Guernsey and Jersey: The ebbing tide THE Channel Islands have stood ready to defend themselves against invasion for 800 years. Jersey and Guernsey, the two largest, both boast imposing medieval castles in their quaint, yacht-filled harbours. But these days the islands and their 163,000 inhabitants are being assailed from many directions. Remnants of the ancient duchy of Normandy, Guernsey and Jersey are dependencies of the British crown but make their own laws. Growing in parallel with the City of London, they came to specialise in housing the offshore wealth of Europe's rich (especially Britain's non-domiciles) attracting fund structures, trusts, banking assets and insurance vehicles through their favourable tax regimes. Finance directly employs about one-fifth of the islands" workforce. Officially, the industry accounts for 40% of their economic output, although some estimate the figure is closer to 75% once related services are included. The financial crisis has therefore hit them hard. HSBC is to axe jobs, most of them in Jersey, which has a larger banking industry than Guernsey; other banks have already made cuts. Jersey used to be a hub for debt securitisation, but the demand for bundling loans has fallen off, leaving lawyers with less work. Cash-strapped Britain, meanwhile, is keen to close tax loopholes, including some that have benefited business in the Channel Islands. In March it went after an exemption called "low value consignment relief," which had allowed firms with operations in the islands to send low-value goods into Britain without paying value-added tax. The exemption was costing the British government £100m ($161m) in lost revenues a year. The islands could see hundreds of jobs go as companies close down their warehouses. In the March budget George Osborne, the chancellor of the exchequer, announced a crackdown on schemes that help companies and individuals avoid paying stamp duty on property sales - another Channel Islands speciality. The rhetoric from Ed Miliband, the Labour leader, and François Hollande, France's new president, is downright hostile to the islands. Mr Hollande has pummelled tax havens and proposed that French banks not be allowed to operate in them. Officials in the Channel Islands are defensive. They hate the word "tax haven," preferring to talk about "tax neutrality." Since the G20 threatened to blacklist them and other offshore centres in 2009, they have promoted themselves as clean and transparent. One boss of a global trust company that has an office in Jersey thinks this has driven some money to places like Luxembourg. "They want to prove they are whiter than white, which is killing a lot of the business," he says. Still, critics claim the Channel Islands are not transparent enough, and do not make public details of who is behind trusts. Another lure to businesses and wealthy folk could yet snag. Income is taxed at just 20% in both islands. Before the financial crisis the islands moved to allow most companies to pay zero taxes, while taxing banking profits at a 10% rate. This has put a large hole in their budgets: Jersey is losing £80m to £100m a year in corporate taxes as a result of the change. The island has had to introduce a general sales tax. The governments of both islands are now trying to reduce spending. Historically rivals for tourist cash and financial assets, they have joined forces in some activities, such as lobbying in Brussels and police training, which has helped them save £600,000 over two years. But some believe they may ultimately have to rethink their "zero-ten" tax policies. Although the islands do not have a culture of protest, some locals have quietly begun to question how much they have gained by wooing the rich. The cost of living is high. House prices in Jersey and Guernsey are around 40% higher than they are in London. Both places have experienced what John Christensen, a former Jersey economic adviser turned tax activist, calls a "finance curse." Just as countries rich in natural resources see other activities crowded out, the success of the finance industry in the Channel Islands has stopped others from sprouting. Recognising that finance may not feed them forever, leaders in both places want to boost tourism. Guernsey and Jersey used to be popular destinations for Britons during the summer, but with low-budget airlines now available to ferry them to more exotic locations, the islands have lost some of their allure. They are also looking to nourish industries like renewable energy, online gaming and data storage. Guernsey has ambitions to be a hub for intellectual property and image rights, so wealthy people could come and register their patents or images there. But even boosters admit the islands are coming late to diversification. Even if the new industries take off, they are unlikely to prove as profitable as finance. In the meantime their finance-promoting groups, Jersey Finance and Guernsey Finance, are trying to draw assets from new countries, and are setting up offices in markets like China and the Gulf. But their location and time zone may put them at a disadvantage when it comes to attracting money from Asia and the Middle East, particularly when there are closer low-tax spots, such as Singapore. Britain will probably remain the islands" biggest customer, and, despite the recent bout of tough love, their main ally. Because the Channel Islands direct hundreds of billions of pounds into the City, boosting liquidity and profits at financial firms, some concede that Britain gains more from the islands than it loses in avoided taxes. Politicians might lob insults, but they are not about to storm the islands and tear down their castles.