Monday, May 23, 2011

Why do so many Chinese companies use the BVI?

From the Treasure Islands site:

Naomi Rovnick of the South China Morning Post has an excellent article looking at the use by Chinese of British Virgin Islands (BVI) vehicles. It is de rigeur to be in the BVI, it seems, as one British tax lawyer says:

Our [Chinese] clients say that you haven't really arrived if you don't have at least one BVI company to your name.

Ten percent of all "foreign" investment into China comes from the BVI, in fact - and growing explosively, as this document (see table 4) shows. Why so? Well, the reporter met quite a lot of obfuscation. The lawyers didn't want to tell her; one Scottish corporate lawyer merely said 'ask the Chinese clients'. But then she extracts this telling quote from U.S. lawyer Steve Dickinson, which says it all:

"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."

That's a nice, frank quote, but Mr. Dickinson might like to straighten out the difference between tax avoidance - which by definition involves getting around the law without actually breaking it, and tax evasion, which is a criminal activity. What this lawyer is talking about is Chinese interests pretending to be foreign - essentially escaping tax, illegally, through offshore deception. This is illegal. It is tax evasion.

And this process of so-called round-tripping - where you take your money offshore, dress up in financial secrecy, then return back home to illegal harvest the tax breaks available only to foreigners - is one of the key raisons d'etre of many tax havens, worldwide. No wonder the BVI hosts over 900,000 corporations. And in case anyone suggests that this is just anecdote - the article also describes, lower down, how the (Chinese) regulator made a rare admission that mainlanders, not foreign investors, were responsible for much of this inflow.

It's not just about tax, and not just about China. There's the fraud element too, as Offshore Alert recently noted:

At least 10% of Chinese companies that have gone public on stock exchanges in the United States are engaged in fraud. The deals often involve establishing offshore holding companies in the British Virgin Islands, Cayman Islands, Samoa or another offshore jurisdiction in order to conceal illegal conduct. . . . although the companies are listed on U.S. markets, their business operations are in China and their holding companies are in a third country, creating a maze of regulatory and jurisdictional conflicts.

Now all this refers to inward investment into China. So how significant are tax havens with respect to outward investment from China? Well, the US-China Economic and Security Review Commission recently estimated that:

"In 2009, Hong Kong, the Cayman Islands, and the British Virgin Islands collectively received 79 percent of China’s net, nonfinancial FDI outflows. . . this makes the ultimate destination of Chinese overseas investment especially difficult to track."

And these aren't the only tax havens Chinese investors use - Singapore is another big one - so the true offshore figure must be even higher than that.

The SCMP article has some wonderful colour concerning one particular BVI address: No. 24 De Castro Street,

"a three-storey building where chickens are pecking their way along the driveway

The address hosts a photography studio, the BVI Tourist Board, and the office of corporate services firm Mossack Fonseca, which is the postal and legal home of an array of Hong Kong and Chinese companies, including -- get this -- the company that owns Hong Kong's International Finance Centre.

This is, perhaps, the BVI equivalent of Cayman's Ugland House, or 1209 Orange Street in Wilmington, Delaware, host to over 200,000 corporations. Read about my visit to Orange Street and Ugland House in Treasure Islands - the former looked, at least from the entrance, like a slightly disheveled pizza parlour. Back to BVI, and the unreality of it all deepens when we find out that

"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."

A sole judge? Details like this that reveal -- more than any academic study can possibly tell you - how offshore financial services industries act as gigantic artificial shams, designed to help Chinese (and other) elites get around their own laws and taxes, in order to get ordinary Chinese (and other) citizens to pay the taxes and costs, and shoulder the risks. Offshore secrecy creates elite impunity, which in turn leads to (and is a feature of) poor governance and authoritarian tendencies. (See more on this here.)

The article also mentions Treasure Islands, looking at the history of the emergence of tax havenry in the Caribbean, and offering one more choice morsel:

The use of Caribbean havens took off in Hong Kong in the lead-up to the handover.

So when the Chinese took over Hong Kong, Britain had a network of other jurisdictions ready to keep the dirty business, and the links to the City of London, ticking along just as before.

And as for the hopeless ineffectiveness of a new information-exchange agreement that China signed with the BVI in 2009 - after which BVI companies were allowed to list on the Hong Kong Stock Exchange the article provides a wonderful quote:

"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.)

It all confirms what I, and others I've worked with, have long been saying.

(TJN adds: recently, someone in Hong Kong sent us an email including the sentence "The vast majority of HK listed companies say in their annual reports that they have BVI incorporated structures, but they usually do not disclose what these subsidiaries hold" and asking more general questions. For those more technically-minded, a TJN senior adviser responded for some reasons why one might use a BVI company instead of a Cayman one:

If the investor is a China based person, the use of an offshore company permits "round tripping" and theoretically hides the identity of the beneficial owner from the Chinese authorities. As you know, the volume of "offshore capital" of persons from China is extremely large. The British Virgin Islands is used most frequently as a place of incorporation in such situations because incorporation in the British Virgin Islands can be done very rapidly, relatively inexpensively, and that jurisdiction is English based and does not have the stigma of "lawlessness" that Panama had.

Other jurisdictions such as the Cayman Islands could be used but the Cayman Islands is more costly and not always so efficient as the British Virgin Islands. The British Virgin Islands is really the "capital" of offshore incorporations. And corporate service providers in the British Virgin Islands have probably been very aggressive in marketing this service/product. Most of the large offshore multinational law firms have offices in the British Virgin Islands. For example, the large Cayman based law firms now have offices in the British Virgin Islands. From a tax point of view, the British Virgin Islands does not offer any tax benefits different from the tax benefits offered by other offshore jurisdictions.

The Cayman Islands is normally used as the Listed Company for public offerings, or for large more complicated financings when an offshore vehicle is used, because (a) Cayman has a much more sophisticated legal/financial structure and expertise; (b ) Cayman is a financial center while the British Virgin Islands is more of an incorporation center. That is why the listed company is almost always a Cayman corporation.

The reasons for a British Virgin Island company being in the chain of ownership is not always easy to determine. One primary reason is that the Group may want an intermediate offshore holding company below the Listed Company in Cayman but above the Hong Kong company, such as the British Virgin Island corporation in the structure that you mention in your email, in order to be able to hold other assets, or engage in offshore transactions, without the use of the Listed Company and without the use of the Hong Kong company.

The British Virgin Island company could be used by the Group in this situation without having possible corporate law/securities law issues/problems of using the Cayman Listed Company, and without having corporate law and/or tax issues/problems of using the Hong Kong company. For example, the Group might want to carry out other business ventures, or hold other investments, which it does not want at the Listed Company level nor at the level of the Hong Kong company.)


Blogger Taxjusticeafrica said...

Considering the huge chinese private investments in developing countries and particularly in Africa, how will country by country reporting address these kind of chinese investments emenating from tax havens? I think that the transfer pricing debate can not anymore continue to ignore the role and impact of China to developing (Africa) resources outflows.

3:56 a.m.  

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