Tax havens under attack

This is my latest cover story for Fund Strategy magazine. It is written mainly from the perspective of British taxpayers and investors. I hope to write a more political article covering some of the same themes before too long.

Until recently investors could make a cardinal distinction between tax evasion and tax avoidance. Evasion was, by definition, illegal. It meant concealing income from the authorities as a way of circumventing tax obligations. Such action was and remains a criminal offence.

Avoidance, in contrast, referred to legitimate tax planning. At its simplest it could involve the use of Isa allowances to minimise the tax payable on savings or investments. It was not only legal but the government created the tax shelter as an incentive to invest.

More elaborate schemes were considered legal if they did not contravene any law. For example, investors could set up elaborate legal structures in offshore jurisdictions to minimise their tax liabilities. If the tax authorities were unhappy with such arrangements they could take action to close the loophole. But in broad terms any measures that respected the letter of the law were regarded as legitimate.

That situation has changed fundamentally in the last few years and indeed even in recent months. Even those who have respected the law have been heaped with moral derision. The targets for such attacks range from international companies such as Amazon and Google to wealthy individuals such as Jimmy Carr, a comedian. Although it is acknowledged that they have obeyed the law they are often treated as moral lepers.

Such criticisms are not the preserve of a few campaigners or journalists although these do exist and they are entitled to express their views (see box one). On the contrary, they originate at the highest political levels. David Cameron, for instance, publically criticised Jimmy Carr for using an entirely legal Jersey-based avoidance scheme. Meanwhile, George Osborne used his 2012 budget speech to describe “aggressive tax avoidance” as “morally repugnant”.

This moral offensive has had important practical consequences. The government has in effect redrawn the legal distinction between evasion and avoidance. Even those who have not set out to break the law can be accused of aggressive avoidance or abuse – labels which are inherently hard to define.

The opprobrium aimed at tax avoidance has coincided with a renewed attack on offshore financial centres. For many critics such tax havens – as they prefer to call them – are seen as hubs for avoidance and evasion. From this premise it quickly follows that the business of such centres needs to be curbed. As Margaret Hodge, a Labour MP and chair of the Public Accounts Committee, has argued Britain needs: “a major crackdown on tax havens – the bedrock of global tax avoidance”.

This article will examine the moral offensive against tax avoidance more closely with a particular emphasis on offshore centres. It will start by considering the criticisms made by politicians at the highest level. After that it will look in practical terms how the framework for taxation is undergoing a fundamental shift. It will conclude by examining the impact of the highly charged discussion of tax matters on offshore centres.

Political criticism

To anyone who followed the G8 summit of world leaders in June it would seem that David Cameron’s offensive on tax was a key theme. His emphasis was not only on tax evasion – by definition illegal behaviour – but also “aggressive tax avoidance”.

In this context the definition of “aggressive” is inherently difficult to pin down. What one-person views as aggressive or abusive another might view as prudent tax planning. By blurring the distinction it becomes easier to mount an offensive against any form of tax planning the authorities deem immoral.

Naturally, the prime minister was eager to emphasise his pro-business credentials and his support for low tax in principle. But whatever his intentions, the result was to stigmatise legal behaviour as improper.

A less widely noticed impact is that it clears politicians of their responsibility to make appropriate tax rules. The onus is shifted to taxpayers to decide for themselves exactly how much tax to pay. Only they risk being found guilty of misbehaviour unless they can prove themselves innocent.

Although the final communiqué did not mention offshore centres by name it implicitly referred to them. The section on tax discussed the need for authorities in different countries to share information. It was made clear that no one should be able to move assets from one location to another to avoid tax even where such action was legal.

The high-profile discussion at the plush hotel and golfing resort was not a one-off measure. On the contrary, throughout its tenure the British government has emphasised the need to create a new framework to ensure taxpayers act morally.

No doubt the government’s concerns are partly practical. With public debt still rising and a yawning deficit it is keen to maximise its revenue. From this perspective tackling aggressive tax evasion can help improve the public finances.

Yet it does not appear to have fully considered the implications of its moral offensive against tax avoidance that it deems aggressive. Such action creates a great deal of uncertainty for business and calls into question what were until recently some fundamental principles of taxation.

Admittedly Cameron was keen to defend offshore centres that are associated with Britain. In an open letter sent to crown dependencies and overseas territories, he said he was confident that they would meet the “gold standard” in transparency. The prime minister was clearly trying to find a balance between his moral offensive on taxation and his desire for Britain to benefit from its links with offshore centres.

But it would be wrong to see the moral offensive against tax avoidance and tax havens in purely British terms. Other national leaders have also made high-profile criticisms of such practices and places (see box two). Such critics share Cameron’s moralism even though they sometimes emphasise different points to the prime minister.

Legal shift

The moralistic criticisms of tax avoidance should not be dismissed as simply political grandstanding. The fundamental principles on which taxation is based are being rewritten. In particular the boundary between illegal tax evasion and legal tax avoidance is being blurred.

