The future of money: How cryptocurrencies with real backing will become the ultimate disruptive technology

The world has been plagued by endless fluctuating exchange rates between countries and persistent and highly variable rates of inflation ever since the major countries of the world began to erode the gold standard during the twentieth century as a direct result of having to finance major wars. Transactions costs, using cash, credit or debit cards, check or wire transfers, are all unnecessarily high. These problems have undermined saving, investment, and trade – all of which have reduced GDP growth, employment and real wage growth.

The solution is to move to a world of privately created money with real backing, such as a basket of commodities, or one or more metals, such as gold, silver or aluminum – which would be exchanged in digital form through the use of blockchains. The innovative blockchain software technology enabled the creation of cryptocurrencies, such as Bitcoin and Ethereum.

The use of the blockchain solves the problem of double spending and, through the use of encryption, protects financial privacy while verifying the transaction in close to real time. The actual transaction cost can be negligible, and national borders are irrelevant. The problem with existing cryptocurrencies is that, even though the developers have found mechanisms to limit the total amount of currency issued, there is no benchmark or real basis for actual value and hence the prices have fluctuated very wildly. In contrast, even though the U.S. dollar, like all major currencies, is what is called a fiat currency with no specific backing (i.e., the U.S. gold reserves are only a tiny fraction of the total money supply), but the government does have the ability to acquire resources through taxation. That is, the value of the U.S. dollar is based on the correct belief that the government has sufficient coercive power to tax real assets.

Private parties could move to the use of gold, aluminum or other commodities as a benchmark and backing for money without government permission. Prices for all other commodities, goods and services could be listed in troy ounces of gold, pounds or kilos of aluminum rather than US dollars, euros, U.K. pound sterling, Japanese yen, or any other central bank-issued fiat money. Nobel Laureate, F. A. Hayek, in his classic, “Denationalization of money – the argument refined,” published in 1974, clearly explained why it was preferable and practical to have non-government issued money, with competitive suppliers. There is no more reason for the government to have a monopoly on money than there is for government to have a monopoly on the production of toasters. Historically, many private parties minted gold, silver and copper coins, which were fully interchangeable with government-minted coins of the same weight. The only need for government to be involved with the production and quantity of money is to designate what is legal tender for the payment of taxes and government payments to others. If the dollar is defined for U.S. government purposes as, for instance, 1/1000 of a troy ounce of gold or one kilo of aluminum, it matters not as to who minted the coins or supplied the metal as long as it meets the defined standard. The technical hurdles for implementing Hayek’s concept for private money no longer exist as result of the Internet and blockchain.

Gold, for many good reasons, has served as the most commonly used commodity standard for money. Ever since being adopted by the U.K. in 1821, as well as by Germany, France and the U.S. in the 1870s, gold has served the global economy well. It became, in essence, the world currency, thereby eliminating the chaos of multiple fluctuating foreign exchange rates. Goods and services, all around the world, were denominated in gold. And given the cost of mining new gold, persistent inflation did not occur. This was an economic golden age in which the world economy grew rapidly.

There are many arguments for going back to gold; but for several practical reasons, it is very difficult. The dollar’s peg to gold at $35 per ounce was officially (and abruptly) abandoned in 1971, and in 1976 the U.S. dollar officially became a fiat currency. But even after the 3,000 percent rise of gold versus the dollar in the 46 years that followed, the money supplies of all nations vastly exceed their gold supplies, even at the current price for gold. It is unpalatable, politically, for central banks to now re-peg their currencies to gold at whatever high rate is feasible and give up the power to control their money supply. The re-adoption of a global gold standard would also restrict governments from running large and persistent deficits.

In theory, there is no reason why private parties cannot issue gold coins. There are many private minters who currently do. The problem arises if these gold sellers call their coins money, because it then falls under government regulation, and the U.S. Treasury has been aggressive in shutting down private issuers of gold money (both coin and digital gold money). It should be noted that under Section 8 of the Constitution, Congress has the power to coin money; however, it does not specify that only Congress should have this power.

The U.S. government places a capital gains tax on any gain in the price of gold coins and bullion versus the U.S. dollar, even when the fall of the dollar is solely due to inflation. The price of gold has also been much more volatile than aluminum and a number of other commodities over the past thirty years. The volatility is due to the fact that the price of gold is very much influenced by world events and the actions of governments – such as gold sales and purchases – who own a major share (18 percent) of the outstanding world stock of gold. Relatively small sales or purchases of gold by governments can greatly affect the price of gold, since, like all commodities, it trades at the margin.

There are many alternatives to gold, including a variety of commodity baskets, but my favorite is aluminum. As unlikely as it may seem, an aluminum-based money overcomes several of the problems with gold. Like gold, most of the aluminum ever produced is still in use today (more than 90 percent of the gold ever produced and more than 75 percent of the aluminum). These two metals do not disappear with endless recycling and environmental degradation (they do not “rust”), unlike virtually all other metals. A high and growing percentage of aluminum is recycled because approximately 40 percent of the cost of primary aluminum production is energy, yet it is only five percent of the cost of recycled aluminum, so there is a strong incentive for recycling.

As unlikely as it may seem, an aluminum-based money overcomes several of the problems with gold.

In the past, gold had the attraction that a tiny amount was of great value, so it was easy to carry around and useful for high-value coins. This advantage disappears in the digital age, and, in fact, can be a disadvantage. Because of its high value to weight, gold is easily stolen, which makes it costly to store. It is much more difficult to steal a significant value of aluminum because of its low value to weight. If aluminum becomes widely used as a global monetary standard, issuers of aluminum-backed money would need to demonstrate that they have possession of – or at least ability to procure within a short period of time – the necessary aluminum to fulfill redemptions. Issuers of aluminum money would likely be aluminum producers, banks, other financial institutions and even major owners of aluminum, such as airlines (the planes).

Global standards would need to be established for issuers, and perhaps insurance might be required. Given that aluminum coins would be digital, each one could be traced back to a specific issuer in case of a redemption problem. The risk would be low – one issuer might possibly have a problem, but not all would.

Aluminum is the most versatile and useful of all metals, in that it can be substituted for most other metals at some price, as well as many plastics, wood, etc. Over the last 30 years, aluminum has had far less price volatility than gold and, as noted above, all other major metals and most commodities. Its price volatility should continue to decline as the stock of existing aluminum grows relative to new production of primary aluminum. The cost of producing secondary aluminum will always be less than that of producing primary aluminum because of the energy cost differential. This imposes a natural limit on how much primary producers can charge.

At the moment, the Chinese have more than half the world’s primary production capacity; but even so, they cannot “corner” the market because of the huge global stock of secondary aluminum, equal to about 15 times yearly primary output, and there are many aluminum producers in many countries who can ramp up production. Aluminum accounts for about 7 percent of the earth’s crust, so no country can obtain a lock on the raw material, most notably bauxite. If the Chinese government decided to adopt aluminum as their official currency backing, others around the world would be wary that they might engage in price manipulation, which they could do to either bankrupt competitors or impose a temporary artificial scarcity. The Chinese would be smart if they let private entrepreneurs create aluminum-backed currencies and then legalize them for domestic use and even for government purposes. This would give them total independence from the U.S. Federal Reserve, which neither China or any other country now has.

The. U.S. government benefits from having the dollar as the world reserve currency. It is not only the Chinese who resent this system, but many other countries, such as the Swiss, who have lost some of their monetary and regulatory independence to the Fed. It is only a matter of time before some countries figure out that they can use the new technologies to regain their monetary freedom. The U.S. and other major governments will not like the competition.

It will be very difficult for them to know who is spending and receiving cryptocurrencies with or without real backing, because of the cost of trying to break the encryption for each largely invisible transaction.

The problem of cryptocurrencies without a real anchor is well recognized, so there will be many attempts to find the most acceptable backing – gold, aluminum, commodity baskets or whatever. (Note: We have already established considerable intellectual property protections for the aluminum-backed cryptocurrency concept and its implementation. Others are working on gold, etc. As always, the market will ultimately determine success.)

The classical gold standard using coins and/or bullion for transactions provided a great deal of financial privacy for the users, particularly if they did not use banks. The new cryptocurrencies have the potential to provide the same level of privacy, because the networks are peer-to-peer, rather than having the money run through a bank or other financial institution.

Governments will, of course, try to ban/monitor/regulate/tax cryptocurrencies, but it is a battle they are likely to ultimately lose in the same way new technologies have been almost fatally disruptive for traditional book stores, video rental shops, film cameras, newspapers, etc. Private cryptocurrencies with real backing are likely to become the ultimate disruptive technology and finally free people from government monetary tyranny.

Semantic traps in tax policy

Tax avoidance. Aggressive tax planning. Harmful taxation. Treaty shopping. Rule Shopping. Law Shopping. Abuse of tax treaty. Abuse of tax law. Secrecy jurisdictions. Black money.

If someone had the patience to read the tons of documentation written on tax policy by the Organization for Economic Cooperation and Development (OECD) or other international organizations, such as the International Monetary Fund or the United Nations, he would see how these texts are full of unreadable words, locutions, acronyms, slogans and definitions. All these papers are well-written, very elegant in their sophisticated terminology, convincing.

Nevertheless, going more in depth with the reading, one realizes that they are only empty shells, beautiful words with no meaning.

The rush for increasing the sophistication level of tax policy language is not left to chance but it is a deliberate strategy by policy-makers to corrupt the meaning of words in order to convince governments, politicians and naive citizens that the global economy is unjust, entrepreneurs are evaders, multi-national companies spend time designing tax strategies to minimize the amount of taxes to pay, and so on. Once they have convinced the reader that the world is unequal, the solution comes naturally: fight corruption through anti-avoidance rules, squeeze taxpayers (mostly capital-owners), and give more money to the state so that bureaucrats can increase public spending for welfare programs, for whatever that means.

Nevertheless, these institutions know that, to achieve their goals, they must convince the greatest number of countries to follow their recommendations. Suppose, in fact, only few countries decide to follow them, while all the others do not. The former would lose all tax revenues, thanks to the freedom to move capitals and tax bases to other jurisdictions, and the latter would host all the taxpayers escaped from the jurisdictions which levy high taxes.

This is a typical equilibrium achieved under a Tiebout competition. To achieve it, a co-ordination of tax regimes is required. This is why these organizations launched a campaign against tax competition, preaching the benefits of “tax harmonization,” a semantic trap meaning that all jurisdictions should adopt the same tax policy, tax rates, tax bases and tax rules.

A semantic trap in the tax policy is recognizable by the distorted use of the adjectives associated with nouns. The idea which stands behind the trap’s creator is to transform an adjective having a neutral connotation into one with a negative meaning. For example, the OECD’s “aggressive tax planning locution,” used by the organization to convince governments they have to join an international convention to tackle the fiscal planning made by multinational corporations and wealthy people, an “emerging global issue,” as they call it.

The OECD moves from the assumption that tax competition can be harmful. It does not say that it is harmful per se but that it can be harmful when it becomes detrimental for government’s revenues because it leads to a sub-optimal provision of public goods. This is a subtle but fundamental difference. Professor Michael Devereux (Oxford University), one of the leading OECD economists and a great supporter of tax harmonization, defines “harmful tax competition” as “the uncooperative setting of source-based taxes on corporate income where the country is constrained by the tax setting behavior of other countries.” In a free-market perspective, competition is always and necessarily an uncooperative game, as market forces always constrain players to behave in order to achieve better results than other players but the goodness of competition stays just in this. Otherwise, it would not be a competition. Therefore, it seems quite paradoxical that supporters of “harmful tax competition” transform a good feature into a negative one. The result is that someone is entitled to decide when behaviors of those who harm the competition (the tax planners) become unacceptable from a social perspective. In other words, according to this view, tax competition, theoretically seen as a good, is subjected to a moralization process which ends with the condemnation some behaviors. Almost never the OECD said tax competition can be beneficial for people and companies, while empirical evidence shows that this is true. It has always highlighted, and often created, only the side effects of tax competition. Over time, they have hinted that “harmful tax competition” leads to a race to the bottom, fueled by a continued fall in corporate tax rates to attract tax bases, undertaken by the use of tax planning and profit shifting activities.

According to the OECD, jurisdictions with low tax regimes are not seen as best practice in terms of effective and efficient tax administration, but as pirates that subtract tax revenues from other jurisdictions. But since they realize that defining what harmful tax competition really means is not an easy task, they have been forced to introduce an ad-hoc language to identify the subjects who harm the competition. Categorizing institutions and finding a culprit is always the most effective way to reach the goal. So, the OECD started to group states into categories: country with preferential regimes, tax havens, and non-member economies.

Then, it established criteria for identifying each of them. “Preferential regimes” and “tax havens” are other two semantic traps. Just pay attention to how the OECD’s definition of the word “havens” is used to connote a jurisdiction “characterized by having only nominal or no taxes, impeding the free exchange of information on taxpayers with other governments through administrative practices or laws, non-transparency, and a lack of substantial activities” as the enemy of the poor and the haunt of the world’s criminals. The idea that low taxes, small governments, privacy and private property’s defense could be values worthy to be defended does not deserve to be considered.

Another example of semantic trap is the “tax avoidance” locution. According to the Cambridge dictionary, this term means “the reduction, by legal methods, of the amount of tax that a person or company pays.” Moving from this definition, the OECD believed it was its duty to limit the taxpayers’ freedom to find legal methods to minimize their tax burden. The organization’s website devotes an entire section to the tax avoidance issue, in which it notes that “OECD is at the forefront of efforts to improve international tax co-operation between governments to counter international tax avoidance and evasion.” By doing so, tax avoidance is raised to the same level of tax evasion, among the activities which must be tackled. Not because it is illegal, but because it is considered dangerous for governments’ public finances. This is the contradiction: fighting a legal behavior in order to build a more legal world. This violent incursion into the sphere of taxpayers’ personal rights is not only tolerated by the OECD but, even worse, encouraged.

But how can you convince people that something legal must be punished? Through morality. Morality is not justice or legality. In policy-making, morality is only an arbitrary vision of an issue, through which what is “legal” may become an “undesirable legality” and, for this reason, should be punished. With a sophisticated language used to sweeten the pill, the institution has produced a great deal of papers, presented at many conferences around the world, and paid officials to lobby governments in order to convince that tax legality is undesirable. The “undesirable legality” weakens justice and legality, because it erases one of the main characteristics of the two: certainty. The tax planner who legally takes an action to minimize a tax burden must fears that a tax administration can always decide that this behavior must be punished.

This is pure arbitration. The same is used by the OECD when it compiles the “black list” of what it calls “uncooperative tax havens,” according to some criteria it has freely established. Jurisdictions which do not respect transparency and exchange of information requirements are blacklisted. Financial privacy is not a right for the OECD.

In conclusion, we should always pay attention when we read the policy papers and “recommendations” by international organizations because behind any word there is a hidden intent to achieve a moral goal, which most of the time aims to reduce the economic freedom of individuals.

Most common semantic traps used in tax policy

Tax avoidance: the use of legal methods to modify an individual’s financial situation to lower the amount of income tax owed. This is generally accomplished by claiming the permissible deductions and credits [Investopedia]. It differs from tax evasion, which uses illegal methods, such as underreporting income to avoid paying taxes.

After-tax hedging: taking opposite positions for an amount which takes into account the tax treatment of the results from those positions (gains or losses) so that, on an after-tax basis, the risk associated with one position is neutralized by the results from the opposite position. [OECD]

Tax Planning: Set of planning activities undertaken by a taxpayer to minimize tax liability through the best use of all available allowances, deductions, exclusions, exemptions, etc., to reduce income and/or capital gains.

