Offshore centers now face a perfect financial storm.

In more prosperous times, revenues from the offshore sector, along with tourism, helped fuel these countries’ economies.

Unfortunately, governments of these jurisdictions emulated those of developed nations.

They borrowed loads of money to build up their infrastructure. They bought votes with social programs and bloated government payrolls.

Of course, when the global economy tanked, tourist revenues fell, along with revenues from their offshore sectors.

But the social programs and bloated payrolls remained.

Blame Offshore Tax Havens! (Again)

The economic crisis also led to worldwide drop in tax revenues.

The biggest losers were big industrialized countries like the United States.

And politicians found a convenient scapegoat for falling tax revenues: dozens of (mostly tiny) offshore centers.

Using the economic crisis as their reason, the world’s richest and most powerful governments saw the perfect opportunity to achieve a long-term goal: forcing offshore jurisdictions to enforce their tax laws.

They acted through non-governmental organizations they control, such as the Organization for Economic Cooperation and Development (OECD).

The OECD has the authority to issue supposedly non-binding “best practices” guidelines.

And, the OECD now decrees that “best practices” meant becoming tax collectors on behalf of these rich and powerful governments.

The one-two punch of the global financial crisis, plus the OECD vendetta, has led to unprecedented economic challenges for offshore centers.

Some – Gibraltar, Hong Kong and Singapore, for instance – are still in pretty good shape financially. Others (particularly in the Caribbean) are having a hard time paying their bills. The British press refers to the Cayman Islands as “bankrupt.”

Could offshore jurisdictions facing the worst challenges actually declare bankruptcy?

Not if they can reduce spending, or qualify for additional loans. A condition of additional lending, however, may be to impose direct taxes, such as personal and corporate income taxes.

Here’s a rundown of where the offshore financial crisis now stands:

U.K. Government Declares War on
English-Speaking Offshore Centers

It used to be official U.K. policy to encourage responsible growth in the offshore sectors of current and former colonies.

But, in the late 1990s, the government began to dismantle the offshore sectors of its former empire.

It was easiest in U.K. overseas territories where the Parliament can enact binding legislation.

And the British Foreign Office simply threatened legislation that would force governments to enforce foreign tax laws.

To avoid that politically unpopular outcome, the overseas territories enacted the demanded laws on their own.

The most recent crackdown began in 2008.

The U.K. government commissioned an independent review of its overseas territories and “Crown dependencies” with offshore sectors.

The Foot Report found that the global financial crisis had led to significant hardships:

”The impact has been pronounced in Anguilla, the Cayman Islands and the Turks and Caicos Islands resulting in depleted public sector cash reserves. Bermuda and the British Virgin Islands have also experienced a decline in government income, but the impact has been less severe. Revenues have held up better in the crown dependencies [Jersey, Guernsey, and the Isle of Man] and Gibraltar.”

The report recommended that those jurisdictions facing depleted treasuries consider spending cuts and imposing direct taxes.

And former Treasury official Michael Foot suggested that any bailout by the U.K. government be contingent on a viable recovery plan, which could include direct taxes.

Nowhere did the report state the most obvious possible recommendation: that the OECD back off and let these islands play by the same set of rules the OECD gives its own members.

Indeed, many OECD jurisdictions are themselves offshore centers: notably, Luxembourg, Switzerland, the United Kingdom, and the United States (the world’s largest tax haven for non-U.S. resident investors).

The reality is that London is using the global financial crisis to undermine the low-tax regimes in place by arguing that the territories need to “broaden their tax base.”

Hardball Politics

Just to make sure what’s left of its colonial empire got the message, the U.K. government has imposed much tougher standards for loans and loan guarantees.

In 2009, the Cayman government, facing an $82 million budget deficit, appealed to its colonial masters in London for permission to borrow $310 million from banks.

Despite the fact that commercial banks had already approved the loans, the British Foreign Office said “no.”

The Cayman government then commissioned a team to conduct an independent review of the islands’ fiscal challenges. The review’s key recommendations were to cut government spending and to privatize most government-run enterprises.

Reaction was swift and furious against the plan.

The Cayman government refuses to make significant spending cuts. This makes an eventual bailout likely, with unfavorable terms in respect to direct taxes.

The government has also recently enacted legislation that authorizes confiscation of local assets in “dormant” companies and trusts.

But it’s not only English-speaking offshore jurisdictions that face serious financial challenges. And in many cases, these jurisdictions are considering – and implementing –new laws and regulations that adversely impact non-resident investors.

Here’s a rundown of what to expect in the months ahead:

Non-English Speaking Jurisdictions Face Problems Too

It’s not only U.K. territories that face significant revenue shortfalls.

Uruguay is a great example. If you’re a legal resident in Uruguay, you pay taxes only on your Uruguay-source income. This policy has made Uruguay a popular destination for well-heeled expats.

However, last May, the government introduced legislation to tax residents of Uruguay on their worldwide income. The law would also impose a wealth tax on all offshore assets.

Needless to say, taking up residence in Uruguay looks less attractive than it once did, although the government now says foreigners who come to retire in Uruguay won’t be affected.

Other popular low-tax jurisdictions facing significant revenue shortfalls include the Cook Islands and Dubai.

Cuba – the Sleeping Caribbean Giant

In the midst of this economic uncertainty, don’t forget about the largest island in the Caribbean – Cuba.

Right now, with their offshore sectors in tatters, tourism is the major revenue stream for Caribbean offshore centers. And in this economic crisis, tourism has fallen sharply. And those tourists that still show up don’t spend as much.

But what happens to the Caribbean tourism industry when the U.S. Congress ends longstanding economic sanctions against Cuba?

There’s broad support for this measure among U.S. farm and business groups.

It’s going to happen, perhaps very soon.

And when it does, U.S. tourists will find a new and exotic vacation haven beckoning them only ninety miles from Key West.

The Caribbean Tourism Association predicts that if the U.S. government drops all travel restrictions against Cuba, more than one million U.S. tourists would visit the island annually. That’s a million tourists who may not have the time, energy, or money to visit more remote Caribbean jurisdictions.

The impact on these islands’ economies will be severe.

How Will Offshore Jurisdictions React?

The most politically expedient stance for cash-strapped offshore jurisdictions is to loot the assets of foreign investors who don’t vote.

In order of increasing severity, such measures could include:

• Imposing personal and corporate tax on worldwide income.
• Confiscation of local assets in companies and trusts deemed “dormant.” Last week, the Cayman Islands enacted legislation mandating this outcome.
• Restrictions or taxes on outgoing funds transfers.
• Forced dilution of shareholder equity in local companies.

What can you do to protect your investments against the increasing likelihood of less favorable tax, regulatory, and asset protection provisions in financially challenged offshore jurisdictions?

In the August issue of The Sovereign Individual I’ll outline six strategies to protect yourself from these outcomes. Just click here to begin your risk-free membership.

The unprecedented challenges now facing the offshore world aren’t going away. Make sure you’re prepared for the unexpected!

Mark Nestmann

Wealth Preservation & Privacy Expert

P.S. It’s not just foreign countries facing possible default – 48 American states face the same fate. Click here for more on the potential outcome, plus how to protect yourself from the Great State Meltdown.

More From the Author:

• 6 Big Expatriation Myths - July 28th, 2010
• Could You Be a Tax Evader... And Not Even Know it? - July 9th, 2010
• Why I Gave Up My U.S. Citizenship - June 17th, 2010