Sun, Sand, and the $1.5 Trillion Offshore Economy

(Bloomberg Businessweek) -- The British Virgin Islands is home to more than 400,000 companies that hold $1.5 trillion in assets. You wouldn’t know it if you walked through Road Town, the capital of this Caribbean archipelago. Hens and roosters compete brazenly with cars on the single narrow lane of Main Street. Law firms that set up and serve thousands of offshore companies occupy modest buildings next to brightly painted wooden houses that host cheap beauty salons and clothing shops with names like Goodfellas..[ Click here to read BVI Finance’s response. Bloomberg disputes its contents and stands by the article.].Besides a few mangled green street signs on Main Street, few roads are marked. The BVI doesn’t have mail delivery; its businesses and 32,000 residents use post office boxes as their addresses, which is why one P.O. box in Road Town can be the nominal home to thousands of companies from around the world. Hundreds of lawyers, accountants, and company agents work from buildings dotted around the main island of Tortola. In some tax havens—Luxembourg, Monaco, or even parts of the Cayman Islands—money is dripping off every corner. In the BVI, the wealth passes through almost without a trace..When I visited in April, my first stop was Tobacco Wharf, a collection of anonymous-looking houses tucked off the main road, where the global accounting company BDO Ltd. occupies a four-story green-and-beige building surrounded by palm trees. Inside I was greeted by Ryan Geluk, a lanky, bearded accountant who serves as the company’s deputy managing director on the island, and Neil Smith, the BVI’s director of international business. Geluk started tapping away on a keyboard to show me the database he’s so proud of: the Beneficial Ownership Secure Search System, or BOSS, which the BVI started using in 2017 to satisfy international demands that it keep track of the owners of its companies. A screen on the wall showed a dataset. He clicked on Almighty Dollar, a company registered to P.O. Box 9272 in Road Town in December 2007, with a passport number and date of birth for its owner, John Zykov-Wumu..Almighty Dollar isn’t a real company but rather a prototype, which is all Geluk could show me. Even though he helped get it up and running, Geluk doesn’t have permission to scan the whole database. In fact, only two people, a pair of unnamed employees of the BVI’s Financial Investigation Agency, are able to search the entire system, which holds details on about 600,000 owners who have directly or indirectly controlled companies here. It’s thought that roughly a third of all offshore companies globally are registered in the BVI..Geluk said BOSS uses encryption that’s never been hacked. “If someone accesses it from somewhere unusual like North Korea, it will be shut down immediately,” he told me, adding that the data are housed in a secret location known only to him and his team. “All I can say,” he said, “is it’s held in a G-7 country, and it’s not the U.S.” .Change is coming to the BVI, though not if the politicians and businesspeople here—as well as plenty of less-connected people—can help it. Last year the U.K. Parliament voted to force transparency on the BVI and the 13 other British Overseas Territories, a collection of former colonies where the flags display the Union Jack, the queen appoints a governor to control foreign affairs and law enforcement, and the judicial system is based on English common law. It was a rare moment of cross-party consensus among British members of Parliament, who have been in gridlock since 2016 over the terms of leaving the European Union. The crucial part of the transparency legislation is a requirement that each Overseas Territory produce something like BOSS and make it public..The BVI’s place in the dark offshore economy was illuminated by the 2016 Panama Papers leak, in which 11.5 million documents from the law firm Mossack Fonseca were released by the International Consortium of Investigative Journalists. The disclosures sparked probes worldwide into money laundering, sanctions violations, and tax avoidance, and it didn’t pass without notice that more than half the companies outed in the leak were registered in the BVI. (The scandal should have been called the BVI Papers, more than a few people suggested.) It was clear from the disclosures that BVI regulation was inadequate, and that remains a concern today: Last year, BVI regulators conducted only four on-site inspections of financial firms..People here are well aware of the outrage over hidden wealth and lost tax revenue. They just don’t believe they’re to blame, and many people deny that their country is even a tax haven or a secrecy jurisdiction. The BVI is, in fact, one of the most vocal opponents of the worldwide transparency drive, which makes the success or failure of its pushback a barometer of whether the global squeeze on the offshore industry is working..When you walk the dusty streets of Road Town, it isn’t immediately clear why local people would be invested in the transparency fight. The companies registered here don’t pay taxes. Entire islands in the 60-island