Shock horror the super wealthy have been using offshore investment companies based in Panama to avoid paying tax. Who would have thought it?
For me the story is in some ways painfully personal. You see I used to work (until 2006-7) in the financial services industry. I became Managing Director (Retail) of a business that ‘successfully’ diversified away from offering plain vanilla financial products, such as unit trusts, to UK customers, into one that marketed and managed offshore funds for ‘high net worth’ global investors. The financial rationale for our change of track was compelling:
The average annual management charge for a unit trust was somewhere in the region of 1.25%. After all costs the margin we, as the product provider retained, was in the region of .6%.
On an offshore fund ( domiciled, in our case, either in Dublin or the Cayman Islands) we were able to charge an annual management fee of 1.5%, on average, and a whopping 20% of the investment returns. In a good year the combination of the annual management fee and the performance fee might equate to something like a 5% margin. Clients were content to pay such high charges because anticipated returns were high and, significantly, outside of the immediate clutches of the tax authorities.
Offshore investment companies, just to be clear, are not illegal. The morality of these products is open to question – although to my shame I can’t ever remember discussing the ethics of these products – but not their legality.
So how do offshore funds such as the ones we were responsible for marketing and managing come into being and then work? The thumb nail sketch below gives a highly simplified guide:
Well the first thing you need is a ‘product idea,’ or specification. The ‘you’ is normally a U.K. domiciled investment management company (or a French, German, Italian, Spanish, American – you get the idea – one.)
But, the problem is that financial products designed to entice the super wealthy are unlikely to be authorized by regulators in countries such as the U.K. The challenge is therefore to find a ‘domicile’ for these products where the U.K. (or French, German, Italian, Spanish, American etc) regulators and tax authorities hold no sway.
So, what you do is go off with your bright idea to a firm of lawyers in an offshore financial centre and ask whether they might like provide a corporate structure, a company in other words, to oversee and govern the day-to-day management of the product. Three things then tend happen:
- The legal beavers will source a number of ‘independent’ directors, who will comprise the majority of the board. The independent directors tend to be ‘professional directors,’ and residents in the offshore centre where the company is registered. They normally serve on multiple boards. The directors will then ask the firm of lawyers to draw up a prospectus and provide secretarial services to the company. Normally a couple of directors will also be appointed from the U.K. company responsible for originating or designing the product. I was a director of the Dublin based company that provided oversight and governance for a range of funds. Two of my colleagues were directors of a Cayman Island Company.
- The offshore company then appoint the company whose bright idea it was in the first place to manage the assets of the company and,
- Appoint the same business to market the product – normally through ‘financial intermediaries’ such as private banks.
The offshore company in effect sub contracts the day-to-day management of the investments and the marketing of the product back to the company who devised the product in the first place.
All fees will be charged by the offshore company, with the U.K. company (as the ‘sub contractor’) then being reimbursed for the management of the funds assets (i.e. the annual management and performance fee). It is therefore ‘clear and obvious’ that the fund is domiciled in the relevant offshore centre! Board meetings also take place in the offshore centre, normally at the ‘registered office.’ Further proof that the company genuinely operates from the its offshore centre.
As I have stressed earlier there is nothing illegal in the scenario sketched out above. But, this of course doesn’t make it ethical. Legality does not necessarily equal morality. In fact I would suggest that most of the practitioners involved in these types of products regard the world of finance they inhabit as ‘morally neutral.’ But, are they correct?
Well, I can only speak from my own perspective and over time I came to believe, as a Christian, that the world of high finance can never be regarded as morally neutral. Let me briefly cite three reasons (or theologically reasoned arguments), and one highly personal experience:
- Money is mentioned more often than almost any other subject in the Bible. Scripture makes it clear that the ‘love of money is the source of all evil.’ When making money, lots of it, becomes your personal motive, when you provide access to products and services which aim to make ever greater absolute returns in the knowledge that such returns are unlikely to attract taxation, it becomes, in my view, difficult to argue that your are not in love with money. Scripture also makes it clear that we should all pay our dues (as a basic duty): ‘render unto Caesar,’ and I can’t for one moment believe that Caesar would have said: ‘Well done, you outmaneuvered me with your clever ideas.’
- The Christian tradition makes it clear that the wealthy should not be offered greater opportunities just because they are wealthy. The epistle of James makes it clear that God shows no partiality ergo, neither should we. The Rule of Benedict it clear that the wealthy, in the receipt of hospitality, should not be provided with special treatment just because they are wealthy. Is it stretching the point to equate the provision of products and services with the exercise of hospitality?
- Reason would suggest that when one group of people find ways to avoid paying their dues, governments have to impose higher rates of tax on those who aren’t capable of sheltering their gains (or don’t have gains to shelter). Capitalists like to refer to Adam Smith’s famously invisible hand; the problem is that the invisible hand can just as easily, in the absence of virtue, be used to perpetuate economic injustice.
- Experience: I arrived at a place where every time I heard the story of the encounter between Jesus and the Rich Young Ruler I felt as though it was being addressed directly at me, or put another way I was the rich young ruler and my choices were therefore both stark and clear. Love of God or love of money.
I am wary of generalizing truths based on individual experience. I felt that I had to resign and leave the city, which I did in 2006. I didn’t think that I could take the huge financial gains on offer without compromising my soul, but I speak only for myself.
It is clear to me that we do in fact need a healthy and robust financial system, and for me that means one that, paradoxically, ceases to be enamored with wealth for its own sake and the supposed ‘needs’ of the wealthy, and worries more about people, ordinary people, and the ethics of ‘high finance.’ This implies a financial system that doesn’t encourage those who work in it to ‘forfeit their soul.’ There can be little overall health in a system staffed by the obscenely high paid focused solely on meeting the requirements of the super wealthy, can there?
Finally let’s return once again to the vexed issue of tax:
My late father-in-law once said to me ‘Andrew there is nothing wrong with paying tax; you only pay tax when you are making money.’ Sadly some may regard his comments as foolish. I think he was wise.