The IFC Economic Report speaks to Paul Astengo by Gibraltar Finance

SPRING 2014

IFC ECONOMIC REPORT

AND THE US SAID “Let there be FATCA”

INSIDE:

• Learning to live under FATCA’s Light • Oﬀshore in Practice: Asia • Beneficial Ownership • Automatic Exchange of Information

Within the European Union Single Market

Contents EDITOR

Ciara Fitzpatrick ciara@ifcreview.com EDITORIAL ASSISTANTS

Michael Agnew editorial@ifcreview.com Ryan McMurtry editorial2@ifcreview.com DESIGN AND PRODUCTION

Colin Halliday Kellie Mills production@ifcreview.com DISPLAY SALES

Comment 4

News

Comment ............................................Prof Michael Mainelli

In the Chair ......................................... Mark Simmonds MP

Cover Feature

12 Tax Co-operation Past, Present and Future ............................................................Prof Allison Christians 18 Here Comes FATCA..........................................Scott Michel 20 FATCA Offspring ...........Louise Gonçalves and Eran Shay 22 Is the Automatic Exchange of Information Good for the Wealth Management Industry and IFCs?

DIRECTORY SALES

Regulation & Policy

ADMINISTRATION

Claire Davison claire@ifcreview.com ACCOUNTS

Fiona Brennan accounts@ifcreview.com PUBLISHER & CHIEF EXECUTIVE

Robert Ayres rob@ifcreview.com

IFC Review

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The Big Debate

Ryan O’Hara ryan@ifcreview.com Adam Whitehurst ads@ifcreview.com Toby Podmore directories@ifcreview.com

26 Transparency & Trust: The Problem with Beneficial Ownership ...................................................... Anna Steward 30 The World Moves Towards Tax Transparency ................. .......................................................................... Monica Bhatia

32 Revised Parent and Subsidiary Directive: Towards a Fairer Tax System .........................................Thomas Neale

Gibraltar in Focus

34 Q&A with ...........................................................Paul Astengo 36 Rising to the Challenge ............................Michael Castiel

Offshore In Practice: Asia

38 An Asian Welcome for Offshore ................. Frances Woo

41 IPO Resurgence in Hong Kong ......................................... ......................................Richard Grasby & Richard Spooner 46 Challenges for Wealth Structuring in Asia ..................... ......................................................................Paul Christopher 48 Enforcing BVI Equitable Share Mortgages in Asia – Receivership ....................... Robert Foote & Faye Griffiths 50 Segregated Structures – An Offshore Innovation ........ ............................................................................Alan Dickson

Sector Research

52 Chinese Incorporation for Institutional Arbitrage and Access to Finance ................................................................. ........ Dylan Sutherland, Hinrich Voss, and Peter J Buckley

Indian Ocean Outlook

56 Mauritius: The African Success Story.............................. ................................................................Nikhil Treebhoohun 59 The Seychelles Vision ................................ Rupert Simeon

The Last Word: The BVI IBC 60 The BVI Act and the building of a Nation .................. ................................................................... Colin Riegels

Professional Directory 64 Professional Directory

IFC economic report • spring 2014

EDITOR’S NOTE Welcome to the IFC Economic Report. The times they are a changing. It seems the West is emerging, bleary eyed from the recession of the last few years and although it will take some time for normality (whatever that may be) to return, recovery appears to be on the horizon. With that recovery is coming some hefty, ‘never again’ type regulation. None quite so far reaching as the omnipresent FATCA. It is hard to open a finance magazine or website without the acronym looming large from the text. And with good reason. The legislation is so far reaching that its very legality is questionable, however, there is a certain inevitability with this attempt by the US Revenue Service to corral in its potential tax payers. The July deadline looms and around the globe financial institutions are frantically trying to get their houses in order and individuals who suspect they may be US citizens are frantically trying to rid themselves of this tax millstone. Along with FATCA, the march towards complete tax transparency continues with onshore governments and pan-national bodies such as the OECD pushing for automatic exchange of information. The voices of opposition to this are being overwhelmed by the noise of governments clamouring aboard the automatic exchange of information bandwagon. In this edition of The Big Debate (p22), we ask our contributors whether this move to automatic exchange is actually good for the wealth management industry and for IFCs in general. With so much exchanging of information, what is to happen to those who need a little bit of privacy? Very few appear to be asking the question whether a certain level of secrecy serves a legitimate purpose. Members of the IFC community are quick to point out that much of the regulatory demands being made currently are already in place in the smaller IFCs – they have had the OECD pressurising them into high levels of regulation for a long time now. A point raised by our commentator, Michael Mainelli, who suggests that IFCs should market themselves as leaders in the regulatory race – competing on the regulation front may at last eradicate the bad press they endure year on year. The innovation that IFCs exhibit in this ever changing industry is the very reason they still survive and thrive.

Ciara Fitzpatrick Editor

BEPS - the next major tax initiative to affect IFCs The OECD’s action plan to combat base erosion and profit shifting (BEPS) is anticipated to be the latest international tax initiative to impact the financial services industry – with sectors such as reinsurance and captive insurance to fund and securitisation to feel the effects. OECD Secretary-General Angel Gurría said: “This Action Plan, which we will roll out over the coming two years, marks a turning point in the history of international tax co-operation. It will allow countries to draw up the co-ordinated, comprehensive and

transparent standards they need to prevent BEPS.” Announced by the G20 at the September 2013 summit in St Petersburg, to address weaknesses in the existing international system, the plan identifies 15 specific actions that will give governments the domestic and international instruments to prevent corporations from paying little or no taxes. Speaking during a webinar on the progress of the initiative, Pascal SaintAmans, Director for the Centre of Tax Policy and Administration at the OECD stated that the proposals were “on track” and that there was an incentive to work at a rapid pace, with the G20 and OECD member states due to receive completed recommendations for action by December 2015, with a number to be addressed by September 2014.

AIFMD bottleneck as the July deadline looms With the AIFMD implementation due on 22 July, research shows that less than a fifth of alternative investment fund managers have applied to continue managing existing alternative investment funds under AIFMD, according to research from BNY Mellon.

In a similar survey conducted by BNY Mellon in July 2013, 26 per cent of respondents had said they planned to submit their application during 2013. With the deadline only months away, a significant number of alternative investment funds (AIFs) are yet to finalise their plans towards full compliance, with 37 per cent saying they are unclear as to how they will address the additional requirements around regulatory reporting. Commenting on the slow uptake, Hani Kablawi, EMEA Head of Asset

Servicing at BNY Mellon said: “There is a danger of a significant bottleneck developing in the application process, as many managers surveyed are yet to fully address their AIFMD requirements in time for the July deadline. Allowing for the time required by regulators to review applications, and for depositary and administrative service providers to make the relevant arrangements, there is a risk that funds will miss the application deadline. The slow progress we see around applications highlights both the uncertainties and practical challenges the industry is facing getting to grips with AIFMD. Certainly, those who have so far delayed their submissions cannot kick the can down the road any longer. Prompt action is required if managers are not to fall foul of the consequences of non-compliance, both in respect of their regulators and their investors.”

NEWS IFC: GO OD FOR THE GLOBAL ECONOMY

EU seeks finance regulation Americans included in US Trade Pact renouncing citizenship The European Union has called for banking regulation to be included in any discussions regarding an EU-US trade pact, despite tough resistance from the US treasury, providing a potential stumbling block to the deal which is already facing widespread public opposition from within the US and Europe. The EU, with support from sections of the finance industry, noted in a position paper in January that leaving such discussions on regulation out would be a gross error stating: “The EU believes that financial regulation is too important to be discussed ad hoc, in informal settings at the very last minute under market pressure.” The paper attempted to ease concerns by insisting that regulators on both sides of the Atlantic would ultimately retain

control of financial regulation while arguing that the differing approaches to regulation are significant barriers to investment and also undermine global financial stability. The EU also stressed that calling for the inclusion of talks on financial regulation was not akin to proposing that both sides accept the other’s regulatory system but merely assessing grounds for equivalence between the two. The US government has indicated concern that Wall Street would use regulatory convergence to circumvent unpopular restrictions placed upon them by the Dodd Frank law. While talks started in July 2013 they are still at an embryonic stage. A ‘stocktaking’ meeting between Karel De Gucht, the EU trade commissioner and Michael Froman, the US trade representative, was held February 17-18, where the main areas of the deal were defined.

Record numbers of US citizens and permanent residents are giving up their citizenship or residency with 2013 seeing an increase of 221 per cent over the previous year.

While the number is still small, just 630 for the last quarter or 2013 the overall total for 2013 is 2,999. The previous record high was 1,781 set in 2011. Unlike other industrialised countries, the United States requires citizens to file tax returns whether or not they live in the country. The pressure to lose US citizenship may increase when the US Foreign Account Tax Compliance Act, or FATCA, comes into force this summer. The act would require financial institutions outside the country to identify and report their American customers, or face punitive taxes on their US investments.

UK plans for beneficial owners registry The UK government has announced plans to create a new central registry of “beneficial owners” of UK companies.

Companies will have to obtain information from their shareholders on individuals who exercise control over how the company is run and provide it to the Registrar of Companies, who will then maintain the central registry. The government has proposed to apply the rules to companies incorporated in the UK and is currently considering covering other

legal entities such as limited liability partnerships. New legislation would be enacted to enable companies to obtain the required information. Also planned is a legal requirement for companies to identify their beneficial owners and proposes to require beneficial owners to disclose this fact to the company. A beneficial owner could also be required to disclose when they become, or cease to be, a beneficial owner of the company. Business Secretary Vince Cable stated: “We believe a public register, listing those who really own companies, makes Britain a better place to invest and do business. People have a right to know

who controls UK companies and greater openness will help tackle tax evasion, money laundering and other crimes.” Limited exemptions from public disclosure would be available, for example where necessary to protect individuals whose safety might be at risk. The method for making this information publicly available and up to date has yet to be disclosed, however, a formal response is expected in early 2014 to the original Department for Business Innovation & Skills’ “Transparency & Trust” discussion paper published in July 2013. See: Transparency & Trust byAnna Steward p52.

IFC economic report • spring 2014

Comment

Protection Ratchets Up: Long Finance and Offshore Centres By Professor Michael Mainelli, Executive Chairman, Z/Yen Group, London Michael Mainelli’s latest book, co-authored with Ian Harris, The Price of Fish: A New Approach to Wicked Economics and Better Decisions, won the 2012 Independent Publisher Book Awards Finance, Investment & Economics Gold Prize. Z/Yen – www.zyen.com - created and compiles the Global Financial Centres Index – www.globalfinancialcentres.net.

From January to June 2013, the UK media had headlines such as “Google, Amazon, Starbucks: The rise of ‘tax shaming’” (BBC), and “David Cameron: Tax avoiding foreign firms like Starbucks and Amazon lack ‘moral scruples’” (The Telegraph).

In late June 2013, Starbucks agreed to pay £10 million to the UK Treasury. Given that Starbucks reportedly paid no tax in the previous four years, £8.6m in corporation tax in the UK over the previous 14 years, yet had sales in the UK of £400m per annum, this might sound like a victory over tax evasion. At no point has any authority accused Starbucks of not complying with tax law. Having followed the tax code correctly, Starbucks reached annual agreements with HM Revenue & Customs that little or no corporation tax was payable. The majority of people seem to have no problem with Starbucks’ payment or feel an urgent need to reform tax laws. However, as an accountant I wonder how the payment should be booked, certainly not to marketing. Tax liabilities have always been a complicated area, but in this case is the payment: • A mistake, an adjustment to historic tax liabilities, or a retroactive tax? • A bonus payment or donation to HM

Revenue & Customs? • A donation or bribe paid to the UK coalition government, or perhaps David Cameron’s Conservative Party? • A shakedown or protection racket payment to a corrupt government? Perhaps I might mischievously suggest that Starbucks be reported to the US authorities under The Foreign Corrupt Practices Act of 1977 which “was enacted for the purpose of making it unlawful for certain classes of persons and entities to make payments to foreign government officials to assist in obtaining or retaining business.” [US Department of Justice website] The rules on international corporate taxation are close to unworkable, though I wonder why more people do not question the theoretical basis for taxing corporations, which is at best dubious. Things are no better with international personal tax, whether it is the inheritance tax nightmares we see in probate courts as lawyers drain away estates, or the future delightful Catch-22s of the US Foreign Account Tax Compliance Act (FATCA) ranging from the illegality of overseas compliance to denial of service for US citizens or residents. Though the intentions of some of the bodies shouting for reform can be questioned, it is clear that tax reform is essential. The road to tax reform is

unlikely to be smooth or straight, so expect a large number of awkward, contradictory, and dangerous steps along the way. It is no surprise that aggressive tax enforcement follows a series of financial crises in developed countries. Monetary systems are under strain following a period of excessive credit growth and banking leverage that now requires much tighter budgets and recapitalisation. During financial crises weightless capital flies to safe havens, yet there are many dangers beyond grasping governments. Global unrest has been enormous. Just mentioning the Arab Spring, Thailand, Turkey, Ukraine, and Russia encompasses huge numbers of people and territory enduring civil unrest. These conditions form a perfect storm for wealth destruction. London, home to a few financial crises, has paradoxically benefitted from capital flight. Though London itself needs to shape up, in comparison with many other places it is a safe haven. Nevertheless, London may have moved from being a centre of wealth creation to a centre for wealth protection, potentially harming its domestic economy’s future. Since 2008, offshore centres have held their own in the Global Financial Centres Index. But that’s not sufficient. In all the turmoil they should have thrived.

comment

A racket is a service that is fraudulently offered to solve a problem that would not otherwise exist. At the moment, larger economies exhibit many of the characteristics of a protection racket, particularly when tax is taken into account. Looking at the EU over Cyprus or Ireland, the USA on FATCA, the OECD on tax equalisation, the UK on retroactive and windfall taxes, and it is easy to see that the value of wealth protection is growing. Offshore centres compete by providing stability and simplifying financial services. What we have here is a failure to take positive action and communicate offshore centres’ roles to clients and onshore authorities. Offshore centres should focus on how they ‘signal’, in economics jargon, to the outside world, credibly conveying their long-term stability. Offshore centres must increase their reputations for longterm stability and openness. Offshore centres must prove that they are far less likely to make capricious changes to rules or regulations. The essential offshore services are to support long-term finance and provide regulatory simplicity. What sorts of action could be taken? A 2013 Long Finance, CISI and BSI report, Backing Market Forces: How To Make Voluntary Standards Markets Work For Financial Services Regulation, contains several signalling ideas such as working more closely with the International Standards Organisation (ISO) on Anti-Money Laundering (AML), Know Your Customer (KYC), alternative currency management, barter, or even developing a standard for a Secure International

“The road to tax reform is unlikely to be smooth or straight, so expect a large number of awkward, contradictory, and dangerous steps along the way.” Financial Centre that could be audited. A few centres are exploring transferable AML and KYC passports. Others are looking at improving intellectual life. Alderney is working on alternative currency regulation. I would suggest going further faster, perhaps even ‘selling’ good regulation. Imagine a value-added silver or gold service where an offshore centre provides external inspection reports to family office owners alongside benchmarks with other family offices on the same island. Large states have a comparative disadvantage in global finance, unable to combine wholesale and retail financial regulation without incurring booms and busts. Our work has identified several possible ‘long finance’ strategies for offshore jurisdictions which I would pull together as: • Get Real - more aggressive promotion directly stating that larger nations do have shortcomings with long-term planning and capricious regulatory change, combined with a clear legislative cycle in finance where finance bills change regularly but not too rapidly; • Get Integrated - consider ‘midshore’ strategies where there is a symbiotic offshore relationship with larger nations allowing businesses

to function under less-than-ideal or complex onshore regulation; • Get Better - tackle long-term skills shortages with better training for indigenous populations rather than relying on imported skills; improve power, transportation and communications infrastructure; • Get Connected – host high-profile regular events, create strong academic links, simplify visa and work permit processes; • Get Serving – increase levels of service both for those entering the centre and long-term residents; use benchmarks, data comparisons, and awards to keep service high. I might also add ‘Get it together’ with other offshore jurisdictions. Cooperation, particularly towards more regulatory uniformity and consolidation, could strengthen the hands of offshore negotiators. As Bob McDowall, Finance Minister for the States of Alderney, says, “No island is an island in the 21st century.” Innovative, integrated and cooperative offshore centres should be thriving in these times of crises. It is hardly too late. As the value of long-term protection ratchets up, offshore centres could underpin global financial reforms to build a safer, more efficient, and longerlasting financial services sector.

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IFC economic report • Spring 2014

interview

In the Chair...Mark Simmonds MP Parliamentary Under Secretary of State at the Foreign & Commonwealth Office Part of Mark Simmonds MP’s remit at the Commonwealth Office is providing support for the Overseas Territories. The IFC Economic Report spoke to Mr Simmonds about what this support entails, particularly with relation to the IFCs that some of the OTs host.

A number of the Overseas Territories (OTs) and Crown Dependencies (CDs) have set themselves up as successful international finance centres. How important do you think their role is in the global movement of wealth? MS: The Overseas Territories, which are part of my Ministerial responsibility, and the Crown Dependencies, include some of the world’s leading financial centres and play an important role in the global economy and driving global economic growth. I discussed these very important issues with Territory Leaders at the Overseas Territories Joint Ministerial Council in November. We agreed in the Communiquė to create a fair, responsible, and effectively regulated global business environment and to work together to promote the application of high international standards. Financial business is global and everybody, not just the Overseas Territories and Crown Dependencies, should play their part in developing and applying international standards. It is not just me who talks about the positive role that international financial centres can play for third countries. Academic literature also supports this. For example, in 2010 Professor Sharman suggested that international financial centres help domestic and foreign investors in developing countries access the kind of efficient institutions necessary

to drive growth, but which are often unavailable locally. How important is the financial services sector to the economies of these jurisdictions? MS: The international financial centres hosted by the Territories are conduits of capital in the global economy where international trade is based on complex value and supply chains. Most Territories rely heavily on one or two economic sectors, one of which is financial services. In some Territories financial services contribute more than 40 per cent to GDP and 20 per cent of government revenues. To give you some examples. The Cayman Islands is the world’s leading centre for hedge funds and is also a significant wholesale banking centre. Bermuda is the third largest reinsurance centre in the world and the second largest captive insurance domicile. The British Virgin Islands is the leading domicile for international business companies and Gibraltar provides an extensive selection of financial services. The Crown Dependencies have similarly established important financial services industries with Jersey being a strong player in trusts. Revenue from financial services activities allows the Territories to be self supporting and so, with the exception of Montserrat, they do not require financial aid from the UK Government. That is why we are working closely with

both the Overseas Territories and the Crown Dependencies as the international standards evolve. We all share the same commitments to high standards, and together, we are in a stronger position to encourage other jurisdictions to follow the path we are taking. The steps announced by the Overseas Territories and the Crown Dependencies in advance of the G8 Summit in June are a clear demonstration of the results we can jointly achieve internationally. How important are they to the UK economy? MS: The Overseas Territories and the Crown Dependencies are separate jurisdictions, which have the right to compete in that market. In some areas there is competition but in others there are mutual benefits. The global nature of business and financial flows means that there is very close interaction between them and the City of London. For example, the UK is a net recipient of funds flowing through the banking system with large inflows from the Crown Dependencies. Financial flows are also generated by insurance business and fees earned by professionals, such as lawyers and accountants. The Foreign and Commonwealth Office promises in its policy document ‘Supporting the Overseas Territories’ to support the OTs and particularly to

in the chair

promote economic growth and the creation of jobs. In what ways can the government actively support the growth of the financial services sectors in the OTs? MS: Economic growth and the creation of jobs are vital for the Overseas Territories. That is why I wanted last year’s Joint Ministerial Council to focus on these important issues. The Territories have come a long way from their predominantly agriculture and fishing based economies of half a century ago, but their economies are still based on a small number of pillars, namely, financial services and tourism. Financial services will continue to be important but Territories should continue to explore opportunities to diversify their economies. Economic diversification is not easy. It requires a clear strategic plan and takes time to implement. But there are opportunities and that is why I was delighted with the very positive response we had to the first ever investment event held for the UK’s Overseas Territories which took place during the Joint Ministerial Council week. Over 140 companies and organisations were represented. It was an opportunity to introduce businesses to opportunities in tourism, infrastructure, services and renewable energy that exist in the Territories. This does not only help the Territories – the UK will benefit as well. It is a win win and our joint efforts to encourage trade and investment in both directions will continue. The Territories are separate jurisdictions with their own Constitutions and economic development policies and therefore the growth of their financial services sectors is predominantly a matter for their democratically elected governments. Our shared ambition is for them to be successful, economically sustainable, and secure - the main themes of our White

Paper on the Overseas Territories. The Territories have demonstrated through their own actions that they are committed to meeting the highest standards in financial services regulation. Meeting these standards will help to demonstrate that they only want ‘legitimate’ business. Would you agree that the OTs and their offshore sectors have been much maligned in recent years, with the negative aspects of offshore superseding the positive economic benefits that arise from the likes of Bermuda’s insurance sector or Cayman’s funds industry? MS: There has been much debate about the role and regulation of financial services business in many jurisdictions around the world. It falls to all of us to explain the positives and to address the negatives. That is why the UK’s Presidency of the G8 in 2013 focussed on what we referred to as the 3Ts – tax, trade and transparency. The key to preserving the benefits of all financial centres whether they are onshore or offshore is transparency. Tackling tax evasion and fraud is a global responsibility. The Territories have demonstrated through their actions that they are committed to this. I am confident that they will continue to play their full part to promote the application of high international standards. Will the UK government help to promote the financial services sectors in the OTs and follow up on the Prime Ministers pronouncement in September that they can no longer be considered ‘tax havens’? MS: We all have a shared agenda on the application of high international standards for financial regulation. This commitment was reiterated by Territory Leaders at the Joint Ministerial Council. I want to reiterate that the Territories and Crown Dependencies responded speedily

“The Territories have demonstrated through their own actions that they are committed to meeting the highest standards in financial services regulation. Meeting these standards will help to demonstrate that they only want ‘legitimate’ business.”

and positively to the Prime Minister’s G8 tax and transparency agenda. The OTs have been doing a lot of work in this area since the G8 Summit: • The extension of the Multilateral Convention on Mutual Administrative Assistance on Tax Matters has been notified to the Council of Europe for Anguilla, Bermuda, the British Virgin Islands, the Cayman Islands, Gibraltar, the Isle of Man, Montserrat and the Turks and Caicos Islands; • Intergovernmental Agreements on automatic tax information exchange have been signed between the UK and the three Crown Dependencies and seven Overseas Territories, ie, all those with a financial services industry; • All are playing an active part in the pilot initiative on automatic tax information exchange launched by the UK, France, Germany, Italy and Spain; • All have published Action Plans setting out the steps that they will take to ensure the collection and availability of complete company ownership information. The Overseas Territories are launching, and in the case of the British Virgin Islands and the Cayman Islands have launched consultations on the question of beneficial ownership and whether this information should be publicly available. These are strong commitments and demonstrate why the Prime Minister noted that the Overseas Territories and Crown Dependencies have taken action to make sure that they have fair and open tax systems and that it is important that our focus should now shift to those territories and countries which really are tax havens. The Overseas Territories Joint Ministerial Council met in November with the objective of promoting economic growth in the OTs and creating jobs – what will be done to follow up on this goal? MS: We have discussed some of this earlier but it is worth re-iterating that, although small, the Territories are open and dynamic economies with exciting opportunities for investment and trade. They have stable legal systems based on common law, the English language, educated workforces and links with growing and emerging markets.

