Notoriusly biased? The ABC offshore misunderstanding

Once again it is election time in the US and once again the Cayman Islands are labelled a “notorious tax haven” by US media, suggesting that something untoward is going. For the media-campaign machinery it does not really matter whether facts are replaced with emotive language; after all in political campaigns, perception is reality. 


It must be a TV journalist’s dream. It is January in the US; slushy and miserable weather everywhere. What better assignment than jetting off to the Cayman Islands? The only problem is how to extract money from the network to fund the trip?  

Clearly a report on a Republican nominee for the US presidential elections investing in funds he helped found in a well regulated offshore jurisdiction won’t cut it. But fortunately all the ABC news crew has to do is create a link between the words Romney, money, secret and tax haven. 

The ABC report begins by stating that “Romney has gone to great lengths to keep secret details of his wealth, including, as ABC News has discovered, whether he uses tax loopholes available only to the super rich”. 

Once the report is over, the viewers still don’t know what Romney supposedly did to keep his investments secret, especially because the journalists knew about them from Romney’s own financial disclosure forms that all US presidential candidates have to submit. But then of course it was only in “tiny print” and he did not mark the fund investments with the term “notorious tax haven” used by ABC News. 

The viewer is also left none the wiser what kind of supposed tax loopholes “ABC News has discovered” that only the super rich can exploit? 

Romney is certainly by far the richest Republican candidate with an estimated wealth of up to $250 million, according to his financial disclosures. He made most of his wealth after beginning his career as a management consultant, by co-founding private equity firm Bain Capital in 1984. He continued to retain a share of the profits at Bain Capital even after his retirement in 2001 until 2009. In 2003 Romney put his wealth into a blind trust to avoid potential conflicts of interest when he became governor of Massachusetts.  


Offshore? For sure  

The trust, which is controlled by his lawyer Brad Malt, still invests among others in Bain’s and Bain subsidiary Sankaty’s equity, hedge and debt funds in Cayman and Bermuda. In an interview with the LA Times Malt said he has invested in many offshore funds for Romney. 

“I don’t care whether it’s the Cayman’s or Mars, if it’s organised in the Netherlands Antilles or the Jersey Islands,” he said. “That means nothing to me. All I care about is whether it’s a good fund or a bad fund. It doesn’t affect his taxes.”  

Investing into Cayman-registered funds makes indeed no difference for taxable US investors like Romney, who will still have to pay tax on their income regardless of where they earn it, a point also made by Cayman Finance chairman Richard Coles in his reaction to the newscast.  

“The report displays a total misunderstanding of the role of the Cayman Islands’ tax neutral framework. All international investors are ultimately responsible for paying their taxes in their home country under their respective laws and there is nothing in the Cayman Islands laws that interferes with that,” Coles said. 

So if taxable US investors cannot avoid paying US taxes by investing in Cayman entities, why are private equity funds registered offshore? 

The ABC report rightly noted companies like Bain set up funds in Cayman to attract foreign investors, who want to invest in US companies without having to pay US taxes. Its conclusion however is wrong. “That is great for Bain and the foreign investors but not so great for the US Treasury and American taxpayers,” said ABC’s Brian Ross. Yet, it is great for US firms that are supplied with funding, and great for US employees, because foreign direct investments mean more jobs.  

By investing through a Cayman fund instead of a US-based fund, foreign investors avoid getting taxed twice, both in the US and in their home country. If a double taxation treaty exists between the US and the investor’s home jurisdiction, the taxes can be reduced, but the investor will still incur greater cost for the needed tax advice. If it was not for the Cayman fund structure, investments would thus yield a lower return and in many cases would not be made at all. 

To say that Cayman fund structures may mean less money for the US Treasury ignores that they certainly mean more investments in the US economy, which somewhere down the line will also be subject to taxes. 

In addition tax-exempt organisations such as charities, pension funds, university endowments and IRAs will also benefit from offshore fund investments. When US tax-exempt investors make money from anything other than their tax-exempt purpose, they are subject to an unrelated business income tax.  

The special tax also covers debt-financed income from investments in private equity firms and some hedge funds. By investing through a structure involving an offshore fund in Cayman these entities, which are meant to be tax exempt anyway, avoid paying the tax. It also explains why private pension funds are among the largest investors in private equity offshore. 