archipelago are owned by rich people from other countries (Richard Branson owns Necker Island; Google’s Larry Page owns Eustasia), and there are few signs that wealthy people who use the BVI spend much money in the local economy. Damage from Hurricane Irma, which swept over the BVI in September 2017, is still evident everywhere. But islanders up and down the economic scale answered my questions about transparency the same way: The BVI would be a much poorer place without its financial-services industry. The government charges a $450 fee to form a company with fewer than 50,000 shares and another $450 a year to maintain registration. As modest as that might sound, it’s what makes the economy go. Financial services account for 62% of the BVI’s $372 million in government revenue, and the number will probably decline if it adopts a public register of company owners..Over the past few years, the EU has threatened to blacklist the BVI and other territories unless they adopt rules to prevent global corporations from avoiding taxes by shifting profits to shell companies in zero-tax offshore jurisdictions. Corporate profit shifting is estimated to result in $600 billion in lost tax revenue annually for countries around the globe, according to the International Monetary Fund. Under new rules that take effect this year, any company that declares itself a tax resident of the BVI must have “economic substance” on the ground in the form of a local office, employees, and appropriate expenditures. Other, more developed offshore centers will be bound by the same rules, but the impact on the BVI is likely to be more pronounced, potentially forcing thousands of companies to shut down or try to scale up in Road Town, with its tiny population and severely limited infrastructure. Some locals are worried that companies may simply go elsewhere..But the U.K. transparency push is seen as the bigger threat. The law passed by Parliament requires the government to order Overseas Territories to create public registers by 2020. Concerned it might cause a revolt from the former colonies, the U.K. government opposed the move by MPs and interpreted the ambiguously worded legislation to mean it could give the territories until 2023. MPs backing the rules say they can force adherence to the original deadline. “They trade under our flag, and they have to accept our values,” says Andrew Mitchell, the Conservative Party MP who pushed for the rules. “Unless you have the transparency that open, public registers bring, you can’t join up the dots and spot clever money laundering and malfeasance.”.The standoff has put the legacy of the British Empire in stark relief. Parliament can legislate for the territories, but islanders, who are U.K. citizens, can’t vote in U.K. elections unless they live in the U.K. Many in the BVI view the imposition of a public register as a violation of their constitutional relationship with Britain. More than 1,000 people marched in protest last May in Road Town, with placards that read “No Imperial Legislation” and “End Colonial Rule.” The then-deputy premier, Kedrick Pickering, declared “open war against the U.K.”.One evening during my visit, islanders lined up in the waiting room of the BVI’s House of Assembly, a tired beige building where pictures of Queen Elizabeth II and the BVI’s newly elected premier, Andrew Fahie, hung side by side. They were all waiting to see Fahie, a stout man in a dark suit who plays piano with the gospel choir at his church. Fahie was elected in February after leading a working group that supported giving Overseas Territories veto power over laws that Parliament passes which affect them. Years ago a previous premier nicknamed Fahie the Brown Bomber, after boxer Joe Louis, reportedly because of his tenacious approach to politics. The name stuck..On a break from late-night budget talks, Fahie told me the BVI won’t introduce public registers until they’re adopted worldwide. “We’re not complying when the U.K. pushes it, but when it becomes a global standard,” he said..Not surprisingly, many people in Road Town argue there are perfectly legitimate reasons to use a jurisdiction such as the BVI. The Panama Papers leak revealed, for example, that British actress Emma Watson bought her London house with a BVI company to prevent stalkers from tracing where she lives. The BVI is seen as a convenient neutral territory for basing international joint ventures without an additional layer of taxation. Silicon Valley investors, for example, might feel more comfortable investing in a Russian tech venture based in the BVI, with its English common-law system, instead of Russia, where courts remain prone to corruption..But transparency threatens none of that. What it threatens is the BVI’s crucial role in often elaborate attempts to conceal the identity of the ultimate owners of assets, making it difficult to trace funds in business disputes, tax investigations, and money laundering probes..Ownership arrangements also often use that other legacy of the British Empire—the Crown Dependencies of the Channel Islands, Guernsey, and Jersey. A simple structure to camouflage the ownership of funds might look like this: