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haven or havoc?  by Natasha Lance Rogoff
A look at why the Cayman Islands has been called a tax haven, how the island defends itself and what reforms the international community has proposed.

The Cayman Islands, located in the Caribbean 480 miles south of Miami is a British territory, best known for its sun-drenched beaches and ocean park where tourists can swim among stingrays. An aerial view of Grand Cayman (the largest of Cayman's three islands) looks like little more than a strip of sand surrounded by exquisite aqua-blue waters, but Cayman is also the fifth-largest financial center in the world. Cayman's bank privacy laws and the lack of income taxes attract not only tourists in search of a thrill, but also blue-chip U.S. corporations -- and IRS tax investigators. In fact, 45 of the world's top 50 banks have subsidiary or branch operations in Cayman, and in 2003 alone $415 billion in deposits flowed through this sandy resort.

In recent years, American corporations and wealthy individuals, in ever increasing numbers, have moved to set up companies or subsidiaries in tax havens like the Caymans. This has led to a significant drain on the U.S. treasury. Though precise estimates of the amount of U.S. income sheltered in the Caymans are hard to come by, it is known that between 1983 and 1999, according to the U.S. Commerce Department, the value of American corporate assets in Bermuda, the Cayman Islands and 11 other tax havens grew 44 percent more than their assets in Germany, the U.K. and other countries with tax rates similar to the United States.

For the U.S. Treasury, offshore jurisdictions like the Cayman Islands pose a double problem: (1) they can offer American corporations and individuals attractive financial deals and access to capital markets at a much lower cost than U.S. banks in America, and (2) they can guarantee virtually complete secrecy about financial deals and assets held by Americans, in accordance with Cayman confidentiality laws (except in the case of criminal activity).

Over the years, the Cayman authorities have moved several times to tighten regulation and oversight of their financial centers -- particularly to stop criminal money laundering and financial deals by drug traffickers. Starting with the Mutual Legal Assistance treaty with the U.S. in 1990, Cayman authorities have set up measures to facilitate the exchange of information between the U.S. and Cayman. In July of 2000, Cayman authorities required local banks, law firms and financial institutions to exercise greater due diligence to identify suspicious clients and required that they report all suspicious transactions to the government's Financial Reporting Unit (FRU). And in November 2001, the Cayman Islands concluded a tax information exchange agreement (TIEA) with the U.S. that provides for exchange of information relating to U.S. federal income tax.

However, the tightened Cayman regime did not specifically target tax evasion by foreign citizens. Moreover, Cayman's privacy laws make it extremely difficult for industrialized countries to follow the trail of money as it passes from reputable U.S. and European financial, accounting and law firms to the Cayman Islands, making it difficult to investigate tax abuses.

While Cayman authorities emphasize their desire to cooperate with the U.S., they are ambivalent about being thrust into the role of tax investigators and tax collectors for high-tax countries. Considering that the financial services industry is the bedrock of the Cayman economy and represents an estimated 30 percent of GDP, it is not surprising that Cayman hesitates to dilute the very criteria -- secrecy and tax advantages -- that make it financially attractive to much of the industrial, tax-paying world.

The Cayman financial community strongly maintains that they do not want to facilitate tax evasion by U.S. citizens. They also claim that they are not, and should not be expected to be, experts on U.S. tax law. Cayman bankers, lawyers and accountants feel that they should not be held responsible for conducting due diligence on financial deals when the deals are brought to them by reputable U.S. banks, accounting and law firms. Anthony Travers, senior partner of Maples and Calder, Cayman's leading law firm, says, "If you are an off-shore lawyer, it may be difficult to ascertain that a particular tax avoidance plan that was sold by a major accounting institution in the United States actually transpired after legal review to be the wrong side of a very fine line."

Furthermore, Travers also says that tax evasion is a U.S. problem that needs to be solved in the U.S. and by U.S. legislation. "By passing laws and enforcing them … you can stamp out all of that [tax evasion] by legislation in the United States," he says. "And we, in the Cayman Islands would be very happy … if you could do it with absolutely certainty."

