The OECD is stepping up efforts to force offshore jurisdictions to toe its line on information sharing and taxation. But as Nick Kochan reports, smaller jurisdictions resent being targeted while OECD members such as Luxembourg and Switzerland appear to escape such censure.

Pressure is building on the global offshore system to conform with on-shore standards of information sharing, or risk being frozen out of the financial community. The threats are familiar, but they come with added ferocity as mainstream regimes take desperate measures to shore up their failing pension and tax systems.

The renewed war on the offshore world is waged with topical slogans such as the “fight against terrorism”, “global security” or even simply “globalisation”. Those pushing them demand that some 40 jurisdictions, deemed offshore, conform to standards of transparency and freedom of information or pay an ever rising price to maintain their particular culture of privacy and freedom from punitive taxation.

Scorn verging on contempt colours the attitude of Liechtenstein lawyers to the new pressures. Ernst Walch of lawyers Walch and Schurti of Vaduz, says: “[France and Germany] believe in their tax laws, they don’t want to change them and they don’t want countries like Liechtenstein to provide alternatives. Instead of changing their system they want others to accept their tax system.” Mr Walch regards international blacklists of low-tax jurisdictions as not merely irrelevant but also largely unenforceable.

The offshore locations are no less scornful of claims that the offshore world is a den of thieves and tax evaders. Otto Hasler, prime minister of Liechtenstein, says: “We believe that fighting criminals and criminal acts is possible while also having a liberal legislation and safe-guarding the legitimate right of every citizen to his privacy. We believe privacy in financial matters should be respected at all times.”

Bryan Jeeves, a local financial adviser, confirms the country’s tough stance on money laundering and tax evasion: “The financial centre of Liechtenstein is not large, it would be impossible to launder enormous amounts of money. And any enormous amounts of money that have been caught in the past have either come from a London or Swiss bank. If you talk about money laundering, there is more money laundered in New York and London than anywhere else, because there is a marketplace that can do it.”

The pressure to enforce on-shore legislation is directed at the offshore jurisdictions from several directions. First, multi-laterals are seeking to make life harder for individual states, who refuse to implement legislation which requires them to exchange information with other countries on the tax and financial affairs of individuals and countries that operate within its jurisdiction. The Organisation for Economic Development and Co-operation (OECD), for example, supervises efforts to control standards in the fight against money laundering and corruption, and has created a blacklist of offshore states that will not play ball with its efforts to implement so-called “exchange of information” treaties.

The non-compliant trio

This blacklist of so-called non-co-operative states currently has just three members – Liechtenstein, Andorra and Monaco. Marshall Islands and Liberia were blacklisted until August, when they were both removed on the grounds that they had agreed to co-operate with the OECD. But the organisation has a secondary list of 35 states, mostly offshore, that it is seeking to push into signing agreements that conform with its policies.

The next ominous warning comes from the US. Countries that have failed to sign up to “exchange of tax information” treaties are put on a list by a group of powerful US senators, including presidential candidate Senator Barack Obama and Senator Carl Levin. The list includes not merely the usual suspects among offshore havens, but also Singapore, which is increasingly winning respect (in parts of the wider financial community) as a jurisdiction prepared to stand up to the wider onshore community.

According to one observer: “Anybody appearing on the list would suffer negative consequences and there would be negative assumptions made against transactions with these countries. The list would be managed by the US Treasury, which would put people on or off it.”

Onshore countries use lists to make life more expensive for companies, individuals and institutions operating or domiciling themselves (for legal or tax purposes) in the jurisdiction and doing business with the on-shore country. Spain, the Nordic countries and Canada have recently stiffened the penalties for countries on their blacklists. No less than 24 countries now operate blacklists of offshore jurisdictions.

Offshore jurisdictions face attack from a number of directions. The imposition of a tax on exports is one route. Another is the penalising of companies created by a company with an onshore presence, to take advantage of a jurisdiction’s tax arrangement. Such companies are typically described as controlled foreign corporations (CFCs). CFCs provide a useful revenue stream to offshore jurisdictions.

The UK, Sweden, Australia and New Zealand seek to deter companies setting up CFCs in some low-tax jurisdictions by denying them tax deferral. Dónal Godfrey, a spokesman for the OECD, explains: “In the UK, the foreign profits of a subsidiary operating abroad are not taxable on a current basis. The subsidiary is only taxed when those profits are repatriated to the UK.

