Tax crackdowns threaten Channel Islands’ haven status

Only in private will a small number of Channel Islands politicians and businessmen betray any trace of personal misgivings about the manner in which the local finance industry trades on complex tax structures to help big business and super-rich individuals cut their tax bills.

"When a horse falls from heaven you don't check its teeth, do you?" said one government figure, who asked not to be named. "And the finance industry is like that here."

Another lawyer who works in Jersey's trust industry, looking after assets of overseas millionaires, explains over a beer that local rules mean he must know the commercial rationale for the structures he administers. "The answer is generally always tax. Tax and inheritance planning." He too spoke only in confidence.

Five years ago, at its peak, the value of assets held through Jersey – its offshore banks, trusts and investment funds – was estimated at £700bn-£800bn, according to the island's former chief adviser Colin Powell. The figure is equivalent to about half of the UK's annual economic output.

Finance dominates life in the Channel Islands, particularly Jersey and Guernsey, where it accounts for almost half of economic activity. The island capitals of St Helier and St Peter Port are dotted with familiar-named banks, many of them institutions that have survived only after bailouts from taxpayers elsewhere in the world.

If the past five years of global financial turmoil have not entirely passed the islands by, they have left them relatively unscathed, even though the economic output of Jersey's financial sector has shrunk by almost a third.

While other small nations with large banking sectors, such as Iceland and Ireland, have been undone by their reckless lending practices, the debt-free Channel Islands have always positioned themselves as dependable repositories of riches.

Visitors touching down at airports in Guernsey or Jersey are confronted with advertising hoardings promising "wealth management", "asset protection" and "tax advice". This is what the islands are good at.

From the start of the 1970s, the Channel Islands enjoyed almost four decades of near-uninterrupted growth, driven by ballooning financial activity. Bank deposits grew from £500m in 1970 to £220bn in 2007.

Over the same period the number of active companies incorporated on the island rose from about 550 to more than 33,000, including FTSE 100 firms such as Glencore, Shire Pharmaceuticals and advertising group WPP.

With the boom Jersey's population has expanded by 40% since 1970 and now stands at 98,000, with a quarter of working-age adults employed in finance last year. Just over 40% of these finance workers were born in Jersey while almost an equivalent number hail from the UK. Despite the impressive roll call of corporate and investment names on the island, for many multinationals their Jersey presence is a flag of convenience. The islands are a tax-neutral conduit for these groups, a popular component in the financial plumbing that connects assets and investors around the world.

For workers in St Helier, however, perhaps the most lucrative corner of Jersey's financial sector is the offshore trusts industry catering to the international super-rich. Efforts by Britain to prevent its wealthy residents from using Jersey trusts to shelter assets from the taxman date back at least to the 1920s. Today, Jersey and Guernsey attract wealth from across Europe, the Middle East and beyond, as well as being the jurisdictions of choice for the UK's non-domiciled super-rich – the wealthy figures who have told Her Majesty's Revenue and Customs they are not permanently based in Britain for tax purposes.

With no register of trusts, the Jersey authorities do not know how many such ownership vehicles exist, who owns them, or what assets they control.

But John Harris, director-general of the Jersey Financial Services Commission (JFSC), is furious at critics who suggest such opacity opens the door to international tax evasion. He said the 180 companies that administer offshore trusts are tightly regulated, required to know the source of funds, who set up the trust, who are the beneficiaries, and to meet strict anti-money laundering criteria.

Harris claimed there was a "prejudice against trusts" simply because they offered a "legitimate degree of confidentiality, no different to bank accounts". Asked how many trusts were administered on the island, he said: "Nobody knows ... It's probably tens of thousands." Responsibility for ensuring all comply with regulations lies with just 675 trust company directors recognised by the JFSC.

Mounting international pressure to throw more light on the offshore trust industry has led Jersey and Guernsey to sign a string of co-operation agreements with countries around the world, allowing overseas tax authorities to request information where they can demonstrate a suspicion of improper tax arrangements. Failure to sign up to these agreements would have put the islands on a G20 blacklist.

Such agreements have been criticised by some for not giving enough powers to overseas tax authorities. The US, which has signed deals with Jersey and Guernsey, has developed its own, more aggressive disclosure demands on offshore financial firms handling the assets of American citizens, which start to become active from next year.

Jersey and Guernsey signed tax co-operation agreements with the UK in 2009 but HMRC told the Guardian it had not yet made a single tax inquiry through this route, though it is expected to in future. Senior figures in the Channel Islands say criticism of offshore trusts from British politicians particularly sticks in their craw because much of the industry exists to service the special tax arrangements that thousands of super-rich non-doms have entered into with the UK government.

"If Jersey did not administer these funds they would most likely flow to another offshore centre that would not provide the same return to the UK," said Geoff Cook, Jersey Finance's chief lobbyist.

