Finances... the art of keeping as much money as possible to your own and taking as much as
possible from someone else without ending behind bars or getting killed in the process.
      — unknown

Money Circulation

Inbound

Payment Model

Payment Processing Software/Framework

There is a dedicated page that goes into detail about the subject.

Electronic Payment

Payment Providers

Outbound

Payroll System

Visa Payroll Card

From the PDF...

Operational

Visa Payroll card transactions are processed through VisaNet®. When a card is used to Considerations make a purchase or obtain cash, a message is sent to the Visa Prepaid card processor. The processor authorizes the transaction and deducts the amount from the card’s prepaid value. You must establish a link with an authorized Visa Prepaid processor and work with your processor to customize your Visa Payroll card Web site interface.

Investments / Investors

Venture Capital

Taxes

Offshore Financial Centres

With this section, I am going to provide an unbiased view on OFCs (Offshore Financial Centres), their weaknesses and their strengths, their dangers and their good impacts on local and global economy. Bottom line pretty much is, that OFCs have been come into critics because of a few black sheeps which is absolutely not justified since OFCs are important and a blessing to our economies if well-regulated and globally harmonized. OFCs are good if used properly!

OFCs, to safeguard wealth, philanthropy, the freedom to conduct business
anywhere at any times with anyone and prevent governments from becoming
bloated by taking advantage of markets they control entirely...
      — The wise man

What exactly is an OFC?

At its broadest, it is any financial centre that takes in a large chunk of foreign funds — in other words, almost every financial capital in the world is an OFC. Much of the business conducted in places such as New York, London or Hong Kong is from outside America, Britain or China.

Britain is arguably one of the biggest personal-tax havens in the world. So-called resident non-domiciles... that is, people who live in Britain but claim domicile abroad — do not have to pay tax on offshore income. America, for its part, soaks up huge amounts of offshore cash because it taxes little of the money held in its banks by non-resident foreigners. Foreigner's bank deposits in America add up to $2.5 trillion, well over twice as much as those in Switzerland.

As most People understand the term OFC

But as most people understand the term, OFC (Offshore Financial Centre) means a smaller jurisdiction where the lion's share of the institutions are controlled by non-residents and many of them are in the financial sector or set up for financial reasons. The volume of business conducted by these financial institutions often far outstrips the needs of the local economy.

When OFCs combine all these attributes with a low- or no-tax regime they are tagged as tax havens, especially if they also have strict banking-secrecy rules, light supervision and a slack grip on business within their borders. Panama, for instance, still allows bearer shares that can be anonymously owned and traded.

The FSF (Financial Stability Forum), a group that monitors threats to the global financial system, has put together a list of 42 jurisdictions that it defines as OFCs. The OECD (Organisation for Economic Co-operation and Development) in 2000 compiled a narrower list of 35 tax havens. There is a great deal of overlap between the two.

A matter of Degree

Dividing the world into onshore and offshore financial centres is difficult because it is a matter of degree, not substance, says one European bank regulator. For example, many people consider Bermuda an OFC, but it is packed with actuaries pricing reinsurance risks. Jersey, where the financial sector accounts for over half of all tax revenues, is home to a sophisticated banking industry, co-operates with other governments on tax matters and requires banks and other licensed institutions to have a real presence on the island.

More confusingly, some jurisdictions straddle both categories. One example is Luxembourg, a tiny country sandwiched between Belgium, France and Germany and one of Europe's most important financial centres. A founder-member of the EU, Luxembourg is considered a well-managed, soundly regulated financial centre with real expertise. It is home to more than 2,200 investment funds with almost €1.8 trillion under management. It is also the euro zone's biggest private-banking centre. The financial-services industry contributes a third of Luxembourg's output and, including its indirect contribution (accountants, lawyers and the like), supplies around 40% of Luxembourg's tax take.

Luxembourg is sometimes lumped with tax havens because of various scandals involving companies based there, including the notorious BCCI and, more recently, Clearstream. But although Luxembourg got most of the bad press, BCCI was operated out of London and Clearstream is mainly a French affair.

Ireland and Singapore are big in manufacturing but also have thriving financial centres that cater to offshore business. Singapore has strict rules on banking secrecy and does not consider foreign tax evasion a crime. Some people consider Switzerland as a tax haven because of its low tax rates and its fabled banking secrecy.

But onshore economies can be opaque too. A report issued by a government agency in America last April found that few states collect information on the true owners of companies set up within their borders. Delaware and Nevada are particularly lax. For more information about what jurisdictions are considered being a OFC please take a look at this list.

Well-regulated or not

Mr Owens at the OECD prefers to differentiate between well and poorly regulated financial centres rather than onshore or offshore ones. Well-regulated centres co-operate with foreign tax and other authorities and have sound supervision. Poorly regulated ones hide behind secrecy. Low or no taxes on their own, says Mr Owens, do not constitute a harmful tax practice.

OFCs - Blessing or Curse?

Offshore financial centres are booming, thanks to their easy-going tax regimes. But the best of them are more than tax havens — they are good for the global financial system, argues Joanne Ramos.

If the deal over North Korea's nuclear-weapons programme holds, Kim Jong Il may be able to indulge his penchant for fine wines and Hollywood blockbusters again. Banks around the world had severed ties with North Korea after America last September blacklisted a Macau bank accused of doing business with the hermit kingdom, making foreign money tighter for the Great Leader. But a move towards more normal relations with America could help restore the flow.

The financial system is modern warfare's newest front. In a globalised economy money moves instantly and anonymously across borders. This can benefit terrorists, drug traffickers and rogue nations in need of cash. Keeping such customers out of the world's sprawling financial system is becoming ever harder.

Financial regulators have another big concern. Footloose capital transmits not just tainted money but financial crises too. The huge growth in the use of esoteric derivatives and the rise of hedge funds have made it increasingly difficult to understand where financial risk lies, partly because much of it is hidden away on islands with variable supervision.

But the most vexing problem that highly mobile financial flows pose for governments is that when they cross borders they may take tax revenues with them. This is particularly serious for rich Western countries with ageing populations that they will have to support in retirement. Such countries have launched a raft of initiatives to strengthen the international financial system against the undesirable side-effects of financial globalisation:

• financial crime
• financial contagion and
• tax evasion.

The idea is to prod financial centres worldwide to adopt international best practice on bank supervision, the collection of financial information and the enforcement of money-laundering rules.

One group has become the object of special scrutiny: OFCs (Offshore Financial Centres). These are typically small jurisdictions, such as Macau, Bermuda, Liechtenstein or Guernsey, that make their living mainly by attracting overseas financial capital. What they offer foreign businesses and well-heeled individuals is

• low or no taxes
• political stability
• business-friendly regulation and laws, and above all
• discretion

In more detail:

The motivations for individuals and corporations to utilise offshore planning and offshore companies include the desire to:

• Reduce tax
• Protect assets
• Manage risk
• Maintain privacy
• Avoid bureaucracy
• Reduce costs
• Enhance assets.

