The New G7 Minimum Tax Initiative And The Cayman Islands

So exclaimed Mark Twain on reading his evidently premature obituary.  And we can similarly characterise the hopelessly inept Economist article of 1^st June 2021 “Twilight of the Tax Haven”, in similarly suggesting that the effect of the new G7 minimum tax initiative will be the demise of the Cayman Islands and other offshore financial centres. The confusion evidenced in The Economist’s analysis is entirely predictable. It is the consequence of over two decades of robotic and repetitive mischaracterisation of the modern offshore financial centre, in which respect The Economist has consistently excelled.  In  light of the tax transparency established in the Cayman Islands over the last 20 years, any writer still using the expression “tax haven” to describe the Cayman Islands in pejorative terms and as being in any way involved in effecting the EU-centric tax avoidance aggressively, but lawfully and routinely, practised by the US global corporates is, by definition, clueless[i].

US Secretary of the Treasury, Janet Yellen, of course, comments to the same effect. I should rest my case. Very possibly, neither of them have read my previous articles.  But in the unlikely event that they read this one, let me try and help. 

Before so doing, and absent as yet, any published detail, we should cut through the tedious virtue signalling and grandstanding of the G7 Ministers and analyse the intention of the newly announced G7 initiative. It seems there are three elements and, driven by the understandable frustration, often reported, that US multi-nationals pay inadequate to zero amounts of tax on their sales in respect of their non-US global, and primarily EU based, business activity. That we all agree, I believe, is a plain daft result, but so too is the newly suggested solution.

Failure Of Double Tax Treaty Networks

The first limb of it, but without saying so, attempts to deal with the failure of the OECD double tax treaty networks which, in concert, are the facilitators of the egregious transfer pricing and profit shifting strategies that are the root cause of the EU’s problem. These, we should remember, are EU based double tax treaty agreements. The OECD base erosion profit shifting initiative was a  failed attempt[ii] to put a band-aid over that particular sore but to no good effect and now, rather than admit that the OECD transfer pricing structuring requires dismantling and rebuilding from ground up, the attempt is to affix a second band-aid.  The intention of the first limb of the G7 initiative, simply put, is to ensure that tax is paid in the jurisdiction in which the profits are made. The second limb is to ensure that US corporates, and this must mean domestically in the United States (it will apply to the corporates of other jurisdictions but the serial offenders are US entities) pay a minimum rate of tax of apparently 15 per cent on these profits (possibly more), howsoever calculated and with whatever allowances[iii]. The third limb, which remains extremely unclear and which would be far beyond the remit of the G7 or even the OECD, seems to imply that every jurisdiction in the world, regardless of whether its methodology of taxation is direct or indirect and regardless of the rate of tax collected as a percentage of GDP, should apply a 15 per cent tax rate to corporations undertaking business activity within its jurisdiction.  This is no doubt a step en route to the ultimate OECD game plan - an overarching global tax authority - but it is currently a far-fetched overreach and not of immediate concern as every jurisdiction, and notably Ireland within the EU, has a sovereign right over its own tax affairs.

So what is it exactly that The Economist and President Biden think they are talking about when referring to tax havens?  In fact, there are tax havens involved.  But not the ones to which they refer. The only relevant tax havens are the provisions of US tax law which enable deferral of non-sub part-F income by the overseas subsidiaries of US corporates undertaking global business activity, and to the extent the income is reinvested annually in legitimate trading activity with a non-related party. The deferral thereby enabled was, of course, partially reduced by the Global Intangible Low-Taxed Income (GILTI) tax provisions of the Tax Cuts and Jobs Act 2017[iv]. It is now proposed that the 10.5 per cent rate then imposed be increased, one supposes, to 15 per cent over the 10 per cent base hurdle.  It should have been blindingly apparent to the editor of The Economist and President Biden that these are provisions of the US, not Cayman Islands tax law. It should also have been blindingly apparent that these provisions are there for good reason. The United States practises a capital export neutrality system of taxation whereas European Union jurisdictions apply capital import neutrality. If it were not for these tax deferral provisions, US corporations in respect of their global operations outside of the US would suffer harmful tax competition in being taxed twice. Indeed, these provisions have had significant beneficial effect in enhancing the profitability of US corporations globally since their introduction in the 1960s[v].  That of itself has been a major source of resentment to the EU authorities.  Simply put, in acquiescing to the reduction of these deferral provisions, President Biden adversely affects the competitiveness of the US corporates globally when it is the EU double tax treaty networks and some now defunct and preposterously aggressive Irish tax structuring that were the root of the problem for all concerned[vi]. Further, President Biden has yet to explain quite how the G7 initiative, which intends taxes on profits to be paid in the EU at the point of sale, will not significantly reduce the tax payable in the US by US corporations to the US Treasury. Prior to the G7 initiative there was a prospect of those deferred tax revenues being taxed in the US on ultimate distribution.  Post this G7 initiative that is less clearly the outcome.

