As Dot-Coms Go Bust in the U.S., Bermuda Hosts a Little Boomlet

As Dot-Coms Go Bust in the U.S., Bermuda Hosts a Little Boomlet By MICHAEL ALLEN Staff Reporter of THE WALL STREET JOURNAL HAMILTON, Bermuda -- Operating out of a hurricane-proof command center in a former U.S. military base, Paven Bratch is a tax examiner's nightmare. Although his Internet company, music and video merchant Playcentric.com (www.playcentric.com1), has just 10 employees, didn't go live until September and has yet to turn a profit, it has the structure of a major multinational. Its computer servers are located here, its operating unit is in Barbados, and it has a distribution deal with a big record-store chain in Toronto. The 36-year-old Mr. Bratch figures this setup will save him so much on corporate income taxes and other expenses that he'll be able to undercut Amazon.com Inc.'s prices by more than 45% and still make a bundle. "One thing that always amazes me is, why would anyone who's planning on generating a profit locate themselves in a full-tax jurisdiction?" he says. 'First Generation' Plenty of dot-coms are asking themselves the same question these days. Undaunted by their industry's growing ranks of flameouts and hoping to emerge as one of the profitable few, dozens of them are popping up in tax havens around the world. In Bermuda, they range from tiny publisher ISI Publications Ltd., which sells hard-to-find business books under the domain name Booksonbiz.com (www.booksonbiz.com2), to E*Trade Group Inc., the big online stockbroker, which is locating its international trading operations here. Further south, on the Caribbean island of Antigua, an American trader has set up Indextrade.com (www.indextrade.com3) to allow small investors to bet on swings in market indexes, while in Cyprus, a former British jazz singer is doing a brisk business by listing vessels such as a Soviet-era submarine on Ships-for-sale.com (www.ships-for-sale.com4). "These merchants are the first generation who can really domicile anywhere, " says Andrea Wilson, chief executive of Bermuda-based First Atlantic Commerce Ltd. (www.firstatlanticcommerce.com5), which provides credit-card payment systems for e-businesses. "They can be a virtual corporation if they choose." The trend started with Internet gambling companies, which fled to the Caribbean to avoid the long arm of U.S. law. But now, thanks to an explosion of new telecommunications links to places such as Bermuda and Britain's Channel Islands -- and an ambitious push by promoters in such countries as Panama to set up facilities capable of hosting hundreds or thousands of Web sites each -- more-legitimate Internet companies are starting to make the leap offshore. A Wealth of Ambiguity There are serious questions about whether some of the structures would pass muster with the Internal Revenue Service and its foreign counterparts. But many accountants figure there's enough ambiguity in the industrial world's offshore tax codes that e-commerce companies could, at least theoretically, rack up tax-free profits for years before the authorities sort things out. The issues are often murkier than for a standard offshore tax shelter, because they involve technological innovations that the U.S. Treasury couldn't have anticipated when it began laying the ground rules for offshore taxation in the 1960s. For instance, nobody's entirely sure how to tax the earnings of a programmer who sells his software by allowing buyers to download it from a Web site hosted on a computer server in a zero-tax jurisdiction. Some tax attorneys take the position that the sale takes place where the server is located, and that the business owes no corporate or sales tax in the buyer's home country. "It would be no different than you or I getting on a plane, flying to the Bahamas, and buying a T-shirt in the hotel," says Lazaro Mur, a Miami tax attorney. New telecommunications options have brought Bermuda and much of the Caribbean even closer than a plane ride away. Cable & Wireless PLC's phone monopoly among former British colonies in the region is breaking up, and C&W's new competitors are starting to lace the seabed with modern fiber-optic lines, breaking down old technological barriers to working offshore. At the same time, so-called server farms -- warehouses built to accommodate row upon row of computer servers -- are sprouting up to accommodate high- tech newcomers. At Fort Clayton, a former U.S. military base in Panama, local entrepreneurs plan to open a 50,000-square-foot "high-tech hotel" later this month they say will be capable of hosting as many as 1.2 million Web sites. HavenCo, a self-proclaimed "data haven," announced plans last year to host Web sites from an antiaircraft platform abandoned by the British after World War II. The North Sea platform has a colorful history: In 1966, a retired British army major seized control of it and has operated it for years as the sovereign "Principality of Sealand." Ryan Lackey, HavenCo's chief technical officer, says the company, which spent the summer upgrading electrical power and air conditioning on Sealand, has more than 30 servers up and running, connected to the mainland by satellite