Reasons for going Offshore — More broadly, the reasons for going offshore and utilising offshore companies for tax planning and offshore business include:

• Free remittance of profits and capital
• Access to top-rated debt history jurisdictions
• Access to tax treaties
• Security of property rights
• Accessing low cost areas
• Banking privacy
• Availability of offshore experts
• Access to foreign insurance and reinsurance
• Enhanced privacy
• Customs and duty exemptions
• Exchange convertibility
• Government cooperation
• Fair treatment
• Territorial taxation on foreign income
• Fewer restrictions
• Sanctity of contracts
• Foreign investment inducements
• Tested legal systems
• Higher yields and returns
• The availability of sophisticated banking facilities
• Reduced taxation
• The search for political stability

Offshore Companies Applications — The principal uses of offshore companies are:

• Trading
• Investment
• Holding
• Financing
• Professional services or consultancy
• Patent, royalty and copyright holding
• Ship management and yacht owning
• Personal and corporate tax planning

Big, rich countries see OFCs as the weak link in the global financial chain. In the past OFCs have indeed permitted various dodgy doings. Critics think their dependence on foreign capital encourages them to turn a blind eye to crime and corporate fraud within their borders. Sani Abacha of Nigeria, Mohammed Suharto of Indonesia and Ferdinand Marcos of the Philippines are just a few of the corrupt leaders who have looted their countries, helped by the secrecy offered not just by certain tax havens but also by some onshore financial centres, a point often ignored by the OFCs' critics. Some of the money used for the terrorist attacks of September 11th 2001 was funnelled through Dubai, which has recently set itself up as a financial centre. The accounting scams at Enron, Parmalat and Tyco were made easier by complicated financial structures based in OFCs (though, again, also in onshore centres such as Delaware).

Tax Wars

But the most obvious use of OFCs is to avoid taxes. Many successful offshore jurisdictions keep on the right side of the law, and many of the world's richest people and its biggest and most reputable companies use them quite legally to minimise their tax liability. But the onshore world takes a hostile view of them. Offshore tax havens have declared economic war on honest US taxpayers, says Carl Levin, an American senator. He points to a study suggesting that America loses up to $70 billion a year to tax havens.

The Tax Justice Network, a not-for-profit group that is harshly critical of OFCs, reckons that global tax revenues lost to OFCs exceed $255 billion a year, although not everybody believes it. Canadians were alarmed by a government report showing that Canadian direct investment in OFCs increased eightfold between 1990 and 2003, to C$88 billion ($75 billion) — a fifth of all Canadian direct investment abroad. The bulk of this was in financial services, mostly in a few Caribbean countries.

Business in OFCs is booming, and as a group these jurisdictions no longer sit at the fringes of the global economy. Offshore holdings now run to $5-7 trillion, five times as much as two decades ago, and make up perhaps 6-8% of worldwide wealth under management, according to Jeffrey Owens, head of fiscal affairs at the OECD. Cayman, a trio of islands in the Caribbean, is the world's fifth-largest banking centre, with $1.4 trillion in assets. The BVI (British Virgin Islands) are home to almost 700,000 offshore companies.

All this has been very good for the OFCs' economies. Between 1982 and 2003 they grew at an annual average rate per person of 2.8%, over twice as fast as the world as a whole (1.2%), according to a study by James Hines of the University of Michigan. Individual OFCs have done even better. Bermuda is the richest country in the world, with a GDP (Gross Domestic Product) per person estimated at almost $70,000, compared with $43,500 for America. On average, the citizens of Cayman, Jersey, Guernsey and the BVI are richer than those in most of Europe, Canada and Japan. This has encouraged other countries with small domestic markets to set up financial centres of their own to pull in offshore money most spectacularly Dubai but also Kuwait, Saudi Arabia, Shanghai and even Sudan's Khartoum, not so far from war-ravaged Darfur.

Globalisation has vastly increased the opportunities for such business. As companies become ever more multinational, they find it easier to shift their activities and profits across borders and into OFCs. As the well-to-do lead increasingly peripatetic lives, with jobs far from home, mansions scattered across continents and investments around the world, they can keep and manage their wealth anywhere. Financial liberalisation — the elimination of capital controls and the like — has made all of this easier. So has the Internet, which allows money to be shifted around the world quickly, cheaply and anonymously.

The growth in global financial services has helped too. Financial services are in essence the business of managing data. It is zeros and ones, says Urs Rohner, the chief operating officer of Credit Suisse, a Swiss bank, adding that in no other industry do you see the impact of globalisation as enormously and dramatically as in finance. This is because these zeros and ones can be traded, structured, lent and sold anywhere. Profits can be booked almost anywhere, too, and are increasingly being shifted to OFCs.

The growing importance of the financial-services industry in many economies means that a greater chunk of profits — and tax liabilities — are easily moved offshore. A paper published last year by Alan Auerbach of the University of California at Berkeley found that whereas in 1983 financial corporations accounted for only about 5% of all corporate-tax revenues in America, between 1991 and 2003 they made up roughly a quarter.

The taxman also has to worry about non-financial companies that are acting like financial ones. The main profit engine for General Electric, a large American conglomerate that makes everything from jet engines to plastics, is its finance division. Non-financial companies run pension funds and stock-option plans for their employees across the world, manage their corporate treasuries in myriad currencies and increasingly employ esoteric financial products such as derivatives to hedge risks and raise money. All of these activities can be set up in OFCs and often are, supported by an army of lawyers, accountants and investment bankers.

Parasites or Pioneers?

OFCs are often portrayed as financial parasites that survive by diverting tax and other revenues from real economies, offering a haven for tax cheats and money-launderers. Some of this undoubtedly goes on — but it goes on in big onshore economies as well.

Businessmen and wealthy individuals insist that OFCs can play a legitimate role in reducing tax liabilities. The business community in particular argues that in a fiercely competitive global economy where national tax regimes can vary widely, minimising tax payments is a competitive necessity and OFCs are one solution. OFCs themselves insist that they are specialist financial centres and have far more to offer than just low taxes.

The main argument against OFCs is that by allowing companies and affluent individuals to avoid taxes, they sap tax revenues from real countries, limiting those countries' ability to pay for public services and forcing them to tax less mobile factors such as labour, housing and consumption. The big risk is that globalisation is perceived to be rigged against the average citizen, says David Rosenbloom, formerly the international tax counsel at the Treasury Department in America.

Critics also worry that OFCs do not supervise business within their borders tightly enough, which gives crooks an opportunity to enter the global financial system and could allow sloppy practices that might spark wider financial crises. Certainly, as many OFCs themselves will admit, only a couple of decades ago regulation in many offshore jurisdictions left much to be desired and bad money found its way in with the good. OFCs argue that this has changed and their supervision is now at least as good as onshore, sometimes better.

Libertarians say that tax, regulatory and other competition is healthy because it keeps bigger countries governments from getting bloated. Others argue that OFCs may be an inevitable concomitant of globalisation. Even if today's OFCs were somehow stamped out, something like them would pop up to take their place, says Mihir Desai of Harvard Business School. Some academics have found signs that OFCs have unplanned positive effects, spurring growth and competitiveness in nearby onshore economies.

Should anything be done about OFCs? Countries try to discourage investment in tax havens through the tax code and pour resources into tracking down tax cheats. But this is a Sisyphean task — close one regulatory loophole and lawyers will open another one — convince one OFC to co-operate in the fight against tax evasion or financial crime and another will take its place.

International organisations have launched various initiatives to try to get OFCs to tighten supervision, co-operate more with foreign governments to catch tax cheats and, at least in Europe, eliminate harmful tax practices. OFCs think such initiatives are designed to force them out of business. The countries that set these standards are an oligopoly trying to keep out smaller competitors. They are both players and referees in the game. How can they be objective?, asks Richard Hay, a lawyer in Britain who represents OFCs.

What is clear is that globalisation has changed the rules of the game. It has produced many benefits for rich countries, but has also provided more opportunities for tax leakage, which explains their anxiety over OFCs.

OFCs, for their part, have by and large done well out of globalisation. Two decades ago, they were mainly passive repositories of the cash of large companies, rich individuals and rogues. Some jurisdictions still ply this trade today and should be put out of business. But the best of them — for example, Jersey and Bermuda — have become sophisticated, well-run financial centres in their own right, with expertise in certain niches such as insurance or structured finance.

This special report will argue that 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.

