What May the Trump Presidency Mean for the Future of International Financial Centres?

International financial centres (IFCs) have been forced to navigate increasingly rough seas churned by shifting tax transparency goal posts, blacklists, and their demonization as conducts for tax evasion, money laundering, or worse. Added to these turbulent waters is the uncertainty generated by the surprise election in November 2016 of Washington-outsider, billionaire real estate mogul, Donald Trump as US president. The question on everyone’s mind is; what does the election of a populist president with a proclivity for unpredictability mean for US policy towards IFCs?

President Trump has promised to boost US jobs and foster economic growth with his ‘America First’ agenda. To do this, he proposes a complete overhaul of US tax, immigration and trade policies with the goal of repositioning America as a best-in-class business and investment destination. At the time of writing, the Trump administration has achieved little legislatively in its first ten months in office. The President has, however, outlined broad proposals on tax; deregulation and immigration reform which, depending on when, and if they are implemented, may present both threats and opportunities for IFCs.

It should be noted, first of all, that unlike his predecessor, President Barack Obama, whose criticism of IFCs was unequivocal, very little is known about President Trump’s personal views on this subject or whether he has personally used offshore vehicles. It is tempting to assume that, as the owner of a multibillion-dollar international conglomerate and an ultra-high net worth individual, with a professed pro-business outlook, President Trump would be appreciative of the important role played by IFCs in the movement of global capital with spinoff benefits for job creation and economic growth. Moreover, his retort to democratic presidential candidate, former Secretary of State Hillary Clinton, that avoiding federal taxes “makes [him] smart”,  certainly indicates that he may subscribe to the traditional, though now changing view, that tax avoidance is a legitimate activity. His administration is comprised largely of former CEOs and bankers, some with direct experience using IFCs. Steve Mnuchin, a key member of his administration, had given a very cautious response about his support for the simplification of the US tax code when he had been challenged about his funds in Anguilla and the Cayman Islands during his confirmation hearings for Treasury Secretary.   

But lest one think that the Trump administration will be a breath of fresh air for IFCs, the populist angst upon which the President rode to victory largely views IFCs as nothing more than accomplices in helping multinationals and high net worth individuals (HNWIs) avoid paying their fair share of taxes. The concepts of ‘tax justice’ and ‘tax fairness’ have gone increasingly mainstream, and research by Gallup has showed that a majority of Americans believe that corporations and upper income individuals pay too little in taxes .

IFCs’ main value proposition is that they are legitimate means for HNWIs and multinational companies to manage and protect their assets and arrange their tax affairs efficiently. The attraction of IFCs comes not just from their low rates of tax (or none, in some cases) compared to most onshore jurisdictions, but the range of flexible and innovative vehicles offered. In turn, IFCs benefit economically from the injection of foreign direct investment, corporation tax, direct and indirect employment, and skills and technology transfer generated by this business.

Populist sentiment against IFCs has been heightened after revelations that major US multinational corporations were using loopholes in the US Tax Code to legally avoid paying billions in taxes by permanently reinvesting profits offshore. A report by Oxfam America has estimated that ‘tax dodging’ by US multinationals costs the US $111 billion each year and has laid the blame on the US’s ‘dysfunctional tax system’. 

The US has not conducted comprehensive tax reform since 1986. The need to overhaul the US tax code was one issue on which President Trump has been consistent and he has promised the biggest tax reform in US history. The Republican tax reform proposals outlined in their ‘Unified Framework for Fixing our broken Tax Code, –released on September 27, 2017 – expands somewhat on the list of tax proposals the Trump campaign had outlined earlier this year. 

The Republican framework is premised on four self-described principles, namely: (1) simplification of the tax code to make it easily understandable, (2) giving Americans a pay raise, (3) making America attractive for job creation, and (4) incentivising companies to reinvest profits kept offshore into the US economy. It should be noted that this is just a framework and that there will need to be agreement on the actual proposals, and that is even before the bill stage. Though all four principles may potentially impact IFCs, it is the fourth which speaks directly to this issue and may indicate that President Trump has adopted the populist view on IFCs.

