Who and What Determines Offshore Ethics? – A perspective on tax avoidance, KYC v2.0

The Cayman Islands may be beautiful, but the world’s wealthy, and some of the world’s biggest businesses are there for another reason, its financial system. This article sheds light on how this works, against the backdrop of tax avoidance, the moral aspects, and financial institutions’ Customer Due Diligence / Know Your Customer.

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By Norbert Braspenning

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The Islands are “British Overseas Territory”, which means it has its own government, however, a British civil servant supervises. The population is approximately 60.000, and the capital is George Town. The Cayman Islands are considered to be part of the geographic Western Caribbean Zone as well as the Greater Antilles. But in fact, the Islands are British, with one big difference, residents do not pay tax.

Is  “not paying tax”  a problem?

Politicians nowadays seem to be obsessed with “tax evasion” and “tax avoidance”. Though the terms are often used interchangeably, they are very different concepts. Basically, tax avoidance is legal, while tax evasion is not. Tax avoidance is the legitimate minimizing of taxes, using methods approved by the relevant Tax Authorities. This article will only focus on concepts that are legal and approved under the applicable Tax (Revenue) Codes. Think of it like bending the rules rather than breaking them. Or, as some put is, avoiding paying unnecessary taxes.

What is the basis?

If you want to understand how Cayman works and how this fits into global economy, you need to understand one simple word “Offshore”. Not Offshore in the sense of exploration for, and production of, subsea oil and gas, but Offshore in the financial sense.

Offshore seems to be a British invention, approved by The Bank of England in the year 1958. It means that deals made in – for example – London are viewed as not taking place in London at all. Where business actually happens, and where it happens from the regulatory point of view, could be entirely different. It is not a tax loophole, but it is at the heart of how the world (including many of our household brands) does business today. The idea has become the basis of Cayman’s entire existence.

How it works.

Tax havens are in essence “neutral” locations where transactions are funnelled through. For example a business transaction between a company in Japan and a company in the USA, does not take place in either country, but is channelled through a Cayman holding company, ensuring the Cayman favourable tax regime is applicable. There is nothing obscure about this. The transaction is legal, perfectly visible, and no attempt is made to conceal it.

There is no commonly accepted definition of what renders a country or jurisdiction a Tax Haven, but it is in general a jurisdiction that offers favourable tax or other conditions to its taxpayers as relative to other jurisdictions. But in order to get Cayman’s tax free benefits, one needs to be a resident. That is not something that businesses should necessary worry about. Registration is quite simple, and should not pose an obstacle at all. Obviously, certain due diligence checks will take place, but nothing that the world’s household brands would not be able to pass.

How to become a resident?

So how do companies solve the issue of establishing a physical presence? During his first presidential campaign, Barack Obama already hinted towards the solution. Obama referred to “a building on the Cayman Islands that supposedly houses 12.000 corporation”. “It’s either the biggest building or the biggest tax scam on record”, Obama continues.

In fact, Obama got it wrong. Firstly, Ugland House, located on South Church Street, is the registered address for nearly 20.000 entities (not 12.000). Secondly, the largest building can apparently be found in the USA. 1209 North Orange Street, Wilmington, Delaware, was, in 2012, home to over 285.000 Delaware corporations. This wrong assumption is most likely because, contrary to Ugland House’s multi-storey, 1209 North Orange Street is a relatively small single-storey building.

All relevant taxes are paid.

Household brands will ensure that all relevant corporate regulations are complied with. Strategies like this are perfectly legal. Cayman itself has tax information exchange agreements with more than 90 countries in the world, preventing companies from hiding tax. All operate within the law. Nonetheless what nowadays worries most is not the illegal, but the immoral and unpatriotic aspect of doing business this way.

KYC v2.0 – preventing aggressive tax evasion.

Regulators expect financial institutions to become the gatekeepers for preventing the misuse of the financial system for activities like money laundering, terrorist financing but also tax avoidance. Therefore compliance-risk, as well as controlling integrity-risks, has become one of the most significant ongoing concerns for financial-institution executives. Tighter compliance regulations have challenged financial institutions in a variety of ways. One of the most recent developments is the implementation of measures to identify suspected aggressive tax evasion, and prevent facilitation/involvement.

Why do Tax Havens exist?

Or rather, should we blame companies for utilizing the opportunities that are offered? It was Britain that turned Cayman into a tax haven in the first place. During an incident that has since become known as the Wreck of the Ten Sail, on 8 February 1794, the Caymanians rescued the crews of a group of ships that had struck a reef and ran aground during rough seas. Legend has it that King George III rewarded the island with a promise never to introduce taxes as compensation for their generosity, as one of the ships carried a member of the King’s own family. It’s a great story, but it’s not true.

The U.K. made Cayman a tax free Island, but not out of gratitude, but because they had a plan. With the end of the empire, the colonies had a choice. Many chose independence, but Cayman opted to become a British dependency. In an attempt to compete with countries like Switzerland, in the 60’s a law was passed to make Cayman a tax haven.

However Cayman is not an isolated case. Several countries and territories have been designated offshore financial centres by notable institutions namely, the International Monetary Fund (IMF), the Financial Secrecy Index (managed by the Tax Justice Network) and the Organisation for Economic Co-operation and Development (OECD). Have a look, you’ll be surprised.

What next, and who decides?

So from this perspective, developed democracies apparently decided that this is an economic model they wish to continue to peruse. So who should feel ultimately responsible? Who is really to blame? Who and what really determines offshore ethics?

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