Offshore Finance - What it takes to succeed

The Jersey cow, a small, honey-brown bovine that is prized by farmers for the abundance of buttery, high-fat milk it produces, is one of the fastest-growing breeds in the world. From its origins in Jersey, a rocky island 14 miles (22km) off of the western coast of France, it now wanders fields in over 100 countries from South Africa to Latin America. It is Jersey's most famous export. But the island's real cash cow is financial services. Jersey's 46 banks, 1055 investment funds and over 200 trusts administer over £700 billion in assets on the island. In St Helier, Jersey's capital, they compete for office space with more than two dozen law firms, 50 accountancy outfits and 20 insurance companies.

Jersey's transformation into an OFC was not part of a grand plan. After the second world war Jersey's low taxes attracted the bank deposits of British expatriates living in the former colonies. The island's maximum rate of income tax of 20% had remained untouched since 1940 when it was set by the German occupiers.

But tax was only the beginning. Jersey used its role as a low-tax repository of cash to build up a sophisticated private-banking and trust business. More recently it has moved into the corporate businesses structured finance, the administration of investment funds, the management of company share plans and the like.

Other OFCs developed in similar ways. Many of them are small territories that were once part of Britain (a number of them are still dependencies). Often they had a history of low or no taxes long before they began to attract the deposits of British expatriates and others. As money flowed in, the cleverer ones began to diversify into more sophisticated businesses. They also began to promote themselves as broad financial centres, not just banking ones. This suited Britain, because it meant its protectorates could become self-sufficient. It also suited the jurisdictions themselves. Financial services are lucrative and provide a much more stable income than crops and fickle tourists. Mauritius hoped to diversify away from sugar, textiles and tourism and attract skilled labour when it launched itself as a financial centre in 1992. Barbados, a poor country reliant on sugar, received help from the IMF and other agencies when it established its financial industry in the 1970s.

Given the attractions, why are there not even more OFCs? After all, cutting taxes to attract foreign capital seems an easy way out of poverty. A study published last December by Mr Hines and Dhammika Dharmapala of the University of Michigan looked at 209 countries and territories, including 33 tax havens, to see why some jurisdictions become tax havens and others do not. Those that do, they found, are overwhelmingly small, wealthy and, especially, well governed, with sound legal institutions, low levels of corruption and checks and balances on government. Badly run jurisdictions cannot attract or retain foreign capital, so many do not even try. Slashing tax rates is not nearly enough.

This may explain why the British empire spawned so many successful OFCs. These jurisdictions inherited strong legal and governmental institutions that reassured investors. Lingering ties to Britain probably helped, too. The appeals process in the BVI and Jersey, among other OFCs, ends up in Britain. Other jurisdictions that have tight cultural or linguistic ties to nearby large financial centres also benefit from a ready clientele happy to do business in a familiar place. Liechtenstein, for instance, does well out of being perched next to Switzerland and using the Swiss franc as its currency.

Whiter than White

Being a successful OFC is tougher than it used to be. The best-run of them compete not only with offshore rivals but also, in certain industries, with onshore ones. Bermuda's biggest competitors in captive insurance (of which more below) are Vermont and South Carolina.

The costs of running OFCs have also increased. Complying with the raft of international standards for financial services introduced since the late 1990s involves a lot of effort. And as standards rise, more is expected of the public companies that use OFCs as well. They must not only make profits, but be good corporate citizens too: paying bosses enough but not too much, for instance, making sure their operations in poor countries are run ethically (no child labour, no sweatshops) and steering clear of shady jurisdictions. So OFCs that are careless about their reputation may find themselves shunned by the big, listed multinationals that are their lifeblood.

OFCs complain that the bar is set higher for them than for their onshore counterparts. When Stanley Works, an American toolmaker, announced in 2002 that it was moving its headquarters to Bermuda, it caused a furore. Along with other firms that had moved to tax havens, including Tyco and Ingersoll Rand, it was pilloried as unpatriotic, even though it was acting entirely legally. Partly as a result, new American captive-insurance businesses now often stay onshore. A regulator in Europe comments: Tax havens have to be whiter than white. It is the only way to shake off their bad reputation—which some of them deserved not too long ago.

Being whiter than white does not come cheap. Introducing anti-money-laundering and other regulations, beefing up bank supervision and tracking down financial crooks takes money and expertise. A paper published last August by the Commonwealth Secretariat, a group of 53 former members of the British Empire, estimated that in 2002-2005 the direct cost of new regulations for Barbados was $45m and for Mauritius $40m — big numbers for tiny islands with small budgets. The indirect hit could be even bigger. For example, the number of offshore banks in Vanuatu plummeted to 7 from 37 in a year after new rules required banks to open a permanent office with at least one full-time employee on the island. The paper concludes that for these three jurisdictions, the costs involved in meeting the new standards have exceeded...identifiable short- to medium-term benefits.

The start-up costs for new OFCs are also much higher than they used to be. As one regulator in a tax haven explains, in the old days jurisdictions were able to build a critical mass of business before turning their attention to legal and regulatory structures. Many OFCs that opened their doors in the 1960s and 1970s have put in place anti-money-laundering systems only in the past few years, for instance. This means that some bad money came in with the good that had to be flushed out later.

These days new OFCs must invest in regulation, legislation and enforcement up front. That explains why some of the newer ones are wealthy countries that can afford to do this. Dubai, for example, has spent billions of dollars setting up the legal and supervisory systems to underpin its new financial centre. A big chunk of this money was spent on hiring regulators, mostly from Britain.

Some countries have decided that all this is more trouble than it is worth. Tonga, Niue and Nauru, three miniscule islands in the Pacific Ocean, have quit offshore banking to avoid the cost of meeting international standards, as, in effect, have the Cook Islands.

Getting down to Business

So what does it take to run a successful OFC? First and foremost, you need a tax system that foreign capital finds attractive but still pays the bills. The model that most OFCs choose keeps corporate taxes low or does away with them entirely but makes up for this through a combination of indirect taxes and fees, which are in any event easier to collect.

Regulation, too, is critical. It must be necessary, appropriate and proportional...and benefits [must] outweigh costs, asserts Timothy Ridley, chairman of the Cayman Islands Monetary Authority. That applies not only to OFCs but also to big financial centres such as New York and London. The job is never easy, but a risk-based supervision regime, which most OFCs use, is more manageable in small jurisdictions because supervisors tend to know most of the movers and shakers. Moreover, in such places regulators tend to be easy to reach and take the gripes of the business community seriously. Regulators in Singapore, for instance, habitually consult local businesspeople to see how they can improve co-operation. Their clients say this is not just public relations. They are willing to listen and change. They are not rigid like regulators in Japan and Korea, says one banker at a British firm.

In the nature of things regulation in small OFCs can also be simpler than in big countries. In America, for instance, a national insurer may find itself being regulated by each of the 50 states. In Bermuda, by contrast, you can focus simply on running a sound business and making money — not on red tape, says Karole Dill Barkley, an insurance consultant.

More importantly, many OFCs are involved mainly in wholesale rather than retail business. Of the Cayman Island's $1.3 trillion in bank deposits, 93% are interbank bookings, not personal or corporate accounts. The 8,000+ hedge funds domiciled in Cayman cater only to rich, sophisticated investors able to look out for themselves, so regulators do not have to worry about protecting widows and orphans and can streamline procedures. In the BVI hedge funds can be set up and registered within a couple of days.

The two pillars of Bermuda's insurance industry — captive insurance and reinsurance — also cater to sophisticated businesses only. Captives are set up by companies (or groups of them) to lower their insurance bills by covering predictable risks themselves. British Airways, for instance, until recently had a captive in Bermuda that insured its aviation and other risks. Because no third parties are involved, regulators in Bermuda apply a lighter touch. Reinsurers underwrite part of the risks of other insurance companies. They are subject to stricter disclosure rules in Bermuda because, under many contracts, unrelated third parties are at risk.

