Info Service on Finance and Development (May16/02)
10 May 2016
Third World Network
Flows to offshore financial hubs remain sizeable
Published in SUNS #8236 dated 9 May 2016
Geneva, 4 May (Kanaga Raja) - Investment flows to offshore financial
hubs, including to offshore financial centres (OFCs) and special purpose
entities (SPEs), while registering a decline, nevertheless remain
significant, the UN Conference on Trade and Development (UNCTAD) has
In its latest Global Investment Trends Monitor (No. 23 of 3 May 2016),
UNCTAD also said that the volatility of investment flows through these
hubs rose significantly in 2015.
It found that financial flows through SPEs surged in volume during
2015, and the magnitude of quarterly flows through SPEs, in terms
of absolute value, rose sharply compared with 2014, reaching the levels
registered in 2012-2013.
UNCTAD however said that pronounced volatility, with flows swinging
from large-scale net investment to net divestment, tempered the annual
result, which dipped to US$221 billion.
"Investment flows to offshore financial centres continued to
retreat from its recent high of US$132 billion in 2013, but remained
roughly in line with the flows of previous years."
Investment to these jurisdictions, which hit an estimated US$72 billion
in 2015, had risen in recent years by the growing flows from multinational
enterprises (MNEs) located in developing and transition economies,
sometimes in the form of investment round-tripping.
"The proportion of investment income booked in low tax, often
offshore, jurisdictions is high - and possibly growing. The disconnect
between the locations of income generation and productive investment
results in substantial fiscal losses, and is therefore a key concern
for policymakers," said UNCTAD.
According to the UNCTAD report, offshore financial hubs offer low
tax rates or beneficial fiscal treatment of cross-border financial
transactions, extensive bilateral investment and double taxation treaty
networks, and access to international financial markets, which make
them attractive to companies large and small.
"Flows through these hubs are frequently associated with intra-firm
financial operations - including the raising of capital in international
markets - as well as holding activities, including of intangible assets
such as brands and patents."
According to UNCTAD, investment flows to SPEs, which represent the
majority of offshore investment flows, registered significant volatility
in 2015. Financial flows through SPEs nonetheless surged in volume
during much of the year.
"Pronounced volatility, with flows swinging from large-scale
net investment during the first quarter to a huge net divestment during
the last quarter, tempered the annual 2015 results."
The primary recipient of SPE-related investment flows in 2015 was
Luxembourg. Flows to SPEs located in Luxembourg were associated with
funds financing investments in the United States. This was especially
apparent in the first quarter of the year, when SPE inflows rose to
SPE outflows in the same quarter reached US$155 billion, which in
turn was reflected in data from the United States, where inward FDI
from Luxembourg topped US$153 billion (77% of total inflows).
"After surging for three quarters, more than tripling their 2014
levels for the same period, SPE inflows turned negative in the last
three months of the year, recording a net divestment of roughly US$115
billion, as SPEs in the country paid down intra-company loans to the
tune of US$207 billion."
According to the report, after registering a sharp decline in 2014,
SPE-related inflows in the Netherlands initially showed signs of a
rebound in 2015, rising from US$2 billion in the first quarter to
US$148 billion in the third quarter (their highest quarterly level
since 2007 Q3).
As in Luxembourg, these flows retreated sharply in the fourth quarter,
with a net divestment of equity capital and reinvested earnings of
roughly US$200 billion.
UNCTAD said that an analysis of the geographical breakdown of total
investment flows suggests that this trend was driven by investors
from Luxembourg and the United Kingdom.
Reflecting the pass-through nature of these flows, outward investment
flows by SPEs also tumbled in the fourth quarter, led by dramatic
declines in overall investments targeting Luxembourg and the United
"The tight interrelation between SPE flows in Luxembourg and
the Netherlands highlights the existence of dense and complex networks
of these entities in both countries, with capital flowing rapidly
among them in response to financing needs and tax planning considerations."
The report noted that recent policy changes may be responsible for
the most recent decline in investment flows to SPEs.
The Netherlands, for instance, adopted new substance requirements
for group financing and licensing companies; these requirements also
allowed for the automatic exchange of information about entities with
little or no substance in the country with tax treaty partners and
other EU countries.
In Luxembourg, the authorities enacted a number of changes in their
tax framework, including greater substance requirements, a revision
of transfer pricing rules, and a reform of the process and substance
of tax rulings.
"Due to the volatile nature of offshore financial flows, the
actual impact of these policy changes will become clearer over the
next few years," said UNCTAD.
