The new EU Blacklist and other Inventions of the Seriously Deluded.

Published in IFC Review - June 1st 2020

“The things that make me different are the things that make me” – Winnie The Pooh.

Being different can be a good thing. But evidently enough if that difference means you are able to provide a superior financial services product to that available in Europe you must anticipate that you will be regarded in the corridors of Brussels as a threat and, if it possibly can, and without reference to the principles of fairness or objectivity, the EU will wield its apparent weight to do something about it. That, in a nutshell, is the entire rationale for the new EU blacklist which currently affects the Cayman Islands. But there is a good deal more to the story than that.

We can agree that the threat to the EU is real. According to the European Securities Market Authority’s most recent figures, the assets under management in the UCITS[1] product in Europe amount to Euro 9.7 trillion. But this is an entirely EU centric product marketed and heavily regulated within Fortress Europe EU for EU investors (and those non-EU investors daft enough to think that EU style securities law and regulation translates into greater investor security.) (See below Re Basle II.)

But UCITS products apart, in the alternative investment space, defined to include hedge funds, fund of funds, real estate, and private equity funds, the total assets under management in Europe amount to only Euro 4.7 trillion. I say only because the comparative Cayman Islands figure[2] for its 8,000 Cayman Islands hedge funds comes in at US$2.5 trillion with like amount estimated to be invested through some 20,000 Cayman Islands private equity vehicles, making a total of $5 Trillion.

So, we can conclude that as a tax neutral financial centre the fund structures of which attract global capital flows for onward alternative investment, the Cayman Islands is at least as compelling a jurisdiction as the aggregate of all the financial centres in the EU. European Tax Commissioner Moscovici and his colleagues in the European Code of Conduct Group (“ECCG”) know that these capital flows when invested onshore (the United States with its competitive tax rates promoting inward investment is the primary beneficiary of Cayman Islands fund structures) generate significant tax revenues for which the EU with 7% of the world’s population and 55% of the world’s welfare spending, a declining birth rate and increasing longevity, is desperate. Those capital flows if reinvested in the EU would generate, on realization of the investment, taxes that would pay for pensions for policemen, firemen, teachers, nurses, social security and welfare benefits generally.

In what is simply a war for capital flows and attendant financial services the EU has limited weapons at its disposal other than its blacklisting process because it remains the case that the Cayman Islands has less than a 6% investor base within the EU (and we can safely surmise that it is unlikely that the AIFMD pan European securities marketing passport will ever be extended and certainly not to the Cayman Islands)[3]. And therefore, the recommended EU “defensive” measures suggested consequent upon the blacklisting are unlikely to be of any practical effect[4] although no doubt the inclusion on a ‘’blacklist” is intended by the EU Commissioner and the ECCG to effect a measure of reputational damage. But justifiably so? Let us examine the rationale for the introduction of the economic substance rules which were described repeatedly by Moscovici as being driven by the “non-compliance of the Cayman Islands in tax matters”. Surprisingly and from deep within the EU Ms. Tove Maria Ryding who heads up the Tax Justice team in the European Network on Debt and Development, makes the point[5] (with an unusual degree of charm for a European high tax advocate) that the EU behavior is entirely arbitrary and prejudicial. “Whenever”, she states,” the EU has sent out its list of non-cooperative tax jurisdictions also known as the “EU Tax Haven blacklist”, all EU Member States have been consistently and noticeably absent”. So far, so good. But Ms. Ryding still fails to make, as do most, the blindingly obvious and crucial point. She cannot say, and does not, with what it is the Cayman Islands is not compliant.

A moment’s analysis should have revealed the true narrative. Firstly, the Cayman Islands is not a double tax treaty jurisdiction and is in no way involved in the aggressive international corporate tax avoidance for which Ms. Ryding concludes, EU jurisdictions are responsible. Further “The BEPS standards”, she says rightly,” have been repeatedly criticized in being ineffective in stopping international tax avoidance”. The reason for that is simple enough. The BEPS initiative is no more a band aid placed over the compound fracture of the hopelessly broken OECD double tax treaty network which has enabled industrial scale tax avoidance by the EU jurisdictions of Ireland, the Netherlands and Luxembourg through the highly artificial mechanisms of the Double Irish[6] and the Dutch Sandwich.

