OFFSHORE FINANCIAL CENTRE

1. INTRODUCTION Any international business unit, whether manufacturing or trading is always looking for funds for their operations. Every company cannot take funds from its home country due to strict regulations or interest cost or taxes. All over the world the business community is in search of locations where their investments are safe and the funds can be taken out without any barriers and invested comfortably for any ventures in any part of the world. Currently, Mauritius, Malta, Panama, Man‘s Island, Cyprus, Seychelles and Hawaii are a few centres attracting offshore banks. Since 2003, the Government of India has permitted banks to set up offshore banking operations in Special Economic Zones. Hence, the system of offshore banking has become part of international business. Offshore banks are banking units set up by foreign banks in territories where the restrictions and regulations are limited and the intervention of the country of location is minimal. Offshore banking units bring foreign currency funds from non-residents and the international money market, and invest them in the host country or in projects set up by the host country in a third country. In short, it is a hassle free and safer banking system for saving and borrowing funds for business. Offshore financial centers (OFCs) are mostly situated in small countries or autonomous districts such as islands in the Caribbean or micro-states elsewhere. These tiny, low-tax jurisdictions are well-known for providing highly-specialized and distinctive international financial and corporate services. With their strengths in easy registration procedures, low risk, lax foreign exchange control and favorable tax policies, these offshore jurisdictions have become popular destinations for individuals and international businesses to park their assets. 1.1 FINANCIAL CENTRE A financial centre is a global city that is home to a large number of internationally significant banks, businesses, and stock exchanges.

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An international financial centre is a non-specific term usually used to describe an important participant in international financial market trading. An international financial centre (sometimes abbreviated to IFC) will usually have at least one major stock market. 1.2 OFFSHORE FINANCIAL CENTRES An offshore financial centre, although not precisely defined, is usually a small, low-tax jurisdiction specialising in providing the corporate and commercial services to non-residents in the form of offshore companies and the investment of offshore funds. The term offshore financial centre is a relatively modern neologism, first coined in the 1980s. Although the terms are not synonymous, many leading offshore finance centres are regarded as "tax havens", and the lack of precise definitions often leads to confusion between the concepts. In Tolley's International Initiatives Affecting Financial Havens the author in the Glossary of Terms defines an "offshore financial centre" in forthright terms as "a politically correct term for what used to be called a tax haven." However, he then qualifies this by adding "The use of this term makes the important point that a jurisdiction may provide specific facilities for offshore financial centres without being in any general sense a tax haven." In 2009 the International Financial Centres Forum (IFC Forum) was established by a group of professional service firms and businesses with offices in the leading offshore centres. According to its website, the IFC Forum aims to provide authoritative and balanced information about the role of the small international financial centres in the global economy. 1.3 DEFINITION Whether a financial centre is to be characterized as "offshore" is a question of degree. Indeed, the IMF Working Paper cited above notes that its definition of an offshore centre would include the United Kingdom and the United States, which are ordinarily counted as "onshore" because of their large populations and inclusion in international organisations such as the G20 and OECD. The more nebulous term ―tax haven‖ is often applied to offshore centres, leading to confusion between the two concepts. In Tolley's International Initiatives Affecting Financial Havens the author in the Glossary of Terms defines an ―offshore financial centre‖ in forthright terms as ―a politically 2

correct term for what used to be called a tax haven.‖ However, he then qualifies this by adding, ―The use of this term makes the important point that a jurisdiction may provide specific facilities for offshore financial centres without being in any general sense a tax haven.‖ A 1981 report by the IRS concludes, ―a country is a tax haven if it looks like one and if it is considered to be one by those who care.‖ With its connotations of financial secrecy and tax avoidance, ―tax haven‖ is not always an appropriate term for offshore financial centres, many of which have no statutory banking secrecy, and most of which have adopted tax information exchange protocols to allow foreign countries to investigate suspected tax evasion. Views of offshore financial centres tend to be polarised. Proponents suggest that reputable offshore financial centres play a legitimate and integral role in international finance and trade, and that their zero-tax structure allows financial planning and risk management and makes possible some of the cross-border vehicles necessary for global trade, including financing for aircraft and shipping or reinsurance of medical facilities. Proponents point to the tacit support of offshore centres by the governments of the United States (which promotes offshore financial centres by the continuing use of the Foreign Sales Corporation (FSC)) and United Kingdom (which actively promotes offshore finance in Caribbean dependent territories to help them diversify their economies and to facilitate the British Eurobond market). Overseas Private Investment Corporation (OPIC), a U.S. government agency, when lending into countries with underdeveloped corporate law, often requires the borrower to form an offshore vehicle to facilitate the loan financing. One could argue that US external aid statutorily cannot even take place without the formation of offshore entities. 1.4 SCRUTINY Offshore finance has been the subject of increased attention since 2000 and even more so since the April 2009 G20 meeting, when heads of state resolved to ―take action‖ against non-cooperative jurisdictions. Initiatives spearheaded by the Organisation for Economic Co-operation and Development (OECD), the Financial Action Task Force on Money Laundering (FATF) and the International Monetary Fund have had a significant effect on the offshore finance industry. Most of the principal offshore centres considerably strengthened their internal regulations relating to money 3

laundering and other key regulated activities. Indeed, Jersey is now rated as the most compliant jurisdiction internationally, complying with 44 of the "40+9" recommendations. In 2007 The Economist published a survey of offshore financial centres; although the magazine had historically been hostile towards OFCs, the report represented a shift towards a much more benign view of the role of offshore finance, concluding: Although international initiatives aimed at reducing financial crime are welcome, the broader concern over OFCs is overblown. Well-run jurisdictions of all sorts, whether nominally on- or offshore, are good for the global financial system. —The Economist, "A survey of offshore finance: Places in the sun", 23 February 2007 The Channel Islands hold that funds generated offshore do indeed go through the Bank of England allowing the UK to benefit from the success of the crown dependencies as offshore centres. 1.5 TAXATION Although most offshore financial centres originally rose to prominence by facilitating structures which helped to minimise exposure to tax, tax avoidance has played a decreasing role in the success of offshore financial centres in recent years. Most professional practitioners in offshore jurisdictions refer to themselves as "tax neutral" since, whatever tax burdens the proposed transaction or structure will have in its primary operating market, having the structure based in an offshore jurisdiction will not create any additional tax burdens. A number of pressure groups suggest that offshore financial centres engage in "unfair tax competition" by having no, or very low tax burdens, and have argued that such jurisdictions should be forced to tax both economic activity and their own citizens at a higher level. Another criticism levelled against offshore financial centres is that whilst sophisticated jurisdictions usually have developed tax codes which prevent tax revenues leaking from the use of offshore jurisdictions, less developed nations, who can least afford to lose tax revenue, are unable to keep pace with the rapid development of the use of offshore financial structures.

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1.6 REGULATION Offshore centres benefit from a low burden of regulation. An extremely high proportion of hedge funds (which characteristically employ high risk investment strategies) who register offshore are presumed to be driven by lighter regulatory requirements rather than perceived tax benefits. Many capital markets bond issues are also structured through a special purpose vehicle incorporated in an offshore financial centre specifically to minimise the amount of regulatory red-tape associated with the issue. Offshore centres have historically been seen as venues for laundering the proceeds of illicit activity. However, following a move towards transparency during the 2000s and the introduction of strict AML regulations, some now argue that offshore are in many cases better regulated than many onshore financial centres. For example, in most offshore jurisdictions, a person needs a licence to act as a trustee, whereas (for example) in the United Kingdom and the United States, there are no restrictions or regulations as to who may serve in a fiduciary capacity. The leading offshore financial centres are more compliant with the Financial Action Task Force on Money Laundering's '40+9' recommendations than many OECD countries. Some commentators have expressed concern that the differing levels of sophistication between offshore financial centres will lead to regulatory arbitrage, and fuel a race to the bottom, although evidence from the market seems to indicate the investors prefer to utilise better regulated offshore jurisdictions rather than more poorly regulated ones. A study by Australian academic found that shell companies are more easily set up in many OECD member countries than in offshore jurisdictions. A report by Global Witness, Undue Diligence, found that kleptocrats used OECD banks rather than offshore accounts as destinations for plundered funds. 1.7 CONFIDENTIALITY Critics of offshore jurisdictions point to excessive secrecy in those jurisdictions, particularly in relation to the beneficial ownership of offshore companies, and in relation to offshore bank accounts. However, banks in most jurisdictions will preserve the confidentiality of their customers, and all of the major offshore jurisdictions have appropriate procedures for law enforcement agencies to obtain information regarding suspicious bank accounts, as noted in FATF ratings. Most jurisdictions also

