Speech at the CATO Institute
Washington DC, October 9, 2009
Distinguished panelists, distinguished colleagues, ladies and gentlemen
Good afternoon
As you now know, my name is Anthony Travers and I was until recently the senior partner of the largest law firm in the Cayman Islands where I have been based for some 35 years. We specialized in the structuring of mutual and hedge funds, structured finance, private equity and global holding companies, and throughout that period, I was heavily engaged in drafting core legislation in these areas.
Today, I continue to serve as the chairman of the Cayman Islands Stock Exchange and as the recently appointed chair of the Cayman Islands Financial Services Association, the private sector representative body. But I am here before you today as a debunker of myth.
How do we explain the mischaracterizations of the Cayman Islands typified by the comments of, let us say, Mr Morganthau, the venerable District Attorney of Manhattan .In truth whilst much that he maintains about the Cayman Islands may have been true 30 years ago, none of what he claims about the Cayman Island is true today .
Yet the allegations persist notwithstanding that Mr Morgenthau‟s suggestions of criminal activity, non transparency and regulatory breach, are easily enough refuted by reference to the statutes and treaties to which I will refer in a moment. And for a far more sophisticated example of mischaracterization, do look at the heavily loaded questions of the United Kingdom Treasury Enquiry on offshore financial centers to which the Cayman Islands responded in June 2008, and I attach a copy to this presentation.
From this you will see the problem that any commentator faces, me now included. The tidal waves of mischaracterization that colour the offshore financial centres are so relentless that it is almost impossible to establish the accurate fact pattern on which to base a meaningful debate. Almost none of the press commentary does so accurately. These constant mischaraterizations are too pervasive to be mere coincidence and are clearly indicative of powerful public relations campaigns driven by onshore Treasury Authorities.
Before we identify the agenda that drives this public relations onslaught and before discussing what it is that actually occurs in the Cayman Islands and why it has been, in fact, of significant fiscal benefit to the United States, let us firstly try to agree the correct terminology. We can then better analyze factually where the Cayman Islands stands in relation to the definitions under its relevant domestic legislation and the international treaties to which it are a party.
Firstly, tax evasion. By this, we mean false tax reporting relying on an offshore law of bank secrecy that enables a resident, individual or corporate of a high tax G20 jurisdiction, to fail to report accurately his foreign income or gains.
This expression is deliberately misused synonymously with the expression „bank secrecy‟ in a pejorative manner by onshore Treasury departments and therefore the press whom they brief, to conflate the argument for legitimate bank confidentiality with criminal conduct and thereby evading any legitimate debate on the former.
To maintain the maximum level of moral opprobrium, the second typical misdescription is to conflate the Cayman Islands with those jurisdictions which until the most recent OECD onslaught maintained strict confidentiality laws that enabled tax evasion, briefly put, we can include in that group, Switzerland, Monaco, Andorra, Hong Kong, Singapore, various of the Gulf states and Prince Michael has just described the position in Liechtenstein.
There are good reasons relating to legitimate financial privacy which ought to be considered quite separately from the issue of tax evasion that will be discussed at length here this afternoon. But the initial point that I want to make is that in fact to describe the Cayman Islands as a jurisdiction where tax evasion could be conducted is, from as far back as 2000 when it was the first jurisdiction to sign up to the OECD accord on tax transparency, simply wrong.
Whilst the Cayman law maintained a legitimate right to privacy, its confidentiality statute provides a clear gateway to ensure tax transparency and specifically with effect from November 2001 when it entered into the world‟s most under reported tax information treaty, that with the United States of America. In medical, if not legal terms, the effect of this treaty is that you would need to be criminal insane to believe you could evade tax in the Cayman Islands as the IRS has full access to all accounts, a power of which it should possibly be reminded since it has exercised it, in relation to the now famous US$1.8 trillion of bank deposits and inter bank bookings in the Cayman Islands, on fewer than 20 occasions in nearly a decade and with no reported or discernable benefit to the United States Treasury as a result.
In 2003, the Cayman Islands signed up to the European Union Savings Directive which created a pro-active income reporting obligation to the relevant EU Treasury in respect of the bank accounts of any European Union resident in the Cayman Islands. The publically available statistics show that these deposits amount in aggregate to a fiscally insignificant US$35 million.
This was followed by the introduction of a unilateral treaty mechanism which provided, much like the US treaty, full tax transparency to 12 further jurisdictions including the United Kingdom and Japan. How then did the Cayman Islands find itself placed on the OECD grey list of non tax transparent tax evasion jurisdictions earlier this year? Simply because the OECD chose to count tax transparency only if it arose from a specific form of treaty that the OECD approved and because it did not have PRC to argue its case as did Hong Kong and Macau. Did, therefore, the Cayman Islands subsequent advance, and I use the word loosely; to the OECD White List improve the issue of global tax transparency.
The answer is absolutely not. All that had occurred was that the Cayman Islands was then obliged to enter into precisely the same tax transparency mechanics in a different form of bilateral agreement. But the outcome was nevertheless hailed as a major win for the OECD jurisdictions and for those G20 politicians engaged in career saving exercises of blame deflection.
