Memorandum from Sol Picciotto, Emeritus
Professor of the Lancaster University Law School
SUMMARY
OFCs are an endemic source of risk, by their
very nature as providers of services to non-residents. They have
become designer jurisdictions, whose laws and regulations are
crafted to facilitate avoidance and evasion of the laws and regulations
of other countries. Policy towards them has been fatally compromised
by attempting to distinguish between legitimate and illegitimate
uses of offshore. Attempts have been made especially since 1998
to develop a more coordinated international approach towards improved
regulation of the offshore system, but these have several limitations
and flaws. In practice, the procedure for monitoring of compliance
with financial supervision standards is enabling OFCs which are
found largely compliant with such standards to represent the process
as conferring on them a general seal of approval. It was also
mistaken for the campaign against tax havens to be led by the
OECD and directed at small OFCs, since OECD countries are themselves
divided on the issue, and many of them (including the UK and US)
are deeply involved with the offshore system. Hence, they have
been rightly portrayed as hypocritical bullies. It is clearly
time for a new approach to phase out the offshore system, based
on concerted action between all relevant regulatory authorities,
nationally and multilaterally. The UK is in a key position to
take the lead.
1. This submission is by Sol Picciotto,
Emeritus Professor of the Lancaster University Law School. Over
the past 20 years, I have researched and written extensively on
tax havens and offshore financial centres (OFCs), including a
book International Business Taxation (1992). I recently conducted
a three-year research programme supported by the Economic and
Social Research Council (ESRC) into Regulatory Networks and Global
Governance, one of the topics in which was the regulation of OFCs
and tax havens. In the course of my research, I have conducted
interviews with both regulators and private sector professionals
involved with this issue, and visited a number of OFCs, including
the Isle of Man, the Cayman Islands, Dubai, Liechtenstein and
Vanuatu.
2. In my view, OFCs are an endemic source
of risk and instability for the financial system. It is their
very reason for existence which creates these risks. The definition
of "offshore" is the provision of services for non-residents.
Hence, OFCs offer the cloak of their laws and regulations to persons
who are not resident in their territory. The central purpose of
this is to make it possible for such persons to avoid or evade
the laws or regulations of other countries, usually those in which
they are resident. Hence, OFCs by their nature are engaged in
a continual war of attrition on the laws and regulations of other
countries. This has now become a refined and continuous process
since these jurisdictions, which have in effect become captured
by elements of the financial services industry, regularly introduce
new legislation or amendments to their laws, often at the behest
of, or designed by, industry advisers. In effect, OFCs offer a
haven for pin-striped pirates.
3. OFCs are quite open about this, and indeed
are mistakenly supported by some academics and commentators, on
the grounds that they provide "regulatory competition".
Even if a case can be made for competition between countries of
the same or a similar type to attract genuine activities, this
does not apply to OFCs, for two main reasons:
(i) they are generally small countries, so that
financial services and related activities can be a relatively
very large proportion of their GDP; their government revenues
from even very low fees (eg for company registrations) can enable
them to maintain a zero or low direct tax regime, which would
not be possible for countries with larger populations and a more
balanced economy; and
(ii) they offer the cover of their laws to activities
which generally have little or no connection with them.
4. OFCs have acted as a corrosive factor
on other countries' fiscal and financial laws and regulations.
Their existence has led states with major financial centres, including
and especially the UK, to introduce laws and regulations which
effectively make them participants in the offshore system. The
result has been serious distortion of the international allocation
of investment, the undermining of national tax systems, and the
creation of such a high degree of opacity as to create serious
risks for the international financial and monetary system.
5. There has long been a fatal ambivalence
in public policy towards OFCs, due to lack of clear understanding
of their nature. This has resulted in a compromise policy, which
has condoned, allowed, or encouraged "acceptable" types
of offshore activities, while attempting to prevent the "harmful"
aspects, through regulation. There are two major flaws in this
approach:
(i) it is often difficult or impossible to distinguish
legitimate from illegitimate activities and transactions; and
(ii) the same features facilitate and protect
both the purportedly legitimate and the clearly illegitimate activities.
