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Whilst there is no precise definition of what amounts to an Offshore Financial Centre (or OFC), the term is usually meant to refer to low-tax, lightly regulated jurisdictions which specialise in providing the corporate and commercial infrastructure to facilitate the use of those jurisdictions for the formation of offshore companies. Offshore Financial Centres are often (but not always) current or former British Colonies or Crown Dependencies, and often refer to themselves as offshore jurisdictions. Up until the 1980s, Offshore Financial Centres were commonly referred to as "tax havens", although that phrase is not frequently used today. The IMF considers the following to be characteristics of an Offshore Financial Centre: Views of Offshore Financial Centres tend to be polarised. Proponents suggest that reputable offshore financial centres play a legitimate and integral role in international finance and trade, offering huge advantages in certain situations for both corporations and individuals, allowing legitimate risk management and financial planning. Critics argue that they drain tax from wealthy (and not so wealthy) nations, they are insufficiently regulated, and they facilitate illegal tax evasion, money laundering and to avoid legal risk by improperly employing the corporate veil. Proponents point to the tacit support of offshore centres by the governments of the United States (who promote offshore financial centres by the continuing use of the FSC) and United Kingdom (who actively promote offshore finance in Caribbean dependent territories to help them diversify their economies and to facilitate the British Eurobond market). OPIC, a U.S. government agency, when lending into countries with underdeveloped corporate law, often requires the borrower to form an offshore vehicle to facilitate the loan financing. What is certainly true of offshore financial centres is that recently they have attracted a great deal more attention than in the past, and international initiatives spearheaded by the OECD, the FATF and the IMF have had a significant effect on the offshore finance industry. A number of smaller, less regulated jurisdictions literally went to the wall, and closed up shop. Most of the principle offshore centres that remained considerably strengthened their internal regulations relating to money laundering and other key regulated activities. Taxation Although most Offshore Financial Centres originally rose to prominence by facilitating structures which helped to minimise tax, tax avoidance has played an increasingly smaller role in the success of Offshore Financial Centres in recent years. Although most Offshore Financial Centres still charge little or no tax, the increasing sophistication of onshore tax codes has meant that there usually is little tax benefit to moving a transaction structure offshore. Most professional practitioners in offshore jurisdictions refer to themselves as being "tax neutral", referring to the fact that, whatever tax burdens the proposed transaction or structure will have in its primary operating jurisdiction or market, having the structure based in an offshore jurisdiction will not create any additional tax burdens. For example, international joint ventures are often structured as companies in an offshore jurisdiction when neither joint venture party wishes to form the company in the other party's home jurisdiction, but both parties wish to ensure that the company's jurisdiction of incorporation will not attract unwanted tax consequences. Many offshore financial centres used to "ring fence" offshore companies formed in those jurisdictions (International Business Companies formed in the British Virgin Islands is a good example). However, recent international pressure has brought an end to ring-fencing in most jurisdictions, and most Offshore Financial Centres simply restructured their tax codes so that the activity of the offshore companies, whilst technically subject to tax in the jurisdiction, was never likely to result in tax being assessed. Critics of Offshore Financial Centres argue that a lack of transparency in Offshore Financial Centres means that they are vulnerable to being used in illegal tax evasion schemes. A number of international organisations also suggest that Offshore Financial Centres engage in "unfair tax competition" by having no, or very low tax burdens, and have argued that such jurisdictions should be forced to tax both economic activity and their own citizens at a higher level. Another criticism levelled against Offshore Financial Centres is that whilst sophisticated jurisdictions usually have developed tax codes which prevent tax revenues leaking from the use of offshore jurisdictions, less developed nations, who can least afford to lose tax revenue, are unable to keep pace with the rapid development of the use of offshore financial structures. Regulation Most Offshore Financial Centres now promote themselves on the basis of "light but effective" regulation, and generally only seek to regulate high-risk financial business, such as banking, insurance and mutual funds. Many capital markets bond issues are structured through a special purpose vehicle incorporated in an offshore financial centre specifically to minimise the amount of regulatory red-tape associated with the issue. Some offshore jurisdictions have sought to replicate this success