LONDON: Britain could be forced to bail out one or more of its offshore tax havens at huge cost, according to early drafts of a UK Treasury report, because the economic crisis has wrecked their finances.

Offshore expert Michael Foot will next month set out a number of options to government ministers in the report as anxiety grows among government officials in London over the health of Britain’s overseas territories and crown dependencies.

Experts suggest the failure of a major tax haven could potentially cost the UK tens, if not hundreds, of millions of pounds.

Government officials say they are aware that some British overseas territories are facing serious problems which could get worse. In the event of further economic deterioration, they could become failed states and be dragged into the illegal drugs trade, Whitehall (UK civil service) insiders warn.

Two weeks ago, the Guardian revealed that the Cayman Islands, the capital of the world’s hedge fund industry and the fifth biggest banking centre, was so cash-strapped it may not be able to pay its own civil servants.

The Caribbean tax haven was forced to ask the UK Foreign Office permission to borrow GBP278 million to repair huge deficits. The Foreign Office refused, advising the island’s authorities to impose property or payroll taxes. Talks are ongoing over a GBP30 million emergency loan package.

Jersey, Guernsey and the

Isle of Man are all UK crown dependencies. The 14 overseas territories under British sovereignty include Bermuda, the Cayman Islands, Gibraltar and the British Virgin Islands.

Any suggestion that Britain will have to rescue offshore financial centres would be extremely controversial as tax havens drain the UK economy of an estimated GBP25 billion annually.

Vince Cable, the UK Liberal Democrat party Treasury spokesman, said: “Britain obviously has some responsibility towards these small number of territories and that’s clearly right, but we can’t get into an open-ended bailout that would reward financial mismanagement.

“It would be extraordinary to bail out these tax havens, especially as additional money

that went to them would come out of aid budgets to the detriment

of poorer countries that

have managed themselves properly.” The Foot report is likely to suggest that tax havens should boost their balance sheets with new taxes, though this would have to be carefully handled as it could drive away businesses that are valuable to them.

Sources close to Foot suggest he is particularly concerned that tourism on Caribbean islands is also suffering which is compounding the downturn.

The Treasury insisted it was not in “the business of bailing out tax havens” while Foreign Office officials said overseas territories were responsible for their finances.

But the global recession has had a severe effect on tax havens — even those close to home. Jersey is projecting a budget deficit of GBP100 million.

The Isle of Man is facing problems associated with the collapse of Icelandic bank, Kaupthing, which had a business on the island. It may be forced to spend hundreds of millions of pounds to compensate savers who have been unable to claw cash back from Kaupthing.

Guernsey could also face similar issues after the collapse of

a Channel Island subsidiary

of Landsbanki.