Businesses worldwide are struggling to contend with the recession, but the offshore world is even more unfortunate.

As if the downturn weren’t enough, a whole raft of additional legislative and supranational challenges lurk on the horizon, caused in part by the desire of onshore politicians and academics to shift the blame from its real causes – onshore banks, subject to inadequate onshore regulation, lending to under qualified onshore borrowers – to the offshore financial centres.

This despite hard evidence to the contrary from several respected sources – for example the Turner Review (p74, March 2009) which specifically acknowledges that ‘the role of offshore financial centres was not central in the origins of the current crisis’.

Why do OFCs like Cayman provoke such visceral enmity among some onshore politicians and journalists? True, there are misconceptions about the nature of our business but they have been disproved time and again, to the extent one is tempted to think that they are being perpetuated nonetheless for political reasons. Those seeking scapegoats have all read their Grishams and their blogs and they've all heard what President Obama has said about Ugland House. So they continue to cry for our closure, ignoring the inconvenient truth that Cayman is actually playing a significant part in the world's recovery from recession by facilitating inward capital flows to countries like the US.

Still, we are not blameless. Cayman committed itself to the OECD to enter into tax information exchange commitments as long ago as 2000, but by this time last year had just one in place. One can hardly blame the OECD for getting impatient with us and only when outside pressure had mounted to an intolerable degree have elements of the public and private sectors decided to take action and start to explain what it is we do. In short, we have been too reactive and too slow to highlight the positive aspects of offshore financial services. Moreover, when we do react we tend to do so in tones of shrill, high-volume bombast which may play well to the home audience but have a tendency to be dismissed as self-serving by those whose mindsets we seek to change.

So what are these supranational initiatives and what stage has each reached? At present the most significant threats come from the United States, G20/Organisation for Economic Cooperation and Development, the European Union and the United Kingdom.

The United States

There are three pieces of legislation that potentially affect Cayman:

• The Stop Tax Havens Abuse Act. On 2 March, 2009, Senator Levin in the Senate and Representative Doggett in the House of Representatives introduced the Stop Tax Havens Abuse Act. The bill is a revision of a bill introduced last session, which was co-sponsored by then-Senator Obama. Its centrepiece is a list of 34 ‘offshore secrecy jurisdictions’ (including Cayman) and various adverse presumptions and rules that apply if a taxpayer engages in any transactions involving those blacklisted jurisdictions. The bill also includes a provision that would tax, as US corporations, certain foreign corporations if ‘the management and control of the [foreign] corporation occurs directly or indirectly, primarily within the United States’. The provision, for example, would subject to US tax offshore hedge funds and other investment funds with US managers or advisers.
• Baucus Discussion Draft Bill. On 10 March, 2009, Senator Baucus, chairman of the Senate Finance Committee that considers tax legislation, released a discussion draft that focuses on the reporting by US taxpayers and financial institutions of transactions involving foreign or offshore jurisdictions as the means of addressing the so-called ‘tax haven’ issue.
• Obama Administration Proposals.Last month the US Administration unveiled far-reaching international tax proposals which would, for example, place significant new limits on the deferral of US taxes on overseas earnings, tighten use of the foreign tax credit and require US companies to treat certain foreign affiliates as corporations. With respect to ‘tax havens’, the proposals focus on strengthening the so-called ‘qualified intermediary’ programme and requiring that any bank outside the United States (i.e. including those in Cayman) acting as a QI issues a tax information report for its US customers in the same manner as US banks do. To encourage foreign banks to become or remain QIs, the proposal imposes a 20-30 per cent withholding tax on nearly all US-sourced payments made to non-QIs.

Neither the Administration proposals nor the Baucus discussion draft includes a blacklist of so-called tax haven jurisdictions, and indeed Chairman Rangel of the House Ways and Means Committee (which considers tax legislation in the House of Representatives) is on record as disliking the use of such lists. Several weeks ago it became clear that it was unlikely that any US anti ‘tax haven’ legislation would include a blacklist. Instead, it is expected that the US legislation will focus on enhanced reporting and particularly on expanded reporting by QIs. It should also be expected that these reporting requirements will be separated from the main Administration tax package and introduced as revenue-raisers, perhaps to help offset, for example, the costs of a new healthcare programme in the US.

G20/OECD

At the G20 Summit held on 2 April, 2009, members pledged “to take action against non-cooperative jurisdictions, including tax havens".

The G20 did not introduce its own list of jurisdictions, but instead had the OECD produce one. The OECD had been working with OECD nations and OFCs over the past decade to build up a network of tax information-sharing agreements and arrangements between these nations. The G20 asked the OECD for an update on this process and the OECD produced a Progress Report. That report comprised lists of ‘jurisdictions that have substantially implemented the internationally agreed tax standard’ (the so-called white list), ‘jurisdictions that have committed to the internationally agreed tax standards’ but are still working on entering into the agreed standard (grey list), and jurisdictions that have done neither (black list).

Cayman is on the grey list. To be promoted to the white list, it must take whatever steps are necessary to ‘substantially implement the internationally agreed tax standards’. The test of which list a nation is on was effectively a numbers game in that it had to have entered into tax information exchange agreements with at least twelve other countries to qualify for the white list. Cayman has actually entered into 20 tax information exchange agreements (eight bilateral and twelve unilateral) and we thought as a result had already ‘substantially implemented’ the tax standard as required. But apparently not: the OECD, having praised Cayman for ‘setting a good example’ in relation to tax information exchange commitments, then said it needs to review our use of unilateral arrangements. So Cayman stays on the grey list for the time being. A meeting of the Committee on Fiscal Affairs of the OECD is scheduled within the next month or so, hopefully to approve the unilateral procedure once and for all. Ireland, Germany and the OECD secretariat have already publicly endorsed it, and in particular Germany has stated that the unilateral mechanism meets the internationally agreed tax standard.