Aggressive Tax Planning: conceptually elusive

Harmful tax competition: Commission communication “a package to tackle harmful tax competition in the United Europe”, discussion initiated by the Commission at the informal meeting in Verona, 1996. From the reading of the text it appears clearly what EU officials wanted to achieve by introducing the slogan “harmful competition”: a needed “coordinated action at European level to tackle harmful competition in order to help achieve certain objectives such as reducing distortions in the single markets, preventing excessive losses of tax revenue or getting tax structures to develop in a more emplyment friendly way”. [conclusions of the Ecofin Council Meeting on 1 December 1997 concerning taxation policy]

The criteria for identifying potentially harmful measures include:

  1. an effective level of taxation which is significantly lower than the general level of taxation in the country concerned;
  2. tax benefits reserved for non-residents;
  3. tax incentives for activities which are isolated from the domestic economy and therefore have no impact on the national tax base;
  4. granting of tax advantages even in the absence of any real economic activity;
  5. the basis of profit determination for companies in a multinational group departs from internationally accepted rules, in particular those approved by the OECD;
  6. lack of transparency.

In a report of November 1999 the Group identified 66 tax measures with harmful features (40 in EU Member States, 3 in Gibraltar and 23 in dependent or associated territories). Following the 1998 report “Harmful Tax Competition: An Emerging Global Issue” the OECD created the “Forum on Harmful Tax Practices” focussed on three areas: Harmful tax practices in Member Countries; Tax havens; Involving non-OECD economies. In the framework of its work on Base Erosion and Profit Shifting (BEPS) the OECD has agreed on recommendations on a number of issues in October 2015 including: Hybrid mismatch arrangements (Action 2); Transparency of rulings (Action 5); Patent boxes (Action 5)

Treaty Shopping: abusive practice of structuring a multinational business to take advantage of more favorable tax treaties available in certain jurisdictions. The search of the most favorable treaty from the tax regime perspective by the subject who abuses.

Rule Shopping: abusive practice consisting in a behavior finalized to making applicable a provision more favorable to the foreign source income, that would not be applicable, otherwise.

Both the Treaty and Rule Shopping belong to the more general Law Shopping.

Abuse of Tax Treaty: improper behavior by a State to suspend or extinct a treaty (Vienna Convention on the Law of Treaties).

It represents a variant of the Abuse of law semantic trap, meant as a subjective right exerted by a single in a contrary manner with respect to the aim recognized or protected by the law.

Hybrid Mismatch Arrangements: arrangements exploiting differences in the tax treatment of instruments, entities or transfers between two or more countries

Related semantic traps:

Hybrid entities: Entities that are treated as transparent for tax purposes in one country and as non-transparent in another country
Hybrid instruments: Instruments which are treated differently for tax purposes in the countries involved, most prominently as debt in one country and as equity in another country.

Hybrid transfers: Arrangements that are treated as transfer of ownership of an asset for one country’s tax purposes but not for tax purposes of another country, which generally sees a collateralised loan.
(see: OECD, Hybrid Mismatch Arrangements – Tax Policy and Compliance Issues, March 2012)

Base erosion and profit shifting (BEPS): tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. The BEPS package provides 15 Actions that equip governments with the domestic and international instruments needed to tackle BEPS

Transfer pricing: transactions involving intangibles; contractual arrangements, including the contractual allocation of risks and corresponding profits, which are not supported by the activities actually carried out; the level of return to funding provided by a capital-rich MNE group member, where that return does not correspond to the level of activity undertaken by the funding company; and other high-risk areas. (OECD, Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 – 2015 Final Reports)

The five technology trends that will change insurance for good and for better

The modern insurance industry evolved out of London, where business was done in person, contracts and insurance policies were written on paper, and pricing was more subjective than objective. Roll forward 330 years and much of the industry really is not that different. A recent Willis Towers Watson report showed 74 percent of respondents felt the industry had failed to show leadership in digital innovation; remarkable for such a massive global industry.

When Saxon was started in 2011, our vision was clear: use technology to create a better customer experience. We have found that by developing buy online, e-signatures, e-approvals and pricing algorithms, we have simultaneously been able to drive down processing times, and increase customer satisfaction. We are far from perfect still, but our adoption rate of new technology, and the Saxon culture mean that every day we get better and stronger. What is exciting from our point of view, is that the industry is at a tipping point, and the big winner will be the consumer. Here are five technology trends that we are embracing because we believe they are going to contribute to an insurance revolution:

Artificial intelligence

AI has a bad reputation. To many, it conjures up images of mass job losses, robotic “customer service” and infuriatingly limited options. Actually, if it is used wisely, the reverse should be true. AI should allow the 70 percent of transactions that are simple – in insurance, think adding a driver to a vehicle policy or claiming for a lost piece of jewelry – to be processed instantaneously through a medium like Whatsapp, Facebook Messenger or even Siri.

Could AI lead to job losses? Absolutely. But only if we do not adapt. AI will force the human workforce to find a way to provide added value. This could be through delivering a heightened customer experience, being empowered to make discretionary service decisions, or creating a deeper connection and thus driving loyalty.

To the contrary of popular opinion, AI will lead to a much greater customer experience if done correctly. And insurance is a frontrunner in adopting it. Just google “Lemonade” to see the stir they are creating in the market, and all the copycats that are emerging – many of them established, traditional players.


Used by military forces for over a decade, the private sector is embracing their use exponentially since the FAA relaxed their rules in 2016 in terms of their commercial use. The insurance industry has shown a particularly keen interest in drones for several reasons, but the two main ones are:

  1. It is much cheaper to send a drone to inspect a high building than a person. From the shorter inspection time, to the fewer workmen’s compensation claims, drones save money.
  2. Post disaster claims inspections can now be conducted within hours of an event. Images of the damage caused by Hurricanes Harvey and Irma were taken very soon after the winds died down. This allows insurers to assess total damage far more quickly than traditional methods. The most advanced insurers are even overlaying real-time images with their policyholders’ information to pro-actively evaluate the extent of damage, and in many cases, offer settlement amounts before a claim is even made.

As for Saxon, as we have developed our own drone program, we have identified another use case: as a verification tool. We have already had examples where we’ve identified customers who had noted on their application form by mistake that they had, for example, a standing seam roof when in actual fact it was shingle. Having inspected the house with our drone, we were able to identify the error and rectified it up front. Without that inspection, in the event of a claim for roof damage following a hurricane, it is likely that any claim would be denied.

Big data

It is a painful process applying for insurance. Even with the ease of doing it online, there are still a lot of questions, and all for a product that, while important, is not that exciting. The question, therefore: is there enough available public data that means the way insurance is distributed can be radically improved? Quite probably, yes, but it is about getting comfortable with data sharing and access. Admiral, a U.K. insurer, was trialing a program whereby it was scraping Facebook data and looking for a link between people’s Facebook accounts – frequency of access, time of use, language employed – to develop a pricing and underwriting model. The project ended when Facebook got cold feet. But sooner or later a similar model will gain traction – and should make the process of buying insurance a breeze.

An alternative distribution model would be a pay-as-you-go model. Using car insurance as an example, the two key factors in determining the cost are 1) how much you drive and 2) the way you drive. An app on your phone that captures and transmits driver behavior information can accurately assess both factors, and would allow you to consume insurance as you would electricity. Or better yet, embed the technology in the vehicle and include in the lease cost.

The same Willis Towers Watson survey mentioned earlier, also shows 94 percent of respondents believe that distribution will be the area most radically improved by technology over the next five years. Big data will be central to this.


The insurance industry can be extremely inefficient. The chain of insurance often goes like this: Consumer – agent/broker – Insurer – broker – reinsurer – broker – reinsurer.

If we conservatively assume that each layer is costing the consumer 10-15 percent on top of the pure insurance cost, then it is safe to assume we are paying about twice as much as we would do in a perfectly efficient market. This is one of the reasons why Saxon is committed to being 100 percent direct to the consumer for our products. Incidentally, we have also cut out the broker between us and reinsurers too.

So, one obvious solution to this inefficient market is peer-to-peer insurance. Just like Uber has erased the inefficiencies of the taxi industry, or Airbnb has become so popular as a source for accommodation, the time is ripe for P2P insurance for certain segments of the industry. In fact, Lemonade originally launched as a P2P insurer, but had not prepared the market well enough, so retreated from that brand position.

No doubt that consumer confidence is critical to success – trusting that someone will pay to repair your house takes a bigger leap of faith than trusting someone will pick you up on time – but it is not hard to imagine a set-up that would provide the required level of confidence.

Self-driving cars

Tesla recently came out and said it would look to include lifetime insurance costs in the purchase price of one of their vehicles, such is the confidence they have in the autonomous driving and collision avoidance technology of their vehicles. Whether or not this is marketing ploy by Tesla to get some column inches, the academic point is extremely valid. At what point, can insurance products switch to becoming warranty products? In the case of a fully autonomous, self-driving vehicle, surely if an accident occurs then it is a product defect? And while this is likely to be backed at an aggregate level by some sort of insurance product, from the consumer’s perspective it would be embedded in the purchase price, and remove the need to buy car insurance annually.

If this is a near reality for car insurance, then it is easy to see how fire-proof homes, or unbreakable phones, will require a new approach to the old way of insuring.

Insurance is a hugely important product and industry, but the reality is no one particularly enjoys buying insurance, reading policy documents or arguing about claims. The good news is that an insurance revolution is occurring, forced by disruptors entering the market, and everything that has not changed in hundreds of years is being critically examined under the new light of consumer experience. There are a lot of reasons to be optimistic.

So while Saxon does not quite have the R&D budget to be a global investor in developing these trends, we will continue to be one of the first to adopt new technologies as long as they are beneficial to our customers.

BVI workers relocate to Cayman after Hurricane Irma


Following the devastating destruction caused by Hurricane Irma and the disruption of essential services in the British Virgin Islands, numerous corporate services providers pulled their employees out of the territory with some of the staff to their firm’s sister offices in Cayman.

Richard Reading, a partner at Baker Tilly’s Cayman office, said about 15 to 20 financial services firms booked a jet to evacuate 250 employees. Other firms worked separately to help their workers leave.

He expected between 10 and 15 BVI employees to come to Cayman on a 60-day work permit exemption that allows them to continue carrying out BVI-related business.

Nick Bullmore, a partner with Carey Olsen’s branch in Cayman, said government had been very helpful in facilitating the relocation. He said his firm is moving between five and 10 of its employees and their families here.

“For what it’s worth, our government has done a fantastic job of facilitating these moves,” he said. “It is wonderful to be able to help our sister islands in their time of need. Even though it has now been 13 years since Ivan, we all still remember the generosity shown by others at that time.”

It is not clear how long it may be before the displaced workers can return to the BVI.

“It could take one month, six months, or a year,” Reading said. “It’s going to be a challenge to rebuild. It’s a hard place to build in.”

When Hurricane Ivan hit Cayman in 2004, BDO Managing Partner Glen Trenouth spent about three weeks in the BVI before returning to Cayman. His employees soon followed him, he said.

However, Trenouth said, he was able to find accommodations for himself and his employees. If the BVI cannot rebuild its infrastructure and housing, it would be pointless to send workers back, he said.

“They’d just be a burden on the territory,” he said. Eight BDO workers were expected to come to Cayman.

Meanwhile, the BVI Financial Services Commission announced that its Hong Kong-based BVI House Asia would be the point of contact for regulatory-related matters with the online portal back up and running.

BVI House Asia’s Elise Donovan insisted that the territory is open for business.
“Our financial services business was built to allow people to do BVI business from anywhere in the world, and to continue business regardless of the physical conditions in this jurisdiction,” Ms. Donovan said.

Record number of suspicious activity reports filed in 2015/16

A record number of suspicious activity reports of potential money laundering and other financial crimes were made in the Cayman Islands between July 1, 2015 and June 30, 2016 according to the Financial Reporting Authority.

The 620 SARs represented a 9 percent increase from 2014/15, and marked the fourth straight year the number of reports filed had increased, the Financial Reporting Authority stated in its annual report.

The authority noted that 124 of the cases resulted in information disclosures to the Royal Cayman Islands Police Service, 24 disclosures to the Cayman Islands Monetary Authority, 23 to other law enforcement authorities, and 22 to overseas financial investigation units.

The number of entities making those reports increased from 116 in 2014/15 to 140 in 2015/16, with the largest number of reports (266) coming from the banking sector.

Most of the reports involved suspected “suspicious activity” – typically reports on accounts showing activity that is out of line with the account holder’s expected level of income – while other reports suspected fraud, corruption, money laundering and “other” financial crimes.

There were 1,257 suspects identified in the reports, 796 of them being “natural persons” and 461 of them legal entities.

Most subjects of SARs came from Cayman – including 71 “natural persons” and 210 legal entities being suspected of wrongdoing. The jurisdiction with the second-most number of subjects was the U.S. (100 natural persons and 19 legal entities), followed by the U.K. (51 natural persons and nine legal entities). The other jurisdictions with more than 30 suspects of suspicious activity reports were Taiwan, Jamaica, Canada, the British Virgin Islands and Brazil.

The financial intelligence unit, whose international call sign is CAYFIN, said that the growing volume of SARs is likely due to the territory’s enhanced financial crime-tackling measures.

“The FRA has long held the view that the growing number of SARs is indicative of the vigilance of the reporting entities against money laundering and terrorist financing,” the Financial Reporting Authority stated. “The substantial number of cases in the past three fiscal years appears to have been influenced by due diligence reviews as a result of overseas tax, legal and regulatory updates coming into effect.”

While noting that Cayman has enhanced due diligence measures, the Financial Reporting Authority stated that the volume of reports has put “considerable strain” on its resources. The authority has “around” 12 staff, including one legal adviser.

Cayman and Bermuda captives outperform commercial insurers

Captive insurers domiciled in Bermuda and the Cayman Islands posted strong operating earnings and outperformed commercial insurance companies, rating agency A.M. Best reported in September.

A.M. Best’s report, “The Beat Goes On: Rated Bermuda & Cayman Captives Continue Their Strong Operating Performance,” noted that among the captives rated by the agency, “premium leverage ratios improved, as capital grew at a healthy rate of 8 percent, buoyed by strong operating earnings.”

The report highlighted that 2016 marked the fifth year of above-par operating results for captives with a total return on revenue of 23 percent, down from 24 percent in 2015.

“Underwriting results declined somewhat, to a combined ratio of 85.3 in 2016 from 80.0 the year before, but were well above the results posted by A.M. Best’s composite of U.S. commercial casualty insurers. In addition, the Bermuda and Cayman five-year [2012-2016] average combined ratio of 82.5 far exceeded the U.S. commercial casualty segment by more than 16 points,” the rating agency found.

A combined ratio of less than 100 indicates an underwriting profit, while a ratio of more than 100 means the insurer pays more in claims and expenses than it receives in premiums.
“The Bermuda and Cayman captives saw their net premiums earnings decrease for the first time in five years, to a modest 4.7 percent compared with a high single-digit growth that averaged 7 percent in the prior four years. This included a 10.1 percent growth in 2014, which was far greater than the premium growth reported by U.S. commercial casualty insurers over the same period,” A.M. Best said.

The rating agency noted that unlike traditional property and casualty insurers, captives are not pressured by stakeholders for returns on equity or revenue growth. In addition, extensive use of reinsurance allows captives to transfer a significant amount of catastrophe risk, resulting in less volatile results compared with traditional insurers.

“Bermuda and Cayman captives have posted strong, double-digit [return-on equity] despite difficult market conditions and challenges, with a five-year compound average growth rate of 13 percent for operating ROEs. Favorable reserve releases and limited catastrophe events are the two key contributors to their solid margins and strong ROEs,” A.M. Best stated.

The rating agency further predicted a healthy future for captive insurers “based on the success of the captive business model, the efficiencies gained from the use of alternative risk transfer and the benefits of increased risk awareness and loss control, as well as the ability to integrate sound risk management practices throughout the organization, all of which lead to operating results that outperform the commercial market.”

Trade body responds to criticism of CLOs

Collateralized loan obligations, securities backed by a pool of debt such as low-rated corporate bonds, have performed well this year but attracted criticism for it.

European CLO issuance for the year to date is higher than during the same period last year, when issuance was the highest since the financial crisis with 16.8 billion euros issued in 41 transactions. In the larger U.S. market, year-to-date CLO issuance of $71.2 billion is twice as high as in the same period in 2016, according to Bloomberg. The majority of CLOs are structured through the Cayman Islands.