One way OFCs maintain a light touch is to involve auditors and other service providers in regulation. Jeremy Cox, the supervisor of Bermuda's insurance industry, describes the island's way of doing things as practical regulation that tries to use the experience of industry. Bermuda also puts some of the regulatory onus on independent auditors, who must sign off on insurer's annual filings and confirm that they meet minimum liquidity and profitability standards.

In Cayman all regulated or licensed professions — including lawyers, auditors, fund administrators and auditors, insurance providers and service providers for trusts — are required to blow the whistle if they suspect that something untoward is going on. This is separate from the money-laundering rules.

Be nimble, be Quick

For all OFCs one of the advantages of being small and predominantly reliant on the finance industry is that they can change existing rules and laws quickly to react to new opportunities. Inevitably this takes much longer in big, diversified economies, where any change in the status quo involves difficult negotiations among an assortment of interest groups.

Thanks to its nimbleness, Singapore has been able to score a number of successes against Hong Kong, its slower-moving rival. New trust laws in Singapore that came into effect a year ago have prompted Hong Kong to re-examine its own. Singapore was also ahead of Hong Kong in passing legislation on real-estate investment trusts (REITs), a relatively new investment class in Asia that has been growing rapidly, fuelled by the local property boom. We are small in a big world. We survive because we stay ahead of the region, says Kelvin Chan, a former government official who is now with the Partners Group, a Swiss private-equity firm. In this, being small is our strength.

Luxembourg manages to move quickly even though it is part of the EU and must comply with all EU directives, which have become increasingly onerous over the years. Luxembourg dominates the market for a type of investment fund called UCIT, similar to mutual funds, that complies with stiff requirements so that it can be sold freely throughout Europe. This is because it was the first country to incorporate the UCIT directive into law in the 1980s.

Being quick on one's feet is important for OFCs not only because competition is fierce but because many offshore products are easily commoditised. There is nothing particularly special about a Cayman-domiciled hedge fund, for instance — indeed more offshore hedge funds are domiciled there than anywhere else, and lawyers have so much practice that they can quickly set up another one. Hedge-fund managers themselves look for safety in numbers. You go there because everyone else does, says one New York investor. BVI companies are popular in Asia for much the same reason: they are familiar, they work, and everybody else uses them.

OFCs with critical mass and expertise in certain niches often act as subcontractors for financial institutions in big onshore centres in the same region. Investment bankers in London, for instance, often work with bankers in Jersey on mergers and acquisitions. Bankers and lawyers in Cayman work with the lawyers of American multinationals on structured-finance transactions.

Such expertise helps OFCs to beat off the competition. Bermuda's reinsurance market is flourishing because it relies on a network of brokers, underwriters and actuaries that would be hard to replicate. By contrast, fund administration — in essence, the back-office work for investment funds — which thrives in Dublin, Jersey, Luxembourg, the Isle of Man and elsewhere, has become commoditised for run-of-the-mill equity funds. This is one reason why so many OFCs are fighting over hedge-fund business. Administering these funds requires expertise in areas such as valuing illiquid instruments and complex securities such as derivatives, so margins are fatter and clients tend to stick around.

But small jurisdictions sometimes find it difficult to attract and retain the people to provide the expertise. OFCs in balmy climates or close to onshore economies do better than tiny islands floating in the middle of the South Pacific. Proximity to real economies makes it easier to lure those experts (almost always expatriates), and clients also like the convenience of being in the same time zone as their OFC and talking to people in their own language.

Some islands are running out of space. Jersey, for instance, imposes strict housing restrictions. Bermuda is facing even greater strains on its capacity. Households are limited to owning one car to cut down on traffic, so affluent businessmen can be seen zipping to work on motorscooters. Getting permanent residency in Bermuda is difficult and house prices are vertiginous, not least because unlike most other OFCs Bermuda is the home base of many huge global businesses with large numbers of employees.

The influx of well-paid expatriates who drive up the cost of living can cause tensions with the local population. Kurt Tibbetts, a government minister in Cayman, says his government works on preserving social harmony by pouring money into education. Bermuda quietly pursues affirmative-action policies that give locals first refusal of any jobs before expatriates can be considered. For the leading OFCs, success comes with its own headaches.

Moving Pieces

Global companies have plenty of latitude to minimise their tax bills...

It was as if America had swallowed Sweden. Since George Bush signed into law a one-off tax amnesty in 2004 that slashed corporate-tax rates from 35% to just over 5%, American companies have repatriated close to $350 billion in previously untaxed foreign profits, according to estimates by JPMorgan, a bank — just shy of Sweden's annual output. Pfizer, a drugs company, alone brought home an eye-popping $38 billion. Well over $150 billion of American companies' foreign profits still sit offshore.

Companies all over the world are increasingly global. They are also facing ever fiercer competition at home and abroad, which makes them increasingly sensitive to costs — including the costs of regulation and tax. That is good for OFCs, often the low-cost middlemen of international financial transactions.

The way companies use OFCs has changed over the years. A few decades ago, before the telecoms revolution made it easy to shuffle money around the globe, companies used OFCs primarily because they had less onerous financial rules. The links between banks in Cayman and those in America, for instance, are rooted in a long-standing American rule barring banks from paying interest on commercial chequing accounts. To get around this, many American banks set up sweep accounts that electronically funnel money to Cayman for an interest-earning overnight stay before being swept back home. Cayman takes advantage of a legitimate loophole — and the financial system is none the weaker for it, says one regulator in Europe.

Luxembourg got established as a financial centre four decades ago partly because it had looser lending rules than other European countries such as Germany, says Fernand Grulms of the Luxembourg Bankers Association. A Luxembourg subsidiary of a German bank could make over twice as many loans for the same amount of equity as its parent. Scandinavian banks were drawn to Luxembourg because they could deal in foreign currency there, which at the time was prohibited at home.

Regulation still matters. In Europe many countries, including Germany, France and Italy, until recently did not allow onshore hedge funds, says Tom Whelan of Greenwich Alternative Investments. That gave offshore hedge funds a chance to establish themselves. In America three-quarters of onshore hedge funds have offshore clones, mainly because hedge funds with foreign investors, who are not required to pay taxes on their hedge-fund investments in America, would still need to file America's unwieldy tax returns if they invested onshore.

These days the main attraction of OFCs for companies is the prospect of lower tax bills. Because of fierce global competition, being as tax efficient as possible is just as important as keeping down labour costs and overheads, which often entails a different kind of offshoring.

In extreme cases companies have moved their headquarters to a tax haven to slash tax bills. In America new rules were introduced a few years ago to stop such corporate inversions, and have recently been tightened further. But a clutch of British insurers, including Hiscox and Omega Underwriting, have recently moved to Bermuda to minimise tax.

Most companies have gone for a half-way house, staying but using OFCs to cut their tax bills. To understand how this is done, a quick tax tutorial is in order.

Broadly speaking, countries opt for one of two kinds of tax system. The first taxes companies and people on their worldwide income, irrespective of where it was earned. This method is used by America, Britain and Japan, among many others. To avoid double taxation, a company receives a credit for the taxes it pays to foreign governments up to the amount it would have paid had it remained at home.

The second, simpler method, called the territorial or exemption system, taxes only profits earned in the home country. This system is used by the vast majority of OECD countries, including France, Canada and Switzerland. For example, France would tax Total, the energy company, on the profits it earns in France but not on those it earns in Venezuela or Kazakhstan.

For companies taxed under the worldwide system, the most straightforward way to use OFCs to minimise taxes is to send money offshore and keep it there, as Pfizer did. This is because countries that tax companies on worldwide profits do not present the tax bill for foreign profits until these have been repatriated.

There are four other main ways in which companies can use OFCs to avoid tax, regardless of where they are based and what tax regime they fall under. The first three do not worry the taxman — the fourth gives him sleepless nights.

