May 3 (Bloomberg) -- The origins of the offshore finance industry dates back to Vienna, Austria, in 1815, when Switzerland’s neutrality was established at the Vienna Congress.
Nurtured by the relaxation of incorporation laws written in Delaware in 1889, and hastened by the decline of the British Empire that began in the late 19th-Century, the business has turned from a nascent tool to facilitate the flow of capital into a point of contention for governments and the media, according to John Christensen, a former economic adviser to Jersey, a Crown dependency of the U.K.
More than 30 percent of the world’s 200 richest people, who have a $2.9 trillion collective net worth, according to the Bloomberg Billionaires Index, control part of their personal fortune through an offshore holding company or other domestic entity where the assets are held indirectly.
“Without understanding tax havens, we will never properly understand the economic history of the modern world,” wrote Nicholas Shaxson, author of ’Treasure Islands.’ “Tax havens are now at the heart of the global economy. Their tentacles have curled their way into pretty much everything.”
Supported by tax treaties and other legislation designed by governments to entice the wealthy and multinational corporations with low tax rates, a world of offshore finance was built during the past 200 years by offering financial a range of financial vehicles that provided security, secrecy and control.
While island locations are the usual suspects in media coverage of tax havens and offshore finance, the largest and most powerful jurisdictions are in the U.S. and U.K., according to Katja Gey, director of the Office for Financial Affairs in Liechtenstein. The largest of them is Switzerland, which in 2011 booked about $2.1 billion in private wealth, established its banking secrecy laws in 1934.
Using its far-reaching influence, the U.K. transformed the elite banking center known as the City of London into the nexus of global finance that, since 1980, has helped orchestrate the movement or parking of about half of all international banking assets and liabilities through offshore financial centers, according to a 2009 paper written by Ronen Palan, professor of international political economy at City University London.
“It wasn’t until the early sixties that the British government understood there was a goldmine in tax havens,” Palan said in a telephone interview. “They weren’t part of a formal policy approach; they came together after certain developments that happened for largely parochial reasons.”
As London’s financial community did with the City of London, U.S. states also underwent a 19th-Century transformation, beginning with New Jersey, which liberalized incorporation laws in 1889 to entice out-of-state corporations to register there by limiting the taxes they were required to pay.
The U.K. passed legislation in 1925 that made it easier for individuals to use trusts to keep their financial affairs under wraps. Four years later, London courts ruled that Egyptian Delta Land and Investment Co. Ltd., which was registered in London and headquartered in Cairo, did not have to pay tax in the U.K., setting a precedent for future tax avoidance.
The ruling allowed the City of London to secure its position as a top center for offshore financial advice. The final piece with the devaluation of the British pound in the 1950s, which led the government to ban banks from lending to non-British borrowers.
An agreement struck in 1957 between the Bank of England and the British banks created what they called the Euromarket, which informal and temporary allowance for U.K. banks to carry out unregulated deals, as long as they were in a foreign currency and between non-British clients.
The agreement created a new industry that elevated to prominence many of the former British colonies, which were bolstered by their ties to U.K. banks and access to its legal system, according to Christensen, director of the Tax Justice Network in the U.K.
“With the U.K. economy and sterling under pressure, and British banks working well below capacity because they were constrained from expanding by exchange controls, the Bank of England turned a blind eye to dollar denominated deposits being held by London banks, creating an unregulated offshore market that took off,” Christensen said in a telephone interview.
Offshore locations were further bolstered by double-tax avoidance treaties, such as the 1998 treaty between Russia and Cyprus that capped taxes on dividends from Russia at 5 percent, and the 1980 treaty between Italy and Luxembourg that capped the tax rates on dividends and profits for citizens of both nations.
The industry is once again in the spotlight since the near bankruptcy of Cyprus -- which is home to $31 billion of Russian deposits, according to Moody’s Investors Services -- and a leak in April from two trust companies operating in the British Virgin Islands and Singapore that exposed account information for 120,000 individuals and companies.
The news, according to Goran Grosskopf, a Swedish economist who has advised billionaires Ingvar Kamprad, the world’s fifth-richest man, as well as the Russian government, is a reality facing all of the wealthy who hold their assets offshore.
“More and more people in the banking and financial industry have come to the conclusion that there is money to be made be selling information like this,” Grosskopf said in a telephone interview. “It is something that would not have been possible before the digital world came about. I think we’ll be seeing much more of this in the future.”
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