Sun, sand and lots of hot money

PUBLISHED : Thursday, 19 May, 2011, 12:00am
UPDATED : Thursday, 19 May, 2011, 12:00am


It's a balmy Friday night on the Caribbean island of Tortola and the Dove wine bar is heaving. The sharp-suited crowd sipping espresso martinis and imported beer aren't tourists, but tax and trust lawyers who frequent the island's tiny courthouse next door.

Mostly British expatriates, the money they're spending on drinks comes from the advice they give to international clients looking for ways to hide their corporate identities.

Set in the east Caribbean sea, Tortola is the administrative centre of the British Virgin Islands. Overseen by Britain, the archipelago of 36 islets boasts a zero tax rate and corporate secrecy laws that effectively shield the true ownership of the 900,000 companies registered here.

The BVI, as it's called, used to rely on European and US clients, but increasingly it has become wealthy clients from mainland China who park proceeds from such things as export sales and share offerings here and later often send them back home disguised as foreign investment to avoid tax.

The upshot is that since 2006, the BVI has ranked No2 behind Hong Kong as the biggest provider of foreign investment on the mainland.

It's a development that has implications for managing the mainland economy and is spurring Beijing to clamp down on the BVI connection.

'Mainland China has been a massive boost to our business,' says a British tax lawyer based on Tortola. 'Our [Chinese] clients say that you haven't really arrived if you don't have at least one BVI company to your name.'

Steve Dickinson, Qingdao-based head of the China practice at American law firm Harris & Moure, said: 'The reason for this strong link between China and the BVI is a very simple form of tax avoidance.

'If you take the money straight back into China you pay capital gains [or income] tax. If you leave it in the BVI, wait a while then send it back, it can be made to look to the authorities like it is a foreign investment, and you don't pay tax on that.'

Currently, the mainland's capital gains tax is 20 per cent for individuals and 25 per cent for companies, while income tax can be up to 45 per cent.

At first glance, Tortola - once a hideout for pirates - doesn't look like the kind of place that is at the pointy end of global high finance.

At 19 kilometres long by five kilometres wide and ringed by white beaches, it is home to just over 25,000 people. Road Town, the island's business district, is jammed along the base of a hill fronting the sea.

Main Street is lined with palms, fragrant frangipani trees and single-storey shops selling souvenirs, coffee and cosmetics as well as the Virgin Islands Folk Museum.

Across the way, yachts bob in their marina berths as cruise ships dock to disgorge Tortola's other big industry - tourists.

Other than a few Chinese restaurants, there isn't much sign of a significant Chinese presence. But it's a different story at No24 De Castro Street, a three-storey building where chickens are pecking their way along the driveway.

Inside the building is a photography studio, the BVI Tourist Board and the office of corporate services firm Mossack Fonseca.

The latter serves as the postal address and legal home of a host of companies that operate in Hong Kong and on the mainland, including the company that owns Hong Kong's International Finance Centre.

Tortola's languid setting, though, belies the action taking place at the nearby two-room Eastern Caribbean Supreme Court.

It is where the island's sole judge presides over multibillion-dollar corporate legal disputes and battles over wealth stored in BVI-incorporated family trusts that lawyers say increasingly involve heirs to Hong Kong fortunes.

Using offshore financial centres for tax planning, avoidance or evasion isn't unique to China, or to the BVI. Other British overseas territories, including the Cayman Islands, are popular tax havens.

Caribbean tax havens first gained popularity in the United States in the 1930s when 'organised crime took an interest in the US tax code,' says Nicholas Shaxson, a British financial journalist who recently penned Treasure Islands, a book on the history of tax havens.

When American gangster Al Capone was imprisoned for tax evasion in the early 1930s, Shaxson writes, his associate Meyer Lansky became fascinated with developing schemes to get mob money out of the US and ' bring it back, dry-cleaned' via small, Caribbean countries.

Today, Shaxson says, 'more than half of world trade passes, at least on paper, through tax havens'.

According to a 2009 report by the US Government Accounting Office, 83 of the 100 largest publicly traded US companies, measured by their 2007 revenues, said they had subsidiaries in jurisdictions offering tax and secrecy advantages.

In a separate 2009 report, the UK's Tax Justice Network found that of the 95 largest listed companies in the UK, the Netherlands and France, all but one operated units in tax havens.

The use of Caribbean havens took off in Hong Kong in the lead-up to the handover. As anxiety grew among Hong Kong's wealthy elite, they looked for options abroad to protect their assets.

In 1993, the South China Morning Post even published a guide to offshore financial centres.

One of the territory's oldest companies, Jardine Matheson, moved its headquarters from Hong Kong to Bermuda that year.

Then in 1996, a delegation from the British Virgin Islands visited Hong Kong to promote the archipelago's superiority over other offshore havens such as Guernsey, Liechtenstein and Bermuda.

A so-called satellite companies registry, replete with Chinese-language services, was temporarily established to help people set up BVI companies without leaving Hong Kong.

As they have grown richer, people on the mainland seem to have caught the BVI bug from their Hong Kong cousins.

There are no official figures on which countries' citizens use the BVI's infrastructure to set up offshore companies.