The first of the less worrying sort involves moving a physical business — such as a manufacturing plant — to a tax haven and then attributing as much profit to it as possible. Ireland is a prime example of this strategy in action. The second is setting up a company in a tax haven to tap its favourable tax-treaty network. Mr Owens of the OECD notes that the vast majority of foreign direct investment in India over the past decade has been channelled through nearby Mauritius because of its tax treaty with India. Cyprus's tax treaty with Russia makes it a favourite for companies investing in that country.

A third involves companies setting up in OFCs that are tax neutral — that is, the main attraction is avoiding extra layers of tax rather than avoiding tax bills. For example, an American mortgage-lender might sell a chunk of its mortgages, and the mortgage payments that go with it, to a Cayman company. This company would not make any profits — it would simply repackage the streams of mortgage payments into bonds and sell these to investors. In Cayman it would not be taxed, but onshore it might have been.

The Taxman's Nightmare

The strategy that gives the taxman nightmares involves shifting profits from high-tax to low-tax jurisdictions. This is done either by transferring a company's financial risk (and its potential future profits) to an OFC, or by exploiting the ambiguities of transfer-pricing rules which govern how multinationals divide up their profits among the countries they operate in.

An example of a risk-transfer scheme would be a company set up in Luxembourg to finance the research and development of a drug in high-tax Germany. Such a manoeuvre could cut both ways. If the drug were a success, profits would be booked in Luxembourg and taxed at a low rate. But if the drug bombed, the company would lose out on the higher tax losses it would have been able to book had it kept everything in Germany.

Financing companies of this type can be set up to pay for all sorts of initiatives that can later be credited with boosting profits to be taxed offshore — a big advertising campaign, investment in technology and the like. Companies can also structure loans between subsidiaries in high- and low-tax countries to achieve the same end.

Another way to minimise taxes is to shift the risk of joint ventures or other transactions offshore. Companies based in the BVI, for instance, are now the second-largest investors in mainland China after Hong Kong, says Robert Briant, a partner at Conyers Dill & Pearman, a law firm based in Bermuda. Many of these investments involve joint ventures.

The second big stick in the corporate treasurer's tax-avoidance armoury is transfer pricing. Companies have a lot of latitude in setting the price that subsidiaries charge each other for goods and services. This can shift profits away from high-tax countries by attributing higher expenses and lower profits to them. This is no small matter for tax authorities: an astonishing 60% of international trade takes place within multinational firms.

The question of where a company creates value, and thus where its profits should be taxed, is tricky at the best of times. Companies are increasingly managed on regional or even global lines, not national ones. It makes little sense to have a separate risk or research division each for France, Germany and Italy, for instance. And a large and growing chunk of the value companies create comes in the form of intangible assets such as patents or brands. These are hard to value as well as exceedingly mobile.

Most countries calculate transfer prices on the basis of what two independent companies would pay on the open market. But many services and intangible assets, say a unique patent or a global brand, do not have a market price, so it is hard to estimate what they are worth. That leaves ample room for quibbling — and, say the tax authorities, manipulation.

These schemes have deprived the taxman of a lot of revenue. A government report published in 2004 found that 61% of American companies paid no federal income tax during the boom years of 1996-2000. Much of this was thanks to moving profits — rather than actual business — to tax havens, reckons Martin Sullivan, editor of Tax Analysts. He looked at Internal Revenue Service data from 1998 to 2000 and found that profits before tax of subsidiaries of American companies during this period grew by $64 billion, or 45%, to $208 billion, with over half of this increase coming from low-tax countries, particularly Bermuda, the Bahamas, Denmark and Cayman. The average effective tax rate on the foreign profits of American multinationals during this period dropped from 24.2% to 20.8%.

Transfer pricing in particular is coming under increasing scrutiny. Mark Everson, the IRS Commissioner, told a group of senators last August that the challenges posed to the agency by transfer-pricing manipulation are acute and ever growing. Offshore abuses are a real problem. A study by Andrew Bernard of the Tuck School of Business at Dartmouth, Bradford Jensen of the Institute for International Economics and Peter Schott of Yale School of Management conservatively estimates that the IRS loses at least $5.5 billion and maybe as much as $30 billion from the manipulation of transfer pricing each year.

Such numbers have made tax authorities in America, Canada and Britain more belligerent. Late last year Merck, a drugs company, disclosed that it is facing four disputes with American and Canadian tax authorities that could cost it $5.6 billion in additional taxes and interest. Another drugs-maker, GlaxoSmithKline, last autumn settled a 16-year transfer-pricing dispute with the IRS for over $3 billion.

Some believe that the best way out for companies is to assign transfer prices according to a formula based on the number of people and amount of property they have in each country. But in practice this does not really make things easier, says Peter Merrill of PricewaterhouseCoopers. For a start, there is no common tax base in a common currency across countries, so there is no coherent pool of taxable profits to allocate by such a formula. Intangible property would still have to be valued. And the formula would probably not work for companies involved in a range of different businesses such as Toyota, which apart from making cars is also involved in businesses such as housing, financial services and biotechnology.

The real problem is that globalisation has rendered the current system of taxing multinationals archaic. Taxation is based on national boundaries, but companies operate across continents and can easily shift money and physical assets around. Until tax systems reflect that reality, the difficulties will persist.

Rich Pickings

In this world nothing is certain but death and taxes, Benjamin Franklin famously proclaimed. But for the well-heeled and well-advised, only the grim reaper is a dead certainty. The private bankers of the rich can find ways to structure transactions that greatly reduce their tax bills and sometimes eliminate them altogether. This often involves moving money offshore.

According to Boston Consulting Group, offshore private-banking assets total almost $6 trillion. Some of this wealth is stashed offshore for safe keeping by the well-to-do from politically turbulent parts of the world. But most of it is there to minimise taxes — sometimes legally, often not. Most OFCs do not levy capital-gains or inheritance taxes, nor taxes on passive income such as interest. Strict banking-secrecy rules in some of them can shield assets from the taxman as well as afford protection from unscrupulous governments. In a number of jurisdictions — including Switzerland, Luxembourg and Singapore — not paying taxes owed to foreign authorities is not a crime. Other OFCs, including many in the Caribbean, do not have any laws against tax evasion because they impose no income taxes.

How to defeat tax cheats...

These benefits have persuaded some prosperous people to set up house in sunny tax havens. Popular destinations include Monaco, a city-state of two square kilometres on the Riviera that Ringo Starr and Roger Moore call home, Switzerland, abode of Tina Turner and Boris Becker. Andorra, squeezed between France and Spain and various Caribbean islands.

Other jurisdictions are trying to elbow into this business, not so much to draw tax exiles as to attract entrepreneurs who bring with them (taxable) businesses and brainpower. Last year the Isle of Man capped income tax at £100,000, in the hope of convincing London investment managers of the charms of island living. Guernsey plans to impose a £200,000 cap.

Singapore is trying to edge out Hong Kong as a home for hedge-fund investors and bankers by offering permanent residency in two years or less and a low-tax, business-friendly environment, as well as a bit of fun. One problem we face is that hedge-fund managers are young and lively, a former government official explains, and compared with Hong Kong we are boring. So Singapore has recently reversed a law that banned dancing on bar-tops, opened a slew of new bars and restaurants and loosened restrictions on racy films.

Famous tax exiles make good headlines, but there are relatively few of them. Most of the rich would rather stay but moving only their assets to tax havens. One simple way to do this is to open a bank account in an OFC that does not tax interest payments. These are meant to be disclosed to the taxman at home, but often are not. Tax dodgers can tap these funds from afar by using debit and credit cards, although tax authorities are now cracking down on this.

One way to get round this is by setting up a trust. This involves putting money, property and other assets into an independent legal entity and designating someone reliable to manage it. Trusts had their origins in the Crusades. Knights would assign their land and other possessions to a trusted friend to take care of their affairs should they die abroad.