Media reports have equated the resurgence of collateralized loan obligations to a new form of systemic risk, similar to the risks that materialized from the more complex collateralized debt obligations during the financial crisis. Given that most of the loans underlying CLOS have a low credit rating on their own, the criticism is specifically leveled at the triple-A ratings assigned to tranches of CLOs, indicating a minimal risk of default.

The Loan Syndication and Trading Association responded to the criticism in a statement, noting: “The suggestion that somehow the companies that CLOs lend to are unworthy because they are not investment grade seems troubling. After all, 70 percent of rated American companies are rated below BBB/Baa3; these are important and iconic American companies such as Burger King, Avis, American Airlines and Dell, as well as many innovative middle market companies.”

The comparison with collateralized debt obligations is unwarranted, the trade body noted, because the long-term loss rate on investment grade CDO notes is much higher at 34 percent – a figure that includes the performance during the financial crisis – than CLOs, which according to rating agency Moody’s only had long-term loss rate of 0.1 percent. The association also stated that there has never been a default on a CLO note that was rated AA or better according to Moody’s.

Not only have CLOs performed better than other asset backed securities, they were also much safer than corporate bonds, the LSTA said, citing cumulative default rates compiled by Wells Fargo in 2015. For instance, A and BBB-rated CLO note defaults were both less than 0.5 percent compared with 2 percent and 5 percent, respectively, for equivalently rated corporate bonds.

For BB-rated CLO notes and corporate bonds the difference is even larger: 2.26 percent compared with nearly 16 percent.

The LSTA also played down the correlation risk between by pointing out that CLOs must invest in loans to a diverse set of industries. For AA-rated CLO notes to be impaired, default rates of the underlying loans would have to be nearly seven times higher than during the financial crisis and for AAA-rated CLO notes there is no default rate high enough to cause losses, the LSTA said referring to research by Bank of America.

OECD report: Cayman remains ‘largely compliant’

Despite numerous government measures to bring Cayman in line with the tax transparency guidelines propagated by the Organisation for Economic Cooperation and Development, Cayman is still only deemed “largely compliant,” according to the latest OECD peer review report.

This is essentially the same result as the 2013 review of the way in which Cayman collects and exchanges tax information with other countries.

Although government has addressed the recommendations in the last peer review report, certain amendments, for example with regard to the availability of beneficial ownership information, were “too new to evaluate,” the latest assessment noted.

Cayman was rated “compliant” in seven and “largely compliant” in three of the 10 elements that made up the assessment.

“Cayman tested very well against this more rigorous set of standards, and this clearly demonstrates the high quality of our cooperation with our treaty partners,” said Minister of Financial Services Tara Rivers.

The new peer review follows a six-year process during which the Global Forum first assessed the legal and regulatory framework for tax information exchange and then the actual practices and procedures in 119 jurisdictions worldwide.

The Global Forum’s new review process combines the two elements with a focus on the ability of tax authorities to access beneficial ownership information of all legal entities and arrangements.

The latest report concluded the requirements to maintain beneficial ownership information are generally well implemented in practice. However, the new beneficial ownership requirements for 11,000 domestic companies, put in place in March 2017, remain untested.

During the review period, one company refused to provide information in response to a notice requesting information that was not held in the Cayman Islands. Although the Tax Information Authority referred the case to the Director of Public Prosecutions, the case was not pursued.

“Therefore, in those cases where information is not maintained in the Cayman Islands, the Cayman Islands should ensure that its enforcement powers are sufficiently exercised to ensure that it has access to all information in all cases,” the peer review stated.

A follow-up report on the steps taken to address the latest recommendations will be issued no later than June 2018, the OECD said.

Protectionism, US manufacturing jobs, and global capital flows

Employment in the United States has shifted away from goods production to services. During that shift, the U.S. balance of trade has been negative, leading many to blame international trade for the decimation of U.S. manufacturing jobs.

In Washington, some politicians react by proposing protectionist policies. Their explicit assumption is that imposing trade taxes and creating other barriers will rejuvenate industrial employment. That’s a very tenuous proposition, as is explained below.

But it’s also important to understand that debates over protectionism have major implications for global capital flows. That’s because a nation with a trade deficit, by definition, has a capital surplus. As a result, if politicians succeed in reducing the amount of tradeable goods entering a nation, they also will reduce the amount of capital flowing into a nation.

Keeping in mind the link between trade and capital flows, let’s consider the debate over international trade, which is often based on concerns that the growing U.S. trade deficit has a negative impact on jobs. When imported goods are substitutes for domestically produced goods, it is easy to see why a trade deficit can be detrimental to goods sector employment.

However, in the United States, declining goods sector employment was accompanied by an increase in employment in other sectors. To what extent are trade deficits actually responsible for the decline of U.S. manufacturing employment? Will employment return to manufacturing and to other goods producing industries when the U.S. trade deficits become trade surpluses?

President Trump’s promise to Make America Great Again included protectionist trade policies meant to bring back U.S. manufacturing jobs. Trump’s whole view on trade is that other people and countries are taking advantage of us. China and Germany were branded currency manipulators to gain an unfair advantage in trade with the U.S. Germany’s response was that the size of its trade surplus is largely a consequence of factors beyond its control, such as the price of oil and the value of the euro, as well as the ability of its companies to compete on the world stage. By penalizing imports that compete with U.S. goods, the Trump administration hopes to reverse the secular shift of employment from goods-producing industries to services-producing industries. The commonly held view among Trumpians and also in policy circles is that reversing U.S. trade deficits generated by U.S. households and government borrowing should cause labor to flow back to goods-producing industries (see, Bivens, 2006 and Scott, Jorgensen, and Hall, 2013). See figure 1

As the United States trades bonds for foreign goods, labor shifts away from domestically-produced goods and is reallocated to the services and construction sectors, which are less substitutable for foreign goods. The implication of this idea is that labor should eventually flow back into the U.S. goods sector to produce the extra goods needed to repay the debt.

Caliendo, Dvorkin and Parro (2015) find that the China trade shock in the early 2000’s resulted in a loss of 0.8 million U.S. manufacturing jobs, about 25 percent of the observed decline in manufacturing employment from 2000 to 2007. Service industries benefited from cheaper intermediate inputs imported from China leading to a rise in service sectors job creation. The China trade shock had heterogeneous effects across different labor markets and while some labor markets were adversely affected, most regions and sectors gained from the increased commerce with China, and overall welfare gains were sizable.

Other examples of sectoral reallocations associated with a trade imbalance include Spain after joining the European Community in 1986 when output in Spain’s traded sectors fell by more than 10 percent (Cordoba and Kehoe, 1999). In the 1990’s, access to international capital markets had a similar effect on the Baltic countries (Bems and Hartelius, 2006).

Lastly, a sudden retreat was Mexico’s experience which was accompanied by a shift away from services back towards goods producing sectors (Kehoe and Ruhl, 2009). See figure 2
Another factor affecting manufacturing jobs is technological innovation. Technological advancement boosts productivity and output growth in both the short and long term (see, Brynjolfsson and Hitt, 2003). In fact, productivity and output growth of firms were up to five times greater over the long-term, due to technological innovations. However, these leaps in productivity also result in fewer jobs, especially for blue collar workers. Economists agree that the biggest threat to manufacturing jobs has been automation, not trade, offshoring and immigration. Although imports have had a negative effect on jobs in parts of the country (see, Autor, Dorn and Hanson, 2016), automation has had a bigger effect than globalization as fewer workers are needed to do the same amount of work.

Was it trade or automation that led to the decline of manufacturing employment? Using evidence on sector-specific labor productivity, Kehoe, Ruhl and Steinberg (2017) estimate the impact of differential productivity growth on the decline in goods-sector employment in the U.S. KRS (2017) highlights three important facts: first, between 1992 and 2012, labor productivity in the goods sector grew at an average of 4.2 percent per year, compared to only 1.3 percent per year in services. Second, the goods trade balance generates most of the fluctuations in the aggregate trade balance since the United States has consistently run a trade surplus in services. Lastly, while reallocation away from goods and into services has been consistent, reallocation into construction was temporary, demonstrating that a shift into one sector from another sector can be reversed.

In addition, KRS (2017) assesses quantitatively the relative contributions of asymmetric labor productivity growth and the saving glut – the increased demand for saving in the rest of the world that made foreigners more willing to trade their goods for U.S. bonds. KRS (2017) finds that U.S. trade deficits only accounts for 15.1 percent of the observed decline in the employment share of goods producing sectors from 1992 to 2012. The bulk of the remainder is attributed to faster productivity growth in goods producing sectors compared to other sectors of the U.S. economy. The U.S. sectoral reallocation is driven by differential productivity growth and not trade, implying that as the United States repays its debt, its trade balance will reverse, but goods-sector employment will continue to fall.

Lastly, empirical evidence suggests that, all else being equal, openness leads to more competition that lowers firm costs. Trade liberalization encourages knowledge transfer and technological advances that raise productivity and the standard of living. Bussiere et al. (2011) shows that protectionist measures harm real GDP growth and the competitiveness of those implementing the measures, as well as the countries being targeted.

The shift in American jobs away from manufacturing and into the service sector that can be attributed to foreign trade is small. However, the rewards from international trade have been reaped, directly or indirectly, by all Americans. The primary driver of this shift was technological innovation that made labor more productive, raised living standards and caused employment in the service sectors to grow by more than the overall decline of manufacturing jobs. See figure 2

Economists widely agree that trade liberalization has permanent positive effects on economic growth. On the other hand, protectionist policies that restrict foreign trade hinder economic growth by raising production costs, slowing the accumulation of productive resources and the propagation of new technology. Protectionism is unlikely to override automation and to reverse the declining trend in manufacturing employment. To enact protectionist policies in an attempt to bring back long-gone manufacturing jobs would be another economic faux pas by the Trump administration since it would reduce U.S. competitiveness and slow economic growth.

And if protectionist policies are enacted, and if they are “successful” in reducing the amount of foreign goods purchased by Americans, that automatically means foreigners will be investing less in the U.S. economy. That distortion in capital flows would be an underappreciated and underrecognized source of risk to the American economy. Moreover, if U.S.-instigated protection triggers similar moves by other nations, the result could be 1930s-style tit-for-tax protectionism that threatens the global economy.

Dealing with information overload

Have you ever considered how technologically inefficient you are throughout the day? Everyone suffers from information overload. A phenomenon whose impact results in wasted time, increased stress levels and decreased productivity. The cause is overloading our brain with more input than it can process. Luckily, the societal issues this overload has led to are far from insurmountable. Knowledge is power. Before knowledge comes information and before information, there is data. Big, juicy, poorly maintained, ever expanding, data.

Examining data in different ways will bring about new information. Turning that into knowledge is the solution that can get us past these technological hurdles. The problem we face is compounded by the fact that most of what we are getting inundated with every day is not knowledge. Because technology as a commodity has been driven by entertainment, we are inundated with a lot of junk. Pointless television shows, radio, a massive amount of news and social updates, etc. We need to organize what we have, what we want and how it is presented to us.

Daniel Levitin is the author of “The Organized Mind: Thinking Straight in the Age of Information Overload” and a McGill University psychology professor. One estimation he discusses is that in the last 10 years, more information has been created than in all of human history before that. Without proper planning and execution, the data we start with gets spoiled. Misinterpreting the knowledge we thought we had and reinforcing another adage; garbage in, garbage out. There is an ever-evolving mass of information available to us. It is no surprise that our human efforts to keep up fall short.

Since late1960’s, the technology industry has been steered by Moore’s Law. It has made computers more powerful and more affordable, expanding access at an expeditious pace. The rapid innovation has given us the ability to create multiple types of information systems.

Examples include data warehouses, search engines, geographic information systems and office automation. We have become addicted to the connectivity this has made way for. The media alerts coming in, from a variety of formats, increase dopamine levels and keeps us unknowingly coming back for more. The components of any information system include hardware, software, data, procedures, people and feedback. How individuals are being impacted by all this is a crucial, and often misunderstood, component.

The flood of technology we have been hit with has influenced social change. Our work lives are now home with us. It blurs the lines that used to separate societal roles. Can you remember a time when businesses communicated via fax machine, mail filtered through a physical office and the thought of keeping pace with everyone else’s time-zone was unheard of? From personal and social relationships to the advent of multinational corporations, the fabric of our lives is changing.

Looking at the history of language and then written word helps put this circumstance into perspective. Starting with runes and storytelling, the transfer of knowledge has been pivotal to development of the human race. In 1450, the first printing press was invented by Johannes Gutenberg. Books were a luxury. By the 1780’s, Thomas Jefferson’s personal library was so vast, that it would later become the base collection for the United States’ Library of Congress. At that point in time, he was able to house a majority of the world’s knowledge within four walls. This feat would be impossible in today’s day and age. Since the 1950’s, publishers have slowly been replacing print with digital data. Technology has given the common man enormous opportunity, correlating to the growing mass of information we are now required to sift through.

The amount of information that individuals create and consume is growing exponentially. We are struggling to keep up with a breakneck pace. The stress this causes attacks our bodies and minds. Chronic disease has also been on the rise. It is not a stretch to say our use, or misuse, of technology negatively impacts our entire wellbeing. Everyone has a vested interest in solving the technology problems that surround us daily. When you take into account the opportunity this creates, the horizon looks bright. Increased information literacy is needed at every level to turn technology from a driver to a tool.

Librarians have long been guardians of information. They understand how to assess validity and weed out unreliable sources. Their ability to create comprehensive, unbiased collections of information is a highly refined skill. There is no intermediary to help us with these tasks now that we turn to our iPhones and search engines instead of a library to search for our information needs. The third party has been removed. To make matters more complex, information is no longer static, it is constantly being updated.

Search engines are filling the shoes of a reference librarian. Google’s core mission is to organize the world’s information. By default, we are allowing a for profit corporation to curate the information we receive, regardless of topic. At a time when information is the economy’s chief product, society is giving companies like Google access to an immense amount of data and therefore potential power. The terms on Google’s website list goals that include reporting to advertisers and defending against external fraud and security threats. It seems like a conflict of interest to also be in charge of an end user’s privacy rights. There are threats that those privacy policy changes pose to the average consumer over time.

However, the job is easier when these end users do not care about what privacy terms and conditions actually say.

Maturing how we are accessing information can help address the issues that arise with for profit technology companies. Librarians are evolving. The term “librarian” no longer reflects the segment of the world’s workforce that holds a Master’s degree in Library and Information Science. Basic coursework typically covers organizing information, research methods and strategies, online reference systems, and internet search methods. Given these skills, “information professional” is now the most common title used to describe an MLS graduate.

Knowledge Management and Competitive Intelligence are two branches of Library Science that have emerged beyond the confines of a physical library. The profession as a whole can help navigate the muddy waters of information literacy. Innovation is now needed in the way users access information. A step beyond gaining access in the first place.

In the meantime, we have Google. In 2015, they restructured and created Alphabet, a conglomerate to segregate their various business ventures. This includes experimental companies involved in life sciences, web browsing records, investment capital and research. Alphabet states one reason for the organizational changes was to increase accountability. At present, the group’s website has two links: one to expand a somewhat generic letter from Larry Page and another for investor reporting. Alphabet brought in revenues of $26 billion in the second quarter of 2017. The bigger it gets, the easier it is for the company to pay fines to governments (as Google was recently required to by the European Commission) for breaking the law instead of actually abiding by it.

A big part of the technology industry’s revenue right now comes from ongoing momentum in mobile search and YouTube. Users have a collective power in how these companies operate, whether they want to take ownership of it or not. The conspicuous consumption of the “containers” for our information, like iPhones and computers, are being used as a status symbol. This results in more revenue for the companies creating these gadgets. The world wants to be connected even if it results in information overload.

Access has been obtained for a significant percent of the population. An individual’s willingness to disconnect from this technology comes into play when we discuss the impact it will have on their lives. Turning off push notifications for things like email on your phone and computer can help a person to keep focused during routine tasks. Levitin recommends working to clear your mind, clumping similar tasks together, and giving up on trying to multitask. There is software like “Freedom” that will disconnect its purchaser from the web based on preset times. Xerox also develops some filtering and managing devices.

