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Bad Facts Make Bad Law

By Jack W. Flader, Jr. - Email Editor

Date : April 23, 2009

Dear Valued Reader,

This old adage known well to lawyers – “bad facts make bad law” – sums up what is happening to the offshore world. The bad facts include citizens of developed countries blatantly cheating on their taxes, geniuses creating financial instruments with no substance and an economic meltdown spurring on entitlement societies.

1. In 1981, the USA Internal Revenue Service conducted a year-long study that resulted in the publication of Tax Havens and Their Use by United States Taxpayers—an Overview. The study focused on the misuse of tax treaties with former British and Dutch colonies, suggested harsh sanctions and ultimately caused the unilateral termination of many such treaties by the USA.

2. In 1990, the Financial Action Task Force developed The 40 Recommendations to Combat Money Laundering, which was later revised in 1996 and finally given teeth in 2003 subsequent to the terrorist attacks in New York in 2001. The 40 Recommendations set out principles for action and, although not a binding international convention, most countries in the world have made a commitment to combat money laundering by implementing The 40 Recommendations.

3. In 1998, the Organization for Economic Co-operation and Development (the “OECD”) published Harmful Tax Competition – An Emerging Global Issue. The report seeks to develop measures to counter the perceived distorting effects of harmful tax competition on investment and financing decisions and the consequences for national tax bases.

4. In 2007, the USA Senate Permanent Sub-Committee of Investigations (the “Sub-Committee”) tabled the Stop Tax Haven Abuse Act, which was revived in 2009 now that a former member of the Sub-Committee has become President of the USA. The Bill seeks to create a rebuttable presumption that taxpayers have engaged in tax evasion when engaging in financial transactions with nationals of certain “secrecy” jurisdictions.

5. In 2008, the Sub-Committee introduced a report entitled Tax Haven Banks and U.S. Tax Compliance, which detailed the illegal conduct of several USA taxpayers and two non-USA banks.

6. In April 2009, the Group of 20 largest economic nations in the world published lists of jurisdictions that have substantially implemented internationally agreed tax standards and jurisdictions that have committed to internationally agreed tax standards, but have not yet substantially implemented. The third list, which included jurisdictions that have not committed to the internationally agreed tax standard, was quickly erased when the four countries apparently complied in a last second effort to avoid being “black-listed”.

During the past 25 years of such “bad law”, the world has seen an explosion in the number of offshore jurisdictions including the following non-exhaustive list:

1. The Isle of Man, Jersey and Guernsey, all self-governing UK Crown Dependencies, flourished with low or no tax systems for companies and individuals from the ‘70s.

2. The various Dutch Antilles continue to attract international business people seeking tax planning opportunities.

3. Hong Kong and Panama have thrived despite experiencing a hiatus due to the resumption of sovereignty by China and the downfall of Noriega, respectively.

4. In 1984, the British Virgin Islands – or BVI - established the cheap ‘n cheerful international business company and now boasts more than 500,000 such companies.

5. A multitude of jurisdictions starting in the ‘80s, including Anguilla, Belize, Seychelles, Cook Islands and Samoa, have followed suit and sought to attract international business persons to their shores with the promise of low taxes, confidentiality and user-friendly regulatory regimes.

6. Jurisdictions such as Singapore have positioned themselves as a financial center combining all the best of the offshore world with the physical and human infrastructure usually reserved to onshore jurisdictions.

7. Austria, Luxembourg, Liechtenstein, Switzerland and other “old” European nations have offered planning opportunities and confidential banking to a global audience for decades. · Estonia, Cyprus, Malta and other “new” European nations have followed suit with low tax regimes.

8. The various States of the USA have enjoyed the success of forming hundreds of thousands, if not millions, of companies for foreign nationals seeking the many advantages of being incorporated in a zero tax, credible environment while banks in New York and other cities offer foreign nationals the ability to pay no tax on interest earned.

9. New Zealand, an OECD member, has developed innovative legislation that has made the jurisdiction a leader for international planners.

The success of these jurisdictions, which have continued to grow despite the previously mentioned attacks, reflects a growing, decades-old dissatisfaction with government policies ranging from excessive taxation, inappropriate use of taxpayers' money, stifling regulation and overall unwanted government intrusion in the lives of ordinary citizens.

