Foot Report raises the spectre of direct taxation

Criticising public fiscal management in the Cayman Islands and other Overseas Territories the independent review of British offshore financial centres recommends the introduction of VAT and corporate taxation. Business Editor Lindsey Turnbull and Journalist Michael Klein analyse the highly anticipated Foot report.

The Foot Report was commissioned by the British Chancellor of the Exchequer in December 2008 to determine how the Overseas Territories (the BVI, Bermuda, Gibraltar, Turks & Caicos, Cayman Islands and Anguilla) and Crown Dependencies (Jersey, Guernsey and the Isle of Man) were coping under the strain of the worldwide recession, and thus determining the UK’s risk exposure to each jurisdiction.

Michael Foot, a former inspector of banks and trust companies with the central bank in the Bahamas, was tasked with the production of an independent review of the long–term opportunities and chal-lenges facing the UK’s offshore financial centres.

In light of the financial and economic crises, the report was mainly motivated by the UK Chancellor’s concern over contingent liabilities that may arise for the UK from its overseas territories and crown dependencies.

While the Report stated that the UK has never had to bail out any Crown Dependency financially, it said the UK has “taken action in the past to support its Overseas Territories and the National Audit Office has concluded that the ‘UK bears ultimate risk from potential liabilities arising from the actions of territory governments’”.

Managing economic risk
The review of the British offshore financial centres analyses the economies of each of the nine jurisdictions and found that the negative impact of the recession has been pronounced in Anguilla, the Cayman Islands and the Turks and Caicos.

The Report suggests that the negative impact on public revenues was particularly significant in Cayman, because the sectors most hit by the economic decline, tourism, construction and financial services, accounted for a larger share of the economy in Cayman than in the other analysed jurisdic-tions.

However, the Foot re-port also singled out the Cayman Islands for its public spending policy and lack of planning.  

“Decisions taken by some of the Overseas Territories to use increased revenues to raise current and capital public spending, sometimes combined with insufficient attention to data quality and the absence of robust medium-term planning, has left local governments facing difficult short-term choices to restore the public finances. This is clearly illustrated by recent events in the Cayman Islands,” the Report says.

In addition it identifies the Cayman Islands as one of the jurisdictions that grossly overestimated gov-ernment revenues.

Foot concludes in his Report that the global downturn should therefore serve as a reminder to implement more robust economic planning and fiscal control measures, including timely and accurate measures of public revenues and expenditures.

He further suggests medium-term economic planning and effective measures to control public spending and enhance the efficiency of the public services.
According to the Report, past economic decisions taken by the local governments in the jurisdictions have inevitably had an impact on their resilience during the downturn, and cites the example of the decision by the Crown Dependencies to build up reserves in the recent years of rapid economic growth, which has served to increase their resilience to the economy now.

Furthermore, these jurisdictions have invested in improving the quality of data they obtained, compiled medium term economic forecasts and stress tested their economy against possible shocks to it.

Although the Report says that economic pres-sures will hopefully ease soon, particularly in relation to tourism, it goes on to state the not all of the economic pressures may have yet come to bear down on the jurisdictions.

The Report states: “…many of the longer term effects on the financial sector may not have been felt fully as many large financial services firms have yet to implement the results of their strategic reviews of their future geographical ‘footprint’ and product ranges.”

Report recommends taxation
Reiterating the position of the UK Foreign Office, Foot recommends that off-shore financial centres should develop a diversified tax base.

However, any decision to broaden the tax base would have to be considered within the context of international tax competition, he argues.

“Most – if not all – jurisdictions in the developed world seek to make their tax regimes internationally competitive. The jurisdictions would therefore need to consider the impact on their position in this competitive landscape of any decision to broaden the tax base.”

Commissioned by Foot’s Review, Deloitte conducted an evaluation of the role that taxation plays for the business model of offshore financial centres.
It also researched the impact the introduction of a corporate tax or a value added tax would have.

Using the examples of the Cayman Islands and Jersey in its high-level analysis, Deloitte comes to the conclusion that there was a “compelling case” to introduce VAT to broaden the revenue base. This was particularly important should the global trend for reducing reliance on Customs Duties continue, Deloitte writes.

Following this logic the impact of VAT on retail prices could be limited in the Cayman Islands by a reduction in import duty rates, Deloitte states, without pointing out, however, what the benefit of this would be.

With regard to a cor-porate tax the accounting firm noted the “substantial direct and follow on impacts” that the reduction of the financial services sector, as a result of taxation, would have for the entire Cayman economy.

It finds the introduction of a corporate tax “may lead to an exit of companies where relative tax liabilities exceed the cost of relocation (including loss of benefits from locating in Jersey and the Cayman Islands).”

An increase in tax li-abilities for domestic and remaining companies in turn could result in reduced investment and output effects, Deloitte writes.

Still Deloitte asserts “the downside of a prop-erly-constructed best practice corporate tax system would appear to be relatively limited”.

The accounting firm assumes that some mul-tinational companies would be able to offset the tax against domestic tax liabilities.

Crucially, however, the report does not sug-gest whether and how much additional revenue could be generated through new taxes.

Deloitte concludes that Crown dependencies have industry bases that are sufficiently diverse to raise “worthwhile levels of corporation tax”, but that this was not necessarily the case in some less diversified economies in the Over-seas Territories.

Moreover, the Report admits that administrative problems, such as the lack of a system to collect the taxes, may constrain the development of these tax systems.

Deloitte’s analysis also touched on the importance of Crown Dependencies and OTs for tax avoidance by UK corporates.

Deloitte estimates that the amount of unpaid tax was likely to be significantly lower than what has been suggested in previous studies.

Transparency and info exchange
Although most of the jurisdictions have “substantially implemented” the OECD requirements to sign Tax Information Ex-change Agreements with countries with which they do business, the Report suggests that “standards in this area will continue to rise” and that even though some had met the magic number of 12 signed TIEAs those jurisdictions should “continue to enter further agreements with relevant countries.” It goes on to say that the jurisdictions must show commitment not just to the letter but to the spirit of these international standards by showing effective implementation and a level playing field by all competitor jurisdictions showing the same com-mitment.

The Report states that the automatic exchange of information will no doubt happen in the long term with the aim of combating tax evasion by individuals on a cross border basis (an objective under the EU Savings Directive). Out of the OTs, Cayman and Anguilla have adopted the Directive and apply automatic exchange while the BVI and Turks have adopted the withholding tax option of the Directive (Gibraltar is directly subject to the EUSD).

Noting that the G20 wants strengthened due diligence procedures to be implemented, the Report states that although this is “attractive in principle, action by the UK and the nine jurisdictions ahead of changes to international standards would be likely to result in a loss of business to other jurisdictions rather than a resolution of underlying concerns”.

Foot therefore suggests that the UK should take the lead internationally in improving KYC minimum standards, in the monitoring of politically exposed persons and the transparency of beneficial ownership of companies and trusts.   

The Report is concerned about the prevalence of locally owned banks in some jurisdictions and states that problems in any of these banks could cause significant economic dis-ruption and might even lead to requests to the UK government for cash injections.

On the whole, Foot says that some of the jurisdictions (of which this writer assumes Cayman is one) have consciously chosen to move ahead of the pack of their international rivals and raise their standards further and faster than the minimum international standards now required.

It states: “It is important that those that move swiftly are seen to benefit from improved international acceptance. It is crucial that international po-litical pressure is main-tained on key competitors as the absence of co-ordinated action would generate arbitrage opportunities and encourage a shift of business away from jurisdictions which have met international standards.”