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have remedies which private citizens can avail themselves of, such as Anton Piller orders, if they can satisfy the court in that jurisdiction that a bank account has been used as part of a legal wrong. Similarly, although most offshore jurisdictions only make a limited amount of information with respect to companies publicly available, this is also true of most states in the U.S.A., where it is uncommon for share registers or company accounts to be available for public inspection. In relation to trusts and unlimited liability partnerships, there are very few jurisdictions in the world that require these to be registered, let alone publicly file details of the people involved with those structures. Statutory banking secrecy is a feature of several financial centres, notably Switzerland and Singapore. However, many offshore financial centres have no such statutory right. Jurisdictions including Aruba, the Bahamas, Bermuda, the British Virgin Islands, the Cayman Islands, Jersey, Guernsey, the Isle of Man and the Netherlands Antilles have signed tax information exchange agreements based on the OECD model, which commits them to sharing financial information about foreign residents suspected of evading home-country tax. 1.8 EFFECTS ON INTERNATIONAL TRADE Offshore centres act as conduits for global trade and ease international capital flows. International joint ventures are often structured as companies in an offshore jurisdiction when neither party in the venture party wishes to form the company in the other party's home jurisdiction for fear of unwanted tax consequences. Although most offshore financial centres still charge little or no tax, the increasing sophistication of onshore tax codes has meant that there is often little tax benefit relative to the cost of moving a transaction structure offshore. Recently, several studies have examined the impact of offshore financial centres on the world economy more broadly, finding the high degree of competition between banks in such jurisdictions to increase liquidity in nearby onshore markets. Proximity to small offshore centres has been found to reduce credit spreads and interest rates, while a paper by James Hines concluded, "by every measure credit is more freely available in countries which have close relationships with offshore centres." Low-tax financial centres are becoming increasingly important as conduits for investment into emerging markets. For instance, 44% of foreign direct investment (FDI) into India came through 6

Mauritius last year, while over two thirds of FDI into Brazil came through offshore centres. Blanco & Rogers find a positive correlation between proximity to an offshore centre and investment for least developed countries (LDCs); a $1 increase in FDI to an offshore centre translates to an average increase of $0.07 in FDI for nearby developing countries. 1.9 OFFSHORE FINANCIAL STRUCTURES The bedrock of most offshore financial centre is the formation of offshore structures – typically: 

offshore company

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offshore partnership

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offshore trust

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private foundation

Offshore structures are formed for a variety of reasons. Legitimate reasons include: 

Asset holding vehicles. Many corporate conglomerates employ a large number of holding companies, and often high-risk assets are parked in separate companies to prevent legal risk accruing to the main group (i.e. where the assets relate to asbestos, see the English case of Adams v Cape Industries). Similarly, it is quite common for fleets of ships to be separately owned by separate offshore companies to try to circumvent laws relating to group liability under certain environmental legislation.

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Asset protection. Wealthy individuals who live in politically unstable countries utilise offshore companies to hold family wealth to avoid potential expropriation or exchange control restrictions in the country in which they live. These structures work best when the wealth is foreign-earned, or has been expatriated over a significant period of time (aggregating annual exchange control allowances).

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Avoidance of forced heirship provisions. Many countries from France to Saudi Arabia (and the U.S. State of Louisiana) continue to employ forced heirship provisions in their succession 7

law, limiting the testator's freedom to distribute assets upon death. By placing assets into an offshore company, and then having probate for the shares in the offshore determined by the laws of the offshore jurisdiction (usually in accordance with a specific will or codicil sworn for that purpose), the testator can sometimes avoid such strictures. 

Collective Investment Vehicles. Mutual funds, Hedge funds, Unit Trusts and SICAVs are formed offshore to facilitate international distribution. By being domiciled in a low tax jurisdiction investors only have to consider the tax implications of their own domicile or residency.

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Derivatives trading. Wealthy individuals often form offshore vehicles to engage in risky investments, such as derivatives trading, which are extremely difficult to engage in directly due to cumbersome financial markets regulation.

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Exchange control trading vehicles. In countries where there is either exchange control or is perceived to be increased political risk with the repatriation of funds, major exporters often form trading vehicles in offshore companies so that the sales from exports can be "parked" in the offshore vehicle until needed for further investment. Trading vehicles of this nature have been criticised in a number of shareholder lawsuits which allege that by manipulating the ownership of the trading vehicle, majority shareholders can illegally avoid paying minority shareholders their fair share of trading profits.

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Joint venture vehicles. Offshore jurisdictions are frequently used to set up joint venture companies, either as a compromise neutral jurisdiction (see for example, TNK-BP) and/or because the jurisdiction where the joint venture has its commercial centre has insufficiently sophisticated corporate and commercial laws.

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Stock market listing vehicles. Successful companies who are unable to obtain a stock market listing because of the underdevelopment of the corporate law in their home country often transfer shares into an offshore vehicle, and list the offshore vehicle. Offshore vehicles are listed on the NASDAQ, Alternative Investment Market, the Hong Kong Stock Exchange and the Singapore Stock Exchange. It is estimated that over 90% of the companies listed on Hong Kong's Hang Seng are incorporated in offshore jurisdictions. 35% of companies listed on AIM during 2006 were from OFCs. 8

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Trade finance vehicles. Large corporate groups often form offshore companies, sometimes under an orphan structure to enable them to obtain financing (either from bond issues or by way of a syndicated loan) and to treat the financing as "off-balance-sheet" under applicable accounting procedures. In relation to bond issues, offshore special purpose vehicles are often used in relation to asset-backed securities transactions (particularly securitisations).

Illegitimate purposes include: 

Creditor avoidance. Highly indebted persons may seek to escape the effect of bankruptcy by transferring cash and assets into an anonymous offshore company.

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Market manipulation. The Enron and Parmalat scandals demonstrated how companies could form offshore vehicles to manipulate financial results.

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Tax evasion. Although numbers are difficult to ascertain, it is widely believed that individuals in wealthy nations unlawfully evade tax through not declaring gains made by offshore vehicles that they own. Multinationals including GlaxoSmithKline and Sony have been accused of transferring profits from the higher-tax jurisdictions in which they are made to zero-tax offshore centres.

1.10 LIST OF MAIN OFFSHORE FINANCIAL CENTRES The list of jurisdictions considered by the IMF to be OFCs is published online. Many offshore financial centres are current or former British colonies or Crown Dependencies, and often refer to themselves simply as offshore jurisdictions. By some measures, there are more countries that are offshore financial centres than not but the following jurisdictions are considered the major destinations for offshore finance: 

Bermuda, which is market leader for captive insurance, and also has a strong presence in offshore funds and aircraft registration.

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British Virgin Islands, which has the largest number of offshore companies.

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Cayman Islands, which has the largest value of Assets under management in offshore funds, and is also the strongest presence in the U.S. securitisation market. 9

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Jersey is the most international of the British Crown dependencies, all of which can be counted as offshore centres. Jersey has particularly strong banking and funds management sectors and a high concentration of professional advisers including lawyers and fund managers.

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Luxembourg, which is the market leader in Undertakings for Collective Investments in Transferable Securities (UCITS) and is believed to be the largest offshore Eurobond issuer, although no official statistics confirm this.

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New Zealand, the most remote jurisdiction, has the advantage of being a true primary jurisdiction but with a tough but practical regulatory regime. It is well positioned for the Asian market but retains close ties to Europe.

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Singapore has recently risen in stature as a centre for wealth management and ranked fourth in the world in the 2009 Global Financial Centres Index. The state is a hub for hedge funds and its private banking industry is growing at a rate of 30 per cent annually.

The following prominent offshore centres now specialise in certain niche markets: 

Bahamas, which has a considerable number of registered vessels. The Bahamas used to be the dominant force in the offshore financial world, but fell from favour in 1970s after independence.

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Panama, which is a significant international maritime centre. Although Panama (with Bermuda) was one of the earliest offshore corporate domiciles, Panama lost significance in the early 1990s. Panama is now second only to the British Virgin Islands in volumes of incorporations.