While the tax agreements somewhat bolster the U.S. government's ability to prosecute corporations and individuals engaging in tax evasion, the agreements are limited, and in most cases do not allow the IRS to investigate suspected corporations or individuals unless there is a court order or strong evidence of criminal activity. As one Cayman official stated, "Despite excellent fishing in the Cayman waters, no fishing expeditions are allowed."

Another obstacle hampering the IRS investigations of tax fraud by U.S. citizens in the Cayman Islands is Cayman's Confidential Relationships Preservations Law (CRPL), which requires banking confidentiality unless there is evidence of criminal activity. While the Cayman government has gone a long way towards enforcing due diligence and the sharing of information with the U.S. government, Cayman's banking privacy laws remain intact. David McConney, CEO of Cayman National Bank, says, "Financial privacy is fundamental to traditional banker/customer relationships. If you have not committed a criminal act, no Cayman financial institution may release any information to any third party without your express approval."

If the IRS wants to investigate potential wrongdoing by a U.S. corporation or individual, it must request information from Cayman's chief justice on a case-by-case basis. Unfortunately, this painstaking process is inadequate to deal with the numerous cases of tax fraud perpetrated by U.S. citizens and corporations. Furthermore, the IRS does not have sufficient resources to pursue investigations of wrongdoing on a case-by-case basis.

What Can the Global Community Do About Tax Havens?

The increased globalization of the international finance community has transformed the movement of capital among the world's markets. Taxpayers can now easily shift their activities and assets to lower tax environments -- a development that has not gone unnoticed by the international community.

The OECD Report

In 1998, the Organization for Economic Co-operation and Development (OECD) issued a report called, "Harmful Tax Competition: An Emerging Global Issue." The report advocated doing away with tax havens and offshore financial centers, like the Cayman Islands, on the basis that their low-tax regimes provide them with an unfair advantage in the global marketplace, and are thus harmful to the economies of more developed nations. The OECD threatened to place the Cayman Islands and other tax havens on a "black list" and impose sanctions against them.

Over the next few years, in an effort to "create a level playing field," OECD pressed for international cooperation to enforce a uniform tax system across the globe. The report set out four criteria that could be considered harmful tax practices:

1. No taxes, or nominal taxes in the case of tax havens

2. Lack of effective exchange of information

3. Lack of transparency

4. No other substantial activities, in the case of tax havens

In May 2000, the Cayman Islands avoided the OECD's infamous blacklist by "committing" itself to a string of reforms to improve transparency, remove discriminatory practices, and begin to exchange information with OECD member states about their citizens.

However, with the election of George W. Bush to the U.S. presidency, cooperation between Cayman and the OECD lost momentum. In May 2001, after the U.S. Treasury Department announced that it would not support the OECD initiative, other than pursuing tax exchange agreements, the OECD turned its attention to another initiative, the EU Tax Savings Directive.


In June 2003, the Cayman Islands, a British territory, were dealt another blow: The U.K. signed the EU Taxation Savings Directive, calling on European governments to tax the savings income of EU citizens who put funds outside their home countries. European officials introduced the new directive seeking to discourage tax evasion and increase tax revenues in their own countries, and because Cayman is a member of the British Commonwealth it is required to abide by the EU directive.

The Cayman business community strongly opposed the directive. Considering that approximately 20 percent of Cayman's financial business involves managing money from EU residents, the consequences of the directive would be significant capital flight from Cayman and numerous bank closures. It would prove difficult for Cayman to compete with offshore jurisdictions that did not have to comply with the directive, such as Hong Kong and Singapore.

But Cayman is not the only jurisdiction outside the EU objecting to the directive, which is supposed to take effect in 2005. The EU must convince Switzerland, Liechtenstein, San Marino, Monaco and Andorra (all EU members) before the directive can go into force. Andorra, Liechtenstein and Monaco are currently on the OECD blacklist of uncooperative tax havens.

On Feb. 13, 2004, the Cayman Islands legislative assembly agreed to support measures stipulated in the EU Savings Directive, but only if those measures came into effect at the same time in EU Member States and in named third countries and overseas territories -- an unlikely occurrence.

Natasha Lance Rogoff was a field producer for "Tax Me If You Can."


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posted february 19, 2004

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