An Ill Wind

And this notwithstanding the implementation of FATCA and the Common Reporting Standard (CRS). We should include I suppose also, under the heading of heresy, the recent ill-founded grey listing of the Cayman Islands by the Financial Action Task Force (FATF). This notwithstanding the absence of anything resembling a legitimate enquiry let alone a conviction for a predicate money laundering offence and in circumstances where onshore law enforcement and tax authorities have an unrestricted right within an hour to obtain documented and verified identities of every ten per cent beneficial owner of any Cayman Islands entity.[i] The Cayman Islands authorities, on the questionable advice of the Cayman Islands accountants, have favoured, in response to these EU “blacklist” threats, continued appeasement over robust rebuttal, which has resulted not merely in the bizarre and unsound extension of Economic Substance legislation to the Cayman Islands but in the wholly unnecessary regulation of its Private Funds industry with the attendant but unnecessary costs involved.  Absent any argument based on a technical analysis of international tax avoidance, this is illustrative of nothing more than a brazen and petulant extraterritorial implementation of EU law and regulation. It would have been politic at least of the EUCCG to suggest that the prior Cayman law was remedying a recognised deficiency to an international standard, but no such suggestion was made. Nor could it be said that the introduction of the Private Funds Law arose because of any client led concern.  And for good reason. None existed.  So how in this sorry state of affairs do we discern any good at all?

Well, only by way of unintended consequence. As thereby revealed is the truth behind the EU antagonism (and by EU I include the EU based acolytes the OECD and the FATF). So now we find from the most recent figures[ii] that of the 34,600 exempted limited partnership vehicles registered in the Cayman Islands at the end of 2021, some 14,600 are now regulated under the aforementioned Private Funds Law which regulation requires, much to the thinly veiled delight of that law’s main protagonists within the Islands, the Cayman Islands audit firms, a superfluous local audit sign off.[iii]  However unnecessary substantively, that audit sign off has revealed an interesting statistic. Net assets under management in the Cayman Islands financial services industry in both the open-ended hedge fund space comprising some 8,500 funds and the aforementioned 14,600 newly regulated private funds (together the alternative investment funds (AIF)) now amount to some US$7.442 trillion. Further, but anecdotally, given that there are 20,000 exempted limited partnerships which by virtue of investing proprietary capital or otherwise are not regulated, we could anticipate a total Cayman Islands AIF net asset figure in excess of US$10 trillion.

If we compare the position to the entirety of the EU domiciled AIF Net Asset Value (NAV)[iv], and evidently excluding the EUR 8 trillion or thereabouts comprised in the specifically EU centric UCITS market (but including EU based fund of funds, real estate funds, hedge funds and private equity), the Cayman Islands AIF industry is larger than the European Union centres of Luxembourg and Dublin in aggregate.  Admittedly the EU figure for hedge fund NAV post-Brexit has been reduced to a minimal US$800 billion as the overwhelming percentage of hedge fund assets remain, post-Brexit, managed in London, but the balance of the EU AIF NAV amounts to US$6.49 trillion.

This illustrates the real rationale for the extraterritorial economic warfare waged by the EU and/or its EU based acolytes on the Cayman Islands financial services industry.  No doubt the EU, muddled as its thinking may be, regards its concerns as two-fold. Firstly, it has come to believe in the deliberate and convenient mischaracterisation that a zero rate of effective tax on Cayman Islands investment entities is in some way harmful in that it involves tax avoidance. This particular sophistry tracks back to the 1998 OECD report on “Harmful Tax Competition”, which by way of imperious assumption and flawed logic not merely overlooked the root cause of EU based tax avoidance but misattributed it to offshore financial centres like the Cayman Islands, notwithstanding that none of them were a party to a double tax treaty let alone a network of them.  This technical and intellectual dishonesty avoids any EU centric consideration of the actual cause of EU based tax avoidance; the abuse of the EU based double tax treaty networks all of which it should be remembered are based on the OECD model form. But notwithstanding the absence of any fact-based analysis, we see the same misunderstanding now relied on within the EU Parliament. The most recent resolution of the members of the European Union Parliament by 587 to 50 on 21 January 2021 to the effect that any jurisdiction with a zero tax rate must, in some way, be implicated in tax avoidance (the EU Parliament put the figure at US$140 billion annually but the real number is of course much greater than that) repeats and further concretises the outrageous perversity of the OECD’s stated position on “harmful” international tax avoidance. Not only does it fail to attribute the tax avoidance problem to the EU member states (Ireland, the Netherlands and Luxembourg) but in addition avoids analysing and providing proper recognition of the onshore taxation on offshore subsidiaries levied through the mechanism of Controlled Foreign Corporation (CFC) legislation.  Or could it possibly be that neither the OECD nor Mr Paul Tang, Chair of the EU Parliament sub-committee on tax matters, and all other 586 members of the European Union Parliament majority are really that naïve?  Is this simply a deliberate mischaracterisation that seeks to avoid the blindingly obvious conclusion that it is the offending EU based double tax treaties that are flawed in permitting epic tax avoidance with the result that the major US corporates pay little or derisory tax in the EU jurisdictions of point of sale?