IFC eConomIC report • sprIng 2014

We have recently concluded successful negotiations on a new EU Overseas Association Decision which ensures that goods and services from Territory firms have tariff and quota free access to the Single Market; to 500 million potential consumers. Across the UK Government we are working closely with the Territories to promote globally the investment and trade opportunities they present including through: • providing co-operation between Territory investment agencies, UK Trade and Investment teams and our diplomatic network; • Informing UK companies of investment opportunities in the Territories and encouraging them to explore the opportunities; • Promoting Territory exports and service industries; • Exploring further opportunities to boost inter Territory trade and investment and the sharing of best practice; • Publishing Territory investment policies Many of the financial services sectors in the OTs have been in existence for many years, do you think that they are now being recognised as reputable financial centres with legitimate and important role to play in the international finance industry? MS: In the lead up to the G8 Summit and at the Joint Ministerial Council the Territories re-iterated their commitment to creating a fair, responsible and effectively regulated global business environment and to continuing to work to promote the application of high international standards. The Caribbean Territories and Bermuda are members of the Caribbean Financial Action Task Force, which was chaired by the British Virgin Islands in 2012, are members of the OECD Peer Review Group as well as other international regulatory bodies. It is important that the Territories also help themselves to promote the good work they are doing on financial regulation through all means available, including social media.

Is automatic exchange of tax information the best way forward for the OTs that wish to continue as successful IFCs? MS: Automatic exchange of information

“We firmly believe that a public registry of company beneficial ownership provides the most effective way of meeting Financial Action Task Force recommendations on company transparency.”

How important is the multilateral convention on mutual assistance for the administration of tax matters to the financial centres in the OTs? MS: We encouraged the Overseas Territories to seek extension of the Multilateral Convention. I am delighted they have done so and this has been recognised as a positive development by the OECD. It will allow more countries to quickly benefit from greater levels of tax information exchange and will be particularly beneficial for developing countries. The extension of the Convention builds on the extensive network (over 160) Tax Information Exchange Agreements the Overseas Territories and the Crown Dependencies already have in place. But the Territories and Crown Dependencies are not holding back as they are continuing to negotiate and conclude further bilateral Tax Information Exchange Agreements.

Task Force recommendations on company transparency. Not only will it assist international cooperation between law enforcement authorities, reducing the time and cost associated with mutual legal assistance requests, but it will also enhance jurisdictions’ reputation as open and transparent places to do business. The Territories have welcomed the G20 agreement at the St Petersburg Summit to take forward international standards on transparency of company ownership. They have committed to consult on the establishment of a central registry and whether the information held therein should be publicly available. The Territories will want to analyse the results of their consultations and will reach their own decisions. We will stay in close contact with them to explain what the UK is doing as we take forward and implement our policy and will continue to encourage them to remain focussed on the effectiveness of their regimes. We want a publicly accessible central registry to become the new international standard. We are in touch with our European colleagues on this issue and the G20 has already committed to lead by example on company transparency and Finance Ministers will be reporting this year on the steps they have taken.

David Cameron announced in the summer the creation in the UK of a public register of beneficial owners of shell companies– how important will this be for the UK and the OTs going forward? MS: Transparency of company ownership and control is a key priority for the UK and was a major element of our G8 agenda. The UK is taking the lead internationally by announcing that we are committing not only to establish a central registry of company beneficial ownership information but also to allow public access to that registry. We firmly believe that a public registry of company beneficial ownership provides the most effective way of meeting Financial Action

What does the future hold for the economies of the OTs that host financial centres? MS: The key is that the Territories should continue to meet international standards. They have constantly said they will do so and will play their full part to root out tax evasion. There is however no room for complacency and all jurisdictions will continue to have work to do. But it is not simply about rules. The standard setting bodies will focus on the effectiveness of jurisdictions regulatory regimes and we all need to have the necessary resources in place to meet these standards. If they do this then there is no reason to believe why they cannot continue to have a flourishing financial services industry.

is the emerging new standard. The Territories have signed Inter Governmental Agreements with the UK and will be doing so with the United States. They are also playing an active part in the pilot initiative on automatic tax exchange launched by the G5 in the summer and to which over 30 jurisdictions are now committed.

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IFC eConomIC report • sprIng 2014

Tax Cooperation, Past, Present & Future: What is

now acceptable in global move towards information exchange professor allison Christians considers the legality of the US IGAs stemming from FATCA, with the proposition that they are indeed treaty overrides and asks, if they are, why are so many countries around the world prepared to enter into them. In 2014, the extra-territorial portions of a controversial law enacted by the United States in 2010 are scheduled to come into effect.

The law, known as the Foreign Account Tax Compliance Act (FATCA), will impose an extensive third-party monitoring and disclosure regime on financial institutions around the world in an effort to ‘smoke out’ US tax cheats and expose their undeclared foreign assets to the IRS. Because this flow of information from non-US financial

FATCA Time Line MARCH 2010 • Hire Act passed including FATCA provisions AUGUST 2010 • IRS issues Notice 2010-60 12

institutions directly to the IRS would violate privacy and confidentiality regimes in other countries (as such a move by foreign governments would under US law), laws around the world must be changed to accommodate US demands. In order to produce that effect, the US is entering into so-called intergovernmental agreements (IGAs) with other countries, under which the ‘partner’ jurisdictions undertake various promises to ensure that FATCA can be implemented as a matter of domestic

APRIL 2011 • IRS issues the second round of FATCA guidance JULY 14, 2011 • IRS issues the third round of FATCA guidance

law with respect to their financial institutions. FATCA and the IGAs meant to implement it feature a number of troubling legal aspects1, including the fact that they constitute a clear breach of the terms found in US tax treaties with other countries. The status of these IGAs is murky under US law and the Treasury 1 For example, their status as legal instruments in the United States is ambiguous at best. See Allison Christians, The Dubious Legal Pedigree of IGAs (and Why It Matters), 69:6 Tax Notes Int’l 565 (2013).

JULY 25, 2011 • IRS issues revised Notice 2011-53 FEBRUARY 8, 2012 • IRS releases proposed regulations JULY 26, 2012 • IRS issues draft Model Intergovernmental Agreement (IGA) Model 1

COVER STORY: FATCA

has suggested that such agreements merely interpret existing treaty terms. For this reason, the IGAs will not be presented to US lawmakers as treaties, but are being implemented under agency discretion in the United States. IGA partners have taken various views, with some treating them as interpretive documents and others treating them as alterations to the existing agreement that must be agreed to under internal ratification procedures. Treaty breach violates principles of international law, and should be rejected by other countries because it compromises the integrity of the entire international tax system. Breach in the form of treaty override is unfortunately not a new behaviour by the United States, but it is an aggressive move that puts the international tax law system, and its implicit need for “commitment projection” through international agreement, at grave risk2. It demonstrates that promises undertaken by the United States in its tax treaties are fundamentally weak as they are vulnerable to unilateral nullification by internal political whims. That should make everyone in the international community wary about making any deals with the US on tax, whether FATCA-related or not, since the government is demonstrating that it is willing and able to unilaterally change agreed upon terms in its own favour, at any time. There is no redress in law for a unilateral US treaty override. But that fact alone makes it imperative that the

international community acknowledge that an override is currently occurring, and that such a breach will have important consequences for tax cooperation among countries going forward.

Treaties as Contracts

To understand why FATCA and the IGAs are treaty overrides, we must begin with the nature of tax treaties themselves. Treaties in general are more or less contracts between sovereigns. Every country establishes its jurisdiction to impose income taxation under sovereign claim of right, and when these sovereign claims overlap in the context of cross-border activity, governments consider entering into treaties to allocate the available tax revenues between themselves. Under tax treaties, the signatories agree to the taxation each will impose on activities that span their respective jurisdictions. Of course, to the extent that sovereignty in the classical sense “means simply the power of law-making unconstrained by any legal limit,”3 a treaty between two sovereigns operates in the space between laws, with attendant difficulties in the case of breach4. Such a breach could occur many ways, but perhaps the most obvious is a failure to implement the treaty terms as agreed. When a country behaves in such a manner, the question of enforceability

arises, and a specter of doubt concerning the whole project appears: if there is no supranational body to lay down the law, what is the basis for entering into such agreements in the first place? This is a well-studied problem and many scholars of international law have produced a volume of work on the subject of treaty enforceability and its related issues, including dispute resolution and the assertion and collection of remedies5. In the case of treaty override, the failure to implement the treaty terms occurs because a domestic law compels it. That is to say, agreed treaty terms are not met because Congress has enacted legislation that imposes conflicting terms. This is the case with FATCA, and the IGAs merely compound the violation. The scenario is perhaps best understood by means of a case study. A ready case is found in the tax relationship between the US and its major trading partner, Canada. Studying this case seems to be at least as appropriate as studying any other US tax relationship for two reasons. First, Canada and the United States already have an automatic informationexchange regime in place (this makes FATCA a clearly unilateral imposition since there is nothing new in terms of tax cooperation to be gained by Canada in signing an IGA). Second, Canada has perhaps the world’s largest population of people who would be immediately and negatively affected by FATCA (with the possible exception of Mexico, though statistics are not currently available to

2 Arthur J Cockfield, The Limits of the International Tax Regime as a Commitment Projector, 33 Virginia Tax Rev 59 (2013).

3 AV Dicey, Introduction to the Study of Law of the Constitution 27 (Liberty Classics, 1982) (1915). 4 For a discussion, see Allison Christians, Hard Law, Soft Law, and International Taxation, 25:2 Wisconsin Int’l LJ 325 (2007).

SEPTEMBER 12, 2012 • First IGA signed based on Model 1

JANUARY 17, 2013 • Final FATCA regulations issued

DECEMBER 31, 2013 • Earliest FFI agreement effective date

OCTOBER 24, 2012 • IRS issues Announcement 2012-42

FEBRUARY 14, 2013 • First IGA signed based on Model 2

NOVEMBER 15, 2012 • IRS issues draft Model Intergovernmental Agreement (IGA) Model 2

JULY 15, 2013 • FATCA Registration Portal expected to open on or before 15 July 2013

JANUARY 1, 2014 • Grandfathered obligation cutoff • Onboarding new accounts • FATCA withholding begins

5 For a discussion, see Allison Christians, How Nations Share 87 Indiana LJ 1407 (2012) (2013).

IFC eConomIC report • sprIng 2014

confirm whether this is the case). It is important to observe that the vast majority of people in Canada who will be negatively affected by FATCA are likely to be so not because they are tax cheats, but instead because they are caught up in the US tax net, often without knowledge or understanding of this fact and its corresponding obligations. This happens because of the exceptionally extra-territorial nature of the US income tax system, virtually alone in the world, which treats people as if they were US residents based solely on their legal status as US citizens or green-card holders. Thus, the United States not only claims the right to tax all of the people actually resident in its jurisdiction—as all other countries with income tax systems do—but it also claims the right to tax all the people in the world that have legal ties to it, which virtually no other country in the world does (with the exception of Eritrea, a dictatorship that has been sanctioned by the UN for attempting to impose a two per cent tax on its diaspora in order to raise money for ongoing war efforts). The US practice of status-based taxation demonstrates why treaty override should be considered particularly pernicious in this case, since its effect is to enable the US to expand its jurisdictional reach beyond that exercised by any other country, in a manner and to an extent that is unprecedented in the history of the income tax. While status-based taxation has long been the law on the books in the United States, it was minimally enforced by the IRS. There is no evidence that FATCA was enacted for the purpose of perfecting this extra-

JUNE 30, 2014 • Complete Due Diligence for prima facie FFIs

JULY 1, 2014 • Withhold on FDAP payments to undocumented NPFFIs (prima facie FFIs) • USWA and FFI grandfathered

territorial jurisdictional claim6. US tax treaties are written in such a way that they acknowledge the legal claim of status-based taxation, but the addition of FATCA to the treaty directly enlists the aid of treaty partners in exercising unprecedented jurisdictional claims of another sovereign over their own residents. That is a fundamental change in the undertakings of treaty partners, which should not be ignored by reframing the change as a mere interpretation of an existing agreement. The US-Canada tax treaty relationship should prove instructive in this regard.

The US-Canada Tax Relationship

Canada and the United States have a tax treaty in force under which each government cooperates with the other to allocate taxing rights between them and to engage in cooperative compliance efforts. As to the allocation of taxing rights, each government agrees to impose specified tax rates on domesticincome received by investors in the other country. For example, a Canadian person (individual or entity) that invests in the stock of a US corporation and receives dividends on that stock would be subject to a maximum rate of 15 per cent US withholding tax on that dividend under the treaty;7 for royalties, the maximum rate would be 10 per 6 In enacting FATCA, Congress was not focused on rounding up its diaspora. Instead the target was resident Americans who were hiding their assets in Switzerland with the help of UBS and other Swiss banks. 7 Tax Convention, US - Canada, art 10 (1985).

obligation cutoff for dividend equivalents - December 31, 2014 • FFIs complete due diligence for highvalue (HV) individual accounts JANUARY 1, 2015 • FFIs begin withholding on US FDAP payments to recalcitrant high-value accountholders

cent8, and for interest and most capital gains, no tax would be withheld by the United States9. In most cases, a tax treaty overrides domestic statutory law that would otherwise impose a higher source-based tax rate on payments made to foreign persons. Accordingly, the statutory US rate on a Canadian resident receiving passive income from US sources in the absence of the treaty would be 30 per cent (with several exceptions)10. The agreement undertaken in tax treaties is that the US will not impose that statutory rate on payments to Canadian residents, but will restrict its tax to the treaty rate; Canada provides a reciprocal promise. In brief, the effect of this reciprocal promise is to allow each country to claim some taxes when it is the country where the income arises (source-based taxation) and some when it is the country where the recipient of the income is resident (residence-based taxation). Every tax treaty also includes information exchange provisions under which each country agrees to “exchange such information as may be relevant for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning taxes to which this Convention applies insofar as the taxation thereunder is not contrary to this Convention.” In the Canada-US treaty the information exchange provisions are located within article 27. The provisions of the treaty are not conditional; that is, the treaty 8 Id at art 11. 9 Id at art 13(4). 10 IRC § 871.

• USWAs and PFFIs — for pre-existing obligations, begin withholding on payments to certain passive NFFEs MARCH 15, 2015 • 1042-S reporting for USWAs, WAs, and PFFIs

COVER STORY: FATCA

entitles Canadian residents to the specified tax rates independent of their government’s compliance with undertakings on information exchange and assistance in collection. FATCA’s effect is to impose a new condition on the treaty-based withholding tax rate. Under FATCA, the only way for resident Canadian institutions to continue to get the treaty rate (of zero per cent, 10 per cent, or 15 per cent, depending on the type of income in question) is to fulfill FATCA information gathering and reporting requirements. If they do not fulfill these requirements, they will not be eligible for the treaty rates and will instead be subject to a 30 per cent withholding rate on all ‘withholdable payments’ - an expansive concept of US-source income items11.

The Override: A New Conditionality

FATCA is thus a new condition on the treaty rate for Canadian residents (it is obviously not a reciprocally imposed condition so would have no impact on US persons’ eligibility for reduced Canadian withholding under the treaty). This is a unilateral, post-agreement term that is not included or in any way contemplated by the text of the treaty as currently agreed-upon. Of course, FATCA could hardly be contemplated by any treaty that came into force prior to 2010, as it did not exist as law before that time. This is not to say that the US cannot place conditions on access to treaty rates by Canadian residents; there are many existing conditions for 11 IRC § 1471.

MARCH 31, 2015 • USWAs and PFFIs begin reporting of owner-documented FFIs • USWAs begin reporting of US substantial owners of passive NFFEs • US account reporting for PFFIs (yearend 2013 and year-end 2014) • Reporting of recalcitrant accounts (year-end 2013 and year-end 2014)

treaty benefits—including the limitation on benefits clause—which are quite expansive and form a major part of any treaty negotiation with the US12. Rather, it is to say that FATCA’s particular condition is not in the treaty. As a result, FATCA overrides the existing treaty by unilaterally denying the treaty rate to Canadian resident financial institutions that would otherwise qualify for those rates under the existing, duly negotiated, treaty provisions currently in force, unless certain conditions are met both by the taxpayer and the government of Canada. It might confuse some readers to say that the United States Congress could enact a law that overrides the treaty. As a matter of law, that appears to be an impossibility in many countries. Accordingly, a brief review of the status of tax law versus tax treaties in the United States is in order.

Treaty Override under US Law

The status of a treaty in a country depends on its internal recognition thereof in law. In the United States, treaties have the same effect as acts of Congress, and are equivalent to any other US law13. As such, they are subject to and may be overridden by subsequent revisions in domestic law under a statutory ‘last in time’ rule14. This is counter to the practice of many countries, where treaties are considered 12 Tax Convention, US - Canada, art. 29A. 13 US Const art VI, cl 2; see American Trust Co v JG Smyth, 247 F2d 149 (1957); J Samann v Commissioner, 313 F2d 461 (1963); Dames & More v Regan, 453 US 654, 686-88 (1981). 14 IRC § 7852(d).

DECEMBER 31, 2015 • Complete due diligence for all remaining accounts JANUARY 1, 2016 • Begin withholding • Limited FFI/limited branch status expire

superior to domestic law and cannot be changed unilaterally. As in contract law, there is an argument to be made that breach can be appropriate; for example, when “what is gained from the party that breaches exceeds what is lost by the party against whom the breach occurred”15. According to this argument, a breach might be appropriate as long as the United States compensates the aggrieved party. The US practice of override is of course long-standing and therefore not an unknown; indeed, it has prompted major rewrites of the US-Canada tax treaty among others. As such, the possibility of unilateral override is a known risk of negotiating with the United States. It should therefore come as no surprise that the US-Canada tax treaty currently in force contains a mechanism for dealing with this eventuality. To the extent this provision is absent in other treaties, FATCA serves as a cautionary tale for treaty negotiators to consider including similar language in any future agreements with the United States, although its inclusion may appear futile in the instant case.

Dealing with Override

Article 29(7) of the US-Canada treaty lays out a regime for the countries to deal with potential tax treaty overrides that arise when one country enacts a domestic law that conflicts with the treaty in effect: “Where domestic legislation enacted by a Contracting State unilaterally 15 See Richard L Doernberg, Overriding Tax Treaties: The US Perspective, 9 Emory Int’l L Rev 71 (1995).

FEBRUARY 29, 2016 • PFFIs: Responsible officer makes certifications related to due diligence and FATCA anti-avoidance MARCH 31, 2016 • Report source payments • Include income information 15

IFC eConomIC report • sprIng 2014

removes or significantly limits any material benefit otherwise provided by the Convention, the appropriate authorities shall promptly consult for the purpose of considering an appropriate change to the Convention”. This is an assertion, expressly within the text of the treaty, that officially identifies the enactment of conflicting legislation as a treaty override. When one country enacts a law that would restrict or remove a material benefit—for example, a specified tax rate on a payment of income to an investor entitled to the treaty— immediate negotiations for a change to the convention are to be initiated. A change to an existing convention is undertaken either in a protocol, or, if the change is fundamental, in a new convention. A protocol is in legal terms nothing less than a new treaty that overrides specific provisions of the existing treaty to reflect the parties’ later agreement. That is, to change a treaty, each government must agree to the change via a new treaty, which each government must ratify under its internal treaty-making processes. The existence of remedial treaty measures to deal with override in the Canada-US treaty demonstrates in the case of Canada (and implies by extension to other treaty partners), that the inter-governmental agreements proposed by the US are not a valid means to implement FATCA internationally. In a bizarre kind of double override, any IGA with Canada that was not implemented as a protocol by both countries would double down on the statutory override FATCA imposes with respect to the

tax rate provisions of the treaty by also bypassing the treaty undertaking with respect to such override.

Consequences of Treaty Override

Treaty overrides have a deleterious effect on tax treaty-making because such occurrences demonstrate the weakness of the commitments purportedly undertaken in treaties involving the United States. Since there is no world tax authority to police compliance with tax conventions, it falls to the parties to assure each other that their promises will be kept. Once it is clear that promises will not be kept, but instead will be broken with little regard for cost or consequence, trust in the system as a whole is indelibly shaken. As a treaty override that comes with great cost and consequence to governments, financial institutions, and most of all human beings, FATCA stands as an ongoing violation of longstanding cooperative efforts on taxation by the international community of states. It is in danger of undermining that cooperation by forcibly engaging the whole world in the project of compelling global compliance with just one tax jurisdiction, and the planet’s most expansive one at that. No compensation has been offered for the breach, and no remuneration is being offered for the cost of complying with the new, unilaterally imposed conditions. Moreover, scant attention appears to have been paid to the fact that accepting the treaty override in this particular case means assisting the US in expanding its extraterritorial enforcement with respect to taxpayers

DECEMBER 31, 2016 • Ability to rely on old Form W-8s expire

passthru payments • FFI grandfathered obligation cutoff for passthru payments [Date TBD]

JANUARY 1, 2017 • Withholding on gross proceeds begins for USWAs, WAs and PFFIs • PFFI withholding on foreign

MARCH 31, 2017 • FATCA reporting adds gross proceeds • Source payment reporting begins

who by overwhelming international consensus do not belong in the US tax net at all. This puts treaty partners in the odd position of accepting a violation of foundational international tax norms based in the residence principle, against residents of their own jurisdictions, and at their own cost. Some believe that in the long run even a flawed unilateral move toward information exchange could lead to a more universal information exchange compact that would benefit other countries as well. But to the extent that the incorporation of FATCA into tax treaties via IGAs demonstrates that the United States is willing to break past commitments in order to secure its own goals, little would seem to stand in the way of future promise-breaking for securing other US domestic goals. There is little reason to believe that US contributions to multinational information sharing efforts would continue with conviction once its own goals have been secured. The international community of states has for a century demonstrated that it relies on tax treaties to create any kind of workable income tax system in an economically integrated world. Accordingly, it seems imperative to recognise a breach where it has occurred, and to call the nation that has caused the rift to task for undermining a system in which all have tremendous resources at stake.

About the Author:

Professor Allison Christians is the H Heward Stikeman Chair in the Law of Taxation at McGill University Faculty of Law, Montreal, Quebec, Canada

JUNE 30, 2017 • PFFIs: Begin every three-year certification by responsible officer that FFI has effective internal controls MARCH 15, 2018 • Gross proceeds included

IFC eConomIC report • sprIng 2014

Here Comes FATCA… What To Expect In 2014 By Scott D Michel, Caplin & Drysdale, Washington, US As the calendar turns to 2014, two major worldwide events loom closer on the horizon. The first, of course, is the World Cup, with cheering masses, big screen TVs in historic public squares, banners in every pub, and agony for all but one nation at the end.