Simplification

The Republican proposals for simplification of the US tax code include a doubling of the standard deduction, the elimination of most itemised deductions (except home mortgage interest and charitable donations) and the consolidation of the current seven personal income tax brackets into three. Importantly for HNWIs, it would involve a repeal of the Alternative Minimum Tax (AMT) and estate tax, paid by top tier income earners. A Preliminary Analysis published by the Tax Policy Centre on 29 September 2017, found that under the proposed Republican framework, the top highest income earners would receive the highest tax cuts.  Although this may encourage some US HNWIs to keep their wealth in the United States, tax minimisation is not the only reason why the wealthy invest offshore. Offshore bank accounts and trusts are used for protection of assets in cases of divorce, law suits and for portfolio diversification so this in itself may not automatically discourage US HNWIs from using IFCs.

Cut in Corporate Tax Rate

The United States has a top statutory federal corporate income tax rate of 35 per cent and once state taxes are added in, a combined corporate tax rate of 38 per cent.  Although research  by the Congressional Budget Office (CBO) shows that the average corporate tax and effective marginal corporate tax rates are lower than the statutory rate, the US’ federal corporate income tax rate is the highest rate among countries of the Organisation for Economic Cooperation and Development (OECD) and is viewed as a disincentive for US companies to repatriate profits earned abroad. Initially mooted at 15 per cent, the Republican Tax Framework proposes a cut of the US corporate tax rate from 35 per cent to 20 per cent which is below the OECD average. This, it is argued, would increase the competitiveness of the US as an investment destination and could disincentivize ‘offshoring.’

That said, several US states, such as Delaware, Nevada, South Dakota and Wyoming, already engage in tax competition. A lower federal rate would apply this tax competition to the federal level, which may undermine the competitive advantages of using structures in low-tax and no-tax IFCs.

The attractiveness of the above-mentioned US states is enhanced by the less stringent disclosure requirements and incorporation processes than those found in offshore IFCs. A study conducted in 2012,  revealed that OECD countries, including the United States, had much more lax regulation on shell companies than IFCs.  Additionally, the  US’ failure to join the OECD’s Common Reporting Standard (CRS) initiative may also give these and other US states a competitive advantage over IFCs which have committed to automatically exchange tax information under the CRS, some of which are actually early adopters. A federal shift toward tax competition may lead the US to retreat from some of the other international tax transparency initiatives, of which it had previously been a major proponent.

Deferred Payment Rule and Territorial Taxation

Under the current US Tax Code, US corporations pay taxes on worldwide income, that is, both domestic and foreign earned profits. The current system allows them a deferral whereby they can delay paying US tax on profits earned abroad for many years once these profits are reinvested in their foreign subsidiaries. The US parent company can claim a credit for foreign taxes paid on that income when the profits are finally repatriated. The deferred payment rule has been argued to be the main reason why US corporations pay such low effective rates of tax and to be an incentive for corporations to permanently reinvest profits in subsidiaries based in IFCs. The Oxfam report estimates that the 50 largest US multinationals have $1.6 trillion in profits invested offshore.

The Republican Tax plan seeks to remove this incentive by ending the deferred payment rule. It also proposes switching to a territorial system by providing a 100 per cent exemption for dividends from foreign subsidiaries in which the US parent company owns at least a 10 per cent equity stake. A one-time tax is also proposed and payable over time, on deemed profits held by US corporations abroad. The last US tax holiday was in 2004 under the American Jobs Creation Act of 2004 where companies were given one year to repatriate profits at a reduced tax rate.

Should these proposals come to fruition, certain IFCs which are currently preferred investment destinations for US multinational corporations may see some erosion of their competitive advantage with implications for their economies.

FATCA

Republican control of all three branches of the US government was seen to be the great hope for lobbyists seeking the repeal of the Foreign Account Tax Compliance Act (FATCA) passed by the US Congress during the Obama administration. FATCA seeks to eliminate tax evasion by US citizens by requiring foreign financial institutions (FFIs) and certain non-financial foreign institutions to report on assets held by US account holders. Although a blatant violation of their national sovereignty, many IFCs signed boilerplate inter-governmental agreements with the US government to avoid their financial institutions being punished by withholding tax on withholdable payments, and on the promise of reciprocity in the exchange of tax information. 