“Exceptions are applied to CFCs operating in low-tax jurisdictions where the company does not carry on an active trade or business. If it is only in receipt of passive income, many OECD countries apply CFC provisions, so passive income is taxed on a current basis, not when dividends are repatriated. Home country tax is deferred until the dividends are repatriated. This is regarded as tainted income.”

Andorran pain

While many countries are targeted by blacklists, one has suffered out of proportion to its size and importance, say observers. This is Andorra, where prime minister Albert Pintat, says: “We are losing a lot of opportunities because we are not able to export our services without a huge charge. If a local businessman wants to export services to France and Spain, his services will be taxed at 33% in France and 25% in Spain, which makes them un-competitive. This is because of the blacklist. This is because we are considered a tax haven. Our economy is not designed to counter this.”

This list, like so many of these arbitrary collections of names and institutions, has perverse consequences. So the OECD’s blacklisting of Andorra has undoubtedly hurt the country’s smaller companies. The larger companies, however, have simply relocated themselves over the border in France or Spain, and thus can take advantage of the new nationality to avoid the punitive tax regime.

Mr Pintat says: “Andorran companies have to cut themselves off from Andorra, and pay taxes to Spain. Then they are treated like a European firm. This is becoming intolerable for us. Our neighbours are asking us to change. We want Andorran companies to pay moderate taxes here, rather than go abroad.”

This tiny state in the Pyrenees mountains has existed for many decades without imposing a tax burden on its companies or individuals. But now it has bowed to pressure from the OECD’s list-makers by agreeing to introduce the bureaucracy of tax raising. This will be paid for out of the taxes raised from corporations, which is expected to be 7.5% on profits. The country is also introducing a value-added tax regime.

Reputational damage

Lists are designed to hurt a reputation as well as its income. According to Nicholas Bray, the head of communications at the OECD: “We are not going to invade Liechtenstein or Monaco. But there is the question of the international reputation of these places. Do they wish to form part of the responsible international community. They have chosen to go it alone. It is up to individual countries to consider if they wish to introduce measures that will in some way restrict the attractiveness of the firms and individuals who operate under their jurisdiction.”

Liechtenstein is particularly concerned to burnish a reputation which has taken some knocks from financial scandals. This small country hidden away in the Alpine mountains between Switzerland and Austria is famous for a tax and legal structure, called the Foundation. This is designed to enable families to perpetuate the transfer of wealth across generations. But the calm and general sound management of the prosperous retreat was broken in 2000 when the German magazine Der Spiegel showed that Liechtenstein companies were used to secretly fund German politicians. The Financial Action Task Force (FATF), an intergovernmental body, jumped to the conclusion the country was corrupt, and immediately added it to its money laundering blacklist.

In fact, Liechtenstein mounted a rear-guard action to extract itself from the blacklist, involving a heavy lobbying campaign in London and New York and the passing of anti-money laundering legislation that is tougher than that in many onshore jurisdictions. The campaign was notably successful and resulted in its removal from the FATF list two years later.

Liechtenstein is now determined to extract itself from the OECD’s list of non-co-operative tax jurisdictions. Mike Lauber, director of the Liechtenstein Bankers Association, says that the country is often perceived as “a jurisdiction where fraud can be perpetrated”.

He adds: “This is not right, but we have to work on it. Reputation is the number one factor in the financial sector. Good reputation allows you to build credible and sustainable business strategies and get new customers. Therefore we are very sensitive to even small-scale problems. We learned the hard way that you lose reputation in a second and you need years to build it up again.”

It stresses the point that it is cleaner than many on-shore countries. In August, Liechtenstein opened a money-laundering investigation into dubious payments from the German engineering group Siemens.

Double standards

The offshore jurisdictions have learnt to turn the reputational sword to their own advantage, claiming the OECD operates double standards. They make the point that Switzerland, Austria and Luxembourg do not comply with the rules on transparency required by the OECD, of which the three countries are all members. According to John Christensen, a noted critic of the offshore havens and the chairman of Tax Justice Network: “The smaller jurisdictions have been remarkably effective in arguing the case for a level playing field that would not put the small islands at a competitive disadvantage to the mainland competitors.”