Ms. Ryding tacitly recognizes that problem in that certain countries, France included, propose now a “digital tax” on gross sales which are not part of international standards. France is driven to this because taxing net profits after the ineffective double tax treaty has permitted deductions for royalties, licensing fees and interest, generates no tax revenue at all in the country of sale. Which is precisely the core of the Starbucks, Google, and Apple problem. And yet the acceptance of the BEPS initiative by the OECD as some form of solution seems alarmingly universal. The BEPS initiative, if it does anything at all, is supposed to avoid the Google Starbucks and Apple tax avoidance by introducing the principle of international taxation known as capital import neutrality which states that taxation should be borne in the jurisdiction in which profits are made .In that context the OECD and EU focus on “economic substance” in the relevant jurisdiction makes sense only as a precondition to a properly taxable entity securing legitimate and intended access to a double tax treaty. That is to say, conversely, that flow through vehicles which pay no appropriate tax on profits should not. BEPS does nothing to cure the underlying flaws in the double tax treaty network which reduce taxable profits to insignificant levels. And in relation to a non-double tax treaty jurisdiction like the Cayman Islands applying economic substance is an invented irrelevance. Ms. Ryding correctly adds “it is high time for the most powerful players, including the EU, to take a critical look at their own performance”: but the BEPS initiative will not improve it. Although, and here the irony is complete, it is Cayman Islands structures that ensure compliance with the foundation principle of the BEPS initiative in that Cayman Islands structures always result in proper taxes being paid in the jurisdiction in which the profits are made.

But, secondly, we can go further than saying that the Cayman Islands, which has no OECD double tax treaties, was not engaged in tax avoidance or non-compliance. In terms of cooperation, rather than “non-cooperation”, the Cayman Islands record is actually exemplary. It has a fully transparent regime. Not only are profits paid on the realization by any Cayman entity of investments made in the onshore jurisdiction, but as an early adopter of FATCA and the Common Reporting Standard, it is unanswerably the case that tax should be paid on distributions or redemption proceeds received by the investor in his jurisdiction of tax residence[7]. And yet, Ms. Ryding still finds herself able to say in relation to the Cayman Islands, “This jurisdiction does cause great concern with regard to tax matters,” but is then incapable of describing any concern whatsoever, let alone a “great” one. And nor has anyone else. And particularly not, Moscovici. His allegations are a fiction. But so often repeated in the halls of Brussels that those in the EU and others with a superficial understanding have actually come to believe them [8].

With this latest blacklist, the abusive behavior of the EU strikes a new low, given that Cayman under identical threat had enacted the economic substance legislation. This new blacklist list has nothing to do with tax matters. Without due notice the ECCG insisted that Cayman Islands private equity funds be regulated in accordance with EU direction, a ridiculous proposition of extra territorial regulation, without any suggestion it should apply only to those Cayman Islands entities marketed in the EU. And no other justification was suggested. Nor did the ECCG comply with its own internal principles for blacklisting. By ECOFIN’s own ‘rules of engagement’, defensive measures (including blacklisting) should be ‘proportionate’ and ‘encourage positive change leading to removal of the jurisdiction from the list’ and should ‘not be applied once the specific reason for listing is resolved’. In the case of blacklisting on a technicality (lateness) there was nothing to be resolved. The rules binding the ECCG show this new blacklisting to be an arbitrary abuse of process. The correlation between the desperation of the EU and its lack of principle seems compelling.

There are though also troubling observations from within about the thinking of the Cayman Islands Government in seeking to appease the EU. Particularly, the Cayman Islands ,having now been blacklisted in any event ( much as predicted) ,we can also conclude, that the advice given to the Cayman Islands Government by certain Cayman accounting firms and bankers in 2018 to avoid Blacklisting at any cost for the reason that it would result in the termination of New York correspondent banking relations with the Cayman Islands banking industry was clearly misguided. No such termination has occurred. Conversely the advice given by others that appeasement would not stop the EU in its endeavor to do further reputational damage to the Cayman Islands, which advice was ignored, has proved correct. But there is a more damaging subliminal concern with the Cayman Islands Government’s policy. As with any course of appeasement it creates the suggestion that there may exist some truth in the EU allegations of “non-cooperation”. Appeasement is as misguided an approach when dealing with the EU allegations of noncompliance as the hens “confessing” to Napoleon crimes they did not commit in Animal Farm[9], and with similar outcome. In consequence the great majority of casual commentators including Ms. Ryding actually believe that there is some veracity (they can never specify what precisely) in the EU suggestion of Cayman Islands “non-compliance”, when there is none. The EU does not just deal in negative interest rates, it has mastered the art of negative truth.

