In this article we will discuss about the issues and developments relating to IOFC.

Issues Relating to IOFC:

(a) Domestic Tax Base Erosion:

Several high-taxed jurisdictions are concerned with the loss of tax revenues, which they believe should be due to them, from the use of offshore centres.

For example:


i. The source countries may lose revenues through treaty shopping by third country residents, who obtain tax benefits not intended by the treaty negotiators.

ii. The monies accumulated in tax havens defer the tax collections, until the income is remitted to the home country.

iii. The offshore centres with less stringent regulations over the use of intermediaries may lead to transfer pricing issues through non-arm’s length transactions.

Anti-avoidance measures have been adopted by several jurisdictions as defensive measures to disallow certain payments made by residents to low-tax jurisdictions.


These restrictions imposed under the domestic tax law include blacklists, denial of deductions, higher withholding taxes, deemed residency rules, denial of domestic tax concessions and enhanced reporting requirements. Several countries have also enacted anti-treaty shopping legislation and transfer pricing rules in their domestic law or included similar provisions in their tax treaties.

Many countries have controlled foreign corporation rules to curb the deferral of tax due on foreign profits, when they have not been remitted as dividend income. Similar measures have also been taken by several European countries to deny benefits under the EC P-S Directive or participation exemption rules.

Several countries still use exchange controls to counter tax base erosion. Increasingly, countries have implemented transfer pricing rules under the OECD Guidelines.

(b) Money Laundering:


Recent experiences suggest that although most organized economic crimes take place in onshore jurisdictions, they often use offshore financial centres for the laundering of the criminal proceeds.

Money laundering involves three stages of activities:

(i) The placement or initial disposal of the cash proceeds usually in the country where the funds originate;

(ii) The layering or concealment of the criminal source through widely scattered accounts in offshore financial centres (also called “smurfing”); and


(iii) The integration or bringing the funds into the legal economy.

Generally, money launderers use countries with low risk of detection due to their less rigorous regulatory environment.

Several international agencies have initiated efforts to curb money-laundering activities. A special body, the Financial Action Task Force (FATF) was set up in 1989 to develop an international response. (See below).

Other regulations include the EU Money Laundering Directive 2001/97/EC of 4 December 2001 that amended and expanded the Money Laundering Directive 91/308/EEC of 10 June 1991.


The Third EU Money Laundering Directive 2005/60/EC of October 26, 2005, which replaced the earlier Directives, is expected to be effective before December 15, 2007. All these measures require a co­ordinated international effort.

It would be incorrect to regard all or only offshore centres as centres of economic crime. Most of them are well regulated and guard their reputation as a “clean” centre for legitimate global businesses.

Not only the international agencies and onshore jurisdictions, but also international investors, demand high regulatory standards. Several offshore centres have enacted or strengthened their anti-money laundering laws and their enforcement in recent years.

They have introduced laws, which require the banks to identify their customers, the source of the money and its use. Under the FATF initiative, many of them have improved the quality of their supervision over economic crime and money laundering.


There is a growing need for both offshore and onshore centres to regulate their own financial operations and adopt effective anti-money laundering and terrorist financing legislation. Criminals can be found anywhere.

(c) Bank Secrecy:

Bank secrecy has become a major issue today for tax authorities. With increasing globalization, it adversely affects their ability to both enforce tax compliance and collect taxes from tax evaders. The problem arises in obtaining financial information on funds held by resident taxpayers in domestic bank accounts, but more so in overseas bank accounts.

The earlier OECD Report on Bank Secrecy in 1987 had concluded that greater international co-operation was needed to combat tax evasion and criminal activities. It suggested a relaxation of bank secrecy towards the tax authorities, and more use of the exchange of tax-related information that could be obtained from banks.


The OECD Report 2000 recommended that access to bank information should be given when specifically requested by tax authorities on domestic and cross-border transactions for OECD Member Countries.

It further suggested that:

(a) “Secret bank accounts” should be abolished,

(b) The banks should identify the beneficial owners of all accounts, and

(c) The countries should simplify their laws and regulations affecting information required by tax authorities in criminal and civil tax cases.

The recommendations, however, did not permit an unfettered access to bank information or “fishing” expeditions for information by the tax authorities. The requests should relate to specific cases and for tax purposes only.


Moreover, the Report did not suggest that bank secrecy should be abolished since it stated that the confidentiality of financial information was needed to preserve the confidence in the financial system.

In 2003, the OECD published a progress report. In three years, anonymous accounts were prohibited, customer identification requirements were established and the domestic tax interest requirement for exchange of information was deleted. However, Report stated that its Member Countries had not been able to agree on a common understanding of tax fraud and the access to tax information for civil tax purposes.

