Event ReportsPublished on Feb 19, 2011
Tax heavens will exist as long as corrupt corporations and looting dictators do. The only way in which tax heavens can be countered is through technological development, and systems like Swift, which increase transparency of transactions, suggested noted investment analyst Mr. K. Arunachalam.
Offshore Tax Heavens: Pirates of Global Finance
Coming hard on the heels of various reports on scams and corruption in the country, the recent disclosures about an exorbitant sum of Indian money stashed away in offshore tax heavens has given rise to much discussion. Mr. K Arunachalam, a banking and investment analyst, made a presentation on "Offshore Tax Heavens: The Pirates of Global Finance";, at the Chennai Chapter of the Observer Research Foundation, on Saturday, February 19, 2011. He opened the session with an account of the history and development of offshore tax heavens, as well as some general characteristics which are (by and large) common to all tax heavens.

Naming the most prominent of them, he pointed out that most tax heavens happened to be former British colonies, such as Hong Kong, Singapore, Dubai, Bahrain and the Cayman Islands. These countries are usually small - both in size and population.  Switzerland, Hong Kong and Singapore are the three exceptions to this general rule. These three countries also have a thriving industry and are well-developed. In contrast, most other offshore tax heavens like the Cayman Islands and the Bahamas depend principally on tourism for revenue (in addition to offshore banking units). As an example, he cited Bahrain, where most banks have a local as well as offshore banking unit. The unit dealing with offshore banking is significantly larger in terms of manpower and business that comes their way. 

In general, most of these nations have an unknown or relatively invisible Head of State. Former colonies of Britain are usually indirectly under British rule -- the people with power in these countries are invariably British. Thus, the UK has a finger in the governance of these nations. With regard to legal systems, civil and commercial laws are very simple and straightforward -- again, with the exception of Switzerland, Hong Kong and Singapore.

The institution of offshore banking began with the flow of illicit money from communist countries in Eastern Europe into London in the 1950's. The demand of the age was for the US dollar, which London banks were able to cater to. This led to the development of the 'Euro-dollar', ie, deposits in US dollars in banks outside the US. The increased use of the Euro-dollar led to the development of the Euro-sterling and the Euro-yen.

Mr. Arunachalam also identified the various purposes for which tax heavens are used - like, for tax-evasion, savings by non-resident nationals of various countries, hiding wealth (since most offshore tax heavens, especially Switzerland, have a very strong secrecy policy), parking of wealth by corporates (an example was that of Enron), speculative transactions involving commodities and currency (Switzerland is especially popular for transactions involving precious metals) and money-laundering. As he pointed out, money-laundering is the practice of engaging in multiple financial transactions in order to obscure the source and destination of illegally obtained money, and the conversion of this money into assets which appear to have a legitimate origin. Since offshore banking units maintain secrecy about the history of the account-holders, they are a popular destination for money launderers.

Certain monetary features are shared by most of these offshore tax heavens. Starting a company in these countries requires only simple formalities. Many of these companies turn out to be one-man enterprises, with a single individual operating alone. Also, the capital required to start an enterprise is very low. There are no regulatory requirements with regard to audits and review of financial statements of a company to establish its credibility. As a result, many of these are 'letter-box companies'. They have no physical presence other than a mailing address.

While most countries have monetary regulations to govern any financial transaction - for example, CRR, legal-lending ratio, these tax heavens have minimal monetary regulations. Switzerland, Hong Kong and Singapore are exceptions to this rule. The central bank in these tax heavens are only a formality and play no real role in the financial life of the country. Unlike the Reserve Bank of India, central banks in tax heavens are not the lender of the last resort, and do not bail out a failing enterprise. If a company does crash, the crash is of major proportions. A defining characteristic of these tax heavens is, of course, that they have very low tax or no tax.

Mr. Arunachalam pointed out that each tax heaven had, over the years, arrived at certain areas of specialisation, with regard to the kind of transaction which is most popular there. The British Virgin Islands mostly deal with offshore insurance. The Channel Islands are popular for trust services and fund transfers, as well as hedge fund operations. Hedge funds are those which are high risk, and seek to 'hedge' some of the risks using method like short-selling and derivatives. Switzerland offers custodial services for hard currencies and precious metals. Since Swiss Banks deal in large scale fund transfers, they are a transit point and destination for money laundering. Hong Kong is well known for its cash dealings, large scale fund transfers and currency speculation. The Cayman Islands and the Bahamas are a popular destination for shell companies. A shell company serves as a vehicle for transactions, but does not have any significant assets itself. In themselves, shell companies are not illegal, but they are an important component of the underground economy. Similarly, other tax heavens have their own specialities. 

It is worth drawing attention to the fact that out of all these countries, only banks in Switzerland and Hong Kong are equipped to handle large cash transactions. Others operate on account-to-account transfers. Most of the funds mobilised are those accruing from tax- evasion, crime, fraud, corruption, deposits of non-residents as well as drug money.

The recent popularity of tax heavens could be attributed to the start of the sub-prime bubble in the US, which later spread to Europe. The ensuing chaos left western governments short of cash, since their priority became spending to bail out investment banks. As a result, they were forced to adopt measures to promote austerity, as well as start looking for alternative sources of funds. This turned their attention to the money stashed away in the tax heavens for the purpose of tax evasion, Mr. Arunachalam said.

The US is also concerned about the potential terrorist risk involved in the existence and functioning of offshore banking units. President Barak Obama is intent on bringing back the money in tax heavens in order to fund public-spending. The figure is put at $ 236 billion. This trepidation has since spread to third world countries after certain European countries (notably Germany) became very committed to getting information for tax heavens. The Organisation for Economic Co-operation and Development (OECD) stated that by March 2010, offshore banking units had to share information about their transactions and account-holders. They even prepared a black list of tax heavens. The list lacked credibility, since the Cayman Islands was excluded. March 2010 passed without any information being obtained, he pointed out.

In reference to the recent allegations that $1.3 trillion of Indian money was being stashed away in offshore banking units, Mr. Arunachalam opined that this figure was exaggerated. By a series of logical arguments, he put forth his estimate of stashed funds at $500 billion. He also pointed out that secrecy is the weapon of these tax heavens, and unlike the US, India is not powerful enough to strong-arm any of the offshore banking units to share their information.

With regard to the future of tax heavens, Mr. Arunachalam opined that they will survive as usual. Opposition to tax heavens is very weak, even in a country like US, as the Republican Party seems to support the presence of tax heavens. Similarly, European and Asian countries also need tax heavens for various expansion and investment plans.

In conclusion, Mr. Arunachalam suggested that tax heavens will exist as long as corrupt corporations and looting dictators do. The only way in which tax heavens can be countered is through technological development, and systems like Swift, which increase transparency of transactions.

The discussion which followed addressed issues such as the effectiveness and importance of Swift, the formation of a Financial Action Task Force, and touched upon the argument that offshore tax heavens or the companies which utilise them are the real pirates. 

(This report was prepared by ArchanaVenkatesh, II MA (History), Loyola College, Chennai)

The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.