Trustworthy

These days users of trusts have more mundane motives. If a trust is set up in a tax haven, assets often accumulate in it free of tax as long as they remain offshore. Money can also be passed on to heirs through the trust, avoiding inheritance taxes. And trusts are a nifty way to protect assets from an angry spouse in the event of a divorce. Long popular in America and Britain, they have now caught on in Europe and, increasingly, Asia.

Another method by which the wealthy can squirrel some of their assets offshore is by setting up a company. It is a particularly straightforward way to hold disparate and worldwide assets — such as land, factories and investments — and transfer them to heirs or spouses, who can take a stake in the company. Such companies can be relatively simple to set up. BVI (British Virgin Islands), one of the cheapest places for doing this, gets a lot of business out of it.

The use of trusts and companies offshore can minimise some taxes — such as inheritance tax — and defer others, such as income tax, until the money is brought home. Both are standard tools in tax planning for the affluent. What has made them controversial is their lack of transparency. Most jurisdictions, including America and Britain, do not regulate trusts. Bermuda, Cayman, Jersey and the BVI do — a point of particular pride for OFCs — but it is still hard to get information on them. Companies are an even bigger problem, as they can be set up easily either onshore and offshore without much disclosure.

The number of people using these methods to minimise their tax bill is burgeoning. One reason is that there are many more rich people than there used to be. According to Boston Consulting Group, global wealth in 2005 increased by 8% to $88.3 trillion and the number of millionaire households (those with over $1m in assets under management) reached 7.2m.

The fastest growth came in the developing world — which arguably needs tax revenues even more than the rich countries do. Between 2000 and 2005 the number of millionaires in India and China increased by over 15% a year, followed by Brazil and Russia with 10%. Many wealthy people in such countries deposit money abroad because they fear tumult, or a grasping government, at home. The rich in Hong Kong, itself a low-tax jurisdiction, move assets offshore in part because they are wary of the Chinese government.

In developed countries OFCs are no longer the exclusive preserve of the very rich. The mass affluent too — dentists, doctors, prosperous small businessmen — are placing money offshore and putting a broader swath of the tax base at risk. Technology has played a big part in this. Anyone who types the words offshore bank account into an internet search engine will score over 1.7m hits, many of them offering advice on how to set up offshore bank accounts, trusts and companies, all at reasonable rates. Electronic banking is providing easier access to untaxed offshore funds. Promoters of tax havens are now also marketing their wares to a broader audience. Where once they advertised only in airline magazines handed out in first-class cabins, they have now embraced business class and, on some airlines, even economy class.

Affluent people these days also lead more cosmopolitan lives. Expatriate employees of multinational firms are likely to manage their financial affairs offshore, completely legitimately. So are owners of overseas holiday homes, who often deposit the rent in offshore bank accounts offshore without telling the taxman — definitely illegal, but often hard to track down.

Taxman Taxed

All of this makes the taxman's job harder, particularly in countries with worldwide tax systems. American tax authorities have waged war on abusive tax shelters — complicated transactions with no economic purpose other than avoiding tax — and the bankers, lawyers and accountants who sell them.

These are particularly damaging to government revenues because they are often standardised and sold to the wealthy by the thousands. The government not only has to unearth such inappropriate tax shelters but to convince the courts that even if they are technically legal they have pushed the boundaries too far.

America's Internal Revenue Service has notched up some big wins. Its biggest, in August 2005, was in a court case against KPMG, one of the world's top four accountancy firms. The IRS accused KPMG of peddling a series of tax shelters to rich investors, involving Cayman and other OFCs, which generated $11 billion in phoney tax losses and deprived the government of at least $2.5 billion in tax revenue. KPMG admitted to criminal tax fraud and paid $456m in fines. That sent a signal to tax accountants and lawyers everywhere to watch their step.

But rather than trying to bend the rules, many should-be taxpayers just hide. Given the current state of technology, this is relatively simple to do because bank accounts can easily be set up over the internet and used from afar. So the tax authorities have to go in through the back door. In 2000 the IRS convinced the American courts to grant it access to the details of thousands of credit- and debit-card accounts linked to (untaxed) offshore accounts in the Bahamas, Antigua and elsewhere, which allowed it to collect some $270m in tax.

The IRS hopes there will be even richer pickings to come. Last spring it won permission to inspect the records of customers of PayPal, eBay's online payment system, who have bank or payment-card accounts in tax havens. The IRS suspects that some of PayPal's 100m accounts worldwide are being used to dodge taxes by using money in offshore accounts to buy goods online.

Britain's Inland Revenue last year won a landmark case obliging Barclays, a British high-street bank, to hand over the bank details of hundreds of thousands of offshore accounts held by British residents. The Revenue estimates that this could yield up to £1.5 billion in unpaid taxes. Other British banks may hear from the taxman soon.

The Australian tax authorities, too, have cracked down on the use of payment cards to draw money from offshore bank accounts. They have reportedly found that over A$10m a day is leaving Australia for Jersey and Guernsey, the Caribbean and other OFCs.

British, American, Australian and Canadian tax authorities hope to unearth more such scams by joining forces. In 2004 they set up the Joint International Tax Shelter Information Centre (JITSIC) to share information on abusive tax shelters and their promoters. Critics complain that such invigilation will eventually lead to the establishment of a global super-cop with the power to pry, unchecked, into people's private affairs. They would prefer tax amnesties to persuade people to repatriate their money. But when this method was used by a handful of countries in continental Europe, the result — the repatriation of about $200 billion — was generally seen as disappointing.

Unintended Consequences

France has always taken pride in its refusal to embrace the harsher aspects of capitalism and globalisation — from its 35-hour work week to laws that make it difficult to sack employees. But in a global economy no one can sit still. In a new year's speech to labour unions and companies in January, Jacques Chirac, France's former president, called for cuts in France's corporate-tax rate from 33% to 20%, and as low as 10% for some companies. That is below Ireland's 12.5%, at which the French have often sniped in the past.

Yet it is OFCs that are seen as tax rogues, for two reasons. First, they are seen to be spurring tax competition among countries. True, some onshore economies are doing much the same, but OFCs use taxes to attract mobile financial capital (and profits) without any real business underpinning it. Second, OFCs are thought to be aiding tax evasion, the unlawful avoidance of tax. These two issues are often confused.

The less obvious uses of tax havens...

The risk of tax competition is that it could spiral out of control, starting a race to the bottom as real economies cut tax rates on mobile capital and transfer the tax burden to labour and other immobile factors in order to keep up with lower-tax competitors. This prompts other countries to follow suit — and so on and downward. In the bleakest scenarios social-welfare models would crumble because governments would be unable to pay for public services and there could be a backlash.

Poorer countries could also find it harder to compete on taxes, reinforcing the perception that globalisation is unfair. A recent paper by Harry Garretsen and Jolanda Peeters of the Central Bank of the Netherlands analysed annual data for 19 OECD countries from 1981 to 2001 and found that big, rich countries, such as Britain and Germany, were better able to resist tax competition and maintain high corporate tax rates than smaller, poorer ones. It concluded that if there is a race to the bottom, it seems that it is more real for some countries than others.

But for now that is still a big if. A stack of academic studies has documented that foreign investment is sensitive to tax rates, and Mr Garretsen and Ms Peeters found in their study that footlose capital did indeed lead to tax competition. A 1% increase in their measure of capital mobility was associated with a 0.5% drop in effective corporate-tax rates.

But this competition does not seem to have started a downward race. As a proportion of GDP, total tax revenues have increased steadily over the past 30 years even as statutory tax rates have fallen. This is true even in the EU, where drops in statutory tax rates have been particularly dramatic. Effective average corporate-tax rates have also fallen (see chart below). Yet according to a paper published last June by Gaetan Nicodeme of the Solvay Business School in Brussels and the European Commission, corporate-tax collections in Europe as a proportion of GDP have remained stable over the past decade, at around 3%. He says this may be because lower tax rates have allowed countries to attract a large corporate-tax base.

