Offshore Financial Centers for Financial Inclusion: An Aligned Industry or Oceans Apart?

There's one factor that FIEC members unanimously highlighted as being the primary driver in deciding where to domicile funds.

In the aftermath of the Panama Papers, the words “offshore” and “tax-haven” are often taboo rhetoric within the investment industry. Perhaps even more so in the impact investing space, where fund managers have both fiduciary and social responsibilities. The Financial Inclusion Equity Council (FIEC; of which CFI is the secretariat) recently published the report Offshore Financial Centers for Financial Inclusion: A Marriage of Convenience to better understand attitudes and practices when it comes to how equity impact investors use offshore financial centers (OFCs). To dive into this topic, CFI and consultants Daniel Rozas and Sam Mendelson interviewed FIEC members from the U.S. and Europe. Conversations resulted in varying opinions on the practice of using OFCs, with three key considerations for doing so: administrative efficiency, tax liabilities, and transparency and ethics.

Among all FIEC members interviewed, administrative efficiency was unanimously a primary driver in making the decision about where to domicile funds. Fund managers cited the importance of understanding local regulatory requirements, the presence of embassies, bank relationships, management facilities, remittance corridors, and convenience of location as important considerations in their decision. The reality is many low income offshore countries lack the infrastructure and capacity for supporting the administrative requirements of investments. Additionally, there are increasingly stringent AML/KYC requirements that disproportionately affect lower-income countries creating administrative burdens. The new CFI report states: “…this is at least one of the goals of using OFCs – not to avoid the regulators, but to outsource some of the reporting burden to entities that specialize in this service that have relationships to do it efficiently.”

When discussing OFCs, it’s impossible to not talk about tax liabilities, which is where opinions of North American and European FIEC investors were strikingly different. It comes down to a difference in philosophy on paying taxes. Most European investors interviewed emphasized the positive impact of taxes paid to support local infrastructure and economy. While across the Atlantic, the U.S. investor’s perspective is more focused on the investor and investee. Taxes are seen as burdensome that get in the way of “the primary objective – social investments to benefit the end-client.” The view is that tax treaties are in place for a reason and investors have a fiduciary responsibility to their investors. Doing otherwise would reduce funds available to their investees.

While OFCs might seem unethical as a means to reduce tax, all investors interviewed were aligned on the importance of transparency. There is no interest in hiding operations. This includes transparency to the target country, to the source country and to their public reputation. Efforts have been made in recent years to disincentivize countries from offering unclear banking services. Industry associations like the Organization for Economic Co-Operation and Development (OECD) work with governments to promote policies that improve economic and social standards through transparency.

A few weeks ago FIEC members met in Copenhagen for an annual meeting to discuss topics like this and other questions challenging the impact investing space. The group conversation about offshore incorporation was less polarizing than the previously-received feedback of individual interviews with members, who felt the Atlantic divide about tax justification was overstated in the paper.

Everyone agreed this is an area that is misunderstood, and that investors should aim for a structure that supports paying an appropriate amount of taxes. This means avoiding double taxation, while responsibly paying the fair share. There was less importance attributed in the conversation to deciding where to domicile and more emphasis on assessing the character of who to invest with.

Debates about OFCs and taxes will become increasingly interesting as more impact funds exit their investments and consider how to do so responsibly, a topic CFI has already explored and will continue to dig into this year.

For more, read Offshore Financial Centers for Financial Inclusion.

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