But, says Maritsa Mercer, the chief operating officer of the government department responsible for promoting the BVI as a financial centre: 'It is definitely a trend.

'Every time I meet Chinese people they say they are sending their business the BVIs' way ... There must be some advantage for them not to have their companies [incorporated] in China if they are registering companies all the way out here.'

Lawyers on Tortola are coy about just how their Chinese clients benefit from the BVI's offshore services.

Over coffee in a local beachside bar, a Scottish corporate lawyer, who declined to be named, advises: 'You will have to ask the Chinese clients.'

A look at some prospectuses for initial public offerings of shares in mainland companies on the Hong Kong stock exchange gives some idea of the role the BVI plays.

The documents show how wealthy mainland businesspeople set up BVI companies to hold their stakes ahead of the stock market listings. But what they do with the money after that is seldom documented.

Take, for example, Wong Kwong-yu, the founder of Gome Electrical Appliances Holdings, who is currently in jail on the mainland for insider trading, bribery and illegal business practices.

He once disclosed that he intended to recycle cash collected by his BVI holding company to China. Whether or not he paid income tax on that capital gain is unknown. A lawyer for Wong didn't respond to emailed questions seeking comment.

In September 2007, Wong sold HK$2.34 billion of shares in the electrical appliances business he held through his private BVI company, Shinning Crown.

A Gome spokesman told the South China Morning Post at the time that Wong brought the money collected by Shinning Crown back into China and spent it on real estate to expand 'Gome Group', a collection of more than 200 electrical appliances stores personally owned by Wong, which he in turn leases to Hong Kong-listed Gome Electrical Appliances Holdings.

According to official mainland figures, BVI companies accounted last year for about US$10.5 billion of new foreign direct investment (FDI) into China, or 10 per cent of the total.

By comparison, the BVI represented more than the US, Britain, France and Canada combined.

Hong Kong was the largest source of foreign direct investment on the mainland with nearly 60 per cent of the total, partly because of a practice known as transfer pricing.

That's when a company sells goods to an affiliate, in this case in Hong Kong, at a low price then the affiliate resells the goods and pockets the profit offshore, dodging steep taxes at home.

Those profits may later be channelled to China dressed up as foreign direct investment.

Policing the offshore flows has proved difficult for Beijing.

Since 2005, mainlanders have been required to ask the State Administration of Foreign Exchange (SAFE) for permission to bring money held in offshore companies back into China.

SAFE seldom says 'yes', according to a senior partner at an American law firm that helps mainland entrepreneurs set up BVI companies ahead of doing IPOs on the Hong Kong stock exchange. Yet, the BVI's contribution to China's FDI inflows has stayed stubbornly high.

In February, SAFE said US$35.5 billion of so-called hot money, or capital brought in without official permission for speculative purposes, came into the country last year.

The regulator made a rare admission that mainlanders, not foreign investors, were responsible for much of this inflow.

Among other things, the SAFE report said, 'fees for processing trades are exaggerated to maximize incomes in foreign currencies.

'Re-export firms try to increase net inflows using the time difference between the receipt and payment of foreign currencies. Shell companies fake foreign investments.'

The SAFE report didn't elaborate on whether BVI companies were involved in the 'hot money,' and SAFE officials didn't respond to telephone calls and faxed questions seeking comment.

But in practice, says Dickinson, the American lawyer, 'it's pretty impossible for the Chinese government to tell whether a BVI company is a Chinese-controlled entity or a true foreign investor.'

He adds that the fact many bona fide international private equity funds choose to invest in China through BVI vehicles muddies the waters. A country's tax base is critical to national economic planning.

So-called round-tripping, where funds are routed through offshore havens to circumvent tax, complicates that task.

Fake foreign investment is 'a big problem for China's economic planners,' says Geng Xiao, director of Columbia University's global centre for East Asia in Beijing. Planners 'need more transparency' about the sources of capital, he said.

Sometimes clandestine offshore financing arrangements such as those available in the BVI play a role in corporate fraud.

Peter Gallo, a former Hong Kong-based fraud investigator who specialised in tracing funds missing from Chinese companies, contends it is 'entirely common' for mainlanders seeking to launder the proceeds of corruption or attempting to subvert the mainland's currency controls to use vehicles in places with strict secrecy laws, such as the BVI.

To try to damp the use of BVI vehicles for nefarious purposes, China struck an agreement with the BVI that allows Beijing to get information from the territory about who really owns companies domiciled there.

The information-sharing accord, similar to agreements the BVI has sealed with other countries, such as the US, came into effect in December and effectively means that if asked, BVI authorities must disclose the owners of companies registered there.

Gallo's response? 'Ha ha!', he scoffs. 'They are probably now being told by their BVI counterparts that the owner of a BVI company is an anonymous Cayman Islands company.' (Cayman companies don't have to say who their shareholders are either.)

Back at the Dove, Tortola's legal fraternity is hoping Gallo is right.

Talk among the tanned lawyers hugging the bar this Friday evening is of plans for parties and sailing dates.

They are counting on the mainland's booming economy and lack of tax enforcement to keep their tropical lifestyles afloat.


BVI companies accounted last year for this sum, in US dollars, of new foreign direct investment into China, or 10 per cent of the total