With the looming decision by the European Union over which countries to put on a tax blacklist, Cayman should look elsewhere for new business says local attorney Anthony Travers.
Cayman was on an initial shortlist of 53 countries and jurisdictions that the EU might consider uncooperative in tax matters. In November the EU sent letters to each of the jurisdictions threatening they would be blacklisted unless they committed to changing their tax rules.
The final decision on the blacklist is expected for Dec. 5.
In a speech to the Cayman Islands Institute of Professional Accountants, Travers, a former managing partner of Maples and Calder, echoed the sentiment expressed earlier by Premier Alden McLaughlin that there is no point in the Cayman Islands offering further concessions to the EU or to the OECD to avoid a blacklisting.
Travers said it is unlikely that EU politicians will ever accept the existence of low or no tax jurisdictions “which are an embarrassment to their profligate spending.”
It is not clear which actions the EU is going to take against any “uncooperative” countries but some form of tax penalty on transactions between EU members and these jurisdictions is anticipated.
“The Cayman Islands, if it should come to it, in my view, should simply accept the European Union black list if it should materialize and focus on portfolio investment from the rest of the world.”
In the short to medium term, EU-based institutions would move to solely using EU havens like Luxembourg, Ireland and the Netherlands, who were excluded from the listing process.
“Effectively, for jurisdictions like the Cayman Islands, the European Union jurisdictions should be regarded as a dead zone,” the senior partner at Travers Thorp Alberga said.
The level of resentment towards offshore centers like Cayman is so widespread, “that the Cayman Islands should write off any consideration of attracting capital flows out of Europe,” he added.
Quoting IMF statistics, he noted only about 8 percent of the US$2.4 trillion of hedge fund investments through Cayman is attributable to the EU jurisdictions.
Since the financial crisis, Travers argued, Cayman had been subject to three macro-trends the negatively affected offshore activity.
Offshore capital flows have declined, especially in the area of structured finance, and could not be balanced by quantitative easing measures, as the money remained largely on the balance sheets of European and U.S. banks.
Meanwhile, regulation has increased with Dodd Frank, the Alternative Investment Fund Management Directive, MiFiD II, Basel III and, in the insurance space, Solvency II, which all, to varying degrees, apply the principle of increased capital adequacy in support of risk retention by the principal.
The net effect has been to increase the capital cost of establishing new offshore structures, Travers said.
Added to that tax transparency initiatives like FATCA, the OECD’s Common Reporting Standard, or beneficial ownership disclosures and increased levels of anti-money laundering laws and regulations have increased the cost for offshore operators.
This in turn had an effect on hedge fund and company formations.
And finally, offshore financial centers are constantly the subject of negative publicity campaigns and mischaracterizations.
Although it is “laughable” to apply the word “secrecy” to the Cayman Island given that tax information is exchanged worldwide under FATCA, the Common Reporting Standard, tax information exchange agreements and the Proceeds of Crime Law, Travers said, “some of the mud has stuck and the expression ‘tax haven’ carries with it a negative connotation and that in itself has increased transactional flow to onshore centers such as Dublin, Luxembourg and the Netherlands, which for no fundamentally good reason have achieved a higher degree of acceptability.”
He apportioned some of the blame to the offshore centers themselves which had done “an extraordinarily poor job of refuting the mischaracterizations.”
“We professionals know tax evasion in the Cayman Islands to be non-existent and the evidence of aggressive or as the extreme left wing would have it, illegal tax avoidance, which is of course a contradiction in terms is in any event, statistically insignificant,” he said.
Ultimately, the exchange of tax information will “not move the needle on onshore tax collections from the Cayman Islands” to a relevant degree and it will also make the criticism of Cayman unsupportable in the longer term.
In the interim, however, Travers expects a continued shifting of transactions to onshore jurisdictions, especially the U.S. states of Delaware, Wyoming, Nevada and South Dakota for private client transactions, which are characterized by a “complete absence of transparency.”
Transactional flows, from Latin America, Asia and the U.S. that anticipate a tax neutral jurisdiction with strong and tested legal structures, will be fewer in number than in the decade’s before the financial crisis, Travers said. “But those offshore financial centers that adopt an enlightened immigration policy with the result that the technical expertise available is no different from that available in New York, Chicago or London, will remain attractive centers for this type of structuring.”
The overall pressure will lead to a consolidation of offshore financial centers, he believes, with a flight to quality.
But the desire to harmonize tax rates at a high level in Europe, could well mean more demand for offshore structures by European competitors.
Another threat comes from the Base Erosion and Profits Shifting project of the OECD, which seeks to eliminate some of the inconsistencies of cross-border tax rules and in particular the double taxation treaty network that has proven to be ineffective in taxing multinationals in certain industries.
Travers said the OECD Model Double Taxation Treaty Network was “a catastrophic failure in dealing with transfer pricing and cross-border payments of royalties, deductibility of interest and cross-border tax credits and specifically, in the context of European Union sales transactions by U.S. corporations.”
BEPS, however, was nothing more than “a Band-Aid,” he said.
Even according to the OECD’s own calculations, global profit shifting, estimated to be between US$100-250 billion annually, represents only about 0.8 percent of the US$23 trillion of global tax revenues.
Still, Travers said, even though Cayman does not have any double taxation treaties, government should not have rushed to adopt the BEPS initiative, because the provisions are harboring a Trojan horse in that they revive the “substantial activity doctrine” advocating that profits can only be taxed in the jurisdiction where substantial activities are undertaken.
In Cayman and other overseas territories, it is highly unlikely that a sufficient substantial presence can be developed, he said, “given the current immigration rules and particularly, with regard to the rollover policy and the manner of its application which make it highly improbable that skilled financial professionals would consider a long-term career in an offshore financial center.”
While it is by no means certain that all of the BEPS measures are going to be implemented, Travers concluded, “attracting the highest quality professionals from overseas is critical to the future development of this and other offshore financial centers.”