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2. OFFSHORE FINANCIAL CENTERS IN SINGAPORE, MALAYSIA AND MAURITIUS 2.1 SINGAPORE Singapore is an established financial centre. The financial service sector is supported by sound economic and financial fundamentals and attractiveness as a base for financial institutions. This has been aided by its geographical location in a fast growing area that bridges the gap between the time zones of the North American and European financial markets, political and financial stability, a skilled labour force and significant government incentives. Singapore is the fourth largest foreign exchange trading centre in the world, the fifth largest trader in derivatives and the ninth largest offshore lending centre. The Asian Dollar market (ADM) in one of the premier offshore banking centres in Asia. The STOCK Exchange of Singapore (SES) is a leading stock market in Asia, and the Singapore International Monetary Exchange (SIMEX) has grown into one of the world‘s leading derivatives exchanges. There are three categories of commercial banks in Singapore: 

Full banks

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Restricted banks

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Offshore banks

Full banks are allowed to carry out the full range of banking services under the Banking Act. Restricted banks may engage in the same range of domestic branch and cannot accept Singapore dollar savings accounts and Singapore dollar fixed deposits of less than Singapore $ 250,000 from non-bank customers. In 1973, with a view to facilitate Singapore‘s goal to become an international financial centre through the entry of more foreign banks, another category of same opportunities as the full and restricted banks in business transacted, their scope of business in the Singapore dollar retail market is slightly more limited. In the domestic market, offshore banks cannot accept any interest-bearing deposits from persons other than approved financial institutions, nor can they open more than one

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branch. By the end of November 1998, there were 104 offshore banks in Singapore, all of which were branches of foreign banks. By 2003 the number of banks crossed 120. In Singapore, offshore banking is carried out by separate book-keeping entities known as Asian Currency Units. ACUs do not have the right to incur assets and liabilities in Singapore dollars but can engage in all types of banking transactions in other currencies. Various incentives have been given to encourage the development of ACUs, the most important of which is that ACUs face a tax on profits of only 10% compared with the standard corporate rate of 27% and are not subject to reserve and liquidity requirements. ACUs have functioned in the region primarily as a centre for routing capital from markets in Europe, North America and the Middle East to the fast growing regions of Asia. Important measures to promote offshore banking in Singapore include: 

1973 – Offshore banking licenses issued to seven foreign banks; corporate tax of ACU on interest earnings from overseas loans reduced from 40% to 0%; interest received by nonresident holders of approved Asian dollar bonds exempted from tax.

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1976 – Non resident deposits with ACUs and approved Asian dollar bonds held by nonresidents exempted from Singapore estate duty.

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1979 – Income earned from offshore general reinsurance business granted 10% concessionary tax rate.

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1980 – Stamp duty on ACU offshore general reinsurance business granted 10% concessionary tax rate.

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1980 – Stamp duty on ACU offshore loan agreements and Asian dollar bond certificates abolished.

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1983 – ACUs granted 5 year tax holiday for all income derived from syndicated offshore loans arranged in Singapore.

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1989 – A concessionary 10% tax rate was granted on income from international oil trading activities.

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1990 – Monetary Authority of Singapore (MAS) raised the ceiling on foreign ownership of shares in local banks to 40% from 20%.

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1992 – Stock Exchange of Singapore (SES) granted membership to seven foreign brokerage houses, allowing them to trade directly on the local market. 12

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2002 – Offshore transactions became equivalent to domestic transactions.

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2006- offshore banks started investing huge money in other Asian countries like India, Sri Lanka, Indonesia, Thailand and Vietnam.

With a view to creating a more level playing field for local and foreign banks, the maximum limit for offshore banks for Singapore dollar credit facilities at any one time to non-bank residents was raised from S$ 200 million to S$ 300 to S$ 1 billion, with a view to boosting Singapore as a financial centre. In 2004, many of the investors and joint venture partners avail of offshore facilities to invest in the mega projects of South Asia and South East Asia. 2.2 MALAYSIA Malaysia established an International Offshore Financial Centre (IOFC) in Labuan in 01991. The Offshore Banking Act 1990 provides a regulatory framework for offshore banking operations in Labuan. As confidentiality is the hallmark of an offshore financial centre, an offshore bank has to maintain strict secrecy in the affairs of its customers. Offshore banks are expected to observe a strong self-regulatory code of conduct which places emphasis on ‗knowing your customer.‘ The Labuan Offshore Financial Services Authority (LOFSA) established in 1996, is the single regulatory authority with the following roles and functions: 

To be responsible for setting national objectives, policies and priorities for the orderly development and administration of the Labuan IOFC.

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To be responsible for the promotion and development aspects and recommend new measures to the government to speed up growth and development of the Labauan IOFC.

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To supervise the activities and operations of the offshore financial service industry in Labuan and to process applications to conduct business in the Labuan IOFC, specially in offshore banking, offshore insurance and insurance related business, offshore trust and fund management, incorporating and registering of offshore companies as well as for setting up of Labuan trust companies.

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To administer and enforce offshore financial services legislation and work with the offshore players in Labuan to promote offshore financial services.

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The Labuan IOFC operates in a free exchange control environment. Offshore companies are given a non-resident status for exchange control status. Offshore companies can continue to transfer funds freely to and from their accounts outside Malaysia without approval from the central bank of Malaysia. The foreign currency accounts held with the offshore banks are not considered as external accounts and are not subject to exchange control measures. The offshore banks are also allowed to issue financial and non-financial guarantees to residents in Ringgit. They can receive fees and commissions related to guarantee in Ringgit. The holding requirement of one year is not applicable to assets in Ringgit held in collateral by the offshore banks for credit facilities granted to residents. The payments of existing loans and guarantees in foreign currency by Malaysian residents to the offshore banks do not require prior approval from the Central Bank. In Labuan no tax is imposed on the income of offshore companies that are non-trading companies, and offshore trading companies enjoy a low tax regime with a rate of only 3% of their net income of RM 20,000 (USD 8000). Other benefits and incentives include: 

No tax on offshore companies carrying out offshore non-trading activities such as holding of securities, shares, immovable properties and taking of loans and placing of deposits.

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No withholding tax for dividends paid by an offshore company, distribution from an offshore trust, royalties received from an offshore company by a non-resident, interest earned on deposits with offshore banks, and interest earned on loans to Malaysians.

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No inheritance, death, or estate duty.

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Exemption from paying stamp duty on all offshore business transactions.

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Double tax treaty agreements signed with over 40 other countries and investment guarantee agreements with 50 countries.

2.3 MAURITIUS Mauritius is fast becoming an international financial and business centre. Offshore transactions are normally conducted with non-residents and in currencies other than the Mauritius Rupee. Mauritius has focused its offshore business on specific areas such as investment funds, investment holdings and international trading. The island is becoming an attractive destination for offshore fund structuring and investment vehicles. Mauritius enjoys international exposure as a domicile for emerging market funds, and is being considered as a gateway for investment into India, the Indian sub-continent and the African region. 14

In 1989, offshore banks were allowed to be set up in Mauritius and subsequently the incorporation of offshore companies was allowed. In 1992, the offshore financial services sector was officially set up with the proclamation of two acts of parliament, namely the Mauritius Offshore Business Activities Act and the Offshore Trusts Act. Offshore business can be conducted through the follo9wing entities: an ordinary status company, an international company, a trust, or a partnership. The Mauritius Offshore Business Activities Authority (MOBAA), set up in 1992 under the Mauritius Offshore Business Activities (MOBA) Act 1992, is entrusted with the task of licensing, supervising and developing non-banking offshore business in Mauritius. The MOBA Act 1992 sets out the broad parameters for the conduct of offshore business. An offshore business activity is defined as an activity carried on from within Mauritius with nonresidents and in foreign currencies. The MOBA Act of 1992 provides fro a whole range of approved offshore activities which include Offshore Funds Management; International Financial Services; Operational Headquarters; International Consultancy Services, Shipping and Ship Management; Aircraft Financing and Leasing: International Licensing and Franchinsing; International Data Processing and Information Technology Services; Offshore Pension Funds; International Trading; International Employment Services; International Assets Management; and Offshore Insurance. Currently, eleven offshore banks of international standing operate in Mauritius. Both the volume and range of business undertaken by offshore banks have registered sustained progress. Various factors have registered sustained progress. Various factors have contributed to the attractiveness of Mauritius as an OFC which include: 

Exemption from compliance with the Exchange Control Act.

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Freedom to conduct all legitimate banking and other financial business with non-residents.

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Exemption from credit, interest rates and other restrictions normally applied to business of domestic banks.

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Low income tax rate of 5 percent on all offshore profits.

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Free repatriation of profits without further taxation.

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Exemption from stamp duty on documents relating to offshore business transactions.

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Exemption from stamp duty on documents relating to offshore business transactions.

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Exemption from customs duty on imported office equipment. 15

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No withholding tax on interest payable on deposits raised from non-residents by offshore banks.

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Double taxation avoidance treaty with a number of countries.

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Expatriate staff is subject to a concessionary personal income tax rate.

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No estate duty or inheritance tax is payable on the inheritance of shares in an offshore entity.

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No capital gains tax.

2.4 OFFSHORE FINANCIAL CENTERS AND INDIA A synthesis of the role and evolution of OFCs in select countries, their operative mechanisms, regulatory framework and privileges delineated in the preceding sections highlight various factors that contribute to the attractiveness of OFCs, Certain common facilities/exemptions/concessions have been worked out to form offshore banking in India. With the Government having announced the policy of promoting Special Econ9mic Zones (SEZs) which would, inter alia, serve to attract world class investors, and at the same time contribute towards the country‘s export efforts, it is pertinent to take into account the factors highlighted above that have contributed to successful OFCs around the world. This is very important, as it is necessary to create a policy environment relating to finance and banking which is conducive as also internationally competitive. The main requirements of such a policy are given below. 

Conducive fiscal regime, such as minimal taxation or low tax jurisdiction with an extensive web of bilateral tax treaties; no income tax, capital gains or wealth taxes on individuals, stamp duty, customs duty, estate tax, inheritance tax, etc.

