Government pushed through new economic substance rules and other bills during a marathon Legislative Assembly session on Monday in a bid to avoid a European Union tax blacklisting.
The EU is specifically targeting companies based in low- or no-tax jurisdictions that have little or no economic activity but attract substantial profits generated elsewhere.
The new rules require Cayman-registered companies active in nine defined areas to demonstrate they have “adequate” economic activity locally to justify the profits they make.
The changes introduced by the three bills passed by the Cayman Islands legislature on Monday are the result of commitments made by the government in December 2017 that it would address any concerns over its tax system identified by the EU before the end of this year through legislative changes.
The International Tax Co-operation (Economic Substance) Bill, the Local Companies (Control) (Amendment) Bill, and the Companies (Amendment) (No. 2) Bill were debated only 12 days after the draft bills were published. This is significantly shorter than the typical 21-day period, designed to give lawmakers enough time to deliberate proposed legislation.
Minister for Financial Services Tara Rivers said the compressed timeline was the result of extensive, months-long consultation with the private sector to develop “a unified jurisdictional position.”
Nine industry working groups, involving more than 100 financial services representatives, had worked on developing substance requirements since May and government had circulated multiple draft bills among 15 industry groups since early October.
“Arriving at this position takes time,” she said. “I don’t want any member or the listening public to think that this was a rushed bill delivered at the eleventh hour. It is quite the opposite.”
Deputy Opposition Leader Alva Suckoo, in turn, said the bills had been “rushed.”
While the minister went to great detail about the industry consultation, “we had to circumvent democracy,” he said. “We had to gazette bills without the required notice and while the consultation went through the various stages, we forgot one important element, the key stakeholder in all of this: the people.”
Both Mr. Suckoo and George Town independent MLA Kenneth Bryan noted the lack of a definition of “economic substance” in the legislation and questioned whether an economic impact or cost-benefit analysis had been done for the substance legislation. Mr. Suckoo also expressed doubts that the new rules would ever become a global standard, as claimed by the government.
Premier Alden McLaughlin responded that the “collective opinion of the Opposition has been wholly unhelpful.” The definition of adequate substance was different for each industry and business and had to be defined in the regulations. Each case would have to be assessed on its own merit, based on the nature and scale of the business.
The regulations have yet to be published and guidance notes explaining how the law should work in practice have not been released so far. In addition, the effect of the legislation on the economy is far from clear.
“The economic impact of introducing substance requirements in Cayman cannot be determined at this stage because there is simply no data on the majority of business being conducted in Cayman,” the premier said.
“Rough estimates suggest that up to 20,000 companies may be affected.”
But the substance requirements should not affect companies that are here for legitimate commercial reasons, he said. It also should not affect companies that are here for tax reasons, provided the income they earn elsewhere is subject to appropriate taxation in the relevant jurisdictions.
“Companies that are here in an attempt to circumvent tax obligations elsewhere will have a choice: They can go back to onshore jurisdictions with direct taxation or they can increase their level of substance in Cayman,” by having adequate physical office space, management presence and a sufficient number of qualified staff employed locally, Mr. McLaughlin said.
The substance standard had recently been endorsed by the OECD Forum on Harmful Tax Practices, the premier said, which thereby elevated it to a global standard in 122 nations, including the United States and other competing jurisdictions. However, he conceded that there was some concern it may not be applied equally in all these countries.
Mr. McLaughlin warned that a blacklisting “would be a disastrous result for this country,” noting that the OECD Forum on Harmful Tax Practices will develop its own blacklist next year.
Reputational concerns extend also to the Caribbean Financial Action Task Force review of Cayman’s anti-money laundering regime, the premier added. “Indications are we are not going to get a terribly good report,” he said.
Mr. McLaughlin noted that among the EU and the OECD, “the thought process was constantly evolving.” This forced the government to make changes to the proposed legislation up to the last minute, to avoid what happened in Bermuda, where the EU Code of Conduct Group flat out rejected the proposed substance legislation earlier this month.
This was why government had taken so long and consulted so broadly both locally and in constant dialog with EU and OECD officials, he said. “There are no guarantees that we have gotten it right, but we believe we are as good as we possibly can be at this stage,” he added.
Members of the Legislative Assembly also approved amendments to the Local Companies Control Law and the Companies Law to address EU concerns that ordinary companies operating locally and exempted companies operating outside of Cayman were treated differently under the law.
Exempted companies were until now not allowed to operate in Cayman, to provide a level of protection from external competition in business activities that Caymanians have the expertise and wherewithal to conduct.
Commerce Minister Joseph Hew said government had ensured that the amendments that give exempted companies the option to operate locally were appropriate for local businesses and that those companies do not have an advantage over local companies.
Exempted companies that choose to operate in Cayman must comply with 60 percent local ownership and participation requirements or apply for a Local Companies Control License.