The issue of implementing these tools to help information overload will always arise. Strategic planning is needed beforehand to analyze how knowledge is transferred and how it flows within the current confines. This will add context and structure to the project, inevitably saving time for anyone involved.

Integrating someone that knows about the transfer and retrieval of information into the core needs of your business tackles the problem of information overload at its base. Some corporations fund inhouse libraries for employees’ access in their pursuit of information. This most certainly expands an individual base of information sources. However, a librarian’s skills in this situation are often called on reactively. After the need has been determined by the user/co-worker. If librarians were engaged in strategic planning an opportunity is created to change the way the entire organization looks at and processes data. Often bringing about an awareness of otherwise unrecognized needs of the company.

Working to proactively involve an information professional to assess goals and determine measurable benchmarks could save a lot of time and money in the long run.


New market for Cayman’s real estate industry

The topic of financial technology will have been discussed at length within this current edition of Cayman Financial Review. No doubt experts in the field will have informed readers on these exciting new trends within the financial services sector, and the many benefits such developments will bring to the industry. As my field of expertise is real estate, I thought it appropriate, as perhaps a parallel discussion, to talk about a new market trend that has opened up in the Cayman Islands recently; one which, I believe, has the potential to be something of a game changer when it comes to home ownership.

There are plenty of great houses on the market that would suit buyers looking for their own spacious accommodation to call home, however, the new development of Stone Island, located at the prestigious Yacht Club development, breaks new ground when it comes to home ownership, cutting an innovative swathe through the current market.

New concept

Up until this point, buyers could choose from a home that would most likely be looked after by the individual owner, in terms of landscaping, pool, deck, dock, etc. If a buyer is looking for a “lock and leave” type of home that is under the control of a strata management company, these have generally taken the form of a condominium. The beauty of Stone Island is that it combines owning a separate home tailored to the buyer’s individual needs with the ease of owning a strata-operated property, where all the hard work of home ownership (i.e. the external upkeep) is undertaken by a third party.

By way of some background, Stone Island is a gated and fully maintained waterfront community that will have 44 luxury residences within its location, each with approximately 4,500-square-feet of open-concept living space. Buyers can choose to upgrade their residence with a number of additional features available, including building in an elevator, a built-in outdoor barbecue, as well as the inclusion of superior finish packages, among other options.

Located in a well-established and prestigious residential community, Stone Island offers easy access to the ocean and is just a short walk from Seven Mile Beach. The Residences of Stone Island are at the heart of a thriving yet quiet community, and enjoy the added benefits of being close proximity to The Cayman Islands Yacht Club, which has a full-service marina, restaurants and amenities.

A unique opportunity

In addition to employing the highest building standards, fixtures and finishes, which include poured concrete, foam insulation, LED lighting, impact-rated windows and smart-home technology, the developers have also gone the extra mile to produce lush landscaping, an additional separate swimming pool to each home’s individual pool, tennis courts, a full-sized gym and on-site security. Exclusivity has been written into every detail – for example, the homes have been carefully designed so that you don’t glimpse the entrances to other homes as you drive up to your property and cars are kept off the driveways and out of sight in a specially built garage. You can buy a home for a similar price to these residences at Stone Island, but house buyers will not have access to the extensive amenities that this development is offering, principally due to the scale of the development and the fact that it will be operated by a strata management company. This is why I am excited by this new concept.

Meeting market demand

It is especially relevant that we are able to offer new niche markets for potential buyers because of the recent upswing in demand for Cayman Islands property by overseas buyers. It is vital that Cayman is able to keep up with the appetite for second (or third homes) for wealthy retirees, in particular. This new type of home ownership will appeal to the overseas buyer who might be looking to buy a sizeable home in the Cayman Islands, but who also wants to be able to lock it up and leave it whenever they travel back home. This was traditionally only a benefit derived from owning a condo within a strata.

The security that will be on site gives additional peace of mind for people only living in their home for part of the year. Local residents who may be retiring will also find such a set-up an attractive lifestyle choice, with people reaching the end of their working life looking to spend just part of their time residing in Cayman.

There are currently three model homes already completed, to give would-be buyers a glimpse of how they could customize a home at Stone Island to suit their individual needs.

I believe that The Residences at Stone Island will be ground breaking for Cayman’s real estate market and it’s a precedent that stands the island in good stead for continued positive growth in the years to come.

Cyprus: Your home away from home

Why live, work and invest in Cyprus? To name but a few reasons, you get at least 340 days of sunshine, sounds good, right? You can enjoy a natural paradise, a diverse multicultural place, with one of the lowest crime rates in the world and truly blessed by nature, with soft sandy beaches, crystal clear waters and proud mountains. A range of high-level public and private schools are available to choose from, highly accessible healthcare and ample recreation and hospitality options to keep you entertained. But there is much more to the island than meets the eye: it’s a reputable international business hub for doing business, supported by political stability and a robust legal system based on common law principles; and offers diverse opportunities across a number of economic sectors to invest in and significant tax benefits to capitalize on.

Not quite convinced? Here’s a little more to go on. In past year, the Cypriot government has demonstrated its commitment and determination by achieving double-figure growth rates in both Foreign Direct Investment and attracting high net worth individuals to settle down and do business in or through Cyprus. For this very reason, and to keep the momentum going, it has recently introduced simplified procedures for issuing permanent residencies and citizenships in Cyprus that have made the possibilities for relocation so much easier.

Permanent Residency in Cyprus

There are two methods by which one can obtain permanent residency in Cyprus, the fast track option and the normal track option.

Fast track option:

To start off, the interested party should submit a confirmation letter from a financial institution in Cyprus that the minimum amount of 30,000 euros has been deposited from abroad into an account in Cyprus. This shall be pledged for a minimum period of three years.

Then, prove that an annual income of at least 30,000 euros from abroad has been secured. This annual income should be increased by 5,000 euros for every dependent person of his/her family and by 8,000 euros for every dependent parent or parent in law.

Additionally, the applicant must have acquired real estate of at least a total market value of 300,000 euros. The application should be accompanied by the title deeds or the sale contract of the property, which has been officially filed at the Land Registry, and official payments receipts of at least 200,000 euros, not including value added tax (VAT). A key point of note is that the property need not be in the applicant’s name but can be in his/her spouse’s name or in the name of a legal person legally established in the European Union and that the sole shareholder is the applicant or his/her spouse. Where a purchased property is alienated without an immediate replacement with another property, the immigration permit is cancelled.

The immigration permit provided to third county applicants covers his/her spouse and their children under the age of 18. Two spouses can be granted two separate immigration permits if a separate application is submitted, with one of them not being required to satisfy the criteria of making a bank deposit, securing annual income and purchasing property. In the event of death of an immigration permit holder, the spouse is granted the permit.

Furthermore, except for the economic criteria/conditions that an applicant must satisfy there are also other qualitative criteria that an applicant must satisfy too. These include:

  1. Have a clean criminal record from their country of origin or residence (if it differs).
  2. Not be a listed person whose assets have been frozen as the result of sanctions within the boundaries of the European Union (EU).
  3. His/her spouse must confirm that they do not intend to undertake any sort of employment in Cyprus.
  4. The holder of an immigration permit is obliged to acquire a residence in Cyprus within one year from the date of the issuance.
  5. Holders of the permit and his/her dependent persons are obliged not to be absent from the Republic for more than two years.

Any violation of the above will lead to the immigration permit being automatically cancelled.
A brief outline of the process to obtain an immigration permit begins with the submission of the application and the required supporting documents directly to the Civil Registry and Migration Department personally or through an authorized representative. A fee of 500 euros is paid for the submission of the application. When applications are submitted by an authorized representative, these must be accompanied with an authorization letter from the applicant stating the particulars, full address and their contact details. The application is then processed by the Civil Registry and Migration Department and submitted to the Ministry of Interior through the Permanent Secretary of the Minister of Interior. An interview with the applicant may need to be conducted if deemed necessary by the Permanent Secretary of the Ministry of Interior. Finally, the decision is communicated to the applicant or the authorized representative by the Ministry of Interior. The procedure described for the examination of the application shall not exceed two months from the date a complete application is submitted.

Normal track option:

The other method to obtain a permanent residence in Cyprus is known as the normal track option. In this case, the applicant must rent or purchase a house or an apartment with a minimum market value of no less than 300,000 euros. Also, the applicant must secure a minimum annual income of at least 10,000 euros from sources outside Cyprus and at least 5,000 euros extra for every dependent person. There is no requirement for employment in Cyprus under in this option. The same qualitative requirements, included also under the fast track option continue to apply. Under this option, the applicant is free to travel to and from Cyprus without any restrictions. The main benefit of the normal track option is the lower threshold of annual income required of 10,000 euros in contrast with the fast track option that requires annual income of 30,000 euros.

The most important difference between the two immigration permit methods is that under the normal track option, completion of the procedure can take up to one year or even longer, while under the fast track option the application procedure is completed within two months.

Citizenship by investment

Naturalizations through citizenship by investment programs, offer a gateway and stepping stone to what might be in today’s dynamic world, a physical person’s most effective tax risk exposure management tool. High net wealth individuals who wish to relocate to the EU can now do so through such a program, in return for investing in Cyprus. The recently revised criteria for granting a Cypriot citizenship by investment requires the applicant to make an investment of 2 million euros, excluding VAT in any qualifying investment category such as:

  1. The acquisition or development of real-estate projects (acquisition of land is not considered a qualifying investment), or
  2. Purchase or create or participate in a Cypriot business or company that is based and operates in Cyprus. Such a business or company should be able to demonstrate its physical substance in Cyprus with significant activity, turnover, and employment of at least five Cypriot or EU citizens, or
  3. Invest in an Alternative Investment Fund, financial assets of Cypriot companies or Cypriot organizations that are licensed by the Cyprus Securities and Exchange Commission, or
  4. Any combination of the above amounting to at least of 2 million euros, which may also include the purchase of governmental bonds of the Republic of Cyprus with a maximum amount of 500,000 euros.

Additional eligibility requirements for obtaining a Cyprus citizenship by investment include:

  1. Have a clean criminal record from their country of origin or residence (if it differs).
  2. Not be a listed person whose assets have been frozen as the result of sanctions within the boundaries of the European Union (EU).
  3. Acquire a private residence of at least a total market value of €500.000 and must be fully paid.
  4. Prior to naturalization as a Cypriot citizen a residence permit in Cyprus must be obtained.

The applicant may also add dependents to the application including his/her spouse, children (up to age of 18 or between 18 and 27 if they are financially dependent on the main applicant) and parents. A residence permit can be issued within five days from the date of submitting a joint application for residency and citizenship by investment.

Depending on the type of investment, relevant documentation will also have to be submitted as part of the application.

The application process is similar to that for permanent residency. Application submission fees amount to 2,000 euros and Certificate of Naturalization issuing fees are 5,000 euros. The expected time frame for the completion of the process is approximately two months. The Council of Ministers has complete discretion on the approval of any Citizenship application.
Here are a few of the key benefits acquiring Cyprus citizenship by investment has to offer:

The right to live and work within the countries of the EU

Citizenship can be passed on to future generations

Free movement of goods, services, and capital

Visa-free travel to approximately 160 countries, including Canada

Dual citizenship is allowed.

Tax residency:

Citizenship does not automatically equate to tax residency. Yes, there is a difference but nonetheless it’s a starting point. A new law for determining tax residency of individuals in Cyprus has been added in addition to the 183-day rule. The below mentioned three criteria must all be met cumulatively for an individual to be considered a tax resident of Cyprus:

  1. Remains in Cyprus for at least 60 days in the year of assessment, and
  2. Carries out any business in Cyprus and/or is employed in Cyprus and/or holds an office to a person resident in Cyprus at any time during the year of assessment, and
  3. Maintains a permanent residence in Cyprus which is owned or rented by such individual

To be considered as a tax resident of the Republic of Cyprus, the above will apply only in the case where an individual does not remain in any other state for one or more periods, which does not exceed 183 days in total, within the same year of assessment and who is not a tax resident in any other state for the same year of assessment. As a Cyprus tax resident, you will be taxed on your worldwide income.

A final point of interest is that individuals who are Cyprus tax residents but are not domiciled in Cyprus will be exempt from Special Defence Contribution (SDC) which are taxes levied on dividends, interest, and rental income.

It’s a competitive world out there, several countries offer similar investments programs. However, Cyprus distinguishes itself through fast track options for obtaining citizenship and permanent residency. Balancing your personal and business desires is always a tough call, so why not consider your center of interest and make Cyprus your strategic hub!

The stage has been set for the next global financial crisis

Last month, the Japanese government auctioned off some US$4 billion worth of new two-year bonds at a new record low yield of negative 0.149 percent. The country’s five-year debt is currently yielding minus 0.135 percent per annum, and its 10-year bonds are trading at -0.001 percent. Strange as it may sound, the safe haven status of Japanese bonds means that there is an ample demand among private investors, especially foreign buyers, for giving away free money to the Japanese government: the bid-to-cover ratio in the latest auction was at a hefty US$19.9 billion or 4.97 times the targeted volume. The average bid-to-cover ratio in the past 12 auctions was similar at 4.75 times. Japan’s status as the world’s most indebted advanced economy is not a deterrent to the foreign investors, banking primarily on the expectation that continued strengthening of the yen against the U.S. dollar, the U.K. pound sterling and, to a lesser extent, the euro, will stay on track into the foreseeable future. See chart 1

In a way, the bet on Japanese bonds is the bet that the massive tsunami of monetary easing that hit the global economy since 2008 is not going to recede anytime soon, no matter what the central bankers say in their dovishly-hawkish or hawkishly-dovish public statements. And this expectation is not only contributing to the continued inflation of a massive asset bubble, but also widens the financial sustainability gap within the insurance and pensions sectors. The stage has been set, cleaned and lit for the next global financial crisis.

Worldwide, current stock of government debt trading at negative yields is at or above the US$9 trillion mark, with more than two-thirds of this the debt of the highly leveraged advanced economies. Just under 85 percent of all government bonds outstanding and traded worldwide are carrying yields below the global inflation rate. In simple terms, fixed income investments can only stay in the positive real returns territory if speculative bets made by investors on the direction of the global exchange rates play out.

We are in a multidimensional and fully internationalized carry trade game, folks, which means there is a very serious and tangible risk pool sitting just below the surface across world’s largest insurance companies, pensions funds and banks, the so-called “mandated” undertakings. This pool is the deep uncertainty about the quality of their investment allocations. Regulatory requirements mandate that these financial intermediaries hold a large proportion of their investments in “safe” or “high quality” instruments, a class of assets that draws heavily on higher rated sovereign debt, primarily that of the advanced economies.

The first part of the problem is that with negative or ultra-low yields, this debt delivers poor income streams on the current portfolio. Earlier this year, Stanford’s Hoover Institution research showed that “in aggregate, the 564 state and local systems in the United States covered in this study reported $1.191 trillion in unfunded pension liabilities (net pension liabilities) under GASB 67 in FY 2014. This reflects total pension liabilities of $4.798 trillion and total pension assets (or fiduciary net position) of $3.607 trillion.” This accounts for roughly 97 percent of all public pension funds in the U.S. Taking into the account the pension funds’ penchant for manipulating (in their favor) the discount rates, the unfunded public sector pensions liabilities rise to $4.738 trillion. Key culprit: the U.S. pension funds require 7.5-8 percent average annual returns on their assets to break even on their future expected liabilities. In 2013-2016 they achieved an average return of below 3 percent. This year, things are looking even worse. Last year, Milliman research showed that on average, over 2012-2016, U.S. pension funds held 27-30 percent of their assets in cash (3-4 percent) and bonds (23-27 percent), generating total median returns over the same period of around 1.31 percent per annum.

