A TAX ON FREEDOM

Portfolio International, 3 October 2001

In May 1996, ministers of the member states of the OECD called upon it to “develop measures to counter the distorting effects of harmful tax competition on investment and financing decisions and the consequences for national tax bases.” The years since that call was made have been a testing time for many of the Caribbean nations and the offshore world in general.

The agenda of the OECD was never in doubt. Many of its European members, and to a lesser extent the United States, were being hampered in the collection of taxes from their own nationals by the ease with which the offshore community accepted foreign capital and then shielded its holders. The OECD talked of a “race to the bottom”, in which the tax bases of its member states would be eroded and evaporated by the flight of capital offshore.

The OECD seized the moral high ground, claiming that only drug dealers and tax evaders need fear a realignment of the global taxation system. Similar logic drove other international bodies to join the hunt. A Financial Action Task Force (FATF) on money laundering was empanelled. The Financial Stability Forum (FSF) added its weight, demanding that many of the world’s leading offshore financial centres improve supervision and co-operate with other regulators to avoid being frozen out of the international financial system.

The European Union, the Group of Seven economic leaders and even Britain, by way of a KPMG enquiry, added their weight. The weapons these bodies brought to the battle were reports and lists - and the threat of economic sanctions of the kind used against rogue nations, to bring the often tiny economies of the offshore world to heel.

At first, Caribbean leaders cried foul, claiming that the OECD had a second agenda. “The language was muscular,” said Arthur Owen, Prime Minister of Barbados. “I confess to having added my share of caustic commentary on the issue, as would the leader of any state whose economic livelihood appears to be threatened by the unilateral action of a powerful organisation in which it has no voice or vote.”

Fifteen months ago, when Bermuda, the Cayman Islands and four others caved in to OECD pressure and agreed to do whatever was necessary to assuage the onslaught, it began to look as if the word “offshore” would be consigned to history, a quaint term from the late 20th century, a time before the globalisation of the world economy was completed, when countries were free to set their own national agendas.

Let’s talk about it

In January of this year, the OECD met in Barbados, with representatives of the small and developing economies (SDEs) and representatives of the Commonwealth, Caricom and the Pacific Islands Forum were also in attendance.

An understanding to work together did not move the debate much further forward. In March, a paper was submitted by the SDEs to the OECD, at a meeting in Paris of the OECD-Commonwealth Joint Working Group on Harmful Tax Competition. The letter listed 17 questions, turning the spotlight on Member States of the OECD. Were they all ready to implement their own standards? Who would monitor this process? Would the OECD care to define its terms - specifically “criminal tax matter” and “civil tax matter”?

Also at that meeting, eight of the SDEs formed their own organisation, the International Tax and Investment Organisation (ITIO), as a forum for SDEs to seek international co-operation in areas where the OECD is discussing rules. “(The SDEs) understand that they need to meet high international standards,” said an ITIO spokesman. “And they want to do that. But they want to be properly involved in the setting of those standards. And that isn’t what’s happening at the moment.”

On May 10, with the OECD deadline of July 31 for the publication of its final list of harmful tax jurisdictions and the imposition of sanctions against them fast approaching, US Treasury spokesman Paul O’Neill dropped a bombshell: the US would not support the OECD sanctions.

In explaining the US decision, O’Neill said that Washington was troubled by the under-lying premise that low tax rates are somehow suspect and by the notion that any country, or group of countries, should interfere in another’s decision about how to structure its own tax system.

“Given the lack of agreement within the OECD, the July deadline is unlikely to be met,” said Sir Ronald Sanders, Antigua’s high commissioner to London and his country’s lead negotiator with the OECD. The ITIO, which had by then grown to 11 SDEs, warned against considering the OECD initiative dead.

It was certainly wounded. The US refusal to impose sanctions meant that their imposition elsewhere was unlikely. The OECD had not answered the ITIO’s 17 questions (it still has not). Without a reply, the SDEs indicated that they would not come to the table on any of the OECD’s demands.

The OECD said nothing and the July 31 deadline loomed. On July 18, O’Neill went before the Permanent Sub-committee on Investigations of the Senate Committee on Governmental Affairs to announce a new world order. The OECD was to get its own house in order before it could enforce its rules on anyone else, O’Neill said. The OECD was being “counter-productive”. The US was not alone among OECD members in its views, O’Neill added.

