modern and innovative legal framework, qualified/multilingual professionals and a blend of local and international banks.” From the perspective of being a global business platform, the jurisdiction provides both tax and non-tax related benefits, through company formation, trusts and foundations. “Besides low corporate tax there are no withholding taxes on payment of dividends, interests, royalties, no capital gains tax and no exchange control in Mauritius,” says Mr. Lutchumun. “The business activities can range from cross border investments, international trade, fund management and other financial services.”
Of particular interest to Chinese investors is the fact that Mauritius is strategically located at the crossroads of Asia and Africa – both physically and financially. “Chinese investors can take advantage of the number of Double Taxation Agreements (DTAs), Investment Promotion and Protection Agreements (IPPAs), and other bilateral agreements that Mauritius has concluded with some 42 countries,”Mr. Lutchumun points out. Mauritius also has strategic access to Africa by being the only recognized international financial center in the continent and Mauritius’ membership of organizations (including the SADC, COMESA, AGOA and AU) mean that Chinese investors can benefit from preferential market access to Africa too.
Like Mr. Riegels, who has been witness to ongoing changes within the industry – many of which are caused by increased attention on offshore financial centers, and a growing number of anti-tax evasion campaigns – Mr. Lutchumun has also noticed the shifts. “The trend nowadays is for larger economies to impose several measures to counter BEPS (Base Erosion and Profit Shifting),” he explains.“We have seen FATCA from the USA, the General Anti-Avoidance Rules (GAAR) from India – albeit still on hold for the time being – and a similar UK type of GAAR.”As a consequence, local rules and regulations are being tightened up, new laws being enacted, and several different Tax Information Exchange Agreements (TIEAs) have been signed both with emerging and developed economies. “However, it is good to note that Mauritius continues to attract high end quality business.”
Mr. Riegels expressed a similar sentiment, characteristic of the optimism that comes with being associated with highly-reputed offshore financial centers. “Not all of the change arising from the publicity has been bad for offshore business,” he explains. “Imposing and policing higher regulatory standards have been a continuous part of the process of engagement with foreign governments – this has also had the benign side effect of shaking out some of the bottom feeders from the industry, as well as effectively raising barriers for new entrants protecting existing market participants.”
One inevitable upshot of heightened regulationssince the OECD stepped up its campaign against money laundering and tax avoidance is the increased need for compliance function, to the point that it is now one of the largest costs for businesses in the offshore industry.
According to Mr. Garst and Mr. Mitchell, “The OECD is piggybacking on international financial upheaval created by US passage of the Foreign Account Tax Compliance Act (FATCA).” Calling FATCA an assault on fiscal sovereignty by the US that brings “onerous and costly burdens on the global financial sector”, they speculate that the OECD was spurred on by FATCA’s bold demands. In fact, the July 2013 Communiquéat the conclusion of the Meeting of Finance Ministers and Central Bank Governors in Moscowformally recognized that FATCA was a catalyst for a move towards automatic exchange of information in a multilateral context.
But offshore financial centers will not be slowed down by heightened restrictions. They may be faced with added bureaucracy, but this has had little to no impact on the efficiency of processes like company formation. According to Riegels, “There are very few specific requirements for setting up an offshore company in the three jurisdictions which I practice [the BVI, the Caymans and Anguilla]. None of them require persons to be resident or physically present in the jurisdiction in order to set up the company, or to act as director or hold shares in the companies. All countries will typically require a person forming a company to provide basic client identification documents as part of anti-money laundering requirements, but most service providers are pretty efficient at this process.”
In outlining the requirements for setting up an offshore company in Mauritius, Mr. Lutchumun explains that they differ depending on the type of vehicles being set up. “As a general rule, we would require: a) Compliance documents on the principals of the entities which include passport copies, proof of address, bank letter of reference and CV; b) A business plan with three years’ projections giving details of the proposed activities, types of customers, products, services, indication of location of target clients, details on mode of operations.”
There may be slightly more involved requirements for setting up an offshore company than in jurisdictions like the BVI or the Caymans, but according to Mr. Lutchumun,Mauritius offers “more sophisticated products and a high level of service.” The setting up of a GBC1 or 2 Company is still relatively quick and easy, and can take an average of four to five working days to be incorporated, provided all due diligenceprocesses go smoothly.
In terms of setting up an offshore company for a client who doesn’t have highly complex or unusual requirements, Riegels advises, “Normally a company can be formed in 24 – 48 hours. The most common reason for delay on timing is where it takes longer is usually obtaining all the necessary client identification documents to complete the compliance obligations.”
In the spirit of constant change that characterizes the offshore industry, Mauritius intendsto evolve into a regional investment platform and to attract global players to position itself as the gateway to Africa, says Mr. Lutchumun. One of the measures that will be taken in order to achieve this involves promoting “Asset and Fund Managers” products via the introduction of a special Financial Sector Incentive Scheme to attract international asset and fund managers to relocate their front-office to Mauritius. Other measures involve ways in which to boost investments in Africa, including redefining the role of the Mauritius Africa Fund Ltd to focus on Special Economic Zones in various countries in Africa.
Mr. Riegels’ comments on trends and developments in offshore company formation in the jurisdictions in which he works take the form of a somewhat broader prediction: “The offshore space is a continually evolving area. What is true in January of any year may not be true any longer in December, and may not even be true by April. Constant change is really the only ever-present feature. In terms of broader shifts, what I think we have been seeing for some years and are likely to continue to see is increasing regulatory and compliance standards. (This is not limited to the offshore world – I think that is just a feature of modern commerce generally). Like anywhere else, greater regulation means more complexity, and that will obviously operate to the benefit of those who are better able to advise their client base in relation to this evolving complexity, and will work to the disadvantage of those who are less familiar or less experienced with it.”
Both offshore experts also have thought-provoking opinions on one particular trend that is certainly among the most important – not just for the offshore industry, but the global financial world too: the liberalization of China’s currency.
Among the effects of China’s ongoing Renminbi liberalization is Chinese citizens’ improved ability to move money out the country, arguably reducing the need for banking privacy and other characteristically favorable offshore policies. Economists are uncertain what its effect on the offshore industry will be. But rather than see Renminbi liberalization as a threat to the offshore industry, Mr. Riegels expresses optimism for the development. “At its heart, the offshore industry is primarily based upon cross border capital movements. Accordingly, any kind of liberalization which increases the ability of one fifth of the population of the globe to move money internationally can only be a good thing. Some people have made some fairly wild predictions as to how this is likely to affect the industry, and it is always possible that some of the wilder predictions may prove to be correct. But whether it is a mild increase in workflow or a boom similar to what we saw in 1997 leading up to the handover of Hong Kong, only time will tell.”
Mr. Lutchumun echoed this optimism with a healthy dose of confidence in Mauritius’ position. “Having been at the center of continuous growth over the last decades has made China one of the most powerful and wealthiest economies. It has created an abundance of local wealthy families with the constant increase of millionaires and billionaires every month. The new Chinese generation including corporate and High Net Worth Individuals are now on the look-out for international investment opportunities and more value added products and services.We have carefully positioned ourselves to attract this new flow of funds and are expecting a substantial increase of Chinese businesses being structured in Mauritius over the coming years. The relaxation on the RMB will definitely fuel this growth and offer further opportunities to the global business sector in Mauritius.”
There are plenty of interesting trends on the horizon for the offshore industry. The changes it has been forced to undergo by the OECD and FATCO have proven its ability to adapt in the face of adversity. And while the offshore landscape will most certainly face new challenges, we can confidently assume that itwill rise to them, and continue down a path of healthy evolution.