But what drives the EU to unprincipled behavior of this sort? Not as Ms. Ryding suggests, simply as retaliation for Brexit. The truth may be found deep within the EU and in the conflict created by the ruling of the German Constitutional court over the ECB acquisition of over Euro $2 trillion sovereign debt, contrary to the principles of the Lisbon Treaty. The truth may be found in the Target 2 debts of Euro1.2 trillion of which Euro 500 billion is owed by Italy to the ECB and Euro 225 billion is owed by Greece neither of which can be repaid. The truth may be found in the sovereign debt on the balance sheets of European banks being given by European banking regulators under Basle II a zero-risk weighting as if to suggest default is an impossibility when the opposite is the probability. The truth may be that the Euro Zone does not and cannot ever constitute a successful Optimal Currency Area[10] with the result that Target 2 must increase and that therefore it is also the truth that two things only can happen to the EU .The first is that despite its attempts to export suffocating European Union tax law and regulation to competitor offshore jurisdictions the EU simply implodes under the weight of its debt and its current rules which mean that debt can never be repaid. Without more, that seems inevitable[11]. The more, in the alternative, is for the EU to advance by way of complete political, monetary and fiscal union to a Federal State. This of course was precisely the contemplation of one of the founders of the EU, Jean Monnet when he said, “I have always believed that Europe will be built through crisis and that it would be the sum of their solutions”. The ruling of the German constitutional court in May, may yet precipitate the crisis that advances that endeavor. We shall see. But either outcome suits the Cayman Islands as well because what seems clear given the weight behind the Common Consolidated Corporate Tax Base, is that if a full monetary and fiscal union prevails across the EU it will be the expense of the tax vetoes of Dublin and Luxembourg, and the shenanigans they have engineered to provide tax neutral vehicles in a taxable environment . And that the rates of taxation in Europe will be uniform and eyewatering, sufficient to meet the conjoined EU Member States welfare and social benefit programs and with E$2 or US$3 trillion in addition to bail out the ECB.

Monnet also said “Europe’s nations should be guided towards the super state without their people understanding what is happening. This can be accomplished by successive steps, each disguised with having an economic purpose which will eventually and irreversibly lead to federation”. Let us hope he is right. Because the objective for the Cayman Islands will be to ensure that it remains different and a fully and an efficiently functioning transparent and tax neutral offshore financial centre if and when that day arrives.

[1] An investment fund that invests in liquid assets and can be distributed publicly to retail investors across the EU pursuant to the undertaking for Collective Investment in Transferable Securities Directive 2009/65/EC.
[2] The Cayman Islands statistics in relation to private equity are anecdotal for the moment but will soon come to hand given the introduction of the Private Funds Law 2020 which requires mandatory Cayman Islands audit sign off and the filing of audited accounts with the Cayman Islands Monetary Authority.
[3] As matters stand, whilst Cayman Islands funds may be marketed country by country under the National Private Placement regimes which remain or by way of reverse solicitation, it is not customary to market Cayman Islands funds within the EU other than by way of very limited and targeted private placement.
[4] The EU has no authority other than to recommend defensive measures be adopted by Member States. These may include (i) withholding taxes from payments from entities in EIU Members States to an entity in the Cayman Islands, (ii) loss of tax deductions, (iii) enhanced requirements for CFC inclusion, (iv) loss of participation exemption benefits.
Given the absence of much in the way of European involvement by Cayman Islands entities, these defensive measures already exist, are largely useless and have only been adopted thus far, astonishingly, by that bastion of international tax integrity, Luxembourg.
[5] See the article, IFC - 16/04/2020 “Time for Real Tax Cooperation”, Ms. Tove Maria Ryding
[6] This highly artificial structure has now been outlawed with effect from 2020.
[7] We have arrived at the ridiculous situation where the Organization for Economic Cooperation and Development which authored the highly subjective and widely criticized“ Harmful Tax Competition: An Emerging Global Issue” initiative in 1998 has concluded that the Cayman Islands is “Not a harmful jurisdiction “.This explains why EU Tax Commissioner Moscovici whose thinking is at least as transparent as the Cayman island tax system has had to shift his description of the Cayman Islands to the wholly unspecific and disingenuous expression “Non-cooperative”.
[8] The use of outrageous mischaracterization is a familiar tactic habitually used by totalitarian leaders in European States over the years when engaged on propaganda campaigns .The essence of it is that the lie must be continually repeated to be fully effective and it seems , “The lie has to be so colossal that no one would believe that someone could have the impudence to distort the truth so infamously”. – Mein Kampf Adolf Hitler 1925.
[9] Animal Farm, George Orwell.
[10] See the very excellent article by Professor David Blake May 2018, “Target II: The Silent Bailout System which Keeps Europe Afloat”.
[11] Otmar Issing, the ECB’s first Chief Economist – “One Day the House of Cards will Collapse”