Not surprisingly, over the recent years, traditionally conservative investment portfolios of the insurance companies and pensions funds have shifted dramatically toward higher risk and more exotic (or in simple parlance, more complex) assets. BlackRock Inc recently looked at the portfolio allocations, as disclosed in regulatory filings, of more than 500 insurance companies. The analysts found that their asset books – investments that sustain insurance companies’ solvency – can be expected to suffer an 11 percent drop in values, on average, in the case of another financial crisis. In other words, half of all the large insurance companies trading in the U.S. markets are currently carrying greater risks on their balance sheets than prior to 2007. Milliman 2016 report showed that among pension funds, share of assets allocated to private equity and real estate rose from 19 percent in 2012 to 24 percent in 2016.

The reason for this is that the insurance companies, just as the pension funds, re-insurers and other longer-term “mandated” investment vehicles have spent the last eight years loading up on highly risky assets, such as illiquid private equity, hedge funds and real estate. All in the name of chasing the yield: while mainstream low-risk assets-generated income (as opposed to capital gains) returned around zero percent per annum, higher risk assets were turning up double-digit yields through 2014 and high single digits since then. At the end of 2Q 2017, U.S. insurance companies’ holdings of private equity stood at the highest levels in history, and their exposures to direct real estate assets were almost at the levels comparable to 2007. Ditto for the pension funds. And, appetite for both of these high risk asset classes is still there.

The second reason to worry about the current assets mix in insurance and pension funds portfolios relates to monetary policy cycle timing. The prospect of serious monetary tightening is looming on the horizon in the U.S., U.K., Australia, Canada and the eurozone; meanwhile, the risk of the slower rate of bonds monetization in Japan is also quite real. This means that the capital values of the low-risk assets are unlikely to post significant capital gains going forward, which spells trouble for capital buffers and trading income for the mandated intermediaries.

Thirdly, the Central Banks continue to hold large volumes of top-rated debt. As of Aug. 1, 2017, the Fed, Bank of Japan and the ECB held combined US$13.8 trillion worth of assets, with both Bank of Japan (US$4.55 trillion) and the ECB (US$5.1 trillion) now exceeding the Fed holdings (US$4.3 trillion) for the third month in a row.

Debt maturity profiles are exacerbating the risks of contagion from the monetary policy tightening to insurance and pension funds balance sheets. In the case of the U.S., based on data from Pimco, the maturity cliff for the Federal Reserve holdings of the Treasury bonds, Agency debt and TIPS, as well as MBS is falling on 1Q 2018 – 3Q 2020. Per Bloomberg data, the maturity cliff for the U.S. insurers and pensions funds debt assets is closer to 2020-2022. If the Fed simply stops replacing maturing debt – the most likely scenario for unwinding its QE legacy – there will be little market support for prices of assets that dominate capital base of large financial institutions. Prices will fall, values of assets will decline, marking these to markets will trigger the need for new capital. The picture is similar in the U.K. and Canada, but the risks are even more pronounced in the euro area, where the QE started later (2Q 2015 as opposed to the U.S. 1Q 2013) and, as of today, involves more significant interventions in the sovereign bonds markets than at the peak of the Fed interventions.

How distorted the EU markets for sovereign debt have become? At the end of August, Cyprus – a country that suffered a structural banking crisis, requiring bail-in of depositors and complete restructuring of the banking sector in March 2013 – has joined the club of euro area sovereigns with negative yields on two-year government debt. All in, 18 EU member states have negative yields on their two-year paper. All, save Greece, have negative real yields.

The problem is monetary in nature. Just as the entire set of quantitative easing (QE) policies aimed to do, the long period of extremely low interest rates and aggressive asset purchasing programs have created an indirect tax on savers, including the net savings institutions, such as pensions funds and insurers. However, contrary to the QE architects’ other objectives, the policies failed to drive up general inflation, pushing costs (and values) of only financial assets and real estate. This delayed and extended the QE beyond anyone’s expectations and drove unprecedented bubbles in financial capital. Even after the immediate crisis rescinded, growth returned, unemployment fell and the household debt dramatically ticked up, the world’s largest Central Banks continue buying some US$200 billion worth of sovereign and corporate debt per month.

Much of this debt buying produced no meaningfully productive investment in infrastructure or public services, having gone primarily to cover systemic inefficiencies already evident in the state programs. The result, in addition to unprecedented bubbles in property and financial markets, is low productivity growth and anemic private investment. (See chart 2.) As recently warned by the Bank for International Settlements, the global debt pile has reached 325 percent of the world’s GDP, just as the labor and total factor productivity growth measures collapsed.

The only two ways in which these financial and monetary excesses can be unwound involves pain. The first path – currently favored by the status quo policy elites – is through another transfer of funds from the general population to the financial institutions that are holding the assets caught in the QE net. These transfers will likely start with tax increases, but will inevitably morph into another financial crisis and internal devaluation (inflation and currencies devaluations, coupled with a deep recession).

The alternative is also painful, but offers at least a ray of hope in the end: put a stop to debt accumulation through fiscal and tax reforms, reducing both government spending across the board (and, yes, in the U.S. case this involves cutting back on the coercive institutions and military, among other things) and flattening out personal income tax rates (to achieve tax savings in middle and upper-middle class cohorts, and to increase effective tax rates – via closure of loopholes – for highest earners). As a part of spending reforms, public investment and state pensions provisions should be shifted to private sector providers, while existent public sector pension funds should be forced to raise their members contributions to solvency-consistent levels.

Beyond this, we need serious rethink of the monetary policy institutions going forward. Historically, taxpayers and middle class and professionals have paid for both, the bailouts of the insolvent financial institutions and for the creation of conditions that lead to this insolvency. In other words, the real economy has consistently been charged with paying for utopian, unrealistic and state-subsidizing pricing of risks by the Central Banks. In the future, this pattern of the rounds upon rounds of financial repression policies must be broken.

Whether we like it or not, since the beginning of the Clinton economic bubble in the mid-1990s, the West has lived in a series of carry trade games that transferred real economic resources from the economy to the state. Today, we are broke. If we do not change our course, the next financial crisis will take out our insurers and pensions providers, and with them, the last remaining lifeline to future financial security.

The only closed economy is the world economy

The U.S. economy grew substantially in the 1980s and ‘90s. Not surprisingly, employment on Wall Street surged in concert with this broad economic boom.

As a Presbyterian minister explained it in 1901, “Wall Street is one of the longest streets in the world. It does not begin at the foot of Trinity Church … and end at the East River, as many suppose. It reaches through all of our American cities and across the sea.” All businesses are formed on the proverbial Main Streets of the world; to grow they require intrepid investment, so Wall Street only succeeds insofar as it brings investors and promising businesses together. Wall and Main are joined at the hip as it were.

Which brings us to a story that Clark Judge, a speechwriter and Special Assistant to President Ronald Reagan, once relayed to me. Sitting in Reagan’s Situation Room, Judge listened intently as Secretary of State George Shultz discussed with Reagan the globalized nature of automobile manufacture. While certain cars were “Made in America,” Shultz detailed the myriad foreign-made inputs without which American-made cars wouldn’t operate.

Shultz’s broad point from decades ago brings to mind a crucial admonition from Nobel Laureate economist Robert Mundell: the only closed economy is the world economy. Much as Wall Street’s wealth is a function of the U.S. and the rest of the world’s prosperity, so is the U.S. most prosperous when the rest of the world is thriving. As the division of labor expands to “hands” around the world, so does the ability of individual workers to specialize their work efforts on the way to exponentially greater productivity. Similar to Wall and Main streets, the U.S. and the world are joined at the hip.

The globalized nature of prosperity can’t be minimized, and arguably requires discussion more than ever. While the Trump administration has expressed laudable goals about reducing the tax and regulatory burden placed on American workers and companies, it has at the same time revealed a nationalist economic agenda on the trade and currency front that, if actualized in terms of policy, would suffocate any of the good that would spring from tax cuts and deregulation.

Recently Steven Mnuchin, Trump’s Treasury Secretary, observed that “as it relates to trade, having a weaker dollar is somewhat better for us.” Mnuchin’s comments were worrisome. They were a reminder that Mnuchin, along with the president he serves, is perhaps unfamiliar with Mundell’s essential truth about the closed nature of the global economy.

Worse, currency traders pay close attention to the musings of Treasury heads simply because they’re the mouthpiece for any administration’s policies with regard to the dollar. Specifically, when they express a preference for a weak dollar, markets usually comply. That they do speaks to the importance of Mnuchin being coached more closely about his currency rhetoric. A weaker dollar will benefit no one, while inflicting great harm on the U.S. and global economy.

Seemingly missed by Mnuchin is what Shultz and Reagan knew instinctively: the U.S. economy is part of a global whole. While there are American-made goods, nothing is solely a product of American inputs. Whether it’s Apple iPhones being manufactured in China, Nike shoes being produced in Vietnam, or the Boeing 787 Dreamliner being manufactured in six countries around the world, the most prominent companies in the U.S. are happily reliant on the world’s labor and inputs.

In that case, a shrunken dollar would raise the cost of the goods and labor necessary to create American products and services such that there would be no trade gains to speak of if the U.S. devalues the dollar. Contrary to popular belief, devaluation renders producers within the devaluing country even less competitive for it raising the cost of imported inputs, labor and transport of products and services.

Also, support for devaluation ignores the dominant role of investment when it comes to enhancing company competitiveness. Stated simply, investment in productivity advances is always and everywhere the path to competitive prices. At the same time devaluation is a certain barrier to investment for it shrinking the income streams that investors are buying when they put money to work.

But the greatest truth missed by Mnuchin is that per Adam Smith, “the sole use of money is to circulate consumable goods.” Money is not wealth as much as it facilitates the exchange of wealth. Along these lines, production is an expression of a desire to import, whether from across the street or from the other side of the world.

Considering the above through the prism of Mnuchin’s expressed comfort with a devalued dollar, such a result would instantly injure American workers eager to receive goods and services in return for their work, thus weakening the economy. We must never forget that American workers are the U.S. economy, and American workers earn dollars.

Adding insult to what is plainly injurious, trade among individuals and without regard to country borders is what enables the specialization without which economies can’t grow. Free trade isn’t just great because it ensures global competition for our dollars, pounds, euros and yen. What makes free trade truly spectacular is that it maximizes the odds that we’ll get to do the work that’s most commensurate with our skills.

Simply put, when we’re free to exchange our production for the production of others, and without regard to country or continent, we have the greatest chance to do the work most likely to elevate our unique talents. With trade it’s products for products, and the act of trading is an expression of our desire to exchange the product of what we do best with others doing what they do best. Translated, American workers gain the most when the world’s workers are similarly prospering.

Crucially, money is once again what facilitates the exchange without which workers can’t prosper. Applied to Mnuchin’s faulty view that there’s something to be gained from currency devaluation, nothing could be further from the truth. Money is once again a measure that facilitates exchange and investment, so when the value of money is uncertain, so is wealth-boosting trade and investment rendered much less likely. That’s why there are no winners when the integrity of money is compromised. Trade is the sole purpose of work, and devaluation makes it less likely.

That the desire to get informs our work efforts is something Treasury secretary Mnuchin will hopefully keep more in mind going forward. Not only does devaluation raise the cost of production, sap our competitiveness, and render us poorer, its cruelest byproduct is that it makes global trade less likely for it creating uncertainty about what we’ll get to import in return for our exports.

Let’s never forget that the act of importing is the wondrous reward for all of our hard work, and it’s also what regularly enhances the product of our work as divisions of labor always do. Currency devaluation is a horrid barrier to importing and the globalization of labor that lifts all boats. As such, when monetary eminences like Mnuchin talk up the benefits of devaluation, they’re actually promoting stagnation.

Category Five

Still reeling from the passage of the “Spanish Ladies” in September, the catastrophic hurricanes Irma and Maria, the Island nations of the Caribbean are, with external assistance, piecing their lives and livelihoods back together. Sadly, there were human losses, and there will be ongoing economic implications for many persons living and working in the region.

Many displaced financial services workers, and evacuees, have been given a place of shelter here in the Cayman Islands, and as a consequence, businesses were able to regroup, rehouse, and recalibrate relatively quickly, once the initial impact was assessed. Customer service was slowed, but not stopped.

As a consequence of the devastation brought on by these category five storms, legal and regulatory minds have since refocussed on force majeure clauses, scope and exclusion terms of insurance policies, disaster preparedness and business continuity plans, all of which to the untrained eye, may seem like separate and unrelated strands. From a regulatory perspective, all of these strands lead into one spool – the risk profile of a business.

Financial services business licensed in the Cayman Islands should be assessing (or reassessing) their own risks and exposures, not least to determine whether their contingency plans are robust. This exercise is separate from the assessment of risks posed by dealing with clients or customers who are located worldwide.

While some leniency is a must in such exceptional circumstances, one fully expects regulators up and down the Caribbean region to express renewed interest in the risk assessment strategies, outsourcing arrangements, business continuity and redundancy plans, and record retention arrangements, of their licencees. Those arrangements now need to be iron clad to withstand what a hurricane can achieve in very little time.

The risks posed by hurricanes are known risks, and their impact on financial services infrastructure laid bare during this season. Geo-political location of front and back offices is also a known risk. Wishing that we are spared the wrath of nature’s fury, or lamenting that your business or sector was a victim of a slower-than-usual governmental or international response, are neither recommended risk mitigation strategies nor sound corporate governance plans.

Regulators are likely to be sympathetic in times of disasters, but one expects that they may be increasingly less likely to accept repeated failures to prepare adequately, as a valid excuse for regulatory non-compliance.

Lest we forget, in the Cayman Islands, the Cayman Islands Monetary Authority is tasked, among other things, with ensuring that licensed financial services business have viable business models, are prudently managed and establish and maintain effective controls for risk mitigation. For licensee, this can no longer be a “tick-the-box” exercise just to get through the initial licencing process or to pass a periodic onsite inspection or offsite supervisory review exercise. Risk assessment should be ongoing and policies responsive.

A risk-based approach to compliance needs to be ingrained both culturally and operationally into our financial services and other organisations, and that tone has to be set by the senior management teams. Clearly, resilience levels suitable only for a tropical storm will no longer suffice in the face of severe meteorological phenomenon.

Assessments should be thorough, kept current and based on the nature and complexity of the financial services and products provided including the relevance of distribution channels. We must at the very least, stop underestimating or disregarding the real risks posed by nature, and do more than check a box. As a region, it is imperative that we consider our interconnectivity and do all we can to reduce the potential implications that damage the confidence and trust in our markets, or our financial stability as offshore financial centers.

A game changer for pension relief


For companies with large work forces, the growing burdens of retirement pensions pose even greater existential threats than economic volatility. Reorganization in insolvency proceedings has allowed many notable companies to slough off or minimize this burden, but this procedure is massively disruptive and likely cost-prohibitive if pensions are the only concern. A new, revolutionary solution now allows some U.S. pensions to deal directly with their underfunding challenges without dragging their sponsor-companies into bankruptcy.

For years, Congress had been hearing dire warnings from the Pension Benefit Guarantee Corporation (PBGC), the agency that guarantees a portion of the benefit obligations of failed pension funds. After absorbing the burden of several large pensions abandoned by their sponsors in bankruptcy, the PBGC itself is in very serious financial distress, with a nearly $100 billion projected shortfall. Of particular concern, the majority of this shortfall is attributable to “multiemployer” plans, which pool liabilities and contributions from scores of companies. Concern rose that the failure of one more of these large multiemployer plans could ruin the PBGC and spell disaster for the partial guarantee system for pension beneficiaries.

Consequently, after intensive negotiations with a broad array of interest groups representing both management and labor, among others, Congress in late 2014 passed the Multiemployer Pension Reform Act (MPRA). The MPRA offers a new compromise solution for large pension funds in imminent danger of insolvency. Anticipating collapse in the face of mounting obligations to their sponsor-companies’ beneficiaries, a multiemployer pension fund’s trustees now have the option not only of demanding greater contributions from sponsor-companies (which is often not sustainable), but of reducing projected benefits to employee-participants.

This extraordinary abdication of contractual responsibility is available only to pension funds in “critical and declining status,” meaning that actuaries have determined that the fund is destined to become insolvent within 15 years. All other reasonable steps must have been taken to stave off insolvency, and benefits may not be reduced below the amount guaranteed by the PBGC, but this figure generally lies far below the promised benefits in common multiemployer plans.