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No withholding of income tax on non-resident depositors in OFCs.

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Stringent banking secrecy rules.

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Absence of exchange control or minimal control.

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Exemption from several prudential regulations including reserve requirements limitations on investments, limitations on acquisitions of immovable property, etc.

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Minimum formalities for incorporation.

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Adequate legal framework that safeguards the integrity of principal agent relations.

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Conducive regulatory framework – a separate banking act to provide a regulatory framework covering the operations of banks and financial institutions in the SEZs. For instance, the Offshore banking licence for the setting up of a branch or subsidiary. 16

3. BENEFITS OF OFFSHORE FINANCIAL CENTRES Today, offshore financial centers have tremendously influenced global financial markets leading to increased international capital flow, greater market efficiency and aggressive competition, thereby creating a cost-effective environment and upholding global transparency and co-operation standards in trade and economy. In this regard, it is very much important for investors planning for overseas investments or businessmen preparing for overseas business operations to have some basic understanding about these centers and the way they operate. The term ―offshore‖ actually originated from a group of Islands that are located in the English Channel called the Channel Islands. These islands are Crown Dependencies that were primarily used by British nationals as centers for keeping their assets safe and secure. Since then, offshore financial centers have been former or existing British colonies, overseas territories or countries that are possessed by The Crown in Right of the United Kingdom. However, there are also various independent nations that encourage offshore services within their territories. Examples of some popular financial centers providing offshore services include Bahamas, Cayman Islands, Bermuda, British Virgin Islands, Luxembourg and Panama. In fact, Panama Offshore Services and Panama Banks are considered as one of the most reliable, professional and secured in terms of quality of service. Apart from these, even advanced nations such as Germany, Singapore, Switzerland, Australia and Hong Kong can also be considered as offshore. In technical terms, an offshore financial center can be described as a jurisdiction that can provide the necessary infrastructure and legal atmosphere, thereby facilitating the incorporation of offshore companies in the country and allow these companies to invest offshore funds. Usually, these jurisdictions are countries that follow liberal taxation policies and do not have any stringent rules and regulations on offshore investment. Mentioned below are some interesting aspects regarding offshore centers. One of the most common misconceptions about offshore services provided by offshore centers is that only rich and wealthy can benefit from these. On the contrary, this notion is far from being true. With the market being extremely competitive, financial services such as those offered by Cayman Banks and other financial centers can no longer be one dimensional. Due to this reason, these centers 17

have expanded their operations in such a way that they serve multiple clienteles and are now providing services that can benefit a wide range of customers. Secondly, offshore financial centers are often believed to be deregulated, thereby ensuring a safe haven for criminals and other offenders to transfer their wealth and other assets from one location to another. Again, this is another belief that has never been correct. In fact, some of the offshore services provided by banking institutions such as Swiss Internet Bank are renowned for their security, confidentiality and measures they adopt in preventing financial crimes. Lastly, there are many advantages one can avail through offshore services offered by offshore financial centers and institutions such as Singapore Banks. Some of these services include asset protection, banking, investment, insurance, securities and trade finance. Apart from gaining maximum returns on their investments such as bank deposits, investors can benefit from tax exemptions on securities, cash deposits and other investments. Also, these services provide a wide range of global investment possibilities, thereby providing individuals with an opportunity to diversify their investment portfolio.

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4. FUTURE OF OFFSHORE FINANCIAL CENTRES The financial services industry is critical to the economic well-being of small international financial services centres (OFCs) such as the Bahamas, Bermuda, the British Virgin Islands (BVI), the Cayman Islands, the Channel Islands, Gibraltar and the Isle of Man. It is the major driver of the high per capita GDP figures. Some of these jurisdictions have thriving tourism industries also. But these, while welcome, tend for the most part to provide unskilled and low paying jobs. Less well understood is the often beneficial role OFC‘s play in the allocation of global capital in legitimate ways. The picture often painted of OFC‘s by the ‗noisy‖ media of shady places for shady people overlooks that the bulk of the flows through OFC‘s are legal and are a natural part of globalization. After a volatile few years since early 2008, the financial services industry in OFC‘s is now slowly recovering from the global financial crisis. For the most part, OFC‘s have dodged the misdirected bullet that ―offshore‖ was responsible for the meltdown. In Cayman, the hedge fund industry is renergised and is growing again, Asian IPO‘s are doing well, captive insurance is hanging in, but the debt side (securitization) is still quiet, albeit with some green shoots. Banking and fiduciary (trust) businesses are essentially flat. Overall, the recovery in OFC‘s is patchy as yet and they cannot afford to become complacent again on the basis it is soon to be ―happy days are here again‖. They must continue to be vigilant to ensure their long term stability and success in the future.

4.1 SCENARIOS First, some possible future scenarios for OFCs. Scenario I – doomsday • This outcome is the cataclysmic decline of these centres. One cause might be the major economic powers implementing domestic policies and programmes that eliminate the need to use OFCs. This would entail the introduction of well balanced regulatory and supervisory regimes and the reduction of tax rates and other costs to levels that made it impossible for OFCs to compete. If this were left to Ireland with its 12% tax rate, that might happen. But it seems remote in reality. • An alternative and alarming cause might be the effective implementation of international agreements between the major economic powers not to compete on regulatory and tax matters, to establish common standards of (over)regulation and standardised (high) tax rates, to create a unified global tax and regulatory regime under the United Nations, OECD (Organisation for Economic Cooperation and Development) or other international organisation and to pass domestic legislation 19

making it hard, if not impossible, for OFCs to be used legally. This outcome seems also rather unlikely, however much the EU (and some in the USA) in particular might like it. • The final alternative would be the reintroduction of exchange/capital controls by all major economic powers, whereby regulatory approval is required to move funds cross border. This was the position in many countries post WWII until the late 1970‘s and early 80‘s, and many of us remember that well. The result might well be ghost communities relying on fishing and tourism reminiscent of the old gold and silver mining towns of the Western USA. Scenario II – Nirvana This outcome is the continued and unchecked growth of such centres driven by increased globalisation of financial markets, continued regulatory and tax arbitrage and competition between sovereign states and the welcoming of the useful role played by OFC‘s. And the pejorative distinction between ―onshore‖ (good) and offshore (bad) disappears. The result will be thriving and much-loved OFC‘S generating wealth for residents and non residents alike. Scenario III – the curate’s egg This outcome is a mix of I and II, i.e. these centres will continue to exist, some will flourish and others die on the vine, but with continued attempts by major economic powers and blocks to reduce the advantages they can offer. Scenario III is the most likely, and it will be interesting and challenging. Success will come to those jurisdictions that can genuinely add value to international transactions and are recognised as so doing. This in turn requires the right mix of a stable and transparent political, legal, judicial and economic environment, no or limited direct taxation or a good network of double tax treaties, a good risk based regulatory and supervisory approach, a flexible and adaptive approach to legislation and regulation to provide the structures, products and supervision expected by the market, a willingness to engage with international standard setters, foreign governments, regulators and law enforcement and tax agencies to agree mutually satisfactory standards of regulation and cross border assistance and law enforcement, modern infrastructure, a welcoming immigration policy to attract the expertise needed and an educated and motivated local work force,

4.2 BACKGROUND It is important to note that OFCs are typically places that facilitate international financial transactions rather than create them. To put this in perspective, London and New York are international financial centres and create the transactions; the Bahamas and the Cayman Islands are 20

international financial services centres that play a role in their execution. It is a little like the difference between the place where Toyota designs its cars and the place where the transmissions are built. Of course, the goal of a financial services centre should be to develop into a true financial centre where products and structures are actually created as well as executed. To do that, it has to attract the necessary expertise. Examples of places that are well on the way are Hong Kong and Singapore. Dubai‘s early promise may have been set back for some years by its domestic real estate bubble and crash, but it is proving quite resilient. The success of OFCs has depended on a variety of reasons. By and large, they all share a common platform of political stability, no or limited taxation, no or very flexible exchange control, sensible company, trust and regulatory and commercial laws, a commitment to confidentiality (subject to appropriate gateways for disclosure) and a welcome mat for legitimate international transactions, service providers and investors. Historically, many of the jurisdictions were or are in the UK fold as territories of one kind or another, e.g. Bermuda, the Bahamas (now independent), the BVI, the Cayman Islands, the Channel Islands, Gibraltar and the Isle of Man. Indeed, the UK encouraged these territories in the early days to develop as financial services centres to reduce the burden on the UK treasury. In similar vein, the Netherlands and the Netherlands Antilles. Others are independent nations such as Liechtenstein, Luxembourg, Panama and Liberia (the latter both noted particularly as ship registration centres). But there is often a certain randomness as to why some centres developed particular areas of speciality. Often it was a mixture of timing, luck, spotting an opportunity, geographical convenience, personal connections or even a fortuitous double tax treaty (Barbados and the Netherland Antilles), rather than a logical analysis of the market and a targeted approach. For instance, Bermuda developed as the leading captive insurance domicile due to lack of capacity and high premiums in the US corporate market and its geographical convenience to the US Northeast and Midwest where many of these major corporations were based. It was also quite well placed for the London reinsurance market. Bermuda‘s expertise in this area provided the base for it to expand into the open market reinsurance business when the traditional US and European reinsurers were not meeting the needs of the market. The Channel Islands and the Isle of Man were well placed geographically, particularly for UK (and being within the Sterling area for exchange control purposes), European and, more recently, Middle East sourced business. The BVI became the offshore corporate Delaware in the late 1980‘s built on the instability of Panama during 21