The mischaracterization surrounding tax avoidance is no less egregious. One would not conclude having listened to the President‟s comments in relation to my former firm‟s building, Ugland House, that tax avoidance is by definition a function of a policy provision, an aberration or an anomaly of domestic tax law not offshore legislation. Indeed, on more careful analysis, the President‟s comments were well chosen, notwithstanding the negative public relations furore attached to that unfortunate building, the President‟s comments notably did not refer to any specific legal wrong doing in the Cayman Islands and nor could they.
The Fortune 500 companies with subsidiaries trading at arm‟s length with non related parties and benefiting from tax deferral on earned income were lawfully and properly relying on a specific provision of the Code designed to improve the competitiveness of US corporations by avoiding double taxation. Interestingly enough, the Administration last week reversed its position and accepted the benefits of this policy should continue. The President, however, has not reversed the negative public relations stigma that still surrounds the lawful and proper involvement of the unfortunate building in obtaining legitimate tax deferral for the trading subsidiaries of United States corporations.
This I think leaves us with the oft repeated canard that bank secrecy in jurisdictions like the Cayman Islands is used as a cloak that facilitates criminal activity. The truth is quite the opposite. In 1990, the United States Senate ratified the Mutual Legal Assistance Treaty with the Cayman Islands which enables the Department of Justice to obtain any file from any professional in the Cayman Islands, including lawyers, who may not rely on attorney-client privilege, and to use the file to bring appropriate prosecution in the United States.
Furthermore, the Cayman Island‟s professional would commit a criminal offence if he told his client that the file had been thus obtained. So draconian was that measure that Senator Jessie Helms held up the ratification of the treaty in the United States Senate for 4 years on the basis of comity.
The attached memorandum at question 3 describes further specific legislative enactments which criminalise terrorism and money laundering generally, and create a highly sophisticated legal framework with respect to suspicious transaction reporting which far exceed the standards applied in, for example, the United States. The operational validity and effect of these procedures is continually and satisfactorily reviewed by on site investigations by the FATF and the IMF, and indeed most recently, fully corroborated by the report of the US General Accountability Office.
In the event, the Department of Justice in 20 years has managed only 250 applications pursuant to its all encompassing authority. The well informed criminal would be better employed establishing his company in Delaware, Wyoming or Nevada where, unlike the position in the Cayman Islands, no information whatsoever is required on ultimate beneficial ownership prior to establishing a corporate structure. There is no empirical evidence however to support the suggestion that that is the reason why there are 217,000 registered offices situate under one roof in one building in the Vice President‟s home State of Delaware.
Mr Gordon Brown recently famously asked when addressing the US Congress whether the world would not be a safer place if jurisdictions such as the Cayman Islands were outlawed? This is a hard question to answer affirmatively, given that throughout the financial crisis and due no doubt to the Cayman Islands Monetary Authority applying the Basle 1 and Basle 2 tier one banking regulations strictly ,no Cayman Islands banking institution failed. Notably Cayman Islands hedge funds were not able to borrow 40:1 from Cayman Islands banks and nor did those banks lend impecunious home buyers.
This leads me to the last of the mischaracterizations. The regulatory response to the financial crisis, and certainly from the European Union in terms of the EU Alternative Investment Fund Management Directive, seems more intent on establishing a protectionist framework that it does on identifying and dealing with the source of the regulatory failure. In doing so, the commentary to date, and indeed Senator Levin‟s Stop the Tax Haven Abuse Bill, conveniently but erroneously conflate the essential distinction between offshore hedge fund and the onshore investment manager invariably located in New York, Connecticut, Chicago or London.
If any sense is to be made of the regulatory response, it is the investment manager that must be subjected to the regulation and it was indeed the failure to apply any or appropriate regulation in the onshore jurisdiction that led to the notable failures from Long Term Capital Management through to Lehmans.
Given the extent of the foregoing mischaracterizations that surround the Cayman Islands what we actually do will come as a surprise. At the height of the market at December 31, 2008, the assets under management of Cayman Hedge Funds amounted to some US$3.6 trillion of which 65% was invested into United States fund managers. The misperception that drives Senator Levin‟s proposed legislation is that somehow this is US money.
With the limited exception of US tax exempts that access Cayman Islands hedge funds through Delaware feeders and a limited exception in respect of qualified investors, that is not the case. Similarly, over the preceeding five year period, I estimate some US$5 trillion of money from the international capital markets was provided to US financial institutions through Cayman Islands securitization structures in exchange for US receivables pools. We are left to surmise as to the position of those US balance sheets without that injection of cash and the removal of those debts.
These are monies that originate in the international capital markets and from an international investor base. Question 1 on the attached memorandum refers. These pools of capital are centralized in the Cayman Islands for reasons relating to economic efficiency, knowledge clusters, because Cayman is an incubator for innovative financial instruments and specifically because it provides a superior legislative framework based on a refined form of English common law.
