'Offshore' And The Common Law Trust
It is fair to say that the beginnings of fiscal globalization, both for taxers and the taxed, can be dated to the emergence of the offshore trust as a means of tax avoidance, which led eventually to the wholesale transfer of capital assets and income from high-taxing jurisdictions into 'lowtax' areas, usually offshore.
Income tax was first levied in England at the beginning of the 20th century, and in many countries had become worth avoiding by mid-century; but initially at least the best way of avoiding it was to turn income into capital, which was not so heavily taxed. It was only when capital taxes of various types became significant that the offshore trust came into its own. Very rich people had begun to use offshore trusts in the first half of the century, although at least as much because of the additional asset protection that they offered, simply by being in a different jurisdiction, as because they were tax efficient.
The administrative overhead and other complications of dealing with an offshore location were initially very great, so that at first only conveniently close-by islands like Jersey (Channel Isles) for the Brits and the Bahamas (for Americans) developed as 'offshore' jurisdictions, and then only for very wealthy people. The first trusts legislation in the Bahamas, surprisingly, dates from 1893. The great expansion of trusts, both in terms of number of jurisdictions and volume of business, came later when telecommunications, air transport and the end of capital controls opened up the world and gave freedom to average investors to move their assets around with relative ease.
When offshore trusts began to be used in a major way, they were usually set up by professionals in the home jurisdiction of the settlor, reflecting the lack of professional expertise in the few offshore jurisdictions that were then available. Eventually the main professional firms began to set up offices in the jurisdictions, and a gradual process got under way which has resulted in the emergence of sophisticated, multi-disciplinary firms offshore. When these firms work for the corporate sector, they can be referred to as 'corporate service providers', a term which implies a blend of tax, legal and financial expertise.
In parallel with the growth of professional expertise, and sometimes in competition with it, those jurisdictions which encouraged banking usually saw the development of 'fiduciary' companies, often run as departments of banks, which specialised in the setting-up and running of trusts. The banks, which were and are rapidly developing their private banking sides, had a ready supply of wealthy clients for a trust business.
By 1980 offshore was burgeoning in response to horrific onshore tax rates, and tax avoidance had taken over as the main driver of offshore growth. In this process, and as more and more countries laid claim to the worldwide income and assets of individuals during life and at the end of it, the trust played a key part.
The Cleaning-Up Of Offshore
Alongside legitimate investors from high-tax countries, 'offshore' also attracted less salubrious income streams including laundered drug money, a wave of 'capital flight' from the economies of the former Soviet Union, and the proceeds of corruption in dozens of developing economies. In most jurisdictions, professional competence ran ahead of legislative controls, and the wall of money that hit offshore from illicit sources in the '90s may have found it all too easy to burrow unseen into the layer of anonymous trusts, IBCs (International Business Companies) and bank accounts that makes up the asset base of offshore.
In the last years of the 20th century, the rich countries' trade union, the OECD, decided to take on 'offshore', overtly in order to 'clean it up', but with an unspoken sub-text aimed at curbing the inroads it was making into its member states' tax revenues. Aided by the FATF (Financial Action Task Force) and the FSF (Financial Stability Forum) on the one side, the introduction by the US of Qualified Intermediary status as part of new withholding tax legislation on the other, along with the European Union's 'Code of Conduct' harmful tax initiative, and finally FATCA, the US Treasury's Foreign Account Tax Compliance Act, the result has been a substantial improvement in supervisory standards offshore. By now, if a jurisdiction wants to remain on the global financial circuit, it has to apply 'know your customer' rules, have very effective banking supervision, and conform to high levels of international mutual assistance.
The Financial Action Task Force (FATF) was considerably more effective than the OECD (of which it is a part, to be fair) in 'cleaning-up' offshore – and some onshore – jurisdictions through its anti money-laundering campaign. While countries were able to get off the OECD's list of transgressors simply by promising to be good, the FATF brought a tougher-minded approach to its targets, and insisted on real legislative change before it would de-list a country. Usually that included extensive improvements in 'know your customer' procedures, the creation of a Financial Intelligence Unit with accompanying reporting rules, and enhancement of mutual assistance legislation, as well as the passing of laws which clearly criminalized money-laundering and terrorist financing.