and immediately after the Noriega era. Many of the Panama service providers established operations in the BVI as a stable and low cost alternative to Panama and actively marketed it as such. The Cayman Islands first developed as an offshore banking centre in the 1970‘s, following perceived political instability in the Bahamas during the lead up to and post independence. The principal reason originally for the development of the Eurodollar market (as it was called) was the introduction of US domestic regulations that made it far more cost effective for banks and corporations to borrow and lend US$ outside the US. That market continues today (but for very different reasons) and the total footings of Cayman licensed banks are now around US1.6 trillion. The Cayman Islands diversified from the banking base into general financial and capital markets, fiduciary (trust/private client), captive insurance (initially largely due to some missteps by Bermuda), mutual funds and general corporate business. Today, it is probably best known for being the major offshore banking and hedge fund domicile and one of the leading captive insurance domiciles. To build an OFC takes time. And it can be threatened very easily as the business is of essence quite easy to move. It does not have bricks and mortar or much physical equipment. The Bahamas lost considerable business in the late 1970‘s and early 80‘s in the run up and post independence due to aggressive nationalism. Panama suffered greatly during and after the Noriega years. Interestingly, both the Bahamas and Panama defied predictions and are once again doing quite well. They would make two very interesting case studies. The Netherlands Antilles had an extremely helpful double tax treaty with the US that made it a major centre for US corporate borrowing in international markets. So successful indeed, that the US eliminated the benefits with the stroke of a pen (a fate that awaits any such treaty where one side benefits far more that the other). The Netherlands Antilles have struggled as a financial services centre ever since. Little remembered is that the BVI once had double tax treaty with the UK. That also received the UK pen treatment. But the BVI did recover and has become the leading offshore corporate domicile. 4.3 INTERNATIONAL THREATS OFC‘s have been wrestling with the alphabet soup of international initiatives for some time. Acronyms like BIS (Bank for International Settlements), EUSD (European Union Savings Directive), FATF (Financial Action Task Force), FSB (Financial Stability Board), IAIS (International Association of Insurance Supervisors), IMF (International Monetary Fund), IOSCO (International Organisation of Securities Commissions), OECD and UNODC (United Nations Office 22

on Drugs and Crime) roll off the tongue. Despite these, or because of them as some would claim, many but not all, OFCs have thrived. The initiatives continue apace, particularly with respect to cross border assistance, principally exchange of information in an ever-broadening range of areas, including tax. It is trite to say that responsible OFC‘s wish to deter abuse of their financial services, to punish those who do and to cooperate cross border with other jurisdictions with equivalent standards and legitimate interests. It is equally trite to say that such OFC‘s wish to implement and maintain sound and effective regulatory regimes that provide the right framework for financial transactions and balance the interests of suppliers and buyers of financial products and service providers. The stated goal of most major jurisdictions is to provide a global environment where legitimate capital can flow cross border into investments and financial products free from arbitrary barriers or controls. OFC‘s that implement the various international initiatives are lead to believe they will not be discriminated against, will be allowed to participate and thus will benefit economically. But the reality to-date is rather different. A few years ago, a Commonwealth Secretariat paper concluded that three OFC‘s (Barbados, Mauritius and Vanuatu) could not show tangible benefits from implementing the recent international taxation and anti money laundering/countering the financing of terrorism initiatives. A similar review has not been carried out in Cayman. Anecdotal evidence is not so much that Cayman has suffered; rather it has not thrived as well as it could have absent the often burdensome and costly compliance requirements that have distracted Government and the industry from continuing the innovative developments for which Cayman has become known . The final communiqué from the Commonwealth Ministers meeting in 2007 specifically recognized the heavy compliance costs for OFCs and called for a more inclusive process in setting international standards. Some lip service has been paid to this suggestion and, for instance, OFC‘s are now having greater participation in the development of international standards and in the peer review of effective implementation. A good example is Cayman‘s (and other OFC) membership of the OECD Global Forum on Taxation that is working on increasing cross border transparency in tax matters. Another is the participation by Bermuda in the IAIS development of its Multilateral Memorandum of Understanding. Five particular points: • First, there is still no meaningful level playing field. The reason is anti competitive behaviour. Many jurisdictions that pay lip service to free market economics only mean it when it applies to 23

others, i.e. others should open their markets to their products, but not vice versa. And in financial products OFC‘s can pose a major competitive threat. So, for instance, the UK and the US are not keen to see OFC‘s thrive too much, but they recognize that, for their own financial service industries to be competitive and to secure inward foreign investment, they must allow their service providers to use OFC domiciled structures and permit investment from OFC‘s, otherwise they risk their service providers migrating to OFC‘s or losing inward foreign investment. Serious competition also exists between the UK (London) and the US (New York). The UK and the US are benign compared with others. Some major EU members maintain dirigiste economic models that are under serious financial pressure from the weight of an ageing entitlement society. Their fear of leakage of capital and revenues is such that their goal is to eliminate OFC‘s. So, while loudly trumpeting their support for globalization of financial services and the desirability of opening all markets to services and products, they continue to impose unequal, burdensome and anti competitive regulation on OFC‘s and continue to maintain barriers to their residents using OFC‘s and to OFC financial products being sold in their local markets. The EU is becoming increasingly aggressive post the financial crisis, and the recent Alternative Investment Fund Managers Directive bears all the marks of misguided protectionism (if the EU can get away with it). The BRIC countries have been less aggressive in the past, as they tended to benefit from large amounts of inward investment from OFC‘s. But recently some of these, particularly India an less so China, have become more questioning of the use of OFC‘s as they fear that they are losing tax revenues (and control of capital) through OFC structures for both inward and outward investment. • Second, the acronym standard setters referred to above and driving the international initiatives are the creatures of and funded and staffed by the very same major countries that have no real interest in a level playing field open to OFC‘s. • Third, there is the natural tendency of bureaucracies to be self-serving and self-justifying, particularly where they are unaccountable. The international standards setters (and the EU Commission) are just that. Their staff has little interest in finishing a project and, if it appears near to finishing, will develop a new or expanded programme. This is clearly evident in the international tax initiatives of the OECD and EU, and from the efforts of the FATF to avoid abolition. And they have every interest in preserving their tax free benefits packages. The most recent example is the manoeuvring of the OECD, through the Global Forum on Transparency and Exchange of Information for Tax Purposes, to become the judge, jury and executioner in tax 24

information exchange compliance and to push the frontier beyond bilateral agreements to multilateral arrangements encompassing automatic/spontaneous supply of tax information. • Fourth, there is widespread specific legislative and regulatory action to reduce or even eliminate the use of OFC‘s. The EU continues to push for an expansion of the Savings Directive (automatic reporting) to include broader types of income and ―cut through‘ to the underlying beneficial owners of companies, trusts and partnerships. The Directive on Alternative Investments (even in its watered down form) presents and attempt to build ―Fortress Europe‖ for the fund industry. The OECD and the FATF continue with their ―name and shame‖ lists and effective implementation reviews of OFC‘s (while ducking attacking the deficiencies in major onshore jurisdictions). The UK Revenue has issued a ―voluntary‖ code of conduct for UK banks under which they agree to abide by the spirit as well as the letter of the tax law. France has established the Evafisc to monitor offshore accounts. US has eliminated the benefit of offshore sweep accounts for corporate customers of US banks and the avoidance of dividend withholding tax through the use of synthetic instruments (derivatives). It has also enjoyed considerable success in its battle with Swiss banks that (may) have assisted US taxpayers to evade their US tax obligations by indicting certain of those banks and/or their officers. It is significantly expanding reporting obligations regarding foreign accounts and other offshore investments of US taxpayers (FATCA) and is considering expanding the automatic reporting of interest income earned by foreigners in US bank accounts and taxing reinsurance premiums paid to offshore affiliates. There is now heightened debate over corporations deferring tax by holding profits in OFC‘s, transfer pricing, carried interest and unrelated business income, all of which could have an adverse impact on OFC‘s. • Last, and most importantly, reputational pressure is now getting real traction and is producing results in key areas. Continual political and special interest group pressure and media focus on finding scapegoats for the financial crisis, and disclosure of the use of OFC structures by major financial institutions and multinationals is having an adverse impact on OFC‘s. The goal is to make it unacceptable to engage even in lawful tax planning and avoidance. The UK media has given considerable critical attention to UK banks with offshore operations. France has pressured its major banks to close their operations in ―paradis fiscaux‖. The EU Parliament adopted a resolution in 2011 demanding inter alia sanctions on financial institutions that ―operate with tax havens‖. The European Investment Bank (EIB) has amended its lending policies so that loans will not be made to entities domiciled in jurisdictions that do not meet international tax information exchange standards. And the 25

