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Written evidence from the International Centres Forum (OTS0094)

The International Financial Centres Forum (‘IFC Forum’) is a not-for-profit membership organisation composed of legal and professional service firms based in Bermuda, the British Virgin Islands (‘BVI’), the Cayman Islands, and Gibraltar, as well as Guernsey, the Isle of Man, and Jersey.[1]  IFC Forum advocates responsible cross-border financial intermediation in support of trade and investment as a means of promoting economic growth and enhancing development prospects.

IFC Forum welcomes the opportunity to respond to the Foreign Affairs Committee’s inquiry into the future of the Overseas Territories.  Four OTs – Bermuda, BVI, Cayman Islands, and Gibraltar – host headquarters of IFC Forum member firms, and throughout this submission, we use the term ‘OTs’ to refer to those four, not to the other Overseas Territories.

We offer our views as a body whose members represent the industry across all four OTs, and offer views exclusively in a private-sector capacity.  We understand that some information may also be subject of comment by some of the OTs, and to the extent that the content or the presentation differs, we defer to each government on their respective jurisdictions as definitive.

1.                   Background

1.1.             International financial services are the largest components of each OT’s economy.  These services are primarily provided to institutional investors, not retail investors, enabling them to specialise in particular niche areas and attract a globally-diverse clientele that cannot be matched elsewhere.

1.2.             The Overseas Territories (OTs) have near-full autonomy, granted by Parliament under successive constitutions.  Despite the explicit devolution of powers, the UK is responsible for their international relations, and so the UK is committed to legislating for the OTs only to prevent the OTs failing to abide by international obligations.

1.3.             The UK’s 2012 White Paper on the Overseas Territories states that the UK would “strongly support those Territories that meet international standards” and “will work in the international arena to ensure that there is no discrimination against well-regulated offshore financial centres and that the same international standards are applicable to all jurisdictions.”[2]

2.                   Role of financial services in the OTs’ economies

2.1.             In each of the four OTs, financial services and international business compose between a fifth and half of the GDP of the territory and employ between 8% and 18% of the population directly.  Below are the proportions of GDP and employment in each of the OTs.

2.2.             Financial services are the largest component of the economies of all four OTs.  The below chart puts the financial and international business sectors into context compared to tourism – the other major export industry in the OTs – and government final consumption.[3]

2.3.             Specialisation in particular sectors is not uncommon in territories of the same size as the OTs.  Similar-sized districts in the UK are often just as concentrated in particular sectors.  The City of London’s financial services industry, Copeland’s energy industry, Watford’s HR and corporate services sector, West Somerset’s tourism sector, Barrow-in-Furness’s shipbuilding industry, South Holland’s food manufacturing industry, and Welwyn Hatfield’s retail trade are just some of the local sectors that employ larger proportions of the local population than even Bermuda’s financial services sector.  Just fifteen districts in the UK do not have a single private-sector industry that is by itself larger than Gibraltar’s financial sector in terms of share of employment.[4]

2.4.             Financial services output is also concentrated in the UK, and not just in London.  The City of London and Tower Hamlets both have much larger proportions of their workforces working in financial services than any of the four OTs (38% and 26% respectively), while districts as diverse as Broadland (14%), Reigate & Banstead (13%), the City of Edinburgh (11%), and Bournemouth (11%) have proportions employed in financial services that are as large as or larger than BVI or Gibraltar.

2.5.             Financial services are the cornerstones of the OTs’ economies.  However, the sectors are respectively not abnormally large compared to other areas of comparable size, where single industries or even single employers often dominate to a greater extent.  Nonetheless, just as with those local authorities in the UK are sensitive to individual locally-important industries’ fortunes, the local economies are sensitive to changes in the financial services sector and their changes in their competitiveness as financial centres.  As such, they should not be seen as anomalies, but as part of a pattern of how small local economies are specialised.

3.                   Why Overseas Territories have financial centres

3.1.             The Overseas Territories have specialist financial centres, not generalist or diversified ones.  The Global Financial Centres Index rates all four OTs as ‘specialist’ centres.[5] Each territory specialises in a particular area, whether fund domiciliation in Cayman, cross-border investment in BVI, insurance in Gibraltar, or reinsurance in Bermuda.

3.2.             These activities all have one thing in common: they are based on reducing risk to maximise returns to customers.  The OTs facilitate pooling of international capital, allowing pension funds, insurance firms, retail banks, and other institutional investors to invest across borders to diversify their investments: reducing overall risk.

