Around the World with Seymour Mansfield
Legal News with an International Perspective
By Seymour J. Mansfield and Roger Nelson
Tax Haven or Hell?
A recent ad for an international tax law firm features a very rich jetsetter musing on his many plush abodes: a villa in the south of France, an apartment in Manhattan, a house outside London and a farm in Italy's wine country. In the second frame, his unflappable butler reminds his master that he still has to pay taxes somewhere. In the last frame, the globe-trotter scion looks glum faced and crestfallen at the unfairness of it all.
In Milton's Paradise Lost, haven was a place where roses were without thorn.[1] But haven on Earth for many mega-companies and wealthy individuals would be far more mercurial-starting with a life without taxes. It is a small wonder then that they search for offshore domiciles with favorable tax regimes, the so-called offshore "tax havens." The battle lines are tightly drawn between the tax collectors and the tax payers, and particularly, the United States Internal Revenue Service and its affluent residents and companies. Without proper due diligence, careful structuring and substance, real separation between the U.S. tax payer and the offshore entity and proper administration, legal tax minimization can quickly turn into illegal tax evasion and a tax haven can suddenly become "tax hell."
Tax Haven: Focusing on the Cayman Islands
Mention the Cayman Islands in conversation and many people's first thought is "tax haven." It is fair to say that the Islands' favourable tax regime is a huge draw for many businesses seeking an offshore domicile, although there are other, less obvious advantages to registering a company in the Cayman Islands. Indeed, as the U.S. Government Accounting Office recently testified to the U.S. Senate Finance Committee:
Gaining business advantages, such as facilitating U.S.-foreign transactions or minimizing taxes, are key reasons for U.S. persons' financial activity in the Cayman Islands. The Cayman Islands' reputation as a stable, business-friendly regulatory environment also attracts business. This activity is typically legal, such as when pension funds and other U.S. tax-exempt entities invest in Cayman hedge funds to maximize their investment return by minimizing U.S. taxes. Nevertheless, as with other offshore jurisdictions, some U.S. persons may use Cayman Island entities to illegally evade income taxes or hide illegal activity.
CAYMAN ISLANDS: Business Advantages and Tax Minimization Attract U.S. Persons and Enforcement Challenges Exist, GAO-08-779T, at 1.
The Cayman Islands continues to rank as one of the world's leading international financial centres for a number of reasons. As the Sovereign Group recently commented in its July 2008 report: "Cayman continues to be regarded as the premier jurisdiction in the Caribbean region... The standards of regulation are second to none. Cayman is a relatively expensive place to do business, but clients may be assured of first class services and attention to detail when establishing corporate structures...in this jurisdiction."
Of most immediate concern here, the tax regime is very simple. There are, in fact, no direct taxes. Tax haven indeed: no direct taxes mean no capital gains, property tax, withholdings, or personal or corporate income tax. This regime is backed by a 30-year government guarantee. In short, businesses have the necessary comfort that this tax regime is not going to change overnight. (The Cayman government raises its revenue through indirect taxes such as stamp duty on land transfers, import duties and various registration and permit fees.) The Cayman Islands' tax regime thus makes the country extremely attractive to labour and capital.
Further, there are minimum reporting requirements and a high standard of privacy within the financial industry. A breach of the confidential relationships (reservation) law concerning "confidential information" is punishable with criminal penalties, as well as damages under common law. Likewise, regulatory standards, while high, are business- and user-friendly. The Cayman Islands Monetary Authority is a great example. It recently implemented an e-Reporting system for the regulation of Cayman Islands regulated funds. These sorts of measures, coupled with strong anti-money laundering legislation, have led to a level of expertise and reputation that consistently attracts good business and clients to the islands.
... or Tax Hell
The View from Haven
Sounds enticing? If your eyes lit up at the thought of tax-free paradise, it is well worth ensuring that you fully understand the framework. The Cayman Islands may not impose income or profit based taxes, but that, of course, does not relieve U.S. citizens from their obligations under U.S. law. The IRS has a particularly long reach, and tax haven can quickly become tax hell.
The U.S. authorities have been widening their international probes of offshore jurisdictions. Consider the case of Walter Anderson: arrested in February 2005 in the largest tax evasion case in U.S. history, he was charged with hiding $500 million in revenues over a five-year period in offshore companies set up in Panama and the British Virgin Islands. Anderson pled guilty to two felony counts of tax evasion and one felony count of defrauding the District of Columbia, admitting to hiding $365 million in income. He was sentenced to nine years in prison, and was ordered to pay $23 million to the government.
Particularly telling is the recent case of billionaire California real estate developer Igor Olenicoff. His experience shows how quickly an ill conceived tax haven can heat up. Mr. Olenicoff had set up a web of secret bank accounts in Switzerland and Liechtenstein in order to avoid paying U.S. taxes on assets worth about $200 million. The U.S. authorities caught up with him and pressed criminal charges. Mr. Olenicoff had to pay $52 million in unpaid taxes, interest and penalties.
Further, it wasn't just Mr. Olenicoff who had to face the consequences of abusing the tax friendly regime of an offshore centre. His advisers in Switzerland and Liechtenstein, who set up the tax evasion scheme, were arrested and face criminal charges.
Critically, the Swiss and Liechtenstein authorities had to cooperate with the U.S. authorities in the investigation surrounding Mr. Olenicoff's tax evasion scheme. Under the Mutual Legal Assistance Treaty ("MLAT"), the Cayman Islands are not greatly different. The Islands balance the need for a high level of privacy and the need for effective procedures in obtaining information, especially when confronted with alleged criminal activity. The MLAT, and various other treaties with the United States, ensure that information can be obtained when necessary.