A wealthy individual sets up a trust in Jersey to own a BVI company that in turn has a Swiss bank account. “They call that entry level,” says John Christensen, who worked as a forensic investigator in Jersey at Deloitte, the global accounting company, before joining Tax Justice Network, a group that campaigns against tax havens. “For bigger players it would be many more jurisdictions.” The Crown Dependencies don’t tax most companies and don’t disclose who ultimately owns the companies registered there, but they, too, are about to change. After British legislators also threatened to impose public registers on them, the Channel Islands, Guernsey, and Jersey announced in June they would do so voluntarily by 2023..The implications are far-reaching. The offshore industry is a sort of Jenga tower, with each tax haven like a block that supports the elaborate structure of the world’s hidden finances. The moves of the past year are akin to pulling out multiple blocks at once. The BVI is near the base of the tower, and if it can be made to shift beyond a certain point, the offshore industry as we know it might crumble. .The man who helped invent the modern-day offshore industry is an 81-year-old Oxford-educated lawyer named Michael Riegels, who moved to the BVI in the early 1970s to escape civil unrest in his home country of Tanzania. I visited him at his hillside villa, where a large living room opens up onto an expansive terrace with views of the Caribbean Sea. Sitting on a wicker chair next to the pool with his wife, Norma, he recalled that when he first came to the BVI, it was like stepping back in time. “Men would take their hat off and say, ‘Morning, sir. Good day to you,’ ” he said. “Then we were discovered by some New York lawyers.”.Calls from New York were unusual back then; undersea cables for the BVI’s international telephone lines weren’t laid until a few years before. At the time, the U.K. and the U.S. had a double tax treaty that extended to the BVI. If an American company set up in the BVI, the treaty reduced its U.S. withholding tax rate on dividends paid out of the U.S. from 30% to 15%, which could then be applied as a credit against the BVI tax of 15%—and presto! Zero tax. Riegels, who was a partner at the local law firm Harneys, says he helped Bob Marley, Cat Stevens, and other musicians set up BVI companies to avoid paying tax on their royalties. (Stevens called his 1973 album Foreigner because he moved to Brazil as a tax exile that year.).The U.S. government issued a critical report on tax havens in 1981, saying the treaty was costing it hundreds of millions of dollars, and canceled it soon after. “That was a bit disappointing to us,” Riegels said. “We were doing quite nicely.”.That’s when Paul Butler, a partner at the New York law firm Shearman & Sterling, suggested BVI law be rewritten to make it attractive to international investors. Five lawyers, including Riegels and the then-attorney general for the islands, Lewis Hunte, set about drafting the new legislation, pinching from statutes around the world but borrowing heavily from Delaware, which had made selling shell companies a big business. With their help, the BVI government approved the International Business Companies Act in 1984. The Bahamas and the Cayman Islands adopted similar legislation..“It took off like an express train,” Riegels said. “Within two years, we celebrated forming a hundred companies in a month, which was beyond our wildest dreams at that time.”.Plenty of international companies used the BVI not necessarily to avoid taxes but to escape regulations, Riegels said. But some companies, and the people who owned them, were clearly using the BVI to avoid scrutiny. Riegels remembered a man who came into his office in the 1980s with a paper bag stuffed with $300,000 to buy a yacht from one of his clients. He said he thought it was odd but took the money without asking too many questions. Later he saw reports that the same boat had been seized, full of drugs, by U.S. officials..“When I read about it, I thought, I shouldn’t have done that,” he said. “We should have realized this eventually would be used by the morally challenged. We were extremely naive to think all our clients were respectable businessmen. We didn’t ask a lot of questions.”.It wasn’t until the late 1980s that the BVI became one of the world’s most popular destinations for company registrations. Riegels said the 1989 U.S. invasion of Panama forced that country’s nascent offshore industry to move to the BVI. Around the same time, Hong Kong investors, led by billionaire Li Ka-shing, the founder of CK Hutchison Holdings Ltd., started using BVI companies to hold assets before the 1997 handover to China. By the 1990s, Riegels said, his firm was incorporating 1,000 companies every month, with the biggest source of business being wealthy Chinese. “The 1990s was the boom period,” he said..Over the past decade, scandals have repeatedly washed over the BVI. Some of the offshore feeder funds that collected money from investors and funneled cash to prop up Bernie Madoff’s Ponzi scheme were based in the BVI, as were some companies involved in the $230 million tax fraud