3.3.             To pool commercial risk and facilitate cross-border investment, centres like the Overseas Territories must have three elements:

3.3.1.      The stable and reliable legal institutions to ensure investors from different backgrounds trust the jurisdiction and ensure disputes between disparate parties can be resolved fairly.  The primary appeal of the Overseas Territories is the well-trusted British legal institutions that they share with the UK.  The predictability and security offered by British-inspired laws, British-trained judges, and British-qualified professionals inspire the confidence of investors.  That is especially important when investing in countries that don’t have strong legal institutions, and where investors do not trust disputes to be resolved fairly.

3.3.2.      The specialisation of regulation, professions, and domestic institutions in catering for specific forms of international commercial transactions.  The Overseas Territories also have regulatory regimes that are tailored to their specific sectors and have accumulated expertise within them.  The Overseas Territories cater almost exclusively for institutional investors and international businesses, and thus regulation can be geared towards a sophisticated commercial audience, not towards retail consumers.  This allows them to reduce administrative burden while still implementing the highest regulatory standards in the world.  As their unique selling point is their trustworthy legal institutions, it is in the interests of the OTs to commit to and fully implement globally-applied regulatory standards (see section 4 below).

3.3.3.      Tax neutrality to prevent the unnecessarily addition of an additional layer of taxation just because business is done in an intermediate jurisdiction.   The Overseas Territories are tax neutral for international capital flows (see section 5 below).  Income passing through the OTs is taxed where the income is earned and taxed again when received by the ultimate investor.  However, their success relies on tax-neutrality, meaning that a third layer of tax is not imposed where the capital is pooled.  This increases returns to investments.  As they do not impose tax themselves and do not have double taxation agreements, onshore countries do not issue tax credits for income accrued there, so doing business there does not reduce individuals’ or companies’ tax liabilities in the UK or elsewhere.  As a result, tax is not the main driver, but tax-neutrality is necessary to allow the real motivation – efficient, well-regulated British-based legal institutions – to be accessed at low cost.  There are deep-rooted economic reasons for small open economies to have zero corporate income taxation (see section 6 below).

4.                   Regulatory overview

4.1.             In line with the commitments and undertakings in the 2011 White Paper, as noted at 1.3 above, the OTs are committed to maintaining well-regulated financial centres, with well-resourced and strong regulators.  They participate proactively in international fora, including the Financial Action Task Force (FATF) and its regional organisations, the OECD Global Forum, the International Organisation of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors (IAIS).

4.2.             The OTs have committed to be early adopters of all international standards, including:

4.2.1.      OECD Common Reporting Standard (CRS): The OTs were all among the first jurisdictions to adopt CRS, under which they automatically provide information on all financial accounts held or controlled by residents of other countries to the governments of those persons’ respective home jurisdictions.  As such, HMRC automatically receives each year the name, address, Taxpayer Identification Number, account details, and account balance of any financial accounts controlled by persons or entities tax-resident in the UK.  This means that HMRC will receive automatic updates on almost all financial assets held by UK taxpayers in or through the OTs.

4.2.2.      UK FATCA: Before CRS came into effect multilaterally, the OTs signed bilateral agreements under which they provided this information to the UK.  This shows the benefits of the OTs’ close working relationships with the UK.

4.2.3.      Convention on Mutual Administrative Assistance in Tax Matters: The OTs were all among the first jurisdictions to commit to the OECD Multilateral Convention: ahead of most EU Member States.  The Convention compels signatories to exchange information on request, assist in recovering assets, and assist in serving documents related to tax collection by other signatory parties.

4.2.4.      2016 Exchange of Notes on beneficial ownership: The OTs have introduced government-maintained central registers of beneficial ownership (UBO) information, and give access to them to the UK on request.  To access this information, the UK does not need to offer explanation or prima facie evidence, as is ordinarily required under the Tax Information Exchange Agreements that the UK has signed with other jurisdictions.  This is the most access that the UK has to beneficial ownership information held in any jurisdiction in the world.

4.2.5.      G5 UBO information exchange: All OTs promptly committed to automatic exchange of UBO information on tax residents with 54 jurisdictions around the world.  This would automatically give UBO information on UK tax residents to HMRC when this project comes into effect.

4.2.6.      EU Code of Conduct for Business Taxation: The OTs are the only financial centres outside the EU that adhere to the EU Code of Conduct and their tax policies have been scrutinised by the Code of Conduct Group since the Primarolo Report in 1999.  The Code of Conduct is a political commitment that prohibits unfair tax competition using certain tax regimes designed to attract internationally-mobile business.  All the OTs have been found to abide by the Code of Conduct, with BVI having amended its tax system to ensure they do.

4.3.             The OTs have well-resourced and highly-regarded financial regulatory regimes to implement and enforce these obligations.  Below are the employee headcounts for each of the OTs’ financial services regulators:

These staff counts are very large for territories of their size, with each regulator being among the largest individual employers in each jurisdiction.  This allows them to examine and scrutinise company incorporations very effectively.  Over 1,000 companies are incorporated each day in the UK – several times all the OTs combined – and its authorities are considerably less well-resourced pro rata.

