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Wednesday
Jan302019

The EU’s blacklisting threat against smaller territories is undemocratic and brutal 

Repetition is to be avoided in most walks of life. But where the offshore world is concerned, it appears to be the fulcrum around which the ill-informed are led by the unknowing. In this instance, it is the European Union’s turn to go on the offensive, with the bloc effectively threatening sanctions and retribution against the overseas territories, including my adopted home and professional base, the British Virgin Islands (BVI).

In December 2017 the EU published an initial blacklist of 17 countries which EU finance ministers claimed had refused to co-operate with its crackdown on so-called "tax havens," and then a series of other nations -- including the BVI -- which were put on a "greylist."

Blacklisted jurisdictions could face reputational damage and stricter controls on their financial transactions with the EU, while those which were on the grey list could be moved to the blacklist if they if they did not meet certain commitments.

These EU bully-boy tactics have recently forced the BVI to pass The Economic Substance (Companies and Limited Partnerships) Act, 2018, which came into force on New Year’s Day. It was pushed through by our government here in order to meet the EU’s deadline to adhere to its brutal demands (or else risk being blacklisted). The EU had previously placed the BVI and other Overseas Territories on its "greylist," supposedly due to concerns regarding their compliance regimes.

The new Act effectively requires offshore financial services companies registered in the British Virgin Islands to physically set up office spaces in the territory, if they are to continue doing business with/through the BVI. Penalties to be hurled at financial services providers who do not comply with requirements of the BVI's new Economic Substance Act will come in the form of fines which, in the most extreme of circumstances, could near a quarter million dollars.

I’ve plied my professional trade as a lawyer specializing in the investigation of international fraud and cross-border asset recovery for over 30 years. So when it comes to the world of offshore companies and trusts, I have something hopefully useful to say here.

Ever since the Panama Papers broke (April 2016) and more latterly the Paradise Papers mass data leaks (November 2017), offshore service providers have found themselves under the cosh. NGOs such as Transparency International, Global Witness and Ethical Alliance have led the way, exerting pressure on governments to make changes that they believe will frustrate those who would abuse the offshore industry for their illicit purposes. The NGOs in question have an admirable objective, but their thinking remains flawed.

During the 1980s and 90s, offshore services were run akin to something from the Wild West -- with an absence of sheriffs -- and many Ultimate Beneficial Owners (UBOs) of offshore companies were indeed dressed in black. But times have changed. The islands’ ability to regulate improved substantially and those governments who were working with them were pushing against an open door. 

In the years that I have been involved in this business, I have seen massive changes: the majority for the better. Many of these changes were already in place prior to the Panama Papers hitting the headlines nearly three years ago and many of the scandals highlighted by the Panama Papers emanated from those historical Wild West days.

We are now in a world dominated by knee-jerk reactions and disproportionate responses. The situation is complicated further because the ordinary taxpayer often sees the rich as “tax dodgers,” and regards offshore companies as centers of darkness. There are moral and ethical questions surrounding the issue of individuals and companies paying taxes commensurate to their earnings and profitability. But the equation here isn’t that simple.

In fact, there is an old saying relevant here: we need to be careful what we wish for. This applies to EU governments too. They are meddling with an offshore eco-system that could blow up in their faces. The EU has taken to threatening to blacklist offshore jurisdictions that do not require locally incorporated companies to venue the “economic substance” of their operations in their place of “tax residence” (a company’s tax residence is typically where it is controlled). 

With the probable exception of holding companies (a massive exception), some companies registered in the British Virgin Islands are now required to physically set up office space and employ people in the island territory if they are “tax resident” here, and if they wish to continue doing business via the BVI.

Local reporting courtesy of The BVI Beacon newspaper and its correspondent, Conor King Devitt, highlights one of the issues:

A VI-incorporated company, for example, may be considered tax resident in Japan if it is headquartered in Tokyo. Such a company would not be subject to the territory’s new [economic] substance requirements.

The highly informative article continues:

The exact [economic] substance requirements differ for different types of economic activity, but, overall, the legislation requires such companies to demonstrate that their “core income-generating activities” happen on the territory’s shores. A company responsible for an intellectual property business developing patents, for example, would need to show evidence that their research and development happens in the VI. A shipping business would need to demonstrate that it manages crew and maintains ships within the territory.

Companies would also have to demonstrate that there are “an adequate number of suitably qualified employees in relation to that activity who are physically present” in the VI; demonstrate adequate expenditure in the VI; and show evidence of appropriate physical offices for their economic activity. Companies that fail to satisfy such requirements can incur fines and eventually be stricken off the Corporate Register.

Given the limitations of the territory’s size, population and infrastructure, industry stakeholders have noted that the physical substance mandates are likely to discourage many types of businesses from incorporating new VI entities or renewing existing ones.

Initial penalties for non-compliance include fines ranging from a minimum of $5,000 to $50,000. The final penalty will be decided by the International Tax Authority (ITA) established under the BVI’s Ministry of Finance.

