May 23 2011

Why do Chinese companies flock to the BVI?

Posted by: Nick Shaxson in: Thoughts

Naomi Rovnick of the South China Morning Post has an excellent article looking at the use by Chinese companies 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. Delaware’s 1209 Orange Street, the legal home of the likes of Google, Coca-Cola, General Motors, and many more corporate giants, looks, at least from the entrance, like a slightly disheveled pizza parlour, highlighting the unreality of it all.)

Back to BVI, and the unreality 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.

P.S. if you are interested in some technical details about the BVI and Cayman, I’ve re-posted this to the blog of the Task Force on Financial Integrity, and added some comments underneath.

9 comments so far

[...] turkey shoot. We put it to him that his paper hadn’t taken into account the gigantic issue of round-tripping. [That is, that much of that investment is not real foreign investment, but the result of locals [...]

[...] We put it to him [Hines] that his paper hadn’t taken into account the gigantic issue of round-tripping . [That is, that much of that investment is not real foreign investment, but the result of locals [...]

[...] in the global economy goes very, very deep. (For more on this particular aspect of the murk, see my earlier blog on Chinese companies and BVI.) Reuters has, until recently, not focused much attention on tax haven [...]

debt relief 11th November, 2011 9.17 am

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[...] Chinese companies are reportedly fond of using the British Virgin Islands as an offshore base for their profits. Why? Oh, you know, just [...]

[...] Perhaps the most significant relationship is that between China and the British Virgin Islands (BVI) around 10% of all “Chinese” investment overseas originates from the BVI. The BVI has become the favoured jurisdiction for Chinese companies to “rest” their money for a period, before sending it home under the guise that it was a foreign investment, thus avoiding tax. Offshore shell companies (The BVI has 900,000 and counting), helps companies to hide assets and tax. The practice of using offshore entities makes it very different to measure China’s true level of FDI, as so many funds are funnelled through BVI and other “treasure islands”. [...]

[...] also be linked to the British Virgin Islands – until recently China’s favourite tax haven - losing some of their appeal as a result of Offshore [...]

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