The Department of the Treasury is charged with evaluating applications for benefit reductions under MPRA, in consultation with the PBGC and the Department of Labor, and it may approve an application only if the proposed benefit reduction is projected to allow the pension plan to avoid insolvency. If Treasury approves a proposed reduction as complying with MPRA’s requirements, the proposal is put to a vote of the plan participants. The voting is conducted by the Treasury Department, and a proposal is finally approved unless a majority of the plan participants votes to reject it – effectively, a presumption in favor of approval.

Navigating between the Scylla of Treasury Department application scrutiny and the Charybdis of plan participant-voting seems quite treacherous, and early results were discouraging. The first application for benefit reductions was submitted in September 2015 by a plan with over 400,000 participants and $35 billion in projected liabilities, 47 percent of which were unfunded, with a projection of insolvency within 10 years. The Obama administration rejected this application, purportedly because it concluded that the proposal would not return the fund to solvency. It similarly rejected four other applications during the course of 2016.

The picture began to improve with the first approved application in December 2016. The small applicant pension plan had only about $250 million in liabilities and was nearly 70 percent underfunded, but perhaps anticipating the imminent transition to a conservative administration under President-elect Donald Trump, the Treasury Department approved cuts averaging 20 percent (up to 60 percent for inactive, already retired participants, who represented the bulk of the plan’s obligations).

One might expect that participants would reject such aggressive benefit-reduction proposals, but plan participants approved the cuts by a margin of nearly 2 to 1. Both active and retired participants had been convinced that the frying pan of benefit reductions was better than the fire of plan insolvency and collapse.

The pace of reform picked up in the new Trump administration. No applications have been denied in the first nine months of the new regime, and two more have been approved. In July 2017, another small fund’s proposal was approved by Treasury, and its participants failed to reject the cuts. “Approved” would be too strong a word here, as the vote was 1,041 in favor and 1,928 against, so a powerful majority of those voting rejected the proposal. But the rule requires rejection by a majority of those eligible to vote, and only about 3,000 of the plan’s more than 9,000 participants cast a ballot. The proposed benefit reductions are thus effective as of September 2017, though the plan trustees must make an annual determination, supported by a written record, that the benefit reductions remain necessary to avoid plan insolvency despite all other reasonable measures being taken.

The second Trump-era approval is particularly noteworthy. The New York Teamsters Conference pension fund coordinates benefits for nearly 35,000 beneficiaries of nearly 200 company employers, including bellwether United Parcel Service (UPS). With more than $1.2 billion in assets, the fund is still 65 percent underfunded, with insolvency projected in fewer than 10 years. In mid-May 2017, the plan trustees proposed 20 percent cuts for about 9,000 active participants, and nearly 30 percent reductions for the remaining, retired and non-active participants. Treasury processed this application with blistering speed and approved it less than three months later, on Aug. 3. Consistent with a developing trend, actual participant ballots cast strongly opposed the measure by more than 2:1, but two-thirds of voters neglected to return a ballot, so the Teamsters plan revision is effective Oct. 1, 2017.

If the Trump administration continues this rapid pace of benefit reduction approval, the MPRA has the potential to usher in massive pension reforms without direct court oversight or general business reorganization. This could be a serious game changer for one of the most significant financial burdens facing large companies and their pension plans today.

The new Italian non-domiciled tax regime

Budget Law 2017 (in force from Jan. 1, 2017), has introduced a special forfait tax regime for individuals who transfer their tax residence to Italy. In a nutshell, the regime provides for the payment of a substitute tax of 100,000 euro per year in lieu of ordinary taxation on (almost) all foreign source income and assets.

Main features

In order to be eligible for the regime, an individual must move his tax residence to Italy without having been resident therein for the previous nine out of 10 years. There is no limitation based on citizenship so that the regime is available also for Italian citizens. For income tax purposes, an individual is considered resident in Italy if at least one of the following conditions is fulfilled for most part of the year: (i) registration with the Italian Official Register of the resident population; or (ii) habitual abode in Italy (i.e. residence according to the Italian civil code); or (iii) center of one’s main business and interests in Italy (i.e. domicile according to the civil code).

The regime is available for a maximum of 15 years. During the period of validity, no income tax, wealth tax and inheritance tax would be due on foreign assets and income (Italian source income remains subject to ordinary taxation). Differently from the (very similar) U.K. resident but not domiciled regime, income tax remains not due even if the income is remitted to Italy, so there is no limitation on bringing one’s income to Italy as long as it is foreign sourced, according to Italia law. Moreover, reporting obligations do not apply on such foreign assets and income, so that the regime can be considered appealing also from a privacy perspective .

There are two exceptions to the general rule whereby the forfait tax covers all obligations. The first is that capital gains on substantial shareholdings realized in the first five years of effect of the option are excluded from the scope of the substitute tax and are subject to income tax under general rules. The rationale behind this is to avoid so called “tax holidays” whereby the transfer of residence is exclusively finalized (and limited) to the realization of latent capital gains. In other words, one must reside in Italy at least six years under this optional regime in order to avoid ordinary taxation on such capital gains.

The second exception is optional. The individual can opt for all income and gains sourced in one or more states to be subject to income tax under ordinary rules. The rationale behind this exclusion is to permit the application of certain double taxation conventions which would otherwise not be applicable due to the forfeit regime (see below).

The regime can be extended also to one or more qualifying family members, provided that they also fulfill the nine out of 10 years non-residence condition, against the payment of a further annual tax of 25,000 euro (rather than 100,000 Euro) per each family member benefiting from the regime. If the individual subject to the 100,000 euro substitute tax revokes the option, the substitute tax regime automatically ceases to apply also to the qualifying family members. However, in such cases, the qualifying family member is entitled to exercise an autonomous option by paying the 100,000 euro tax with effects for the remaining tax years up to a total of 15 years. On the other hand, the extension of the substitute tax regime to qualifying family members can be revoked without affecting the application of the substitute tax regime to the main applicant.

The regime, which is in force as of January 2017, is proving very appealing for individuals whose income is exclusively or mostly sourced outside of Italy, and already quite a large number of applicants have come forward.

Treaty application

The issue raises the question of whether double taxation conventions on income and capital based on the OECD Model concluded by Italy will be applicable to individuals who will be resident in Italy under the flat tax regime. The issue is relevant mainly in two cases: (i) claim of residence by both contracting states (double residence) ; and (ii) application of the so-called allocation rules by the source state.

Article 1 of double taxation conventions provides that the Convention applies to persons who are resident of one or both of the contracting states. According to Article 4, paragraph 1, the term resident “means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence” or similar criterion and that “the term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein.” Prima facie, based on the wording of this provision, one would conclude that the treaty is not applicable to Italian residents under the flat regime, since one could argue that the flat tax is not an analytical tax on foreign items of income so that the condition of Article 4 of being liable to tax is not met. The issue is not completely new to international tax practitioners, since other countries have either territorial taxation (Hong Kong) or alternative tax regimes for foreign income (U.K., Switzerland, Portugal). The scope of this article does not allow an in-depth analysis of this technical issue, but the main arguments and conclusions can nonetheless be summarized.

There are a number of elements that would lead to conclude that the treaty remains applicable. First, there are indications within the OECD Commentary to the Model that suggest that the intention of that provision is not to exclude the application of the treaty to individuals who are resident under forfait regimes. Paragraph 8.3 of the commentary, indeed, expressly states that that sentence is “clearly not intended” to exclude from the scope of the Convention residents of countries adopting a territorial principle of taxation. A territorial system of taxation occurs when one country taxes its own resident only on income sourced therein with the exclusion of foreign income. As a consequence, one should conclude that DTCs are a fortiori applicable if, as in the case of Italy, foreign income is subject to a substitute form of taxation, albeit flat. Another indication is given by paragraph 26.1 of the Commentary to Article 1 which – under the section on remittance based taxation (e.g., U.K. system) – affirms that contracting states wishing to restrict the application of the Convention to income that is effectively taxed in the hands of those persons may do so, adding a specific provision to the Convention, thus suggesting that treaties not departing from the OECD Model do remain applicable also to persons who are resident under these specific type of regimes.

Moving to treaty practice, the conclusions do not seem to differ. Many countries that have wished to expressly specify that the treaty was not applicable to persons who were resident under forfait regimes have specified so in an ad hoc provision, thus suggesting that the standard wording of the Model did not suffice to this purpose. Similarly, other treaties – without departing from the wording of the Model – contain interpretative clarifications in their Protocols to clarify that the last sentence of Art. 4, paragraph 1, “does not preclude a person from being treated as a resident of a contracting party by reason of a territorial source principle.” Others (especially with the U.K.) contain (in line with para. 26.1 of the Commentary to Art. 1 discussed above) clauses specifying that treaty relief is granted only to so much of the income taxed/remitted in the other state. There are nonetheless some treaties concluded by countries that have a similar system (Switzerland and Portugal) that may cast some doubts on the interpretation of that provision, namely those that (though subsequent to 1977) do not contain the second sentence of Art. 4, paragraph 1, thus suggesting the argument that treaty application would have otherwise been precluded (although one can argue that the sentence was deleted only for the avoidance of doubts).

Finally, the Italian tax authorities have expressly taken the view that Italy will regard persons who are resident under this regime as resident for treaty purposes due to the fact that foreign income is taxed with the 100,000 euro. Though important, treaty application is a bilateral exercise and much is left to the other countries, especially the source country who must apply relief clauses (exclusive taxation in the country of residence or reduced withholding taxes). And it is within this very context that the above-mentioned provision of the new regime, whereby one person may elect to subject to ordinary taxation items of income sourced in one or more specific countries (see above), could prove useful for those countries that will take the view that the second sentence of Art. 4, paragraph 1 restricts treaty application.

The Multilateral Instrument: Can the OECD improve international tax treaties?

Since the inception of the Base Erosion and Profit Shifting (BEPS) initiative, the Organisation for Economic Co-operation and Development has sought a means of implementing and enforcing their recommendations in member states. The OECD lacks treaties that stipulate a common set of rules or a method of resolving disputes between members. Without these treaties, the OECD must rely on legislators in each country to translate the BEPS recommendations into law. However, this practice gives legislators considerable liberty over how or if the recommendations are written into laws.

In general, each country legislating its own version of the rules is not a problem, but when countries have different definitions for similar concepts, the recommendations can be applied inconsistently across countries. These inconsistencies create situations where the same income is taxed by two countries. In addition, the inconsistencies create opportunities to avoid taxes by designing a business’s legal structures around these differences. In both cases, the asymmetric taxes can damage economic growth as well as reduce tax revenues.

Moreover, when inconsistencies are identified, tax authorities and taxpayers alike have little recourse other than bilateral bargaining. Taxpayers are particularly vulnerable when two countries attempt to tax the same income. Without a formal set of rules to resolve disputes, taxpayers must appeal to each country for relief. Even if both countries agree to accept the taxpayer’s appeal, the bilateral bargaining to determine which country has the right to claim the income may drag on indefinitely.

To address these issues, the BEPS project included the Multilateral Instrument (MLI) as Action 15 of the discussion items. The MLI lays out a set of multilateral treaties that set default legal definitions, limit acceptable remedies, and create a process for adjudicating disputes between signatory countries over tax issues. These treaties effectively streamline the process of developing and amending bilateral tax treaties as well as implementing a process for ironing out details as problems arise.

Recommendations for the MLI were initially reported in September 2014 and refined in the October 2015 final report. In November 2016 an ad hoc group concluded negotiations and produced a model treaty for the MLI. As of December 31, 2016, a convention was open to all countries and jurisdictions, and support for the treaty gained momentum in the spring of 2017. This culminated in 68 countries agreeing to the MLI in a signing ceremony on June 7, 2017.

The MLI treaty contains 39 articles addressing issues common in tax treaties as well as specifying the rules of the treaty convention. The articles are split into seven major sections: hybrid mismatches, treaty abuse, avoidance of permanent establishment, improved dispute resolution, arbitration and two administrative sections. These sections represent common disputes between countries over tax policy.

Articles 3 and 4 introduce rules for hybrid mismatches. Hybrid mismatches are situations where one country classifies taxable income as occurring from one source, e.g., income from a corporation, while another country considers the same income as from another source, e.g., income from a partnership. In these cases, the income may never be taxed, because each country is expecting the other country to tax the income, due to different definitions of income. The MLI sets rules to resolve this problem by requiring tax authorities to agree upon the definition of the income. Moreover, if there is no consensus, then the taxpayer is required to pay the taxes on the same income in both countries.

Article 5 establishes acceptable methods for eliminating double taxation, particularly with respect to foreign source income. Income tax paid in one country can be deducted from the tax base, exempted from income, or be claimed as a tax credit in another country.

Articles 6 and 7 set grounds for denying a treaty’s benefits to an individual or business. The MLI treaty includes model language for adding a purpose to a tax treaty. If the purpose of the tax treaty is not met by the action of an individual or business, then the tax authority of a country can deny the individual or business the benefits of the treaty. It also defines a process for adjudicating the denial of treaty benefits.

Articles 8 and 9 put limits on passing dividends and ownership of assets between related entities to avoid treaty abuse. Article 8 sets a minimal time between receiving and paying dividends between related parties. Article 9 defines when capital gains can be assessed on the sale of assets, particularly when assets are held for a short period or on transactions involving real estate.

Articles 10 to15 set additional requirements for permanent establishment. In order to tax business income, a tax authority must prove that the business has a substantial economic presence in the country, which is known as permanent establishment. Article 10 strengthens the test for permanent establishment by assigning permanent establishment to any “habitual” activity conducted by a business in a country. Article 14 requires split contracts to be summed over the entire year as part of the permanent establishment test. Article 15 establishes that agents who do not garner at least 50 percent of the profit from a transaction are not considered independent. Moreover, the articles restrict treaties from exempting or redefining permanent establishment.

Articles 10-15 also restrict permanent establishment when a third-party country is involved. Assume a business is a resident of country A, has a permanent establishment in country B, and has sales from country B to country C in which the business does not have permanent establishment. Country C can claim the income from sales if the taxes paid on the income in country B is less than 60 percent of the taxes it would have paid if the income was attributed to country A. This provision is intended to reduce income shifting from high-tax countries to low-tax countries.

To enforce these rules, articles 16 to 26 establish procedures for resolving conflict that may arise, particularly when third parties are involved. An individual or business has three years to dispute a tax claim. The tax dispute can be logged in either of the countries under a tax treaty or in the country in which the individual or business is a resident.

The countries have two years to resolve the dispute among themselves. If the dispute is not resolved, then the two tax authorities are required to undergo arbitration. Arbitration consists of a council of three tax experts: one from each country and a chair from an unrelated country. The council’s decision is final and binding.

Articles 27 to 39 define how the treaty is administered and conditions for entering and exiting the convention. Article 28 stipulates that signatory countries have the right to reject portions of the MLI but enumerates the articles that cannot be rejected. None of the articles related to binding arbitration are included in the list of mandatory articles. The MLI also included the option to withdraw from the convention in Article 37.

The MLI tackles many of the common problems in developing and amending tax treaties, but the benefits of the MLI are only realized when the rules are consistently applied across many countries. The MLI provides a framework for signatory countries to develop bilateral tax treaties with each other. The framework facilitates the bargaining process by starting with a common set of rules, which reduces confusion and saves time. However, if countries apply the framework differently, negotiators are likely to spend just as much time reconciling the frameworks as they would have spent bargaining without a framework.

Unfortunately, most signatory countries have chosen to reject at least one article within the MLI. In some cases, several articles from each section were rejected. For example, India rejected seven of the 39 articles. This has created a patchwork of default rules, which is likely to negate the intended benefits of the MLI.

The parts of the MLI involving dispute resolution are particularly vulnerable to a lack of consensus. The mandatory binding arbitration is one of the most controversial articles in the MLI. Of the 68 countries that signed the MLI treaty, only 26 countries opted into the article involving binding arbitration. As such, one of the key provisions of the MLI may not have the critical mass needed to ensure arbitration decisions will be enforced.