The OECD amended Article 26 (Exchange of Information) of its Model treaty in 2005 to further discourage the denial of information on grounds of bank secrecy, and provided a model tax information exchange agreement for countries (TIEA) without tax treaties. The OECD’s Harmful Tax Project was also committed to access to bank information for exchange of information purposes on request. (See below).

Developments Relating to IOFC:

Globalization has resulted in the erosion of business boundaries. As a result, it is easier to shift profits and activities across borders and to OFCs with financial liberalization. This mobility has also raised international concerns on the governance standards and stability of financial centres, in particular in smaller offshore jurisdictions. They have been subject to much international attention.

Some of the major international initiatives include:

(a) Financial Action Task Force (FATF):

Financial Action Task Force was established at the G7 summit as an independent international body in 1989 with a mandate that specifically addressed proceeds of serious crimes, including drug trafficking. Its membership has grown from the original 16 to 33 countries today.

Money laundering is estimated at 2 to 5% of world GDP or around USD 2.1 trillion. Compared to this figure, drug trafficking only accounts for around USD 400 billion and all forms of organized crime just over USD 1 billion.

In 1990, FATF published its “Forty Recommendations” for countries to implement an effective anti-money laundering programme. In 1996, its scope was extended to “serious crimes”.

Subsequent to the September 11, 2001 attacks in New York, eight additional recommendations were added to counter terrorist financing. Revised recommendations were issued in 2003 and a ninth Special recommendation was added in 2004.

In June 2000, the FATF published its report “Review to Identify Non-cooperative Countries and Territories (NCCT)”. The report reviewed 29 countries and listed more than half as non-compliant, based on a set of 25 practices said to help money laundering.

According to their latest reports, most NCCTs have taken appropriate legislative and regulatory actions. Currently, there are only three countries on the list: Myanmar, Nauru and Nigeria.

FATF initiative has improved financial reporting, transparency and client identification. For example, Forty Recommendations ban shell banks and require KYC (“Know your Customer”) rules to identify the true owners.

(b) Financial Stability Forum (FSF):

The Financial Stability Forum was established under a G7 initiative in April 1999 to monitor the role of offshore banks in global financial stability. It studies their banking system for systemic financial risks and banking supervision (e.g. prudential concerns and market integrity).

FSF pays special attention to all traditional offshore financial centres (OFC) to improve cross-border cooperation and information exchange.

In its initial study, FSF listed 42 jurisdictions as OFCs and classified them into three groups on the quality of supervision and degree of cooperation, as follows:

(i) High and internationally acceptable;

(ii) Adequate procedures but substantial room for improvement in practice; and

(iii) Low quality of supervision.

Its report, which was published in April 2000, concluded that “OFCs to date do not appear to have been a major causal factor in the creation of system financial problems”. However, it recommended that jurisdictions should improve their adherence to international standards, particularly on international cooperation.

This work on OFCs is currently conducted by the International Monetary Fund (IMF). According to its press release in 2005, the 2000 list had served its purpose and was no longer operative. The IMF also conducts a Financial Sector Assessment Programme (FSAP) to ensure the adequacy of supervision and the availability of relevant data.

Its recent progress report mentions that “the compliance levels for OFCs are on average better than in other jurisdictions assessed under the FSAP”. Moreover, “on average, OFCs meet supervisory standards superior to those of other jurisdictions”.

(c) Harmful Tax Project (HTP):

Taxation is based on national boundaries but companies operate globally. In 1996, the OECD established a project to study and eliminate harmful tax competition that led to the erosion of governments’ fiscal capacity. A further concern was tax competition among the OECD countries. This project was renamed as “harmful tax practices” (or HTP) in 2001.

In 2000, the OECD listed 35 countries as tax havens and demanded time-bound commitments from them to actively assist with its programme for global “transparency” (collection and exchange, on request, of financial data).

By 2002, most of the listed countries agreed to support the OECD project under the threat of certain defensive measures. However, as the project subsequently met with considerable opposition the OECD goals were modified downwards.

For example, OECD now accepts that countries are free to operate their tax system both in terms of tax rates and how they apply them (see below). The issue is no longer low or nil taxes but tax information exchange and transparency. It has also drafted a model TIEA to encourage bilateral agreements covering them.

Today, the OECD’s goal is limited to ensure tax transparency and exchange of tax information for civil and criminal tax offences. Its initial Project was unilateral without the support of the offshore centres. Over the years, the OECD has established a dialogue with cooperative offshore financial centres under a “Global Forum”.

However, the future of this project remains uncertain since it does not provide a level playing field for traditional offshore centres with its own Member Countries. In this respect it has not been helped with the recent developments under the EU Savings Directive.

Currently, offshore centres are committed to comply with OECD requirements not applied or followed by several OECD members, such as Switzerland, Luxembourg, Austria and Belgium.