The horror of 9/11 of course enormously accelerated this process, and faced with extremely sharp-toothed US legislation such as the Patriot Act, the major offshore jurisdictions have raced to become cleaner-than-clean in terms of their anti-money laundering and anti-terrorist funding regimes, to the point that many of them are by now far 'cleaner' than the very OECD countries which began the anti-offshore process in the mid-90s. More to the point, as regards globalization, they now largely conform to international standards of regulatory control.
'Transparency' is a buzz-word among international financial regulators, and refers both to the absence of impenetrable barriers to information flow between countries, and also to the 'level playing field', ie that domestic and foreign investors and companies should receive equivalent regulatory and fiscal treatment.
In one word, this is what is close to having been achieved internationally in the twenty years from 1995 to 2015, at first through the moves to regularize 'offshore', and then through some more general initiatives applying to regional groupings of countries or in some cases globally.
In October, 2000 the EU agreed to step up the fight against money laundering and organised crime on its territory with tougher penalties and a pledge to abolish the barriers to criminal investigations posed by banking secrecy and confidentiality in tax matters. By May, 2005, the European Commission was able to welcome the European Parliament's decision to approve the third money laundering directive which incorporates into EU law the June 2003 revision of the Forty Recommendations of the Financial Action Task Force (FATF).
The directive requires those within the financial services sector, lawyers, notaries, accountants, real estate agents, casinos, trust and company service providers and retailers receiving cash payments in excess of EUR15,000 to:
The Patriot Act and other legislative initiatives in the US including FATCA achieved largely similar goals.
In November, 2004, the G20 group of major industrialised nations and emerging economies rubber-stamped an initiative aimed at standardizing the exchange of tax information across national borders by adopting the standard OECD protocol when exchanging information on tax matters, a move that then German Finance Minister Hans Eichel declared was a "big step forward," in the fight against 'harmful tax practices'. In addition to the G7 group of nations, the G20 includes Argentina, Australia, Brazil, China, India, Indonesia, South Korea, Mexico, Russia, Saudi Arabia, South Africa and Turkey.
By 2015, through the Egmont Group (which oversees Financial Intelligence Units or their equivalents in almost all countries), the FATF with its 40 anti-money-laundering recommendations which have become de rigeur for any country wishing to host international financial business, the IMF with its country reviews which focus on financial transparency alongside economic performance, and the various other international organizations with quasi-legal powers over individual countries, the goal of 'transparency' is within sight, and it is reasonable to say that there is already a globalized financial and information-sharing regime, with fiscal rate-setting one of the few remaining areas of national discretion.
Confidentiality isn't what it used to be, but to some extent is still one of the attractions of 'offshore'. Along with low tax rates and the achievement of 'transparency', it was one of the targets of the OECD's anti-offshore campaign; but of the three goals only transparency has been comprehensively achieved so far. The OECD's battle for 'harmonized' (= high) tax rates has probably been lost; but in the end secrecy will have been substantially weakened if not altogether abolished.
After the initial success of the fightback by 'offshore' against the OECD, '9/11' seemed at first as if it would hand back power to the regulators, and it has certainly increased the level of co-operation between national authorities both onshore and offshore, particularly in the fight against money-laundering; but so far it does not seem to have been responsible for a major shift in the overall legal situation regarding banking secrecy. However, one of the more important legislative responses to '9/11' has been the United Nations Convention For The Suppression Of The Financing Of Terrorism, which in the long-term can only tend to weaken banking secrecy.
Between 2002 and 2004 no major new international initiative was launched against banking secrecy as such, but the cumulative effect of additional Mutual Assistance Treaties, Tax Information Exchange Agreements (TIEAs), Financial Intelligence Units and other bilateral or jurisdictional measures was to weaken privacy in many if not most offshore jurisdictions. And of course the EU's Savings Tax Directive continued on its cumbersome journey, although since most of the EU's dependent territories, along with Switzerland, Liechtenstein, Luxembourg, Belgium and Austria opted initially for a withholding tax rather than information exchange as such, the effect of the Directive on banking secrecy was not at first as dramatic as once seemed likely. In the last ten years, though, further international initiatives orchestrated by the OECD and the G20 such as the Convention on Mutual Administrative Assistance in Tax Matters have continued to dilute banking and fiscal secrecy wherever they continued to exist. By now, in 2015, one can confidently predict that international financial transparency is an inevitability.