Detail shots of Money from Cayman Islands

The world’s hidden wealth

Britain leads the world in offshore finance—it must reform its tax havens
Read more: Don't call them tax havens

Scroll to the bottom to see the take of Bronwen Maddox—Prospect's Editor

From Britain’s perspective, the most significant element of the recent Panama Papers scandal was David Cameron’s involvement. Amid the 11.5m documents leaked from Mossack Fonseca, the Panamanian law firm, were revelations that forced him to admit he profited from an offshore trust set up by his late father. Though the reported profits of £19,000 were modest, his involvement with the scheme chimed with a deep unease about the role of elites in Britain and other western societies. The campaign for Britain to leave the European Union is being harnessed to this anti-establishment sentiment.

The other big story for Britons was that Mossack Fonseca’s favourite jurisdiction for incorporating secret shell companies for its clients was not Panama, but the British Virgin Islands. The BVI, alongside other tax havens such as the Cayman Islands, Bermuda and Gibraltar, is a British Overseas Territory. These places—along with Jersey, Guernsey and the Isle of Man, the Crown dependencies closer to home—sport the Queen’s head on their stamps and bank notes. The Queen also appoints their governors or the equivalents, and their laws are approved in London, where their final court of appeal sits.

In the early 1970s the Bahamas, then a British colony, was the dirty-money haven for North and South America—it was a favourite of the mob in the United States. When Bahamian Premier Lynden Pindling led the island nation to full independence in 1973, the offshore money fled almost overnight. “It wasn’t that Pindling said or did anything to damage the banks,” explained Milton Grundy, a lawyer and tax expert. “It was just that he was black.” Most of the hot money went to the nearby Cayman Islands, with its reassuring British-run system.

The offshore world scoops up all sorts of money. There are companies involved in perfectly legal businesses, who base themselves offshore because it’s easier. There are those who want to avoid regulation, or tax. And there are those at the criminal end, who are disguising the proceeds of crime. It is part of the frustration with offshore finance that the lines between these types of money are so blurred and this leads to a curious double game. Offshore jurisdictions want to create an appearance of probity, so as not to frighten those with money—but they also want to keep standards as low and unobtrusive as possible. The classic offshore pitch is therefore that the jurisdiction can be trusted not to steal the money that is deposited there, and that if your line of business is in any way morally dubious, don’t worry—no questions will be asked. A Bank of England internal memo from 1969, marked SECRET, gives a flavour of the attitude: “We need to be quite sure that the possible proliferation of trust companies and banks, which in most cases would be no more than brass plates manipulating assets outside the Islands, does not get out of hand. There is of course no objection to their providing bolt holes for non-residents.”

From the 1970s on, legal offshore finance grew explosively in Britain’s Overseas Territories and Crown dependencies. Previously, tax havens had been dominated by understated, cagey Swiss bankers. Now a more vigorous Anglo-Saxon strain of capitalism took over, which became a central, though discreet, component of financial globalisation. The system expanded and grew ever more complex, with each part serving one or more functions.

It is difficult to measure the size of the offshore system, not least because there is no agreement as to what a tax haven is, and because so much of that world is kept secret. Gabriel Zucman, an assistant professor of economics at University of California, Berkeley, estimates that $7.6 trillion (£5.26 trillion) is held in undeclared offshore funds. James S Henry, a lawyer and economist who advises the Tax Justice Network, a British-based organisation founded in 2003, puts the figure at $24-36 trillion. Zucman also estimates that, as of 2014, Britons held at least $284bn (£170bn) offshore, costing the UK over £5bn a year in lost tax revenues.

First among the parts of the offshore system is the British network: the Crown dependencies and Overseas Territories, as well as a group of more loosely connected Commonwealth tax havens such as the Bahamas and the Cook Islands. Although independent of Britain, their final court of appeal is at the Privy Council in London and they feed huge amounts of money into the City. Jersey Finance, the promotional arm of the island’s offshore sector, says: “For many corporate treasurers, institutional bankers and treasury specialists, fund promoters, brokers and other corporate financiers, Jersey represents an extension of the City of London.” The Caribbean havens predominantly attract funds from North and South America and enhance the profits of many London banks, law firms and accounting companies; the Crown dependencies have more of a focus on Europe, the former Soviet Union and Africa.

