Offshore Finance

Offshore finance refers to financial activities that take place in jurisdictions that are outside the country of residence of the parties, typically in centres that offer favourable regulation, taxation, or secrecy. Offshore finance is a central feature of the international financial system.

Characteristics

Offshore financial centres are jurisdictions that provide financial services to non-residents, often with a favourable regulatory and tax regime. The centres may be small economies that specialise in financial services, or larger economies that offer particular advantages.

The characteristics of the centres include low or zero taxation, light regulation, and strict confidentiality. The combination of these features attracts funds and activities from around the world.

Activities

The activities conducted in offshore centres include banking, fund management, insurance, and the registration of companies. The centres also host special purpose entities, which are used for securitisation, for holding assets, and for other purposes.

The activities are often conducted for legitimate reasons, including the desire to reduce tax, to diversify risk, and to access specialised services. The centres also attract activities that are intended to evade regulation or to conceal the origin of funds.

Tax and Regulation

Offshore finance is central to the analysis of international tax competition. The centres allow firms and individuals to reduce their tax liabilities, by shifting profits and by holding assets in low-tax jurisdictions.

The responses to tax competition include the negotiation of agreements for the exchange of information, the introduction of rules to counter base erosion and profit shifting, and the imposition of measures against jurisdictions that do not cooperate. The design of these responses is a subject of international negotiation.

The regulation of offshore finance is a concern for financial stability, since the activities may escape the supervision of the authorities in the countries where the ultimate risks reside. The response includes the extension of regulation to the activities and the strengthening of international cooperation.

Debate

Offshore finance is a subject of debate. Some argue that the centres provide legitimate services and that they contribute to the efficiency of the international financial system. Others argue that they facilitate tax evasion and the concealment of illicit funds, and that they undermine the ability of countries to raise revenue and to enforce their laws.

The debate reflects broader questions about the governance of the international financial system and about the balance between national sovereignty and international cooperation. The design of the framework must address the concerns while preserving the legitimate functions of the centres.

Tax Havens and Profit Shifting

Offshore financial centres are often described as tax havens, since they offer low or zero taxation to the firms and individuals that use them. The use of the centres allows the profits of multinational firms to be shifted to low-tax jurisdictions, reducing their global tax liability.

The profit shifting is achieved through several mechanisms, including the transfer pricing of transactions among the affiliates of the firm, the allocation of debt and of intangible assets, and the location of the headquarters. The mechanisms exploit the differences in the tax treatment across jurisdictions.

The reform of the international tax framework addresses the profit shifting through several measures, including the requirement for the reporting of the activities of the firms, the rules against base erosion, and the introduction of a minimum tax on the profits of multinational firms.

Secrecy and Information Exchange

The confidentiality that the centres provide has been used to conceal the origin of funds and to evade taxation. The concealment is a concern for the enforcement of the tax laws and for the fight against financial crime.

The response includes the negotiation of agreements for the exchange of information, which allow the authorities to obtain information about the accounts held by their residents in the centres. The agreements have been extended to a large number of jurisdictions, and the exchange of information on request and automatically has become the standard.

The effectiveness of the exchange depends on the quality of the information and on the capacity of the authorities to use it. The reform of the framework continues, and it addresses the remaining gaps and the emerging forms of concealment.

Financial Stability

The activities conducted in offshore centres may escape the supervision of the authorities in the countries where the risks reside. The activities can therefore accumulate risk outside the oversight of the regulators.

The response includes the extension of the regulation to the activities and the strengthening of the international cooperation among the supervisors. The standards set by the international bodies provide a common framework, and the assessment of the compliance of the jurisdictions is part of the framework.

The assessment of the risks also requires the collection of data on the activities of the centres and on their linkages with the rest of the financial system. The data inform the analysis of the potential for contagion and the design of the policy.

Summary

Offshore finance raises issues of tax competition, of secrecy, and of financial stability. The responses to these issues, including the reform of the international tax framework and the strengthening of cooperation, are central to the governance of the international financial system.

See also

• Financial Economics
• Taxation
• International Economics