The second is the implementation of the US Foreign Account Tax Compliance Act (FATCA), which creates an automatic information exchange regime between global financial institutions and the US Internal Revenue Service (IRS). Under FATCA, financial institutions worldwide – irrespective of any jurisdictional ties to the US – must provide the IRS with information about American account holders or face 30 per cent withholding on their US investment portfolio. FATCA is part of the US government’s multi-faceted enforcement actions against Americans hiding money abroad. It has arguably erased bank secrecy for Americans, and it impacts structures in place for any high net worth family with a US connection. So what’s on the horizon for 2014?

More IGAs

Originally under FATCA, foreign financial institutions (FFIs) and nonfinancial foreign entities (NFFEs) would contract with the IRS to comply. Since enactment, the US has negotiated

a series of ‘Intergovernmental Agreements’, known as IGAs, whereby the US and a partner country agree on a compliance process for the partner’s financial institutions. In 2013, the US signed or negotiated IGAs with many countries. Most IGAs were ‘Model 1’, which provide for government to government data transfers rather than transfers directly from the entity to the IRS. Recently, Italy, the Netherlands, Malta, the Isle of Man, Guernsey, the Bahamas, and the Caymans have signed Model 1 IGAs. Eleven more are apparently on the way, and discussions continue with other countries. Singapore, Hong Kong and Russia have signalled a willingness to pursue IGAs. The IGAs will leave most FFIs and NFFEs in an IGA jurisdiction little option but to ramp up and begin to comply. Some IGAs provide for reciprocal information sharing with the partner jurisdiction as to their own taxpayers. This, combined with IRS rules requiring US financial institutions to report interest paid to non-resident aliens affiliated with treaty partner countries – recently upheld by a Florida court – signals enhanced two-way cooperation by the US with other taxing authorities.

Forthcoming Deadline and Difficulties for FFIs and NFFEs The IRS has issued substantial technical guidance on FATCA and more regulations are expected. However, in

January 2014 the IRS announced that it will not extend the July 1, 2014 start date for most of FATCA’s disclosure and withholding provisions. There are, however, gaps in FATCA’s regulatory framework, and institutions face difficulties in changing their systems. Many foreign entities hesitate to implement FATCA until they know if their tax authority will sign an IGA. They also wait on local guidance to ensure compliance with domestic privacy laws. Yet, a deadline is a deadline, although as a practical matter, it is difficult to imagine the IRS imposing an immediate withholding sanction if an entity is taking all reasonable steps to comply.

Fallout Among FFIs and NFFEs Globally

FATCA has caused huge compliance costs and created an enhanced risk climate for dealing with US clients. Many banks have ceased doing business with known Americans. For Americans living abroad – many of them working for US companies – it is increasingly difficult to obtain basic financial services. Many nonUS businesses and partnerships are barring American participants because of enhanced information reporting requirements. FATCA is proving challenging in the Middle East and Latin America, where US efforts have run into cultural opposition, regulatory delays,

cover story: fatca IFC: Good for the Global Economy

and skepticism about the benefits of cooperation. In the Middle East, many wealthy residents hold American passports as insurance against regional turmoil, but none of the Gulf Cooperation Council states have a tax treaty with the US. As to Latin America, the banking federation criticised the statute, citing prohibitive operational costs, the need to alter their constitutions, and the absence of mutual benefits to compliance. How quickly FFIs and NFFEs in these areas will begin to comply remains to be seen. China is an issue unto itself. Observers find it difficult to imagine that the US would withhold, or even threaten to withhold, 30 per cent on a principal financier of the American government. In August 2013, the US and China issued a joint statement pledging efforts to reach an IGA in advance of the implementation deadline but there have been no public developments since then. In a nod toward potential cooperation, China has implemented its own regulations requiring the country’s wealthy to declare offshore holdings, resembling the US ‘FBAR’. Even so, the prospect of the Bank of China implementing procedures to ferret out US persons among clientele in remote branches is hard to envision.

Compliance Issues for Americans

Yet, in Europe, Canada, Mexico, and Israel, impacted entities are reasonably far along in preparing for FATCA. Banks are identifying US account holders, seeking waivers of local privacy laws and issuing notices that accounts will be subject to information disclosure to the IRS. If these clients have not been compliant with US reporting requirements, they have a problem. The IRS still offers its Offshore Voluntary Disclosure Program, but its onerous administrative requirements and ‘one size fits all’ penalty structure have little appeal for the many Americans who have long resided outside the US. Yet, even without

“FATCA is part of the US government’s multi-faceted enforcement actions against Americans hiding money abroad. It has arguably erased bank secrecy for Americans, and it impacts structures in place for any high net worth family with a US connection.” a perfect option for resolving prior reporting failures, bank customers who are out of tax compliance need to seek competent US tax advice.

IRS Preparing for FATCA Data

FATCA’s fundamental benefit to the IRS will be to allow it to match data from global financial institutions to US tax returns, more specifically the new Form 8938, another component of FATCA, in place since 2011. The Form reports “Specified Foreign Financial Assets,” including foreign bank accounts, even if the accounts are reported on an FBAR. The technology necessary for the IRS to utilise FATCA-based information is in the early stages of development. The IRS has finalised a format for exchanging FATCA under IGAs is completing the requirements for data exchange services for further automatic disclosure. Eventually, the IRS can be expected to take data suggesting non-compliance by a US taxpayer and generate a series of escalating contacts, leading to audits, criminal investigations, and generating, perhaps, a new round later in this decade of offshore enforcement actions.

Trusts and Trustees

A looming issue for 2014 will be how trust companies and trustees sort out under FATCA. The regulations create a complicated framework by which some foreign trusts are NFFEs and some are FFIs, and are similarly varied as to how corporate and individual trustees are classified. The rules can differ depending on whether an IGA is in place, and among jurisdictions. Trusts themselves may be FFIs in some circumstances and NFFEs in

others, sometimes depending on the precise legal status of the trust under US tax law. Foreign trust companies, individual trustees, and persons affiliated with foreign trusts should be evaluating their status under FATCA. They are subject to the same forthcoming deadlines as major banks around the world.

Conclusion

Much of the world’s financial community has accepted that FATCA will remain the law of the US. Indeed, tax authorities are looking to FATCA as one mechanism by which the flow of financial information across borders can serve their own fiscal purposes. Wealth managers, trust companies, private banks and others should move forward to review their potential regulatory responsibilities under the statute, and US persons whose accounts and structures may now be subject to automatic disclosure, if they are not in full tax compliance, should consider their legal options.

About the Author: Scott D Michel is the President of Caplin & Drysdale, with offices in Washington DC and New York. He advises and represents clients in tax matters such as criminal tax investigations, sensitive civil tax examinations, voluntary disclosures, and US taxpayers living abroad about coming into tax compliance. He is internationally recognised for his extensive experience in handling matters arising from the US government’s recent crackdown on undeclared foreign accounts. In addition to private practice, he is an Adjunct Professor of Law at the University of Miami School of Law Graduate Program in Taxation, and he serves as a Council Director for the ABA Section of Taxation.

IFC eConomIC report • sprIng 2014

FATCA Offspring By Louise Gonçalves & Eran Shay, Deloitte Limited, Gibraltar The term FATCA has been circulating for a while now, however, not everyone is aware of what this means other than perhaps what the acronym stands for.

It all began in March 2010 when the United States created new withholding and reporting rules under the Foreign Account Tax Compliance Act (FATCA). The driver for this significant change was the number of high profile failures to prevent tax evasion by US persons through existing US information reporting systems. These measures have been implemented to address the US IRS’s concerns about US persons escaping their US tax obligations via the use of non-US structures and products. Under FATCA, foreign financial Institutions (FFIs) and other financial intermediaries such as funds, trusts, custodians and wealth managers, will be required to comply with a number of obligations, including reporting on accounts held by specified US persons. To encourage compliance FATCA introduced a 30 per cent withholding tax on US source payments to noncompliant institutions (although this has now been superseded through InterGovernmental Agreements (or ’IGAs’, see

below). It should be noted, however, that this not only affects FFIs and financial intermediaries with US clients but also those with non-US clients as other third party FFIs may require that these institutions be participating in FATCA in order to transact with them. A monthly list of all registered FFIs will be made publically available from June 2014. The key issues for businesses affected by this are primarily interpreting the FATCA legislation and what this means to their own internal compliance procedures as well as the interaction with their own customers. Operational processes and internal controls will need to be reviewed and adjusted to factor in the additional requirements introduced by FATCA both from an initial implementation perspective as well as a continuing perspective. The main elements of FATCA commence from 1 July 2014 and there are a number of steps that FFIs need to take before this date to ensure compliance. The FATCA compliance journey for most firms is illustrated by the following diagram: A number of governments, including the UK, have signed IGAs with the US with the intention of facilitating compliance. The UK has signed a

“These measures have been implemented to address the US IRS’s concerns about US persons escaping their US tax obligations via the use of non-US structures and products.” 20

Model 1 IGA with the US, which means that compliance with FATCA will take place under UK domestic legislation instead of under US regulations. The IGA enables entities within said jurisdiction to comply with the FATCA requirements without contravening local legislation. By complying with these rules, the entity would not be subject to the 30 per cent withholding tax for non-compliance. There are still a number of significant steps that an entity needs to complete in order to achieve compliance and, due to the specific local legislation, the FATCA obligations for some FFIs may differ depending on the location. This variation may make compliance more complex for multinational organisations where they operate under several different agreements.

cover story: fatca

UK FATCA or the ‘Son of FATCA’ FATCA has proved to be a watershed moment for international information exchange policy. As noted above, a number of jurisdictions have entered agreements with the US and some of these have announced their intention to develop their own ‘FATCA-like agreements’. In June 2013 UK HMRC released a draft model agreement which is intended to facilitate information exchange with the Crown Dependencies and British Overseas Territories. This agreement, sometimes referred to as ‘Son of FATCA’, seeks to gather information on UK persons investing in and/ or through those jurisdictions. The wording of the draft agreement is very similar to that of the US FATCA IGA and is intended to be implemented on a similar timescale. Nevertheless, the key differences between US and UK FATCA are as follows:

“FATCA has proved to be a watershed moment for international information exchange policy... and some [IFCs] have announced their intention to develop their own ‘FATCA-like agreements’.” • UK FATCA is not global like US FATCA and so potentially may face greater international issues. • Difference in taxation of the UK, ie, by residence v citizenship in the US also potentially problematic. • There is no withholding tax under UK FATCA. • It offers an alternative reporting regime for UK non-domiciles. With regard to the US FATCA, it is anticipated that the UK Crown Dependencies and Overseas Territories will enter into IGAs with the US. FFIs based in the Crown Dependencies and Overseas Territories should start to

familiarise themselves with FATCA requirements if they have not done so already, register themselves on the US ‘FATCA Registration Portal’, and begin looking through their client accounts and portfolios to identify US client accounts as well as consider their internal controls and compliance procedures going forward. As part of the UK FATCA package, it is expected that British Overseas Territories will be allowed to participate in a disclosure facility available to UK resident clients of structures run by financial intermediaries in these territories.

14TH ANNUAL

TAX PLANNING STRATEGIES U.S. AND EUROPE

10-11 APRIL 2014 · CICG · GENEVA, SWITZERLAND WEALTH MANAGEMENT WORKSHOP · THE PICTET GROUP · 9 APRIL TAX EXECUTIVES WORKSHOP · 9 APRIL

For more information and to register: http://meetings.abanet.org/meeting/tax/GENEVA14/

The 14th Annual Tax Planning Strategies - U.S. and Europe Conference will focus on practical issues that confront multinational corporations in the new tax environment spurred by the G-20 focus on tax issues. The government panel will examine how the BEPS Action Plan will affect taxpayer behaviors. Other panels will address cross-border financing, treaty dispute developments, intangible asset planning, cross-border M&A developments, and new innovations in transactions. A new topic will be introduced that is devoted to opinion practices in light of aggressive government positions, which will address the scope of modern opinion practice. Another panel will take an in-depth look at the evolving global information reporting and exchange landscape and how those changes will affect not only financial institutions but other corporate taxpayers as well. Finally, other panels will focus on developments in cross-border investment funds, the evolving PE standard, and consider how U.S. multinationals are monitoring VAT planning in Europe. The Conference will be supplemented by a half day Private Wealth Management Workshop and a Corporate Tax Executive Workshop on Wednesday, April 9. Panelists will include industry leaders, senior government officials, and leading tax practitioners from the United States and Europe.

USA Branch

geneva14-ifc-ad.indd 1

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IFC eConomIC report • sprIng 2014

The Big Debate

We ask leading commentators from across the international finance industry: Is automatic

exchange of information good for the wealth management industry & IFCs? Carlyle Rogers

Stafford Corporate Services, Anguilla

I would not say that automatic exchange of information is good for the wealth management industry and IFCs by any stretch of the imagination. My take on this issue is that it appears to be the future and as a result, IFCs and the industry have to find ways to adapt to this new paradigm as well as diversify their product and service offerings. What it means is that the old ways of doing business, which were often driven solely by taxation issues, opaqueness, and a lack of substance will end while new approaches focused more on what some of us in Anguilla have termed: substance over form, will need to develop. Automatic information exchange is clearly not good for IFCs if the sole purposes of using them were to hide income from tax authorities or for pure secrecy reasons.

Tim Ridley

Attorney-at-Law and former Chairman of Cayman Islands Monetary Authority

The international standard on exchange of information has undergone a paradigm shift in a very brief time from bilateral treaties and like arrangements to exchange of information on request to multilateral treaties for spontaneous and automatic exchange. These new arrangements also look down the road to the potential for enforcement of foreign tax judgments. No-one would espouse the cause of illegal activity, whether it be drug running, money laundering, terrorist financing, fraud, tax evasion or the like. And we have

I still of course believe that there are valid reasons for confidentiality and financial privacy and to the extent that they have been compromised by automatic exchange of information, especially for HNWIs in countries like Mexico, Venezuela and other parts of Latin America, this is a worrying development and cause of great concern to those of us who advise them. Financial privacy serves a valid security purpose for persons whose information, if in the wrong hands, could be used by criminals to commit further crimes inclusive of kidnapping, murder, theft and blackmail amongst others. Thus, automatic exchange of information is in effect a dangerous development which could have serious, long-term and unforeseen consequences which those who support it have not, in my opinion, thought through properly. It is my opinion, that the law of unforeseen consequences will be seen manifested as, if and when automatic exchange of information is implemented on a wide-scale basis. Be that as it may, and I will return to this issue later, the new paradigm will allow for IFCs to focus less on pure company incorporation work, or trust domiciliation and move into more valued added areas such as actual trust administration being done from within their geographical confines; fund become used to the compliance procedures (and costs) for appropriate ‘know your client’ and due diligence under the FATF driven programme. Equally, under the programme for cross-border mutual legal assistance in criminal matters. More recently we are becoming accustomed to the exchange of tax information on request (and automatically under the narrow European Savings Directive). The US FATCA programme, the product of the Swiss banks’ “very poor judgment” with their US taxpayer clients, was initially seen as typical US extraterritorial overreach, producing howls from foreign banks and yawns from other governments. But like Saul on the road to Damascus, other nations (particularly in the EU) suddenly saw huge advantage in implementing similar regimes themselves and proceeded accordingly. We have only just started down this road and the massive implementation issues cannot be overstated, given the significant and often competing legal and tax differences and mismatches between the participating nations. And all

THE BIG DEBATE

management and administration taking place on the ground and companies with real mind and management physically located in the same place as their domicile particularly in the area of captive insurance. This will force persons wanting to take advantage of the tax benefits, ease of doing business, risk diversification and financial intermediation role that IFCs play in the global economy to think more strategically about how they structure their affairs and will build a deeper bench of talent in the IFCs who will live and work from them locally. Automatic exchange of information will hopefully, and I am not too optimistic about this, remove some of the stigma attached to IFCs and integrate them more into the global financial system. Transparency will lead to more importance being placed on issues like reputation capital, making use of taxation arbitrage as opposed to hiding assets overseas from tax authorities, entrepreneurship, intellectual capital, active income as opposed to passive income and the need for actual foreign direct investment as opposed to the use of IFCs for being mere conduits of capital. The potential opportunities that I see for the wealth management industry and IFCs, despite my deeply held concerns about the lack of financial privacy and confidentiality, in general include chances to move up the of this costs a great deal, both for the public and private sectors (cost benefit analysis does not appear relevant in the minds of the politicians and various government and international agencies involved). Individuals and corporations using IFCs must expect that their professional and service providers (both onshore and offshore) will require more information about them (and their families), their tax status and tax compliance. Fees will inevitably increase to reflect this. Clients must also expect that information about them and their financial affairs will be supplied (either directly or indirectly, depending on which FATCA type model is used) to appropriate tax departments both on an automatic and on request basis. Those engaged in illegal activity will doubtless find ways of continuing to evade the law, just as they have in the past. Those engaged in legal activity, including tax avoidance (not a crime despite the rhetoric), may decide that the cost and hassles are just not worth it and will stay onshore

value-food chain by being able to offer broader and more sound legal, accounting, structuring and other advice with regards to setting up legal entities that meet the new morality and economic purpose tests. This would include areas such as how a business with mind and management located in the IFC can properly take advantage of the jurisdiction’s low or no income, corporate, capital gains, dividend etc tax regime and how the IFC could be used to build start-up companies that provide services via the internet as part of an incubator programme. IFCs will likely see an increase in job creation, the moving of highly mobile and talented professionals to their shores, which in term will serve as the nucleus for even greater entrepreneurship and hopefully long term direct inward investment. The advent of concepts such as Cayman Enterprise City and the drive to lure those who would be inclined to physically relocate to the IFCs, whether or not through government incentive programmes, will only increase. So, while there are opportunities to be had, potentially, from automatic exchange of information on balance it is not something I would support but we must be inclined to take advantage of the new paradigm to the extent possible in order to survive.

Those engaged in illegal activity will doubtless find ways of continuing to evade the law, just as they have in the past. Those engaged in legal activity, including tax avoidance (not a crime despite the rhetoric), may decide that the cost and hassles are just not worth it and will stay onshore. (where they will still require professional and investment advice). Those with larger bank balances and long term global wealth creation, management and succession plans will certainly stay the course. But they must expect the level of scrutiny, challenge, cost and compliance burdens to increase significantly. The challenge for IFCs is to be able to deliver the facilities and services these clients require in a cost effective manner that minimises the ‘hassle’ factor.

IFC eConomIC report • sprIng 2014

Francoise Hendy

International Tax Treaty Negotiator and Attorney at Law

From a practical perspective early allegiance by international financial centres (IFCs) to the Automatic Exchange of Information standard as set out in the OECD Multilateral Convention on Mutual Assistance in Tax Matters makes good sense. IFCs who recognise that the real issue is not the idea of AEI but its implementation, understand that from a strategic position it makes good sense to demonstrate an interest in a standard which is a natural and an expected progression from the test run that properly characterised the global preoccupation, since the financial melt-down, with exchange of information ‘on request’. This view finds support in the fact that early subscribers to AEI, who signalled this adoption by signing the Convention, especially in the weeks before and following the 2013 G20

Denis Kleinfeld

Counsel, Fuerst Ittleman, United States

Let’s agree on a definition of good for purposes of answering this question. Tax is a political action. As such, concepts such as being worthy, noble, virtuous, upright or moral are not applicable in this context. What is appropriate for this inquiry is the concept of that good means what is in the best interests of the wealth management industry and oﬀshore financial centers. What is the bench-mark or standard by which we should judge whether something is in the best interests or not? It seems to me that the objective of the wealth management industry and the oﬀshore centers that depend on them for economic survival is to thrive and prosper. How is this done? They do so by obtaining their clients and customers trust. In the final analysis, clients and customers use professional services and jurisdictions because they trust that their needs will be a priority over all else. What is good is to create and maintain the circumstances

Ministers of Finance meetings, escaped further description as tax havens, at least by the OECD. Indeed, it is clear that acceptance of AEI provides IFCs with a greater level of immunity from characterisation as an uncooperative tax haven than does the dogged pursuit of TIEAs or even tax treaties codifying bilateral adherence to the current information exchange ‘on request’ benchmark. IFCs who fail to adopt AEI, even with stellar credentials with respect to the existing global norm will be blacklisted as uncooperative tax havens not only as a part of the OECD Peer Review Group process but also pursuant to Recommendations arising from the European Union Savings Tax Directive. Avoiding unnecessary epithets that not only reduce the competitive advantage of legitimate and successful IFCs can only be described as good for IFCs, especially those involved in wealth management, an industry perhaps more sensitive to negative press about jurisdictions where they keep their assets than corporations who are somewhat more hardy. It is, however, true that signing onto a Convention and ratifying it so that it becomes binding law in the domestic legal context are two entirely different things. State diplomacy expects that signing a treaty is not just a ‘place-marker’ but a genuine commitment by the signatories to complete the necessary steps to apply the provisions therein. That said however, the fact is that create client trust such as the perception of reliability and security. I think it is unnecessary to provide citations to support the actuality that the major countries of the world, particularly the United States, are not trusted and not viewed as reliable. In short, they are all in turmoil. As relates to wealth management, a principal area of hostility to government by its citizens and residents is because of the intrusive and oppressive methods used to enforce tax impositions. Clearly, the taxpayers perceive that are being terrorised by their own government. If you accept that this brief background description is accurate, then any further analysis depends on what you perceive are the factual answers to relevant questions. Among these questions, should be the following: Do you think that your clients and customers will be enticed to use your services if they see you as the tax enforcement agents of a foreign government? Would you expect that this would increase your market or limit your market? What does it take in time, personnel, equipment, and money for international wealth managers and OFCs to comply with ever changing and growing draconian information exchange rules? Is there any way of quantifying how much money you will need to spend to become compliant and stay compliant? Is the advice being given to you by your professionals, such

THE BIG DEBATE

Although one cannot say with certainty the reasons that have informed the rush to sign up to AEI and the reticence so far to ratify the Convention, one reasonable suggestion is the lack of clarity about how a mutliateralised system of AEI will work.

Paul Astengo

Senior Finance Centre Executive, Gibraltar Finance

that some of the most vocal proponents of AEI have signed and not ratified the Convention. Although one cannot say with certainty the reasons that have informed the rush to sign up to AEI and the reticence so far to ratify the Convention, one reasonable suggestion is the lack of clarity about how a mutliateralised system of AEI will work. It is too soon to determine whether the practice of AEI will be good for IFCs because central elements of the standard are yet to be worked out including the regime to ensure compliance. It is, however, clear that it is not a good thing for IFCs to remain outside the standard-setting exercise that will accompany the implementation and monitoring of AEI. Absent membership of the OECD or the G20, the only way for IFCs to be a part of this discussion is through early adoption of the standard through signing onto the Convention.