by Russian officials that was exposed by Russian lawyer Sergei Magnitsky, who died in prison in 2009 after uncovering the scheme..Then, in 2013, the International Consortium of Investigative Journalists began rolling out stories based on a leak of 2.5 million offshore documents. The investigation, dubbed Offshore Leaks, would turn out to be the first of many disclosures that made the BVI look like the jurisdiction of choice for money laundering and tax evasion. Everyone from arms dealers to wealthy Americans and Indonesian billionaires had BVI companies..Offshore Leaks spurred global regulators to attack the secrecy of offshore jurisdictions. That year, the Organization for Economic Cooperation and Development in Europe established a standard for the automatic exchange of financial information, endorsed by the Group of 20, allowing countries to trace funds that were “unknown or unknowable.” More than 100 jurisdictions signed up..When the Panama Papers hit, the fallout was severe. This time politicians worldwide were among those shown to have undisclosed offshore accounts. Labour Party leader Jeremy Corbyn said the U.K. should consider imposing direct rule on the Overseas Territories if they continued to condone tax evasion on an “industrial scale.” (The U.K. government set up its own public register after the Panama Papers, revealing for the first time who owns or controls companies in Britain.).The succession of leaks put enormous pressure on BVI authorities to do something that would save their financial industry while satisfying global regulators. In June 2017 the BVI enacted legislation requiring company formation agents—there are now roughly 140—to upload information on the beneficial owners of companies to a private database. Hence BOSS, which makes it harder for individuals who control a company to hide behind nominee shareholders if U.K. law enforcement agencies start asking questions. Most companies registered in the BVI since 2016 need a real person standing behind them with passport details, a name, and an address. Those details can be shared with British investigators. But loopholes exist, allowing, for instance, trusts and corporations listed on stock exchanges to escape scrutiny. .Perched on a sloping hill in Road Town, surrounded by palm trees, is a gated white mansion that serves as the office of the BVI’s 40-year-old governor, Gus Jaspert, a blond, blue-eyed, soft-spoken Brit. Sitting next to a picture of Queen Elizabeth II, who appointed him to the post in 2017, Jaspert sounds like the quintessential diplomat, stuck between British MPs intent on forcing transparency on the Overseas Territories and a BVI government determined to fight them every step of the way. He says the BVI is already doing a good job of providing the U.K.’s National Crime Agency with information on individuals with companies in the BVI. Jaspert, who oversees the BVI’s Financial Investigation Agency, says it turns around 90% of requests in 24 hours. He suggests a compromise could be found by somehow designing a public register that would also safeguard people’s privacy..“It’s quite easy to throw around buzzwords like transparency,” Jaspert says. “What a final register looks like, that’s still in development.”.If BVI officials get their way, the register will be far from fully accessible to the public. One idea under consideration is a system to notify individuals that their information is being sought and by whom, allowing them an opportunity to stop the release of details. Another idea I heard: making it accessible only in the BVI, forcing people to physically go there to see the information. How exactly these ideas would work and whether the U.K. would greenlight them remains unclear, but it sounds like an attempt to create a public register in name only if the BVI is backed into a corner..When British MPs voted to impose public registers on the Overseas Territories, the islands were still reeling from Hurricane Irma. Bishop John Cline of the New Life Baptist Church, who helped lead the march against public registers, said the U.K. was undermining the local economy when it was most vulnerable. “It’s nothing more than modern-day colonialism,” said Cline, sitting in his Road Town office, where he’s hung a picture of Martin Luther King Jr. “I don’t see how you can oppress us on the one hand and on the other hand expect us to function in any viable way.”.That said, Cline thinks the BVI’s dependence on financial services has skewed the economy, taking the focus away from building infrastructure that might help the tourism industry flourish. “The financial industry became almost the cash cow, and right now the cash cow is sick,” he said..The mantra on the ground is that the U.K. should clean up its own act before imposing more stringent rules on the BVI. The BVI’s company agents are required to check the identity and source of funds of owners before setting up companies. In the U.K. there are no agents, which means you can form a company in less than a day for only £12 ($15) by simply logging on to the Companies House registry’s online system and uploading three pieces of personal information. For all the transparency of the U.K. system, anticorruption campaigners say it’s been used for fraud and money laundering. In the $230 billion money laundering scandal that has engulfed Danske Bank, regulators traced money flowing from Russia via Baltic banks using U.K.