4.4.             The OTs are primarily used by investors because of their world-leading and specialised legal institutions.  They have robust legal frameworks, using common law based on English law and benefiting from judges and legal professionals that are ordinarily trained in and dual-qualified in England & Wales (see section 7 below).

4.5.             Overleaf is a table of regulatory compliance and cooperation for each OT, alongside each member of the G7 and the Crown Dependencies.

5.                   Tax neutrality and transparency

5.1.             Institutional investors, such as pension or insurance funds, reduce risk and thus increase returns by spreading investments across different asset classes and geographic markets.  In addition, multinational enterprises earn income in multiple jurisdictions, either by exporting through subsidiaries or branches.  This geographic diversification can lead to double taxation if governments tax all income earned domestically in addition to worldwide incomes of their residents – as almost all developed economies do – or where governments adopt differing definitions of where income is earned.  Double taxation of income earned internationally would make investment internationally uneconomical and thus reduce returns.  Almost all governments have a policy of preventing double taxation.

5.2.             To avoid the double taxation of income, institutional investors pool their resources in tax-neutral environments, where zero corporate income tax is imposed on income from their activities.  This does not reduce the tax paid in the UK or another counterparty jurisdiction, as they will still impose taxation on earnings when it is repatriated to the home jurisdiction.  As such, the non-imposition of taxation by the OTs does not reduce tax revenues in the UK.

5.3.             Indeed, their non-imposition of taxation increases returns to investors and allows the UK to levy more tax, as no deductions or Foreign Tax Credits are issued, as they would with jurisdictions.

5.4.             This works in conjunction with corporate transparency and exchange of information, including via the mechanisms listed above.  These allow HMRC and other national tax authorities to see earnings by entities incorporated or based in the OTs, and thus scrutinise whether structures there enable the evasion or avoidance of taxation.

Regulatory standards in the Overseas Territories, the Crown Dependencies, and the G7

Numeric cells colour-coded (green/yellow/orange/red) by their quartiles in the overall rankings, including jurisdictions not considered here.

5.5.             This is backed up by the imposition of criminal sanctions for evasion of foreign taxation.  It is a criminal offence to facilitate or engage in the evasion of taxation, either foreign or domestic, in all OTs.  The OTs also have a ‘single criminality’ approach to money-laundering, under which it is a criminal offence to handle in the OTs the proceeds from any criminal activity, without having to prove that such an activity would be a criminal offence in the OT in question.  As such, the evasion of UK taxation in the OTs is a crime there, as is the handling of the proceeds of it.  This gives the authorities significant powers to prevent evasion.

6.                   Optimal taxation in small open economies

6.1.             The OTs now maintain tax neutrality to facilitate international financial services, which are integral to the global economy, but the origin of their tax-neutral environments is due to the size of the economies.  There is a large body of economic literature demonstrating that small open economies, such as the OTs, maximise the welfare of their inhabitants by not imposing corporate income tax.

6.2.             The European Commission paper The Corporate Income Tax, written by Prof Michael Devereux – Director of Oxford University’s Centre for Business Taxation – states, “An important result in the theory of optimal taxation says that a small open economy maximising its national welfare should not levy a source-based capital income tax.”[14]

6.3.             The effective incidence of a tax falls on the party that ultimately bears the reduced welfare from its imposition.  This will often differ from the legal incidence – the party that is legally responsible for paying the tax – as taxes may be passed on to consumers through higher prices, workers through lower wages, or investors through lower returns.

6.4.             Smaller and more open economies are ‘price-takers’, in that they depend on world prices, which they are too small to affect, for their exports and for capital.  This means that businesses in small open economies cannot pass the cost of a corporate income tax onto consumers or investors.  It thus falls on domestic workers.  Indeed, due to knock-on effects, more than 100% of the cost of a corporate income tax in small open economies falls on local workers.[15]  As such, the OTs refrain from imposing corporate income taxation, which would be more harmful and less equitable than for larger economies, which can affect the world price of exports or capital.

7.                   Benefits to the UK’s soft power

7.1.             As noted at 3.2 above, the primary attraction of the Overseas Territories’ financial centres is their use of English-based legal systems in commercially-attractive, specialised, tax-neutral environments:

7.1.1.      The highest court of appeal in all four of the OTs is the Judicial Committee of the Privy Council.  This ensures foreign investors can rely on a British court to arbitrate in the event that the local courts’ impartiality is questioned.

7.1.2.      Most judges presiding in OT courts have previously sat on the bench in England & Wales.  The UK’s Judicial Appointments Commission actively promotes judicial vacancies in Bermuda, Cayman, and Gibraltar, which all require prior judicial experience – ordinarily in the UK – to sit as a judge in their superior courts.