Many UK non-doms using Jersey trusts have also used offshore companies to avoid stamp duty on the sale of UK expensive properties – another practice George Osborne pledged to outlaw in his March budget. Ben Newman of IFG Trust, a Jersey arm of stock market-listed IFG Group, this month told a conference of trustees: "A number of trust companies on the island have this as a significant part of their portfolio and, as such, changes here could have a major impact on their businesses and possible structuring requirements."

In his budget, Osborne condemned the stamp duty dodge as "a major source of abuse – and one that rouses the anger of many of our citizens".

Such comments rankle with Jersey's treasury minister, Philip Ozouf, particularly when Jersey's reputation is dragged through the mud. Challenged on Jersey's role in the controversial tax affairs of comedian Jimmy Carr, he said: "It is not up to us to close the loopholes. These are UK taxpayers using UK loopholes and it's up to the UK to change them. We can't legislate for around the world."

Meeting the Guardian before the furore, Ozouf proudly points to the long esplanade that faces out onto the Channel in the centre of St Helier, naming the financial institutions that occupy plots where once stood potato warehouses loading produce on to ships. "You don't put bread on the table by running an agricultural economy. Jersey has no natural resources apart from its nice beaches and countryside. It's got these to work with … [he taps his temples] … brains.

"Did people come here with suitcases full of cash in the 1970s? Of course they did. Was tax evasion widespread? Of course it was. But Jersey moved away from all that a long time ago."

But as the Carr furore has shown, popular opinion in the UK cares little for nice distinctions between illegal evasion and clever artificial schemes to reduce tax bills for the wealthy while remaining within the letter of the law. The same message is now coming through in a barrage of tax and regulatory crackdowns around the world that collectively threaten to erode the foundations of the Jersey and Guernsey economies.

Back from a tour of the islands this month, Lord McNally, the justice minister with responsibility for the UK relations with its Crown Dependencies, told the Guardian he had left locals in no doubt that the days of Britain turning a blind eye to aggressive loophole industries in the Channel Islands were over. "Treasuries all over are making tough decisions in these difficult times," is his message to the Channel Islands.

Following a series of tough measures in the March budget, he recalls being asked: "Is this the last time [the UK] Treasury is going to come stopping us doing things?"

He replied: "No. The Treasury will continue to do its job."

Many in the Channel Islands bridle at such language, pointing to the huge money flows coursing from the island to the City of London, helping to support the UK's largest banks, not least RBS and Lloyds Banking Group, in which the British taxpayer has major stakes.

A report for the Treasury found that more than $300bn (£190bn) was flowing from bank branches and subsidiaries in Jersey and Guernsey up to UK head offices three years ago.

Jersey's treasury minister Ozouf said: "We're a secondary centre to London. We collect deposits from around the world … and we provide about $200bn of liquidity to the UK banking system. We argue that liquidity is as important to the UK economy as quantitative easing has been."

This message, island ministers believe, is quietly heeded by wise heads in Whitehall. But there is a limit to how much local politicians can bite their tongues in the face of what are seen as cheap political attacks trashing Jersey's reputation. In March, the islands took the extraordinary step of using British courts in an attempt to stop Osborne closing a loophole in VAT rules for online retailers which is said to be costing the UK exchequer £110m a year.

Amazon, Tesco.com, Play.com and others had been shipping more than £500m of CDs, DVDs and other postable goods to UK customers tax-free from Jersey and Guernsey for almost a decade. The crackdown, Jersey lawyers told the high court, would "result in more than a 50% increase in unemployment, with the consequent social and economic consequences – that is to say, a catastrophe".

The legal challenge was unsuccessful and retailers were blocked from shipping VAT-free from the islands two months ago. Freight levels have plummeted and hundreds of warehouse job losses have followed.

The blow comes as the islands' political establishments are still smarting from the impact of a Brussels directive to stamp out "harmful" tax policies, among which were seen to be the special corporation tax deals offered by Guernsey and Jersey to overseas companies.

This fundamental attack on the islands' offshore economic model began to bite three years ago, forcing a radical reshaping of public finances. Jersey faced a 20% hole in its tax take. Desperate to remain an attractive offshore hub, politicians sought to plug the deficit with a regressive VAT-sales tax and deep cuts in spending.

Looking to the future, bold changes to the regulation of UK banks and new European rules for hedge funds are also a concern. Meanwhile, Brussels has again identified "harmful" elements in both Jersey and Guernsey's revised fiscal arrangements.

Increasingly radical policies to combat tax avoidance and evasion are being drafted by governments across the western world. While the Channel Islands regard themselves as among the most respectable and well-regulated offshore centres, many senior figures fear little care will be taken to protect their interests.

Ozouf puts a brave face on it. "It's a never-ending, moving task. We're a jurisdiction that accepts the inevitable conveyor belt of change. Jersey has succeeded because it's moved with whatever the market demands are."