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Offshore Financial Centres:
OFCs' Response to recent International Initiatives
© 2002 Dr Jean-Philippe Chetcuti. All Rights Reserved.

1. An Introduction to the Offshore World

Definition of ‘OFC’

Used interchangeably with ‘tax havens’, “offshore financial centres” are very difficult to define.  Not only countries which we usually call ‘tax havens’ engage in the provision of offshore financial services.  While London, New York, Frankfurt and Tokyo are among the largest offshore financial centres, none of these deserves the nomenclature of ‘tax haven’. The difficulty of definition is evident from the recent discrepancies present in the various rankings or black lists issued by the OECD, FATF and the FSF[1]

In an attempt to narrow the scope of the definition, many have sought to define an OFC as one where the larger part of the financial service activity carried on is in respect of non-residents.  Nonetheless, in absolute terms more offshore business can be expected to be undertaken through London or New York than the OFCs so more narrowly defined. Then we have problem of categorising centres such as Luxembourg and Switzerland who disliked the “offshore” label given them by the G7 FSF. There are also substantial differences between well established centres such as Hong Kong, Singapore, Jersey, Guernsey and the Isle of Man, which can be compared with Luxembourg and Switzerland in the range and level of financial services provided, and islands in the Pacific which engage in providing financial services to non-residents on a much more limited scale and with a much narrower range.[2]

Nonetheless, one can reasonably think of “offshore” jurisdictions as jurisdictions enjoying a competitive edge based on fiscal or regulatory advantages that differ significantly from those in the major economies.[3]  Irrespective of definition, the trend internationally is to distinguish “not between onshore and offshore centres, but between centres which comply with international standards and those which do not.”[4]

Why go offshore?

Nowadays, offshore financial centres (OFCs) fulfil a multitude of diverse needs, including tax planning, international estate planning, global investing and banking, protection of privacy, facilitation of international business transactions, relief from regulatory burdens, reinsurance, shipping, expatriation planning, and asset protection planning.  Investors who “go offshore” are motivated by any of the following factors:[5]

(1)   OFCs offer countless profit opportunities which make domestic investment look senseless;

(2)   Backed by civil and criminal penalties, strict offshore confidentiality laws ensure financial privacy and secrecy: banking and other financial records are shielded from the national tax authorities, creditors, competitors, ex-spouses and others interested in the investor’s patrimony.[6]

(3)   Tax benefits: while it is illegal to conceal any portion of one’s assets from the government, it is not illegal for one to locate funds beyond the jurisdictional reach of one’s national tax authority.  Zero tax, no tax opportunities as well as tax deferment constitute effective incentives for banking offshore.[7]

(4)   Family patrimonies embedded in asset protection trusts can be protected from litigious attacks by predator plaintiffs, national tax authorities and other creditors, especially in jurisdictions that do not recognise the judgments emanating from the home state.[8]

Features of OFCs

Traditionally, an investor looking beyond his shores based his OFC choice on the centre’s political stability, the predictability and sophistication of its legislative infrastructure, the repute of its judiciary, the reliability of its service providers and professionals, and finally, the soundness of its transport and communications infrastructure.  Aggressive competitive strategies have seen most major OFCs making an effort at satisfying most or all of these investment criteria.  Now, most OFCs boast a level of sophistication in particular areas which is often unrivalled even by some of the principal onshore financial centres.[9]  However, common features which distinguish OFCs from their onshore counterparts are scarce supervision, substandard policy  in the combat against money laundering, deficient tax regime, lack of transparency or deficiencies in international collaboration.[10]

To chisel out a greater competitive advantage, offshore centres allure offshore investment to their shores by developing low-tax or no-tax policies as well as strict secrecy rules.  In times of falling commodities prices and a highly competitive tourist markets, these baptised “tax-havens” proved very capable in economic diversification.[11]  As a result, OFCs flourished and their economies became heavily dependent on their financial services sector.[12]

Offshore banking

The use of a financial institution in a tax-free environment which is essentially free of fiscal and exchange controls is a major incentive for offshore banking.[13] An individual or entity can carry on banking and financial activities in foreign jurisdiction using an established offshore bank.  Alternatively, an individual or entity can form its own offshore bank.[14]

Amongst the advantages enjoyed by offshore banks over traditional domestic banks we find:

n        the unrestricted scope of private offshore banks’ activities (restricted only by their legality) means that they can carry out any imaginable activity: insurance, underwriting, manufacturing, the sale of securities.

n        the high level of confidentiality, often supported by civil and criminal sanctions, (subject only to OFCs various “informal” ways of disseminating proprietary information)[15]

Criteria for offshore fund positioning

Some OFCs have also developed a niche in the field of investment management.  Offshore funds are being used more frequently even by institutional investors seeking to invest on a collective basis but discouraged by the heavy burdens of home state regulation (e.g. US regulation).  In this arena, OFCs also provide a more tax efficient platform for investors worldwide. Offshore funds may also be used in connection with structured financial products as well as offshore variable insurance products.

Offshore fund jurisdictions vary as to:

n        the degree of local regulation;

n        the minimal contacts necessary with the jurisdiction (e.g. resident directors);

n        the requirement to maintain local fund administration;

n        minimum capital requirements; and

n        their status and reputation in the financial community.

Regarding the necessity of minimal local contacts with the jurisdiction, “legitimate” jurisdictions such as Dublin or Luxembourg tend to require the presence of significant local administration and to be stricter in enforcing compliance with international money laundering treaty obligations.[16]

Abbreviations

BIAC

OECD’s Business Investment and Advisory Committee

FATF

Financial Action Task Force

FSF

Financial Stability Forum

G7

“Group of Seven”, Canada, France, Germany, UK, Italy, Japan, US.

IBC

International Business Company

IMF

International Monetary Fund

MS

Member State

OECD

Organisation for Economic Co-operation and Development

OFC

Offshore Financial Centre

2. A changing scenario – international upheaval

 
 

  

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