A second part of the global haven network is European: notably Switzerland, Luxembourg, Liechtenstein and Andorra for secrecy, and Luxembourg and Ireland for corporate tax planning and wild-west offshore finance. The third part is Asian, primarily Hong Kong and Singapore, as well as the gambling entrepôts of Macau, and Labuan in Malaysia.

A fourth part is the US, a huge player in the creation of shell companies. States such as Delaware and Nevada charge people only a few hundred dollars to set up shell companies to hold assets, so that it is all but impossible to work out who owns either the company or the assets. In addition, the US is refusing to sign up to the Common Reporting Standard, a global scheme for banking transparency set up by the Organisation for Economic Co-operation and Development (OECD). Most major tax havens have been pressured into joining the scheme, which will allow financial information to be shared between countries. But unless the US takes part, people will continue to stash assets there and it will share very little information about them.

Pretty much all the big players mentioned so far are rich countries or their dependencies. But there is a fifth, more eclectic, group of free-floating radicals. These include Mauritius, a favourite of wealthy Indian and Chinese investors in Africa; Liberia (whose offshore shipping registry is actually located in Virginia, near Washington Dulles Airport;) the Seychelles, Belize, St Kitts and Nevis—and, of course, Panama. Over time, each tax haven has found its own niche in this constantly mutating and growing system. One such niche involves corporate tax planning, or rather, the deliberate misalignment of profits away from where real economic activity takes place. The dominant players here are Ireland, Luxembourg, the Netherlands, Bermuda, the Cayman Islands, Switzerland and Singapore. The corporate tax havens justify their activities by saying that they serve as “efficient” and “tax-neutral” platforms to smooth the path of investment and financial flows around the world. They also claim to offer freedom from “double taxation,” where governments tax earned profits once in corporation tax and again in income or capital gains tax.

Yet there are problems with this explanation. First, those tax-services also allow multinationals to avoid tax altogether. Second, it is open to question whether allowing finance—as opposed to trade—to flow unrestrictedly across borders has done the world any good. Here’s a quick example of how multinationals shift profits. Let’s say it costs a multinational company $1,000 to fill a container of bananas in Ecuador; it will sell that container to a supermarket chain in Germany for $3,000. It sets up three subsidiaries: EcuadorCo, GermanyCo and Tax-HavenCo.
"States like Delaware specialise in allowing people, for a few hundred dollars, to set up shell companies"
EcuadorCo sells the bananas to Tax-HavenCo for $1,000; Tax-HavenCo sells them to GermanyCo for $3,000; GermanyCo sells to the supermarket for $3,000. This means that EcuadorCo bought for $1,000 and sold for $1,000, while GermanyCo bought for $3,000 and sold for $3,000: there has been no profit and hence no tax in either place. Tax-HavenCo, however, bought the bananas for $1,000 and sold them for $3,000, a $2,000 profit—but the tax rate in the haven is zero. Hey presto: no taxes to pay!

The real world is more complex than this: there are other ways to shift profits and countries have defences against this stuff. But accountants and lawyers find ways around them, requiring new defences to be devised. In this game of cat and mouse our tax codes become more squirrelly and complex—and ever more lucrative for those able to navigate them.

The world of financial secrecy is a different game. The Tax Justice Network publishes a Financial Secrecy Index (FSI). It has 15 “secrecy indicators” grouped into three main types: plain-vanilla Swiss-style banking secrecy; entities and arrangements (like impenetrable shell companies, trusts, foundations or bearer bonds); and countries erecting barriers to cross-border information exchange, whether by refusing to collect information on locally-incorporated entities, or refusing to exchange relevant data. Each secrecy jurisdiction focuses on one or more of these mechanisms: the Cook Islands, for instance, offers impenetrable offshore trusts; the British Virgin Islands, Delaware, Panama and many others are known for cheap, secret shell companies.