Simply stated, the attack on offshore jurisdictions is nothing new and will never stop. Equally, the development by the offshore world of new legislation, products and solutions to meet the growing, legitimate demand of international business people will also move forward. More importantly, these onshore efforts have NOT and will NOT be the demise of the offshore world!

Why?

First, legitimate jurisdictions and practitioners who use them are in full agreement with the developed world that tax evasion is illegal, unacceptable and not the raison d'être of the offshore world. The offshore world understands “bad facts make bad law” and has been regulated to a level not even practiced in the onshore world.

Second, the hypocrisy of the onshore world will always ensure they cannot, with any sense of justice, eliminate the legitimate activities of offshore jurisdictions. As stated in the telling article Haven Hypocrisy (Economist, May 26, 2009), “The most egregious examples of banking secrecy, money laundering and tax fraud are found not in remote alpine valleys or on sunny tropical isles but in the backyards of the world's biggest economies.” The article continues with the following revelation by the person who was conducted a min-study of global company formation and bank account setup:

“He tried to open anonymous shell companies and bank accounts 45 times across the world. These were successful in 17 cases, of which 13 were in OECD countries. One example was Britain, where in 45 minutes on the internet he formed a company without providing identification, was issued with bearer shares (which have been almost universally outlawed because they confer completely anonymous ownership) as well as nominee directors and a secretary. All was achieved at a cost of £515.95 (US$753).”

Third, the hypocrisy also was highlighted in the proposed Incorporation Transparency and Law Enforcement Assistance Act. The Sub-Committee found, among other disturbing facts, that

1.  the various States do not require the disclosure of virtually any or in some instances any information, including beneficial ownership, to either the State or the company formation agent handling the formation; and

2. dozens of Internet websites highlight the anonymity of beneficial owners allowed under the incorporation practices of some States, point to those practices as a reason to incorporate in those States, and list those States together with offshore jurisdictions as preferred locations for the formation of new corporations, essentially providing an open invitation to criminals and other wrongdoers to form entities within the USA.

Fourth, as noted by many a well-respected commentator, the largest “offshore” banking jurisdiction is, not surprisingly, an island. The surprise is the island is Manhattan where interest on bank deposits is earned tax free by foreign nationals.

Fifth, the Group of 20 always talks about free markets. Governments will continue to find it difficult to allow free markets while stifling tax competition. The very fact that Hong Kong, Macau, Mauritius and Seychelles exist with their low or no tax systems tends to suggest that, perhaps, some form of competition when backed with political muscle will result in tax competition.

Sixth, the USA Government Accountability Office published a report entitled International Taxation: Large US Corporations and Federal Contractors with Subsidiaries in Jurisdictions Listed as Tax Havens or Financial Privacy Jurisdictions (December 2008) (the “Report”). The stated objectives of the Report were:

“…to determine how many of the 100 largest publicly traded U.S. corporations in terms of revenue have subsidiaries in jurisdictions listed as tax havens or financial privacy jurisdictions and the amount of federal contract obligations these corporations have, if any.

…to determine how many of the 100 largest publicly traded U.S. federal contractors in terms of contract obligations have subsidiaries in jurisdictions listed as tax havens or financial privacy jurisdictions.”

It will come as no surprise that eighty-three of the 100 largest publicly traded USA companies in terms of 2007 revenue reported having subsidiaries in jurisdictions listed as tax havens or financial privacy jurisdictions. Tax havens, given the support of large companies, are not going anywhere!!!

Finally, the onshore jurisdictions cannot avoid the inevitable consequences of shutting down offshore jurisdictions including, but not limited to, an influx of offshore nationals seeking refuge onshore with the attendant social issues; and a need to give aid to the offshore jurisdictions to avoid the complete collapse of their economies.

It is true that “bad facts make bad law”. Although these bad facts may make for bad proposed legislation, I remain confident that ultimately the shared objectives of eliminating tax evasion and terrorism; the intelligence of a powerful few who recognize hypocrisy, avoiding unintended consequences guiding policy decisions and the adaptability of the offshore world to create legitimate solutions for law-abiding international business people will avoid the proposed legislation becoming law.

Onwards and upwards,

Jack W. Flader, Jr.

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