As former Cayman Islands Monetary Authority board member Richard Rahn points out in his Washington Times column, most large and midsize companies, unions, universities, non-profit organisations and state and local governments that have pension plans for their employees will find that some of the pension fund investments will actually be made with funds registered in the Cayman Islands. 

This means that not only is an offshore investment not a tax loophole, but it is something that it is used, albeit often unknowingly, by most US tax payers. 


Just because you don’t know, doesn’t mean it’s secret  

Amid the standard footage of sunny Seven Mile Beach, Bodden Town beach and Smith’s Cove, the ABC’s TV audience could also see a news reporter standing giddy with excitement at the George Town post office pointing at post office box 908, saying: “There are rows and rows of post office boxes here at the central postal station in Grand Cayman for all the companies that come from overseas to take advantage of the tax haven here.” 

Surely it would not have taken more than entering the post office for the news team to find out that there is no home or business delivery of mail in the Cayman Islands and as a result everybody who wants to receive mail will need a post office box. Instead they talked to the law firm that registered the fund to ask them about their client’s “accounts”, whatever that may be, knowing full well that no service provider anywhere in the world would discuss the affairs of a client with a random TV crew. 

But the expected, polite “we cannot comment on that” makes for good television, because it supports the allegation that “the Caymans are best known as one of the world’s great tax havens where secrecy is the rule”. 

A breathless Ross claimed, “In fact official documents show Bain Capital has set up some 138 secretive offshore funds in the Caymans that are nothing more than a post office box.” 

The irony of widely available official documents confirming something that is allegedly secret, escaped the ABC news team, but not the Cayman Islands government, which said in a response: “Despite the unfounded allegations of improper secrecy made in its report, ABC News was able to verify the existence of various investment funds through documents, which are publicly available from the government of the Cayman Islands.” 

Cayman’s government further refuted the allegations that the Cayman Islands is a secrecy jurisdiction, citing a whole laundry list of information sharing arrangements it has in place with the IRS and other US federal agencies, which also covers information requested for the purposes of enforcing US income tax laws. 

The statement further noted “the registration of companies in the Cayman Islands and arrangements for receipt of mail at their registered addresses are essentially the same as arrangements for companies registered in Delaware and elsewhere in the US”.  


Capital gains  

On the whole the report is indicative of the considerable confusion in the US about why wealthy people who can invest much of their wealth offshore often pay lower effective tax rates than ordinary workers.  

The short answer is of course that offshore is just a red herring and has nothing to do with it. Romney’s campaign manager confirmed that the tax consequences of a fund investment to Romney are the very same whether the fund is domiciled in the US or offshore. 

Instead the reason for the confusion is the US’ very own tax code. The US like many other countries imposes higher taxes on labour, such as income tax on wages and salaries, than on investment income, ie capital gains tax. In Romney’s case he would be subject to a 35 per cent income tax on any wages he is paid (exceeding $380,000), but only a 15 per cent capital gains tax on any return from long-term investments he has made.  

The reason capital gains are taxed at a lower rate than salaries is that dividends for instance have already been taxed at the corporate level. The idea is also to reduce a potential barrier to important investments for the economy. 

Romney acknowledges that his personal tax rate is closer to 15 than 35 per cent because most of his income is derived from investments. He also says that like every other tax payer he tries not to pay more taxes than he has to. “I can tell you we follow the tax laws. And if there’s an opportunity to save taxes, we like anybody else in this country will follow that opportunity.”  

According to the Congressional Budget Office the top 1 per cent of earners, to which Romney belongs, receives just under a fifth of the country’s pre-tax income (19.3 per cent), more than double their share 30 years ago. The Tax Policy Center estimates the top 1 per cent of earners paid 70 per cent of the total federal tax on capital gains in 2011. Meanwhile the capital gains tax for the lowest two income brackets in the US is zero, but these income groups have much less capital to invest. 

The growing income inequality in the US can thus largely be explained by the significantly lower 15 per cent capital gains tax, compared to income tax rates, and it is no surprise that it is set to rise to 20 per cent from 2013.