What do these places get out of being tax havens? How can a place that charges no income tax collect any tax revenue? The simplest answer is fees: registration fees to the government, and yet more fees to local private providers for their services.

In tiny Niue, an island state in the South Pacific, its shell company business makes up 80 per cent of the micro-state’s $2m annual budget. The US state of Delaware is bigger: it registers some 500 companies per day and at several hundred dollars a throw, that adds up to $1bn of revenue per year, a quarter of the state’s budget. One building in Delaware is technically home to around 285,000 companies. It is an unsightly yellowish brick low-rise structure opposite a six-storey car park, its modest maroon awning of the kind favoured by pizza restaurants.

A visit in 2009 was described in Nicholas Shaxson’s book Treasure Islands: “I turned up 10 minutes ahead of time, and was buzzed into a reception room, about four yards by four, with an ageing scuffed grey-patterned carpet, two potted plants and light-coloured walls dotted with grease smears. Behind a glass window sat the receptionist, an unshaven man in a baseball jacket who was replaced, soon after I arrived, by an attractive well-dressed young woman in a vivid red coat.”

No tour of the premises was permitted, but a peek through the windows revealed long rows of work cubicles. This was not real business, but low-level, rubber-stamping secretarial work. It was a reminder that so little of what happens offshore is real. New research on the Cayman Islands underlines this, showing that international banks’ claims on the Caymans (their assets) have a value equivalent to 350 per cent of the islands’ GDP.

The Cayman Islands and a few other places focus on more expensive, high-end stuff than shell companies. Annual fees for private trust companies, which help wealthy individuals escape taxes and rules, can start at $35,000.

But when it comes to helping large multinationals, the fees can be higher still. A paper by Omri Marian of the University of California, Irvine looks at Luxembourg’s multinational tax-escape factory. The paper examines Advance Tax Agreements (ATAs, or tax rulings) for multinationals. As Marian explains: “Luxembourg was a tax haven made by administrative practices, not by law. This enabled Luxembourg officials to maintain a façade of a legitimate tax regime.
"What do these places get out of being havens? How can a place that charges no incomes tax get any tax revenues?"
Cameron’s father set up Blairmore in Panama, one of the most opaque jurisdictions in the world. Cameron told parliament that the Blairmore fund was set up when Margaret Thatcher’s elimination of capital controls first allowed UK investors to buy assets denominated in dollars. But Thatcher made it possible to do that business effectively from the UK, so the only reasons to take it offshore would be for tax or other purposes.

In contrast to Panama, the Caymans moved in a different direction: from being a free-for-all in the 1970s, it drew on its British credentials to go upmarket and become the domicile of choice for hedge funds and private equity “vehicles,” mainly from the US. Jersey has done something similar.

Another function of tax havens, involving a different menagerie of players, involves helping wealthy individuals to escape tax. Products such as Luxembourg “insurance wrappers” are designed to circumvent international rules and regulations and are not illegal. For example, offshore discretionary trusts allow the wealthy to separate themselves, technically speaking, from their assets, while allowing for the original owner or their family members to continue to enjoy or control those assets. The “discretionary” part means that the trustees who control the assets after the original owner has “given them away” have discretion to decide which beneficiaries might receive what, how and when. But until there’s an actual distribution you can’t identify any ultimate beneficiaries who are entitled to those assets either, because the trustee may use their “discretion” not to distribute to anyone you might think ought to be seen as a beneficiary. Those assets are in a kind of ownership limbo.

Many jurisdictions offer these kinds of facilities. For British elites, Jersey is probably the jurisdiction of choice.

Corporations use secretive shell companies too. In early May, the campaigning website Global Witness outlined substantial corporate activity in the Democratic Republic of Congo which has its origins in the British Virgin Islands. The damage from all this secrecy, once you start looking for it, is everywhere.

