November 30 2003

Global crackdown on tax evasion begins to stall

By Andrew Parker

On a busy day at least six enormous cruise liners can be seen moored off Seven Mile Beach, the most beautiful stretch of sand on the Cayman Islands. Most of the thousands of passengers who disembark want to enjoy a few hours on dry land, marvelling at the beauty of the Caribbean islands and spending some of their money in the jewellery shops of George Town, Cayman's capital.

A few passengers, though, are known to go ashore carrying suitcases stuffed full of cash, hoping to take advantage - as they have for the past 30 years - of Cayman's status as a leading offshore tax haven, with its combination of banking secrecy and no personal or corporate tax.

Bankers in Cayman insist that such passengers will on Monday find it impossible to open a bank account on the islands. They say there is now strong regulation to deal with money launderers and other criminals.

But having made progress to counter the nefarious business of laundering, Cayman is fighting a new threat to its wellbeing. The UK dependent territory fears its financial services industry could suffer dire consequences because of the British government's demand that it comply with a European Union crackdown on tax evasion.

Both the EU and the Organisation for Economic Co-operation and Development are keen to demand more co-operation from tax havens to try to bolster revenues. The US , for example, estimates that offshore financial centres deprive it of $70bn (£40bn) each year through uncollected tax. Australia has identified up to A$60m (£25m) in suspicious transactions on credit cards issued in the tiny South Pacific island of Vanuatu alone. Italy's 2002 tax amnesty resulted in the repatriation of €60bn (£28bn), much of which had been placed in Swiss banks.

The OECD and EU also want to step up vigilance over funds that they fear could be used for terrorist financing. Initiatives to crack down on tax havens gained fresh impetus following the terror attacks of September 11 2001.

Without the participation of jurisdictions such as Cayman, the EU initiative to combat tax evasion could stall or fall apart. Furthermore, the EU plan itself is seen as a messy compromise, which as well as incurring the anger of Cayman has led to an unprecedented stand-off among OECD member countries that is damaging the organisation's global crackdown on tax evasion. Implementation of both the EU and the OECD initiatives could be substantially delayed.

Cayman, so far, has been impervious to pressure from the UK to comply with the EU plan, known as the European savings directive. McKeeva Bush, Cayman's outspoken chief minister, accuses the UK of behaving like the colonial power of old, ruling by dictat and treating the islands' citizens like slaves. "It is not the 1800s where as a territory they can shove us around with laws and regulations," he says. Mr Bush is holding talks on Monday in London with Dawn Primarolo, Britain's paymaster general, which are supposed to find a way through the current impasse.

For the Cayman Islands the financial services industry is the bedrock of its economy, representing an estimated 30 per cent of gross domestic product. The banking sector had liabilities denominated in foreign currency worth $943bn in March, according to the Bank for International Settlements, which makes it the world's fifth biggest centre.

The EU directive seeks to ensure that EU residents pay tax on cross-border interest payments derived from savings. But a report by Sir James Mirrlees, the Nobel prize-winning economist at Cambridge University, suggests the EU directive will cause significant capital flight from Cayman and prompt bank closures.

Cayman has 4,037 registered mutual funds, most of which enjoy exemptions from any form of tax, and Sir James estimates that 20 per cent of Cayman's financial business involves managing money from EU residents. Some of the funds are expected to be caught by the EU directive's provisions, and therefore EU investors would find their distributions or redemptions liable to tax.

"The fact that interest earned on funds deposited in the Cayman Islands is not reported to the tax authorities makes it more attractive to investors than countries where interest is reported," Sir James says in his report commissioned by Cayman's government. "The directive will change the relative attractiveness of investing in the Cayman islands rather than, say, Hong Kong or Singapore."

Bankers in Cayman say the EU directive could also deter US investors, who play a big role in its financial services industry, because it will require identity checks on all clients to establish whether they are EU residents.

Cayman has become one of the leading centres for hedge funds over the past 10 years, with an estimated $150bn in assets administered from the islands. Niels Heck, president of the fund administrators' association in Cayman, cites a survey that found about one in five hedge funds administered in Cayman believes it will fall under the EU directive's provisions.

"If that is going to happen some managers may reconsider [whether] they want to do business in the Cayman islands," he says. "They can move to Bermuda or the Bahamas." Those jurisdictions are not covered by the savings directive.

But the risk to business is not the only reason why Cayman is resisting the EU directive. Relations between the UK and Cayman were badly strained in January when it emerged that MI6, the British intelligence service, had an agent on the islands who was also a police officer responsible for processing suspicious transaction reports from local banks. The trial of four people charged with money laundering offences collapsed because the agent had shredded evidence about MI6's work in Cayman.