-registered companies as well as BVI shells..Law enforcement officials in the U.K. say the BVI has helped them with ongoing investigations, but BVI regulation still doesn’t look rigorous, given the low number of on-site inspections. It’s telling that although regulators fined Mossack Fonseca $440,000—the largest fine ever in the islands—after the Panama Papers leak, the firm retained its license to operate until it shut down last year..I wanted to explore this with the BVI Financial Services Commission, which is in charge of licensing and inspecting company agents. But for weeks before my visit, no one answered the phone numbers listed on the commission’s website and various officials ignored my countless emails. I went to the commission’s office on the east end of Road Town, where a sign outside the building reads “Vigilance, Integrity, Accountability,” and spoke briefly with the commission’s deputy managing director, Kenneth Baker, explaining I was writing a story about the BVI. He told me to leave a note for the commission’s communications chief. A few days later, the FSC finally responded, but only to decline my requests for an interview. Elise Donovan, the head of BVI Finance, the industry trade body, told me later that the territory is compliant with global anti-money-laundering regulations and carries out more checks on company owners than the U.K. does..One of the most passionate and prominent opponents of public registers is the Canadian lawyer and fraud investigator Martin Kenney. Sitting in his office in Road Town, surrounded by towers of papers, Kenney said transparency will simply cause the fraudsters to use more devious means to avoid detection and migrate to black holes like the Seychelles, or even Delaware, where he said it’s more difficult to get information than in the BVI. That will only make it harder and more expensive to track them down, he said. “Al Capone isn’t stupid. Whatever mousetrap you build, they will find ways to get around it.”.He told a long and complex story about his recent recovery of millions in stolen assets tied to a bankrupt Brazilian energy company, whose principal shifted the ownership of assets into offshore companies in multiple jurisdictions and established dummy nominees to shield them from Brazilian bankruptcy court. In a process that required court orders in three countries, Kenney proved that the nominees—two Costa Ricans, one of whom owned a small laundry shop and the other a computer repair shop—were fronts. He clawed back the assets. “The system worked,” Kenney said emphatically. “If you disrupt it, I fear the costs and the risks from the victim side will go up and up.”.Anticorruption campaigners disagree with Kenney’s whack-a-mole theory, arguing that just because the bad guys might pop up elsewhere doesn’t mean regulators shouldn’t attempt to crack down where they can. At any rate, the global push for transparency may be unstoppable. Last year the EU passed new rules requiring public registers in all member states by January 2020. Germany and the Netherlands have led the way. There are some in the BVI who say the only way to survive is to embrace the changes..At the Island Roots cafe in Road Town, I talked with Colin Riegels, Michael’s 47-year-old son, who sipped an iced latte while reggae music blared and lawyers and accountants mingled. Just a bit older than the BVI’s offshore industry itself, Riegels is carrying on his father’s mantle as Harneys’ managing partner for the BVI. He was sanguine about the new rules, saying public registers were inevitable. He observed, too, that with all the changes afoot, the BVI’s model of pocketing a steady stream of fees from an ever-rising number of offshore incorporations was likely to falter anyway. Since 2014 the number of companies registered annually in the BVI has fallen by 16%. “There’s been a fairly steady move from what you might call a more Wild West type of environment to a much more closely regulated and transparent business environment,” Riegels said. “It’s a bump in the road, but the road isn’t coming to an end.”.Fahie, for all his talk about defying the U.K. on increased transparency, is also developing a vision of a transformed BVI. He said he wants to diversify the economy to reduce reliance on company formations, rebrand the islands as a tourist destination, and get into cryptocurrencies. It was a little vague. What was clear was that he recognized the BVI is not entirely in charge of its own destiny. “When you get in a fight,” the premier said, “you have to understand you may win or you may lose.”.To contact the editor responsible for this story: Daniel Ferrara at dferrara5@bloomberg.net, Bret Begun.©2019 Bloomberg L.P.

Sun, Sand, and the $1.5 Trillion Offshore Economy

People here are well aware of the outrage over hidden wealth and lost tax revenue. They just don’t believe they’re to blame.

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