7.1.3.      Most lawyers practising in the OTs were trained in and are dual-qualified in England & Wales, and their standards for lawyers are tied to England’s.  For example, admission to the Bermuda Bar is permitted only to those admitted to the English Bar, qualified as a solicitor in England, or qualified in a jurisdiction ‘comparable to England’.[16]  Similar preference for English-qualified practitioners applies in the other OTs.

7.2.             All of this extends the UK’s soft power by entrenching laws and legal institutions modelled on British institutions as the commercial gold standard globally.  Investors in emerging economies in particular look to the OTs as a means by which they may access sturdy and sound legal institutions, and this has helped English law – and by extent, the United Kingdom as a whole – to become a byword for reliability and commercial flexibility.

7.3.             Furthermore, because of their shared legal bases, commercial practices in the OTs are congruent with those in the UK, making it easier for those that are familiar with the OTs’ legal systems – as, for example, most Chinese investors and their counsel are – to invest in the UK (see section 9 below).  Four times as much is invested in China with BVI companies as United States companies: increasing Chinese familiarity with, and respect for, British laws and institutions.

8.                   Analysis of the tax gap

8.1.             We note that the UK is one of the few countries to conduct thorough tax gap analysis.  The HMRC Measuring Tax Gaps series estimates total avoidance amounts to £1.7bn.[17]  Of this, a small minority will be attributable to the OTs.

8.2.             This has been corroborated by a number of other sources:

8.2.1.      The Foot Review, published in 2009, estimated that corporate tax avoidance and evasion amounted to a maximum of £2bn, but that leakage through the OTs would necessarily be a small proportion of that.[18]

8.2.2.      Capital Economics separately estimated that the maximum amount of tax evasion that BVI could facilitate globally is £750m a year, a small fraction of which would be in the UK: while generating 21 times as much extra revenue for governments worldwide.[19]

8.2.3.      Similar figures have been produced for the Crown Dependencies.  Capital Economics estimated that the maximum amount of UK tax evasion that Jersey could facilitate is £95m a year, or just 2% of the extra revenue generated for the UK by Jersey.[20]

9.                   Contribution to the UK’s economy

9.1.             Any tax leakage due to the OTs must also be considered in the context of the contribution that they make to the UK economy due to their international financial centres.  There have been a number of analyses of the extent to which they provide jobs and government revenue to the UK.

9.1.1.      Capital Economics separately found that BVI supported £127bn ($169bn) of investment in the UK, which provided 150,000 jobs.  This adds £2.9bn ($3.9bn) of additional tax revenue to HM Treasury’s receipts.[21]

9.1.2.      Transnational Analytics found that Bermuda supported 69,000 UK jobs.  This was four times as many jobs as Bermuda created in Germany: demonstrating the benefits of the UK’s particularly close ties to Bermuda.[22]

9.2.             As noted, the OTs’ financial centres offer particular benefits to the UK’s financial services sectors, including:

9.2.1.      Increasing pension returns by reduce the cost and administrative burden of diversifying investments internationally.

9.2.2.      Reducing the cost of insurance, as Lloyd’s of London globalises its business through Bermuda: increasing its insurance capacity by over a third.

9.2.3.      Increasing lending to business by providing access to international capacity markets.

9.2.4.      Providing much needed liquidity to the UK banking sector.

9.3.             This also further benefits the UK’s real economy in significant ways:

9.3.1.      The housing sector benefits from investment via the OTs.  Cayman-based vehicles alone are responsible for investing £900 in social housing (Cheyne Social Impact Fund), developing over 3,000 new affordable homes a year in brownfield sites (TDR Sun Capital), investing in over 7,000 student accommodation units (Oaktree), and supporting refurbishment (Keepmoat).

9.3.2.      UK exports benefit from the OTs facilitating foreign expansion,[23] with capital flows into the OTs leading to markedly higher levels of goods exports from the UK.[24]

9.3.3.      UK infrastructure is heavily invested in through and by OT vehicles.  Capital investment in Heathrow, Gatwick, and other airports is often done by issuing bonds through subsidiaries in the OTs and the Crown Dependencies, while aircraft are financed through OTs, with Cayman and Bermuda financing hundreds of UK-based aircraft.

10.              Conclusion

International financial services are the largest industry all four of the largest OTs, although they are not significantly more concentrated than industries in similarly-sized local authorities in the UK.  Institutional business investors, who make up the large majority of users of the OTs, are attracted by their use of English-based legal institutions, high regulatory standards and specialised regulatory environments, and tax neutrality.  This, in turn, benefits the UK’s economy and projects its soft power.

September 2018