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Gone Offshore

By Peter Gillespie

As corporations and wealthy individuals shift their assets into offshore tax havens, the loss in global tax revenues is now estimated to be at least $500 billion a year, more than enough to finance the UN's Millennium Development Goals. Civil society groups are challenging the offshore financial system and the social costs that tax evasion is imposing on societies around the world.

There is growing public concern about the social costs that tax avoidance and tax evasion are imposing on societies around the world. Offshore tax havens are a central part of this problem. Tax havens are shifting the tax burden from wealthier to poorer people and forcing governments to rely on more regressive forms of taxation. The International Confederation of Free Trade Unions is warning of an impending global tax crisis due to tax competition and the role of tax havens in concealing income and profits from regulators and tax authorities.

Offshore tax havens – now known by the more polite term "offshore financial centres," or OFCs – are today a deeply entrenched part of the global financial system. There are more than seventy OFCs in places such as the Cayman Islands, the Bahamas, Barbados, Jersey, the Isle of Man, Monaco, Cyprus, Luxembourg, Macao and a number of South Pacific islands. Most but not all are small island states. Some of the banking facilities based in these tax havens are little more than a computer in a closet, but most are subsidiaries of mainstream banks headquartered in London, Zurich, New York and Toronto.

OFCs levy little or no tax on income or property, and provide minimal rules related to licensing and incorporation. Financial institutions and corporations can conduct their business without having a physical presence in these jurisdictions. Most importantly, OFCs guarantee anonymity so that their clients are beyond the scrutiny of tax authorities and regulators in their countries of residence.

These characteristics have attracted corporations and wealthy individuals to move their assets offshore. In the early 1990s, the Bank of International Settlements estimated that total offshore cash holdings were five times the sum available to the world's central banks. In its 1998 World Wealth Report, Merrill Lynch reported that one-third of the wealth of the world's richest individuals, or US$11 trillion, was held offshore. Between 50 and 60 percent of all global trade is conducted through OFCs, and half the global monetary stock is estimated to pass through OFCs at some point. Statistics Canada reported that $88 billion of Canadian corporate assets were held offshore in 2003, mostly invested in Barbados, Ireland, Bermuda, the Cayman Islands and the Bahamas.

For multinational corporations, OFCs provide opportunities for "profit laundering," carrying out transactions that assign profits and losses on paper according to where taxes can be minimized. Profit laundering is frequently done through offshore shell companies that have no function other than holding corporate assets.

To conceal profits a company might transfer the ownership of patents, copyrights or other intangibles to offshore shell companies and collect royalties in a low tax jurisdiction. Earlier this year, the pharmaceutical company Merck was assessed $2.3 billion in U.S. back taxes for transferring its drug patents to a Bermuda shell company and then deducting from its taxes the royalties it paid itself. High technology companies are engaged in similar strategies.

Shell companies can also be used to hide debt liabilities from regulators and shareholders. Before being exposed as a spectacular fraud, Enron had established a network of 3,500 shell companies, 440 of which were registered in the Cayman Islands.

One of the most common methods of concealing corporate income and profits is through falsified transfer pricing. Today, half of all global trade is conducted within multinational companies, among affiliates of the same parent company. Much of the trade between parent companies and affiliates is falsely priced so that companies can allocate profits and losses at will.

A company might, for example, sell an export item to an offshore affiliate at a sharply reduced price; the affiliate then sells the item at market price with the profits remaining offshore. Alternatively, the offshore affiliate might import an item at the real market price, but sell it to the parent company at a grossly inflated price so the company has a huge cost to deduct. Among the falsely-priced export items uncovered in a recent U.S. study were bulldozers priced at $527.94 each and forklift trucks priced at $384.14 each. Falsely-priced import items included flashlights from Japan at $5000 each and toothbrushes from Britain at $5655 each. The study concluded that falsified pricing resulted in tax losses to the U.S. Treasury of $53.1 billion in 2001 alone.

A U.S. expert on tax evasion calculates that the percentage of U.S. tax revenues from corporations has declined since the 1960s from around 30 percent to 8 percent, largely due to shifting income to offshore havens. In a recent study of the 250 largest U.S. corporations, a third paid no income tax between 2001 and 2003, despite reporting overall pre-tax profits of $1.1 trillion to their shareholders in the same period. Raymond Baker, author of Capitalism's Achilles Heel, estimates that multinational companies account for a global tax loss of at least $200 billion a year through the use of shell companies and falsified transfer pricing.

Canada's Auditor General warned in 1992 that Canada was losing tax revenues through Canadian corporate investments in tax havens. The Auditor General raised the issue again in 2002, reporting that "tax arrangements for foreign affiliates have eroded Canadian tax revenues of hundreds of millions of dollars over the past ten years."

Wealthy individuals are also escaping their tax obligations by holding their assets offshore. Financial institutions based in OFCs have aggressively pursued "high net worth individuals," encouraging them to move their assets to offshore accounts and trusts. A 2006 U.S. Senate subcommittee report concluded that wealthy Americans avoid $40 to $70 billion in taxes each year by holding their assets offshore. The Tax Justice Network in the United Kingdom calculated that if the returns on $11 trillion of individual assets now placed in OFCs were taxed at 30 percent, it would generate $255 billion in tax revenues globally.

If these issues are cause for concern in Northern countries, the situation facing transition economies and developing countries is even more serious. OFCs have enabled massive illicit capital flight out of transition economies such as Russia and China as well as from developing countries.

Russia appears to have suffered the greatest theft of resources in the shortest period of time, an amount estimated to be between $200 and $500 billion in the period 1989 to 2004. Between 1995 and 1999, a senior staff member of the Bank of New York laundered $7 to $10 billion of Russian money. In the late 1990s, an estimated $70 billion of Russian illicit capital flight was reportedly laundered through Nauru, a tiny island in the South Pacific with a population of 15,000, one road, and 400 banks.

