On or Off?

Dividing the world into onshore and offshore financial centres is ''a matter of degree, not substance,'' says one European bank regulator.
Joanne RamosMarch 1, 2007

What exactly is an offshore financial centre? At its broadest, it is any financial centre that takes in a large chunk of foreign funds — in other words, almost every financial capital in the world. Much of the business conducted in places such as New York, London or Hong Kong is from outside America, Britain or China.

Britain is arguably one of the biggest personal-tax havens in the world. So-called “resident non-domiciles” — people who live in Britain but claim domicile abroad — do not have to pay tax on offshore income. America, for its part, soaks up huge amounts of offshore cash because it taxes little of the money held in its banks by non-resident foreigners. Foreigners’ bank deposits in America add up to $2.5 trillion, well over twice as much as those in Switzerland.

But as most people understand the term, “OFC” means a smaller jurisdiction where the lion’s share of the institutions are controlled by non-residents and many of them are in the financial sector or set up for financial reasons. The volume of business conducted by these financial institutions often far outstrips the needs of the local economy.

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When OFCs combine all these attributes with a low- or no-tax regime they are tagged as “tax havens”, especially if they also have strict banking-secrecy rules, light supervision and a slack grip on business within their borders. Panama, for instance, still allows bearer shares that can be anonymously owned and traded.

The Financial Stability Forum (FSF), a group that monitors threats to the global financial system, has put together a list of 42 jurisdictions that it defines as OFCs. The OECD in 2000 compiled a narrower list of 35 tax havens. There is a great deal of overlap between the two.

Dividing the world into onshore and offshore financial centres is difficult because “it is a matter of degree, not substance,” says one European bank regulator. For example, many people consider Bermuda an OFC, but it is packed with actuaries pricing reinsurance risks. Jersey, where the financial sector accounts for over half of all tax revenues, is home to a sophisticated banking industry, co-operates with other governments on tax matters and requires banks and other licensed institutions to have a “real presence” on the island.

More confusingly, some jurisdictions straddle both categories. One example is Luxembourg, a tiny country sandwiched between Belgium, France and Germany and one of Europe’s most important financial centres. A founder-member of the EU, Luxembourg is considered a well-managed, soundly regulated financial centre with real expertise. It is home to more than 2,200 investment funds with almost €1.8 trillion under management. It is also the euro zone’s biggest private-banking centre. The financial-services industry contributes a third of Luxembourg’s output and, including its indirect contribution (accountants, lawyers and the like), supplies around 40 percent of Luxembourg’s tax take.

Luxembourg is sometimes lumped with tax havens because of various scandals involving companies based there, including the notorious BCCI and, more recently, Clearstream. But although Luxembourg got most of the bad press, BCCI was operated out of London and Clearstream is mainly a French affair.

Ireland and Singapore are big in manufacturing but also have thriving financial centres that cater to offshore business. Singapore has strict rules on banking secrecy and does not consider foreign tax evasion a crime. Some people consider Switzerland as a tax haven because of its low tax rates and its fabled banking secrecy.

But onshore economies can be opaque too. A report issued by a government agency in America last April found that few states collect information on the true owners of companies set up within their borders. Delaware and Nevada are particularly lax.

Mr Owens at the OECD prefers to differentiate between well and poorly regulated financial centres rather than onshore or offshore ones. Well-regulated centres co-operate with foreign tax and other authorities and have sound supervision; poorly regulated ones hide behind secrecy. Low or no taxes on their own, says Mr Owens, do not constitute a harmful tax practice.

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