The local financial services industry is sanguine that the EU’s decision to put the Cayman Islands on its list of uncooperative jurisdictions in tax matters will be short-lived. At least for now.
Most advisors to hedge funds like offshore law firms or fund-governance firms describe the move as a temporary “technical listing” that is merely the result of bad timing.
In its ongoing dialogue with the EU, Cayman’s government committed last year to reform, before the end of 2019, the supervision and regulation of Cayman funds, particularly those with few investors or close-ended funds that were exempt from registration with the Cayman Islands Monetary Authority.
However, this deadline passed, and lawmakers enacted a new Private Funds Law and amendments to the Mutual Funds Law on 31 Jan., with the new legal framework not entering into force before 7 Feb.
This was three days after a meeting of the EU Code of Conduct Group on Corporate Taxation, which assesses third countries for Europe’s tax list.
EU finance ministers concluded accordingly that Cayman had not delivered on its commitment on time.
The government has in response reaffirmed that it would constructively cooperate with the EU to achieve a delisting as soon as possible. The next review of the tax list is scheduled for October.
Cayman law firms and other service providers have advised their clients that the impact of the tax blacklisting will be limited at this time.
The EU council itself has asked member countries to implement at least one non-tax and one tax-based measure for the treatment of transactions, or individuals dealing with, uncooperative tax jurisdictions by the beginning of 2021.
In the non-tax area, these defensive measures include limiting the access to the European funding for sustainable development or strategic investments, as well as access to the general framework for securitisation.
Transactions with listed countries may also be subject to stricter monitoring and taxpayers who benefit from listed regimes or use structures or arrangements involving these jurisdictions are more likely to be audited.
In November 2019, the council also invited member states to apply controlled foreign company (CFC) rules, withholding tax measures, limited tax deductibility, or a limited participation exemption on profit distribution to listed countries.
Offshore law firm Maples informed clients that, in practice, EU member states already apply some or all of these measures, particularly with regard to jurisdictions which do not have a tax treaty network and operate a tax neutral system, such as the Cayman Islands.
“For example, Ireland applies withholding tax on interest payments if the recipient is not resident in an EU Member State or a country which has signed a tax treaty with Ireland, subject to certain exceptions. Ireland also operates CFC rules and has rules restricting tax deductibility on certain payments which are not subject to tax in the recipient jurisdiction,” Maples wrote in a client advisory. “Finally, Ireland does not provide for a participation exemption on profit distributions to Irish companies. Accordingly, it can be said that Ireland already applies those four measures.”
EU member states also already apply defensive administrative measures, such as increased transaction monitoring and audits, to jurisdictions without a tax treaty network or those that are tax neutral, like the Cayman Islands, Maples wrote.
This means in practice that the EU blacklisting does not trigger any automatic sanctions or penalties.
Fund governance firm DMS noted in a client advisory that unless EU members provide otherwise, Cayman funds can continue to be marketed in the EU and EU investors can stay invested or increase their investment in Cayman funds.
Nevertheless, Cayman’s listing as uncooperative does have a negative impact on its reputation. European institutional investors, for instance, might find it even more difficult to invest in Cayman-based fund structures than they already have.
US law firm Ropes and Gray said in a note to clients that “the blacklisting of the Cayman Islands is likely to be short-lived” and fundamental changes to existing structures should therefore be considered in this context. But the firm also noted that some investors have increased reputational concerns about investing in Cayman funds.
“New funds, or funds looking for new investors, may therefore wish to consider an EU alternative for the fund vehicle,” the law firm said.
Some limited partners may also have increased concern “over the audit risk and risk of increased tax leakage if there are Cayman blockers or other Cayman corporate vehicles in fund structures”.
Ropes and Gray advised that funds may wish to consider alternative jurisdictions for such vehicles if the Cayman Islands remains on the blacklist.
Additional compliance costs in connection with Cayman’s recently introduced economic substance law are another factor that funds should factor in, the law firm said.
Israeli newspaper Haaretz raised similar concerns regarding Cayman’s new fund regime which could impact venture capital funds that invest in the country.
The new Private Funds Law, the article suggested, requires private equity and venture capital funds to hand over more information about their managers and limited partners, as well as data that these funds do not typically like to share.
Independent valuations, currently done by the general partner of the fund, annual audit reports, and third-party custodians and administrators all add costs, the Haaretz article said, quoting partners at Israeli law firm GKH.
These factors, together with entities from blacklisted countries facing difficulties to raise money from European institutional investors, could “force” funds to move their place of incorporation “possibly even to Israel”, the newspaper speculated.
About 80% of venture capital funds active in Israel are incorporated in Cayman.