The IMF estimated that illegal outflows from China were $127 billion between 1992 and 2001, a figure that is likely under-estimated by half. Raymond Baker notes that as much as half of all foreign direct investment (FDI) in China is actually Chinese money that came out of the country illegally, disguised itself as a foreign company and returned to China as a joint venture with a foreign partner. Almost 45 percent of FDI in China originates from shell companies based in the Cayman Islands, Hong Kong and the British Virgin Islands, ensuring that royalties, fees and dividends flow offshore.

Developing countries often have weak tax administration systems and lack the capacity to track the complex financial maneuvers of multinational companies. Oxfam (UK) estimates that OFCs contribute to tax losses in developing countries of about $50 billion a year, roughly equivalent to annual aid flows. This figure is likely conservative and does not take into account outright tax evasion, falsified transfer pricing or under-reporting of corporate profits.

The African Union reported that at least $148 billion illegally leaves the continent every year, most ending up in offshore accounts. Falsified transfer pricing by multinationals is reportedly costing Africa $10 to $11 billion annually. Some estimates suggest that Africa's political elites hold between $700 and $800 billion in offshore accounts outside the continent.

Corrupt political leaders of some developing countries have embezzled vast amounts of wealth from their national treasuries. Md. Suharto, the Indonesian dictator who was courted by Western countries including Canada, looted his country for years and up to $35 billion found its way to the Cayman Islands, Panama, the Bahamas, Cook Islands, Vanuatu and West Samoa. Citibank helped Raul Salinas, brother of Mexico's former president, establish anonymous offshore trusts, international business companies and secret accounts to hide his stolen wealth.

The venerable Riggs Bank of Washington set-up off-shore dummy corporations and anonymous accounts for Augusto Pinochet, the murderous former dictator of Chile. In its required "Know Your Customer" documentation, Riggs described Pinochet as "a retired professional who achieved much success in his career and accumulated wealth during his lifetime for retirement in an orderly way."

Some of Africa's poorest countries have also been plundered. Sani Abacha, the dictator of Nigeria between 1993 and 1998, looted the country's treasury and sent billions to secret accounts in Switzerland, Luxembourg, Liechtenstein and London. Mobutu Sese Seiko of Zaire and Emperor Bokassa of the Central African Republic plundered their countries to the point of starvation.

It would not be an exaggeration to say that illegal capital flight and thefts from the treasuries of poor countries have resulted in the deaths of thousands, perhaps tens of thousands, of vulnerable people as health facilities have been dismantled and basic public infrastructure crumbled. All of this looting has been carried out through the secretive infrastructure of OFCs, facilitated by pinstriped legions of well-paid accountants, lawyers and bankers. Yet public attention is only drawn to the kleptocrats, rather than to the people and institutions that enable these thefts.

What is to be done?

Governments around the world are well-aware of the costs OFCs are imposing on societies and a number of initiatives are underway to address the problem. The Organization for Economic Cooperation and Development (OECD) is playing a leadership role in addressing these issues, and several inter-governmental bodies are working to share information and to monitor abuses of the financial system.

Many countries, including Canada, are adopting more aggressive strategies to audit individuals and companies with offshore assets. But as capital markets are globalized, nationally-based tax policy and revenue collection strategies are increasing difficult and often ineffective. Ultimately, the solutions to these problems must be multilateral. The Tax Justice Network and other civil society groups have proposed a number of measures, including the following:

• Ending secrecy. The privacy rights of citizens must be distinguished from regimes of financial secrecy. It is secrecy that drives the offshore economy. It is secrecy laws that allowed Swiss banks to hide Nazi loot for fifty years. If any progress is to be made on corruption, money laundering and fair taxation, banks and financial institutions must be legally required to disclose all income from all sources paid to citizens of other countries, with sufficient information identifying the persons receiving that income. This information should be routinely exchanged between countries to ensure that income is properly taxed.
• Unitary corporate taxation. Competing and contradictory national tax standards for corporations operating in multiple countries are a critical problem. A multilateral process needs to be put in place to develop a common set of principles to define the tax base and an appropriate formula for profit allocation for multinational companies. Reaching an international consensus on this approach would be challenging. However, without a common set of standards and principles, multinational companies will continue to escape their obligations to society.
• Criminalize those involved in money laundering and tax evasion. Money laundering and thefts from national treasuries is enabled by accountants, lawyers and bankers. Very few of these people have ever faced charges for participating in laundering the proceeds of crimes committed in other countries. Intentionally servicing money from crime should be a crime, no matter where the act is committed. Corporate executives, and their accountants and lawyers, should be liable for criminal prosecution for tax evasion.
• Establish a World Tax Authority. Establish an international body to follow global tax developments, provide a forum for discussion on international issues related to tax policy, deal with tax competition, provide a dispute forum, develop codes of conduct and best practices and promote tax systems that are in the public interest.
• Establish an International Convention on the Recovery of Stolen Wealth. Much of the wealth that has been illegally appropriated from national treasuries has never been recovered and has been converted into public debt. An international convention would assist in challenging the secrecy laws that prevent recovery, and help repatriate this wealth to the countries to which it belongs.

The economic and social consequences that tax avoidance and tax evasion are imposing on societies around the world have reached a crisis point. Democratic public debate about these issues is urgently required.

Civil society groups are insisting that the issue of taxation be integrated into current discussions about social justice and corporate social responsibility. Taxes are not a business cost; rather, taxes are the price of living in a democratic society. Taxes are a crucial foundation of equitable societies as they pay for the public goods and services which benefit us all.

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Reviewed July 10, 2007		Publishing Policies

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