Fortunately, there does appear to be some common sense evident, at least where the estimated 400,000 BVI holding companies are concerned. Under the new law, such companies only have to show that they have “adequate employees and premises” to manage their equitable interests or shares. However, what might be considered “adequate” is not yet known at this time. If the EU stipulates a number of employees per company, this could devastate the islands’ offshore service industry.

The EU seemingly fails to appreciate ‎that the business of the majority of BVI companies is to act as passive holding companies for share capital in subsidiary undertakings domiciled and operating elsewhere. The “economic substance" of a holding company does not involve employing many people or producing "widgets" or services. It is to act as an aggregator of capital to go on risk through investments through subsidiaries or holdings in the capital of other companies all over the world.  

If we look at the new statute, it includes as a part of the definition of economic substance the idea that a BVI holding company can be in compliance with the Act (as maintaining adequate economic substance inside the BVI) without actually requiring an influx of employees or economic activity being "onshored" onto Tortola. Holding companies fall into an exception to what an analyst may consider to be adequate economic activity to show economic substance to being "venued" in the BVI. This test of adequacy of economic substance will, it seems, be ultimately decreed by the overlords in the EU. What is it that the grey suits in Brussels consider acceptable and not a source of unattractive tax avoidance? Who knows? 

The EU's blacklisting threat against smaller countries or territories for not adhering to its unclear standards in the area of tax avoidance is undemocratic and brutal. It also reveals a misunderstanding of what BVI companies do in large measure.

BVI companies form an integral part of the world's economic plumbing, which in turn has stimulated the movement of surplus capital from rich nations to go on risk in developing nations -- thereby pulling many people out of poverty tax efficiently. This has been one of the most positive benefits of globalization. Many of the NGO campaigners remain unaware of this role the BVI can, and does play, along with her sister service providers elsewhere in the Caribbean and the Channel Islands.

The EU is seemingly unwittingly threatening to destroy the plumbing of globalization over its own political ineptitude, in order to get its internal tax policy equalized and to negate tax competition in the internal EU market (for example, comparing Irish corporate tax rates with those in France) or outside the EU. The EU threat is more to do with political expediency. It is unjust and wrong-headed for the EU to blame small Caribbean Islands for their own tax mess. 

Contrary to the EU’s and the NGO’s assertions, according to the International Investment website, reporting on research carried out by economists commissioned by the BVI government at Capital Economics, the territory “has become more of a domicile of choice for corporate clients looking to achieve an efficient cross-border structuring than for stashing private wealth.”

The International Investment article added:

The research found that assets held on the island on behalf of offshore companies currently total around $1.5 trillion, more than twice what had been estimated to be there seven years ago. It also found that more than 140 listed companies in London, New York, Hong Kong and elsewhere use BVI business companies to manage their cross-border activities.

Capital Economics’ report, said by BVI Finance to be the first of its kind, estimated that: 

More than $15 billion of tax revenues are generated annually for governments around the world, via investment mediated by the BVI and the resulting economic activity. The UK ($3.9 billion), the EU excluding UK ($4.2 billion) and China and Hong Kong ($2.1 billion) are the largest beneficiaries of this tax generation.

The Capital Economics researchers concluded:

The BVI is not, "some supposed tax haven," as it "has no banking secrecy rules, and compares well against many other jurisdictions on international standards for transparency, tax information exchange, anti-money laundering, and measures to combat the financing of terrorism." What is more, the "BVI is ‘tax neutral’ and is not a center for corporate profit shifting," it adds. "Just because a company is incorporated in BVI does not stop it being liable for full taxation in other jurisdictions."

In other words, serious economic research would indicate that the BVI is not some form of hell on earth, presided over by Beelzebub. It is in fact the most important offshore service provider for the world’s corporate investors and risk takers. I was delighted when the Panama Papers highlighted criminal tax evasion and money laundering scams. I was less pleased when I realized that common sense and reality was totally lost in the ensuing maelstrom. What part of the fact, that this was historical wrongdoing, didn’t the lobbyists and campaigners grasp?

The use of blacklists to try to extort policy results ‎in small foreign sovereign states is an open form of economic warfare and hostility -- and a direct assault on the sovereignty of democratically elected local government. It is a horribly blunt instrument which is pregnant with unintended consequences. 

With thanks to Tony McClements, Senior Investigator at Martin Kenney & Co, for his assistance with this post.

____

Martin Kenney, pictured above, is Managing Partner of Martin Kenney & Co., Solicitors, a specialist investigative and asset recovery practice based in the BVI, focused on multi-jurisdictional fraud and grand corruption cases www.martinkenney.com | @MKSolicitorsIn 2014 he was the recipient of the ACFE’s highest honor: the Cressey Award for life-time achievement in the detection and deterrence of fraud. He was selected as one of the Top Thought Leaders of the Legal Profession in 2018 and 2019 by Who's Who Legal International and as the number one offshore lawyer for asset recovery in 2017 and 2018.