The FATCA reporting requirements are onerous for Caribbean IFCs, many of which are small island developing states (SIDS) whose tax authorities have limited capacity to meet these reporting requirements. The reporting requirements are also burdensome for US citizens living abroad, to the extent that there has been a sharp increase in the number of US citizenship renunciations. There have also been cases of US citizens living abroad being denied new accounts by FFIs due to the requirements of reporting.

Republican Senator for Kentucky, Rand Paul, and Republican Representative of North Carolina’s 11th District, Mark Meadows introduced companion bills in the House of Representatives and the Senate respectively to repeal FATCA. So far, it does not appear that a FATCA repeal is on President Trump’s radar. Moreover, FATCA has been cited as a main reason for the US not joining the FATCA-inspired CRS. 

Deregulation

Besides tax policy, there are other aspects of President Trump’s proposals which may impact IFCs. The President has signed numerous executive orders aimed at starting the ball rolling on regulatory roll-back. Excessive and overlapping regulation has been blamed for the de-risking practices of US-based global banks, which has been manifested most severely in the restriction or outright termination of correspondent banking relationships with Caribbean banks, with implications for trade and investment. On this front, there may be some benefits for IFCs but these have not yet been realised.

Immigration

Immigration is another often overlooked issue on which Trump administration policies may potentially have some impact on IFCs. To reduce their dependency on traditional sources of investment, Caribbean IFCs’ diversification efforts have targeted HNWIs from emerging markets seeking to protect their assets from economic and political instability in their home countries.

However, there are few (if any) direct flights between many of these emerging markets and Caribbean countries, requiring HWNIs from these countries to transit through major international hubs, oftentimes in the US, to reach the region. The Trump administration has already tightened US border policies through its controversial travel bans, which were recently extended from certain Muslim-majority countries to other countries, including Venezuela. More stringent US visa requirements and the outright banning of the entry of nationals from certain countries would increase the costs of travelling to the Caribbean and could potentially reduce the region’s attractiveness as an investment destination to these investors. On the other hand, such persons who may typically have looked to the US as an investment destination may be put off by the more stringent border policies and may be willing to invest somewhere more hospitable despite the travel costs, which is something IFCs could capitalise upon

What Does This Mean?

The Trump presidency is still in its infancy, with very little on which to assess definitively what the administration’s policies mean for the future of IFCs. As the saying goes, the only constant at this point is uncertainty.

On the tax front, the potential impact is more clear-cut, although the process of US tax reform will be a long and arduous one and we are not even at the bill stage as yet. However, the proposal for lowering the US federal corporate tax rate to 20 per cent does signal that the US is willing to engage in tax competition. It remains to be seen what this shift in perspective will mean for US participation in global tax transparency initiatives under the Trump administration.

What can IFCs do in light of the possible erosion of their competitive advantage? Offshore business is more than just about helping HNWIs and corporations reduce their tax liability. It is about asset protection and management and providing investors with reliable and secure access to their wealth. It is these functions, along with their wide range of innovative products and services, ease of doing business and standard of living, which make IFCs attractive to international capital seeking security and efficiency.

With the growing number of international tax transparency initiatives and calls for tax fairness, it is likely there may be a flight to quality by investors and corporations seeking to avoid being caught up in Panama Papers-like scandals or being branded as tax cheats. Those IFCs, therefore, which promote themselves as jurisdictions of substance and quality may have the upper hand in this regard. IFCs must also continue to make the case of their continued survival, by highlighting their participation in and compliance with international tax transparency initiatives and their role as conduits in the smooth and efficient flow of global financial capital and the knock-on benefits for job creation and poverty alleviation.

Alicia Nicholls, BSc, MSc, LLB. is an international trade consultant and Principal Consultant of Caribbean Trade Law and Development.

Alicia Nicholls
Alicia D. Nicholls is an international trade consultant with over a decade of experience providing bespoke trade research and advisory services to a variety of clients. She is currently a research fellow and part-time lecturer with the University of the West Indies. Miss Nicholls is the founder of the Caribbean’s leading trade policy and development blog, www.caribbeantradelaw.com, since 2011. She also presents regularly at both regional and international academic and industry-related conferences and webinars. While she maintains an interest in all issues affecting Caribbean trade and trade policy, her specific research focuses primarily on global financial regulation and small States, foreign investment law and policy and international business.