US President and the Congress continue to proclaim loss of tax revenues to OFC‘s by both tax evasion and legal tax avoidance planning and the need ‗to do something about it‖. The latest example of this is the President‘s Framework for Business Tax Reform is the latest salvo in this effort, ably supported by the Stop Tax Haven Abuse and similar moves lead by Senator Levin. In the meantime, a number of publicly listed holding companies domiciled in OFC‘s and with significant USconnections have moved their domicile to jurisdictions that have full double tax treaties with the US. And finally, many US citizens living overseas are finding increasingly difficult to obtain normal banking services for their legitimate needs! 4.4 OFC DEFENCES/ACTIONS There is a dangerous brew of self-interested behaviour by large countries and their client international standard setters. So what to do – certainly OFC‘s cannot safely ignore these developments and pressures? • First, OFC‘s must ensure that their regimes meet currently accepted and applied international standards and are effectively implemented. In particular, OFC‘s must become more transparent and better at prompt and effective enforcement of their laws and regulations. Currently, they shoot themselves in the foot by defending outdated regimes and by encouraging Luddite attitudes in certain professional circles, make themselves an easy target for critics and lose high quality business for reputational reasons. Further, OFC‘s should learn which battles to fight. It may seem counterintuitive not to object to a financial transactions tax. But if everyone were to implement one, such a tax at a competitive rate would be a very useful additional source of revenue for OFC‘s. • Second, OFC‘s must continually upgrade and improve their laws, regulations, infrastructure and Government and professional services to remain competitive in the financial services arena. For instance, OFC stock exchanges could start offering derivatives trading and settlement if the onshore rules become too burdensome. • Third, OFC‘s must continue to engage with the key major jurisdictions and standard setters to shape and inform the development and implementation of fair international standards that create an inclusive and non-discriminatory playing field open to all legitimate OFCs and recognizes the equivalency of their regimes. • Fourth, they must develop and implement networks of well crafted and mutually beneficial agreements with relevant jurisdictions for cross border assistance in terms of information exchange 26

and law enforcement, subject to appropriate safeguards for legitimate confidentiality, due process and the rule of law. • Fifth, they must remain vigilant and ensure their advance intelligence is as good as possible to ensure proactiveness rather than reactiveness. • Sixth, better and more proactive political, media and educational campaigns are essential. There have been some successes as seen in academic papers and conferences showing the benefits provided by OFC‘s and commentary in the responsible media. However, these successes are still overwhelmed by extensive media coverage of strongly critical and inaccurate statements about OFCs from foreign politicians, regulators, standard setters, adverse lobbying groups, charities and church groups (even the Vatican). • Seventh, OFCs should join together (recognising they are also competitors) in building a cohesive group to conduct this engagement. Lonely tilting at windmills will not succeed. There has been remarkably little progress in this cooperation. Even the Channel Islands, Guernsey and Jersey, seem only sporadically to coordinate their efforts effectively. • Eighth, OFC‘s need to seek out new sources of quality business in, for example, Asia, South America and the Middle East where the threats to their existence are considerably less. And where legitimate facilitators of globalcapital allocation are still welcome. • Last, but perhaps most importantly, OFC‘s should strive to have real economic activity carried out and value added within their jurisdictions by the vehicles domiciled there…that means warm bodies in seats in physical offices in the OFC‘s making substantive decisions. And not simply delegating all those functions to third party service providers. This requires the appropriate local infrastructure and the right immigration policies and procedures to welcome the necessary expertise and to provide an educated and motivated local labour force. But this is probably the best defence against the ―lack of economic substance‖ argument levied against OFC‘s. This is a long term and many dimensional project and the challenges are formidable. To survive and thrive, Governments and the private sector in OFC‘s must devote the necessary resources and energy to the task. 4.5 DOMESTIC THREATS OFC’s must also pay heed to domestic issues. • OFC‘s must ensure that they continue to provide a stable and reliable political, legal, judicial, economic and social environment. International investors have little interest in locating their 27

investment structures and transactions in jurisdictions where there are concerns about corruption, disregard for the rule of law and xenophobic hostility. • It is imperative that the local community understands and supports its financial services industries and benefits from it. There is frequently insufficient effective engagement between the domestic stakeholders, who tend to take each other for granted. Unless the financial services industry is understood, trusted and supported by Government and the community, industry positions on issues such as a sensible application of the immigration regime, targeted legislation to enhance financial products and the regulatory regime, reasonable revenue raising measures and improved human and financial resources for relevant Government departments and agencies risk being seen as narrowly self interested and may fall on fallow ground. • We see local expressions of dissatisfaction with the financial services industry (even in Switzerland) and questions raised about the industry‘s contribution to the broader community as a whole. These criticisms are broadly unjustified and unwise. OFC‘s typically do not simply ―rent out‖ their legal and regulatory system and infrastructure to foreigners and without any benefit resulting to the local community. One only has to look at other small islands in the Caribbean and elsewhere to see the value of the financial services industry. It is this industry, not tourism, that has given Bermuda, the BVI, Channel Islands and the Cayman Islands such high per capita GDP. After all, places such as the Dominican Republic and Jamaica dwarf Cayman in terms of its total tourism activity; not so in per capita GDP. • It appears that Governments and the financial sector in some OFC‘s have become complacent; if so, they must both work harder to ensure that the broader community understands and remains convinced that the financial services industry is critical to the well-being of the Islands. Without strong and committed local support, the preservation and expansion of the industry in an increasingly challenging and competitive international environment becomes a daunting task. 4.6 WINNERS AND LOSERS So what might OFC‘s expect for the future? • The pendulum is still swinging against OFC‘s for the moment. But unless the world goes back to the dark economic ages, the rhetoric (even from the French and Germans) should reduce and some semblance of balance will return. • The world is full of global businesses and families. And their number and wealth (despite wealth destructors such as Bernie Madoff and Allen Stanford) should increase over time. The real growth will probably be in the new BRIC worlds and not so much the traditional (old) world of the G7/8. 28

• Expanding taxation and burdensome regulation will make proper planning for corporations and wealthy families even more important and also lead togreater demand for tax and regulatory advantaged and pleasant places to live and domicile, and where there is access to quality professional services and advice. • Global economic competition inevitably means tax and regulatory competition. No-one has yet created the perfect tax or regulatory regime, so competing regimes (within broad agreed norms) are perfectly proper, just as there are many ways to make a safe automobile. Individuals and corporations are still entitled legally to maximise their wealth. Indeed, corporations have an obligation to their shareholders to do so. • Legitimate tax and regulatory planning will always have a place. OFC‘s with high standards of sensible regulation, appropriate transparency, cross border assistance arrangements and good infrastructure and providing quality valueaddedservice have a valuable and vital role to play in this scenario. • The barriers to entry as an OFC are ever increasing. The cost of developing the infrastructure and meeting international standards is significant and success cannot be achieved overnight or guaranteed. • There are probably now too many OFC‘s. Competition is increasingly fierce, and jurisdictions and structures are increasingly fungible. • Darwin‘s theories argue for survival of the fittest. The OFC survivors will be those who are stable, transparent and soundly regulated, meet international standards, have an established infrastructure and track record (in all its aspects), tax/regulatory efficiency, professional expertise and support services, a solid and diverse base of business, and the ability quickly to adapt and innovate in the ever changing global environment and to add real value to legitimate international transactions and capital flows in an efficient and cost effective way. CONCLUSION So applying all this, what is the future for OFC‘s? Do they thrive as a financial services centre or go back to tourism, fishing and rope making (with meager handouts from aid agencies) until global climate change finally sinks them? Many (but not all) OFC‘s meet the foregoing tests for being survivors and need not suffer death by a thousand cuts. But to really thrive as financial services centres, OFC‘s must learn better from history and from their and others‘ mistakes and work more effectively to be fully accepted as legitimate participants in the global financial world. These are challenges indeed. 29

