The business secretary, Vince Cable, has promised to investigate the worldwide trade in offshore sham company directors. Matt Packer delves through a mountain of stock certificates, legislation and caselaw for the origins and progress of these safe zones for the super rich
Taxation – of whom, by how much and under what circumstances – is one of the most significant battlegrounds in the financial world.
And history has shown that the world has a controversial tendency for establishing places of refuge for tax-shy people or businesses. Those financial ‘bubbles’, as it were, have become known as tax havens. Like any other institutional tradition, such as banking or the stock market, tax havens have a rich history. And appropriately enough, those bubbles actually flowed from one, very big one…
The South Sea Bubble (1711-1720)
It all seemed like a brilliant idea at the time. Up to the early 1700s, Britain’s extensive trade in the South Seas was 100% owned and operated by the government – but entrepreneurs felt that an opportunity was going to waste, and approached Parliament with the idea of taking that trade into private hands.
The government liked the idea – or at least the terms. The newly-formed South Sea Company had snapped up trading rights for the region on submission to the government of an IOU basis for a cool £10m (unadjusted). This was an almost incomprehensible amount of money at the time, and landed the new body with a mammoth instant debt. To plug the yawning £10m gap, the Company needed investors, and offered stock options at £1,000 apiece (again, this figure is unadjusted – it is a fortune in real terms).
Yet businesses piled into the fray, desperate for a slice of this trading Shangri-La, and emptied their coffers liberally in the Company’s direction. The Company, meanwhile, began to splash out tax-free dividends to keep the investors sweet, and staged shares reissue after reissue to keep the money rolling in.
However, in 1720, Company bosses realised that they had hardly earned anything thanks to vast operating costs, and sold their stock on the quiet. Or so they thought. News of the sale leaked, and furious investors began to dump their stocks. The bubble collapsed – triggering a bailout from the British Empire, which promptly banned the issue of stock certificates for the next 105 years. To encourage discipline, it also put a considerable tax hike on incorporation rates.
New Jersey and Delaware (1820)
One century on from the South Sea debacle, high tax rates on the creation of companies still prospered. But the 1800s was a very different world to that that existed a hundred years prior, thanks in no small part to a phenomenon known as the United States of America.
Entrepreneurs who’d found the rates too restrictive now had a reasonably large, decentralised government to play with, and much to their delight, New Jersey and Delaware deliberately set out to provide low corporation-tax levels to attract an influx of overseas players. In so doing, they became the first-ever Preferential Tax Regimes (PTRs).
Egyptian Delta Land and Investment v Todd (1929)
In this bitter legal dispute between a purveyor of Middle East real estate and the UK Inland Revenue, the Taxman had been determined to secure a hefty payout from Egyptian Delta Land as it had originally incorporated in London – notwithstanding that all of its activities were carried out abroad. The Court of Appeal and the High Court were both sympathetic to that view, but the House of Lords felt differently.
By implying that a London-registered company need not trouble itself with shelling out on levies, so long as it could demonstrate that it worked predominantly overseas, the Lords’ ruling effectively turned Britain into a tax haven.
Between the two World Wars, financiers encouraged some of Switzerland’s poorest Cantons – federal regions – to set themselves up as registration authorities for overseas firms. This process gave them much in common with Switzerland’s tiny neighbour Liechtenstein, which had made similar moves. All that those areas had done was to put the implications of Britain’s Egyptian Delta Land ruling into practice in their own jurisdiction.
But in 1934, something happened of altogether greater significance: the Swiss Banking Law. That imposed a legally enforceable code of silence around the activities of Swiss banks, and even made researching them a criminal offence on the grounds that it breached trade secrets. Scarily clandestine, you might say, but the foreign customers loved it.
The Euromarket Effect (late 1950s to early 1960s)
Over the past five years, we have all read copious headlines on the dangers of banks trading complex financial instruments among themselves. Well, that activity has its roots in the Euromarket boom of the late 1950s. In that episode, banks began to engage with a variety of novel products that did not fit in with conventional, commercial banking – so they were not scrutinised by national regulators such as the Bank of England.
US banks leapt in for a piece of the action and, in short order, the various holding companies that had sprung up to handle this kind of trade began to settle in Jersey, Guernsey and the Isle of Man – all offshore jurisdictions run by terribly welcoming, independent governments.
Cayman Islands (1966)
This British Overseas Territory in the sunny Caribbean passed three major laws in one year, in a concerted effort to become an appealing base for complex financial firms. It quickly imitated the Channel Islands and Isle of Man success stories, and tax havens began to look decidedly paradisiacal …
An unstoppable rise? 1966 to present
Since the Cayman Islands took offshore tax havens into more exotic climes, others have emerged in locations such as Singapore, Dubai and parts of Latin America. Their global reach, diversity and internal particularities will make them a challenge for regulators for years to come.
Matt Packer is Online Editor at Think Publishing.
Matt Packer is a freelancer journalist who has contributed to Accounting Technician magazine, 20 magazine and the CMI website.