Anthony Travers responds to a recent claim made by the European Parliament that the EU tax blacklist is "not catching the worst offenders."
The initial indications are not good. It seems that without British competence and guidance in the EU decision making process, matters are not going well for the EU. Two recent events should be causing alarm bells to ring throughout the 27 remaining Member States. Forgetting to order vaccine and seeking to divert attention by reversing four years of negotiated position on the Northern Irish border on a whim, may be described as simply unguided. As Allister Heath comments in the Daily Telegraph:–
“The EU’s descent into madness or even downright malignancy can be explained by a combination of Covid-related desperation, incompetence, Brexit and the panicky realisation that the historic vision that inspired Europe’s elites since the Second World War is crumbling before the eyes of despairing, devastated electorates[i]”.
But his comment is as appropriate in describing the most recent nonsense spouted in the debate of the EU Parliament on the subject of “Tax Avoidance” and “Tax Havens” (in so far as that term has any meaning), and the resulting EU Parliament resolution for yet another EU “Tax Haven Blacklist” which, on analysis, verges on unhinged. MEP Paul Tang’s press release headed “EU Tax Haven Blacklist is not catching the worst offenders”[ii] states:
“By calling the EU list of tax havens “confusing and inefficient”, the Parliament tells it like it is. While the list can be a good tool, member states forgot something when composing it: actual tax havens. The truth is the list is not getting better, it’s getting worse. Guernsey, the Bahamas and now the Cayman Islands are only some of the well-known tax havens that Member States have taken off the list. In refusing to properly address tax avoidance, national governments are failingtheir citizens to the tune of over €140 billion. Especially in the current context, this is unacceptable.
“That is why the Parliament strongly condemns the recent delisting of the Cayman Islands and calls for more transparency and stricter listing criteria. However, if we focus on others, we also need to look ourselves in the mirror. The picture is not pretty. EU countries are responsible for 36% of tax havens”.[iii]
We can be sympathetic to Mr Tang’s dilemma to a point; obviously, the EU needs help with its tax avoidance problem. But unless and until Mr Tang and his colleagues in the EU Parliament demonstrate an understanding of the nature of the problem and where and how tax avoidance occurs, there is not the slightest possibility of them improving their position. It is also, in this day and age, particularly clueless to seek to identify “tax havens” as Mr Tang does by reference to the number and percentage of jurisdictions and their location without analysis of the specific structuring undertaken within them. For the reasons discussed below, the expression “tax haven” is now otiose and its use serves only to deflect focus from identifying the true nature of the EU’s problem. As we will see below, the EU MEPs have fixed on the Cayman Islands’ “zero corporate tax rate” as “harmful” because all previous EU blacklist attempts have failed to dampen Cayman’s success[iv]. But that “zero tax” is irrelevant to EU tax avoidance.
Before we get to the why, we should, in fairness to Tang, identify the source of his confusion. It appears his notions, and those of his MEP colleagues, are reliant on the largely intellectually and economically bankrupt propaganda written by the OECD in its 1998 report “Harmful Tax Competition – An Emerging Global Issue”. To remind the reader of the four indicia of the therein pejoratively defined “tax haven” –
But, as was clearly stated at the time by US Treasury Secretary O’Neill, the only point of validity in that list was the absence of exchange of information in relation to tax matters because a lack of tax transparency could enable or facilitate tax evasion. But now, and consequent upon that Report, exchange of information in tax matters has been achieved in all relevant offshore financial centres, not only by way of reactive tax reporting with complete transparency to tax authorities under the 36 Cayman Islands Tax Information Exchange Agreements but, in addition, the proactive reporting of every Cayman Islands account under FATCA and the Common Reporting Standard. It is worthy of note that at no time since the Report has the OECD ever been able to establish that tax revenues in any onshore jurisdiction increased as a direct result of the tax transparency achieved and so we are able to argue that the previous allegations of tax evasion in the Cayman Islands were unfounded from inception.
But what now of the suggestion that the Cayman Islands is involved in EU tax avoidance? This withstands no scrutiny and nor, interestingly enough, does the EU Parliament produce any statistical evidence to suggest tax avoidance is undertaken in and through the Cayman Islands nor how it is supposed to be undertaken. And for one very good reason. The EU Parliament cannot because there is none. There is simply nothing in the remaining three indicia in the Report and specifically not a zero corporate tax rate that is “harmful” for tax purposes and there is nothing in those indicia that contributes to the EU tax avoidance problem.
Whilst we can say that offshore financial centres like the Cayman Islands have only themselves to blame for allowing the three remaining OECD indicia to continue to frame the debate and thereby give support to the mischaracterisation that a “tax haven” must involve tax avoidance, these financial centres have not been assisted by the weight of so called academic analysis. Various writers, including Hines[v] and Dharmapala, have endeavoured to establish a fact based analysis but those like the University of Amsterdam CORPNET group, Zuckerman, Shaxson, Piketty, and others, none of whom evidently have any understanding of actual structuring in jurisdictions like the Cayman Islands, have perpetuated the misunderstanding. They continue to suggest that in the “sink offshore financial centre, a disproportionate amount of value disappears from the economic system”. This is economic and fiscal illiteracy of the sort we expect from the Tax Justice Network, not from academics who should know better. Their, and therefore necessarily, the EU position which adopts the same fallacies, is entirely misguided for the following reasons.