Hypocrisy by large countries that can afford to tread on the toes of the small jurisdictions is the key charge made by many offshore regimes. Josep M Francino Battle, a spokesman for the government of Andorra, and the country’s chief liaison with the OECD, says: “They should not be tough with one country, and not tough with another. The OECD is treating Andorra differently to countries that are inside the OECD. If banking secrecy stays elsewhere, why shouldn’t it stay in Andorra? Luxembourg and Switzerland have bank secrecy. The better question to ask is: does bank secrecy have a future in the world?”

Andorran prime minister Mr Pintat continues: “They put us on the list because we are a small country, but we are not obsessed with it. We don’t like it. They decide who are in and who are out. We are working to be out. This path is not easy.”

Monaco’s Counselor for Finance and the Economy, Gilles Tonelli, puts the matter straightforwardly: “Monaco considers that OECD countries are treated differently from non-OECD members, some of the former still having bank secrecy law that prohibit exchange of banking information. Moreover, centres such as Singapore and Hong Kong were not participants in the initiative.

“This prevents the entire operation to be undertaken on a level playing field. Due to its small and fragile economy, Monaco will not be the first country to engage and put in place exchange of information.

“Furthermore, there has been no evidence that the offshore countries that committed to exchange information have put their commitment into practice. Some of them need to change their law to do so. When there is a real global level playing field, exchange of information could be considered.”

The OECD’s Mr Godfrey says this is a recipe for inaction and defiance of the OECD’s high principles: “The level playing field cannot be a pre-condition, otherwise there would be no progress. If everybody says they were not moving until the slowest guy in the pack moves, then nobody ever moves.”

Yet Mr Godfrey is forced to admit that Switzerland fails to comply with the OECD’s standards, which require respect for domestic civil and criminal law of jurisdictions requesting information. He says: “Switzerland used to have a very narrow scope for exchange of information, but it has now begun to negotiate treaties with a number of countries which allow it to exchange information to apply the domestic law of the country making the request. It is still only in criminal matters in some cases.”

Switzerland is equally wayward in applying the OECD rule that tax authorities should have access to banking information for all civil and criminal tax matters. Mr Godfrey says that Switzerland “doesn’t currently apply the principle and it does not exchange information in all of those circumstances, but it has agreed that this is the ideal standard to which countries should aspire. Members countries would hope that it is working to this standard. It hasn’t reached that standard. There is progress, it is incremental progress. Most OECD countries would prefer that it did more, and in time they expect that it will do more.”

Financial middlemen clampdown

Meanwhile, the OECD is stepping up pressure on what it considers unfair tax practices and tax evasion by launching an investigation of financial intermediaries who participate in offshore tax structuring. Some observers fear that the OECD intends to create a blacklist of financial intermediaries, not dissimilar to the list of non-co-operative jurisdictions. According to Chris Davison, a former deputy director of the UK Revenue’s Special Compliance Office, who heads the OECD team: “If people are not paying tax, which Revenue bodies expect to be paid, the Revenue should draw it to the attention of the policy makers so they can change the law. If tax is not being paid because people have engaged in legally effective tax minimisation arrangements, which weren’t intended to be available, the Revenue should point this out to the politicians, to decide if the law should be changed.”

Grace Perez-Navarro, an OECD official, denies that yet another blacklist is in the offing: “We do not intend to have a name-and-shame list of financial intermediaries. Our intention is to explore the role of tax intermediaries and this includes financial institutions. We are looking at both the positive role as well as the less positive role, in terms of aggressive tax planning.”

The refusal of the offshore community to fall in with the demands of the on-shore world is testing the patience of the OECD and its members, claims Mr Godfrey. He says: “We have spent the past four or five years working out principles and trying to agree a framework within which people agree to move forward. For the most part, the approach has been a very co-operative one. Now countries are showing signs of impatience on the negotiation front.”

The OECD’s bark is a lot worse than its bite and offshore jurisdictions would be well advised to maintain the cool indifference they have shown in the past. That will see them through this particular bout of bureaucratic hyperactivity and enable them to recede into invisibility where they are happiest and work best.

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