We can recharacterise Teather‟s observations as to the role of the offshore financial center in the structuring (note the reference at question 1 in the attached memorandum), thus. “Taxes are paid where profits are made”. That is so either at the point where the profit of the fund is crystallized or the interest paid or when the relevant dividend is received from the fund by the investor. The economic efficiency point to which I refer means that a third layer of taxation does not introduce dead weight to the capital flow in the Cayman Islands.
The tax neutrality of the Cayman Islands thus avoids the application of an additional layer of tax but it would be wrong to say that it is simply the tax neutrality of the Cayman that attracts this structuring. The 18,000 companies in one building in the Cayman Islands are there for precisely the same reasons the 217,000 companies are located in one building in Delaware. Both the Cayman Islands and Delaware have superior corporate law in the former case designed to facilitate structuring that accesses the international capital markets and as we see for the benefit of financial institutions in G20 jurisdictions.
To take advantage of those laws those corporations must have a legal domicile but it is superficial to criticize that structuring on the basis that it does not resemble the labour intensive profile of a car manufacturing plant in Michigan. Traditionally, structures that access the international capital markets will have service providers located globally for reasons that relate to time zone sensitivity, relevant regulation and the availability of professional services.
There is no requirement as a matter of law or practice that supposes these service providers should be located under one roof but note that the OECD Harmful Tax Competition Initiative too specifically focuses on the lack of” substantial activity” in any one jurisdiction as being an indicia of “harmful” tax competition activity.
What then justifies the continued mischaracterizations of the Cayman Islands form and function. In my view, the answer can be tracked back to that 1997 OECD “Harmful Tax Competition Initiative”. This European inspired thesis originally suggested that it was a combination of no or low taxes, non transparency, lack of tax information agreements and no substantial activity which, however subjective the determinations, defined the harmful tax jurisdiction.
What is now of real interest is that given that the Cayman Islands has obtained OECD white list status and tax evasion is clearly off the table , we see the goal posts once again shift, so far in fact that they are clearly no longer on the field of play. The true nature of the OECD initiative is now revealed but without now the ability of the OECD and G20 jurisdiction to obfuscate its agenda by hurling the stigma of the tax evasion argument at the unwitting offshore jurisdiction.
What we are left with is the tax competition argument plain and simple. We see now introduced into that debate, the suggestion that there should be a “one global high rate of tax that fits all” so that there will be no flows of mobile capital from high tax to lower tax jurisdictions and no tax leakage. Given the transparency that the Cayman Islands has maintained over 20 years, we can only conclude that this has been the objective from the outset.
Nor will there be any restraint on what that top rate of tax might be .When I left England in 1975 to find my fortune the top rate of tax on unearned income in excess of $40k per year was 98%. For that reason some of you may recall from their seminal work on the subject, “Taxman”, that the Beatles dolefully warbled “There‟s‟ nineteen for you and one for me.
Taxman Mr Wilson, Taxman Mr Heath”. In that no distinction was thereby made between the fiscal approach of the then leaders of either the Labour party or the Conservative party, Lennon and McCartney‟s piece may also prove to be grimly predictive of prospective UK domestic tax policy some 40 years later.
What is troubling is that the anti tax competition element of the OECD thesis was robustly rejected in 2000 by then US Treasury Secretary O‟Neill but there is mounting evidence of a shift in policy under the new US Administration with the result that the G20 may be in the process of establishing a more unified position that tax competition is indeed harmful.
So is there a broader policy issue that is of direct relevance to the United States? The answer is that there most certainly is .If indeed there are no such tax haven abuses in the Cayman islands we might properly ask the purpose of the Stop the Tax Haven Abuse Act in so far as it might apply to a transparent tax neutral jurisdiction .
The proposed legislation assumes tax evasion, creates rebuttable presumptions that all transfers to or from the designated offshore jurisdiction are thus tainted and seeks to apply US tax law extra territorially by virtue only, for example, of a Cayman Islands hedge fund having an investment manager located in New York. Should US tax law be extended extraterritorially when it has not been established that the offshore jurisdiction harbor weapons of tax destruction?
There are usually good reasons why fund managers are located in places like Manhattan or St James. Invariably, they include lifestyle issues but they are not so compelling that they would withstand an application of a third layer of taxation to the profits of the Cayman Islands hedge fund with the result that the US resident investments manager‟s return to investors is thus reduced. And thus, as with all flawed legislation, the unintended consequences of the Stop the Tax Haven Abuse Bill may well be that US tax revenue declines as US investment managers are obliged to move operations out of the United States in the same way that UK based fund managers are fleeing from the City of London to Switzerland to avoid Gordon Brown‟s new 50% tax rate.
The problem with the mischaracterizations of jurisdictions like the Cayman Islands is that an erroneous understanding creates bad domestic tax policy and bad tax policy of this sort will not generate additional US tax revenue but could possibly reduce it. There is no pot of gold that can assist the funding of the US deficit anywhere within the Cayman Islands financial system.
Anthony Travers OBE