Yes undoubtedly so. Gibraltar is only interested in developing a transparent and collaborative business model. We have already signed 27 TIEAs for example. We signed our IGA with the UK in November 2013 and will shortly sign a similar arrangement with the USA. We continue to actively pursue further TIEA’s. In addition, Gibraltar has TIEA-equivalent arrangements with all EU member states under the provisions of the Directive 2011/16/EU on administrative cooperation in the field of taxation, which came into effect on 1 January 2013.

as lawyers, accountants, and consultants, reliable? Have you considered that they have a financial interest in mining this gold vein for all its worth? Will all this money that you will need to spend now and ongoing, all of which comes oﬀ your bottom line, ever earn a rate of return or is it just pure loss? Other than the dollar for dollar loss of cash flow, will any of the expense serve any benefit at all to in enabling you to provide more and better services to your clients and customers? By signing onto the information sharing system are you also agreeing to be subject to enforcement to a foreign jurisdiction, like the United States, for purposes of more than just their civil or criminal tax law? Or even new law? When you obtain all the required information on your clients and customers, is there an actual existing international standard computer system for information sharing? Will all your client’s and customer’s most intimate information be cyber-secure at every point in the pipeline? What cyber-security certification can possibly be given that can be absolutely relied upon? When the information is delivered or made available to the foreign revenue authorities will it be limited just for tax purposes? Isn’t that vast amount of information tempting for a government to use for corrupt political purposes or nefarious economic reasons? What are the Directors and officer personal liability exposure for data privacy breaches or misuse of information? Is there

liability insurance available, and in what amount and cost, to specifically cover FATCA liability costs, attorney fees, and related expenses? What about insurance coverage should there be a class action lawsuit by shareholders for the loss of share value? Does tax compliance with FATCA provide any form of immunity, exemption, or just a defence from liability? With the linchpin of the tax information reporting system being the implementation of the International Government Agreements, how likely is it that the United States will actually implement internal legislation enabling it to give reciprocity? Are the IGAs really treaties, and not just administrative agreements, that will need to be consented to by the United States senate? Is it possible that after the November election in the United States, the congress will repeal FATCA altogether? Although there have been quite a number of IGAs signed only one country has enacted implementation legislation. In Switzerland, two-thirds of the banks declined to voluntarily enter into FATCA compliance. Why is this? Whether tax information exchange is good for the wealth management industry and oﬀshore jurisdictions ultimately depends on the perspective from which the question is examined. Getting the right answer, like all exercises in due diligence, depends on asking the right questions.

IFC economic report • spring 2014

regulation & policy research

Transparency & Trust: The Problem with Beneficial Ownership By Anna Steward, Senior Counsel, Charles Russell LLP, Geneva The response to the UK government’s proposals as set out in a discussion paper entitled Transparency & Trust is expected in early 2014.

In brief, the proposals, as set out in the discussion paper, are as follows: • Where the legally registered owner of shares holds those shares as a nominee for different beneficial owners, then details of the beneficial owners would have to be notified to Companies House (presumably as part of a company’s annual return process) and would therefore become a matter of public record. • Bearer shares should be abolished as they allow shareholders to hide behind the document and their names to not appear on the company’s register of shareholders (which is publicly accessible through Companies House). • Where directors are acting as nominees on the instructions of a third party, then the identity of the person exercising actual control must be disclosed to Companies House. Whilst the proposals only relate to UK companies, they should be viewed in the context of similar commitments on transparency made in June 2013 by all G8 heads of government and also by the UK’s Crown Dependencies (Isle of Man and the Channel Islands) and Overseas Territories (which include Bermuda, the Cayman Islands, the British Virgin Islands and the Turks and Caicos). These broader international proposals include proposals for the registration of

beneficial interests in relation to trust structures as well as companies. As a follow up to the discussion paper, on 31 October 2013 UK Prime Minister David Cameron publicly stated that a list of the owners of so-called ‘shell companies’ would be published in order to discourage tax evasion. Mr Cameron went as far as to say that the current ability to keep beneficial ownership private had lead to “questionable practice and downright illegality”. Therefore, the information collected relating to beneficial ownership of UK companies would be made available in a public register. The assumption is that this register would be searchable through Companies House much like information which can be gleaned through a search of a company’s publicly available information declared in its annual return. In the context of the proposals, a beneficial owner is defined as anyone with more than 25 per cent of the shares or voting rights in a company or who otherwise exercises control over the company or the way in which a company is run. Individuals who collectively with others hold more than 25 per cent and agree to vote the shares together would be treated as a beneficial owner. Where company shares are held in trust and the trustees hold an interest in more than 25 per cent of the shares or voting rights or otherwise exercise control it is proposed that the trustee should be disclosed. Beneficiaries might also be disclosable in certain circumstances, for example, if they had express powers to acquire or dispose of shares (although

this seems unlikely unless a beneficiary is named as a protector or some other form of consent holder in relation to the shares in the company and even then a power of consent is not the same as a power to buy or sell shares or other assets). It is proposed that companies should have a right to obtain information about beneficial ownership from their shareholders. This would be linked with a legal requirement on companies to identify the beneficial owners of any block of shares representing more than 25 per cent of the voting rights. These measures could be reinforced by placing a new legal obligation on beneficial owners to disclose their beneficial ownership of the company. These proposals are not especially surprising. The G8 and the OECD are pushing for greater transparency globally and increasing pressure is being put onto jurisdictions which enable individuals to hide behind corporate nominees. Most offshore centres are actively seeking to input the FATF Recommendations 24 and 25, which address transparency and beneficial ownership of legal persons and arrangements. Both state that countries should ensure that there is adequate, accurate and timely information on the beneficial ownership and control of legal persons and express trusts (including information on the settlor, trustee and beneficiaries) that can be obtained or accessed in a timely fashion by competent authorities. The French authorities took steps in 2011 to force trustees to disclose information relating to French resident

IFC: Good for the regulation Global Economy & policy

beneficiaries and settlors, threatening substantial fiscal penalties if the required information is withheld. In December 2013 a new law came into effect in Italy requiring Italian residents to disclose the value of directly or indirectly held foreign assets which includes assets held in trust where they are beneficial owners. The introduction to the Transparency & Trust discussion paper sets out clearly that the aim of the new proposals is to help the government tackle tax evasion, money laundering and terrorist financing. It will improve the investment climate and make doing business easier. However, the discussion paper makes no reference to the reasons why people want to stay hidden in the first place. Of course no one would argue on the side of those who are involved in criminal activity and effective measures which combat money-laundering and tax evasion are only to be welcomed. But there are any number of reasons why an individual or groups of individuals may wish to remain anonymous, not least

of which may be concerns for personal security and legitimate asset protection. It is far from unheard of for assets to be aggressively nationalised in the wake of political or regime change or subject to criminal attack. Nominee and trust arrangements are commonplace in the context of international succession planning where assets may be held for minor heirs or beneficiaries who may not legally be entitled to own those assets or, in certain circumstances, where it is not advisable for young or vulnerable individuals to have full control of family assets, in particular where there is considerable wealth involved. The discussion paper clearly acknowledges the current inability to force foreign companies to comply with the new requirements – so how effective will the new rules be in relation to shares which are held by foreign corporate nominees? What if the shares in a UK company are held, as is sometimes the case for wealthier, non-resident or non-domiciled

private individuals and families, in offshore holding companies the shares in which are held by nominees or by trustees? Where trusts are employed as a succession planning mechanism, it is often the case that there is no ‘real’ beneficial owner. This difficulty has become all too apparent in the context of the new French legislation referred to above where any named (or even implied) beneficiary of a trust who is French resident can find himself treated as a beneficial owner for the purpose of the trust disclosure obligations. The new Italian rules throw up the same issues: just who is a beneficial owner? Does being named as the object of a discretionary power in a trust deed mean someone is a beneficial owner – any number of trust lawyers – and indeed Italian experts on trusts – would beg to differ. What of the family member named in the trust deed who has a mere hope of benefitting if a multitude of conditions are satisfied and even then in the sole discretion of

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IFC economic report • spring 2014

the trustees…with the consent of the protector…in consultation with other adult beneficiaries – in all likelihood he or she doesn’t even know that this remote possibility of benefit exists. Is it appropriate then that a member of the public might be able to access this information through a search of a public register? The Italian approach has been to identify ‘capital beneficiaries’, that is beneficiaries who are identified in the trust deed and are entitled to 25 per cent or more of the trust capital, beneficiaries who are members of a class of beneficiaries in whose main interest the trust has been established or acts or a person who exercises control in respect of more than 25 per cent of the assets. This attempt to identify beneficial ownership, in particular when referring to beneficiaries who are members of a class, entirely ignores the concept of a fully discretionary trust – but it seems that in relation to identifying the beneficial owners of trust the options are limited.

The new UK proposals relate to companies and there is no suggestion at this stage that they should extend to trusts. However, in order for the proposals to be fully effective in the long term, extending this approach to trusts (or at least attempting to) is the next logical step and is certainly contemplated in a number of offshore jurisdictions. Where foreign shareholders are involved from the outset one can envisage a process which is already in place in a number of popular offshore jurisdictions whereby, on registration, shareholders should be obliged to provide detailed information regarding ultimate beneficial ownership. The administrative burden on Companies House would dramatically increase but the concept itself does not seem unworkable. But the problem remains that it is sometimes not possible to identify any beneficial owner. And what of the example in the discussion paper about shareholders working together to exercise control over 25 per cent or

more of the shares – will that always be obvious? In general, the UK government’s commitment to increase the transparency of companies is to be welcomed in underlining the attractiveness of the UK as a wellregulated jurisdiction for investment and business. However, if the proposals on transparency are to be implemented to full effect, they need to be formulated in the context of a broader global initiative with consideration given to the importance of protecting personal information, in particular in the context of minors and legitimate asset protection and personal security concerns. IFC

About the Author:

Anna is Senior Counsel at Charles Russell LLP in Geneva. She advises high net worth individuals and families, trustees, family offices, and private banks on international tax, governance, trust structuring and succession planning issues.

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IFC REVIEW 2014 IFC Review is the most comprehensive guide to IFCs and the services that they offer, with a readership of 38,000 professionals worldwide, in print, online and with a presence at major industry events. Providing practitioners with extensive coverage of the latest regulatory and legislative initiatives, unique factfile reference sections for over 30 jurisdictions and a Professional Directory featuring the details and services for leading firms in each jurisdiction, the IFC Review is the industry’s leading guide to international finance. In section one, leading industry figures and academics offer a comprehensive analysis of all the latest major developments within this dynamic industry. Through a series of commentary pieces and technical articles they unravel the major issues within the offshore world, incorporating comprehensive regional overviews and look at developing trends across key industry sectors. Section two provides state of play guides for the world’s foremost international financial centres by experts from within the jurisdictions themselves. Supported by a detailed tax-planning reference section on each jurisdiction, the IFC Review provides the professional practitioner with a vital reference source to utilise time and again throughout the year. Publishing date: April 2014

IFC CARIBBEAN 2015 Caribbean financial centres have been described as the ‘plumbing’ of the global economy, they have been integral to the efficient flow of wealth throughout the established financial marketplace, but more significantly have proven to be key in the development of the emerging economies. IFC Caribbean examines the function of the offshore centres in the region, illustrating their practical application with detailed case studies, interviews and commentary from the professionals either working in the Caribbean or using the elite financial services available there, and the politicians and regulators directly responsible for creating and promoting such a competitive financial environment. Now in its fourth year, the IFC Caribbean has established itself as the region’s industry-leading publication, with regulatory and legislative updates together with analysis on economic developments. Jurisdictions in profile include: BVI, Cayman Islands, the Bahamas, Barbados and Bermuda. Publishing date: September 2014

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IFC economic report • spring 2014

The World Moves Towards Tax Transparency By Monica Bhatia, Head of the Global Forum on Transparency and Exchange of Information for Tax Purposes, OECD There has been tremendous progress in the last few years in the efforts to fight tax evasion. The international community has universally acknowledged the importance of building a world where everyone pays their fair share of taxes.

One of the key steps that has been taken in this area is to end secrecy for tax purposes, by strengthening transparency and boosting the comprehensive exchange of information between governments worldwide. Since 2009, when the Global Forum on Transparency and Exchange of Information (the Global Forum) was restructured, membership has increased to 121 jurisdictions, comprising many small jurisdictions, all major financial centres, OECD economies, as well as all G20 jurisdictions. Having all members working together, sharing the same objective is a turning point for progress towards a truly level playing field. A big step forward towards comprehensive transparency was achieved on 21-22 November 2013, when over 200 delegates from 81 jurisdictions and 10 international organisations and regional groups came together at the sixth meeting of the Global Forum in Jakarta, Indonesia. Participants took decisions which will have far reaching implications on the exchange of information environment. These were: • Publication of compliance ratings for 50 countries and jurisdictions on the practical implementation of the Global Forum’s information exchange on request standard. Eighteen jurisdictions were rated Compliant, 26 jurisdictions were

rated Largely Compliant, two jurisdictions were rated Partially Compliant and four jurisdictions were rated Non-Compliant. Fourteen additional jurisdictions were not given compliance ratings, pending further improvements to their legal and regulatory frameworks for exchange of information in tax matters. (See Figure 1). • Establishment of a new Automatic Exchange of Information (AEOI) Group, open to all interested countries and jurisdictions, to prepare the move towards AEOI implementation. • Agreement for further work aimed at strengthening the definition of beneficial ownership and the availability of this type of information. • Agreement that the Forum continue monitoring implementation of the transparency and information exchange standard, in particular through a new round of reviews starting in 2016, while further developing its Terms of Reference and review processes. These achievements signal a great success for the Global Forum and a reaffirmation of the resolve to ensure full implement effective exchange of information on an ongoing basis.

effectiveness of that framework. The ratings exercise was carried out at one go for 50 jurisictions so as to have a representative cross section of Global Forum membership include G20 members, OECD countries, non-OECD countries, offshore financial centres and some developing countries and to allow for a comparative perspective. The ratings, which were discussed and approved by the entire membership of the Global Forum, have been largely accepted very positively by the jurisdictions rated and there have been commitments made to address recommendations. Many rated jurisdictions have already begun the process of making the required changes in order to be able to seek an upgrade of their ratings as soon as they are eligible. While noting that 14 jurisdictions could not receive ratings because their Phase 2 reviews could not take place1 pending changes to their legal and regulatory framework to allow for effective exchange of information, the Global Forum agreed to undertake close, on-going monitoring so that these jurisdictions move forward expeditiously. It is encouraging that many of these jurisdictions have since made progress so that focus can be on those that lag behind.

The Ratings

Completion of peer reviews does not mean that nothing more needs to be done in implementing the standard. There was agreement that continued monitoring of the implementation of the standard on EoI is essential to ensure jurisdictions do

The assignment of ratings to the first 50 jurisdictions marks the fulfilment of a major part of the original mandate of the Global Forum and a culmination of the peer review exercise. To date, 124 peer reviews have been completed, including 74 Phase 1 reviews, which assess the jurisdiction’s legal and regulatory framework and 50 Phase 2 reviews which assess the practical

What’s Next After Peer Reviews?

1 Botswana, Brunei, Dominica, Guatemala, Lebanon, Liberia, Marshall Islands, Nauru, Niue, Panama, Switzerland, Trinidad and Tobago, United Arab Emirates and Vanuatu.

The OECD

OECD Jurisdictions Overall Ratings COMPLIANT (18)

LARGELY COMPLIANT (26)

PARTIALLY COMPLIANT (2)

NON-COMPLIANT (4)

Cannot move to Phase 2 review until they act on recommendations

Australia Belgium China Denmark Finland France Iceland India Ireland Isle of Man Japan Korea New Zealand Norway South Africa Spain Sweden

Argentina The Bahamas Bahrain Bermuda Brazil Cayman Islands Estonia Germany Greece Guernsey Hong Kong, China Italy Jamaica Jersey Macao, China Malta Mauritius Monaco Netherlands Philippines Qatar San Marino Singapore Turks and Caicos Islands United Kingdom United States

Austria Turkey

British Virgin Islands Cyprus Luxembourg Seychelles

Botswana Nauru Brunei Niue Dominica Panama Guatemala Switzerland* Lebanon Trinidad and Tobago Liberia United Arab Emirates Marshall Islands Vanuatu

not fall back on their commitments. To this effect, there will be another round of reviews for all Global Forum members and relevant non-members beginning in 2016. For this purpose, the Global Forum will re-examine its Terms of Reference to identify and agree on any necessary changes. Key issues to be examined in this context include the issue of beneficial ownership of legal entities and arrangements, revisions to Article 26 of the OECD Model Convention and its commentary, which were part of its 2012 update, and other appropriate changes based on the experience gained from the present round of peer reviews.

Automatic Exchange of Information- The Next Frontier

The exchange of information environment has developed very rapidly over the past year, with strong support coming from the G20 to move towards automatic exchange of information that supports and enhances exchange on request. The pilot project for multilateral information exchange started by

* The Phase 2 of Switzerland is subject to conditions. the G5 countries (Italy, Spain, UK, France, Germany) has seen many other jurisdictions join in and the OECD, working with G20 countries has finalised the new standard. Many Global Forum members are affected by these developments and are keen to make quick progress while ensuring a level playing field. In recognition of these developments, the Global Forum has taken on the challenge of reviewing and implementing the new AEOI standard. A sub group on AEOI has been established comprising 50 Global Forum members who wish to come together to work towards a common goal of engaging in AEOI. Apart from establishing criteria to to guide implementation of AEOI, it is tasked with identifying obstacles to AEOI and helping developing countries identify their needs for technical assistance and capacity building before engaging in AEOI. All these are very good results but the Global Forum is now facing new challenges and needs to move forward quickly as global focus on preventing tax evasion continues unabated.

The immediate task is to complete the ongoing peer reviews, assessing the standard of exchange of information on request while laying the groundwork for the next round of peer reviews to being in 2016. The pace at which jurisdictions are amending their legal framework and practices foretells that many supplementary reviews will be undertaken to assess the changes made. At the same time the Global Forum will be working towards developing effective ways to ensure implementation and review of the new standard on automatic exchange of information. The G20 countries have already committed to exchange information amongst themselves as early as 2015 and through a Joint Statement, 40 jurisdictions have indicated their commitment to be early adopters. Many other members are keen to understand the benefits of engaging in AEOI or moving towards implementing it in the near future. The Global Forum, with its wide membership and expertise in exchange of information is uniquely placed to respond to the varied needs of its members. IFC

IFC economic report • spring 2014

Revised Parent and Subsidiary Directive: Towards a Fairer Tax System By Thomas Neale, Head of Unit, Company Taxation Initiatives, EU Commission During the mandate of this European Commission (2009 – 2014), the EU and global approach to taxation has made a big step forward.

For decades, the focus of international tax policy has been on lifting tax obstacles to trade, in particular double taxation. Recently, a second leg of international taxation has been put forward both at EU and global level: ensuring that individual countries could enforce their tax rules in an international context and fighting double non taxation. At global level this new approach is incarnated by the work of OECD at the request of G20 on a global standard for automatic exchange of information and on base erosion and profit shifting. On the European level we have seen unprecedented progress, too. On 6 December 2012 the Commission adopted a very ambitious Action Plan in order to give a more effective European response to tax fraud, evasion and avoidance. Since the adoption of the Action Plan, the Commission has tabled concrete proposals to expand automatic exchange of information, better fight VAT fraud, monitor international tax good governance, launch a much-needed debate on digital taxation and ease VAT compliance. Progress in this field is vital: each year vast amounts of money are lost due to tax fraud and evasion in the EU. Not only is this is a loss of much-needed revenue in times of budgetary constraint, it is also a threat to fair taxation and fair competition in the single market. The most recent initiative within the framework of our Action Plan is the revision of the Parent-Subsidiary Directive (PSD).

The PSD was originally conceived in 1990 in order to prevent samegroup companies based in different Member States (a parent company and a subsidiary, for example) from being taxed twice on the same income (double taxation). To do so, the Directive gives a tax exemption for dividends and other profit distributions paid by subsidiary companies to their parent company. However, in an increasing number of cases, companies abuse the Directive to avoid paying taxes in any Member State (double non-taxation). Companies do so using a particular tax planning technique called ‘hybrid loan arrangement’. The purpose of the revision of the Directive is to close this loophole and to make sure that all businesses make their fair contribution to public finances. We made two changes to the Directive which Member States have to adopt by 31 December 2014. First, hybrid loan arrangements are being tackled. They are financial instruments that have the characteristics of both debt and equity and are therefore subject to different tax treatment in different Member States. As a result, cross border hybrid loans may be treated as debt (ie, a tax deductible expense) in the Member State of the subsidiary and as a tax exempted dividend in the Member State of the parent company. This can – until now – result in a deduction in one Member State followed by tax exemption in the other. Under the proposed amendment, the Member State in which the parent company resides, would not grant the tax exemption. Second, a general anti-abuse rule (GAAR) has to be implemented by the Member States in order to generally block off tax avoidance

strategies. If, for example, a parent company outside the EU has a subsidiary operating in a Member State that levies withholding taxes on dividend payments, the parent ca0n – until now – be tempted to create an artificial intermediary company in another member state which does not charge withholding taxes. The subsidiary can then avoid the withholding tax by channelling its profits through the artificial intermediary towards the parent company. Harmonising Member States GAAR will ensure that Member States have a common approach in rejecting artificial tax planning instruments. These two changes will make sure that not only the letter of the law, but also the spirit of the PSD, will be respected in the future. Hybrid loan arrangements are a typical example of how some multinational companies try to abuse differences in the tax codes of the Member States in order to artificially reduce their tax bills. The revised PSD illustrates how committed the Commission is to closing such loopholes and to creating a level playing field for honest businesses across Europe. However, it is also an illustration of the Sisyphean work the Commission is doing to keep pace with the increasing complexity of international taxation and its exploitation by tax avoiders. Despite the substantial progress already achieved under this Commission, the ultimate step to putting a lasting end to harmful tax avoidance strategies would be more harmonisation across the EU such as the Commission proposal for a Common Consolidated Corporate Tax Base. More similar national tax codes mean fewer differences that can be exploited. What has become reality in several other field of European economic policy is equally true in the field of taxation: We need a single approach for the single market. IFC

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IFC economic report • spring 2014

Q&A with... Paul Astengo, Senior Finance Centre Executive, Gibraltar Finance The IFC Economic Report speaks to Paul Astengo on how Gibraltar is developing as an international finance centre and what the future holds for the ‘Rock’.