The United States has also not compelled several of its states (e.g. Delaware) to maintain records of beneficial ownership under their incorporation procedures. There is also concern about other offshore centres, such as Hong Kong, Singapore and Dubai, which were not listed by OECD.

To succeed, the OECD’s project has to ensure that its own members also meet the tax transparency and exchange of information norms, both in terms of the precise measures and their timing, as required from offshore centres, i.e. maintain a level paying field.

The traditional offshore centres are also compelled to collect and exchange tax information under this project at their own cost without any positive financial incentives. Many of them have so far accepted it as a price to pay for access to onshore markets. They need clients, banking networks and global markets in onshore jurisdictions to promote their own financial services. Their own domestic markets are not big enough.

OECD Report 2006:

In May 2006, the OECD issued its Report “Tax Cooperation: Towards a Level Playing Field”. This Report, which was presented at the meeting of the Global Forum in Melbourne in November 2005, listed the progress made on the Harmful Tax Project. It stressed the need for a level playing field for “fair competition between all countries, large and small, OECD and non-OECD”.

The key principles of transparency and exchange of information were mentioned as:

(i) Existence of mechanisms for exchange of information on request.

(ii) Exchange of information for purposes of domestic tax law in both criminal and civil matters.

(iii) No restrictions on information exchange due to dual criminality principle or domestic tax interest requirement.

(iv) Respect for safeguards and limitations.

(v) Strict confidentiality rules for information exchanged.

(vi) Availability of reliable information and power to obtain and provide them on request. The Report also provided a detailed factual assessment of the current practices on tax information collection and exchange in 82 countries.

Some of the significant findings were:

(a) Exchange of Information:

All but 12 countries permit exchange of information on request for both civil and criminal tax purposes under tax treaties or TIEAs. Six countries would refuse a request unless domestic tax interest was involved (Cyprus, Hong Kong, China, Malaysia, Philippines and Singapore). Four countries apply the dual criminality principle (Andorra, Cook Islands, Samoa and Switzerland).

(b) Access to bank information:

Nearly all countries provide for some access to bank information for tax purposes. Only 50 of them can exchange information on all tax matters. Seventeen of them would only grant access for criminal tax matters. They include Singapore, Switzerland, Austria and Luxembourg.

(c) Access to ownership, identity and accounting information:

Nearly all countries can obtain information from a local person legally responsible for record keeping. A large number are also authorized to obtain it from persons not required to keep such information.

(d) Availability of ownership, identity and accounting information on companies:

Nearly 95% of the countries require companies to report their legal ownership information. Bearer shares can be issued in 48 countries. Most of them either have means to identify the legal owners themselves or through an approved custodian. The remaining countries rely on anti-money laundering rules or other means of information. In seven countries, companies are not required to keep accounting records.

(e) Trusts:

54 out of 82 countries had trust laws. 47 countries require the information on the identity of settlors and beneficiaries in domestic trusts to be held by the trustees. In 36 countries, a domestic trustee is required to have information on settlors and beneficiaries in a foreign trust.

Of the 28 countries that do not have trust laws, 18 allow their residents to act as trustees of a foreign trust; all, except Luxembourg, require resident trustees to identify settlors and beneficiaries of foreign trusts.

According to the Report, further progress was needed on certain issues and in certain countries. They included exchange of information in criminal tax cases, domestic interest and dual criminality cases, lack of beneficial ownership information on trusts, issue of bearer shares and keeping of accounting records.

The Report also clarified the requirements of transparency and effective exchange of tax information under HTP as:

(i) Availability of information:

Information, (in particular on ownership, bank and accounting information) to be available on specific request;

(ii) Accessing information:

Countries should have the power to obtain the information when specifically requested; and

(iii) Exchanging information:

Countries should have the legal framework to exchange information on request, for tax purposes, subject to safeguards and limitations.

Overall, the Report was positive in terms of the progress of HTP project towards transparency and exchange of information (no longer harmful tax practices). OECD has also relaxed many of its initial requirements.

For example:

i. It only requires government access to ownership data (including beneficial owner) from a local corporate service provider.

ii. Accounting records may be kept by the corporate service provider, and provided only on request to the authorities.

iii. There is no requirement to prepare financial accounts, but the records must be adequate to prepare them.

Although much has been achieved since 1998 to improve the regulatory framework of offshore centres, the OECD now accepts that the initial programme to counter tax competition was not appropriate. The best that can be achieved was a defensive attempt (however imperfect) to improve measures to counter cross-border tax evasion under the domestic laws.

The 2006 Report mentions:

“Countries are free to have whatever kind of tax structure they think is appropriate to their own economic circumstances including not having income tax at all. … there is nothing in any of the other reports that the OECD has produced that suggests they should consider a direct tax. The 1998, 2000, 2001 and 2004 Reports all acknowledge that there is no reason why countries should have the same level and structure of tax – these are essentially political decisions for national governments”.