Offshore centers now face a perfect financial storm. In more prosperous times, revenues from the offshore sector, along with tourism, helped fuel these countries' economies. Their governments emulated more developed nations by borrowing heavily to build up their infrastructure. They also bought votes with social programs and bloated government payrolls.
When the global economy tanked, tourist revenues fell, along with revenues from their offshore sectors. But the social programs and bloated payrolls remained.
Blame Offshore Tax Havens! (Again)
The economic crisis also led to worldwide drop in tax revenues, with the biggest losers big industrialized countries like the United States. Politicians in these countries found a convenient scapegoat to blame for falling tax revenues: dozens of mostly tiny offshore centers.
Using the economic crisis, the world’s richest and most powerful governments had the perfect opportunity to achieve a long-term goal: forcing offshore jurisdictions to enforce their tax laws. They acted through non-governmental organizations they control, such as the Organization for Economic Cooperation and Development (OECD). The OECD has the authority to issue supposedly non-binding "best practices" guidelines. And, the OECD now decrees that “best practices” meant becoming tax collectors on behalf of these rich and powerful governments.
The one-two punch of the global financial crisis and the OECD vendetta has led to unprecedented economic challenges for offshore centers. Some—Gibraltar, Hong Kong and Singapore, for instance—remain in relatively good shape financially. Others, particularly in the Caribbean, are having a hard time paying their bills. The British press, for instance, refers to the Cayman Islands as "bankrupt."
Could offshore jurisdictions facing the worst challenges actually declare bankruptcy? Not if they can reduce spending, or qualify for additional loans. A condition of additional lending, however, may be to impose direct taxes, such as personal and corporate income taxes.
Here's a rundown of where the offshore financial crisis now stands.
U.K. Government Declares War on English-Speaking Offshore Centers
It was once official U.K. policy to encourage responsible growth in the offshore sectors of its current and former colonies. But, starting in the late 1990s, the U.K. government began to dismantle the offshore sectors of its former empire.
It was easiest in U.K. overseas territories, where the U.K. Parliament has the authority to enact binding legislation. In those territories, the British Foreign Office simply threatened legislation that would force those governments to enforce foreign tax laws. To avoid that politically unpopular outcome, the overseas territories enacted the demanded laws on their own.
The most recent crackdown began in 2008, when the U.K. government commissioned an independent review, led by former Treasury official Michael Foot of its overseas territories and "Crown dependencies" with offshore sectors.
The Foot Report observed that the global financial crisis had led to significant financial hardships:
"The impact has been pronounced in Anguilla, the Cayman Islands and the Turks and Caicos Islands resulting in depleted public sector cash reserves. Bermuda and the British Virgin Islands have also experienced a decline in government income, but the impact has been less severe. Revenues have held up better in the crown dependencies [Jersey, Guernsey, and the Isle of Man] and Gibraltar."
The report recommended that those jurisdictions facing depleted treasuries should consider spending cuts and imposing direct taxes. Foot suggested that any bailout by the U.K. government be contingent on a viable recovery plan, which presumably could include direct taxes.
Nowhere did the report state the most obvious possible recommendation: that the OECD back off and let these islands play by the same set of rules the OECD gives its own members.
Indeed, many OECD jurisdictions are themselves offshore centers: notably, Luxembourg, Switzerland, the United Kingdom, and the United States (the world's largest tax haven for non-U.S. resident investors).
The reality is that London is using the global financial crisis to undermine the low-tax regimes in place by arguing that the territories need to "broaden their tax base."
Hardball Politics
Just to make sure the remnants of its colonial empire got the message, the U.K. government has imposed much tougher standards for loans and loan guarantees.
In 2009, the Cayman government, facing an $82 million budget deficit, appealed to its colonial masters in London for permission to borrow US$310 million from banks. Despite the fact that commercial banks had already approved the loans, the British Foreign Office said "no."
The Cayman government then commissioned a team to conduct an independent review of the islands' fiscal challenges. The review’s key recommendations were to cut government spending and to privatize most government-run enterprises.
Reaction was swift and furious against the plan. The Cayman government refuses to make significant spending cuts. This makes an eventually bailout likely, with unfavorable terms in respect to direct taxes. The government is also in the process of confiscating local assets in “dormant” companies and trusts.
Other popular low-tax jurisdictions facing significant revenue shortfalls include the Cook Islands and Dubai.
Non-English Speaking Jurisdictions Face Problems, Too
But it’s not only English-speaking offshore jurisdictions that face serious financial challenges. And in many cases, these jurisdictions are considering—and implementing—new laws and regulations that adversely impact non-resident investors.
Uruguay is a great example. If you’re legally resident in Uruguay, you pay tax only on your Uruguay-source income. This policy has made Uruguay a popular destination for well-heeled expats.
However, last May, the government introduced legislation that would tax residents of Uruguay on their worldwide income. The law would also impose a wealth tax on all offshore assets. Needless to say, taking up residence in Uruguay looks less attractive than it once did, although the government now says foreigners who come to retire in Uruguay won't be affected.
Even Panama, the economic powerhouse of Central America, could face financial difficulties if global trade continues to contract. Global credit agencies recently upgraded Panama's debt rating to "investment grade" with a positive outlook. Yet, the Panamanian government remains highly dependent on revenues from its namesake canal. The canal generates more than $2 billion annually, or about 20% of the government's $10 billion budget.
Now in the midst of a $5 billion expansion, Panama is counting on a rebound in global trade to help pay for the renovations. However, global trade contracted 12% in 2009, according to the World Trade Organization. And while the WTO predicts global trade will resume its expansion in 2010, many factors could derail this rosy scenario. Among them are heightened protectionist sentiment in many countries, continued tight credit, and the systemic failure of major global economies to create private-sector jobs.
Cuba—the Sleeping Caribbean Giant
In the midst of this economic uncertainty, don't forget about the largest island in the Caribbean—Cuba.
Right now, with their offshore sectors in tatters, tourism is the major revenue stream for Caribbean offshore centers. And in this economic crisis, tourism has fallen sharply. Those tourists that still show up don't spend as much.
But what happens to the Caribbean tourism industry when the U.S. Congress ends longstanding economic sanctions against Cuba? There's broad support for this measure among U.S. farm and business groups. It's going to happen, perhaps very soon. And when it does, U.S. tourists will find a new and exotic vacation haven beckoning them only ninety miles from Key West.
The Caribbean Tourism Association predicts that if the U.S. government drops all travel restrictions against Cuba, more than one million U.S. tourists would visit the island annually.
That's one million tourists who may not have the time, energy, or money to visit more remote Caribbean jurisdictions. The impact on these islands' economies will be severe.
How Will Offshore Jurisdictions React?
The most politically expedient stance for cash-strapped offshore jurisdictions is to loot the assets of foreign investors who don't vote. In order of increasing severity, such measures could include:
• Imposing personal and corporate tax on worldwide income.
• Confiscation of local assets in companies and trusts deemed "dormant." Last week, the Cayman Islands enacted legislation mandating this outcome.
• Restrictions or taxes on outgoing funds transfers.
• Forced dilution of shareholder equity in local companies.
The unprecedented challenges now facing the offshore world aren't going away. Make sure you're prepared for the unexpected!
Copyright © 2010 by Mark Nestmann
(Update: Uruguay has now clarified its legislation to stipulate that there are no taxes on assets owned abroad by foreign residents.)