with equity issues by forming local stock exchanges, but these have not been a notable success to date. A number of internet-based businesses have recently set up business in offshore financial centres which, whilst lawful in the offshore financial centre, would not be lawful in its target market. These businesses often relate to pornography or gambling. Critics of Offshore Financial Centres suggest that they are not effectively regulated in all areas, and in particular that they are vulnerable to being used by organised crime for money laundering. However, partly in response to international initiatives and partly in a defensive move to protect their reputations, most Offshore Financial Centres now apply fairly rigorous anti-money laundering regulations to offshore business. Some even argue that offshore jurisdictions are in many cases better regulated than many onshore financial centres.* For example, in most offshore jurisdictions, a person needs a licence to act as a trustee, whereas (for example) in the United Kingdom and the United States, there are no restrictions or regulations as to who may serve in a fiduciary capacity. Some commentators have expressed concern that the differing levels of sophistication betweeen Offshore Financial Centres will lead to "regulatory arbitrage",* and fuel a race to the bottom, although evidence from the market seems to indicate the investors prefer to utilise better regulated offshore jurisdictions rather than more poorly regulated ones. Confidentiality Critics of offshore jurisdictions point to excessive secrecy in those jurisdictions, particularly in relation to the beneficial ownership of offshore companies, and in relation to offshore bank accounts. The criticisms are slightly difficult to assess. In most jurisdictions banks will preserve the confidentiality of their customers, and all of the major offshore jurisdictions have appropriate procedures for either law enforcement agencies to obtain information regarding suspicious bank accounts. Most jurisdictions also have remedies which private citizens can avail themselves of, such as Anton Piller orders, if they can satisfy the court in that jurisdiction that a bank account has been used as part of a legal wrong. Similarly, although most offshore jurisdictions only make a limited amount of information with respect to companies publicly available, this is also true of most states in the U.S.A., where it is uncommon for share registers or company accounts to be available for public inspection. In relation to trusts and unlimited liability partnerships, there are very few jurisdictions in the world that require these to be registered, let alone publicly file details of the people involved with those structures. However, there are certainly well documented cases of parties using offshore structure to facilitate wrongdoing, and the strong confidentiality laws in offshore jurisdictions have clearly played a part in the selection of an offshore vehicle for those purposes. Offshore structures The bedrock of most offshore financial centres is the formation of offshore structures. Offshore structures are characteristically involve the formation of an: Offshore structures are formed for a variety of reasons. Legitimate reasons include: Illegitimate purposes include: Ship and aircraft registrations Many Offshore Financial Centres also provide registrations for ships (notably Bahamas and Panama) or aircraft (notably Bermuda and the Cayman Islands). Critics suggest that permitting vessels to fly flags of convenience makes ships more difficult to arrest, and permits the evasion of labour laws applicable to seamen. Similar criticisms are rarely made in relation to aircraft registration for a variety of reasons. Aircraft are frequently registered in offshore jurisdictions where they are leased or purchased by carriers in emerging markets but financed by banks in major onshore financial centres. The financing institution is reluctant to allow the aircraft to be registered in the carrier's home country (either because it does not have sufficient regulation governing civil aviation, or because it feels the courts in that country would not cooperate fully if it needed to enforce any security interest over the aircraft), and the carrier is relucant to have the aircraft registered in the financier's jurisdiction (often the United States or the United Kingdom) either because of personal or political reasons, or because they fear spurious lawsuits and potential arrest of the aircraft (particularly in the U.S. States). For example, in 2003 Pakistan International Airlines, the state carrier, re-registered its entire fleet in the Cayman Islands as part of the financing of its purchase of eight new Boeing 777s; the U.S. bank refused to allow the aircraft to remain registered in Pakistan, and the airline refused to have the aircraft registered in the U.S. Insurance A number of offshore jurisdictions promote the incorporation of captive insurance companies within the jurisdiction to allow the sponsor to manage risk. In more sophisticated offshore insurance markets, onshore insurance companies can also establish an offshore subsidiary in the jurisdiction to reinsure certain risks underwritten by the onshore parent, and thereby reduce overall reserve and capital requirements. Onshore reinsurance companies may also incorporate an offshore subsidiary to reinsure catastrophic risks. Critics