If so, the OECD narrative of competence in international tax affairs might be maintained regardless of the paradox by the introduction of a Global Minimum Tax (GMT). This has been designed (in the first instance at least) to tax certain multinational corporations (for which read mainly US) on their profits in the point of sale jurisdictions by simply overriding the flawed double tax treaty networks through the mechanism of the Subject to Tax rule, which disallows certain treaty deductions and the Qualified Domestic Minimum Top Up Tax Rule.  This latter rule has far reaching implications in its ability to strip out a multinational’s profits cross-border and tax them in the point of sale jurisdiction whilst enabling that jurisdiction to lower its own corporate tax rates to provide a competitive advantage for inward investment.  That avoids any need to admit or remedy the treaty abuses by way of a clumsy Digital Services Tax (DST) on gross revenues (there is no better evidence of the failure of the double tax treaty networks) by cloaking the solution in a new world tax framework.[v] What it will not do is act as an enhancement to offshore jurisdictions to introduce taxation. None would be collected in the offshore jurisdiction as multinational parents will realise there is no longer a tax advantage in the offshore subsidiary.  No doubt part of the OECD agenda, but of statistical irrelevance in the Cayman Islands which has very few such subsidiaries.  In fact, as the current GMT rules give no allowance for GILTI tax paid they would farcically result in double taxation of the multinationals offshore subsidiaries’ profits. Possibly another unintended consequence but I doubt it.

It remains to be seen whether the GMT initiative will gain traction when it is understood and particularly in the US.  For the time being, the EU and its acolyte EU based organisation’s agenda remains to regard a zero-rated tax neutral jurisdiction as an inconvenience to be removed by fair means or howsoever if indeed the EU is to increase its tax rates to a level that will support its on and off balance sheet welfare funding obligations. And so, it covets the trillions of dollars flowing through Cayman Islands AIF vehicles as a source of inward EU investment and EU tax revenue. 

But the inherent fallacies in the EU position are almost too numerous to mention.  Two will suffice.  Firstly, and perhaps needless to say there is no quid pro quo.  The Alternative Investment Fund Management Directive (AIFMD) has not and will never be extended to the Cayman Islands which will therefore never obtain the passporting of Cayman Islands AIF securities throughout the EU.  But this in turn means that there is no moral argument based on EU investor protection that would justify the extraterritorial extension of EU law and regulation to the Cayman Islands or anywhere else.  We know that EU based investors comprise less than 5 per cent of the Cayman Islands investor base. The second fallacy reveals a further flaw in EU logic. We understand that the EU sees capital as a source of much needed tax revenue but if the Cayman Islands’ capital flows were not conducted through Cayman Islands AIF investment vehicles, there is no reason to suppose, in the alternative, that they would be conducted in and through the EU because clearly, they did not originate from EU investors in the first place and do not contemplate EU investment.

So, the EU blacklist threat amounts to no more a than non-Queensbury’s rules no holds barred dog fight for international financial dominance of the EU model designed to ensure the heavily regulated EU AIF industry remains competitive.  But what must be frustrating to the members of the EUCCG and the EU Parliament is that notwithstanding the blacklist threats of the past two decades, the position of the Cayman Islands financial services industry, evidenced by the significant growth of assets under management and assisted by complete tax transparency, has continued unabated, albeit with some additional and unnecessary cost to investors.  This frustration is manifesting itself in increasingly arbitrary EU behaviour.  Evidence the recent determination that EU investors may not invest in Cayman Islands securitisation vehicles (which vehicles do not form part of the abovementioned net assets value calculations).  But how has this played out?  Well not to the benefit of the EU.  There is some migration currently of collateralised loan obligations (CLOs) from the Cayman Islands to Jersey and Bermuda which are not similarly affected but none of that will assist the deficit position of any tax hungry EU jurisdiction.  Meanwhile Cayman Islands exempted limited partnerships continue to be formed at a rate of over 400 each month.

Notwithstanding that the negative EU campaigning against the Cayman Islands has no sound basis, it would be a mistake to conclude that it has not had a formative effect on the mindset of otherwise sensible executives in EU financial institutions whose response to investment in the Cayman Islands is uniformly negative.  When questioned the lack of any intellectual rigor on the subject of the mechanics of tax avoidance, and the absence of any concrete evidence implicating the Cayman Islands in anything untoward at all is indicative of a worrying degree of brain fade although no doubt toeing the EU anti offshore jurisdiction party line accurately reflects the anticipated hostility of EU based regulators to any form of Cayman Islands structuring. This I conclude is unlikely to change until such time as the Cayman Islands government devotes sufficient resources to revealing the deceptions that drive the EU blacklist initiatives.  In the meantime, life, it seems, goes on.

Footnotes:

[i]   Compare this to the shambolic position at Companies House where Donald Duck and Adolph Hitler routinely appear as directors and shareholders of English incorporated companies and in which respect, there is no legislation requiring verified documentation and some 25 staff available to supervise over 4 million companies.  What is astonishing about this can of corporate worms is that UK legislators including Dame Margaret Hodge and Andrew Mitchell MP believe themselves to have the moral right to lecture transparent jurisdictions like the Cayman Islands on the advantages of public beneficial ownership registers.  They would have some credibility if they first placed their own house in order. 

[ii]   Cayman Islands Monetary Authority: 2021 Year End Review Looking Ahead

[iii]   The additional costs of which for the benefit of the Cayman Islands audit firms at current levels of private fund registration may be estimated at some US$200 million annually.

[iv]   ESMA 2022 Review

[v]   Astonishingly, whilst the DST imposed by certain EU jurisdictions invoked the ire of the Trump Administration in that it sought to transfer profits from US corporates to EU jurisdictions, no similar outrage appears to have been recorded on the effects of the Qualified Domestic Minimum Top Up Tax Rule which can do so to far more devastating effect. 

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.