In the new era of transparency, offshore jurisdictions must offer more than secrecy to attract investors
Offshore investing has garnered a reputation the world over well-founded or not for helping people hide money, whether from taxes, creditors or unwanted inheritors. This idea that offshore jurisdictions peddle secrecy has persisted for decades, with onshore authorities occasionally taking action but not consistently pressuring so-called tax havens to disclose information.
But in the last decade, a movement has gained momentum in onshore jurisdictions to open the books of the offshore world. The global financial crisis in particular drove cash-strapped governments to pursue tax evaders as a means to shore up falling tax revenues.
Although China is not a direct party to many of these reform efforts, Chinese investors with assets abroad will no doubt be affected by the shifting landscape. The reform movement has spawned new international laws and bolstered existing efforts that has some industry watchers proclaiming ?the death of secrecy in offshore jurisdictions.
That may be, but the death of secrecy does not necessarily mean the death of offshore. Offshore jurisdictions can offer Chinese investors advantages beyond secrecy to continue to attract business.
There absolutely no choice any more, you have to plan legitimately on the basis that everything will come out, or there?s no point in doing it, said William Ahern, a principal at industry consultancy Family Capital Conservation. ?The old method of keeping stuff outside your home jurisdiction on the basis that ? wink wink, nod nod, nobody will know ? is really completely finished.
Roots of reform
Many of the present reforms have roots in the 1990s when concerned governments began to investigate offshore money laundering for drug trafficking and terrorism purposes, according to Richard Murphy, director of UK-based Tax Research, a center that serves the non-profit sector. It was only in the late 1990s that the Organization for Economic Cooperation and Development (OECD) issued a report detailing ?harmful tax practices? in tax havens, and the EU issued guidelines on how to handle such matters. Although the initial intention was to combat more serious crimes, these guidelines also promoted standards that would stop the most basic of tax evasion practices.
In 2002, OECD launched its tax information exchange agreement (TIEA) program, providing a framework to exchange information when governments suspect tax evasion or other tax-related crime has occured using offshore jurisdctions. Territories began signing TIEAs in earnest in 2009 when the G20 and OECD adopted the standard for territories to sign 12 TIEAs or incorporate equivalent language in treaties aimed at eliminating double taxation between two jurisdictions in order to be removed from a gray list and put on a white list of compliant countries.
More than 400 TIEAs have been signed since 2009. China has signed such agreements with offshore industry heavyweights including the British Virgin Islands (BVI), the Cayman Islands and Bermuda. If China suspects one of its taxpayers has committed a crime linked to accounts in these jurisdictions, it can follow the rules set forth in the TIEAs to request information on the relevant accounts.
But reformers and those in the offshore industry often disagree about how effective TIEAs are. The reality is that the tax information exchanges are hardly worth the paper they are written on, Murphy said. The standard of evidence a country must provide to obtain information is too high, since the accused tax evader must be firmly linked to the accounts. A tax evader can easily keep their name off an account and instead list a company headed by a trustee or nominee shareholder, which can make it nearly impossible to connect it back to the individual. According to anecdotal accounts, actual exchanges of information are rare, Murphy said.
But Andrew Auerbach, head of peer reviews for TIEAs at OECD, said the system does work in many cases. It strikes a balance between free flow of information and complete lack of information exchange. Yes, you need a certain level of information [to request information], Auerbach said. You need to be investigating someone. The kind of catchword is no fishing expeditions. You cant just guess that maybe there's some information somewhere, [and say] Please give it to me.
The OECD's Global Forum, which administers the TIEA program, is in the midst of a peer review that looks at whether territories are complying with these agreements. The peer review system represents a shift away from the quantitative benchmark requiring jurisdictions to sign 12 TIEAs toward a qualitative evaluation to see whether territories are actually complying or merely affixing their signatures.
Jurisdictions that are not following the rules may suffer on the open market. [investors] want a jurisdiction that is engaged with these efforts, Auerbach said. There's just a cost of doing business internationally, and this is one of them. And if people aren't willing to pay it, I think you've got to be nervous about it.
