Rules of Engagement

The Lawyer
30 April 2001

"Time longer than rope" may describe the lackadaisical lifestyle of the Caribbean jurisdictions, but there has been nothing lackadaisical about the legislative response to the Organisation for Economic Cooperation and Development (OECD) initiatives. A June deadline is fast approaching for both the Harmful Tax Competition initiative and the Financial Action Task Force (FATF) in relation to anti-money laundering. There are those in both the onshore and offshore world who believe that both initiatives have more to do with the unfunded pension problems of France and Germany than with any genuine desire to enhance economic development or eradicate money laundering. Nevertheless, the Caribbean jurisdictions are likely to undergo a radical change in levels of regulation and business flows as a result.

Indeed, while the FATF deliberations continue, the two-year  Harmful Tax Competition initiative of the OECD approaches a publicised June deadline. This promises sanctions against the 35 jurisdictions that remain listed, and subject to threatened sanctions, notwithstanding evident flaws in the OECD's basic premise that tax competition is fundamentally harmful (a proposition challenged by the United States Heritage Foundation with a view that seems to be finding increasing congressional support in the US).

Accepting for a moment that the OECD and the FATF initiatives are, in fact, separate, they are both subject to the criticism that they seek to distinguish between Caribbean jurisdictions as part of the offshore world and onshore jurisdictions that provide the same range of services. If a tax-free mutual fund is available in Dublin, how does the OECD distinguish and conclude that an identical vehicle in the Bahamas or the British Virgin Islands is harmful? If Bermuda and the Cayman Islands have agreed with the OECD (being two of eight jurisdictions to have done so) to provide information pursuant to treaty arrangements to be negotiated with regard to criminal and civil tax evasion by the years 2003 and 2005 respectively, why should a different a system be permitted in Luxembourg and Switzerland?

The answer to this double standard must be political. While Luxembourg and Switzerland have rights of veto at either or both the OECD and European Union (EU) levels, the Caribbean jurisdictions do not, and therefore represent a softer target. Nevertheless, the concern here may simply be one of chronology. It is likely that eventually the EU and G7 initiatives will apply similar principles throughout Europe, although there seems to be confusion as to whether the basis should be an exchange of information, as favoured by the UK Treasury, or the seven-year withholding tax solution favoured by Luxembourg and Switzerland. It does, though, seem reasonably certain, on the question of a level playing field, that following the failure in the US of the Leach bill last year, there is no prospect of "new age" anti-money laundering legislation being introduced domestically in the US. The La Falce/Kerry anti-money laundering bill now introduced (hot on the heels of Senator Levin's senate committee hearings on money laundering through offshore "correspondent" banking relationships), attributes the money laundering problem firmly to the offshore world. But why, then, does the well-advised Russian money launderer avoid the Caribbean and go directly to the Bank of New York, or perhaps the more convenient Delaware company through banking arrangements in San Francisco?

What exactly is being asked of the Caribbean jurisdictions? As far as the OECD is concerned, the Cayman Islands and Bermuda have agreed to an exchange of information in relation to civil and criminal tax matters. It also seems that, regardless of the fact that these matters were initially negotiated on a jurisdiction-by-jurisdiction basis, some sort of common test will be applied with the result that there should be no special deals. This means, for example, that although Jersey and Guernsey are yet to announce any accord with the OECD, the terms of their arrangement should be no more or less favourable than those  agreed by the Cayman Islands and Bermuda. What also seems clear is that the OECD has retreated from its initial suggestions that lower or zero tax rates and a lack of "substantial activity" and "non-transparency" in the offshore jurisdiction should of themselves be regarded as harmful. Perhaps this is a sensible position, since the OECD at no time offered anything other than a subjective analysis of a lack of "substantial activity".

The FATF initiative at least is clear in its intended legislative framework. What is being legislated is effectively mandatory UK-style suspicious activity reporting within a framework that criminalises the money laundering offences, albeit with the remaining doubt as to whether fiscal offences are necessarily included. This particular doubt is compounded in a number of the offshore jurisdictions - for example, the Cayman Islands, the Bahamas and the Turks and Caicos Islands, which have no direct taxes and which may therefore have a dual criminality argument in relation to tax evasion. It must be doubtful, however, that the dual criminality argument would prevail in relation to the attendant common law offences of false accounting or perjury in the jurisdiction of residence or domicile of the individual or corporation in question. In addition, in keeping with the new fiscal puritanism, the FATF requires a form of highly bureaucratic and mandatory record-keeping with regard to the beneficial owners of accounts and companies established in the offshore jurisdictions, particularly those 15 jurisdictions listed as having had insufficient legislation in this regard (which include the Cayman Islands and the Bahamas). It may be reasonably anticipated, then, that the amount of form filling will increase substantially. The question of whether or not money laundering will be reduced as a result is a far more interesting question, particularly when one looks at the percentage of reports to the National Criminal Intelligence Service made by the legal and accounting profession in the UK.

What, then, is the likely effect of the legislation required by the two initiatives?

If we assume that accords with the OECD and the FATF will be reached in all the Caribbean jurisdictions and that the notion of sanctions should be relegated to the category of overexcited rhetoric, then it seems possible to discern definite conclusions based on the book of business in the jurisdiction. Bermuda seems well placed to continue its position as the leader in offshore insurance and reinsurance products. It has a very small banking industry, dominated by the two major banks - Bank of Butterfield and Bank of Bermuda - and a relatively small mutual fund industry with a good administration capability.

Bermuda, the Cayman Islands and the Bahamas have substantial private client industries that seem likely to suffer, as will be the case for all offshore jurisdictions, save to the extent that the trust and underlying structures are in compliance with the tax laws of the jurisdiction of residence or domicile of the settlor and beneficiaries. It is the consequent outflow of funds in relation to structures that are not so compliant which poses the greatest threat to the private client industries in the smaller Caribbean jurisdictions. This raises the second point: it is only those jurisdictions that have sophisticated banking, mutual fund administration and structured debt administrative functions, and that have developed an institutional book of business in the areas of mutual funds, structured debt and initial public offerings that are likely to survive the onslaught of supranational initiatives, and indeed enhance their positions (notably the Cayman Islands and the Bahamas). Forty-three of the world's top 50 banks have representative offices in the Cayman Islands, which has some $700bn (£485bn) in banking deposits. In addition, it has in excess of 3,000 mutual funds with some $200bn (£138.6bn) under management and 70 mutual fund administrators. The Bahamas, although smaller, is also a domicile for recognised banks and service providers.

Where the industry or the offshore jurisdiction has been administered by recognised institutions, there is every prospect that the book of business will have been subject to reasonable internal compliance procedures and will withstand the tests now applied by the supranational initiatives. It is those Caribbean and other offshore jurisdictions with no recognised service provider infrastructure that are likely to sustain net outflows of business as a result. The contrary position is also true - the likely outcome of these initiatives must be to enhance the larger and stronger Caribbean jurisdictions and to reduce the choice.