Tax evasion through the creation of offshore financial centres (OFCs) is usually blamed on the islands that were formerly part of Britain – Bermuda, the British Virgin Islands, and the Cayman Islands are usually the worst culprits – but a new paper from a group of academics working in the Netherlands points to major western economies as the worst offenders. The paper identifies a small set of five countries – the Netherlands, the United Kingdom, Ireland, Singapore, and Switzerland – that are responsible for funneling the majority of corporate offshore investment, as what it terms conduit-OFCs.

First, some definitions. The paper refers to two groups of offenders: sink-OFCs and conduit-OFCs. “Sink-OFCs attract and retain foreign capital while conduit-OFCs are attractive intermediate destinations in the routing of international investments and enable the transfer of capital without taxation.” It identifies 24 primary sink-OFCs, as well as the five conduit-OFCs already mentioned. 

The paper also gives some pretty breathtaking examples. For example, the British-based banking and financial services company HSBC is composed of at least 828 legal corporate entities in 71 countries. The largest brewing company in the world, Anheuser-Busch InBev, consists of at least 680 corporate entities involving 60 countries.

Some jurisdictions are particularly popular as sink-OFCs, such as Bermuda, the British Virgin Islands, and the Cayman Islands. These jurisdictions attract financial activities from abroad through low taxation and lenient regulation. While all these sink- and conduit-OFCs comply with international laws on trade and money laundering, they are typically characterised as facilitating corporate tax avoidance. And this is not a small problem; the paper estimates that “50 percent of the world’s cross-border assets and liabilities (US$21-US$32 trillion)” pass through OFCs of one type or another.

So why do corporations utilise these OFCs? Firstly, for legal protection. “By organizing parts of their corporate structure in certain trusted territories with favorable legal conditions they can increase legal certainty for their operations or for joint-ventures,” says the paper. Companies also hedge their investments against government decisions which might adversely affect their strategy “by setting up subsidiaries in specific jurisdictions and using such subsidiaries to invest in other countries.”

Secondly, favourable regulatory regimes in OFCs are used by companies to “avoid corporate accountability and public scrutiny of their operations….” The paper cites the example that many of the opaque structured financial products that caused the global financial crisis in 2008 were created in OFCs.

Sink-OFCs by order of offence

British Virgin Islands
Cayman Islands
Marshall Islands
St. Vincent and Granadines
Hong Kong
Source: Uncovering Offshore Financial Centers: Conduits and Sinks in the Global Corporate Ownership Network

The final reason is that complex corporate ownership structures help to minimise tax payments – especially for corporations that “have many intangible assets, such as intellectual property rights.” Again, there are many examples. Between 2007 and 2009 Google moved the majority of its profits generated outside the United States (US$12.5 billion) to Bermuda through corporate entities in the Netherlands. “As a result, Google paid an effective tax rate of 2.4% on all operations.” The Apple instance is also mentioned, where the company notoriously used Ireland to avoid US$14.5 billion in taxes. Finally, another high-profile case, Starbucks U.K. voluntarily payed £20 million after it came to light that it had paid virtually no taxes since establishing in the U.K. The paper then gives a global picture of tax evasion in the two major economies in the world: “In total, every year multinationals avoid paying US$50-200 billion in taxes in the European Union using OFCs. In the U.S., tax evasion by multinational corporations via offshore jurisdictions is estimated to be at least US$130 billion per year.” Of course, while the paper admits that reducing costs is good for shareholders and part of board and management’s overall strategy, and that what these corporations are doing is not necessarily illegal, their activities significantly diminish tax revenues placing a greater burden on companies which are unable to access these tax evasion activities.

The paper's biggest statement, however, is that these very conduits play the major role in “the global corporate ownership network by allowing the transfer of capital without taxation.” There is still a “prevalent conjecture that offshore finance resembles an ‘atomized’ marketplace in which a multitude of approximately equal jurisdictions compete and where regulation is therefore unfeasible….” But the paper challenges this with its finding that corporate use of OFCs is in fact concentrated in five, mostly highly-developed OECD countries. No wonder that G20 and OECD efforts to combat tax evasion have been largely unsuccessful, since the major players are part of these groups.

One of the paper's other major findings is that Panama, despite the notoriety it gained after the release of the Panama Papers, is not a sink-OFC. This is because Panama is mainly a tax haven for individuals, thanks to its relatively high corporate tax rate of 25 per cent. Such a finding is reinforced by the fact that most of the shell companies set up by those exposed in the Panama Papers were actually domiciled in the British Virgin Islands.

Interestingly, the paper also identifies Taiwan is an “unnoticed tax haven.” The country has not signed the “OECD Common Reporting Standard for the automatic exchange of financial information and maintains bank confidentiality.” Nor does it participate in Foreign Direct Investment statistics collected by the International Monetary Fund. It has therefore flown under the radar of previous studies identifying tax havens. Until now.

Of course, the five, large conduit-OFCs are also used as conduits to non-sink-OFCs, countries that are not hiding profits from tax authorities. In other words, these countries are also major ‘above-board’ economies. Other significant conduit-OFCs, such as Russia and China, are used solely as conduits to sink-OFCs.

But the researchers also warn that their estimates may be low-balling the figures because of lack of data from the U.S. This is because its analysis does not capture companies incorporated in the state of Delaware, which are not required to file information on such issues. And, of course, unless another Panama Papers release occurs it is almost impossible to trace investments back from sink-OFCs because these countries do not “consistently report the companies registered in their territories.” The paper suggests that “if we are missing data, then this data is more likely to be missing in an OFC than in a non-OFC.”

Its findings, says the paper, mean that authorities faced with the impossibility of imposing jurisdiction on sink-OFCs have a new method of tracing the offshoring of profits: “Targeting conduit-OFCs could prove more effective than targeting sink-OFCs, since… the conditions for conduit-OFCs (numerous tax treaties, strong legal systems, good reputation) can only be found in a few countries.” And it lists them. Looking at money being channeled into the Netherlands, for example, would not, until now, look suspicious. Now that the authorities know that this money could be going to a sink-OFC, regulators can clamp down far more effectively.