Free flow
Meanwhile, some governments are pushing to change the industry independently. The EU instituted a savings tax directive in 2005 that requires financial institutions to automatically report any interest income earned abroad by an EU resident. This system of automatic exchange is set to be expanded later this year, Murphy said, but will still exclude income from capital gains and dividends. Those who don't comply are subject to a withholding tax.
The US similarly passed the Foreign Account Tax Compliance Act (FATCA), mandating that foreign financial institutions comply by June 30. FATCA more broadly demands that US taxpayers citizens and residents permitted to work in the US must disclose all foreign accounts or the Internal Revenue Service will institute a 30% withholding tax on all income that is remitted back to the US.
FATCA places the burden of compliance on financial institutions who must implement new systems themselves to ensure the law is followed. Chinese investors can expect to answer a few additional questions from financial institutions seeking to discern whether or not they should be paying taxes in the US. Chinese banks will have to sign this agreement if they want to do business in America, if they want to hold American assets, said Ahern of Family Capital Conservation.
This will mostly result in added intake procedures for new clients, much like those that ensure compliance with anti-money laundering regulations, said Jay Krause, a registered foreign lawyer with Whithers. If you have no US citizenship or green card, if you just answer the additional identification details that will be asked in due course, then it doesn't affect you in the least, Krause said. However, China accounts for 75% of EB-5 investor visas. These are the visas to get a green card?so there are lots of Chinese out there with US connections. Chinese holders of these visas will need to comply with US tax obligations under FATCA or possibly face a US withholding tax.
The future of offshore
Industry watchers disagree on the impact of increased transparency on offshore. Some say there will be little to no change while others, such as Murphy of Tax Research, envision a cataclysmic end to offshore investing.
If we actually get full information exchange, [offshore jurisdictions] have almost no advantage at all, Murphy said. Let's be honest: They only sell secrecy. Without secrecy, countries will be able to see how its residents are avoiding or evading taxes in offshore jurisdictions. They can use this knowledge to institute measures to eliminate offshore tax advantages step-by-step until all or most of that money moves back onshore.
But those who work with or in the offshore industry forsee a far more moderate impact. Onshore jurisdictions are unlikely to relent on new regulations related to transparency, said Nils Johnson, director of market research firm Spence Johnson, which specializes in wealth management and trusts. Undoubtedly, offshore territories will see some capital outflows as they give up secrecy, but not enough to shut down most offshore jurisdictions.
Jurisdictions will need to differentiate themselves through other means than secrecy. You can look between the different centers and the differences between them with secrecy being dead are less great than they were. So now you're looking more at nuanced factors, Johnson said. For example, Switzerland can still tout its vast pool of talent in the financial industry, while Asian jurisdictions like Singapore and Hong Kong attract investors with low tax rates. Strong legal systems will also help attract investors.
Tax shouldn't be your first and only motive, because you'll be disappointed in the treatment you get from your offshore center and provider, Johnson said, when asked what advice he would give Chinese investors. The quality of jurisdiction will carry with it a commensurate quality of providers and people working in the area Seek out quality.
[video=youtube_share;SrQNTlQQpuA]
It is unclear whether China will someday follow suit and institute its own automatic exchange of tax information, along the lines of FATCA in the US, or otherwise try to curb offshore investing. Chinese have used offshore jurisdictions extensively to invest abroad, so it seems unlikely it will institute any laws that would curb their use, Crawford said. For example, many Chinese companies have used offshore jurisdictions to route investments into natural resource ventures in Africa.
[China] will be a slow follower, Crawford said. I don't see China wanting to dampen their ambitions globally. I don't see them wanting to close down these conduits for capital. But as China increasingly gains clout in the global economy, it may be able to impose its own rules that place responsibility for tax compliance on other countries and territories. Other nations could be forced to hand over tax information, just as they have been forced to accept US FATCA regulations.
?The only reason that the Americans have been able to [institute FATCA] is because [nearly one-third] of the world's market cap is in America When you have [one-third] of the market cap, not to mention all of the debt instruments and other US dollar-denominated assets, you can boss the world around, because people can't afford not to have American assets, Ahern said. In 10 years, China may be in the same spot.
