The costly financial scandals at Enron and Parmalat have shone a spotlight on how big business uses offshore tax havens. Can regulators prevent them from abusing the advantages of offshore centres and so prevent the next scandal? By Tim Hyam

On 14 January this year a packed US courtroom heard Andrew Fastow, the man who masterminded the secretive offshore dealings at the heart of the collapse of energy giant Enron, plead guilty to two charges of conspiracy. The former Enron CEO received a ten-year prison sentence for his part in cooking Enron’s books, a scheme that earned him more than $45 million and ultimately sent the company into a tailspin that cost thousands of jobs and caused billion-dollar losses for shareholders.

Hopes that bringing Fastow to justice would end the bad publicity that Enron has brought to big companies, and in particular the way they use offshore centres, were dashed before Fastow set foot in court. Just before Christmas, Italian dairy company Parmalat shocked investors by announcing its bankruptcy, and it soon emerged that Parmalat’s use of offshore havens was a key part in its demise.

It doesn’t take a genius to realise that there is a pattern here. For a number of decades, accelerating in the 1980s and 1990s, big multinational corporations have been using offshore jurisdictions to reduce, sometimes massively, their overall tax liability. Without wanting to invite a writ from Rupert Murdoch, it has been estimated by some tax experts that News Corporation’s decisions on where to file annual returns can make the difference between its returning a healthy profit and going into the red big time.

Increasing scrutiny

Is this fair? Is it inevitable? Whatever your views on those moral questions, it is plain that leading industrialised countries are increasingly turning their attention to the issue of offshore centres and how businesses use them.

One thing is clear at the outset: regulation to remove the benefits of using offshore centres would have a big effect on the world’s economy. Half the world’s money is estimated to be held in low-tax jurisdictions. To remove the tax benefits provided by offshore centres would radically change the structure of world banking and investment, and slash the profits of many of the world’s biggest companies to boot.

For that reason, among others, quite such radical changes are unlikely. The governments of high-tax countries would find it almost impossible to intervene directly in the regulations of an offshore jurisdiction on a large scale.

Even so, some indirect moves are being made in an attempt to stop the obviously corrupt businesses out there from using offshore centres. “The big change in offshore centres is that now there is much more reporting between governments,” says Andrea Reed, senior expat tax manager at BDO Stoy Hayward.

Governments of high-tax countries such as the US and the UK, she says, now routinely exchange information to keep track of money flows. US tax authorities have also tightened their rules on which offshore agents companies can use, to ensure that they comply with the Revenue Service’s ‘know-your-customer’ rules.

But removing the right of multinationals to place chunks of their businesses in offshore centres to reduce their overall tax burdens is another matter. It is intensely difficult to do, for a couple of good reasons.

First, any individual government cracking down on a multinational might swiftly find it relocating elsewhere – at least that’s the threat that big business routinely comes out with. Secondly, accounting standards vary even between the major onshore jurisdictions (Europe, Asia and the US all use different standards), making it difficult for any one of them to argue that offshore jurisdictions should adopt this or that standard. Moves are afoot to standardise global accounting procedures, but there are deep problems in the way of bringing homogeneity about.

These criticisms are aimed at companies that have gained a significant tax advantage over their nationally based competitors by using offshore tax havens. Onshore competitors compete on an uneven field even if they are more efficient or innovative than their offshore rivals.

The logic of this uneven competition requires either that all businesses ultimately move offshore to compete on even terms, or that onshore tax authorities adjust their tax regimes to place a greater burden on other factors, such as employees and consumption.

Campaigners for social justice have also joined the critics of offshore tax havens. According to Oxfam, the use of offshore havens by global corporations is depriving developing countries of some $50 billion of revenues each year. The UK is estimated to be losing £85 billion in tax revenue each year because of offshore tax shelters, and the US could lose $70 billion, says Oxfam.

Changes are also being made at banks that operate offshore accounts for companies. Citigroup, the world’s biggest bank, set up special-purpose financial vehicles in offshore centres for Enron, and also arranged offshore loan financing for Parmalat. But the bank claims that it has now changed its procedures. Referring to the Parmalat offshore loan account, a Citigroup spokesman said: “Today we would only do this transaction if a client agreed to provide greater disclosure.”

But though there is pressure on governments to regulate offshore business accounts and transactions, the chance of significant change in the near future is small, despite the incentive of higher onshore tax revenues for governments to clamp down on it. One reason for this is the complexity of finding ways to close all the loopholes. But another big reason is the power wielded by the companies that now take advantage of tax shelters. Few governments have the political will to reduce dramatically the profits of the world’s biggest and most influential corporations.

Enron in brief

The full details of how Enron used offshore centres to conceal information from investors are still not clear. But what is known is that the firm had almost 900 offshore subsidiaries – 692 in the Cayman Islands, 119 in the Turks and Caicos, 43 in Mauritius and 8 in Bermuda – as a key part of its financial deception. The fact that offshore centres often have strict banking-secrecy laws and are beyond the reach of tax inspectors was crucial.

Enron was set up in 1985 as an energy company sending natural gas through pipelines. In 1989 it entered the natural gas commodities market, where traders make bets on future gas prices. In 1994 Enron started trading electricity contracts and soon became the largest US electricity trader. By the late 1990s Enron had started trading coal, paper and even telecom bandwidth. By this time most of Enron’s revenues came from trading.

Enron’s rapid growth came crashing to a halt in 2001, when in October the company astonished investors by saying it was worth $1.2 billion dollars less than it had previously claimed.

The discrepancy was largely due to debts and losses that the company had attributed to separate investment partnerships, which it had created in the late 1990s and kept off the company’s books. Enron declared bankruptcy on 2 December 2001.

Since then investigators have been trying to establish how much the company’s directors knew about the partnerships. Arthur Andersen, the company’s accountant that approved the financial statements, also came under scrutiny.