How is the financial services sector in Gibraltar developing and how important is it to Gibraltar’s economy? PA: The three main pillars of contribution to our economy from financial services are asset management and funds, insurance and private clients. The financial services sector contributes approximately 23 per cent of Gibraltar’s GDP making it a very important cornerstone of our economy. Gibraltar’s insurance industry has expanded from just 12 licensed insurers in 1993 to 56 licensed insurers writing new business today. In 2011, the total gross premium income that was written by insurance companies in Gibraltar was £3.2bn, and these companies held assets worth over £7.5bn. Gibraltar motor insurers currently write 16 per cent of the total UK motor market. There are 16 banks and building societies currently licensed in Gibraltar, employing more than 500 people. They range from large global institutions to specialist private and investment banks and building societies. They are able to provide a full breadth of solutions to their clients’ needs in all areas of banking. Almost 100 experienced investor funds have been established in Gibraltar since the Financial Services (Experienced Investor Funds) Regulations 2005 came into effect in August 2005. The government introduced new Financial Services

(Experienced Investor Fund) Regulations in 2012, which allow large funds to use reputable and substantial administrators based in jurisdictions of equivalent standing to Gibraltar. The continued and growing investment in the human and financial resources available to Gibraltar Finance, which markets Gibraltar as a financial services centre, is testament to the importance of this sector and of the perceived benefits that will accrue. What is Gibraltar’s unique selling point as an IFC? PA: Gibraltar is a self-governing and self-financing parliamentary democracy within the European Union. Gibraltar’s EU membership provides passporting rights in banking, investment services, insurance, insurance mediation and reinsurance across all EU and European Economic Area countries and access to a market of 500 million people. Gibraltar offers a competitive low tax rate within the EU. This, together with the fact that there is no wealth tax, no VAT, no inheritance tax and no capital gains tax makes it a very favourable jurisdiction in which to do business. It has become a catalyst for the development of the wider region. How has Gibraltar and its financial services sector come through the global recession of recent years?

“The type of company that should look to Gibraltar is one that cares as much for its own reputation as we do for ours.” 34

PA: The simple answer is largely in excellent shape. Gibraltar as a whole is buoyant and we have bucked global trends. Gibraltar is Europe’s success story. This does not mean that we are complacent. We are making significant investment, reinvesting the fruits of our success, across all areas of our economy not least in the marketing activity of Gibraltar Finance as the onshore, European finance centre of choice. In the last 12 months we have added four senior executives to the team charged with increasing the business that is done in and from Gibraltar. Which areas of the sector are experiencing growth and which less so? PA: Gibraltar has an extensive and diversified service-based economy. The principal contributors to its economic base are financial services, maritime services, e-gaming, communications and tourism. It is forecast to grow from £1.1bn to £1.65bn between 2011 and 2015, and the government of Gibraltar has maintained a budget surplus throughout the recent economic slowdown that has affected much of the developed world. Our economy has often been described as ‘running on all cylinders’. That’s something we’re immensely proud of. The Finance Centre, banks, trust and company managers, insurance and reinsurance companies, funds, (both investment and alternative) together with high quality ancillary services such as accountancy, legal practices, communications and information technology providers have all made Gibraltar the first class international business hub that it is today.

gibraltar in focus IFC: Good for the Global Economy

What sets it apart from other jurisdictions carrying out similar operations in other parts of Europe? PA: There are two elements to this reply. Comparing ourselves to our direct competitors not in the European Union Single Market I would have to say the fact that we are within gives us very specific leverage. To those with whom we compete within the single market undoubtedly our regulation, reputation and speed to market is our stock in trade. The fact that we have consciously evolved into a mainstream, onshore, European finance centre serves us well in both cases. Gibraltar has recently become a full signatory to the Multinational Memorandum of Understanding of the International Organization of Securities Commissions (IOSCO) - what impact will this have on the jurisdiction? PA: We set our stall out to be a responsible and professional member of the cross border financial services community. There is in Gibraltar undoubted political support for this and industry will to remain very firmly on this path. As a result of choosing this we are required to participate in a wide range of initiatives like the MMoU with IOSCO, we do so readily and with a desire to participate fully. This adds to our existing credentials as an established and respected IFC, such as our being on the OECD instigated white list and being IMF reviewed. Gibraltar has signed an IGA with the UK, how important is FATCA to Gibraltar? PA: Gibraltar remains wholly committed to this form of initiative. We have nurtured a culture of compliance and FATCA is a very important demonstration of how we embrace integration into an onshore, compliant and mainstream financial centre. I would draw a parallel with the significant achievements in entering into the TIEAs as testament to this. Is automatic tax information exchange good for the wealth management industry and IFCs? PA: Yes undoubtedly so. We are only interested in developing a transparent and

“We are making significant investment, reinvesting the fruits of our success, across all areas of our economy not least in the marketing activity of Gibraltar Finance as the onshore, European finance centre of choice.” collaborative business model. We have already signed 27 TIEAs for example. We signed our IGA with the UK in November 2013 and will shortly sign a similar arrangement with the USA. We continue to actively pursue further TIEA's. In addition, Gibraltar has TIEAequivalent arrangements with all EU member states under the provisions of the Directive 2011/16/EU on administrative cooperation in the field of taxation, which came into effect on 1 January 2013. Are the regulatory demands being made on IFCs excessive when compared to other ‘mainstream’ financial centres? PA: Not at all, Gibraltar is regulated to the highest EU and UK standards. We do this because we believe that we are part of the mainstream community and want to continue being so; we have moved away from the ‘offshore’ environment. In addition initiatives such as FATCA apply across all developed markets and do not discriminate between onshore and offshore centres. How important are new markets outside the EU to Gibraltar– such as Asia, Africa even Latin America? PA: Gibraltar is alive to any new opportunities that become available. We have a very intense programme of events and visits programmed for 2014, more than at any other time. Our traditional markets are the UK and Switzerland and these continue to serve us well. We will be at the main industry conferences and forums, GAIM, Fonds 14, Trans Continental Trust, Captive Live, Pay Expo 14, AIRMIC and BIBA among them - so very much a pan European footprint. In addition we will continue with our flagship and hugely successful Gibraltar Day in London later in 2014. It is our intention to take this formula and replicate it in other jurisdictions. We have identified specific high value opportunities of working in partnership

with a number of jurisdictions including for example Johannesburg, Bermuda, Hong Kong, Singapore, Geneva, Zurich and New York. We are conscious of the need to maintain a high level of focussed activity, build on the foundations that have been established over the time that the finance centre has been in existence and take our message to those areas where we can offer some real benefit and value. What does the future hold for Gibraltar as an IFC? PA: We firmly believe that we are well positioned to take advantage of our strengths and drive growth for the long term sustainable benefit of our stakeholders. The world has been in a difficult place but there are signs that it has come out of intensive care and is on the road to recovery. Our conscious evolution to an open, transparent, collaborative mainstream finance centre has paid dividends. As always we will face the challenges that present themselves from time to time but continue to be dynamic, flexible and leverage on our three main virtues reputation, regulation and speed to market. There is a raft of refreshed or new legislation coming into force over the next few months covering a wide range of areas. This includes for example an entirely revamped Companies Act to a range of pension and private client initiatives that local industry have identified as absolutely essential to our continued growth and success. We remain committed to attracting quality players and are not in the market of quantity for quantities sake. The type of company that should look to Gibraltar is one that cares as much for its own reputation as we do for ours. Gibraltar is open for business and we look forward to giving a warm Mediterranean welcome to new entrants while continuing to grow the excellent relationships we enjoy with our existing stakeholders. IFC

IFC economic report • spring 2014

Rising to the Challenge By Michael Castiel, Partner, Hassans, Gibraltar Two major developments in Gibraltar’s financial services sector during the first half of this year will further enhance the jurisdiction’s strength and reputation as a player in global finance, with new offerings of both local and international appeal.

The Rock’s first stock exchange GSX Ltd, granted a license by the Financial Services Commission in February, and the establishment of the Governmentbacked Gibraltar International Bank provide exciting investment facilities both for High Net Worth Individuals and overseas investors in both the EU and US. Linked to the London Stock Exchange and with the possibility of other ties to the giant Nasdaq bourse, GSX - a readily simple acronym - initially will trade in funds allowing them to ‘build a public track record’ easily accessible and providing an indication to shareholders as well as potential investors to see how specific funds are performing. As many as 100 funds could be listed. GSX is also expected to attract a flow of Swiss funds in the wake of changing tax and management regulations there. Several have already indicated plans for a change of domicile to Gibraltar. The two main players behind the establishment of GSX, Nick Cowan and Marcus Wohlrab, have impressive records on the international financial stage. Cowan (currently the CEO of GSX and a professional trader at NJC Trading) is a former head of equities and global head of equity trading at ING Barings as well as managing director at Bear Stearns in the UK. Wohlrab, a respected Experienced Investor Fund

director, has been executive vicepresident at EASDAQ and a director at NASDAQ International. As well as attracting a significant number of Swiss funds, the new bourse is likely to have a strong appeal to US investors when, later this year, the Gibraltar government signs a FATCA agreement with Washington to disclose financial transactions - so allowing US taxpayers to place assets legitimately in non-US financial institutions or other non-US entities as their assets will no longer be concealed from the US tax authorities. As a result, FATCA will be introduced into Gibraltar legislation. The UK government have adopted a similar scheme for the UK’s Crown Dependencies and Overseas Territories (known to some as ‘Son of FATCA’). Gibraltar signed an agreement with the UK under this scheme in November last year, though unlike FATCA, there is no withholding tax. And there will be a further boost in US investor interest in March with the launch of a new Chamber of Commerce directed at US businesses and investors - though not a branch or off-shoot of the American Chamber of Commerce in Washington. There will be further stimulus in May when a Gibraltar trade mission including funds and other financial services experts visits the US. GSX is the third – but first successful - attempt to establish a Gibraltar stock exchange. A first attempt in the 1990s failed to get off the ground and a subsequent second attempt also failed Plans for the new bank – the Gibraltar Investment Bank – which will have a start-up capital of £15 million of government funding were disclosed

last year in the wake of Barclays Bank’s decision to retain only its large corporate and private banking operations in Gibraltar, while closing its large, but less profitable, retail section by October this year. The Rock’s three other high street banks – RBS, NatWest and Jyske – are clearly unable, and in many cases reluctant, to absorb all of the 17,000 retail accounts of Barclays customers, including many of the smaller shops catering to Gibraltar’s growing tourist industry. (This has been hit recently by the border friction with Spain but efforts are proving successful to increase lucrative cruise ship visits.) The bank is already licensed, has acquired premises and has begun recruiting staff. Some of these have already been drawn from the experienced tranche of Barclays employees who have been or are still to be made redundant. Gibraltar also has a wealth of highly experienced university graduates who see time spent in banking as an important step into other areas of Gibraltar’s burgeoning finance sector. For, although Gibraltar is clearly facing challenges - from FATCA, from British proposals to alter its approach to tax on internet gaming, and from the constant stream of financial rules and directives emerging from Strasbourg and Brussels – it has been able to escape most of the damaging effects of the economic downturn which have lashed other jurisdictions. In the past Gibraltar has shown its ability to adapt to crises and maintain a competitive position in every circumstance and these two new institutions (GSX and the Gibraltar International Bank) are poised to ensure further successes and growth. IFC

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IFC eConomIC report • sprIng 2014

Offshore in Practice: ASIA While European jurisdictions are still emerging from the depths of recession and grappling with untold levels of new regulation, growth and development have been continuing apace in Asia with IFCs in the region reaping the benefits of the movement of wealth into Asia. In this edition of Offshore in Practice our contributors bring to us examples of Asian international finance centres in practice with case studies and illustrations of new and innovative structures coming out of the East.

An Asian Welcome for Offshore By Frances Woo, Partner and Global Chairman, Appleby, Hong Kong The global financial crisis and its aftermath have brought a great deal of focus, controversy and hype regarding offshore finance in Europe and the US, where those governments are running significant budget deficits.

Erosion of tax base and loss of tax revenue were determined as the primary culprits but interestingly, public overspending, systemic banking risks or other factors are muted. This characterisation together with pressures to enhance tax harmonisation, especially in the EU, has led to a surge in new regulations and a sustained media campaign against international finance centres (IFCs). It has been populist and simplistic to malign the IFCs without a full understanding of their important role in the efficient movement of capital and aiding of developing countries. The distinction between tax avoidance and tax evasion has also been blurred. This stands in marked contrast to

Asia, where IFCs such as Hong Kong and Singapore have thrived over the last decade and are now ranked alongside London and New York as among the best in the world. In tandem, the use of pure offshore IFCs in the Atlantic/ Caribbean and Europe has also steadily increased – these would include Bermuda, the Cayman Islands, the British Virgin Islands, Jersey, Guernsey and the Isle of Man. Asian countries and their governments are all developing at different rates and maintain their own fiscal sovereignty. Tax rates are generally lower in Asia than in Europe and the US. Asian growth is also highly dependent on international cross border investment and deal flow and requires efficient access to capital. IFCs help to facilitate and intermediate and provide a familiar, comfortable and stable platform for investors moving into an often opaque and fast-moving regulatory environment in the emerging Asian nation. There is less friction for IFCs in Asia and as a result we have witnessed a

re-alignment in the Asian strategies of IFCs, with Cayman and the BVI seeking to bolster their already well-established reputation in Asia, and newer Asian players such as the Channel Islands – who are facing increased hostility from European governments and the UK – aggressively pursuing a piece of the market in China and India. Mauritius continues to play a strong role for India and increasingly is seen as the gateway to continental Africa. So why is it that IFCs and offshore finance more generally have faced such significant challenges in the West, but been more welcome for their role in the economic prosperity of the East – so much so, indeed, that some established European IFCs have shifted focus from their traditional markets in the City of London and Europe and have headed to Asia? The answer is, of course, multi-faceted. Hong Kong and Singapore’s relationships with China and South East Asia respectively is not unlike that

offshore in practice: ASIA

between the Channel Islands and the UK, Switzerland and Europe or the Atlantic/Caribbean jurisdictions and the United States (US). Hong Kong was a refuge for Chinese business since the 1930s, with many individuals shifting their wealth there before the revolution. Likewise, Singapore has always been a home for wealthy individuals from Malaysia, Indonesia and India. But as the years passed – and countries in Asia opened up and have grown prosperous themselves – this relationship has shown remarkable improvement, whereas in the West, regulations from the UK, Europe and the US have hit their own offshore finance centres hard, persuading them to look to Asia. Bermuda has had a presence in Hong Kong as far back as the 1980s, quickly followed by Cayman and the BVI, and Switzerland’s links with Singapore remain very strong. The first point to note is that IFCs have always provided a service that China, India, Indonesia and other South East Asian countries cannot – namely a well-regulated, simple, stable and efficient business environment. China, for all its growth in recent years, still suffers from often opaque regulation and long standing bureaucracy, a less than open capital market and an almost nonexistent wealth management platform. Although China’s business and regulatory environment continues to develop and evolve and it has matured

and grown rapidly over the past decades, there continue to be barriers to trade and investment and the free convertability of capital. Restrictions and control remain, as illustrated by the Shanghai Free Trade Zone (FTZ) established in August last year. In the run up to the launch there was talk of corporate income tax concessions, the opening of China’s capital account and freer conversion of the Renminbi (RMB) – to date, the status remains unclear. What is clear is that China is not yet ready to establish its own City of London on the mainland and, as a result, IFCs will likely continue to play significant roles in China’s outgoing investment. India, Indonesia and much of South East Asia share China’s problems but to an even greater degree as they are at earlier stages of their growth, with undeveloped domestic banking systems, a myriad of red tape and protectionist attitudes towards the domestic economy. It is therefore of little surprise that citizens of these countries prefer to bank in Singapore. Wealth management aside, it is in the realm of corporate finance and investments that IFCs have excelled in Asia and as a result, made offshore finance a major part of Asian growth. The number of Chinese/Asian companies using offshore vehicles to list in international markets in London, New York or Hong Kong has continued to rise – as has the number of Western

firms looking to access Asia through similar structures. A recent report by Offshore Incorporations Limited, Offshore 2020, found that expectations for more outbound business from China is increasing, as China remains the most significant driver of offshore activity in Asia. It had Chinese outbound M&A activity jumping five-fold between 2005 and 2011 to US$63 billion. What is more, as Appleby noted in its Q3, 2013 offshore M&A report, two of the largest outbound deals last year had an offshore element to them. Firstly, Shuanghui International’s US$7 billion purchase of US pork producer Smithfield Foods: Shuanghui International is the Cayman Islandsincorporated arm of China-based Shuanghui, the country’s largest meat producer. And while China is concerned about tax revenue, it is also cognisant of the role offshore plays. State Owned Enterprises have definitely benefitted from offshore vehicles facilitating investment outside of China, which play an important role in the economic growth of the country. China National Offshore Oil Corporations (CNOOC) US$15.5 billion buyout of Nexen, the Canadian oil and gas company, is a good example of this; structured, as it was, through its network of offshore entities. These illustrations show the importance of IFCs as a conduit

IFC economic report • spring 2014

of capital from East to West, assisting Chinese companies to gain access to Western capital or technology through foreign listings or acquisitions. Equally, IFCs permit Western companies to invest in Asia simply and efficiently, bypassing the complex bureaucracy and language barriers of going directly to Beijing, Jakarta or Mumbai. The question now, of course, is whether Asian governments such as China will continue their entente cordiale with IFCs and offshore finance in the years ahead. After all, the economic outlook for Asia is, according to many analysts, less positive than it was and China’s GDP growth has been revised downwards compared to years past. Firstly, taking China, 2013 was a bit of a bumpy ride and a slowdown is expected in the first quarter of 2014, but a predicted 7.5 per cent growth for 2013 – according to official Chinese figures – is still pretty healthy. Since it first brought in market reforms in 1978, Chinese GDP growth has averaged around 10 per cent a year and the country is predicted to be the world’s largest economy by 2020. Meanwhile, the world’s fourth largest economy, India, narrowly beat analysts’ growth forecasts in the third quarter of 2013, with economists polled by Reuters putting the figure at 4.6 per cent. It is true that Indian growth has been disappointing since its nine per cent 2010 heyday, but Goldman Sachs recently claimed that an improvement and increase in investment demand would see the 1.2 billion-strong country bounce back in 2014. Many are less bullish on Indonesia, where growth was down last year, to 5.6 per cent in the third quarter of 2013 compared to 5.8 per cent in the second. The country was hit by a global trend in 2013 of investors withdrawing money from emerging markets. The World Bank, in its most recent report on Indonesia, said that the country needed to focus on increasing foreign direct investment and bolstering exports. But despite mixed results in Asia, it is likely that the service that IFCs and offshore finance have provided to countries such as China, India and

Indonesia will remain an asset. China continues to open up its economy. There are predictions for free convertibility of the RMB by 2020 which is heavily debated. Whenever this occurs, this is only one step and as international and western financial banks/institutions were not created overnight, it too may be decades before the domestic Chinese banking system will offer sophisticated and tailored wealth management options in any way comparable to those in Singapore or Hong Kong or other IFCs. Other than the Shanghai FTZ, Shenzhen set up its special economic zone in Qianhai a few years ago to assist with the internationalisation of the RMB. The BVI has very recently announced the signing of a memorandum of understanding with Qianhai to promote cooperation in the financial industry. This development provides the ability to increase international investment in the region through the BVI, both to facilitate and intermediate foreign inward capital as well as outbound capital. For Chinese companies looking to invest abroad, IFCs will continue to be invaluable – as the recent Shuanghui and CNOOC deals show. The only question will be whether firms opt to adhere to the favoured structures in the BVI and Cayman, or put their faith in new players like Jersey and Guernsey. There is certainly a precedent for these Asian new kids on the block. Since global commodities giant Glencore raised over US$10 billion in a joint initial public offering (IPO) in London and Hong Kong in 2011 using a Jersey company, capital markets has been a growing area of interest for Jersey and Guernsey. Since then, Jersey and Guernsey companies have now been used by organisations as far afield as Russia and China and list on a range of global bourses, including the London Stock Exchange (LSE) main market and Alternative Investment Market (AIM) and the Hong Kong Stock Exchange (HKSE). Much will depend on the needs of Asian companies. As they grow in sophistication, they will gravitate to those IFCs that best suit them, investors,

regulators and the environment they are targeting. Finally, many in the offshore world are suggesting that IFCs look to the successes of Hong Kong and Singapore in the face of the on-going crackdown from Europe and the US. Both cities have not only sold themselves for their low tax policies but on their effectiveness as business hubs, combining the offshore with the onshore, while maintaining good relations with the countries that surround them. Hong Kong, Singapore and Asia more generally are not immune to the anti-tax avoidance agenda, and the recent crackdown by Chinese tax authorities on multinationals avoiding tax in China demonstrates that the authorities are conscious not to let things get out of hand. The South China Morning Post reported in December that unpaid taxes worth RMB34.6 billion were recovered in 2012. There have also been developments on tax information sharing. Beijing and Washington have agreed to negotiate an intergovernmental agreement (IGA) that would enable compliance with the US Foreign Account Tax Compliance Act (FATCA) and require higher due diligence and disclosure requirements. Further, both Hong Kong and Singapore have too signalled their intention to enter IGAs. However, on balance China and other Asian nations still do not have large fiscal deficits and there is not the same need to bring in tax revenue to balance budgets. Asian affluence continues to grow and its middle class, prominent drivers of consumption and growth, as well as its younger populations, are powerful forces. The United Nations estimates that the middle class will grow to 3.2 billion by 2020 (from 1.8 million in 2009) and that Asia is almost entirely responsible for this growth. By 2030, Asia’s middle class is predicted to be 10 times larger than North America and five times larger than Europe. As long as the offshore world continues to facilitate trade and investment and adapt to increasingly more highly-regulated environments, it will continue to find a home in the Asian economic landscape. IFC

IFC: Goodoffshore for the Global in practice: Economy ASIA

What Happens Before and After an IPO in Hong Kong By Richard Grasby, Partner and Head of Trusts and Private Wealth and Richard Spooner, Of Counsel, Corporate Team, Maples and Calder, Hong Kong Hong Kong is one of the world’s largest financial centres for initial public offerings (IPOs). Hong Kong was the global leader for IPOs in 2009-11, dropping to fourth in 2012. However, it seems that the Hong Kong market is resurging – mainly due to renewed confidence in the Chinese economy.

According to the Financial Times1, in November 2013, 13 companies filed their listing documents with the Hong Kong Stock Exchange and were hoping to raise more than US$6 billion. Many of the companies being listed are themselves incorporated in the Cayman Islands or BVI and are also owned via structures containing other Cayman Islands and BVI entities. The BVI estimates that 40 per cent of its financial services business has ties to Asia. In emerging markets such as China, it is very common for businesses to be closely held or controlled – often by a single individual (the ‘Founder’). Using one or more trusts can have major advantages for all concerned with the IPO. This is an area of growth in Hong Kong at present and due to the familiarity and confidence with the jurisdictions, many of the trusts are set up in the Cayman Islands or BVI. Let us take the following case study using the Cayman Islands as an example2: Mr Wong owns 80 per cent of a Cayman Islands company (‘Listco’). A 1 4 December 2013 2 Could equally be BVI.

private equity fund (‘Fund’) – also based in the Cayman Islands –has just acquired the other 20 per cent. Both Mr Wong and Fund are hoping for a listing of Listco in Hong Kong. Mr Wong has a wife and two adult children who both work in the business. Mr Wong is considering two trusts – one to benefit him and his family (‘Family Trust’) to hold 78 per cent of Listco and the other to benefit the employees of Listco (‘EBT’) to hold two per cent of Listco3. The trustee will be a licensed 3 Before listing- post listing the figures will be reduced. Fig. 1

trust company (‘Trustee’) based in the Cayman Islands. The ownership structure (pre-listing) would be as set out in Fig 1.