and wireless service, and hopes to expand to as many as 5,000. He says the company has fielded "several thousand" sales inquiries. "The big thing people really want is e-mail servers, because in the past people have been getting their e-mail servers subpoenaed," he says. He adds that HavenCo would only comply with subpoenas issued by the Court of Sealand. "But there's no Court of Sealand, so it's very unlikely." Tax savings are the big selling point for many of the installations. "Offshore + Ecommerce=Tax Free Heaven," screams a banner ad for Bahamas.net, which offers server facilities in the Bahamas for as low as $2,200 a month. Bermuda, which has a rich history of helping foreigners shave taxes, also is doing its best to encourage the migration offshore. Its two biggest banks, Bank of Bermuda Ltd. and Bank of N.T. Butterfield & Son Ltd., have launched major e-commerce initiatives, establishing systems to allow online merchants to bill customers in several major currencies. A common refrain among business leaders on this tiny fishhook-shaped island is that Bill Gates would be a much-richer man today if he had originally established Microsoft here. The pitch helped reel in Robert Edwards, an editorial cartoonist who lives in Canterbury, England. Not long ago he went looking for help in setting up a Web site to sell works by him and about 30 other artists from around the world. Tipped off to Bermuda by a visiting delegation of businesspeople, he registered his company online through Appleby, Spurling & Kempe, a local law firm here, and was quickly directed to Web designers, a hosting site and a credit-card intermediary, First Atlantic. Late last year, at a total cost of less than $200,000, his Drawnandquartered.com (www.drawnandquartered.com6) went live, offering 4,000 artworks, which can be downloaded online with a credit card, for $200 and up. His company doesn't pay any income or sales taxes, and he only has to pay personal-income tax on the salary he draws. "I'm a perfect example of how it can be done," he says. Playcentric's Mr. Bratch, a former Procter & Gamble Co. manager, says he relied on advice from an international tax attorney in structuring the online retailer, which will market its compact disks, videos and DVDs partly through packaged-goods makers who want to reward loyal customers. Mr. Bratch, a Canadian citizen, put his operating unit in Barbados, which, unlike Bermuda, has a tax treaty with Canada, in order to take advantage of the Caribbean nation's corporate income-tax rate of just 2%. He says he located his computer operations in Bermuda because of its extensive banking and telecommunications infrastructure. Its attractions include a state-of-the-art server facility built in an old U.S. naval base by 360networks Inc.'s TeleBermuda International unit, which laid an undersea fiber-optic cable to the U.S. in 1997. Tax considerations also helped lure Todd Middagh, chief executive of Originals Online Ltd., to Bermuda. His brainchild: a site that will allow importers, exporters and shipping companies to swap legally binding trade documents online, instead of wasting days with couriers. "It's a digital product, global in nature, 24-hours-a-day world-wide," says Mr. Middagh, who has already attracted the interest of several major grain companies, including Archer Daniels Midland Co. "We're going to be in almost every jurisdiction over time," he says. Meanwhile, Mr. Middagh, a native of Canada, will be presiding over the company from his house here, which overlooks the Atlantic Ocean. Scott Rubman, a Long Island, N.Y., real-estate attorney whose family has long been in the fur trade, is putting together Furs.com (www.furs.com7), a Bermuda-based site that plans to match mink farmers in, say, Norway, with fur-coat manufacturers in North America and China. As an American, Mr. Rubman may face a bigger hurdle in shielding any offshore profits from taxation. Unlike many other countries, the U.S. taxes its citizens on their income world-wide. "If you move offshore strictly to evade taxes, that's something the U.S. will always look at," says Mr. Rubman, who is getting plenty of advice from U.S. tax experts. "When you have a legitimate business purpose to transact business offshore, I'd think the U.S. would be supportive of that." And if the U.S. isn't supportive? Cryptographer Vince Cate thinks he has that covered. In 1998, the onetime Carnegie-Mellon University Ph.D candidate walked into the U.S. Embassy in Barbados and renounced his American citizenship, declaring that he was henceforth a citizen of Mozambique, thanks to a document he purchased for $5,000 over the Internet. Then, he went back to the Caribbean island of Anguilla, where he had developed a reputation as a computer-encryption visionary. Among his many ventures, he has taken over the operations of an online marketer of driver's-license information that had run afoul of a new privacy law in Texas. Mr. Cate plans to build the business without paying a cent of taxes. "Because I'm not a U.S. citizen, I'm not in the United States, and Anguilla has no taxes, I don't believe I have any problem," he says. Write to Michael Allen at mike.allen@wsj.com8