They are an extraordinary part of international finance, surrounded by secrecy, scattered around the world. Tax havens and offshore finance allow companies and individuals to move their money to places where they may do little or no actual business, but where their tax liabilities are much reduced.
Tax havens have attracted increasing critical attention in recent years – from governments eager to ensure that they do not lose income, and from protestors who claim that companies are failing to pay their dues. Yet they have been an established feature of global finance for decades. Estimates suggest that as much as a half of all international banking assets and liabilities are routed through these offshore centres. So how and why did they develop on such a scale?
Avoiding paying tax has deep historical roots, says Professor Ronen Palan of Birmingham University, a specialist on this complex area. But this modern form has strong links with the British empire – and its dissolution.
States within the empire began in the early 20th century to diverge more in their economic and fiscal policies. And there were key legal developments. Professor Palan highlights a 1929 case involving a company based in Egypt which had no activities in Britain and did not pay tax there but was allowed to be registered in London. This meant that international companies could now enjoy the benefits of a London base while opting to pay their tax somewhere more favourable.
As the British empire disintegrated after the Second World War, the City of London became more and more desperate to maintain its place as a global financial centre. It developed the so-called Euromarket, whereby transactions took place in London in currencies other than sterling and between lenders and borrowers not based in the UK and not subject to UK regulation and taxation.
It became increasingly popular for banks to base such operations in places like Guernsey or Jersey – dependent territories of the crown that enjoyed great fiscal autonomy and offered very low taxation. The Bank of England, hoping to sustain London’s international position, supported this. The UK Treasury, worried about its loss of revenue, was more sceptical. But the Bank, says Palan “was trying to keep the Treasury in the dark”, to stop it from intervening.
One of the most spectacular examples of a tax haven emerging from empire is the Cayman Islands in the Caribbean, which became a British overseas territory in 1962. At first, British officials were alarmed by what they saw as the territory’s economic weakness: “They can’t just live off bananas” was one reported comment. So financial services were encouraged as an alternative, and the Caymans have proved, says Ronen Palan, “an astonishing success story”, with more registered businesses than people. A territory of around a hundred square miles was said by the Bank for International Settlements in 2008 to be the fourth largest financial centre in the world.
A huge global business has now evolved advising companies on how to minimise their tax liability by making use of such locations. However the border between tax avoidance and tax evasion has always been controversial. Critical voices question the legitimacy of companies avoiding paying tax in places where they are so active and complain of ‘harmful tax competition’ between countries. Strict banking secrecy laws pioneered in the 1930s by Switzerland were copied by others but are now questioned more rigorously.
So, concludes Professor Palan, “it appears that tax havens are under greater threat today than ever.” But they are such a varied phenomenon, with friends in many high places, that concerted action against them is unlikely. Many, based in tiny far-flung territories, will remain powerful legacies of the British empire. The great web of imperial finance has found an afterlife in the tax loopholes and offshore businesses which modern finance loves so much.
Chris Bowlby is a presenter on BBC radio, specialising in history. This series is produced with History & Policy. You can find out more about them and read their papers at www.historyandpolicy.org