Tax Transparency

But how concerned are we in the Cayman Islands about these developments? The answer, to the intense irritation of the Tax Justice Network (TJN) which does not demonstrate the capacity to analyse offshore financial structuring, is not very. There are possibly no more than 100 US corporations involved in this sort of activity of which possibly one third may have subsidiaries in the Cayman Islands out of a grand total (increasing annually) of Cayman Islands registered corporations numbering 110,000.  It should also be obvious to the editor of The Economist (and in fairness, he draws reference to the offending EU based double treaty tax jurisdictions) that the zero tax jurisdictions, notably the Cayman Islands, are in no way involved in the mechanics of profit shifting by way of the application of the excessive transfer pricing practices of these US corporates. It is not the Cayman Islands subsidiaries that are parties to the double tax treaty arrangements.

If it needs to be said again, and it shouldn’t, Cayman Islands financial structuring is entirely tax transparent. Not only is there automatic financial reporting to the home jurisdiction of every account of a Cayman Islands entity under US Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard but HMRC, the IRS, and almost every other tax authority of relevance has unrestricted access in the Cayman Islands under the tax information exchange agreements of which there are some 36 in place. The suggestions of TJN, Zucman and Piketty that monies are in some way secreted away in offshore financial centres like the Cayman Islands and not taxable are, not to put too fine a point on it, intellectual and fiscal nonsense.  Further, the irony, which should be apparent, is that the main drivers of the Cayman Islands financial services industry, the open and closed ended hedge and private equity funds and the structured finance vehicles which onward invest in the US$4-6 trillion range, do so on a basis entirely consistent with the Base Erosion and Profit Sharing (BEPS) initiative in that all applicable taxes on investment are paid in the jurisdiction where the profits are made. As far as the statistically irrelevant parent subsidiary arrangements are concerned, sophisticated tax jurisdictions, and certainly the United States, United Kingdom and the major EU jurisdictions, already have controlled foreign corporation legislation which, save for the deferral provisions above mentioned of the US Tax Code, consolidate the profits of overseas operating subsidiaries with the parent. It is therefore open to any jurisdiction to tax an overseas subsidiary of any parent within its taxing authority by consolidating offshore profits for domestic tax purposes. Most do so already to an extent.    

If the result of these G7 proposals is simply that a greater percentage of profits that would previously have been deferred become so consolidated and a higher level of taxation is applied to the parent in, say, the United States, the net effect of that adjustment is not material to the Cayman Islands budget and even if it renders the subsidiary concerned redundant. 

It would have been refreshing to have seen The Economist writing an article about the real cause of the problem, the failure of the OECD double tax treaty network and the incompetence of the OECD generally. The fact that France and the United Kingdom were to implement taxation on the gross revenues of US corporates (rather than the net amounts resulting after the aggressive double tax treaty manipulation and transfer pricing undertaken within the EU) is all the evidence that needs to be presented as to the failure of the OECD double tax treaty architecture. At some point, the OECD needs to be subjected to a competence test. Not only does its transfer pricing architecture fail at the base level but the OECD’s subsequent initiatives seek to avoid accountability by obfuscating the root cause of the problem which persists.  As far as President Biden’s support is concerned, US tax revenues are likely to decline as a result of the G7 initiative as taxable profits are reallocated back to the EU jurisdictions from which they were shifted in the first place.  But these newly proposed machinations, however circuitous, are of peripheral concern to the Cayman Islands financial services industry. 

Footnotes:

[i] See also The Times, Tuesday June 8^th, 2021 - “Overseas Territories to be left stranded by G7 tax reforms”  -  which makes the same mistake of relying on the hopelessly flawed Tax Justice Networks narrative on offshore financial  centres.

[ii] Evidently so or we would not need this new G7 initiative.

[iii] The current suggestion that the new minimum 15 per cent tax applies only over a base profit level of 10 per cent laughably facilitating precisely the same profit shifting mechanisms which created the problem in the first place.

[iv] A surprising introduction for a Republican President otherwise intent on otherwise cutting corporate taxes.  

[v] President Kennedy attempted to reverse these deferred provisions in 1962 but common sense prevailed in the House and Senate until possibly now.

[vi] See the now abolished “Double Irish”.

Anthony Travers OBE
Anthony Travers OBE is the Senior Partner of Travers Thorp Alberga, former Chairman of Cayman Finance and former President of the Cayman Islands Law Society. The former Managing and Senior Partner of Maples and Calder, he has extensive experience in all aspects of Cayman Islands law and has worked closely with the Government and prepared the Cayman Islands legislation for Mutual Funds and Private Equity vehicles, in the Private Trusts area, the Asset Protection Legislation and drafted the Cayman Islands Stock Exchange Law. Anthony was made an Officer of the Most Excellent Order (OBE) for his services to the Government and the Financial sector in August 1998. Anthony has written numerous articles and has spoken regularly at conferences and seminars.