argue that attractions of an offshore financial centre in these circumstances include favourable tax regimes, and low or weakly enforced actuarial reserve requirements and capital standards, but evidence that offshore actual reserve requirements and capital requirements are weak or poorly enforced is difficult to come by in an industry that is most effectively regulated by the markets. Proponents of offshore markets suggest that only experienced market participants tend to form offshore affiliates in the insurance market, and this is a very useful way to facilitate arbitrage of risk pricing between insurance and re-insurance markets. In Bermuda the insurance and re-insurance market has grown so large and sophisticated, that it is now the 3rd largest reinsurance market in the world. There are also signs the the primary insurance market is becoming increasingly focused upon Bermuda; in September 2006 Hiscox PLC, the FTSE 250 insurance company announced that it planned to relocate to Bermuda citing tax and regulatory advantages.* Collective investment vehicles Many offshore jurisdictions specialise in the formation of collective investment vehicles, or mutual funds. The market leader is the Cayman Islands (the Cayman Islands have been estimated to home to about 75% of world’s hedge funds, with nearly half the industry's estimated $1.1 trillion AUM), followed by Bermuda, although a market shift has meant that a number of hedge funds are now formed in the British Virgin Islands. By incorporating the investment vehicles (usually an offshore company or a unit trust) offshore, the promoters seek to minimise additional tax complications for incoming investors. But the greater appeal of offshore jurisdictions to form mutual funds is usually in the regulatory considerations. Whilst most well regulated offshore jurisdictions do regulate who may form mutual funds, and restrict the class of investors who may subscribe in the fund accordingly, offfshore jurisdictions tend to impose few if any restrictions on what investment strategy the mutual funds may pursue. Offshore jurisdictions also tend not to limit or regulate the amount of leverage which mutual funds can employ in their investment strategy. This has had the natural effect of pushing more and more high risk funds (particularly hedge funds) offshore. Many offshore jurisdictions (Bermuda, British Virgin Islands, Cayman Islands and Guernsey) also allow promoters to incorporate segregated portfolio companies (or SPCs) for use as mutual funds; the unavailability of a similar corporate vehicle onshore has also help fuel the growth of offshore incorporated funds. SPCs are particularly well suited for the formation of umbrella funds. Banks Traditionally, a number of offshore jurisdictions offered banking licences to institutions with relatively little scrutiny. International initiatives have largely stopped this practice, and very few Offshore Financial Centres will now issue licences to offshore banks that do not already hold a banking licence in a major onshore jurisdiction. The most recent reliable figures for offshore banks (from 2003) indicates that the Cayman Islands is the largest domicile for offshore banks with a reported 580 licensed banks; the Bahamas is second with 301. By contrast, the British Virgin Islands only has 7 licensed offshore banks. List of main offshore financial centres There are a large number of Offshore Financial Centres (by some measures, there are more countries that are Offshore Financial Centres than not), but the following jurisdictions could be considered to be "market leading" jurisdictions for various reasons: See also:The golden triangle Recent developments The European Union has recently made a large number of Offshore Financial Centres (Barbados and Bermuda being the notable exceptions) sign up to the European Union withholding tax and exchange of information directive. Under those regulations, brought into force by local law, banks in those jurisdictions which hold accounts for EU resident nationals must either deduct a 15% withholding tax (which is split between the offshore jurisdiction and the country of the national's residence), or permit full exchange of information with the country of the national's residence. A number of larger jurisdictions which are also sometimes considered as being offshore (notably Hong Kong and Singapore) refused to sign up to the directive. Although recently new, anecdotal evidence suggests that the effect of the withholding tax has been limited, although it is disputed whether this is because the regulations lacked effectiveness, or because the predicted amount of funds in offshore bank accounts transpired to have been greatly exaggerated. Similarly, the widely predicted capital flight to Hong Kong and Singapore appears not to have materialised. It has also been suggested that the regulations implemented were simply too basic, and relatively easy to circumvent in jurisdictions familiar with putting together sophisticated financial structures.* However, a ruling by the Special Commissioners in the United Kingdom in May 2006 indicated that the Revenue authorities can still compel UK based banks to release information in relation to offshore bank deposits where illegality is suspected, even where the customer had elected to pay a withholding tax rather than to exchange information.* | |||||||
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