Even if it does not cause a race to the bottom, tax competition is not necessarily benign, says Michel Aujean of the European Commission. Corporate profits have boomed in recent years and tax collection has followed. More companies are being set up, so there are more to be taxed. And in many countries cuts in statutory tax rates were accompanied by measures that closed loopholes, thus broadening the tax base. All this means that the numbers may not be as reassuring as they seem to be.

Oxfam, a not-for-profit group that works to alleviate poverty, says tax competition is already very real for poor countries. In a report published in 2000 it estimated that developing countries lose at least $50 billion a year to tax havens, about the same amount as rich countries dole out to poor ones in foreign aid.

John Christensen of the Tax Justice Network takes issue with the term tax competition. He says that true competition spurs productivity and efficiency in the market, while tax incentivisation — which is what this is — only increases after-tax profits. The two are not the same. He argues that the tax regimes of OFCs and their onshore copycats distort economic decisions.

Many economists and businessmen disagree with Mr Christensen, arguing that competition of any kind is a healthy, disciplining force. Tax competition is the only agent of productivity for governments — it is the only competition they have, says Jacques de Saussure, a partner at Pictet & Cie, a Swiss private bank. But he agrees that it can go too far, because the rich tend to be more mobile than the poor and can hire advisers to minimise their tax bills.

Complements or Substitutes?

Even those in favour of tax competition seem to assume that tax havens take business (and hence taxable profits) away from onshore economies — that the amount of economic activity in the world is fixed and that a dollar booked in Guernsey is a dollar less for France. However, a wealth of academic research has shown that when a company opens a plant abroad, demand in its home country gets a boost too — sales by the parent company grow and jobs and exports at home tend to rise. But does this also hold true if profits are simply shifted to tax havens?

A fascinating study published in 2006 by Mr Hines of the University of Michigan and Mr Desai and Fritz Foley of Harvard Business School provides evidence that it does. Looking at data on American multinational companies from 1982 to 1999, the economists found that tax havens boosted economic activity in nearby non-havens rather than diverting it.

They offer two possible explanations for this surprising result. The first is that a company's subsidiaries in tax havens may add value by providing important intermediate inputs used by its operations elsewhere. The second, more interesting one is that in helping multinational companies lower their effective tax rates — even if this is done simply by profit-shifting — OFCs could make high-tax countries more attractive to foreign investors. So a relatively high-tax country such as France might see a drop in foreign investment if nearby tax havens went out of business, because foreign companies would no longer be able to use them to minimise French tax bills.

If true, this opens up the possibility that tax havens complement onshore jurisdictions rather than substituting for them, and that the interaction between the two increases total economic activity in the world. If the pie gets bigger, then both tax haven and onshore jurisdiction will benefit. An interesting side-effect may be that onshore economies are able to maintain higher general levels of income tax because mobile capital, which is sensitive to tax rates, will help itself to a lower effective tax rate by using OFCs. Tax havens are like pressure valves, says Mr Hines. The companies that might otherwise leave a high-tax country for a lower-tax home stay but because they can use tax havens to lighten their tax load.

This could be the reason why governments in onshore jurisdictions the world over do little to stop the use of tax havens, even though they constantly complain about them. British politicians, for instance, sometimes talk about scrapping their country's rule on resident non-domiciles because it allows wealthy people domiciled abroad, often in tax havens, to live in Britain tax-free. That would simultaneously increase Britain's tax take and seriously dent the offshore business of nearby tax havens. Yet nothing is ever done, perhaps because doing away with the rule would cause an exodus of wealthy and often brainy residents that would hurt the economy more than the tax forgone. Similarly, America and others could quite easily curb the use of tax havens by tightening those parts of the tax code that already penalise the use of OFCs, but they choose not to do so — which is probably a wise thing to do since it would cause more harm than it would bring value.

In a paper published last spring, Andrew Rose of the Haas School of Business at the University of California at Berkeley and Mark Spiegel of the Federal Reserve Bank of San Francisco argue that OFCs may offer other benefits too. They studied the banking sectors of 221 countries and territories and found that the nearer a country was to a tax haven, the more competitive and efficient its banking system appeared to be. Offshore competitors can keep onshore banking sectors on their toes, explains Mr Spiegel. They probably facilitate sleaze but can still have unintended positive effects.

Laundry List

The sleaze factor is conspicuously absent from all these studies, which concentrate on the OFC's role as low-tax jurisdictions. But what if a low-tax OFC is shoddily regulated or its rules are opaque?

By definition there are no reliable figures on money-laundering worldwide, because its perpetrators try to make the proceeds of financial crime indistinguishable from legitimate money. Michel Camdessus, a former managing director of the IMF, once estimated the amount of money laundered globally at 2-5% of world GDP. Based on world output in 2005, that would put the current figure at about $2.1 trillion. This is a problem not just for tax havens but also for some onshore financial centres. Augusto Pinochet, the Chilean dictator, hid millions of dollars with the help of Riggs Bank, based in Washington, DC.

The proportion of illicit funds that is detected is minuscule, and would be even tinier without co-operation across borders. This is where criticism of OFCs is justified. Some of them have rules that make it very difficult to exchange information with foreign enforcement authorities. Others do not register the companies that set up on their shores, so could not provide such information even if they wanted to. Cayman does register its offshore companies, of which it has over 70,000, and willingly assists foreign law-enforcement agencies, but it does not require companies to disclose their beneficial owners, so the information is not all that helpful.

Other financial centres that co-operate on money-laundering and other criminal investigations balk at sharing information on tax matters. This includes not just OFCs but onshore jurisdictions with strict banking-privacy rules.

Jurisdictions that cling to secrecy rules are selling a shield against the laws of foreign governments, says Mr Merrill. Enforcement is almost impossible when faced with this shield. Indeed, although tax revenues have been on the upswing, the OECD's Mr Owens insists that tax evasion is a real problem, and a growing one — Ireland, which some consider to be a tax haven in its own right, last year recovered almost €1 billion in unreported tax revenues from banks in the Channel Islands. South Africa reckons it is losing 64 billion rand ($ 8.8 billion) a year to tax havens. Crackdowns on tax cheating in America, Britain, Canada and Australia have netted billions of dollars. Most of the cheats are individuals who cannot argue that global competition is driving them to it.

Mr Desai of Harvard is studying the effect of OFCs on the corporate governance of companies that use them. He reckons that they may facilitate corporate misdeeds, even unwittingly, because unscrupulous managers can use the often complex and opaque structures companies set up in tax havens for all sorts of dodgy doings. Mr Desai points out that Tyco and Parmalat both had thousands of subsidiaries offshore which its managers used not only to reduce their tax bills but also to loot the company. Enron's 700 companies in Cayman allowed its corrupt bosses to minimise taxes but also manufacture earnings. This is the underappreciated real cost of OFCs, rather than lost tax revenues, says Mr Desai.

Summary on OFCs

Somerset Maugham, a British novelist, once described Monaco, a tiny city-state on the Mediterranean coast that offers sun, secrecy and minimal taxes to its many super-rich residents, as a sunny place for shady people. That used to be true for many other OFCs as well. For some of them it still is. But things are changing, even in free-wheeling Monaco. Prince Albert, who took the throne in 2005, has vowed to rid the country of its reputation as a haven for tax cheats and crooked businessmen. In future, he said, his rule would be guided by morality, honesty and ethics.

Crooked OFCs have to be kept down, but good ones must be allowed to flourish...

The city-state, one of just a handful of jurisdictions still blacklisted by the OECD for its tax practices, is belatedly following other OFCs. Somewhat grudgingly, they have all been responding to international pressure that goes back to the early 1990s, when the G7 group of big, rich countries started to debate the risks of financial globalisation. This produced three separate but related international initiatives launched in the late 1990s.