6. The view that some offshore services
are legitimate rests on the assumption that it is acceptable to
try to finds ways of avoiding the law. This argument is made especially
in relation to tax avoidance, and has been strongly made in the
UK, where the view took hold that "every man is entitled
if he can to order his affairs so that the tax attaching | is
less than it otherwise would be" (Lord Tomlin, in IRC v.
Duke of Westminster, 1936). Especially since the 1970s, this attitude
spawned a massive tax avoidance industry, which has poured enormous
resources into the entirely unproductive activity of devising
complex avoidance schemes. Many of these turn out to be invalid
under existing law, others require legislative changes to shore
up the basic principles which they try to undermine. The UK has
now introduced some specific anti-avoidance rules in its tax legislation,
as well as a notification procedure, and there is considerable
support for the enactment of a general anti-avoidance rule, such
as is available in a number of other OECD countries. However,
the cat-and-mouse game of tax avoidance is made much more complex
by the existence of tax havens. They offer the facilities to form
artificial corporate, trust or other entities, which can be used
to manage assets and international transactions, to avoid other
countries' taxes. This greatly exacerbates the problems of the
Revenue. First, the difficulty of finding out about schemes and
arrangements, due to the secrecy rules and lack of information
agreements with havens, makes it very hard to take effective enforcement
action. Secondly, international tax avoidance schemes can take
advantage of loopholes or ambiguities in tax treaties, which it
is difficult and time-consuming to renegotiate.
7. Avoidance is inevitably linked to evasion,
due mainly to the secrecy offered by havens. While all countries
accept commercial, banking and professional confidentiality, most
place limits on this, both for the protection of the public, and
especially for the purposes of law enforcement, including tax
laws. Havens create an opaque smokescreen by:
(i) allowing formation of entities such as "international"
companies, with no or minimal information required about directors,
shareholders or beneficial owners;
(ii) reinforcing confidentiality rules by special
laws criminalising information disclosure eg by bank employees;
and
(iii) offering no or very limited provisions
to obtain information for the purposes of enforcing other countries'
laws.
8. Tax havens and OFCs are virtually synonymous,
for several reasons:
(i) tax liability has a direct and significant
impact on competitiveness, so that arrangements to avoid other
types of regulation are usually combined with tax avoidance;
(ii) financial engineering is central to tax
avoidance, since it is very easy to create notional and essentially
fictitious entities and transactions to organise and route financial
flows; and
(iii) it is difficult to counteract avoidance
techniques based on financial engineering using standard methods
such as taxation of Controlled Foreign Corporations (CFCs), since
it is hard to distinguish between "active" and "passive"
income from financial services.
Consequently, all OFCs are also tax havens,
and most tax havens are or have ambitions to become some type
of OFC.
9. It is by now well-known that the secrecy
offered by the offshore system facilitates money-laundering. This
runs the whole gamut of concealment of illicit funds, ranging
from tax avoidance through bribery and corruption to terrorist
financing. I am sure that the Committee will receive ample evidence
detailing the extent of these funds. I will therefore limit myself
here to stressing once again the point that it is in practice
impossible to distinguish the clearly criminal from potentially
legitimate flows, and that in practice all funds using OFCs should
be regarded as tainted. Practitioners in and defenders of OFCs
like to give examples of legitimate uses, such as enabling confidential
family estate planning. However, such activities can easily be
done without resorting to OFCs. As already stated, all jurisdictions
protect legitimate financial confidentiality. There is no good
reason why legitimately confidential transactions should not be
done in jurisdictions which accept a high level of financial transparency
for regulatory purposes.
10. Some steps have been taken to try to
establish such transparency. OFCs have been put under considerable
pressure to implement the Recommendations of the Financial Action
Task Force (FATF) on anti-money-laundering and countering the
financing of terrorism (AML-CFT). Since 1998 also, the Financial
Stability Forum (FSF) has established a Compendium of Standards
and Codes for all financial centres, including the FATF Recommendations.
Compliance with these standards is monitored by the International
Monetary Fund (IMF), in conjunction with the World Bank and the
FATF, under the Financial Sector Assessment Programme, which operates
a rolling programme of Review of Standards and Codes (RoSCs).
