Hunting the havens

The age-old art of prospering from the ultra-low taxes of far-flung offshore centres is under threat from a combination of resentful neighbours and the global financial crisis.

FT.com

When Guy Hands, the British private equity tycoon, upped sticks for Guernsey this year, it was a coup for the picturesque island 20 miles west of the French coast. His departure from the UK drew attention to one of the world’s richest and most idiosyncratic states. A remnant of the medieval dukedom of Normandy, it is a dependency of the British crown but prides itself on its autonomy.

Paris or London may be less than an hour by private jet, yet they are a world away from this old-fashioned corner of the British Isles where householders do not need to lock their doors and even Ferraris cannot be driven faster than 35 miles per hour.

But a prosperity built on ultra-low taxes is suddenly under threat from a combination of resentful neighbours and the crisis in the financial system. A month ago, Stephen Timms, a British Treasury minister, delivered a shocking message to the three crown dependencies: Guernsey, Jersey and the Isle of Man. He told them that their corporate tax system – under which many companies pay no tax – was viewed as unacceptably predatory by some European Union states.

Looking out over the picture-perfect harbour in St Peter Port, the capital, Peter Niven, an ebullient former banker who represents Guernsey’s financial sector, says a requirement to levy corporate tax is an affront to the island’s fiscal autonomy. "We are basically being blackmailed into doing it,” he says darkly. "We are not masters of our destiny.”

The harder line being taken by big western countries reflects their hunger for revenues to replenish treasury coffers that have been badly depleted by bank bail-outs and economic stimulus measures. For their part, small offshore centres such as Guernsey are agitated not only at being pushed around but at the sudden jeopardy into which the long-established basis of their livelihood has been put. The outcome of the battle is shaping up to be one of the defining elements of the new international financial order that is intended to emerge from the wreckage of the global crisis.

The States of Deliberation, Guernsey’s parliament, has already decided to "proceed on the presumption of a 10 per cent general rate of corporate tax”. But it is nervously calculating the cost. Although it believes that the vast majority of its finance industry can survive the imposition of the tax, it fears that it could drive some foreign insurance business away to competitors such as Malta.

Its predicament is symptomatic of the latest phase of an assault on tax havens and offshore centres that was triggered last year not only by soaring deficits in big industrialised countries but evasion scandals in Switzerland and Liechtenstein, political changes in the US and a growing emphasis by campaigners on the link between capital flight and poverty in developing countries. Tighter regulation affecting alternative investment funds, including private equity, poses another potential threat.

From the initial skirmishes, Guernsey and the other crown dependencies appeared to come out as winners. Their decade-long attempt to improve regulation and compliance was rewarded by the Group of 20 leaders of the industrialised and developing world in April when they were put on a "white list” of financial centres. Laggards, including Switzerland, were told to give up bank secrecy and become more cooperative, under threat of sanctions.

Yet Guernsey’s tangled relationship with other financial centres is creating problems. In particular, half its bank deposits come from Swiss banks, which allegedly recycle foreign tax dodgers’ cash into other tax havens to get around withholding taxes.

Lyndon Trott, Guernsey’s chief minister, bristles at this supposition. "It is emotive and there is no proof,” he says. But a recently published report into Guernsey’s banking sector by Lord Hunt, a Conservative peer in Britain’s House of Lords, urged the island to reduce its dependence on deposit-taking in response to the global drive for greater tax transparency as well as other threats from the aftermath of the banking crisis. It was "not the performance of Guernsey’s banks or its regulators that is a potential source of difficulty”, he said. "Rather it is the performance in other jurisdictions on which Guernsey relies as a source of funds.”

The G20 campaign is catching jurisdictions such as Guernsey in the crossfire as some of the countries forced to give up bank secrecy, such as Luxembourg and Austria, demand more scrutiny of other means for hiding the ownership of financial assets. Their sights are trained on the anonymous shell companies found in Delaware and some other US states as well as trusts, the tools for transferring and managing assets that have deep roots in Britain and its offshoots. "I hope that those who seek a quarrel with us react just as vehemently to British trusts or the tax legislation of some US states,” Jean-Claude Juncker, Luxembourg’s prime minister, said this year.

For all the myriad legitimate ways in which trusts are used, suspicions about their role in tax evasion run deep. Guernsey, like Jersey, moved a decade ago to improve the regulation of trusts by insisting that information about the beneficial ownership of assets was held on the island. This compromise between transparency and confidentiality makes Guernsey markedly less opaque than many other jurisdictions, but critics want further action to stop evaders slipping below the radar.

Josef Prll, Austria’s finance minister, said recently that if the G20’s anti-tax-haven campaign "remains as lopsided as it is, focusing on banking secrecy only and ignoring anonymous investment vehicles, the only result will be to give the Anglo-Saxon banking sector a competitive advantage at the expense of European banking”.

His suspicions touch on a commonly held view that big governments protect their own offshore centres in an effort to attract capital and support their financial services business. Guernsey and the other crown dependencies channel large sums into the City of London: a net $US333 billion (198 billion, €224 billion) in the second quarter of this year alone.