How Will The Trusts Be Of Benefit?

Family Trust – Mr Wong The Family Trust will be of benefit to Mr Wong since it will result in the legal ownership of the shares in Listco being in the hands of the Trustee and not in the name of Mr Wong. As far as Listco is concerned, the Trustee is the shareholder. This insulates the share ownership in the event of anything

Shareholding of Listco

Mr Wong

Trustee of Family Trust 78%

Fund

Trustee of EBT

20%

Listco 41

IFC economic report • spring 2014

happening to Mr Wong. For example, in the event of Mr Wong’s death, were he to remain the shareholder, the 80 per cent shareholding would be frozen until such time as appropriate persons obtained the authority of the Cayman Islands’ court4 to deal with the shares. The shares would not be able to be voted or sold until such authority had been granted. This period could be several months or more. Equally were Mr Wong to lose capacity – permanently or temporarily- until someone had proper authority from the court, the shares would be frozen. Having the Trustee as the owner of the shares avoids the impact of such traumatic events on the shares and enables action to be taken. Equally, under the Family Trust, Mr Wong can give the Trustee the ability to delay and restrict distributions to his family members – including future

generations - and to make provision for charity or philanthropic purposes5. On the death of Mr Wong, without a trust, his widow and any adult children would inherit sizeable wealth and it is likely that the 80 per cent shareholding would be broken up among the family. The Family Trust would be structured to make use of the Cayman Islands reserved powers legislation such that persons other than the Trustee with suitable knowledge of the business (Mr Wong and his adult children would be obvious candidates) are able to give directions to the Trustee as to how to vote or dispose of the shares in Listco. This meets with the wishes of Mr Wong (who will usually wish to retain a significant degree of control), the Trustee (who does not want to be responsible for investment decisions) and the market (who wish to see Mr

4 Assuming the register of Listco is held in the Cayman Islands.

5 The latter would require a special (“STAR”) trust.

In addition to their popularity as listing vehicles in Hong Kong, Cayman Islands companies also continue to be the listing vehicle of choice for Chinese businesses wishing to list in the United States, whether on the New York Stock Exchange or the Nasdaq Global Market. Any buyer wishing to take such a company private will therefore need to consider and understand the Cayman Islands legal framework under which such an acquisition can be effected.

What is a merger?

2013 saw a number of such take privates of Cayman companies listed in the US, such as the high profile Focus Media deal, and that trend looks likely to continue throughout 2014. Almost all such transactions have been effected by means of a statutory merger, which is a relatively simple and quick procedure (particularly compared to the traditional mechanism, which was a court-supervised scheme of arrangement).

In essence, a merger is a procedure between two (or more) constituent companies, whereby one such constituent company is subsumed into the other (which becomes the surviving company) – the undertaking, property and liabilities of both constituent companies automatically vest in the surviving company, whilst the nonsurviving company ceases to exist.

How can a merger be used to take a company private?

In the take private context, the bidder incorporates a new Cayman Islands company (‘Merger Sub’) for the sole purpose of merging with and being subsumed into the listed company (‘Listco’), the latter of which survives the process and de-lists. Under the Companies Law of the Cayman Islands, the terms of the merger may provide that the shares of each constituent company may be converted into or exchanged for different types of property, including cash or shares in the surviving company or any other company. In a take private,

Wong and the existing management in control). This separation of ownership and control is a useful feature of the common law trust structure. Family Trust – Fund The Fund also likes the fact that the majority shareholder is the Trustee. The Trustee is not going to die, lose capacity, get divorced, act impulsively or disappear as could be the case with an individual. The Trustee is going to take proper advice and stand behind its obligations and promises. This is of comfort to the Fund. EBT The EBT will benefit those employees who satisfy the eligibility criteria. A loyal and well-motivated workforce will be of benefit to Listco and this will increase the value of the holdings of the Family Trust, the Fund and, post listing, the investors at large. IFC

the terms of the merger will most commonly provide that the shares of Listco will be cancelled in exchange for a specified cash consideration. (Alternatively, if the bidder is itself a listed company, the consideration may include shares in the bidder.) Simultaneously, each share in Merger Sub will be converted into one share in the surviving company. Once the merger becomes effective, the Surviving Company therefore will be wholly owned by the bidder, whilst the former Listco shareholders will receive the stipulated consideration (cash, or cash plus shares in the bidder).

Procedure

The procedures to implement a merger are set out in the Cayman Islands Companies Law. In summary, these are as follows: a) The directors approve a plan of merger, which sets out the terms and conditions of the merger, including the manner of converting the shares of the constituent companies into cash, shares of the surviving company or other property.

IFC: Goodoffshore for the Global in practice: Economy ASIA

Position immediately prior to Merger

Bidder vehicle

Public investors (holding ADSs)

Founders and other shareholders

ADS Depositary

100%

Merger Sub

Listco Merger

Figure 1 above shows the position of a company immediately before a merger and immediately after a merger as laid out by Cayman Islands Companies Law.

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IFC economic report â&#x20AC;˘ spring 2014

Position immediately after the Merger

Bidder vehicle

100%

Surviving Company

b) The plan of merger must then be approved by a special resolution of the shareholders of the Listco, voting as one class, which requires a two-thirds majority of the votes cast at a general meeting. c) Once approved by the shareholders, the plan of merger is then filed with

the Cayman Islands Companies Registrar. The merger will become effective once the plan of merger has been registered by Registrar, who will issue a certificate of merger to that effect. The Merger Sub will be struck off and cease to exist. d) In the case of US Listcos, the shares consideration will be paid to the ADS depositary, who will in turn pay such amounts to the ADS holders in consideration for the cancellation of their ADSs. The ordinary shares will be delisted from the relevant US exchange. Once approved and effective, the terms of the merger will be binding on all shareholders of the constituent companies, even those who vote against it. To protect the interests of shareholders who dissent from the merger, the Companies Law provides them with a right to receive the fair value of their shares (which, if not

agreed, will be determined by the Cayman court), provided they give notice of their objection and follow certain procedures. The position of creditors is protected by requirements that the constituent companies are and will be solvent, that the merger must be bona fide and not intended to defraud unsecured creditors, and that the consent of any secured creditors must be obtained. There is no requirement for the merger to be approved by the Cayman court (unlike a scheme of arrangement), and provided the requisite shareholder approvals have been obtained (and other procedures complied with), the merger can be expected to be made effective without objection by the Companies Registry. As a result, the Cayman Islands statutory merger regime provides a modern and simple mechanism for implementing takeovers involving Cayman Islands companies. IFC

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IFC economic report • spring 2014

Challenges for Wealth Structuring in Asia - and a Potential Solution By Paul Christopher, Managing Partner, Mourant Ozannes, Hong Kong Asia: A Driver for Changes in Wealth Structures?

I have recently heard it said that clients in Asia may be driving a new and different client model for the wealth management business due to their very specific requirements. Further, it has been suggested that this is potentially challenging the fundamentals of the wealth planning structures that have historically been used in other parts of the world. The argument goes that the usual rules of the road for wealth structures (eg, trusts) are not acceptable to them. It is an interesting thought. Over the last 15 years there has been a substantial increase in the development of flexible legislation in the leading offshore jurisdictions relating to trust products, For example, the BVI and the Cayman Islands introduced Vista trusts and STAR trusts respectively and further, the trust laws in Guernsey and Jersey have been updated (providing, for example, for settlor reserve power trusts). Laws have also been adopted to reduce the extent of the personal liability of directors of trust companies. Whilst this may, in part, be due to the requirements of clients in Asia, there is perhaps a deeper philosophy at play which, in line with other areas of management, is providing for a more team based solution for clients who may no longer be entirely content to rely on outside parties to advise them. They are to some extent encouraged to take on more of a role in the administration of the wealth structures, this is particularly so with

private trust companies where settlors, beneficiaries, family members, and other advisers may all be on the board of that trust company.

The Unique Asian Market

Against this background and the irrepressible rise in the strength of the Asian economies, what are the issues and concerns of clients in Asia? What are the unique challenges presented in the Asia region and how are these being addressed by practitioners on the ground? The initial point to make in relation to this is that there is no single ‘Asian market’ − what is referred to as the Asian market is really a combination of various different markets. However, for all of the increasing wealth within Asia and the significant wealth in the hands of some families in the region, and notwithstanding the extensive opportunities for families to plan for their future (particularly given their likely global mobility and global investment base), the planning for wealth succession and intragenerational transfer is (as one senior practitioner who has been based in the region for many years described to me) “lamentable”. There are many and varied reasons for this and to some extent this could be a generalisation, but practices in Asia tend to boil down to: issues of culture with regard to a patriarch over his unquestionable authority; a patriarch’s failure or concern to relinquish control; the failure of succeeding generations to be able to address their concerns

properly; discussions around death being extremely sensitive, as well as in large parts of the market there being a lack of infrastructure, experience and general education as to the options that may be available. Each of these issues is not unique to the Asian market and they do not only exist with respect to families in the region, however, they are issues that arise in Asia with a greater frequency and predictability than possibly other parts of the world. There is common thinking that this may change for a variety reasons.

A Solution?

Given these various challenges and in particular issues around control of assets there has been a sharp focus on the use of private trust companies (PTCs) as a solution for some families. A PTC is a company whose sole purpose is to act as trustee for specific trusts or related groups of trusts, typically in respect of a particular family. One of the key benefits of the PTC is the opportunity for the (often) patriarch and his family to create a structure which retains greater control over decisions made in relation to the trust and the family wealth assets than certain ‘traditional’ trust structures. A PTC structure can be developed as a specific solution to suit the needs of the client and their family, taking into account important aspects of their financial, tax and regulatory requirements whilst retaining flexibility of management. Since assets which are transferred into a trust cease to belong to the client and

IFC: Goodoffshore for the Global in practice: Economy ASIA

are held by the trustee on the terms of that relevant trust (or group of trusts), a PTC can give a client confidence that the trust (which may often contain broad powers and discretions) will be administered by reference to those who have a good knowledge of, and are sensitive to, the particular circumstances of the case. Certainly one of the key aspects of wealth planning in Asia is that a family’s assets may still be trading companies and are not necessarily ‘bankable’ assets. The transfer of those trading assets needs to be handled carefully and sensitively to avoid conflict and tensions between the generations and intra-generationally.

Considerations on Jurisdiction

Before embarking on any planning it is important to understand what the options are. In this case we recommend consideration is paid to the following aspects in relation to the jurisdiction of the incorporation and operation of the PTC structure (note the two may not be the same): 1. The political stability of the jurisdiction. An offshore jurisdiction of choice should not be subject to local volatility or an unstable environment. Clients in volatile and unstable environments may well wish to use offshore jurisdictions for that reason. 2. Clients will wish to establish a structure which has certainty. Legal certainty is therefore an important consideration and the quality of a jurisdiction (the legal infrastructure of a jurisdiction) should be measured, ie, the breadth of experience of lawyers, as well as the independence of the judiciary and, ultimately, consideration of the final court of appeal. Clients do not expect litigation but problems may arise from time to time and the client should be confident that there will be a wellconsidered, unbiased outcome, based on the rule of law. 3. Care should be taken to ensure appropriate taxation is only charged in the relevant jurisdictions of the parties to the trust − there should not be any tax leakage in the jurisdiction

in which the trust is created. 4. Clients may want to make use of the modernity and flexibility that many of the leading jurisdictions have incorporated into their legislation. 5. Pricing, this is always an issue. 6. Jurisdiction perception – both locally and internationally. A client will want to operate in a jurisdiction, which allows him to carry out business that he requires without political and administrative hurdles (ie not on blacklists). 7. Experience of service providers. The client should investigate and understand the experience of its proposed service providers. A PTC should be regarded as a legacy and be properly established and advised from its inception so as to give it the best possible start to its life. It should be regarded as a living entity and be impartially reviewed on a regular basis to ensure its aims are being met. 8. Confidentiality. This has been the source of enormous focus in the last few years. BVI, Cayman, Guernsey and Jersey share a common background in English law with its common law providing a broad duty of confidentiality for fiduciaries (trustees themselves as well as directors of PTCs). This is overlaid in certain jurisdictions by statutory and regulatory requirements to maintain confidentiality. This is an area which will continue to develop but clients should seriously consider the appropriateness of establishing structures in jurisdictions which fail to enter into such international dialogue. Those jurisdictions are likely to have restricted (or heavily penalised) access to markets, as well as being perceived as a potential reputational risk. In these circumstances, it may be difficult to deploy capital and receive returns from investments, as well as to generally operate the structure with professional and competent advisers and service providers.

Issues Relating To PTCs

1. The first issue to consider in relation to the PTC is the ownership structure. There are a wide of variety options: a. A family (or settlor) owns the shares

directly in the PTC. However, this is possibly storing up issues for the future as it is likely that those shares will include the power of appointment and removal of the board of directors. Shares personally owned will also pass on death into the estate of the legal owner. This may not be desirable. b. A non-charitable purpose trust holds shares in the PTC. For instance, the laws in Guernsey and Jersey have been specifically drafted to provide for this structuring option. This helps to mitigate the issues identified in a. above. c. In addition to a non-charitable purpose trust, there are a variety of entities that can own a PTC ranging from a foundation to a company limited by guarantee. All of these can be tailored to suit the families’ specific requirements. 2. The composition of the board of the PTC. Tax and applicable regulations will need to be taken into account, though the board can be populated with as many directors as may be considered appropriate. The board will typically include a professional trustee to provide day-to-day administration of the PTC. The board should be able to property function on a practical basis. 3. The participants involved in developing and operating the structure need to understand the requirements and aspirations of the settlor and the family members. This type of understanding is not developed overnight – there must be a long-term commitment provided by everyone if the structure is to operate at its optimum level. Whilst there may be consistent areas of concern from clients in Asia in relation to their wealth planning, the leading offshore jurisdictions continue to develop flexible and innovative rules and legislation to cater for their needs. The typical PTC structure can provide many benefits to families in Asia and address the issues and concerns they may face. However, clients should give careful consideration at the outset to the practical issues and potential pitfalls in tandem with a well experienced and impartial adviser. IFC

IFC economic report • spring 2014

Enforcing BVI Equitable Share Mortgages in Asia – Receivership

By Robert Foote, Senior Counsel and Faye Griffiths, Associate, Walkers, Singapore Five years on from the start of the global financial crisis, there has been an increase in parties seeking legal advice on how security interests can be enforced against debtors or third party security providers in order to safeguard creditors’ financial interests.

Given the predominance of BVI companies within Asian financing structures, it is quite common to find that an equitable share mortgage has been granted over the shares of a BVI Business Company. Where such security has been granted pursuant to a BVI law governed security document, an obvious enforcement option for any secured creditor is likely to be the appointment of a receiver. Such financing structures are used in a variety of cross-border applications in Asia, for example, where an equitable share mortgage is granted by the owners of a BVI company as security for an equipment loan and a working capital loan advanced by a creditor to the BVI company’s trading subsidiary in the

PRC. Alternatively, an equitable share mortgage granted by the owners of a group of BVI companies as security for a loan to a BVI company’s subsidiary in Hong Kong, for the purposes of developing a large commercial property in Hong Kong. Whilst other types of security may be available, depending on the nature of the assets of the debtor company it is often the case that the company will have no assets other than the shares it holds in its subsidiaries. For that reason, the most common form of security given by BVI business companies is the equitable share mortgage. In an enforcement scenario, this type of security provides a quick and efficient route for the creditor to gain control of the shares that are the subject of the security. Equitable mortgages are generally more commonly used than legal mortgages (where the mortgagee becomes the registered holder of the shares for the period of the security.) This is because borrowers are reluctant to give up registered title (with its rights to vote, dividends etc in respect of the shares)

“In typical Asian investment structures where the underlying assets are held in jurisdictions such as Indonesia or China, it can be difficult to enforce local law security over those assets directly.” 48

prior to any default in respect of the loan. Becoming the registered holder of the mortgaged shares can also cause complications for mortgagee banks, which may be obliged to consolidate the company on their balance sheets under applicable accounting principles. In typical Asian investment structures where the underlying assets are held in jurisdictions such as Indonesia or China, it can be difficult to enforce local law security over those assets directly and can result in local court involvement leading to significant time delays and costs for the security holder. For that reason it makes better sense to take security over the shares held by a BVI company because this helps to assist the secured creditor to take control of the shares that are subject to the security interest. Occasionally, we see situations where the BVI company, over whose shares security has been granted, being struck off the register of companies and/or dissolved. Whilst this does not, of itself, create a bar to enforcement, steps may need to be taken by the creditor to restore the company to the register before the security can be enforced. Where a secured creditor holds an equitable share charge it must first perfect title to the shares that are the subject of the security. This typically involves using the suite of documents that are annexed to the share charge to appoint a sole director over the mortgagor who then

offshore practice: ASIA IFC: Good for the in Global Economy

liaises with the mortgagor’s registered agent in the BVI to update the original register of directors. The secured creditor then dates an instrument of transfer in respect of the shares that are subject to the mortgage and the new director passes a written resolution to: (i) approve the transfer of the shares to its nominated shareholder; and (ii) update the mortgagor’s register of members. The registered agent should then update the register of directors and the register of members and deliver copies to the mortgagee or its nominee. If the registered agent’s client of record is uncooperative and refuses to instruct the registered agent to update the register of members (which happens infrequently), it may become necessary to make a short application to the BVI Commercial Court for an order rectifying the register of members. That application would typically be listed between two to four weeks after the Notice of Application and supporting evidence were filed with the Court Registry. It is usual to see the power to appoint a receiver expressly set out in the share mortgage, and, in such circumstances, the powers of the receiver are derived from the terms of that security document as well by statute. Where the ability to appoint a receiver is not provided for in the share mortgage, it is possible to apply for a court order appointing a receiver. However, the BVI court will generally only appoint a receiver where the power to appoint a receiver under the share mortgage is insufficient or where the BVI court is satisfied that the mortgaged

“The primary duty of a receiver is to exercise his powers in good faith, for a proper purpose and in a manner he reasonably believes to be in the best interest of the person in whose interest he was appointed.” shares are in jeopardy. Further, the powers that the BVI court is prepared to grant to a receiver (acting as an officer of the court) are ordinarily restricted to securing and protecting the mortgaged shares. It should be noted that there is statutory requirement for receivers to file a notice of their appointment with the Registrar of Corporate Affairs in the British Virgin Islands. The primary duty of a receiver is to exercise his powers in good faith, for a proper purpose, and in a manner he reasonably believes to be in the best interest of the person in whose interest he was appointed. Further, and to the extent consistent with this primary duty, the receiver must exercise his powers with reasonable regard to the interests of certain third parties (including, but not limited to, any other creditors). The company and every officer of the company owes a statutory duty: (i) to make the books and records and other information relating to the assets of the company available to the receiver; (ii) if required by the receiver, to verify that such information is complete and correct; and (iii) to give the receiver such assistance as he may reasonably require.

Unless the share mortgage expressly provides otherwise, the receiver is deemed to be the agent of the security provider. The receiver is not obliged by statute to exercise any power of sale and realise the mortgaged shares within any defined time period following his appointment. However, if and when the receiver does decide to exercise a power of sale over the mortgaged shares, he must take steps to obtain the best price reasonably obtainable for those shares at the time that he decides to sell. The terms of a receiver’s remuneration, including any indemnity given by the appointing secured creditor, will usually be governed by the share mortgage and the instrument of appointment. Typically such remuneration is paid from the realisation of the secured property, in priority to any distributions to the secured creditor. Any defect in the form of the appointment or relating to the validity of the security document itself, may render the appointment invalid. Where the appointment is invalid, the BVI Court may, if satisfied that the receiver acted honestly and reasonably, order the secured creditor who appointed the receiver to indemnify the receiver against any liability arising from the invalidity of his appointment. IFC

IFC economic report • spring 2014

Segregated Structures – An Offshore Innovation By Alan Dickson, Director and Head of Singapore Office, Conyers Dill & Pearman Despite the many challenges presented by one of the most severe global financial crises in modern history, offshore financial centres remain active, vibrant and innovative.

When the recent financial crisis was unfolding, perennial onshore critics pointed to the tax neutral attributes of offshore centres such as Bermuda, the Cayman Islands and the British Virgin Islands, and focused the attention of international bodies and tax authorities in the world’s giant economies on possible illicit offshore activity. Significant offshore jurisdictions responded constructively to this focused attention. Protocols for interjurisdictional co-operation have now been established, assuring mutual information exchange and investigative processes with major onshore economies and virtually ensuring transparency in the offshore world at a more sophisticated level than exists in many onshore jurisdictions. The truth is, major offshore jurisdictions, including those mentioned above, are sophisticated and innovative financial centres that play an important role in legitimate international financial activity. These jurisdictions are striving to become even more efficient, by constantly updating their practices and legislation to meet the needs of the international financial community and the expectations of the regulators of that community. Recent efforts include the development of modern, flexible investment fund and insurance laws, which keep red tape and regulation offshore to a minimum, ensuring efficiency and ease in structuring offshore

financial products. By way of example, a common concern of fund managers in emerging economies is how to cost-effectively launch a new offshore investment fund. New managers face strong investor pressure to control start-up and operating costs. Most managers of multiple fund products now know about the cost-saving benefits offered by the use of offshore incorporated segregated fund platforms. These segregated portfolio products are efficient options and an excellent example of how offshore innovation and a business as usual attitude prevails offshore, notwithstanding increased focus and attention of enforcement agencies in the onshore world. A segregated portfolio company, or ‘SPC’, is an efficient and cost effective option for structuring an offshore investment fund. SPC structures were commonly used by private legislation as early as the 1990s in Bermuda and are now available via public legislation under the laws of most recognised offshore jurisdictions, including Bermuda, the Cayman Islands and the British Virgin Islands. An SPC structure offers the opportunity to launch new, structurally separate fund products within an existing fund company and is an optimum way to manage cross-liability issues arising in entities issuing multiple asset linked securities. The cost savings arise from avoiding the need to incorporate, license and service a separate new legal entity for each separate fund. SPCs are routinely used now by many fund managers in major jurisdictions including in Asia, the USA and Europe.