A further function of these offshore jurisdictions is what is euphemistically termed “asset protection”—which to a significant degree means escaping creditors. This can damage market integrity because it creates incentives for people to engage in abusive activity such as Ponzi schemes, financial scams named after the 1920s swindler Charles Ponzi. In these schemes, returns being paid to investors are their own capital rather than legitimately produced profits; to keep things going, yet more investors are needed, until the scheme eventually collapses in a heap of bad debts. A Ponzi scammer who has “given away” his or her assets to an offshore trust does not technically own them any more—so how can creditors get at them and recoup their money? Luxembourg specialises in this: it has resolutely refused, for example, to help the creditors of Bernie Madoff’s fraudulent operation to get redress from its banks, and as explained by Sigrún Davíðsdóttir on Prospect’s website (“Icelanders have never been shy about getting a foot in the door”) it has failed to help the losers in the fraud-infested collapse of Iceland’s banking system.

Davíðsdóttir highlights another function of the offshore world—arguably the biggest in terms of absolute impact—which is the ability to escape from the financial regulations that aim protect against financial disasters. The offshore escapades of the Icelandic banks resulted in one of the costliest per-capita banking busts in modern history. And, as Shaxson has explained before in Prospect (“Don’t call them tax havens,” May), the UK is easily the biggest player in the game of offshore financial regulation. Since the 1960s it has built a business helping Wall Street banks escape financial regulations that were crimping their profits. The UK regulatory authorities’ laissez-faire oversight of these institutions allowed them to take great risks that would not have been allowed back at home. When the Wall Street giants collapsed or were bailed out—AIG, Lehman Brothers, Bear Stearns—it was discovered that much of the most damaging stuff happened in London. As we’ve noted before, AIG Financial Products, the division of the US insurance giant that built up derivatives positions valued at $2.7 trillion, did so while based in an office in Curzon Street, Mayfair.

It is in this context that we need ask how far Cameron has gone in cracking down on tax havens.
"How far has Cameron gone in cracking down on tax havens? Compares to his predecessors he has done a lot"
Compared to his predecessors, he has done a lot. Since the 1970s, financial crises or recessions have led developed country politicians and policy-makers to call for a crackdown on tax havens, or announce the end of banking secrecy. These moves are a reaction to popular anger at economic misfortune. Typically, a return to economic growth removes the public pressure and no effective action is taken.

The recent global financial crisis has proved different in that its effects have endured and public anger has continued to the point where reforms had to be delivered. This has heightened the scrutiny of government policy, and increased the sensitivity to the gap between political rhetoric and the reality of the commitments that are made.

So it is to Cameron’s credit that his government hosted a G8 summit in 2013 that, along with that year’s G20 meetings, made tangible progress against financial secrecy. These events gave the OECD a mandate for three hugely important policies.

First, the OECD was to ensure that multinationals provided transparency about where they make their profits. Companies can no longer scoop up their financial results from different countries into global or regional numbers that cannot be unpicked into their component parts. Now they must break this data down on a country-by-country basis. So far “country- by-country reporting” will only be available to tax authorities rather than to the public but still, it is a significant step.

The second policy is the previously mentioned Common Reporting Standard, which takes effect in 2017. It establishes the multilateral automatic exchange of relevant tax information between jurisdictions as the global standard. This is a dramatic improvement on the OECD’s old standard of exchange “on request” (which meant rarely, if ever—and certainly not if the country requesting information was small and poor.) Once data begins flowing, it will be harder for residents of a given country to hide their offshore income from the home tax authorities. The remaining challenges are the full inclusion of developing countries and ushering the last non-cooperative jurisdictions like Panama and the US into the transparency club.

A third, somewhat limited, area of progress is the UK’s adoption of a public register of the owners and beneficiaries of incorporated companies, which comes into force in June. The UK’s insistence on blocking equivalent transparency for trusts and foundations, traditionally a more important part of secrecy in the English law havens, and a refusal to extend corporate transparency to its Crown dependencies and Overseas Territories, led the French and Austrians to refuse to support company ownership transparency.