5. CASE 5.1 OBAMA’S AND OFFSHORE FINANCIAL CENTERS President Obama has had a dislike for offshore financial centers since he was a Senator. He cosponsored a bill called the Stop Tax Haven Abuse Act and it appears that his administration will pursue the bill in the near future. President Obama pledged to crack down on ―tax havens‖ during his election campaign. He has vowed to investigate and put pressure on banking secrecy in over thirty-four jurisdictions that practice a high level of protection that may lead to tax evasion and fraud. The then Senator Obama was a cosponsor of the Stop Tax Haven Abuse Act, which was introduced on February 17 2007. A House bill was developed simultaneously, but no action was taken on either bill. Obama aides have indicated that the bill may be resurrected. Since the recent scandals with banks like UBS and the investigation into tax evasion coupled with the recession and the financial fall out, Senate Permanent Subcommittee on Investigations has placed a priority on international investigations of individuals with connections to offshore financial centers. Similar pressure is happening in other countries. The Stop Tax Havens Abuse Act would restrict the use of offshore financial centers by imposing that transactions between US persons and offshore jurisdictions be taxable. It will also raise the reporting requirements and increase the penalties for tax evasion with the use of offshore jurisdictions. The Committee feels that an additional $50 billion in additional tax revenue will be gained. Within the Act is a provision that would force taxpayers to prove that they do not have control over any offshore entities with which they contract and the act takes a ―guilty until innocent‖ approach. The Act presumes that a US citizen has control of entities including trusts, corporations, limited liability companies and partnerships created or domiciled in a so-called Offshore Secrecy Jurisdiction if the US person directly or indirectly formed, transferred, received assets or is a beneficiary of that entity. The objective of the Stop Tax Havens Abuse Act creates taxable income for all transfers to offshore entities and presumes that income from these transactions remains unreported. The thirty-four jurisdictions include almost every Offshore Financial Center such as Guernsey, the Isle of Man, Switzerland, the Cayman Islands, the British Virgin Islands, the Cook Islands, the Bahamas, Bermuda, Hon Kong, Jersey, Belize and Costa Rica.

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5.2 CASE FOR AN INDIAN OFFSHORE FINANCIAL CENTRE Section 18 of the Special Economic Zones (SEZ) Act, 2005, provides for an International Financial Services Centre (IFSC), with resident units to be treated as SEZ units for levy of income tax and excise as well as Customs exemptions and concessions. The Act envisages an IFSC within an SEZ, which does not mean that IFSC units' operation would be confined to only SEZs. Although the Act became effective in 2006, the proposed IFSC is yet to materialise, with many continuing to question the need for such a centre. The million-dollar question is whether such a centre makes business sense for India. The cynics cite decreasing relevance of such centres in liberalised financial markets, while the votaries bank on mammoth business transactions in other centres, employment generation prospects, foreign exchange inflow and global capital at global cost for players in domestic tariff area (DTA). Given the different offshore financial jurisdictions — traditional, regional or international — and varying regulatory frameworks, the answer would lie in the IFSC model, regulatory framework, operational

flexibility

and

concessions

or

exemptions

India

chooses

to

adopt.

Pragmatism suggests that India has nothing to lose provided concerns on money laundering and confidentiality — as postulated by the International Monetary Fund (IMF) and Organisation for Economic Cooperation and Development (OECD) — are addressed. Success stories of Hong Kong, Singapore or even the newer Labuan Offshore Financial Centre in Malaysia should be a good reason for India to establish an IFSC. Dubious offshore centres in the Caribbeans should not be a deterrent. The IMF define such hubs as "centres where the bulk of financial sector transactions on both sides of the balance sheets are with individuals or companies that are not residents" . Apart from the wellestablished offshore financial centres such as London, New York, Japan, Hong Kong and Singapore, new centres have come up in Mauritius, Malaysia, Shanghai and Dubai. The total cross-border assets of select offshore financial centres, as per an IMF report, were about $4.6 trillion in 1999, i.e., 50% of the total cross-border assets, of which $0.9 trillion was in the Caribbean, $1 trillion in Asia, and most of the remaining $2.7 trillion by the IFSCs in London, US and Japan. In India too, the proposed IFSC will go a long way in boosting the country's economic growth by facilitating higher foreign capital inflow and adding vibrancy to its financial market, foreign exchange earnings, SEZs, creating employment and, most importantly, making global capital available at global cost. 31

If the Reliance and Tata groups can deal with financial institutions in London and New York, an IFSC in India will only bring such financial institutions to our own backyard. Indeed, India faces the daunting task of placing itself on a par with established centres such as Amsterdam, Berlin, Frankfurt, Milan, London, New York, Zurich, Paris and Rome. But it's difficult to fathom a specific reason for India to fail as well, given its convenient time zone, skilled human capital, stable political system and conducive business environment. 5.3 NEW ‘INDIAN’ HEAD-ACHE FOR OFFSHORE FINANCIAL CENTRES Mauritius – a popular OFC and intermediary jurisdiction for investments into India is worried that companies set up there to take advantage of the country‘s lack of capital gains tax and the significant benefits under its tax treaty with India will come under increasing scrutiny if the ‗form over substance‘ doctrine becomes law under new general anti-avoidance rules (GAAR) proposed by the Indian government. In fact Mauritius is so worried that this could end its reign as the leading offshore financial centre for investment into India that although its authorities have indicated a willingness to renegotiate its tax treaty to include a limitation of benefits clause it is reported that they have also demanded that structures set up before April 1, 2013 be left untouched. Blurred Lines. In practice the new GAAR means that the real intention of the parties, the purpose of the arrangement, and the effect of the transactions will be taken into account to determine the tax consequences of the transactions, regardless of the legal structure used by the taxpayer. It will also grant the tax authorities considerable administrative discretion in applying the rules, potentially creating uncertainty about where accepted tax planning ends and abusive tax avoidance begins. Real Commercial Substance. It is expected that an arrangement will be deemed to have been created with the main purpose of avoiding capital gains tax in India if the legal ownership ostensibly resides with the intermediary holding company but the beneficial ownership rests with the foreign investor. Such arrangements

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typically are characterized by all of the funding for the investment in India coming from the foreign investor and simply being routed through the offshore holding company. The test of substantive commercial substance can however be satisfied if the holding company conducts business in the jurisdiction where it is incorporated, if its board of directors meets in that jurisdiction, and if it carries out business with adequate personnel, capital, and infrastructure of its own. This presents a real problem for such companies as typical holding companies are set up to ‗hold‘ assets and not engage in ‗active‘ business. Who Has the Burden of Proof? Under existing law the Indian tax authorities have the burden of demonstrating a lack of commercial substance. It was originally proposed that the taxpayer would have the burden of showing commercial substance, but this was changed while the Finance Bill was being debated in Parliament. Under existing rules, a taxpayer can provide a tax residence certificate to obtain benefits under one of India‘s tax treaties unless the treaty contains more onerous requirements, such as having to satisfy a limitation on benefits clause. The GAAR will give the Indian tax authorities discretion to determine whether the offshore holding company has substantive commercial substance. State of Play. In announcing the budget, former Finance Minister Pranab Mukherjee assured taxpayers that detailed guidance would be issued on the application of the GAAR to allay the concerns of foreign investors and ensure that the provision is not applied indiscriminately. A committee was immediately set up to formulate guidance for implementing the GAAR. 5.4 MAKINGMUMBAI AN INTERNATIONAL FINANCIAL CENTRE Implications for India and Mumbai Given that an IFC in Mumbai must be rooted in (and serve) India‘s financial system, rather than be an artificial offshore appendix, the call for creating an IFC in Mumbai at this time is implicitly a metaphor for (and synonymous with) deregulating, liberalizing and globalising, all parts of the Indian financial system at a much faster rate than is presently the case. Raising the issue of an IFC in 33

Mumbai now suggests that the pressing need for a new, more intensive phase of deregulation and liberalization of the financial system has been anticipated by India‘s policy-makers and regulators and that the IFC is a device to accelerate movement in that direction. An IFC will not be created quickly in Mumbai, nor will it succeed, if action on further deregulation and liberalisation is not taken in real time. In sustaining its trajectory as an emerging, globally significant, continental economy, the HPEC believes that India has no choice but to: (a) become a producer and exporter of IFS; and (b) capture an increasing share of the rapidly growing global IFS market. To achieve these two goals, its financial centre in Mumbai must compete to become a successful IFC. Incremental growth in the global IFS market is now being driven by the growing demands of China, India and ASEAN. With its strengths in human capital, a globally powerful IT services industry, and its own hinterland, India has many natural advantages for competing successfully in this market. In evolving as an IFC, Mumbai will probably grow in two distinct phases: 1. In the first phase (2007–2012) Mumbai must connect India‘s financial system with the world‘s financial markets through IFS. That is what IFCs like Frankfurt, Paris, Sydney, Tokyo and a host of smaller IFCs do now in respect of their national economies. 2. In its second phase (2012–2020) Mumbai must develop the capacity to compete with the three established GFCs for global IFS business that goes beyond meeting India‘s needs. After 2020, HPEC would hope that Mumbai would hold its own in competing with the other GFCs and acquire increasing global market share. India‘s financial services industry will not become export-orientated, nor derive significant IFS export-revenues, if Mumbai fails to become an IFC. That will compromise not just export earnings from IFS, but the quality, efficiency and range of domestic financial services offered in India as well. For Mumbai to become an IFC, India‘s policy-makers and financial operators need to understand fully the nature of and opportunities in: the global IFS market; the activities undertaken in GFCs; and the gap in capabilities that now exists between Mumbai and established GFCs.