Naturally it remains a criminal offence for anyone, including investors and companies, to break the law. But it has become possible even for those who obey the letter of the law to get into trouble for allegedly breaking its spirit.

This shift is clearly spelt out in the General Anti-Abuse Rule (GAAR) published in April. According to the HMRC’s own guidance note, it:

“Rejects the approach taken by the Courts in a number of old cases to the effect that taxpayers are free to use their ingenuity to reduce their tax bills by any lawful means, however contrived those means might be and however far the tax consequences might diverge from the real economic position.”

This overturns, among other precedents, the 1936 Duke of Westminster case that for decades provided a key underpinning of tax law. The ruling in this case was essentially that no one could be compelled to pay more tax than is required by statute.

For the government the GAAR is mainly designed to stop individuals or companies using complex structures that flout the spirit of the law. As David Gauke, the Exchequer secretary to the Treasury, said in the House of Commons in April : “It targets only avoidance schemes that are clearly abusive. By ‘abusive schemes’, we mean schemes that can be seen from the outset to be simply highly contrived and artificial arrangements designed to enable people to get around the tax law and avoid paying tax.”

But whatever the government’s intentions this shift introduces a great deal of uncertainty into an individual’s tax affairs. The boundaries between proper and improper behaviour are no longer clear. Even those who have not broken any rules run the risk of being morally tainted for not paying their fair share of tax – with the definition of what is “fair” open to considerable debate.

Although GAAR is not specifically aimed at offshore structures there are other measures that are focused on them. The proposed “Son of Fatca” rules – based on America’s Foreign Account Tax Compliance Act (Fatca) – would require crown dependencies and overseas territories to disclose even more information to the British tax authorities. Although offshore centres often vehemently deny they are secretive such initiatives potentially send out a message that they are not to be trusted.

Offshore reaction

Many of those associated with offshore financial centres are reluctant to talk to the media. Perhaps this is understandable given the public flaying such centres have received from many quarters. But those who are willing to talk are generally vociferous in their defence of the centres with which they are involved.

Fiona Le Poidevin, the chief executive of Guernsey Finance, a body that promotes Guernsey, insists that the island should not be described as a tax haven. “We see it as a pejorative term,” she says. In her view, it gives a highly misleading impression of financial services on the island. “That sort of moniker isn’t reflective of the standards and regulatory expertise on the islands”.

She denies that it is secretive or that it facilitates tax evasion. “We are an investment conduit as I see it,” she says.

Le Podevin is keen to point out that Guernsey complies with many international agreements. These include the EU Savings Directive of 2005 (Note: this was wrongly noted as 2003 in the original text), America’s Fatca legislation and the G5 pilot programme on exchanging tax information (involving Britain, France, Germany, Italy and Spain).

Indeed she holds strongly to the view, common among offshore centres, that in many respects they are more open and better run than other centres. “The UK in certain areas needs to come up to our standards.”

Caroline Garnham, the founder and chief executive of familybhive.com, a platform for the ultra high-net-worth community, takes a similar view. For her, “the reality is that the offshore financial centres are the squeakiest clean places for reporting and compliance anywhere in the world”.

Garnham also says large countries have the upper hand when it comes to relations with offshore tax centres. “The amount of anti-avoidance legislation is massive,” she says. “The opportunity to legitimately avoid tax is being narrowed”.

A senior financial figure with close ties to the Isle of Man was indignant that offshore centres should be singled out for attack. He also reacted strongly against the idea that morality rather than law should govern tax payment. “I am perplexed”, he says. “It is up to governments to work out a framework that works.”

However, not all financial practitioners are quite as sanguine about offshore centres. One UK-based wealth manager interviewed for this article was wary even though he had no objection to such places in principle. He said of one offshore centre that: “You are relying on unusual legal structures to protect your assets and there is no form of investor protection if things go wrong.” He also pointed out that the HMRC could react strongly against schemes that it perceived to be avoiding tax unreasonably.

Joe Donohoe, an independent trust and wealth management professional based in Jersey, confirms that many advisers are shying away from complicated schemes. “If something looks too dramatically complex it becomes something most advisers would shy away from,” he says. That is in contrast to 20 years ago or more when such schemes were more common.

As long as everyone involved acts within the law it makes sense for investors to choose whether or not to use offshore financial centres on their own merits. They can be judged on normal business criteria such as the quality of regulation and the tax regimes they offer.

The moral offensive against tax havens detracts from this goal. By blurring the line between evasion and avoidance it unwittingly introduces a new element of uncertainty into the decision. Even those who follow the law scrupulously risk being branded morally repugnant.

This problem is emerging on an even larger scale with taxation more generally. The blurring of the boundary between legal obligations and moral disapproval is likely to have unintended consequences that the critics may well regret. Although relatively few observers have noticed there should be little doubt that the government has swept away a fundamental principle on which taxation was long based.

[BOX ONE] Campaigners

Although politicians have led the way in campaigns against offshore centres other organisations, including media outlets and campaigning groups, have taken a broadly similar stance.