Mr Bush, who had no knowledge of MI6's activities, says trust between Cayman and the UK was broken by the affair. He doubts British assurances that it no longer has agents on the islands.

However, Cayman is not the only jurisdiction outside the EU with strong feelings about the directive, which is supposed to take effect in 2005. The EU must finalise participation agreements with Switzerland, Liechtenstein, San Marino, Monaco and Andorra before the directive can come into force, since these are jurisdictions where EU citizens have significant amounts of deposits. Andorra, Liechtenstein and Monaco are currently on an OECD blacklist of unco-operative tax havens.

Switzerland, long the home of much EU money because of its banking secrecy and low taxes, has agreed in principle to co-operate. But the country - seeking to preserve confidentiality for its banks' clients - has insisted it should tax any interest income earned by EU residents and then pass most of the revenue back to the countries where those clients live. The arrangement is known as a retention or withholding tax.

In contrast, 12 of the 15 EU member states are to operate a different system of cross-border exchange of information, under which banks must provide annual data about any interest payments to EU residents to those customers' home tax authorities. However, Austria, Belgium and Luxembourg, which cherish their banking secrecy and do not want to lose business to Switzerland, have won the right from the EU to apply withholding taxes.

The EU directive says the withholding taxes are transitional measures - although no date is set for the switchover. But the concessions over withholding taxes have damaged the OECD initiative against tax evasion, which is based on exchanging information.

OECD member countries are supposed to provide access to banking information on request from 2006 to enable authorities to verify people's tax liabilities. But Switzerland says it cannot support this deadline. "The deal we made with the EU is the last word of Switzerland," says Daniel Eckmann of the Swiss federal department of finance. This suggests it will persist with its opposition to an exchange of banking information in the OECD as well as the EU. Luxembourg also says it cannot back the OECD's 2006 deadline, partly because it believes it has secured the right under the EU directive to apply a withholding tax until at least 2011.

In September, Switzerland and Luxembourg blocked agreement among OECD member countries on access to banking information. It was the first time that OECD members had used a veto inside the organisation's governing council.

The position of Switzerland and Luxembourg has angered 32 offshore financial centres - including the Cayman Islands, Gibraltar and the Seychelles - that have made commitments to the OECD initiative on exchange of information. They are demanding a level playing field, worried that their financial industries will move to Switzerland and other places such as Hong Kong and Singapore that are outside the initiative.

A threatened revolt by the offshore centres was contained at a meeting with the OECD's senior officials in Ottawa in October. Only St Vincent and the Grenadines, a Caribbean territory, tore up its commitment to the initiative. However future co-operation came at a price. An OECD working party will consider ways to ensure that the initiative does not result in some financial centres stealing business from others.

Pressure is mounting on Switzerland to accept the OECD's 2006 deadline. John Snow, US treasury secretary, said last week that "more must be done to bring the US Swiss tax information exchange relationship up to international standards".

Peter Costello, Australia's finance minister, said in October: "If you want to have a look at a weakness in the enforcement of taxation law, we know where it stands: the secrecy of Swiss bank accounts."

The UK is threatening to force Cayman into compliance with the EU directive by passing special legislation if it does not fall into line voluntarily. Cayman, in turn, is looking at whether it could challenge any legislation in the UK.

In a letter to Mr Bush last month Ms Primarolo held out some possible concessions to Cayman if it drops its opposition to the EU directive. A face-saving compromise is the most likely outcome of Monday's talks.

While Cayman's participation in the EU directive would bolster its chances of a smooth introduction in 2005, however, it will not help the OECD's crackdown on tax evasion and the goal of exchange of banking information from 2006. Mr Bush, noting the stances of Switzerland and Luxembourg, says: "I have even heard phrases used such as 'Slowing down to the speed of the last ship in the convoy'. "

Most of the 32 offshore financial centres will eventually be bludgeoned into acquiescence on exchange of banking information. They do not want to be "named and shamed" by the OECD on its blacklist of unco-operative tax havens. The reputational stigma is too damaging to their financial services industries.

But the offshore centres take their lead from the world's richest nations, which are currently bitterly divided over the OECD's crackdown on tax evasion. Unless Switzerland and Luxembourg can be persuaded to support the OECD initiative, the organisation's other member countries may have to wait well beyond 2006 before their coffers start to fill with the fruits of the crackdown.

 

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