Offshore investing has garnered a reputation the world over well-founded or not for helping people hide money, whether from taxes, creditors or unwanted inheritors. This idea that offshore jurisdictions peddle secrecy has persisted for decades, with onshore authorities occasionally taking action but not consistently pressuring so-called tax havens to disclose information.
But in the last decade, a movement has gained momentum in onshore jurisdictions to open the books of the offshore world. The global financial crisis in particular drove cash-strapped governments to pursue tax evaders as a means to shore up falling tax revenues.
Although China is not a direct party to many of these reform efforts, Chinese investors with assets abroad will no doubt be affected by the shifting landscape. The reform movement has spawned new international laws and bolstered existing efforts that has some industry watchers proclaiming ?the death of secrecy in offshore jurisdictions.
That may be, but the death of secrecy does not necessarily mean the death of offshore. Offshore jurisdictions can offer Chinese investors advantages beyond secrecy to continue to attract business.
There absolutely no choice any more, you have to plan legitimately on the basis that everything will come out, or there?s no point in doing it, said William Ahern, a principal at industry consultancy Family Capital Conservation. ?The old method of keeping stuff outside your home jurisdiction on the basis that ? wink wink, nod nod, nobody will know ? is really completely finished.
Roots of reform
Many of the present reforms have roots in the 1990s when concerned governments began to investigate offshore money laundering for drug trafficking and terrorism purposes, according to Richard Murphy, director of UK-based Tax Research, a center that serves the non-profit sector. It was only in the late 1990s that the Organization for Economic Cooperation and Development (OECD) issued a report detailing ?harmful tax practices? in tax havens, and the EU issued guidelines on how to handle such matters. Although the initial intention was to combat more serious crimes, these guidelines also promoted standards that would stop the most basic of tax evasion practices.
In 2002, OECD launched its tax information exchange agreement (TIEA) program, providing a framework to exchange information when governments suspect tax evasion or other tax-related crime has occured using offshore jurisdctions. Territories began signing TIEAs in earnest in 2009 when the G20 and OECD adopted the standard for territories to sign 12 TIEAs or incorporate equivalent language in treaties aimed at eliminating double taxation between two jurisdictions in order to be removed from a gray list and put on a white list of compliant countries.
More than 400 TIEAs have been signed since 2009. China has signed such agreements with offshore industry heavyweights including the British Virgin Islands (BVI), the Cayman Islands and Bermuda. If China suspects one of its taxpayers has committed a crime linked to accounts in these jurisdictions, it can follow the rules set forth in the TIEAs to request information on the relevant accounts.
But reformers and those in the offshore industry often disagree about how effective TIEAs are. The reality is that the tax information exchanges are hardly worth the paper they are written on, Murphy said. The standard of evidence a country must provide to obtain information is too high, since the accused tax evader must be firmly linked to the accounts. A tax evader can easily keep their name off an account and instead list a company headed by a trustee or nominee shareholder, which can make it nearly impossible to connect it back to the individual. According to anecdotal accounts, actual exchanges of information are rare, Murphy said.
But Andrew Auerbach, head of peer reviews for TIEAs at OECD, said the system does work in many cases. It strikes a balance between free flow of information and complete lack of information exchange. Yes, you need a certain level of information [to request information], Auerbach said. You need to be investigating someone. The kind of catchword is no fishing expeditions. You cant just guess that maybe there's some information somewhere, [and say] Please give it to me.
The OECD's Global Forum, which administers the TIEA program, is in the midst of a peer review that looks at whether territories are complying with these agreements. The peer review system represents a shift away from the quantitative benchmark requiring jurisdictions to sign 12 TIEAs toward a qualitative evaluation to see whether territories are actually complying or merely affixing their signatures.
Jurisdictions that are not following the rules may suffer on the open market. [investors] want a jurisdiction that is engaged with these efforts, Auerbach said. There's just a cost of doing business internationally, and this is one of them. And if people aren't willing to pay it, I think you've got to be nervous about it.