The FSF (Financial Stability Forum) was put in charge of monitoring the systemic risks posed to the increasingly interlinked world financial system. The FATF (Financial Action Task Force) was set up to find a way to keep money-launderers out of the financial system (terrorist financing was added after the attacks of September 11th 2001). The OECD (Organisation for Economic Co-operation and Development) launched its harmful-tax initiative to get rid of unhealthy tax competition and prod jurisdictions into helping foreign tax authorities with their investigations.

OFCs were not the only target, but they received special scrutiny because the FSF and the FATF worried that they might prove the weakest link in the global financial system. The FSF paid particular attention to the banking system. International principles for banking regulation had already been set out by the Basel Accord in 1988. They were based, among other things, on the idea of consolidated supervision in which a bank's home supervisor took responsibility for monitoring the risks of the entire bank. This called for co-operation from host regulators. Many OFCs fell far short of this requirement.

The FATF drew up 40 standards for keeping money-launderers out of the financial system, including a ban on shell banks and a requirement that jurisdictions must know the true owners of all companies set up within their borders. Like the FSF, the FATF found that supervisors in OFCs often lacked expertise, good information and the mechanisms (and sometimes also the will) to exchange it.

Both bodies decided, separately, that the way to prod OFCs into action was to name and shame them. In 2000 the FSF blacklisted 42 OFCs and the FATF 23 non-co-operative countries and territories, including the Bahamas, Israel and Russia. Countries on these lists were often barred from doing business with banks and other financial institutions in the rich world or made subject to much more onerous disclosure requirements.

The IMF was put in charge of checking on the progress that OFCs and other big financial centres had made in meeting international standards. In a recent study it found that, on average, supervisory standards in OFCs were superior to those of other jurisdictions. OFCs met 80% of the standards on co-operation and disclosure related to bank and insurance regulation, though they still had further to go on anti-money-laundering measures. The FSF's worries are now largely about newer risks, such as the rapid growth of derivatives and hedge funds in OFCs.

By and large, good progress has been made. The FSF withdrew its list in 2005, though it set up a group to continue monitoring OFCs. The FATF recently removed Myanmar, the last country on its blacklist.

Caring, Sharing

But on the vexing issue of taxation, progress has been slow. The OECD's harmful-tax project, launched in 1996, covered some of the same ground as its sister initiatives. It aimed to get jurisdictions to collect better information and to share it with foreign tax authorities when necessary.

But four of the OECD's members — Switzerland, Belgium, Austria and Luxembourg — would not sign on to the project because they would have to give up their banking-secrecy rules, which do not allow the exchange of information about foreign tax evasion. The Bush administration also complained that the project would stifle tax competition, so the focus was narrowed to better information-gathering and exchange.

In 2000 the OECD blacklisted 35 tax havens. Only five of them still remain on the list: Andorra, Liberia, Liechtenstein, Marshall Islands and Monaco. Only two countries, Guatemala and Nauru, have no legal system for the exchange of tax information, although they are working on it.

But the real measure of success for the OECD project is progress on Tax Information Exchange Agreements (TIEAs) — bilateral agreements between tax havens and bigger countries to help each other on tax matters. The OECD sees these agreements as the answer to the problem of tax-dodging. America has signed over a dozen TIEAs, most of them with OFCs in its backyard, mainly because these tax havens depend so heavily on their big neighbour that they are bound to comply. But only three other TIEAs have gone through in the decade since the project was launched — although dozens are said to be in the works.

Europe has fared little better. In 1999 the EU launched a code of conduct aimed at harmful tax measures, using the same definition as the OECD's. The code was extended to EU members' dependencies, so it covered tax havens such as Jersey, Guernsey and Cayman. Jurisdictions dutifully abolished their harmful preferential tax regimes — but some simply extended the same low rates to everyone. Such moves technically comply with the code of conduct, but the EU is watching them warily.

The EU's savings directive, designed to squash tax evasion by individuals within Europe, took effect in 2005 after a decade of wrangling, but has proved something of a flop. The original plan was to get EU members and their dependencies automatically to exchange information on savings kept in their banks by citizens of other European countries. But once again the usual suspects — Luxembourg, Belgium, Austria and Switzerland (not an EU member but included in the savings directive) — would not budge. Under a compromise, countries could either exchange tax information or deduct a withholding tax on the offshore accounts of EU members and remit it in bulk to the investor's home tax authorities. Most member states chose to exchange information — most European tax havens went for the withholding tax.

So far, the countries that opted to withhold taxes have remitted a paltry €210m. The directive defined savings so narrowly that it was easy to find ways around it. The interest on bonds is subject to the directive, for instance, but dividends on shares, bond-like insurance products or income from derivatives are not.

Compared with the glacial progress on initiatives to counter tax avoidance, international projects on financial crime and bank regulation have done rather well. This is because most governments agree that money-laundering and financial meltdowns are best avoided. Many OFCs have co-operated in these initiatives, and the rest will have to come round — if only because they would lose their livelihoods if, say, a terrorist attack in America were financed through one of their banks.

The problem with getting agreement on tax matters is that the interests of big countries are not aligned — indeed there is vigorous competition on tax. This is why there is no international standard on tax evasion or tax competition along the lines of international standards on bank regulation or fighting financial crime. For example, Britain convinced the EU to exempt the eurodollar market, which thrives in London, from the definition of savings under the savings directive because it did not want to lose this business. Switzerland and Luxembourg fear — not without cause — that giving up banking secrecy would hit their private-banking business.

Where big countries do seem to be able to agree is in objecting to small tax havens that make life easy for cheats, particularly individuals. For multinational companies the picture is mixed. They are prolific users of OFCs, and their home countries generally do little to stop them. The most straightforward way to do so would be to tighten up controlled-foreign-corporation (CFC) rules. Under these rules companies with subsidiaries in tax havens are taxed more heavily, making the use of OFCs less attractive. Every country has such rules, but detailed provisions vary.

If big countries were to make these rules more stringent, they would deprive tax havens of a lot of business — but they themselves would get hurt too as their companies lost competitiveness against foreign rivals. So they do a bit of sabre-rattling but mqostly let their companies use tax havens to suit their needs.

Here to Stay

The trouble with trying to curb the use of tax havens by companies is that tax systems are based on national boundaries, but multinational companies increasingly are not. Companies are in business to maximise profit, so they will base themselves in the lowest-cost and lowest-tax jurisdictions. Tinkering with transfer-pricing rules or CFC rules will not solve the problem.

Taxing individuals poses less of a dilemma. Individuals do not face global competition. They have to pay taxes in their home countries in return for the servies provided by government. If an individual feels his tax burden is unfair, he can vote for tax-cutting politicians or go to live in a less heavily taxed country — or, if he does not mind breaking the law, he can hide his money abroad.

Some experts believe that the only way of reconciling a system of national tax regimes with a global economy is to harmonise tax systems across borders. But this is not going to happen soon. Singapore, Hong Kong and other offshore jurisdictions are outside the scope of the OECD's tax project. They also show little interest in getting involved with the EU's efforts. Given the trouble the EU had introducing even a watered-down savings directive, broader tax co-ordination seems out of the question for now. Nor is it necessarily desirable, because a healthy dose of competition is good for the financial system.

The best bet is, first, for countries both onshore and offshore to exchange tax information and target cheats — individuals and corrupt companies seeking obscurity offshore — that harm the financial system.

Second, rich countries should look in the mirror. A recent World Bank study showed that cutting tax rates and simplifying tax systems can greatly reduce the incidence of tax evasion. Doing so would make tax havens less attractive.

But until and unless these things happen, OFCs are here to stay. That may be no bad thing. The small, unsuccessful ones are already being driven out. Those that remain should be monitored more closely. But the well-run, nimble ones will continue to thrive because they have something to offer in a globalised world.