Firstly, the suggestion of value disappearing from the economic system is evident nonsense. All investments in Cayman funds are made with the specific intent of onward investment into an onshore jurisdiction where these investments are fully documented and completely and transparently so.
Secondly, tax cannot be avoided in the EU without the mechanism of a double tax treaty arrangement. It should be obvious to even the most ill-informed Member of the European Union Parliament that the Cayman Islands has no such double tax treaties. If the EU are genuinely concerned, and they should be, about Base Erosion and Profit Shifting (BEPS) in the EU, they need look no further than the Netherlands, Ireland and Luxembourg[vi], the double tax treaty jurisdictions which enable US multi-nationals to reduce taxable profit in the EU to derisory levels by shifting otherwise taxable profit as interest and royalty payments. The EU MEPS cannot, though, eat their cake and have it. It is an astonishing paradox that the EU jurisdictions affected identify and seek to solve the profit shifting problem (entertainingly disregarding the OECD BEPS initiative in its entirety) by introducing taxation on the gross revenues of those multi-nationals generated at the point of sale in their EU jurisdiction, and yet fail to recognise fundamental failings of the OECD and its double tax treaty model which enabled the problem[vii].
Thirdly, it may well be that jurisdictions like the Cayman Islands and, indeed, Bermuda have subsidiaries of major US corporates which serve a Treasury function in retaining their profits offshore to the US but that is entirely a function of US tax law and of the modified system of capital export neutrality which the US has applied since the early 1960s. But those profits are disclosed to the IRS annually by way of consolidated accounting and under the applicable US Controlled Foreign Corporation legislation and are well identified by those with average accounting ability (possibly not Zuckerman or Piketty and certainly not the Tax Justice Network). These profits were previously taxed to the extent they constituted sub-part F income under the US Controlled Foreign Corporation Company provisions if not reinvested in arms-length trading activity with a non-related party and are taxed now, in any event, to an extent under the GILTI provisions of the Tax Cuts and Jobs Act 2017. But the point, simply put, is that the extent to which Cayman Islands subsidiaries are involved in retaining profits offshore to the United States is entirely a function of the intention of the United States tax law which sought to avoid its corporations that undertake global trading activity from being double taxed and has nothing whatsoever to do with the reduction of tax on profit in the European Union.
And fourthly, the worst heresy concerns the supposed “harm” of a zero rate of corporate tax under Cayman Islands law. The zero tax rate is irrelevant to the issue of tax avoidance in the EU or anywhere else as it cannot be said by anyone, Tang included, that any tax is thereby avoided. Cayman Islands structures, and open and closed ended funds in particular, are all invested in onshore jurisdictions and are subject to taxation on realisation of their investment in the jurisdiction of investment (most usually the United States) exclusively in accordance with the laws of that jurisdiction. Furthermore, no tax can be avoided when the profits net of that onshore taxation, as may be, are distributed from the Cayman Islands structure to its investors because the automatic reporting provisions of FATCA and the Common Reporting Standard make full disclosure to those authorities. Interestingly, the OECD now claim that US$10 trillion is now reported pursuant to the Common Reporting Standard to the jurisdictions of the investors’ tax residence and pursuant to its provisions, but even more interestingly, the OECD makes no claim whatsoever as to any increase in tax revenues in those jurisdictions as a result. So where precisely is this tax avoidance complained of the EU MEPS and their spokesman, Tang?
Moving The Goalposts
It follows from these four points, unanswerably, that the absence of direct corporate taxation in the Cayman Islands financial services industry is irrelevant to the issue of tax avoidance in the EU. So too, it should be said, is the issue of Economic Substance and Substantial Activity because the investments made by Cayman Islands structures are fully subject to tax in the onshore jurisdiction of investment. It also follows that the BEPS initiative at no time had any relevance to offshore financial centres like the Cayman Islands, and that the BEPS initiative should have been focused entirely on the tax avoidance techniques practised in Europe (and arguably, other jurisdictions where double tax treaty abuses occur). Such tax avoidance is admittedly a global problem whenever double tax treaties are in effect. But neither the EU nor the OECD will come close to solving that problem unless they understand or admit to (I am really not sure which) the true nature of it.
The threat and implementation of successive EU blacklists has resulted in Economic Substance Legislation and the regulation of Private Funds being introduced into the Cayman Islands. The EU further seek now to move the goalposts to include partnership activity within the Economic Substance Legislation and, it seems in any event, to blacklist Cayman Islands if it maintains a zero corporate tax rate. But none of these issues have anything whatsoever to do with tax avoidance in the EU and are simply an arbitrary and discriminatory exercise in extraterritorial legislation.