By now, the SDEs had retaken the moral high ground. Prime Minister Owen said: “The power to tax is a sovereign right that cannot be compromised and certainly cannot be yielded to institutions which have no standing in law to determine the tax policies of other countries.”

The Commonwealth Ministers Meeting in Malta in mid-September opened with that statement. The Secretariat spoke of a “virtuous cycle” of job and wealth creation by the 29 of its members who are offshore financial centres.

The July 31 deadline duly passed without the publication of an OECD hitlist. The SDEs raised the volume on their demands to be included in the Global Tax Forum, a body of 55 nations attempting to decide the key issues, from which the SDEs are excluded.

Ralph O’Neal, Chief Minister and Finance Minister of the British Virgin Islands, warned the OECD that unless the SDEs were invited to participate, the OECD would face “the very real danger that the objectivity, quality and viability of the group’s deliberations will be called into question and its output meet resistance rather than acceptance.”

Meanwhile, Cheryl-Ann Lister, the head of the Bermuda Monetary Authority, has warned that Bermuda would not install rules not already in force throughout the OECD. “While it often seems that Bermuda’s response has to be entirely driven by the various international pressures confronting us, the reality is that we continue to set our own agenda,” she said.

Impasse

Not much has happened publicly since the July deadline passed. The ITIO has grown to 12: Anguilla, Bahamas, Barbados, Belize, British Virgin Islands, Cayman Islands, Cook Islands, Malaysia, St Kitts & Nevis, St Lucia, the Turks & Caicos Islands and Vanuatu. The Secretariats of the Commonwealth, Caricom and the Pacific Islands Forum have been granted observer status.

The OECD list of harmful tax jurisdictions remains in play, although it is now down to 30 countries. On the list are Andorra, Anguilla, Antigua and Barbuda, the Bahamas, Bahrain, Barbados, Belize, the British Virgin Islands, Guernsey, the Cook Islands, Dominica, Gibraltar, Grenada, Jersey, Liberia, Liechtenstein, the Maldives, the Marshall Islands, Monaco, Montserrat, Nauru, Niue, Panama, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines, Western Samoa, the Turks & Caicos Islands, the American Virgin Islands and Vanuatu.

FATF, the anti-money laundering arm of the OECD initiative, has switched its focus almost exclusively onshore. Its latest list still includes St Kitts & St Nevis and St Vincent & the Grenadines, but the balance - the Cook Islands, Dominica, Israel, Egypt, Guatemala, Hungary, Indonesia, Lebanon, Myanmar, Nauru, Niue, the Philippines, Russia - shows how much the focus has swung away from the offshore Americas.

Despite the hard political reality that the US is unlikely to declare economic sanctions on Russia any time soon, FATF has issued Russia (and Nauru and the Philippines) with a warning that they would face “counter-measures” if they failed to control their financial systems by September 30.

Bush’s intervention came too late to save many of the smaller economies from rethinking the way in which they operate. With the British preparing for entry to the European Union, its Overseas Territories have had to retool their legislative and regulatory regimes or face the introduction of new laws directly from Whitehall. Other offshore jurisdictions have begun the process of change and viewed it as preparation, hoping that, sooner or later, international capital will find a use for their services.

The due diligence pills have not been easy to swallow. The economic powers have insisted on a new paradigm offshore, one in which identities are more difficult to hide and information more easily divulged. Yet, ironically, all the initiatives have failed to dent the international drug trade, which continues with impunity to find ways of laundering and then burying the proceeds of crime. As long as dollars can be had for a fraction of their value, it seems, individuals and companies will step forward to facilitate the laundering process.

Meanwhile, the offshore world has emerged from the past five years in many ways in better shape. Those countries that bowed to the demands of the OECD now wear its stamp of approval with honour. Those that did not, presumably will not earn the badge. As Bermuda and Cayman wrestle with the effects of increased demands for their services, smaller jurisdictions are better positioned to pick up the next wave of industry that will look to structure in the competitive advantages offshore can offer. No more eloquent statement of those benefits can be found than in German reinsurer Allianz Re’s decision to operate in Bermuda and pay US taxes on profits made there voluntarily.

But the member states of the OECD and other bodies now face a far greater challenge than undeclared income. The advent of e-commerce threatens more directly to unravel their tax bases, as companies trading in cyberspace find national boundaries increasingly irrelevant. A couple of the smaller jurisdictions, notably Anguilla, are exhibiting significant growth and several are looking at e-commerce initiatives, from server farms to improvements in corporate architecture.

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