dwleindecker /
28 November 2018Accounting & tax analysis

Grey skies for sunny Cayman?

Although Cayman has substantially more compliance requirements when compared to other jurisdictions such as even the US, it has always struggled to shake off misunderstandings about the nature of its regulatory regime and the perception among some that it is a tax haven.

At the end of 2017, the Council of the European Union published a list of non-cooperative jurisdictions for tax purposes in an effort to clamp down on non-EU countries that are not doing enough to tackle tax avoidance schemes.

In assessing whether a jurisdiction is cooperative, the EU has set requirements that must be met, including tax transparency, fair taxation, and the commitment to measures against base erosion and profit shifting (BEPS).

In this list, the Cayman Islands had been confirmed as a cooperative jurisdiction, and excluded from the EU’s ‘blacklist’: jurisdictions that have been determined uncooperative in tax matters.

Industry bodies within the Cayman Islands have welcomed the EU’s cooperative jurisdiction confirmation. The Insurance Managers Association of Cayman (IMAC), for example, highlighted the fact that the Cayman Islands is committed to supporting global efforts to tackle corruption, tax evasion and money laundering.

Some examples of this include Cayman’s membership within the Global Forum on Transparency and Exchange of Information for Tax Purposes, where it maintains a ‘largely compliant’ rating in 2017’s Global Forum Peer Review.

But while Cayman has avoided the blacklist, it has been placed on the ‘grey list’, which means that while it has been deemed cooperative, it will have to demonstrate that it has addressed certain concerns surrounding tax matters—and demonstrate that companies domiciled in and conducting business from the jurisdiction have an acceptable level of economic substance—before December 2018 in order to avoid getting placed on the blacklist for 2019, and potentially beyond.

The Cayman Islands government has been working closely with the relevant EU representatives in meeting its targets, and in September 2018, Tara Rivers, financial services minister, met with EU officials about Cayman’s latest efforts to develop proposals and update legislation where appropriate to keep it off the blacklist.

A close look at Cayman

In terms of the EU’s checklist, the concerns have little to do with tax transparency or tax information-sharing—areas where Cayman has scored highly for the steps it has taken to address these issues over the last decade or so—according to Robert Humphries, an attorney at legal firm Solomon Harris.

Instead, Humphries notes, Cayman has been accused of falling short of one of the EU’s more subjective “tax fairness” criteria, aimed at tax regimes that facilitate offshore structures which attract profits without real economic activity.

“The EU feels these companies are formed as ‘letterboxes’ aimed at facilitating the evasion or aggressive avoidance of taxes,” explains Humphries.

Entities that are accused of being letterboxes are those that are used solely to avoid tax obligations rather than to achieve economic objectives, and some Cayman-based companies have come under fire for not having an appropriate level of physical presence.

“The reality is very different and although it is true that many Cayman companies lack bricks, mortar and a permanent staff contingent, they are formed for legitimate purposes such as pooling and onward investment of international investor funds critical to liquidity and capital flows in international financial markets, rather than some sort of mechanism for the evasion of taxes,” adds Humphries.

Many captive insurance entities in the Cayman Islands insure against the risks of their parent companies based in the US, and are liable for applicable US taxes.

“As most owners of for-profit Cayman captives will know, the Internal Revenue Service and US state tax collectors receive a healthy flow of tax dollars generated directly by Cayman captive insurance programmes.”

Blacklist impact

There is a great deal of uncertainty surrounding the possible impact of the EU’s blacklist and grey list, whether countries’ reputations will be damaged or whether they could even face sanctions from the EU and its individual member states.

However, beyond being named, the jurisdictions targeted face few, if any, consequences from the blacklist.

In terms of captives operating in the Cayman Islands, Humphries suggests that the impact will likely be limited—although there is some uncertainty over the extent to which any newly introduced substance and reporting requirements might extend to already regulated entities like captives.

“Vexing as the situation is for Cayman as a jurisdiction, there is not currently a great deal of concern for Cayman captives who will likely remain largely unaffected and should be able to get on with business in the normal course,” he says.

Aside from the consequences of the EU’s list, it has also been subject to a great deal of criticism, in the Cayman Islands and worldwide.

“The Cayman Islands government is currently working closely with the relevant EU representatives in an effort to educate on the nature of Cayman Islands companies, the role they play in international financial markets, and to discuss what steps Cayman can take to address concerns, and hopefully avoid a place on the blacklist moving forward,” says Humphries.

One of the major criticisms of the list is the inconsistency in the treatment of non-EU countries that have been targeted, compared with those within the EU’s borders.

In November 2017, Oxfam published a report, Blacklist or whitewash?, which showed that, according to the EU’s own criteria, four countries within the EU should be blacklisted but are not. These countries are Ireland, Luxembourg, the Netherlands, and Malta.

Oxfam criticised the EU list and suggested that by taking aim at countries outside the EU, this step has strongly harmed the credibility of the process, as Ireland, Luxembourg and the Netherlands are some of the most powerful tax havens in the world, enabling the largest corporations to pay minimal tax.

Along with Cayman, jurisdictions such as Bermuda, Jersey, Guernsey and the Isle of Man are in talks with the EU over how to address its concerns around tax matters, in particular economic substance.

“Many, if not all of these jurisdictions, will have to implement some level of change to increase economic substance and have more ‘mind and management’ actually located in the relevant jurisdiction,” explains Humphries.

“At this stage it’s very difficult to know exactly what these requirements will be because no set definition or test exists and there has been very little indication from the EU (at least publicly) of what their expectations will be.

“Negotiations are ongoing and we hope to have more clarity on the issue in the very near future.”