Only two OECD countries chose to abstain from the MLI: Estonia and the United States. The United States participated in the BEPS report and was part of the negotiations of the MLI treaty. However, the U.S. Treasury has already implemented many of the anti-treaty-shopping and base erosion rules present in the MLI. Henry Louie, deputy international tax counsel at the U.S. Department of Treasury, stated that the “multilateral instrument is consistent with U.S. tax treaty policy that the Treasury Department has followed for decades.” Louie’s position was supported by Pascal Saint-Amans, director of the Centre for Tax Policy and Administration at the OECD, who argued that U.S. tax treaties currently have sufficient measures to guard against base erosion and profit shifting.

In addition, the United States already has dispute resolutions agreements with other countries. Eight of the 26 countries that signed the binding arbitration portion of the MLI are part of a similar treaty with the United States. “That is a pretty big chunk of the willing countries,” Louie argued. “Even with respect to arbitration, the Treasury Department concluded that the potential benefits to the U.S. would be incremental.”

Louie also realized the political realities on the ground. The U.S. Treasury requires approval from the U.S. Senate to sign treaties like the MLI. The process would have generated additional debate and bargaining in which senators would have necessitated some assurances that the MLI would not change existing treaties.

Unlike the United States, Estonia has promised to review and sign the MLI in the future. Its caution may ultimately pay off, particularly if there are problems with integrating the MLI into existing treaties. The wait-and-see tactic is advantageous because it shifts the cost of hammering out the details onto the signatory countries. This may have been the original intention of the United States as well. The U.S. Treasury has not ruled out reopening MLI negotiation in the future.

With so many countries deciding to opt out over many of the MLI’s articles, it is uncertain whether the MLI can deliver the promised benefits of a streamlined tax treaty process. In fact, the patchwork of agreed-upon articles is likely to frustrate the process of negotiating future treaties. There also remains the question of how the MLI will affect existing tax treaties and to what extent it will affect non-signatory countries. Overall, it remains to be seen whether the OECD’s efforts will have the intended impact on the international tax system.

OECD Watch

The Organisation for Economic Co-operation and Development (OECD) has gradually carved for itself a central role in global tax matters over the last two decades. Today, its many initiatives impact global economic activity in a variety of ways. OECD Watch summarizes and analyzes the organization’s recent activities relating to international finance and tax matters.

The assimilation continues

The OECD celebrated Bahrain’s signing of the Multilateral Convention on Mutual Administrative Assistance in Tax Matters as the 112th jurisdiction to join. Barbados and Montserrat joined the Inclusive Framework on BEPS as the 101st and 102nd jurisdictions. Mauritius, Cameroon, and Nigeria signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, bringing it to 71 jurisdictions, while Nigeria also became the 94th jurisdiction to join the CRS Multilateral Competent Authority Agreement.

Judge and jury

Fifteen jurisdictions previously given less than satisfactory ratings on peer reviews for the exchange of information upon request standard (EIOR) were subjected to a fast-track review process in the run-up to the G20 Leaders Summit in Hamburg, where the OECD was to prepare a list of “non-cooperative jurisdictions.”

Of those reviewed, Andorra, Antigua and Barbuda, Costa Rica, Dominica, the Dominican Republic, Guatemala, the Federated States of Micronesia, Lebanon, Nauru, Panama, Samoa, the United Arab Emirates, and Vanuatu were given provisional ratings of Largely Compliant with the EIOR standard, while the Marshall Islands were rated Partially Compliant, and Trinidad and Tobago was not upgraded from its previous rating of Non-Compliant.

The OECD previously established that in order to avoid being placed on the list of naughty (non-compliant) jurisdictions, two of the following three criteria need to be met: 1) At least a “Largely Compliant” rating by the EOIR standard, 2) A commitment to implement the automatic exchange standard, and 3) participation in the Multilateral Convention on Mutual Administrative Assistance on Tax Matters or a sufficiently broad exchange network permitting both EOIR and AEOI (a U.S-only carveout thanks to FATCA).

Following the fast-track reviews, only Trinidad and Tobago was identified as non-compliant, though the OECD promised that “discussions are continuing” and that “progress is anticipated soon.”

Not long after, the first 10 outcomes from a “new and enhanced” peer review process for the EIOR standard, combining the prior Phase 1 and Phase 2 elements while adding in the ability of tax authorities to access beneficial ownership information, were released. Ireland, Mauritius, and Norway received ratings of Compliant. Australia, Bermuda, Canada, Cayman Islands, Germany, and Qatar were rated Largely Compliant. Jamaica was rated as Partially Compliant, which will require a supplementary report on follow-up measures.

Economic surveys

Economic surveys were released for New Zealand, Belgium, Slovak Republic, Iceland, Luxembourg, Austria, Argentina, and South Africa. For New Zealand, the OECD recommended reducing barriers to foreign investment and lowering the corporate tax rate to increase productivity. It also called for Belgium to reduce the statutory corporate rate, but then undermined that good advice by suggesting, under the guise of promoting “inclusive growth,” the introduction of a federal capital gains tax. Argentina should undertake revenue-neutral tax reform, according to the OECD, with a focus on lowering the threshold where taxpayers start paying personal income taxes, broadening the VAT base, and adding progressivity to social security contributions. The other nations were not given particularly noteworthy tax and fiscal advice.

In addition, in the fourth annual edition of Revenue Statistics in Asian Countries, the OECD lamented that “some countries have experienced a decline in tax revenues in recent years,” and suggested that “further efforts are needed to increase tax revenues.”

“Bridging Divides” with big government

Continuing its full-throated embrace of the ideology of big government, the OECD made “Bridging Divides” its central theme of the 2017 OECD Forum and ministerial meeting in June. Further fleshing out the organization’s focus on what it terms “inclusive growth,” the event demonstrated just how far the OECD has drifted from its initial focus on facilitating trade and economic cooperation.

In the lead-up to the meeting, OECD Secretary-General Angel Gurría wrote, “We’re beyond quick fixes to address the discontent of citizens. … The only way forward is not to patch up globalisation, but to shake it up.” What he wants to “shake up” is not the growth of the parasitic class in the form of ever bigger governments – which is the actual source of most economic problems facing the world – but the system of free markets and limited governments that emerged over previous centuries and lifted billions out of poverty in a surge a growth never before witnessed in human history.

His end game is made clear when he speaks of “rising inequalities of income” and “limited progressivity of our tax systems” as part of the “core concerns” in need of addressing, as the obvious implied solutions are higher taxes and more government redistribution, both of which will reduce global economic growth. There are of course political and economic challenges which nations may wish to address, such as workers’ displacement from rapid technological advancement. However, options to mitigate such growing pains are much more modest than a “shake up” of globalization and the free enterprise system.

A pair of statements summed up the work of the ministerial meeting. A Statement of the Chair, held by Denmark, addressed “International Trade, Investment and Climate Change.” On the plus side, it affirmed “the importance of international investment and free flow of capital,” and “the need to … push for the removal of support by government and related entities that distort markets.” Less impressive was its cheerleading for the Paris agreement, which has estimated costs of at least 1 percent of global GDP for very little environmental gain.

The Ministerial Council Statement, titled “Making Globalisation Work: Better Lives For All,” was also a mixed bag. It began with nods to the indisputable facts that “we have seen hundreds of millions lifted out of poverty” thanks to globalization, and that “increased productivity and continued economic growth provide the best opportunity to raise prosperity and well-being for our citizens.” But then it delves into the OECD’s misguided obsession with inequality, flogging its work on “Inclusive Growth,” conflating tax avoidance with evasion once again, and praising BEPS and the automatic exchange of information standard.

Inclusive growth is the new rallying cry

The meeting also saw the release of Update Report 2017 – Inclusive Growth, featuring several troubling observations and recommendations. It calls redistribution “vital for reducing market income inequality.” In a swipe at tax competition, it laments the mobility of capital and the inability of politicians to impose onerous tax burdens without consequence.

Particularly bad news for the global economy is the section on raising taxes on capital with an aim to “increase the overall progressivity of the tax system,” as well as calls for “strengthening international cooperation on the taxation of mobile tax bases” – a euphemism for the OECD’s efforts at forming a global tax cartel.

A Policy Brief titled Time to Act: Making Inclusive Growth Happen further outlines how inclusive growth will be used to advance a big government agenda. It calls “to re-write the rules of the economic system to make them work for everyone,” with specific recommendations to “enhance the progressivity of residential property taxation” and “strengthen inheritance and gift taxes.” It also self-servingly calls to “bolster global governance of tax policy” and thus further undermine fiscal sovereignty.

Unfortunately, things are likely to get worse going forward. The Ministerial Council Statement requests the OECD work on the development of a “Framework for Policy Action on Inclusive Growth” for the 2018 Ministerial Council Meeting, which means the OECD will continue pushing forward with its new, politicized agenda.

Compulsory public country-by-country reporting and CCCTB – harbingers of total tax harmonization in Europe

In issue 47 of the Cayman Financial Review I have illustrated how the misuse of country-by-country (CbC)-type data facilitates the publication of misleading tax gap estimates. To counter the tax grabbing agenda that is promoted based on such inflated estimates, I have urged and pleaded with those tax practitioners wishing to preserve tax competition to challenge these questionable estimates and to put BEPS in a more somber perspective. Considering the rather worrisome recent developments within the EU, notably the further steps towards the introduction of compulsory public CbC-Reporting and the adoption of the Common Consolidated Corporate Tax Base (CCCTB), I feel compelled to renew my plea. Underestimating the long-term effects of these ostensibly technical and preliminary legislative proposals on the degree of tax harmonization and indeed, in more general terms, the further centralization of political power in the EU could be a costly blunder indeed.

The legislative train towards further tax harmonization gained momentum when the European Parliament approved the draft report for compulsory public CbC-Reporting on July 4 by 534 votes to 98 votes (62 abstentions). In other words, it wasn’t even close. While the draft will now need to progress through the legislative treadmill of the EU, eventual ratification seems to be a foregone conclusion. In light of the broad consensus within the EU and the unwavering public support for enhancing tax transparency, it is not conceivable that the legislative train will grind to a halt, even when, as it is often the case in the EU, progress might be slow. Once implemented, MNEs with a global turnover of more than 750 million euro must publicly disclose how much tax they pay to each jurisdiction they operate in, as well as country-specific data on their turnover, employees, assets and other supplementary data on their business activities. The public CbC-Reporting is touted by EU officials as a vital step towards increased tax transparency which will help to prevent abusive tax structures.

While the reliability of identifying abusive tax structures based on CbC-Reporting data is at least questionable, analogous to the tax gap estimates, it is completely unclear why publication of the CbC-Reporting is considered to be an additional benefit, i.e. how exactly is public availability of the data thought to contribute to preventing abusive tax structures? Indeed, the limitations (“The information will certainly not be sufficient for the public to determine whether a company paid the right amount of tax due under the law. Indeed, this is not the proposal’s objective”) as well as the dangers (“disclosed figures can be sensationalized or misunderstood, thus increasing the heat and lowering the quality of the public and political debate”) of publicizing such data have been explicitly pointed out to the European Parliament TAXE Special Committee. While the debate on the ‘pros’ and ‘cons’ of public CbC-Reporting is often dominated by technical considerations, including valid concerns in respect to additional compliance burdens for taxpayer, these are likely to pale compared to the political implications, i.e., the additional political pressure for stricter tax and transfer pricing legislation that is the only logical outcome (and arguably the primary purpose) of making CbC-Reporting data readily available to pressure groups which will not hesitate to (ab)use the date to push their tax grabbing agenda.

It would, however, be naïve to look at the public CbC-Reporting in isolation. The proposal for the adoption of the CCCTB is frequently referred to within the same parliamentary reports and is explicitly conceived as an integral part of the comprehensive anti-tax-avoidance package. While it may be true that the adoption and implementation of the CCCTB is further away than the public CbC-Reporting and (luckily) not an entirely forgone conclusion, the paradigm shift (i.e. abolition of the arm’s length principle) would be a game changer. The proponents of policies such as the public CbC-Reporting and the CCCTB share, to put it mildly, a deeply imbued and “mistrust” of all multinational enterprises. Their arguments in favor of the CCCTB are political rather than technical and may, as reflected in the parliamentary vote cited above, ultimately be more effective in influencing the legislative process.

The success of the tax grabbing agenda should not come as a surprise, as taxes are ultimately a political choice. Unfortunately, most tax experts, especially those hailing from Europe, prefer to steer clear of politics and limit their participation in the debate to commenting on technical aspects. One conceivable explanation might be the fear of being perceived as accomplices in aggressive tax planning and tarnishing their professional reputation by wading into the murky waters of politics. Considering the increasing influence of pressure groups such as the so-called BEPS Monitoring Group (BMG), a global network of researchers on international taxation sponsored by “tax justice” organizations (Tax Justice Network, Oxfam etc.), the professional detachment and aloofness of tax experts is not going to suffice for preventing large scale tax harmonization. Far from following a strategy of stealth, the BMG is rather blunt in castigating multinational companies as being prone to criminal activity and stating their demands for granting additional powers to tax authorities, as illustrated by these recent statements:

“People’s life chances are shaped by corporate control of food, water, medicines, air, energy, savings, jobs, news, investment, pensions and much more. … Corporations also profit from their involvement in tax avoidance, bribery, corruption, money laundering and exploitation of employees, consumers and the environment.”

“[OECD] draft clearly acknowledges, but fails to adequately address, the endemic and serious problem of information asymmetry between a tax authority and a company … issue could be addressed through a reversal of the burden of proof, with a presumption that any intra-firm transfer of HTVIs should be subject to pricing based on subsequent consideration of the actual income produced, unless the taxpayer can show that specified criteria were satisfied … proof that the transfer did not result in a significantly lower effective tax rate.”

Such statements are by no means to be discarded as irrelevant ramblings of obscure academics. The proponents of the BMG are highly influential in shaping legislative proposals for tax policies in Europe. Not only are they frequently referenced by the EU as landmark papers on tax avoidance (notably Richard Murphy), they also prominently participate in public hearings on tax policies. It should be a clear signal to European tax experts in respect to who is relevant in shaping tax policies, that Murphy was invited as one of only five participants in the public hearing on the CCCTB on May 3, 2017 in Brussels. The most worrisome aspect of this public hearing, however, is to be seen in the fact that Murphy encountered virtually no opposition. To the contrary, the other four participants more or less applauded the CCCTB initiative and some even happily proposed a variety of additional “perks” for high taxing governments such as introducing a minimal corporate tax rate of 25 percent and “full global transparency” and the detailed publication of CbC-Reports.

Among the five participants, two organizations exhibit profiles suggesting general support for the business community and entrepreneurs: Accountancy Europe and Business Europe. Alas, neither showed any inclination to question, let alone challenge, the adoption of the CCCTB. While Accountancy Europe pointed out that the CCCTB should not be expected to be much of an anti-tax avoidance measure, they had no qualms whatsoever to signal their support and making irksome notions about “arbitrating between short term individual pain and long term collective benefit.” The position paper of Business Europe was especially saddening. Despite pointing out several fundamental shortcomings of the CCCTB, importantly implementing more stringent measures than those contained in the BEPS Action Plan that put the EU at a competitive disadvantage as well as risking that the consensus (presumably regarding the arm’s length principle) at OECD level will eventually break, Business Europe managed to conclude that, based on the condition that a variety of technical concerns (accounting, depreciation rules, R&D allowances, etc.) are adequately addressed, the benefits of a CCCTB may outweigh the negatives. It is hard to understand how a reputable organization whose mission statement prominently features “standing up for companies across the continent and campaigning on the issues that most influence their performance” can be coaxed into cahoots with the likes of the BMG. Possibly they are lulled to sleep by technical details. Sure enough, keeping depreciation rules simple and competitive is important and a super deduction for R&D is enticing. Bickering about such details at the cost of losing sight of the bigger picture, however, hardly reflects political maturity.