While big countries dislike their own citizens evading tax, they are often accused of turning a blind eye to the exploits of other nationals. The US banking system sucks in billions of dollars of capital from foreign investors who enjoy both an exemption from tax and a degree of secrecy because America automatically exchanges bank information only with Canada. This loophole was highlighted this year by the leak of a letter in which the Mexican government pleaded with the administration of President Barack Obama to be put on the same basis as Canada to help it identify "tax avoiders and criminals” hiding money in US banks.

Complicity by powerful nations in some controversial aspects of offshore finance has invited scepticism about politicians’ determination to stamp out evasion. John Christensen of Tax Justice Network, a campaign group, says that "nothing short of a political movement comparable to the 19th-century anti-slave trade campaign will put an end to Britain’s dependence on dirty business”.

But the British government – which this year promised "the beginning of the end of tax havens and offshore centres” – has become markedly less supportive of its offshore centres, adding to the strains resulting from the tax and regulatory crackdown and the downturn in financial services that has exposed the fragility of the centres’ tax bases. Tensions with Britain mounted in the Cayman Islands, home to most of the world’s hedge funds, after a spat over borrowing. But they have been most apparent in the Isle of Man, whose credit rating is under review after Alistair Darling, UK chancellor of the exchequer, last month altered a tax-sharing arrangement, in effect slashing the island’s budget by 24 per cent. As Tony Brown, Isle of Man chief minister, sees it: "This situation is clearly extremely serious for the island and unprecedented.”

The financial centres that operate in the last remnants of the British empire face a bleak future, according to Rodney Gallagher, a veteran Foreign Office adviser. "Only those jurisdictions with political muscle or the backing of major states like China seem likely to survive” in the business, he says. Panama, Hong Kong, Singapore, the Gulf states and perhaps Switzerland top his list of survivors, although he thinks the prospects of Guernsey and Jersey are boosted by having deep-rooted accountancy and law firms that will not shift to more accommodating jurisdictions at the first sign of trouble.

Marty Sullivan of Tax Analysts, a US non-profit group, also thinks the two Channel islands will survive, adding: "They have done a pretty good job.” But many of the more peripheral havens will not. "It has always been dangerous to invest in tax havens. Who are these people? Will they be there tomorrow? Will they freeze assets when the banks fail? Who is going to bail them out?” As some tax havens fade away, others will benefit, he says. "Somebody’s crisis is someone else’s bonanza.”

All eyes now are on the fast-growing Asian financial centres. "With the European Union stepping up its scrutiny of European tax havens, wealthy Europeans are increasingly looking at Singapore and Hong Kong as offshore investment centres,” the latest Merrill Lynch Asia-Pacific wealth report says.

Hong Kong and Macao escaped being put on the G20 tax haven "grey” list, instead appearing, after a diplomatic fudge, in a footnote. But they are both putting legislation in place to become more transparent and Singapore has just won a place on the white list. "Among the big players, everyone recognises that what we want is a level playing field,” says Jeffrey Owens, the Paris-based Organisation for Economic Co-operation and Development’s top tax official.

While Asia picks up European clients, Europe’s offshore centres are in turn marketing their wealth management services to the fast expanding number of rich Asian families. Guernsey’s Niven, recently returned from China, reports a positive reception in an Asia where offshore services are deemed to "oil the wheels” of financial centres rather than simply be the "pariahs” they are often seen as in the west.

While Guernsey focuses on attracting the money of the ultra-rich, it is also nurturing a niche as a place where rich people choose to live. British rules have recently grown tougher for tax exiles who want to make regular trips back to the UK, but Guernsey’s light tax regime remains tempting for some – particularly now that Britain, as part of a bilateral deal on tax information, is set to give up the right to tax exiles’ pensions.

The main hurdle Guernsey sets settlers is the wealth to afford its housing, which is steep but not exorbitant by British standards. The 7 million ($US12 million, €8 million) Guy Hands paid for his high-technology house with panoramic sea views was a near-record.

As Britain prepares to levy one of the highest top tax rates in the world, at 50 per cent on annual income above 150,000, Guernsey is seeing a rise in immigration enquiries. "We used to get two or three a year,” says Tony Mancini of KPMG, the professional services firm. "Now it is two or three a month.”

    The push for transparency Cayman Islands: The world’s leading centre for hedge funds has "substantially implemented” international standards on information exchange by signing enough tax information exchange agreements to allow it to leave the Group of 20’s tax haven "grey list” and move on to the tax compliant "white list”. Bermuda: The International Monetary Fund last year identified some failings in its approach to tackling financial crime, although the third largest reinsurance centre has now signed enough exchange agreements to take up a place on the white list. British Virgin Islands: The world’s leading base for registration of global businesses won a promotion to the white list following the signing of exchange agreements but accepts it needs to do more to fight financial crime. Jersey: This centre for banking, fund administration and trusts has been on the white list of tax compliant countries since the ranking was launched in April. The IMF has given a positive verdict on its tackling of financial crime. Guernsey: Like its Channel island neighbour, this specialist in banking, fund administration and wealth management was put on the white list in April. Isle of Man: A launch position on the white list was secured after signing exchange agreements. The banking, investment fund and insurance centre was declared broadly compliant with measures to fight financial crime by the IMF.

Additional reporting by Michael Peel