The 2013 G8 summit marked real progress. At the same time, however, the UK has gone backwards on the subject of corporate profit-shifting. One particular problem remains the “patent box,” a complex arrangement that uses intellectual property (real or imagined) to divorce taxable profits from the activity that gave rise to them. In addition, the ideological insistence on cutting the corporate tax rate—despite the government’s own compelling estimates that there would be no resulting increase in either business profits or investment—keeps the race to the bottom going. The result has been a redistribution towards top executives and asset-rich shareholders, many, if not most of them, citizens of countries other than the UK.

The judgement on Cameron’s performance should be then, that he has made some welcome if limited progress on financial secrecy; his anti-corruption summit in May introduced welcome new rules banning the use of anonymous shell companies to buy UK property; he has gone in the opposite direction on corporate tax, giving multinationals a huge and unnecessary tax giveaway, and he has gone in the wrong direction on offshore financial regulation.

Ten years ago, corruption was widely seen as a developing country problem, but that moment is long gone. All too often, perceptions of corruption have been perceptions of poverty, tinged with racism. But as protectors of tax havens, we must recognise that we are players in the picture too. The UK has the power (although it never likes to give that impression) to force its dependencies to commit to the following measures: public registers of the beneficial ownership of companies, trusts and foundations; automatic exchange of tax information including with developing countries that may not immediately be ready to reciprocate; and public country-by-country reporting (on the OECD standard) by all multinationals.

If Cameron can help to deliver any of these improvements, it would be a big shift, and bring tremendous pressure to bear on other major secrecy jurisdictions (the US might still need a bigger push.) The UK would need to provide financial assistance to those havens that depend on the secrecy business, but those costs would be tiny when compared to the damage their regimes of secrecy wreak around the world. In any case, much if not most of the measured wealth that the havens such as the Cayman Islands enjoy accrues not to locals but to transient expatriates.

Given that the UK’s network is the single biggest player in global financial secrecy, and the biggest driver of corruption around the world, it is uniquely well placed to act and it has a unique responsibility to do so. A failure to bring the UK network into line would amount to a national embarrassment.

Pointing the finger

David Cameron was right to call the global anti-corruption summit in May in London, even though the proposals were inevitably watered down in advance. He was right to push for more agreement on clamping down on tax avoidance when Britain hosted the 2013 G8 summit. The release of the Panama Papers and Downing Street’s eventual concession that the prime minister benefited from one of his father’s offshore trusts provoked public accusations of hypocrisy. But he hasn’t—until now—been confronted with the even more inconvenient truth that the UK runs a third of these tax havens and is in prime position to tighten the rules.

Whether he can do so will be a test of international co-operation, without which the exercise is futile. But the UK is in an excellent place to take the lead—and has many reasons to do so.

Cameron is right in his objective because collecting tax has become one of the hardest challenges for a modern democracy. You can’t run a country without public finances, and those finances have been strained by lack of growth and by excessive spending, on wars and public services—in layers of promises which have been laid down by successive governments since the Second World War. More strain is coming, in the shape of an ageing population and its entitlements, as they stand now, to pensions and healthcare.

At the same time, international companies and the highly international people who run them have got ever more adept at avoiding taxes, levied by national governments, by moving the jurisdiction in which they deemed themselves to be located. Much of this avoidance complies with the laws of the country in which they operate (and those of the tax havens).

But as Moisés Naím commented in The End of Power, it is one of the reasons why it is so hard to run a government. Ministers go to pull the levers, and find the levers are not connected to anything—nothing that brings in more tax revenue, anyway.

Public anger is rising, driven by awareness of the problem, by austerity, and by a belief that the world’s richest individuals and companies can choose whether to follow national laws, where ordinary people cannot. That anger is helpful for governments in securing change, but can also be a handicap. As the Panama leak shows, people are not inclined to distinguish between legal tax avoidance and illegal tax evasion. Yet the distinction is not meaningless.

But individual governments will not get far on this problem without cooperation. Cameron was not quixotic to pursue this. Many governments share the same problems, and have the same interests on this. However, they are likely to point a finger straight back at Cameron, suggesting that he start by looking at the regime under which Britain and its overseas dependencies operate.

Bronwen Maddox is Editor of Prospect