Perhaps the most high profile campaign revolved around the “offshore leaks” revelations in April. The International Consortium of Journalists (ICIJ), a global network of reporters, announced that it had collated 2.5m files in offshore centres “exposing hidden dealings of politicians, conmen and the mega-rich the world over”. The ICIJ collaborated with many other media organisations, including the Guardian and the BBC in Britain, Le Monde in France Süddeutsche Zeitung and Norddeutscher Rundfunk in Germany, the Washington Post in America and the Canadian Broadcasting Corporation.

During the G8 summit of world leaders in June the IF campaign against world hunger, made a direct link between the problem of insufficient food and tax avoidance. The campaign claimed that avoidance could mean that the poor in developing countries can go hungry as a result. One of its demands was that Britain should “use its presidency of the G8 to launch a Convention on Tax Transparency”. The campaign is backed by a wide range of organisations, including Actionaid, Christian Aid, the Methodist Church, the National Union of Students and Save the Children.

The Tax Justice Network is the closest thing to a critical think tank on the question although it also does campaigning work. Its position is similar to the British government’s in that it promotes transparency, opposes corruption, favours tax compliance and opposes evasion. However, it goes much further in arguing that it opposes tax havens and offshore finance.

It is striking how closely such media outlets and campaigns follow the agenda on tax already mapped out by western governments. Although campaigners often draw more far-reaching policy conclusions it is easier for them to do so when they are not constrained by the realities of power.

[Box two] The international debate

Tax evasion and offshore financial centres are far from uniquely British preoccupations. On the contrary, they have featured in international discussions for many years.

Tax policy was identified as a problematic area at least as far back as the G7 Lyon summit of world leaders in 1996. According to the summit communiqué: “Globalization is creating new challenges in the field of tax policy. Tax schemes aimed at attracting financial and other geographically mobile activities can create harmful tax competition between states, carrying risks of distorting trade and investment and could lead to the erosion of national tax bases.”

Despite this continuity there have been important changes of emphasis over time. During the Asian financial crisis of 1997-8 there were concerns that offshore centres could lead to increased global financial instability. In the aftermath of the attacks in New York and Washington DC in September 11, 2001 there was heighted concerned about potential terrorist links. More recently the emphasis has shifted to the risk that governments will lose much needed revenue as a result of tax evasion and aggressive avoidance.

The best-known piece of legislation on international taxation is probably America’s 2010 Foreign Account Tax Compliance Act (Fatca). This far-reaching law requires foreign financial institutions to provide information on financial accounts held by American taxpayers to the US tax authorities. It also provides the model for the proposed “Son of Fatca” legislation that Britain looks set to introduce.

Even legislation that does not look like it has much to do with finance can sometimes have implications for taxation. For instance, America’s Patriot Act, introduced in the wake of he September 2001 terrorist attacks, has a set of provisions related to money laundering.

Yet is looks likely that laws introduced with the specific purpose of tackling terrorism or organised crime are often put to wider uses. Joe Donohoe, an independent trust and wealth management professional based in Jersey, says: “many such rules were used almost instantly by tax authorities to gather information that would be useful for taxing purposes as well.”

In continental Europe the discussion of tax havens often has a different flavour. In many cases such centres are held up as negative examples of freewheeling Anglo-Saxon “casino capitalism”.

François Hollande, the French president, has even called for the eradication of tax havens. By threatening to raise the top rate of income tax to 75 per cent he has also raised the ire of some of France’s wealthy elite. Gérard Depardieu, one of France’s most famous actors, has even taken on Russian citizenship in protest.

At least in one respect this hard line on tax has backfired in a spectacular way. Hollande’s credibility was damaged when Jérôme Cahuzac, his then budget minister, admitted to concealing €600,000 (£510,000) in an undeclared foreign account.

Germany too has taken a strong line against tax evasion. For example, Angela Merkel, the German chancellor, made a joint statement on the need for “global leadership” to tackle it. Suspicion of tax havens also played a role in shaping German attitudes to the Cyprus bailout in March. Accusations that many offshore depositors in Cyprus were Russian oligarchs helped to legitimise a tough line towards the rescue package.

Not that the discussion in German has been straightforward either. Conservative politicians were embarrassed by a tax scandal involving a prominent German footballing figure. Ulli Hoeneß, the president of Bayern Munich and a former World Cup winning player, has admitted avoiding taxes by using a Swiss bank account. Although there is no suggestion of any financial wrongdoing by politicians they were keen to be associated with the celebrity. In the wake of the scandal the Social Democrat candidate for Chancellor in the upcoming federal elections, Peer Steinbrück, was keen to reiterate his opposition to tax evasion.

Indeed there is ample room for accusations double standards in this debate. Although Britain’s Conservative government has criticised aggressive tax avoidance the prime minister has publically suggested that high-rate French taxpayers could move to Britain. Not surprisingly, the French president did not take kindly to the suggestion. Meanwhile, the American government is often critical of offshore tax centres yet is happy for the state of Delaware to remain a low-tax jurisdiction.