Free flow
Meanwhile, some governments are pushing to change the industry independently. The EU instituted a savings tax directive in 2005 that requires financial institutions to automatically report any interest income earned abroad by an EU resident. This system of automatic exchange is set to be expanded later this year, Murphy said, but will still exclude income from capital gains and dividends. Those who don't comply are subject to a withholding tax.
The US similarly passed the Foreign Account Tax Compliance Act (FATCA), mandating that foreign financial institutions comply by June 30. FATCA more broadly demands that US taxpayers citizens and residents permitted to work in the US must disclose all foreign accounts or the Internal Revenue Service will institute a 30% withholding tax on all income that is remitted back to the US.
FATCA places the burden of compliance on financial institutions who must implement new systems themselves to ensure the law is followed. Chinese investors can expect to answer a few additional questions from financial institutions seeking to discern whether or not they should be paying taxes in the US. Chinese banks will have to sign this agreement if they want to do business in America, if they want to hold American assets, said Ahern of Family Capital Conservation.
This will mostly result in added intake procedures for new clients, much like those that ensure compliance with anti-money laundering regulations, said Jay Krause, a registered foreign lawyer with Whithers. If you have no US citizenship or green card, if you just answer the additional identification details that will be asked in due course, then it doesn't affect you in the least, Krause said. However, China accounts for 75% of EB-5 investor visas. These are the visas to get a green card?so there are lots of Chinese out there with US connections. Chinese holders of these visas will need to comply with US tax obligations under FATCA or possibly face a US withholding tax.
The future of offshore
Industry watchers disagree on the impact of increased transparency on offshore. Some say there will be little to no change while others, such as Murphy of Tax Research, envision a cataclysmic end to offshore investing.
If we actually get full information exchange, [offshore jurisdictions] have almost no advantage at all, Murphy said. Let's be honest: They only sell secrecy. Without secrecy, countries will be able to see how its residents are avoiding or evading taxes in offshore jurisdictions. They can use this knowledge to institute measures to eliminate offshore tax advantages step-by-step until all or most of that money moves back onshore.
But those who work with or in the offshore industry forsee a far more moderate impact. Onshore jurisdictions are unlikely to relent on new regulations related to transparency, said Nils Johnson, director of market research firm Spence Johnson, which specializes in wealth management and trusts. Undoubtedly, offshore territories will see some capital outflows as they give up secrecy, but not enough to shut down most offshore jurisdictions.
Jurisdictions will need to differentiate themselves through other means than secrecy. You can look between the different centers and the differences between them with secrecy being dead are less great than they were. So now you're looking more at nuanced factors, Johnson said. For example, Switzerland can still tout its vast pool of talent in the financial industry, while Asian jurisdictions like Singapore and Hong Kong attract investors with low tax rates. Strong legal systems will also help attract investors.
Tax shouldn't be your first and only motive, because you'll be disappointed in the treatment you get from your offshore center and provider, Johnson said, when asked what advice he would give Chinese investors. The quality of jurisdiction will carry with it a commensurate quality of providers and people working in the area Seek out quality.
[video=youtube_share;SrQNTlQQpuA]
It is unclear whether China will someday follow suit and institute its own automatic exchange of tax information, along the lines of FATCA in the US, or otherwise try to curb offshore investing. Chinese have used offshore jurisdictions extensively to invest abroad, so it seems unlikely it will institute any laws that would curb their use, Crawford said. For example, many Chinese companies have used offshore jurisdictions to route investments into natural resource ventures in Africa.
[China] will be a slow follower, Crawford said. I don't see China wanting to dampen their ambitions globally. I don't see them wanting to close down these conduits for capital. But as China increasingly gains clout in the global economy, it may be able to impose its own rules that place responsibility for tax compliance on other countries and territories. Other nations could be forced to hand over tax information, just as they have been forced to accept US FATCA regulations.
?The only reason that the Americans have been able to [institute FATCA] is because [nearly one-third] of the world's market cap is in America When you have [one-third] of the market cap, not to mention all of the debt instruments and other US dollar-denominated assets, you can boss the world around, because people can't afford not to have American assets, Ahern said. In 10 years, China may be in the same spot.
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