Although this is a laudable effort, it suffers from several major
flaws, in particular:
(i) it requires considerable resources to conduct
Reviews even every four to five years;
(ii) it relies, especially for the AML-CFT component,
essentially on a "peer-review" process, which tries
to use poachers as gamekeepers, and tends to reinforce views from
within the existing system;
(iii) the IMF has rejected the use of "black-listing"
which proved a very effective means of improving compliance when
applied by the FATF; although this is admittedly a crude method,
no alternative such as a compliance scoresheet or ranking has
been introduced; and
(iv) finally, it does not include compliance
with international tax enforcement standards.
This means that jurisdictions which have been
found to be compliant or largely compliant in a RoSC can in effect
use it as a seal of approval.
11. The campaign against tax havens has
been led by the Committee on Fiscal Affairs of the Organisation
for Economic Cooperation and Development (OECD-CFA), working in
tandem with the EU's Code of Conduct group. This has also been
flawed in several key respects. The main problem is that the OECD
is the wrong forum, even though the OECD-CFA has considerable
resources and expertise. The OECD countries have themselves been
divided, especially as they include the leading financial centres,
several of which are lynch-pins of the offshore system. Thus,
Switzerland and Luxembourg continue to offer minimal levels of
transparency in tax matters. However, other OECD financial centres
are also significantly deficient. In particular, both the UK and
the US allow payment of interest gross to non-residents without
requiring any notification of payee details, so that they are
not able to supply such information even to treaty partner countries.[349]
Proposals to introduce notification of such details were shelved,
apparently due to fears of a large outflow of portfolio capital
and bank deposits. Thus, the OECD campaign was easily and to some
extent validly portrayed as a form of bullying of small countries.
This led to the establishment of a Global Forum, which has attempted
to develop "level playing field" standards. This effort
is greatly hampered by the refusal of some key countries to participate,
such as Singapore and Dubai. Overall, little progress has been
made. Although many havens made "commitments" to introduce
some transparency, few tax information exchange agreements (TIEAs)
have actually been negotiated. This confirms that it was a mistake
to abandon the initial intention to establish a multilateral framework
for cooperation, since the pursuit of an adequate network of bilateral
TIEAs would be a never-ending task.
12. It is clear that a new approach is needed.
It must begin with a firm policy commitment to tackle all aspects
of the offshore system. This must be done in a fully joined-up
manner between all relevant authorities and agencies, both at
the national level and multilaterally. Much can be done by authorities
in the OECD countries themselves, using their own powers and resources,
especially as they are the hosts for the leading financial centres.
In particular, they could obtain more extensive reports from banks
on international financial transactions with an offshore component,
and make such available to all relevant regulators, including
the tax authorities. Some have begun to do this. Notably, Australia
has established the AUSTRAC (Australian Transaction Reports and
Analysis Centre) database, including data collected under AML
legislation, which is more extensive than in most other countries.
Importantly, officials of the Australian Tax Office (ATO) have
direct access to this database, which is exceptional, perhaps
unique, even among OECD countries. This enables the ATO to make
systematic analyses of currency flows, to identify possible suspicious
transactions. The UK is in a key position, both because of the
importance of the City of London as a centre of global finance,
and because very many OFCs are British Crown Dependencies, Overseas
Territories, or Commonwealth countries. In fact, the initial emergence
of OFCs took place with the connivance and even encouragement
of some parts of the UK Government, especially the Foreign and
Commonwealth Office (FCO), despite concerns voiced by the Inland
Revenue. The FCO's proved a very short-sighted policy, which we
should now do everything we can to reverse. We can and should
take the lead in a renewed drive to end the offshore system.
I would be happy to amplify or provide further
details on any points made in this submission, and to give oral
evidence if this would assist the Committee.
19 June 2008
349 However, the UK has introduced regulations in compliance
with the EU Savings Directive, for individuals (not companies)
who are resident in EU or other "fully reportable" countries:
Reporting of Savings Income Information Regulations 2003 (Statutory
Instrument 2003/3297, as amended) which came into force on 1 July
2005. Back
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