Taxing Times For Tax Havens

Developed nations crack down on the Bahamas and its ilk

When SG Hambros, a British private bank, was looking to open an office to be closer to its trust and banking clients in Latin America, it considered New York and Miami. But after an exhaustive review, Hambros opted not to locate its Latin office in one of the U.S. financial centers, but in Nassau, the tiny capital of the Bahamas. After all, the island offered liberal trust laws, no income tax, frequent direct flights to the U.S., and, of course, balmy weather year-round. It also promised inviolable secrecy, with access to bank records given only to the signatories on the account. "There is no case where information [on a client] is going to be provided for fiscal reasons," says Pascal Hammerer, CEO of SG Hambros Bank & Trust (Bahamas) Ltd. and head of private banking for the Americas, in his office facing a tropical garden.

Such secrecy laws have been key to thriving tax havens such as the Bahamas. But the lucrative empire of ultraprivate banking in and around the Caribbean is now under siege. In recent months, the Bahamas and neighboring islands have come under attack from developed nations, which are threatening economic sanctions unless these regimes more seriously combat money laundering and behave more cooperatively when it comes to international tax investigations. In June, the Paris-based Organization for Economic Cooperation & Development (OECD), a group of 29 countries, including the U.S., denounced 35 jurisdictions around the world--among them the Bahamas, Barbados, the U.S. Virgin Islands, and 12 other Caribbean regimes--as engaging in "harmful tax practices."

And unless the Bahamas and others on the blacklist agree to revamp their current tax systems by next July, the developed nations are threatening to hit them with sweeping sanctions--everything from disallowing the large tax write-offs offshore companies typically take for business costs to ending double taxation accords, by which companies avoid paying taxes at home if they pay them at the offshore address. "This is all about providing a level playing field," says Jeffrey Owens, head of fiscal affairs for the OECD in Paris. "If you want to be in this business, you have to be competing by rules that are transparent."

TOUGH MOOD. The tough new mood at the OECD comes as Western officials grasp an unwanted side effect of globalization. National barriers are falling and capital is now able to move globally at a quicksilver pace. This has given rise to new levels of tax evasion--costing the developed world billions in tax revenues. Despite the rising level of tax payouts--or perhaps, because of it--the share of personal income taxes as a percentage of all taxes in OECD nations has fallen to 27%, vs. 31% in the early 1980s. In the U.S., the Internal Revenue Service is concerned about the growth of fraudulent foreign trusts. They typically consist of several layers of offshore trusts, and each layer distributes income to the next, reducing taxable income to small amounts and returning buckets of nontaxed income to the owner. "We have a major problem in our country right now with foreign trusts," says an IRS official.

The threats from Europe and the U.S. are blowing like gale-force winds through the Caribbean and its environs, which account for 20% of the $4.6 trillion in assets in offshore financial centers, says the International Monetary Fund. Bermuda and the Cayman Islands--both British territories--avoided the blacklist by agreeing in advance to exchange information on tax matters. But other jurisdictions such as Barbados and Bahamas refused to make prior commitments. Government officials bristle at the intrusion by what they perceive as an elite club of rich nations. They say they're now being penalized for following the advice of the World Bank, which has been counseling them to diversify beyond tourism and commodities and into more value-added services. "The Caribbean is certainly trying to attain the best international practices," says Maurice Odle, economic adviser to Guyana-based Caribbean Community & Common Market, a trade group. "What the Caribbean resents is having to do this under duress and with the threat of sanctions."

The prospect of sanctions would hit particularly hard in the Bahamas, an archipelago known for its turquoise seas, sandy beaches, and pristine resorts. Roughly 3.5 million tourists flocked last year to port cities such as Nassau, where Fendi, Cartier, and other tony boutiques sit as a backdrop to festive street bazaars. While tourism still accounts for 40% of the island's $4.5 billion economy--one of the largest in the region--financial services are becoming an increasingly important sector, representing almost 20% of the Bahamas' economic activity. More than 400 banks and trust companies have offices there, as well as 600 mutual funds. Together, these institutions now manage nearly $600 billion in assets.

INCREASING PRESSURE. While the government imposes steep import duties--which can run as high as 75% for a car costing $25,000 and higher--and generates millions in fees from the island's financial institutions, it imposes no taxes on corporate profits, retail sales, capital gains, or income from inheritances. "In order for foreign investment to come to your country, you have to make it attractive. This is not a fly-by-night tax policy," says Joshua Sears, Bahamas' ambassador to the U.S., who denounces the OECD offensive as retribution against the smaller countries' competitive tax regimes. Insists Hambros' Hammerer: "The way we do business here is no different from how we do it in London, Paris, or New York. I go to jail in the Bahamas if I don't report a suspicious transaction."

What the OECD wants most is for the countries on the blacklist to enter into tax-information exchange pacts, which would force the tax havens to cooperate with investigations by the larger governments chasing down their citizens' fortunes. Since the Bahamas has no income tax, it has no such accord with any country. For years, the U.S. has pressured the Bahamas to enter into a tax treaty, to no avail. But now the pressure is intensifying, and private attorneys expect the Bahamas to accede to U.S. wishes for access to bank records. On that, the Bahamas may have no choice, because all U.S. dollar payments come through New York. A U.S. freeze on those assets "could put us out of business," says Lennox Paton, a Nassau attorney.

For all its bluster, the Bahamas is showing signs of giving in on some issues. The government just passed an act enabling outside jurisdictions to get information on cases before they go to court. It also is forming a financial intelligence unit to probe suspected money laundering and is reviewing laws that make it difficult for authorities to trace the true owners of companies.

But even if the OECD wins greater transparency, some experts believe the developed nations may still have trouble collecting on unreported gains--since it would, in effect, require a global police network to track down all the hidden treasure. And even then, illicit activity could simply shift to other locales, always staying one step ahead of the law. For countries such as the Bahamas, though, the sun could soon set on its freewheeling financial ways.

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