Sadly, the EU position is even less coherent than that. As matters stand, the Cayman Islands is not on any EU Blacklist because under threat of Blacklisting, apparently, it introduced both Economic Substance and Private Funds regulation. But that notwithstanding, the Netherlands and Luxembourg, both of which, if memory serves, are located within the EU and both of which with certainty are heavily implicated in EU based tax avoidance, have each determined to blacklist the Cayman Islands, in any event, for their own reasons which clearly have nothing to do with tax avoidance. As against that, the OECD has not (currently) blacklisted the Cayman Islands and concludes that because Cayman introduced Economic Substance legislation, which itself had nothing whatsoever to do with Base Erosion and Profit Shifting, the Cayman Islands is not on any OECD blacklist and should not now be considered “harmful”. Nothing in the foregoing suggests a rational position based on an accurate analysis of where and how tax has been avoided in the EU. The EU position is at best arbitrary.
Illustration by Michelle Bryan
Of course, we understand it is an embarrassment to the EU that jurisdictions like the Cayman Islands can have a headline zero tax rate and function highly effectively, although not incidentally, with an average tax generated per capita by its particular system of indirect taxation of around 36 per cent of GDP which is very much within the OECD average for direct tax jurisdictions. The EU Parliament’s threats of further Blacklists on spurious and unsupported grounds seem no more than an exercise in deflecting attention from the fact that EU tax rates across the board must increase significantly to meet not only the off balance sheet liabilities of their EU health and welfare benefits, but the on balance sheet deficits and debt of the major participant jurisdictions[viii]. It seems hard to conclude otherwise.
Tang defines the nature of the problem as being US$140 billion of tax avoided in the EU and, in fact, although he does not say so, he must mean through the EU double tax treaty networks. The OECD puts the problem of Base Erosion and Profit Shifting initially at US$250 billion but the BEPS initiative has incurred hundreds of millions of dollars of time, effort and expense in implementation without ever dealing with the root cause of the problem. All that said, the reality is that if global taxation is in the order of US$25 trillion annually, the avoided taxation complained of, does not amount to 1 per cent of the total tax take of governments.
It is accepted that the EU can behave in as protectionist a manner as it wishes with regard to the passporting of Cayman Islands securities within the EU and, of course, it does so. No such passport has been extended under the Alternative Investment Fund Managers Directive (AIFMD) and it will not be[ix]. Further, the Cayman Islands brand is regarded, as a result of deliberate and continual mischaracterisation by the EU and its institutions, as deeply toxic within Europe with the result that the EU investor base is irrelevant for the purposes of Cayman Islands structuring, at best comprising 6 per cent of Cayman Islands inward investment. But it is not appropriate EU policy to endeavour to extend EU style regulation to the Cayman Islands and its financial services products with the intention of rendering it as inefficient and cost ineffective as those available in Dublin or Luxembourg by mischaracterising the financial structuring undertaken in and through the Cayman Islands as based on or involving tax avoidance in the EU.
If the EU wants to be taken seriously about “catching the worst offenders”, it needs first to identify and articulate the conduct it is concerned about and deal with tax avoidance at its source within the EU. As matters stand, the EU position in seeking to export its regulatory regime extraterritorially by way of the threat of Blacklists does not solve the EU tax avoidance problem. We are left to conclude that the only logical explanation for the EU approach towards the Cayman Islands is to seek to render it less competitive. It would be honest if the European MEPS came out and said so; to try to justify their policy on the basis of tax avoidance conducted in or through the Cayman Islands is simply sounding increasingly deranged.
[i] The Trumpian EU has demolished its final reasons for existing. The Daily Telegraph Feb 3rd, 2021
[ii] The chair of the European Parliament sub-committee on tax matters, a Dutchman whose cluelessness on the subject of tax avoidance seems at odds with the spectacular understanding of the art of tax avoidance demonstrated for decades to the tune of hundreds of billions of dollars annually through the mechanism of the Dutch sandwich.
[iv] See the author: “The new EU Blacklist and other Inventions of the Seriously Deluded” IFC Review 1st June 2020.
[v] James R Hines Jr (2010) “Treasure Islands” Journal of Economic Perspectives
Hines Rice National Bureau of Economic Revenues Quarterly Journal of Economics 1990
[vi] And see also, the Guardian 5th November 2014 “Luxembourg tax files: how tiny state rubber-stamped tax avoidance on an industrial scale”.
[vii] See also the proposals now from the UK to impose taxation on US multinationals gross revenues. And yet, despite these irreconcilable approaches, the OECD is able to maintain a façade of competence.
[viii] See also current balances of the Target 2 account in excess of Euro 1 trillion, a precursor of the collapse of the Euro.
[ix] The Cayman Islands government, which is altogether too good natured, spent a good deal of time introducing regulations in the mistaken belief that the EU AIFMD passport might be extended.
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.