Urban infrastructure and governance in Mumbai The lure of the burgeoning Indian market has already attracted a large number of foreign financial firms to Mumbai. They have, in turn, located an increasing number of high-level expatriate staff in the city, creating intense competition and driving up prices quite dramatically for limited accommodation and lifestyle facilities that are not yet world class. A Mumbai-IFC that provides IFS 34

only to the Indian market will not face the same pressures from foreign firms and expatriates to remedy the privations that they presently have to suffer: i.e. inadequate infrastructure, massive congestion, rampant pollution, along with poor standards of urban governance and law enforcement. In HPEC‘s view the present state of play can be tolerated reluctantly even as Mumbai grows as an IFC in its first phase, connecting India to the rest of the world. But that can only last for the next five years or so. In its second phase of growth, if Mumbai is to be a successful GFC that exports to global markets competitively, it will have no choice but to match London, New York and Singapore in terms of attracting the requisite high-level human talent to the city. If it fails to do so it will not succeed as a GFC. To match these global cities in the span of the next 5-10 years for their world class quality of infrastructure and their global standards of governance, Mumbai needs to make a start now. The individuals that Mumbai must attract (and who matter most) to be globally competitive in providing IFS– whether Indian or not and whether working for Indian or foreign firms – are affluent, mobile, and multi-culturally inclined in terms of their habits, tastes and preferences. They demand world class facilities to live, work and play, as well as world standards of infrastructure and urban governance. They have ample choice in terms of where they (and their families) choose to be located, and how their time is allocated. Whether they choose to locate in Mumbai will be influenced by the attractions of Mumbai as a global city in which they can live, work and play in a manner similar to what they can do in other GFCs. This reality may involve the creation of facilities to support lifestyles that could result in increasing social tension in the city; that risk will need to be managed sensitively and adroitly. For Mumbai to become an IFC that can operate on a par with the three established GFCs, it will eventually need to attract a large population of individuals who are an integral part of the globally mobile (globile) finance workforce that already exists. Perhaps 25–30% of them will be of Indian origin. The remainder will be expatriates from around the world representing every country that has significant trade and investment links with India (and Asia). Most of them will be working for foreign financial firms that will include, inter alia: commercial and investment banks, asset management companies, insurance companies, securities and commodities brokerages, bills discounting houses, private equity firms, venture capitalists, hedge funds, as well as the financial media and financial reporting agencies (such as Bloomberg, Reuters, major global financial publications) and exchanges – even external and global regulatory agency representatives – from over a hundred different countries. 35

The choice India has already become a large purchaser of IFS from the rest of the world; much larger than is realised in policy-making or commercial circles, leave alone by the public at large. As its economy grows, its demand for IFS will increase in a non-linear fashion. India can, of course, choose to continue buying IFS from abroad indefinitely. But the amounts it will need to spend for that purpose are staggering. They represent a waste of resources on purchasing services that India could provide more competitively for itself. Moreover, an inability to meet its own needs – and those of its trading and investment partners – for IFS will compromise India‘s growth. Oddly enough, India does not need to rely on foreign providers for IFS. Quite the contrary: India has several significant strengths that give it an edge in providing IFS not just to itself but to the rest of the world on a competitive basis. Indeed, there is no city in the world that can become an IFC on the scale of London or New York, within a 20-year horizon, in the way that Mumbai can. This reflects India‘s unique strengths of: democracy, open-mindedness, cultural comfort with foreigners living and working inMumbai, use of English, a wellplaced time zone, high quality labour force, a 200 year tradition of speculation and risk taking, and a hinterland advantage. But such a future for Mumbai is far from guaranteed. At present, India is absent from the global IFS space, owing to weaknesses in financial sector policy, financial market structure, financial regime governance, legal system infirmities, as well as in the urban infrastructure and governance of Mumbai. The situation is worse than initial conditions were for manufacturing and software exports in 1991. India does not have a low market share in the global IFS market: it has a zero market share. Looking ahead, the growth of IFS demand in India is inevitable, given the sheer growth of crossborder flows. The pressure of IFS demand that will flow from cross-border transactions of $1–2 trillion per year will inevitably trigger the emergence of rudimentary IFS capabilities in one way or another. The question that India faces is whether incremental evolution towards a limited range of IFS capabilities is adequate, or whether there is a more promising future for India in exporting IFS. If decision-makers fail to tackle the policy issues outlined in this report, Indian IFS demand will fuel the growth of Wall Street, Singapore, DIFC and the City of London; often through the aegis of Indian financial firms that will graduateinto multinationals and relocate their IFSoperations outside the country. The maturity of Indian finance in 2006, in terms of coping with competition and globalisation, is comparable to where Indian manufacturing stood in 1991. The exportof financial 36

services from India in 2006 sounds about as unlikely today as the exportof automobile components or softwaresounded in 1991. The outlook for export ofautomobile components or software in 1991 was nothing but bleak. Yet India managedto find the energy to unleash revolutionary changes in policy. Such radical changes now need to be replicated in finance, if export competitiveness in the rovision of financial services(domestic and international) is desired and to be achieved. Visionary thinking needs to be applied to issues of financial architecture, the role of the central bank, and regulatory philosophy. In parallel, Mumbai needs to become a first-world city that can attract the brightestminds of the world by being an attractive place to live, work and play.If India is able to meet these twinchallenges, then IFS exports could outstripIT service exports by 2025. The benefitsto the Indian economy, from taking the IFC path, are much greater than thedirect revenues that would accrue from sale of IFS to local and foreign customers. India‘s experience with manufacturing hasdemonstrated that outward orientation and export competitiveness are the best tools for producing world class quality for the domestic market. An Indian financial sector that can export IFS will do a better task of financial intermediation for India. That is likely to generate an acceleration of GDP growth as growing investment resources (now exceeding 30% of GDP) are more efficiently allocated. These benefits need to be weighed carefully by India‘s leadership against the political capital that needs to be expended in overcoming the technical and realpolitik constraints of: (a) changing the financialsystem in India with a second, moreintensive set of reforms; and (b) urban governance in Mumbai.This report has tried to bring objectivity and professional competence to sketchingthe trajectory, should India‘s leadershipdecide to take the IFC path. It strives to deliver a nuanced appreciation of the likelycosts and benefits of the path to an IFC, based on understanding of which policymakerscan make a reasoned choice.

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CONCLUSION In future, however, the tax havens will need to take as much note of attitudes in large developing countries as in the OECD stalwarts. They understand that the balance of power in global economic governance is shifting, which is why they have lately been trying to forge high-level regulatory and political relationships in Asia and Latin America. They are relieved that China, with Hong Kong and Macau under its wing, seems less hostile to offshore finance than Western governments currently are. India and Brazil, though more critical, take a pragmatic approach. India became aware of the dangers of trying to interfere with a popular tax haven last year when it sought to rewrite a tax treaty with Mauritius that had caused large amounts of inward investment into India to be routed via the island. Financial markets went into a deep dive at the prospect and India had to moderate and delay its move. Harmonisation of financial rules looks as far away as ever. And where there are differences in national tax rates, regulatory standards and confidentiality laws, there will be opportunities for ―international financial centres‖ to offer ―legitimate arbitrage‖—or, as their detractors see it, for ―secrecy jurisdictions‖ to provide ―boltholes‖ that allow elites to undermine their home countries‘ policies. Offshore financial centres are not ready to sink into the sea yet.

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BIBLIOGRAPHY 

The Future of Offshore Financial Centres- Rereading The Tealeaves From A Cayman perspective by Timothy Ridley Paper presented to the UCCI/UWI/ICCI Caribbean Conference 21-23 March 2012

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Moran Harari, Markus Meinzer and Richard Murphy (October 2012) "Financial Secrecy, Banks and the Big 4 Firms of Accountants" Tax Justice Network

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Offshore

Financial

Centre:

http://www.mbaknol.com/international-finance/offshore-

financial-centers-ofcs/ 

Offshore Financial Centers – What You Need to Know to Benefit From Them: http://www.globaltrialbank.org/offshore-financial-centers-what-you-need-to-know-tobenefit-from-them.html

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Obama’s and Offshore Financial Centers http://assetprotectionworld.com/obamas-and-offshore-financial-centers/

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Case for an Indian Offshore Financial Centre http://economictimes.indiatimes.com/policy/case-for-an-indian-offshore-financialcentre/articleshow/5888043.cms

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New ‘Indian’ Head-Ache for Offshore Financial Centres http://franhendy.com/2012/07/17/new-indian-head-ache-for-offshore-financial-centres/



Sunshine and shadows http://www.economist.com/news/special-report/21571559-offshore-financial-centres-willalways-be-controversial-they-will-stay

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