An offshore financial centre (or OFC), although not precisely defined, is usually a low-tax, lightly regulated jurisdiction which specializes in providing the corporate and commercial infrastructure to facilitate the use of that jurisdiction for the formation of offshore companies and for the investment of offshore funds.

The term offshore financial centre is a relatively modern neologism, first coined in the 1980s. Although the terms are not synonymous, many leading offshore finance centres are regarded as “tax havens”, and the lack of precise definitions often leads to confusion between the concepts. In Tolley’s International Initiatives Affecting Financial Havens the author in the Glossary of Terms defines an “offshore financial centre” in forthright terms as “a politically correct term for what used to be called a tax haven.” However, he then qualifies this by adding “The use of this term makes the important point that a jurisdiction may provide specific facilities for offshore financial centres without being in any general sense a tax haven.”

Offshore financial centres are often (but not always) current or former British Colonies or Crown Dependencies, and often refer to themselves simply as offshore jurisdictions.

The term is fluid to a certain extent, and it has been remarked more than once that whether a financial centre is characterized as “offshore” is really a question of degree.

The IMF considers the following to be characteristics of an offshore financial centre:

  • Jurisdictions that have relatively large numbers of financial institutions engaged primarily in business with non-residents;
  • Financial systems with external assets and liabilities out of proportion to domestic financial intermediation designed to finance domestic economies; and
  • Centres which provide some or all of the following services: low or zero taxation; moderate or light financial regulation; banking secrecy and anonymity.

Views of offshore financial centres tend to be polarised. Proponents suggest that reputable offshore financial centres play a legitimate and integral role in international finance and trade, offering huge advantages in certain situations for both corporations and individuals, allowing legitimate risk management and financial planning.

Critics argue that they drain tax from wealthy (and not so wealthy) nations, are insufficiently regulated, and facilitate illegal activities such as tax evasion and money laundering while avoiding legal risk under corporate veil.

Proponents point to the tacit support of offshore centres by the governments of the United States (who promote offshore financial centres by the continuing use of the FSC) and United Kingdom (who actively promote offshore finance in Caribbean dependent territories to help them diversify their economies and to facilitate the British Eurobond market).

OPIC, a U.S. government agency, when lending into countries with underdeveloped corporate law, often requires the borrower to form an offshore vehicle to facilitate the loan financing. One could argue that US external aid statutorily cannot even take place without the formation of offshore entities.

What is certainly true of offshore financial centres is that recently they have attracted a great deal more attention than in the past, and international initiatives spearheaded by the OECD, the FATF and the IMF have had a significant effect on the offshore finance industry. A number of smaller, less regulated jurisdictions figuratively went to the wall, and closed up shop. Most of the principle offshore centres that remained considerably strengthened their internal regulations relating to money laundering and other key regulated activities. On 23 February 2007 The Economist published a survey of offshore financial centres; although the magazine had historically been very hostile towards OFCs, the report represented a shift towards a very much more benign view of the role of offshore finance, concluding: “…although international initiatives aimed at reducing financial crime are welcome, the broader concern over OFCs is overblown. Well-run jurisdictions of all sorts, whether nominally on- or offshore, are good for the global financial system.”

EU withholding tax

The European Union has recently made a large number of offshore financial centres (Barbados and Bermuda being the notable exceptions) sign up to the European Union withholding tax and exchange of information directive. Under those regulations, brought into force by local law, banks in those jurisdictions which hold accounts for EU resident nationals must either deduct a 15% withholding tax (which is split between the offshore jurisdiction and the country of the national’s residence), or permit full exchange of information with the country of the national’s residence.

A number of larger jurisdictions which are also sometimes considered as being offshore (notably Hong Kong and Singapore) refused to sign up to the directive.

Although recently new, anecdotal evidence suggests that the effect of the withholding tax has been limited, although it is disputed whether this is because the regulations lacked effectiveness, or because the predicted amount of funds in offshore bank accounts transpired to have been greatly exaggerated. Similarly, the widely predicted capital flight to Hong Kong and Singapore appears not to have materialised. It has also been suggested that the regulations implemented were simply too basic, and relatively easy to circumvent in jurisdictions familiar with putting together sophisticated financial structures.

However, a ruling by the Special Commissioners in the United Kingdom in May 2006 indicated that the Revenue authorities can still compel UK based banks to release information in relation to offshore bank deposits where illegality is suspected, even where the customer had elected to pay a withholding tax rather than to exchange information.

OECD List

In a report issued in 2000, the Organisation for Economic Cooperation and Development (OECD) identified a number of jurisdictions as tax havens according to criteria it had established. Between 2000 and April 2002, 31 jurisdictions made formal commitments to implement the OECD’s standards of transparency and exchange of information.

Seven jurisdictions (Andorra, The Principality of Liechtenstein, Liberia, The Principality of Monaco, The Republic of the Marshall Islands, The Republic of Nauru and The Republic of Vanuatu) did not make commitments to transparency and exchange of information at that time and were identified in April 2002 by the OECD’s Committee on Fiscal Affairs as unco-operative tax havens. All of these jurisdictions subsequently made commitments and were removed from the list of unco-operative tax havens. Nauru and Vanuatu made their commitments in 2003 and Liberia and the Marshall Islands in 2007.

After G20 leaders agreed to crack down on tax havens on during 2009 G-20 London Summit in April 2009, the OECD published a list of countries that still needed to implement internationally agreed tax standards.

In May 2009, the Committee on Fiscal Affairs decided to remove all three remaining jurisdictions (Andorra, the Principality of Liechtenstein and the Principality of Monaco) from the list of uncooperative tax havens in the light of their commitments to implement the OECD standards of transparency and effective exchange of information and the timetable they set for the implementation. As a result, no jurisdiction is currently listed as an unco-operative tax haven by the Committee on Fiscal Affairs.