In Asia, another interesting use of offshore SPCs has developed, as offshore SPCs have been used to structure investments into China under the Qualified Foreign Institutional Investor (‘QFII’) scheme. The QFII and a similar program, the Renminbi Qualified Foreign Institutional Investor Scheme (‘RQFII’), enable certain foreigners to use offshore foreign currency, or in the case of the RQFII, Renminbi held outside of mainland China, for investment in the Mainland China securities markets. Offshore SPCs have been qualified under the QFII scheme to allow multiple investors to participate in the QFII scheme without holding QFII licences – only the SPC is required to hold the QFII licence. Multiple investors in an SPC holding a QFII licence enjoy the benefits of the licence, without the red tape required to obtain one. The use of offshore SPCs to participate in the QFII scheme was not forseen when the SPC legislation was developed, however, such usage highlights the innovative thinking offshore, which envisaged a potential for any number of uses of an SPC product, and responded by developing the SPC product. There are other potential uses for an offshore SPC product and it is a tool that onshore advisors would do well to research and understand. An SPC is a single company that acts like a host or honeycomb for any number of separate portfolios, with the assets and liabilities of each portfolio being legally segregated and separate in all ways from all the others. An application to register as an SPC is generally made at the same time as an application is made to register

offshore practice: ASIA IFC: Good for the in Global Economy

a new company. The assets and liabilities of each portfolio are as separate from all other portfolios of the hosting company as though they were in a separate company. Each portfolio can issue special securities to investors that can be specifically tailored to meet its individual business goals. Creditor and investor recourse is limited only to the particular assets and liabilities of the portfolio they invest and/ or deal with. Each portfolio is treated as a separate company for the purposes of legal and regulatory tests for dividend declaration and distribution. SPCs offer an ideal solution where there is a substantial risk of such ‘cross-class’ liability. Once duly established, most SPCs can establish any number of segregated portfolios and issue different classes of shares, the proceeds of which will be held within or on behalf of its various segregated portfolios. The assets, liabilities, income and expenditure attributable to a segregated portfolio will be applied in the books of the SPC only to such segregated portfolio, and no other. Where assets are not ascribed to a particular segregated portfolio, they will comprise the ’general assets’ of the SPC. In practice, this means that, for example, a multi-class, umbrella or master-feeder investment fund is able to ‘ring-fence’ against cross liability issues between its segregated portfolio,s without the need to incorporate separate companies or resort to trust or contractual ‘limited recourse’ structures. A good example of where this is particularly significant is when an investment fund wishes to protect certain of its portfolios from the risks associated with any leverage employed by another portfolio within the group. A creditor of an SPC will have recourse only to the assets of the segregated portfolio with which it has contracted and not to the assets of any other segregated portfolio. An SPC may also maintain general assets; available for the benefit ‘pro rata’ of all portfolios, but generally this is not a material part of most SPC structures. This ‘ring-fenced’ liability between portfolios was the subject of review in a significant decision of the Cayman Islands Court of Appeal in ABC Limited (SPC) v J & Co (May 2012). This decision

affirmed the integrity of the segregated portfolio company structure under Cayman Islands law and is expected to be highly persuasive in any similar litigation in other offshore common law jurisdictions such as Bermuda or the British Virgin Islands. SPC companies. which are also open ended investment funds will be regulated by the applicable offshore regulators, (ie, in Cayman – the Cayman Islands Monetary Authority). An SPC is typically required to include in its name a designation such as the letters ‘SPC‘ or the words ‘Segregated Portfolio Company’. Each segregated portfolio must be separately identified or designated in such identification as a segregated portfolio. The set up of an SPC will include all the paperwork associated with the launch of a traditional investment fund, including an offering memorandum where the SPC will be an open ended investment fund, constitutional documents and contracts with service providers. The opportunity to achieve a segregation of assets and liabilities within a single company can otherwise be achieved only by incorporating separate subsidiary companies. Within the investment fund industry this is particularly useful for managers wishing to establish master feeder fund structures, structures providing for multiple classes of shares linked to only certain types or classes of investments, or any structure where the statutory segregation of assets is desired across multiple investment fund strategies. In Bermuda, a segregated account of an SPC may also invest in another segregated account of the same SPC, which is a further useful innovation to be taken into account when planning. Separate books and records must always be carefully maintained for an SPC and each of its segregated portfolios, to ensure the integrity of the segregated structure. Upon liquidation, after application of the assets held for the account of each segregated portfolio to pay the liabilities of that portfolio, the surplus assets of the portfolio will solely benefit holders of shares attributed to that portfolio. The advantage of using an SPC structure involves more than just cost

savings. Subsequent portfolios avoid the initial effort and expense incurred in setting up the host SPC structure. An SPC that is properly structured will offer a fast launch opportunity for a new fund by the same management group, by offering a segregated portfolio of the group’s existing SPC. An established SPC may create additional segregated portfolios and issue related shares, generally as its board of directors determine. When creating a new segregated portfolio, the directors can decide the relevant investment objectives, policies, whether or not to use leverage, and all other incidental terms, conditions and any investment or other restrictions or guidelines relating to each new segregated portfolio. It is important to highlight that each segregated portfolio within a single SPC may have a distinct investment objective, style and characteristics, and may employ different investment techniques and strategies to fulfil the relevant investment objectives. The investment objective, policy and strategy of each segregated portfolio in an open ended investment fund structure will usually be required to be set out in a prospectus supplement relating to the relevant segregated portfolio. Investment fund promoters will generally consider establishing a new investment funds as an SPC from the outset. But existing offshore investment funds may also wish to consider the alternative of converting to be registered as an SPC. Such a conversion may offer attractive cost-saving alternatives for established investment funds with a ‘portfolio structure’, particularly multiclass and umbrella funds. The conversion procedure is generally straight-forward, involving a filing process that is focused on identifying the assets and liabilities to be segregated and notifying/obtaining consent from relevant creditors and shareholders of the segregation process. The opportunity to structure a vehicle as an SPC should not be overlooked when planning a new financial product that will require an offshore component. This type of structure is a true example of how the world’s most significant offshore financial centers are responsibly managing their affairs to offer innovative products of real use in complex international financial transactions. IFC

IFC economic report • spring 2014

sector research

Chinese Incorporation for Institutional Arbitrage and Access to Finance

By Dylan Sutherland*, Hinrich Voss**, and Peter J. Buckley***1

Emerging Markets, Tax Havens and Offshore Financial Centres Comparatively little theoretical or empirical consideration has been given to the most prominent destination of emerging market outward foreign direct investment (OFDI), namely tax havens and offshore financial centres (THOFCs).

Brazil, Russia, India and China, all record very significant outward FDI to such destinations. By 2007, one half of Brazil’s OFDI stock was located in just three havens and by 2009, two thirds of Russia’s FDI stock was found in four. In 2008 and 2009, 40 per cent of Indian OFDI flows went to two havens and the majority of Chinese OFDI is also destined for several specific THOFCs, which accounted for 69–87 per cent of the annual outflow between 2003 and 2011.

1 * Durham University Business School, University of Durham ** Centre for International Business, University of Leeds *** University of International Business and Economics, Beijing

The stock of Chinese investments in these locations now stands at around 80 per cent of the total. In 2006, one tax haven alone, the Cayman Islands, had become the largest recipient of Chinese OFDI, with 44 per cent of officially recognised flows (and 18 per cent of its global OFDI stock). Subsequently Hong Kong became the lead recipient, ahead of the Cayman Islands and British Virgin Islands (BVI). As such, the triad of the Cayman Islands, BVI and Hong Kong are undoubtedly very important to understanding the characteristics, motivations and behaviour of Chinese MNEs. A recent research project, published in the Journal of Economic Geography, attempted to get to the bottom of this very high geographical concentration of outward FDI from emerging markets, and specifically from China. How we account for investment flows through tax havens is an important question to address if we want to better understand emerging market MNEs and their FDI strategies. As noted, the share of national outward FDI stock for these large

emerging markets held in in havens is very high, considerably higher than that of the developed market economies. It is often suggested that tax-induced regulatory arbitrage is the main driver for investments into THOFCs and that such FDI does not constitute a productive activity. The notion that THOFCs are somehow ‘fictitious spaces’ created purely for tax related reasons does not, however, explain the geographic concentration of FDI in specific THOFCs or why the average national OFDI shares to these jurisdictions are higher for many large emerging than for developed economies. An important historic explanation for the use of THOFCs in the Chinese case, of course, has been the preferential tax rates afforded to foreign invested enterprises in China, which has led to ‘round-tripping’, a form of tax-induced regulatory arbitrage that involves moving capital offshore only to bring it back onshore again in the guise of FDI to benefit from preferential tax treatment. A variety of measures, however, have been introduced to restrict the registration of offshore holding

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companies by Chinese firms and discourage round-tripping. Since January 2008, for example, the new Enterprise Income Tax Law has harmonised tax rates for foreign invested enterprises and Chinese businesses. This law provides that enterprises established under the laws of foreign countries or regions but whose ‘de facto management body’ is located in the PRC actually be treated as a resident enterprises for PRC taxation purposes. As such the tax benefits of setting up offshore holding companies appear to have been eliminated. In addition, withholding taxes may now also be levied on dividends paid offshore. If round-tripping for lower taxes was the primary explanation for the use of THOFCs, we might expect to see a reduction in their use. Yet this has not been the case. Why?

Augmenting Capital Through IFCs: The Cayman Islands

Emerging market businesses are often forced to undertake a wide variety of innovative responses in an attempt to mitigate high transactions costs. In emerging markets financial systems are considered to be quite inefficient and their capital markets are imperfect. The capital markets of the People’s Republic of China, for example, are generally considered not to be driven purely by market forces. State owned enterprises, particularly ‘national champion’ business groups, have privileged access to capital through the state banking sector at favourable rates and preferential access to capital markets owing to their embedded nature within the Communist Party system. Private firms, by comparison, generally face acute challenges in securing bank loans because of state control over lending within Chinese banks and control over domestic stock markets. Consequently, private firms tend to be crowded out of the domestic capital market. As access to domestic capital is limited by regulation, discrimination by lenders and by the restricted range of outside funders, private firms must search for alternative ways to augment their capital stock, sometimes outside of China. Accessing international capital markets, particularly through international listings, is an increasingly

“If round-tripping for lower taxes was the primary explanation for the use of THOFCs, we might expect to see a reduction in their use. Yet this has not been the case. Why?” popular alternative for Chinese businesses. The most successful THOFCs, by contrast to the Chinese domestic market, are recognised for their well-developed legal and financial systems. This is particularly so for those havens that also act as OFCs. The drive for offshore incorporation and the accompanying outward FDI flows we see may well be driven not only by domestic capital market imperfections and the needs of EM MNEs to augment their existing capital structure, but also by access to a more favourable institutional environment. Outward investors, after all, seek locations that minimise the cost of their activities so as to achieve optimality in location for the firm. Registering as a company in an IFC/offshore haven could enable Chinese companies to circumvent imperfections in the domestic Chinese capital market. In other words, this may drive what has been referred to as ‘institutional arbitrage’ in the academic literature, in which MNEs use THOFCs to internalise institutional and market differences between countries, with the strategic intent of guaranteeing their long term economic viability. As such, firm-level financing and institutional arbitrage decisions become an important determinant of where MNEs invest. Chinese outward FDI to the Cayman Islands is a case in point. It offers zero rates of tax on income and capital gains and may have certain secrecy regulations, which are advantages that might be exploited through the use of complex transfer pricing mechanisms and intracorporate loan strategies. But it also offers firms an opportunity for Chinese MNEs to minimise their costs of raising capital. The Cayman Islands, after all, is the world’s fifth largest financial centre by asset size and has become an important adjunct to the North American capital markets. The most recent comparisons show it had 464 offshore banks, compared

with nine in the BVI, 30 in Cyprus and 77 in Guernsey. As an OFC it also specialises in business related cross-border financial services, particularly in banking. It held total banking assets of US$1.7 trillion in 2009 and has become jurisdiction to 75 per cent of the world’s hedge funds and nearly half of the estimated US$1 trillion assets under management. Most importantly of all, however, by vertically locating a listing vehicle within the Cayman Islands, IPOs may be undertaken on multiple stock exchanges, including both Hong Kong and US stock exchanges. Historically, no other havens have provided this facility (although we believe the BVI has recently acquired this status). Thus, the Cayman Islands has historically been the jurisdiction of choice for listing vehicles for Chinese MNEs with a view to raising capital. As such, many finance, accounting and legal professionals have argued that the use of a Cayman vehicle is not wholly or mainly for tax planning purposes. This is not, of course, to say zero tax rates are unimportant, rather simply that many other jurisdictions also offer such incentives. So taxation alone does not seem like a good enough explanation for the high concentration of Chinese FDI in this particular haven. In our research on the use of THOFCs by Chinese firms, we found that 72 firms raised estimated gross IPO proceeds of US$11 billion and net proceeds of US$9.8 billion through listings in the USA. The vast majority of them did so by creating listing vehicles in Cayman Islands. This is also the case for Chinese MNEs that list in Hong Kong. Suntech Power is a representative example, illustrating the sequence whereby Chinese businesses develop their offshore corporate structures. Suntech was originally incorporated in Wuxi (Jiangsu province), China as Suntech China. It designs, develops and manufactures a variety of

IFC economic report • spring 2014

photovoltaic cells and modules and is one of the world’s largest producers. Suntech raised net IPO proceeds of US$321.8mn on the New York Stock Exchange (NYSE) in 2005 via the use of an offshore holding company structure involving a company incorporated in the Cayman Islands as the ultimate controlling shareholder. Once in place, these offshore structures allow Chinese companies to raise further capital. In 2009, for example, Suntech closed a follow-on offering on the NYSE with net proceeds of US$277 million and received through corporate bond offerings of US$1.1 billion. Following its IPO, access to short term bank borrowing dramatically improved, its net proceeds from short-term bank borrowing increased from US$15.3 million in 2005 to US$305.8 million by 2008. Suntech was able to realise net proceeds of US$294.1 million in longer term bank loans by 2009. Both Chinese and international banks lent to Suntech. The capital raised allowed Suntech to expand its production capacity, exploit its China based lowcost manufacturing model and to allow it to undertake a series of international acquisitions and investments.

Exploiting Institutional Differences: The role of the BVI

THOFCs also may provide institutional support for the restructuring of operations back in China. The market for property rights of Chinese businesses was late in its development and the domestic transactions costs are reportedly high. OFDI to THOFCs allows Chinese firms to reduce costs arising from various types of institutional misalignments. Chinese firms, moreover, avail of administrative and professional institutions and advanced business services, and engage in a form of arbitrage whereby they exploit the comparatively superior institutions of foreign markets. It was also notable in our sample of Chinese MNEs (see methodology box) that many important transactions involving the buying and selling of mainland Chinese businesses took place via the use of investment holding companies held in these offshore jurisdictions, particularly the BVI. We found that 22 firms have acquired fully or

partially one or more other China-based companies that were themselves held through offshore holding companies, supporting the idea that havens offer a supportive institutional environment for organisational restructuring. Chinese firms may, of course, also benefit from foreign banking and financial expertise, which can add value to the Chinese capital, as well as more sophisticated and stable legal institutions. This allows businesses to undertake significant restructuring of their mainland operations via THOFCs and reduce their exposure to, and negotiation with, Chinese institutions in this process. As with the high transactions costs incurred in domestic capital markets, transactions costs in the domestic market for property rights may force businesses to seek less costly and effective alternatives. More specifically, when transactions costs are high, firms investing in the havens follow strategies to reduce exposure to domestic institutional conditions. Xinhua Sports & Entertainment Limited (XSEL) is a sports and media entertainment group that conducts all of its operations in mainland China. It has grown significantly since its inception, primarily through the acquisition of assets and businesses and development of its distribution channels. After XSEL secured access to international capital markets it has undertaken numerous acquisitions. The proceeds from the IPO were used to fully acquire at least seven privately held offshore holding companies that own (or control) other onshore Chinese media businesses. These companies in turn effectively control at least 29 mainland Chinese subsidiaries and a further eight offshore holding companies. Through its 2007 acquisition of East Alliance Limited, a BVI holding company, XSEL controls all of East Alliance’s wholly owned subsidiaries and variable interest entities collectively known as the M-Group, a mainland China-based mobile service provider.

Completing the Triad: What about Hong Kong?

As mentioned, as well as the Cayman Islands and BVI, Hong Kong is also another large recipient of Chinese FDI.

Unsurprisingly, we also found that the incorporation of offshore Chinese investment holding companies in Hong Kong was common. Indeed, our investigation of a sample of Chinese MNEs found that it has been very popular for them to simultaneously incorporate offshore vehicles within the triad of Hong Kong, the BVI and Cayman Islands. There is, of course, a common shared past – related to the former British empire – linking these THOFCs. But what can explain the recent hike in FDI to Hong Kong from China? Since 2006 new regulations imposed by the Chinese State Administration of Foreign Exchange, as well as the new enterprise income tax law of 2008, appear to have created incentives to hold Chinese mainland businesses via a Hong Kong incorporated investment holding company. A common discussion we found in the financial statements of the Chinese MNEs filed with US SEC was the pending review of the tax status regarding the introduction of withholding taxes paid on dividends from mainland Chinese firms to offshore holding companies. Many of the sample firms clearly stated that all necessary measures would be taken to mitigate the adverse impacts of any possible rescinding of preferential taxation rates currently applied, and cite the use of Hong Kong holding companies as a possible solution. In effect, some disincentives to incorporate offshore (and round-trip) appear to have been put in place, with the use of Hong Kong investment holding companies considered as one possible solution. In this light, it is of interest to note that many of our sample firms still looked to use offshore vehicles, even despite the introduction of taxes levied on dividends to offshore companies. Again, this would suggest that lower tax rates alone are unlikely to be the sole explanation for the extensive use of the specific THOFCs we identified, found in the triad of the Cayman Islands, BVI and Hong Kong.

Conclusion

We believe the very high levels of outward investment from China to the triad can in part be explained by Chinese

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MNEs wishing to exploit offshore capital markets and superior institutional environments. Chinese MNEs invest in specific THOFCs because it is these jurisdictions alone that allow them to access capital markets and institutions unavailable to them domestically. Particular THOFCs, moreover, have different specialisations and are networked together in ways that provide unique and inimitable services. So even despite the increased regulation and higher costs associated with offshore incorporation, Chinese MNEs continue to undertake FDI to these THOFCs. And, of course, while many countries aspire to become tax havens, it is actually only those with the best governance and institutions that actually succeed. Low taxes, therefore, appear to be only one, albeit important, attraction of THOFCs. In light of the above arguments it is also important to keep in mind the idea that finance is also a vital component of economic activity that cannot be considered in isolation from production.

The capital raised offshore by our sample of Chinese MNEs has facilitated both further domestic and international expansion, illustrating its direct links

to production and the need to further incorporate the role of the offshore world, particularly in explaining emerging market MNE behaviour. IFC

METHODOLOGY

Comparatively little academic research has been undertaken at the micro (firm)-level on the use of THOFCs. This is in part owing to the inherent secrecy of havens. This veil of secrecy makes it difficult to determine which firms have interests in THOFCs and what activities they engage in once offshore. One of the few windows through which to observe such behaviour is the publicly available data of firms that have raised capital on foreign stock markets. All businesses listed on stock markets in the USA, for example, must submit various formal documents to the US Securities Exchange Commission (SEC) (US SEC EDGAR database), including annual financial statements and reports. It is a requirement of the SEC that foreign private issuers complete a 20-F form annually. These submissions, owing to legal obligations, are generally candid in nature and provide detailed information on company accounts; capital raising activities and use of proceeds from such activities; information on the organisational structure; subsidiary information including the country in which any listing vehicle is incorporated and the use of offshore vehicles for such purposes.

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Mauritius: The African1 Success Story

By Nikhil Treebhoohun, CEO, Global Finance, Mauritius “Suppose someone were to describe a small country that provided free education through university for all of its citizens, transportation for school children, and free health care – including heart surgery – for all. You might suspect that such a country is either phenomenally rich or on the fast track to fiscal crisis.But Mauritius, a small island nation off the east coast of Africa, is neither particularly rich nor on its way to budgetary ruin. Nonetheless, it has spent the last decades successfully building a diverse economy, a democratic political system, and a strong social safety net. Many countries, not least the US, could learn from its experience.” Joseph E Stiglitz, The Mauritius Miracle, March 2011 The title of this article is borrowed from a paper by Jeffrey A Frankel (2010) from the National Bureau of Economic Research, published in the context of a project on African Successes.

It is more appropriate than the term ‘Mauritius Miracle’, which has been used by various academics and international institutions to describe the economic trajectory of this small island (2,400 square kilometers) of 1.3 million inhabitants off the east coast of Africa – miracle implies that some sort of deus ex machina has been at work whereas economic success is the result of strategic thinking and planning, elaboration of effective policies, human and institutional capacity building to implement the policies, a governance structure that inspires all segments of the population to strive together towards a shared objective. Prior to its independence in 1968 after almost 150 years of British rule (and a little less than 100 years of French rule before 1810) a future full of gloom and doom was predicted for Mauritius by James Meade (Nobel prize winner) as it had all the characteristics of a typical African (colonial) economy: monocrop,

1 Mauritius became the 40th member of the Organisation of African Unity in August 1968

rapid population growth, adverse terms of trade, and susceptible to ethnic tensions. However, in Stiglitz’s words: “As if to prove Meade wrong, the Mauritians have increased per capita income from less than US$400 around the time of independence to more than US$6,700 today. The country has progressed from the sugar-based monoculture of 50 years ago to a diversified economy that includes tourism, finance, textiles, and, if current plans bear fruit, advanced technology.Mauritius’s GDP has grown faster than five per cent annually for almost 30 years. Surely, this must be some trick. Mauritius must be rich in diamonds, oil, or some other valuable commodity. But Mauritius has no exploitable natural resources.” How did this happen?