The newly-elected Cayman Islands Government has confirmed that it intends to meet its obligations under the original OECD commitment and move Cayman from the grey list to the white list as soon as possible. It aims to do this both by pursuing bilateral agreements with various OECD member states and via the unilateral mechanism. Currently it has publicly stated that it is in negotiations with the United Kingdom, Netherlands, Australia, Canada, Czech Republic and Spain with respect to bilateral agreements.

European Union

On 30 April, 2009, the European Commission published the final text of a proposal for an EU Directive on Alternative Investment Fund Managers. Politically motivated, opaquely worded and difficult to understand, it contains several provisions aimed against offshore funds. It has a long way to go before it becomes law: several elections at both parliamentary and Commission levels could cause it to be altered. But it has already achieved political traction in the EU, and is causing serious concern in the London hedge funds market and, interestingly, with the UK Government.

One of its more significant requirements is to attempt to limit the marketability of shares of non-EU investment funds, for example those established in Cayman. Subject to compliance with detailed rules and a notification to the regulator in an EU-regulated alternative investment fund manager's home EU Member State, the Directive will allow an EU-regulated fund manager to market shares in a hedge fund in any other EU Member State. This is colloquially called ‘EU passporting’. However, it also states that an EU-regulated fund manager may only market shares in a non-EU fund to professional investors in another EU Member State under the new EU passport regime following the expiry of a three year period after the EU Directive is implemented. It is possible that during that three year period non-EU funds may still be marketed to professional investors under existing private placement rules with some EU Member States, but non-EU funds will not be able to benefit from the EU passport regime during this three year period. This may put non-EU funds (including those established in Cayman) at a severe disadvantage to EU domiciled funds when being marketed in certain EU Member States (e.g. France and Italy), where existing private placement laws restrict or prohibit non-EU funds from being marketed.

Moreover, the EU Directive states that an EU-regulated manager may only market shares in a non-EU fund to professional investors in an EU Member State if the country in which the non-EU fund is domiciled (by Cayman) has signed with the relevant EU Member State a bilateral tax information exchange agreement which fully complies with the standards laid down in the OECD Model Tax Convention and ensures an effective exchange of information on tax matters (a novel distinction). So for the purpose of the Directive it doesn't really matter even if Cayman finds its way on to the OECD's white list; it will now have to comply with these additional requirements too.

The European Commission has also published a draft Directive to amend the European Union Savings Directive, the so called 'Son of EUSD' or 'EUSD II'. There are three main changes:

• adoption of the ‘look through approach’ by paying agents so that in determining whether a payment has been made to an EU resident, the paying agent is required to ‘look through’ certain specified entities (including Cayman exempted companies and Cayman trusts) and, using information collected for KYC purposes, ascertain whether the beneficial owner is an individual resident in the EU. If so, then the paying agent would need to report the payment to the intermediary entity;
• all investments funds, and not just UCITS and UCITS equivalent funds, are brought ‘within scope’. This means that all Cayman funds with EU or Cayman administrators could be required to report payments to EU individual residents if all the other criteria is met (currently all non-UCITS equivalent funds are ‘out of scope’);
• payments made from certain life insurance products and principal protected products are brought within the definition of ‘interest payments’. In April 2009 the European Parliament published its report on the Directive and it is being fast-tracked through the EU legislative process. There are still a number of issues to be determined, in particular how paying agents are going to make the determination in relation to beneficial owners using the EU Third Money Laundering Directive, which has not yet been implemented in a number of EU members states as yet. But this still needs to be watched carefully, in particular for Cayman-based fund administrators. Already the Member States with large fund administration businesses, e.g. UK, Ireland and Luxembourg, are the subject of intense lobbying by the industry.

United Kingdom

Late last year HM Treasury commissioned Mr Michael Foot to prepare a review on OFCs. Mr Foot has already published a progress report, which although admirably balanced, contains comments on such matters as bank deposit insurance which will need watching. The substantive report is not due out until later this year, so it is not worth speculating too much about it at this stage. One can suspect that overall it will give a fair and balanced view of the offshore industry, which means that it will be ignored.

We also are awaiting publication by HM Revenue and Customs of a ‘Code of Conduct’ for UK banks, which, while not directly affecting Cayman, is expected to call on UK banks to observe not just the letter but the ‘spirit’ of UK tax legislation, with HM Government being the self-appointed arbiter of what that ‘spirit’ is. This is extraordinary, revolutionary stuff: as John Whiting of PwC in London says, "it would be like a court convicting you of speeding, not because you exceeded the speed limit, but because a policeman said you were going too fast". It could introduce a high level of uncertainty into legitimate tax planning in the UK, which could in turn affect transactions structured in Cayman. Several UK banks are more or less owned by the UK Government now, so they may well be obliged to adopt the Code, flawed though it may be. One thing is certain, though: when the Code is circulated for consultation, there will be howls of protest in the UK.

To conclude: Everyone working in the offshore financial industry knows by now that the level of threat against it is unprecedented. And while there's no need to despair, there is no excuse for burying our heads in the sand and hoping they will all go away, or that somehow someone else will fight the battle for us unaided. This is a struggle of perceptions, of truth against easy, idle prejudice and it has to be fought by all of us. It is vital that we engage with the media worldwide and explain that Cayman is not a haven for tax evaders and money laundering, but is a sophisticated, well-regulated jurisdiction, enjoying high professional and legal standards and actually delivering tax-neutral products that are vital to the world's economic survival and recovery. Not only that, but to prevent it from doing so could trigger disastrous unforeseen consequences.

Dated 8 June 2009