The disclosure of all relevant documents and information in a criminal investigation can thus be compelled pursuant to the MLAT. The provisions of the MLAT go further than simply providing a high-level framework through which U.S. authorities can apply for information through their Cayman counterparts. It also enables state-side authorities to request the attachment of the proceeds of a suspected crime, the repatriation of assets to the United States for restitution to victims of a crime, and the outright forfeiture (through the courts) of assets by both the U.S. and Cayman Islands governments. Since its implementation, the treaty has proven to be an effective weapon in the battle to deter and combat abuse of the Cayman Islands' tax-free regime.
While the MLAT was intended to combat serious crime rather than as an aide to the IRS, there is justifiable concern that the distinction can be blurred, despite careful vetting of applications at the Cayman end. Stringent anti-money laundering regulations apply in Cayman. There are no obligations upon Cayman service providers to help the IRS collect taxes. (Indeed, it remains a criminal offence to make unlawful disclosures). Please keep in mind, however, that no reputable professional service provider is likely to willingly participate in a foreign national's attempt to evade tax payable in his home county.
On the other hand, financial arrangements designed to lawfully minimize tax liabilities, reduce regulation, facilitate international transactions or further some other legitimate purpose remain welcome. (In these situations professional service providers in Cayman will work closely with their counterparts from the relevant onshore jurisdiction).
United States Tax Law
This is consistent with U.S. tax law on the subject. It is fundamental that citizens and residents of the United States are taxed on their worldwide income. While U.S. taxpayers may tailor their businesses and investments to minimize lawful taxation, they may not conceal income from the IRS. Thus, the service will consider as abusive schemes those that create structures making it appear that a non-resident alien or a foreign entity is the owner of assets and income, when in fact and substance, true ownership remains with a U.S. taxpayer. In sum, attempt to conceal income by making it falsely appear that the income or asset is owned by a non-U.S. person or entity is a line where smart planning stops and unlawful tax evasion begins.
IRS regulations regarding the taxation of income by a foreign-owned entity run, predictably, hundreds of pages. Purely local activity by a purely local subsidiary, for example, will be treated as local income, and not taxed until or unless repatriated. But the general rule applies - U.S. taxes will apply to worldwide income. The thousands of words in the regulations define ownership of a subsidiary, character of its income, and determination and quantification of taxable income, among many other things. The judicious attorney or adviser will walk the line between minimization of taxes and tax evasion with the greatest of care.
Additionally, proposed legislation goes further. In early 2007, Senator Byron Dorgan presented a bill to the U.S. Senate to amend the Internal Revenue Code to treat controlled foreign corporations established in designated tax havens, including the Cayman Islands, among many others, as domestic corporations subject to full taxation. Other proposed legislations, including a bill co-sponsored by presidential candidate Barack Obama, aim in the same direction, for example, creating a presumption that an offshore company or offshore trust is controlled by the U.S. taxpayer who formed it; empowering the U.S. treasury to take special measures against foreign jurisdictions that "impede" U.S. tax enforcement; requiring U.S. financial institutions which open accounts for foreign entities controlled by U.S. clients to report such actions to the IRS; increasing current penalties on financial advisers promoting unlawful tax shelter; prohibiting the issuing of patents for "inventions designed to minimize, avoid, defer, or otherwise affect liability for federal, state, local, or foreign tax," among other measures.
Conclusion
The Cayman Islands are a business haven in many respects. The Islands do have a favourable tax regime. They also are well set up for international financial business with a solid infrastructure, excellent communications and competitively priced professional management services. Cayman is politically- and economically-stable with business-friendly laws and regulations. In a small jurisdiction, the government and legislators are able to focus keenly on finance and other matters that affect the international business community. They can react quickly and amend laws to adapt effectively to changes in the financial industry.
Indeed, today, describing the Cayman Islands as a "tax haven" is simply misleading. The Cayman Islands continue to thrive as an offshore financial centre and offer a very attractive, stable environment for companies and individuals looking for an offshore domicile. So long as you play strictly by all the rules.
NOTICE: In accordance with IRS Circular 230, any tax advice in this article is not intended to be and can not be used or relied upon for preparation of a tax return or to avoid tax penalties imposed by the Internal Revenue Code. If you desire a formal opinion on a particular tax matter for the purpose of filing a return or avoiding the imposition of any penalties, you should seek such an opinion from an independent tax advisor or contact us to discuss whether the further Treasury and Code requirements can possibly be met based on your particular circumstances, as well as the anticipated time and fees involved.
Seymour J. Mansfield is a founding shareholder of Mansfield Tanick & Cohen, P.A.; the Firm's primary representative to Lawyers Associated Worldwide (LAW), an association of over fifty independent law firms located in over 100 major commercial centers throughout the world, and has served on LAW's Executive Committee (governing board) since 2004. His expertise over the last decade has grown to include international business transactions and dispute resolution. Seymour can be reached at 612-339-4295 or via email at smansfield@mansfieldtanick.com
Roger Nelson is the founder and managing partner of Nelson & Company, Attorneys-at-Law, in Grand Cayman, a member of LAW. Mr. Nelson's practice includes advising clients in the establishment and administration of offshore entities in the Cayman Islands. Mr. Nelson can be reached at 345-949-9710 or rnelson@nellaw.com.
The authors gratefully acknowledge the able assistance of Denise Tomlinson, Senior Associate of Nelson & Company in writing this column.
[1] Heaven has "Flowers of all hue, and without thorn the rose." John Milton, Paradise Lost, Line 256.