Investment flows to Caribbean offshore financial centres continued
to decline from their 2013 record levels, when a single large cross-border
M&A caused them to surge markedly. Compared with that year, inflows
in these economies were down 42% to an estimated average of US$75
billion in 2014-2015.
Nevertheless, said UNCTAD, this is in line with their 2008-2012 period
average of US$75 billion, due to the high level of flows to two major
The report said that while MNEs from developed economies, in particular
from the United States, traditionally dominated flows to these jurisdictions,
in recent years rising investment flows from developing and transition
economies have played an important role.
Between 2010 and 2014, Hong Kong-China, the Russian Federation, China
and Brazil accounted for 65% of investment flows to the largest Caribbean
financial centres, the British Virgin Islands and the Cayman Islands.
UNCTAD said that a key concern for policymakers globally is the potential
for a substantial disconnect between productive investments and income
generation by MNEs with implications for sustainable development in
their economies. "The significant share of MNEs' total FDI income
booked in low tax, often offshore, jurisdictions remain therefore
It said that ratios of income attributed to foreign affiliates of
outward investing countries to the gross domestic product (GDP) of
the economy where those affiliates are resident reveal profits that
are out of line with economic fundamentals.
For example, MNEs from a sample of 26 developed countries registered
more profits in Bermuda (US$43.7 billion) than in China (US$36.4 billion)
in 2014. Unsurprisingly, the share of their profits relative to the
size of Bermuda's economy is an impressive 779.4% of GDP, compared
to less than 1% of GDP in a number of countries.
Elevated FDI income to GDP ratios can also be observed in other countries.
For example, the FDI income of foreign affiliates (as reported by
their home countries) in the Netherlands, Luxembourg, Ireland and
Singapore relative to their GDPs all exceed the weighted world average
by a substantial margin.
According to UNCTAD, high FDI income to GDP ratios reflects the emergence
of holding companies as major aggregators of MNEs' foreign profits.
In the case of Bermuda, the outsized profits of foreign affiliates
in the country largely reflect income attributed to investors from
the United States.
Taking a longer term view, data from the United States highlights
a significant shift in the sources of overall FDI income since the
global economic and financial crisis. Prior to the crisis, most FDI
income was generated from entities other than holding companies, the
latter accounting for an average 40% of total quarterly income between
2003 and 2008.
In the aftermath of the crisis, however, the share of FDI income attributed
to holding companies has steadily risen to a quarterly average of
52% in 2015.
"The growing importance of holding companies is due to a number
of factors, including the greater reliance on regional centres to
coordinate activities in host countries, but their frequent location
in jurisdictions with low tax rates or favourable fiscal regimes suggests
that tax motivations play a key role," said UNCTAD.
The six countries that each accounted for 5% or more of the United
States' outward FDI stock in holding companies in 2014 - Bermuda,
Ireland, Luxembourg, Netherlands, United Kingdom, United Kingdom Islands
(Caribbean) - generated an average 40% of FDI outward income between
2005 and 2008.
In 2015, said UNCTAD, this share had risen to a quarterly average
of 59%, an increase of nearly 20 percentage points in the span of
less than a decade.
NEED FOR POLICY COORDINATION
The UNCTAD report said efforts to stem offshore financial flows have
been underway both at the national and international levels.
Revelations that firms large and small have been using offshore financial
centres and jurisdictions to evade or avoid taxes have provided additional
impetus to policy reforms in these areas. More efforts are indeed
necessary, and the persistence of investment flows routed through
offshore finance centres, as well as the level of profits booked in
these jurisdictions, highlight the pressing need to create greater
coherence among tax and investment policies at the global level.
"A lack of coordination between these two crucial policy areas
will limit positive spillovers from one to the other, limiting potential
gains in tax compliance as well as productive investment," said
The international investment and tax policy regimes are closely inter-related,
it noted, adding that both have the same ultimate objective: promoting
and facilitating cross-border investment.
They have a similar architecture, made up of a "spaghetti bowl"
of mostly bilateral agreements. The two systems face similar challenges,
such as, for example, strengthening their sustainable development
dimension and maintaining their legitimacy. They interact, with potential
consequences in both directions; and both are the object of reform
"These reforms must maintain the effectiveness of both policy
regimes to sustain confidence in, and support for, both. The policy
imperative is to continue facilitating cross-border productive investment
and taking action against tax avoidance to support domestic resource
mobilization for the pursuit of sustainable development."
UNCTAD said ensuring that international tax and investment policies
are mutually reinforcing is fundamental to building and maintaining
an enabling environment for investment, maximizing the chances of
securing financing for development targets, and supporting the integration
of developing countries in the global economy.