Permanent Reinvention

Since Mauritius had no natural endowments (except for its natural beauty) its human capital was recognised very early on as its main asset. Human capital formation has always been considered as a priority to ensure the sustained growth of the economy. Thus, free education was made available up to pre-university level in 1976 and later extended to those admitted at the University of Mauritius. Furthermore, as the founding fathers of Mauritius

were inspired by Fabian socialism, free healthcare as well as old age pension is provided to all. It was clear from the outset that it would not be possible to sustain a welfare state with the proceeds from sugar alone. While there was a guaranteed market at a negotiated price under the Sugar Protocol, the economy was too exposed to the vagaries of the weather. Manufacturing was encouraged, initially through an import substitution strategy aimed at building local expertise; as the local market was limited Mauritius had to turn to export oriented industrialisation: the Exports Processing Zones Act was passed in 1970 and provided incentives to attract investment (both local and foreign) in terms of tax holidays, industrial estates, free repatriation of profits. Access to European markets was not an issue since Mauritius was a signatory of the Lome Convention. Manufactured exports grew slowly but steadily initially and really took off after a structural adjustment programme (1979-84) was undertaken, which included the devaluation of the currency twice before it was put on a floating regime, and a simplification of the fiscal regime, which saw the top marginalcorporate and personal rates brought down from 70 to 35 per cent while the EPZ sector was eventually taxed at 15 per cent. The fiscal reform of

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2006 ended the discrimination between EPZ and non-EPZ and the same rate of 15 per cent applies to all. Thus, within two decades the manufacturing sector overtook sugar as the main foreign exchange earner, employer and contributor to GDP. The relatively rapid economic growth resulted in near full employment by 1990 leading to an increase in costs of production. At the same time the Multi-Fibre Agreement (MFA) was to be replaced by the General Agreement on Tariffs and Trade (GATT) which would see the erosion of protectionist measures which had benefited Mauritius. The only sector which had to compete internationally was tourism, the third pillar of the economy in the late 1980s. The need to reinvent itself was again felt acutely. A two-pronged strategy was elaborated: First, consolidation of existing sectors through technological enhancement to improve productivity and quality enabling a movement up the value chain; and second, diversification of the economy. The rapid developments in Information and Communications Technology (ICT) pointed the direction for Mauritius, which is geographically far from its major markets but is in a time zone (+4 GMT) which straddles the West and the East. It must be pointed out that in the early 1980s, before garment exports took off, different sectors were being touted: printing, light engineering, offshore banking, and jewelry. Only the financial services sector took off in a big way by a quirk of history. Indeed, a Double Taxation Avoidance Agreement with India had been signed in 1983, essentially to protect Indian investment in Mauritius. But it was only as from 1992 (when India was in dire need of foreign capital and was opening up its economy) that this treaty was to be the catalyst for the emergence of the international financial centre, the first such centre in Africa. Mauritius had the essential ingredients in place to become the preferred route for inward investment to India: rule of law where the Privy Council is the ultimate court of appeal, democratic system, business friendly environment, trading and cultural links with India.Unsurprisingly, some 42 per

Table 1: Mauritius, Selected Economic Indicators (2012) Sector

%GDP

GDP (Rs. Bn)

Employment (No)

Financial Intermediation

10.3

31.2

12,005

Hotels & Restaurants

7.0

21.2

40,300

Agriculture

3.5

10.5

47,400

Manufacturing

16.7

50.5

73,354

ICT

6.4

13.4

18,800

(US$1= Rs 30 approx.)

cent of FDI into India came through Mauritius in that period. The snapshot of the economy in 2012 below gives an idea of the extent to which diversification policies have been successful in the last 40 years: Whilst the financial services industry has registered the highest growth rate in the last decade (around five per cent on average) it is now nearing the end of its first cycle of growth (its infant industry phase), where the ease of doing business attracted mainly investment holdings and some funds and regional headquarters. Private wealth management (trusts, foundations, private banking), fund domiciliation (private equity funds, limited partnerships, protected cell companies, collective investment schemes), trading and Freeport, PanAfrican revenue recognition (ITrelated business, intellectual property) and regional headquarters (shared services –IT,BPO, Finance, Treasury, HR, Compliance, procurement, expat services) are some of the elements of the value proposition for business from Mauritius as it moves ahead. But it will have to overcome some important challenges: 1. Reputational risk arising mainly from erroneous perception of the jurisdiction as a tax haven. 2. Policy issues in terms of creating the proper environment for a healthy growth of the industry. 3. Need for diversification of products and markets to ensure continued growth.

4. Need to build the right skill set to support the industry. Already new areas of growth are being envisaged. The most ambitious of these and which will redefine the economic architecture of Mauritius in the next 50 years (if successful) was announced in the Budget Speech of November 2013: namely the development of a ’Blue economy’, which refers to the exploitation of the 2.3 million square kilometres of maritime zone of Mauritius. The following clusters have been identified: • Petroleum & Mineral Exploration; • Seafood and Aquaculture; • Deep Ocean Water Applications (DOWA); • Marine Renewable Energies; and • Ocean Knowledge.

Linking up with the African Continent

In the meantime, as Mauritius begins to feel the effects of the financial crisis that has gripped the global economy since 2008, it has to review its marketing strategy, which has been too Eurocentric so far even though the natural outlets for Mauritian products and services are in continental Africa. The sluggish growth in the region did not provide the right setting for this to happen. However, Tables 2 and 3 show the trade pattern with the two regional groupings (SADC and COMESA) has been improving in spite of Mauritius still being a net importer overall. Nonetheless, there has been a long standing collaboration with specific

IFC economic report • spring 2014

Table 2: Mauritius Trade with SADC states (Rs 000) 2010

2011

2012

Imports: value (c.i.f)

Exports: value (f.o.b)

Imports: value (c.i.f)

Exports: value (f.o.b)

Imports: value (c.i.f)

Exports: value (f.o.b

13,517,218

8,217,470

13,354,166

10,114,161

13,561,478

12,734,619

Table 3: Mauritius Trade with COMESA states (Rs 000) 2010

2011

2012

Imports: value (c.i.f)

Exports: value (f.o.b)

Imports: value (c.i.f)

Exports: value (f.o.b)

Imports: value (c.i.f)

Exports: value (f.o.b

3,965,812

4,966,638

4,565,391

5,579,283

4,687,118

6,491,865

countries as from the early 1980s when Mauritians were recruited as teachers in Zimbabwe and Botswana; Ivory Coast and Tanzania were provided assistance to develop their sugar sector; the EPZ (especially the garment industry) in Madagascar benefited initially from Mauritian investment and knowhow; in Mozambique there has been Mauritian investment in sugar, textile, tourism, poultry; several accounting and auditing firms have supplied their services in several francophone as well as Anglophone African states. However, given the chequered economic performance of most of these states in the past Africa did not live up to expectations of it being the natural hinterland of Mauritius! Now that Africa is rising, Mauritius is well placed to finally benefit from regional growth. The November 2013 Budget mentioned some key measures aimed at ensuring that Mauritius participates fully in the predicted growth of the region. A Mauritius-Africa Fund has been set up to “participate in the equity financing of businesses investing in viable projects in any African country”

and to also “offer fee paying consultancy services on the continent to Government and Public Sector entities in fields where [..Mauritius...] has a competitive advantage”. Secondly, it was announced “that Government will provide a subsidy of 25 per cent of the freight cost on containers to selected countries”. Thirdly, 50 scholarships are being offered annually to students from mainland Africa to assist in capacity building and to foster peer-to-peer learning. Another area where Mauritius is already playing a crucial role is in the mobilisation of financial resources for infrastructure development in several states on the continent. Many international banks, donor agencies, funds and foundations engaged in charitable work in Africa are based here. It is also slowly developing into a regional treasury centre. Companies are establishing their headquarters in Mauritius from where they are providing services; some examples sourced from Global Finance Mauritius(www. globalfinance.mu) of firms which are using Mauritius as a base to partner development in continental Africa are:

“The country has progressed from the sugarbased monoculture of 50 years ago to a diversified economy that includes tourism, finance, textiles, and, if current plans bear fruit, advanced technology. Mauritius’s GDP has grown faster than five per cent annually for almost 30 years.” 58

(1) AFGRI which is focused on the revival of the continent’s agricultural sector and aims to enhance food security – among its various projects mention must be made of AFGRI Mauritius Financing that will provide finance to support equipment rental to farmers in countries where AFGRI does not have direct lending capability. (2) ArystaLifeScience, which focuses on the development, marketing and distribution of innovative, high-quality chemical solutions uses Mauritius as a “hub for all public health businesses in Africa”. To fulfil its mission it has posted the CEO of the Africa Western Europe Business Unit, the Group Purchasing Manager, and the Head of Sugar Technology, in Mauritius. (3) TransCentury Ltd (TCL), a Kenyan infrastructure company, uses Mauritius as a platform for its investments across Africa and Dr Kiuna, the CEO, explains: “Mauritius provides TCL a window to the international capital markets, enabling the company to gain access to vital capital injections”. The danger facing Mauritius today is that it gets sucked into the middle income trap if it is not able to reinvent itself and to find new engines of growth. At different points in time it has been lucky as external conditions moved in its favour. As the traditional drivers of growth begin to stutter, the ray of hope comes from the predicted economic leaps in its natural hinterland –the rising African continent. It can only be a mutually reinforcing partnership. IFC

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The Seychelles Vision

By Rupert Simeon, CEO, Seychelles Investment Board, Seychelles The Seychelles international financial centre is making great strides towards meeting international compliance and transparency standards and has negotiated and signed nine Tax Information Exchange Agreement and 28 Double Taxation Agreement, the most recent one being with Guernsey. The Seychelles Government has at the forefront of its economic development a vision of making Seychelles the premiere financial centre for Africa and the Middle-East. It intends to add to the 28 DTAAs and nine TIEAs, which have already been signed and will soon move towards becoming part of the Multilateral Convention on Mutual Administrative Assistance in tax matters. In 2013 Seychelles was ranked the highest East-African country in the 2013 Ibrahim Index of African Governance and in the categories of Human Development, Infrastructure, Education and Health. The political and social stability, modern legislative framework, advantageous time zone and wealth of experience in tax planning and management makes Seychelles the ideal gateway for investment from the rest of the world into Africa and Asia. The jurisdiction so far has incorporated over 100,000 IBCs and registered over 500 International Trusts. Seychelles as a reputable well-

regulated jurisdiction offers “compliant confidentiality” - that is: confidentiality which does not contravene international tax rules and best practice regarding transparency and the prevention of financial crime. This means that provided the trust has not been established to evade tax, or conceal the source of funds, or for any other unscrupulous reason, then the beneficiaries’ identities and details regarding the assets placed into trust remains a private matter. Seychelles has in the past been heavily reliant on its fishing and tourism sector but now the government has realised the discernible need to position Seychelles as a service based economy and has invested in education in the financial services and banking sectors. Today, the country boast over 70 licensed corporate service providers, trustee service providers and foundation service providers operating in Seychelles. As a result, Seychelles has a number of attractive products and services to offer such as the CSL (Company Special License), which is subject to only 1.5 per cent tax of its worldwide (gross) income and is incorporated as a domestic company under the Companies Act 1972 but is awarded a special license, which grants the company a special status as it benefits from access to the Seychelles’ growing network of Double Taxation Avoidance Agreements (DTAAs) and can also operate part of its business within Seychelles.

“The Seychelles Government has at the forefront of its economic development a vision of making Seychelles the premiere financial centre for Africa and the Middle-East.”

Meanwhile, the Seychelles Mutual Fund & Hedge Fund Act, 2008 allows for full exemption from Seychelles business tax on the income of licensed funds and exempt foreign funds are additionally exempted from withholding tax and stamp duties. Foreign funds, which are licensed in a recognised jurisdiction and listed on a stock exchange, are exempt from requiring a Seychelles license. These ‘Exempt Foreign Funds’ can be of particular interest to fund managers looking for the best location from which to operate their fund. Seychelles is also advancing in other areas of the financial sector and saw the launch of Trop-X, its first Securities Exchange in December 2012. Trop-X is part of the Quote Africa Group, which is underway with the establishment of a Pan-African Exchange Network. It provides an ideal platform for investment banks, fund managers, venture capital/private equity firms, private client brokers and asset managers focused on African securities. The Seychelles Investment Board in partnership with SAOPRA (Seychelles Association of Offshore Practitioners & Registered Agent) are moving forward in a very cohesive and bold manner to explore new frontiers of financial services and at the same time raising standards of practice to continue serving clients in a professional and efficient manner to maintain the excellent reputation of the jurisdiction. The Government of Seychelles is presently looking into the prospect of introducing legislation that will allow for the operation of Islamic banking and finance. Overall, Seychelles is well placed to become a key Indian Ocean hub. IFC

IFC eConomIC report • sprIng 2014

The BVI IBC Act and the Building of a Nation

By Colin Riegels, Global Head of Banking and Finance, Harneys The response to the UK government’s proposals as set out in a discussion paper entitled Transparency & Trust is expected in early 2014. Although nobody knew it at the time, the inception of the British Virgin Islands’ International Business Company Act occurred at some point during the year 1976. Nobody now recalls the exact date, except that it was during the summer.

Amongst the offices on Road Town, Tortola was the law firm of Harney Westwood & Riegels, the only law practice in the Territory at the time. Within their offices on Russell Hill there were just two lawyers: Neville Westwood, a veteran of the Second World War who had settled in the Caribbean with his wife and daughter in search of a more peaceful life, and Michael Riegels, who had recently come to the BVI with his family from Tanzania after a period of civil unrest. Harold Harney had by this time passed away. On this otherwise unremarkable day, the rotary telephone rang and on the other end of the line was a Wall Street lawyer by the name of Paul Butler from renowned New York law firm Shearman & Sterling. Like so many Wall Street lawyers Mr Butler was a highly capable and astute businessman. He also had characteristic American friendliness and charm in abundance. Mr Butler asked politely if he could speak to either Mr Westwood or Mr Riegels, and in the end he was connected with Michael Riegels. There would have been few pleasantries and Mr Butler got down to explaining the purpose of his call. He was an American corporate lawyer, and there were double taxation treaties between the USA and various ‘micro-states’ in the Caribbean which offered the potential for generous US tax relief. He had been dealing with lawyers in the Netherlands Antilles, but had been having trouble with the language barrier, and he was interested in trying to use the BVI going forward. Mr Riegels said they would be very happy to assist and he would start looking into it right away. The transaction went well. Undoubtedly issues would have arisen, but nothing which proved insurmountable. The transaction was then followed by another, and then

another, until there was a steady stream of US tax related work going through the offices of Harneys. Mr Butler would later remark that he had been rather lucky selecting the BVI and Harneys. Although he had anticipated having to closely supervise inexperienced local lawyers, he had accidentally stumbled across two very able men. Neville Westwood was a Cambridge graduate who, after spending time at the English bar, had worked extensively in industry. Michael Riegels was an Oxford man who had come fifth in the entire country when he sat for the English bar. The relationship between the three men became very warm. Shortly thereafter the two Harneys partners hired a third man to join them: Richard Peters, a brilliant young tax barrister from London and a former Cambridge organ scholar. The future seemed spectacularly bright at this stage. But even 35 years before Edward Snowden catapulted into news headlines the all-seeing eye of the American Government fell upon the BVI soon enough. The success of the double tax treaty was causing concern in Washington, and the American authorities summoned a delegation from the BVI to discuss the treaty. The delegation was led by McWelling Todman QC – ‘Mac’ to his friends - a native Tortolan lawyer of exceptional ability. The delegation was not especially successful. Mac Todman would later joke grimly that their meetings had been not so much a case of “negotiation” as “plea-gotiation”. In any event, the Americans unceremoniously cancelled the double taxation treaty in 1982. The situation looked potentially grim. Up until the mid1970s the BVI had been something of an economic backwater. There was little infrastructure or industry, but the increasing economic traction that the incorporation work had brought had injected a certain degree of prosperity into the islands. People were anxious that the momentum should continue. The Attorney General of the day was a man named Lewis Hunte. A man of infectious charm and good humour, Mr Hunte was a native of Barbados who had come to the BVI and proved himself a skilled draftsman during the much needed modernisation process which was underway in relation to the BVI’s legislation. Mr Butler suggested that the best way to respond to the cancellation of the double tax treaty was to

THE LAST WORD: THE BVI IB C

try and offer a new corporate product in the market. Instead of promoting a structure which would create tax leakage in powerful states such as the USA, the BVI should seek to create a tax-neutral company using up to date legislation, which would provide a user friendly flexible modern corporate vehicle for multiple commercial purposes in any country in the world. The idea enjoyed the encouragement and support of Kenneth Bain, the Financial Secretary of the BVI at that time. In the end a committee of five people: Paul Butler, Lewis Hunte, Richard Peters, Michael Riegels and Neville Westwood were tasked with developing the legislation to create this new type of corporate vehicle. Paul Butler in New York and Richard Peters, Michael Riegels and Neville Westwood in the British Virgin Islands worked on producing a first draft of the proposed new legislation. This draft was then gone over section by section in minute detail with Lewis Hunte in the Attorney General’s Chambers on a daily basis to work the draft into a suitable legislative format for the BVI. Although later they would sometimes be referred to as the ‘gang of five’ who were responsible for the drafting of the IBC Act, in truth the majority of the work was done by Richard Peters, the youngest member of the group. At the suggestion of Mr Butler, the legislation was based upon Delaware corporation law, which was thought to be the most modern in the world at the time, but incorporating additions from innovative company legislation in other jurisdictions as well. At points this led to some grating jurisprudence – using American legal terminology within an English common law system – but after 18 months the task was completed and on 15 August 1984 the Legislative Council of the British Virgin Islands passed the new Act into law. Looking back at the International Business Companies Act now, it is easy to overlook how radical it was at the time. It streamlined the incorporation procedure and removed the requirement of corporate capacity. It abolished the need for corporate benefit, recognised that companies could exist without members, and permitted companies to provide financial assistance for the acquisition of their own shares. It provided for true statutory mergers, and created new statutory tools for restructuring and reorganisation. Most of these innovations would not appear in English company law until the Companies Act 1986, and some did not appear until the Companies Act 2006. It is not mere hyperbole to say that

the IBC Act was ahead of its time. However, the Government and private sector of the British Virgin Islands were not really concerned with how radical the new statute was. What they were really concerned about was whether accountants and lawyers in other jurisdictions would use these new International Business Companies, or IBCs. So they waited. At first it was slow. Very slow. Very few new companies were incorporated under the Act. People were tempted to write the whole endeavour off as a failure. However, suddenly, from about 1989 to about 1997 the incorporation numbers exploded, growing exponentially at the almost unmanageable rate of nearly 50 per cent growth yearon-year. The infrastructure at the Companies Registry struggled to keep pace with the sheer volume of incorporations. Lawyers, accountants and trust companies poured into the sleepy capital of Road Town like miners in the California gold rush. New offices had to be built. House prices surged. Infrastructure was upgraded. For better or worse the BVI experienced rapid economic growth on a scale it had not contemplated at the outset. In 1999, after a study on behalf of the British Government, the accountancy firm KPMG estimated that the BVI had amassed a 41 per cent global market share for offshore vehicles. By 2004 the BVI would have the 12th highest GDP per head of population in the entire world. There are several theories explaining the BVI’s swelling popularity but one person who played an undeniable role in kick-starting the IBC is an Australian accountant by the name of Frank Mullens. Living in Hong Kong Mr Mullens recognised the talismanic power of the number eight in Chinese culture. Being in the business of selling offshore companies, Mr Mullens thought that there would be a huge demand in Hong Kong for companies which had the unfathomably lucky providence of being incorporated on 8 August 1988, or 8/8/88 if you prefer. And so he set about trying to organise the incorporation of a large number of IBCs on that day. However there was a serious problem. In the BVI, the first Monday, Tuesday and Wednesday of August are public holidays, celebrating the end of slavery in 1834. All Government offices would be closed on the fateful day, including the Companies Registry. A lesser man may have given up, but not Mr Mullens. He enlisted

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the services of a highly capable local lawyer named Richard Parsons and between them they begged, bullied or cajoled (history does not record which) the Registrar of Companies to open the Registry for a limited period that day to incorporate the companies. Those lucky companies proved to be just as popular as Mr Mullens had predicted, and the rest, some might say, is history. In truth, no one can be certain what caused the rise in popularity of the IBC, or even if there was one single cause of the popularity. It may simply have been a combination of a good product, with good timing, and a decent slice of luck. The IBC Act itself was rarely amended during its lifetime. Most of the effort focused on managing the infrastructure of the Companies Registry to cope with the growth. But there was at least one amendment which was to have notable beneficial reception. In 1991 changes were introduced to create a simple but comprehensive system for registration of security interests created by IBCs. This proved extremely popular with lenders in terms of providing debt financing to BVI companies. The leading international finance lawyer Philip Wood QC once remarked that he thought the BVI security registration system was the “best in the world”, and this was the start which later helped to cement the BVI as a market leader in the structured finance market. Eventually, in the early 2000s the industry in the BVI effectively plateaued. Incorporation numbers were high, but stable. Cynics like to suggest that the end of the period of growth coincided exactly with the creation of a new regulator for the industry, the Financial Services Commission. However it is more likely that this was just a coincidence. Like any industry, there is a stage where further growth is not really possible, and the objective is then to consolidate the gains. The new regulator focused on trying to create a regulatory environment which would foster growth in higher value products such as investment funds and captive insurance. By this time the IBC Act had been driving the BVI’s economy for the better part of two decades. Almost like a quasi-religious text, the statute had rarely been amended. But all around it the world of commerce had moved on. The world where Michael Riegels had a conversation with Paul Butler over newly laid undersea cables had metamorphosed unrecognisably into a world of high speed satellite communications and electronic commerce. The time when lawyers might send carefully typewritten documents to each other by post for review and comment over the course of several weeks had been replaced by electronic versions rebounding back and forth between Blackberries several times a day. At times the IBC Act appeared increasingly out of pace with this new world, almost as if it was trying to send a telex to an e-mail address. Industry practitioners began to realise that it was time to replace the model. There was also external pressure on the BVI to change its model company legislation. The IBC Act had been predicated on ‘ring fencing’. Broadly speaking, so long as the company did not conduct any business in the BVI, then it was treated as tax exempt for BVI purposes. This was seen as creating ‘unfair tax competition’ by the OECD and other international bodies.

“Looking back at the International Business Companies Act now, it is easy to overlook how radical it was at the time…Most of these innovations would not appear in English company law until the Companies Act 1986, and some did not appear until the Companies Act 2006. It is not mere hyperbole to say that the IBC Act was ahead of its time.” The process of replacing the IBC Act with a modern statute began. After two years of work, this would eventually come to fruition in the form of a ponderously named new statute, the BVI Business Companies Act, which was passed into law on Christmas Eve 2004. Because of the vast numbers of companies incorporated under the IBC Act, it was necessary to impose a transitional period to allow the migration of the existing companies from one corporate regime to another. Although no new companies could be formed under the older statute from 1 January 2006, the IBC Act itself was not actually repealed until 31 December 2006. However before it was repealed, Richard Parsons – the same man who was involved in the 8/8/88 incorporations - made an unusual request of the Companies Registry. He asked if he could submit a request for the incorporation of an IBC on behalf of a client, a leading Hong Kong trust company. But his special request was that the Registry staff might please wait until the very end of the day before processing the incorporation. The name of that company was, fittingly, ‘The Last IBC Limited’. Looking back on the transformative changes brought about in the BVI by a single piece of legislation gives rise to mixed feelings. In many ways it all seems so recent, although much of the history occurred nearly 40 years ago. In other ways it all seems so impossibly far away. The tall steel and glass offices in modern Road Town seem a million miles away from the old offices with ceiling fans and telexes chattering in the background. A generation of lawyers is now growing up in the BVI who have never seen an incorporation under the IBC Act. Although the BVI is still a small place and Tortola still has a small island feel, the prosperity brought about by the Act is evident everywhere. Mac Todman and Neville Westwood have sadly passed on, but other key players from the early days of the IBC Act are still with us, although most of them are enjoying well-earned retirements. You have to wonder when those five men sat down in the Attorney General’s chambers and one of them picked up a pen, whether they really had any idea at all that what they were about to do would transform the economic status of a nation. IFC

About the Author:

Colin Riegels is a partner at Harneys, global head of its banking and finance practice and son of Michael Riegels QC.

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