With the European tax experts being too coy to address political implications of the CCCTB and business representatives being asleep at the wheel, the legislative train towards further tax harmonization will continue chugging happily towards the elimination of tax competition, maximizing global transparency and eventually minimal corporate tax rates of 25 percent (to start with). It is time to wake up and make a stand.

European Union targets finance centers – again

The European Union is drawing up a “blacklist” of “tax havens” and is proposing measures for its member governments to use to attack them.This is the EU’s latest effort to prop up its member governments’ collapsing finances.

Europe’s out of control public spending, bloated bureaucracies, expanding welfare states and massive unfunded pension liabilities have led to 21 of the EU’s 28 member governments running budget deficits. Spain has already breached the Eurozone’s maximum annual deficit of 3 percent of GDP, France and Romania are very close at 2.98 percent, and five other countries were thought to be at risk of “non-compliance” this year.

But with politicians unwilling to control their spending or rein in their welfare states, not surprisingly they are trying to squeeze more money out of businesses and investors. To try to deflect the responsibility for their economic problems, politicians are increasingly using offshore finance centers as a scapegoat, blaming “aggressive tax avoidance” rather than overspending for their budget deficits.

The current proposal is for a “common EU listing” of “non-co-operative tax jurisdictions” and a list of measures for EU member governments to apply to them.The first stage in the process was drawing up a preliminary “scoreboard” of countries that the EU thought needed investigation. This was based on six factors; three “selection indicators” to decide whether they were important enough financial centers (to European businesses and investors) to be worth examining, then three “risk indicators” to see whether they might be regarded as “tax havens.”

Selection indicators

The EU’s “selection indicators” identify the potential finance centers that they are most interested in challenging; they examine:

  • Strength of economic ties with the EU (e.g. trade data, companies controlled by EU residents; bilateral FDI flows);
  • Financial services exports as a proportion of the local economy; and
  • Stability factors, “to see if the jurisdiction would be considered by tax avoiders as a safe place to place their money”.

This shows the problem of trying to appease the EU.

For years the European Commission, and its friends in the OECD and high-tax campaigning groups, complained that offshore finance centers did not have proper regulatory systems. Many jurisdictions have worked hard to resolve this, and with great success: The EU’s Scoreboard listed Cayman and Jersey as having a better regulatory regime than South Korea and Israel, which are both OECD members. Indeed, several offshore centers now have better regulatory systems than some EU member states.

But where is the incentive to comply if having a stable economy and a well-functioning regulatory regime, as demanded by the EU and its friends, now marks a jurisdiction out as a potential tax haven? This shows the hypocrisy of the high-tax governments’ position; although they say this is about improving the global economy and preventing illegal activity, their actions show that their main objective is actually to collect more tax money.

By the way, the Cayman Islands can pat themselves on the back. In the EU’s scoreboard of finance centers, it comes third for the proportionate size of its finance sector and joint second for the strength of its ties with the EU. But since the prize for this competition is to become the target of the regulatory firepower of the European Union, perhaps it was not a good one to win.

What the “selection indicators” do is largely to identify successful finance centers that are stable democracies with efficient, effective regulatory regimes. No wonder the European Union wants to stamp them out; their good example shows up the gross deficiencies of the EU’s own member governments.

Risk indicators

The EU’s “risk indicators” are an attempt to make it look as if they have objective criteria for directing their attacks on more successful jurisdictions. The three indicators that show which jurisdictions they may consider to be “tax havens” are:

  • Lack of transparency (particularly in meeting international standards on exchange of information on request and automatic exchange of information);
  • Preferential tax regimes; and
  • No corporate income tax, or a zero rate.

Again, look how they shift the goalposts when it suits them.

For years, right back to the early days of the OECD “Harmful Tax Competition” initiative, we have been told that jurisdictions have the right to choose their own tax rates, including zero, and that all the EU and its allies want to stop is “harmful” tax practices – secrecy and distortionary systems that tax some activities but not others.

Offshore finance centers have worked hard over recent decades to change their systems to comply with the EU and OECD demands. The old “offshore regimes” that used to be seen in some jurisdictions, where on-Island businesses were taxed but “offshore” business or “international finance corporations” were tax-free, have been dismantled. I was involved in that process more than ten years ago, working in Jersey on making their corporate tax system compliant with the EU and OECD requirements. It was a lot of work, and it was done not for the benefit of the finance centers or their clients but at the insistence of the EU and its allies. But now that the EU have achieved their stated goals, and removed discriminatory practices, they now reveal what they really want – to stamp out tax competition and prevent more efficient jurisdictions from embarrassing the failing, high-tax big European governments.

A whiff of hypocrisy

The European Commission says that its process is designed to identify those jurisdictions which ”refuse to comply with international tax good governance standards.” But is it really? When one of its criteria for inclusion is having a stable and well-regulated economy, what the European Commission is actually doing is identifying those jurisdictions which do “comply with international tax good governance standards”. Nauru, for example, escapes inclusion in the primary list not because of its transparency (it has previously been judged “non-compliant” on information exchange by the OECD) but simply because it is not regarded as having a sufficiently stable political, economic and regulatory regime to be a viable threat to the EU’s way of doing things.

And the second “selection indicator,” of having a proportionately large financial sector, primarily identifies those finance centers which are successful. We see the same story on the “risk factors.” Some of the most successful, well-regulated offshore finance jurisdictions are given a clean bill of health on transparency and not having distortionary preferential regimes, but are still included on the EU’s list purely for choosing not to levy a corporate income tax. Cayman is in that category, as are Bermuda, the BVI, and the Crown Dependencies of Jersey, Guernsey and the Isle of Man.

What the European Union are objecting to now is not discrimination, distortion or disguising profits, but the embarrassing (to EU governments) fact that some jurisdictions can run a stable, successful economy without corporate taxes.

Common EU list of non-cooperative tax jurisdictions

The preliminary long-list was drawn up a year ago, in September 2016, and contained scores of jurisdictions that fell foul of the European Union’s six tests.But in order to whittle that down to a useable blacklist, for the last few months the jurisdictions on the long-list have been under examination by the EU’s Code of Conduct Group, a non-statutory body described by the EU Observer as “one of Brussels’ most secretive groups.” Their task is to look at those jurisdictions on the initial list of 92, identified by the “selection indicators” and “risk indicators” above, and from it produce a “common list” of “non-cooperative tax jurisdictions” that will be subject to targeted attacks by all EU member governments.

As I write this in September 2017, that shortlist is expected soon, and the European Commission’s aim is to have it agreed by the member states’ governments by the end of December. The Code of Conduct Group was set up to prevent EU member states from themselves engaging in “harmful tax competition,” offering preferential regimes to tempt businesses and investors to move to them from elsewhere in the EU. But its focus has now shifted to trying to regulate non-EU jurisdictions. Operating in an absolute secrecy that is rare for an EU body, the group has been busy examining those 92 non-EU tax systems to identify the ones to be blacklisted. An insider, reported in the EU Observer, said “it’s a very big task,” and “we don’t have time to do our usual work anymore.” So rather than put its own house in order, preventing discriminatory practices in its own members, the EU’s efforts have now been diverted into putting the blame for its economic failures onto non-EU countries.

As I wrote above, the Cayman Islands is on the long list, not because it is discriminatory or harmful but merely because it has an effective, well-regulated low-tax economy. Jersey, the BVI and other leading offshore centers join Cayman on the list for the same reason. Some of the other offshore centers are also on the long list for the more traditional reasons of being non-transparent or having preferential tax regimes; Antigua, Curacao, the Maldives, St Kitts, Singapore and so on.

In addition, several non-EU European countries also make the list, mostly for non-transparency and having close economic ties with the EU (due to their geographic proximity); Armenia, Bosnia, Georgia, Montenegro and others.

EU members are exempt from these attacks, as are a handful of European countries with close ties to the EU, such as Switzerland. Although there is still much tax competition between EU countries, that is not the focus of this work; this is an attempt to blame non-EU jurisdictions for the European countries’ economic problems. Also sanctions generally cannot be applied against EU member governments, who are protected by the EU’s free trade and free movement rules.

But there are some interesting countries on the long list, including China and South Africa (for having preferential tax regimes), and the United States (for both preferential regimes and lack of transparency, the U.S. believing that, under FATCA, information “exchange” only goes one way). If the U.S. appears on the final blacklist, life will get very interesting.

Zero tax

There is some argument within the EU as to whether merely having a low or zero corporate tax rate should put a jurisdiction on the blacklist. Certainly, it was one of the criteria in producing the long list last year, and several jurisdictions that were otherwise fully compliant were put on the long list for that reason alone, including Cayman.

Technically a zero rate was not included in the EU’s official criteria for drawing up the final blacklist, so Cayman ought to be removed from the list. However, the zero tax test seems to have sneaked in by the back door. One of the tests is that “the jurisdiction should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction,” which sounds similar to the old OECD rules against harmful tax practices.

However, the EU Council’s official guidelines for drawing up the blacklist, adopted in November 2016, say that, when applying that test, the Code of Conduct Group should consider “the absence of a corporate tax system or applying a nominal corporate tax rate equal to zero or almost zero” to be “a possible indicator” that the jurisdiction is “facilitating offshore structures … aimed at attracting profits.”

Will Cayman be included?

With the Code of Conduct Group supposedly close to finalizing the draft shortlist, and an agreed list expected by the end of the year, it will be very interesting to see which of these countries is on the shortlist for sanctions. In particular, what of jurisdictions such as the Cayman Islands, that have met all of the EU and OECD requirements for transparency and non-discrimination? Will they be on the final blacklist or will their compliance be accepted? That will depend on how far the EU pushes the definition of “facilitating offshore structures,” and the weighting they give to “a nominal corporate tax rate equal to zero or almost zero.”
If they do feature on the blacklist, despite having worked hard to make their tax systems comply with EU and OECD demands, the EU will find it much harder in future to persuade jurisdictions to voluntarily comply with its requests. But do not expect much fairness or objectivity; Bermuda has already said that the EU’s process appears to be “designed to lead to a predetermined conclusion.”

We shall know soon whether the EU is applying objective tests or if this is a mere self-interested attack on successful non-EU finance centers.

Substance over form: the sine qua non of international tax planning in the age of transparency and BEPS


In October 2015, the Organisation for Economic Co-operation and Development (OECD) issued its report on its BEPS Project titled: OECD/G20 Base Erosion and Profit Shifting Project 2015 Reports. This was accepted by the G20 (Group of 20 largest economies in the world) at its November 2015 meeting in Turkey. In actuality, there were 15 Reports/Actions covering the following areas which were presented that day:

  • Action 1: Addressing the Tax Challenges of the Digital Economy
  • Action 2: Neutralising the Effects of Hybrid Mismatch Arrangements
  • Action 3: Designing Effective Controlled Foreign Company Rules
  • Action 4: 2 Limiting Base Erosion Involving Interest Deductions and Other Financial Payments
  • Action 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance
  • Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances
  • Action 7: Preventing the Artificial Avoidance of Permanent Establishment Status
  • Actions 8–10: Aligning Transfer Pricing Outcomes with Value Creation
  • Action 11: Measuring and Monitoring BEPS
  • Action 12: Mandatory Disclosure Rules
  • Action 13: Guidance on Transfer Pricing Documentation and Country-by-Country Reporting
  • Action 14: Making Dispute Resolution Mechanisms More Effective
  • Action 15: Developing a Multilateral Instrument to Modify Bilateral Tax Treaties

The OECD says BEPS refers to: “tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity. Although some of the schemes used are illegal, most are not. This undermines the fairness and integrity of tax systems because businesses that operate across borders can use BEPS to gain a competitive advantage over enterprises that operate at a domestic level. Moreover, when taxpayers see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all taxpayers.”

Others, like the author, see BEPS as the latest step in a move toward global tax harmonization which began in 1998 when the OECD launched its harmful tax competition report.

The purpose of this two-part article is not to litigate the merit or demerits of the report. It is to focus instead on how the new proposals will change the landscape and the rules for international tax law, wealth and tax planning and legal tax minimization if and once they are implemented.

I have no doubt that at least some of the proposals will be implemented. Irrespective of the extent of their implementation, they will change the international tax law infrastructure. It is interesting to note that I presaged the overall thrust of the proposals set out by the OECD in my January 2014 article in this magazine titled: “Substance over form: How international financial centers can survive in the age of automatic exchange of information and transparency.”

The main focus of this two-part article, then, is to show that in this new world, whether or not anyone likes it, the concept of substance will not only be essential for survival, but more importantly, will be central to complying with the law.

The reports are voluminous and thus all the points cannot be covered by an article of this length. I will thus highlight two of the proposals which require substance and in so doing will define through illustration what that concept entails. In this first part, I focus on the new proposed rules on Permanent Establishments.

The rules on Permanent Establishments

The most profound change which the new proposals call for is in the definition of what constitutes a Permanent Establishment (PE). Double taxation treaties (DTTs) provide that the business profits of a foreign enterprise are taxable in a State only to the extent that the enterprise has in that State a PE to which the profits are attributable. The Model uses a two-prong test to identify a PE, namely:

  1. Whether the corporation has a fixed place of business within the foreign country as defined under the language of a specific treaty.
  2. Whether the corporation operates in the foreign country through a dependent agent that habitually exercises the authority to conclude contracts on behalf of the corporation in the target country.

Under the first prong of the PE test outlined above, a corporation must operate in a foreign country through a fixed place of business to create a PE. A fixed place of business has been defined in Article 5 of the Model to include the following types of physical locations:

  1. Place of management;
  2. Branch or an office;
  3. Factory;
  4. Workshop;
  5. A mine, oil, or gas well, quarry, or any other place where natural resources are extracted.

The Model in Article 5(3) also states that a building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months. However, despite these provisions, the Model includes wide exceptions which allowed for creative tax arbitrage and mitigation strategies to which I shall refer to later in this article.

These exceptions, and for purposes of this article I will call them Article 5(4) exceptions, to differentiate them from the Article 5(5) exceptions stated below, include the:

  1. use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
  2. maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
  3. maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
  4. maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise;
  5. maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;
  6. maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

Further, an enterprise of a contracting state shall not be deemed to have a PE in the other contracting state merely because it carries on business in that other contracting state through a broker, general commission agent, or any other agent of an independent status. This is conditional only if such persons are acting in the ordinary course of their business.

In the report, these are referred to as commissionnaire arrangements as set out in Article 5(5). However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise, he/she will not be considered an agent of an independent status within the meaning of this paragraph. This will only be the case if it is shown that the transactions between the agent and the enterprise were not made under arm’s-length conditions.

The analysis to determine whether an agent is working as an independent agent can be determined by examining whether the agent is:

  1. Acting in the ordinary course of their business.
  2. Economically independent from the home country corporation that has contracted for their services
  3. Legally independent from the home country corporation that has contracted for their services.

The report itself notes that “through these sorts of commissionnaire arrangements, a foreign enterprise is able to sell its products in a State without technically having a permanent establishment to which such sales may be attributed for tax purposes and without, therefore, being taxable in that State on the profits derived from such sales.

Since the person that concludes the sales does not own the products that it sells, that person cannot be taxed on the profits derived from such sales and may only be taxed on the remuneration that it receives for its services (usually a commission).”

It goes on to state that a “foreign enterprise that uses a commissionnaire arrangement does not have a permanent establishment because it is able to avoid the application of Art. 5(5) of the OECD Model Tax Convention, to the extent that the contracts concluded by the person acting as a commissionnaire are not binding on the foreign enterprise. Since Art. 5(5) relies on the formal conclusion of contracts in the name of the foreign enterprise, it is possible to avoid the application of that rule by changing the terms of contracts without material changes in the functions performed in a State. Commissionnaire arrangements have been a major preoccupation of tax administrations in many countries, as shown by a number of cases dealing with such arrangements that were litigated in OECD countries. In most of the cases that went to court, the tax administration’s arguments were rejected.”

It further notes that “similar strategies that seek to avoid the application of Art. 5(5) involve situations where contracts which are substantially negotiated in a State are not formally concluded in that State because they are finalised or authorised abroad, or where the person that habitually exercises an authority to conclude contracts constitutes an “independent agent” to which the exception of Art. 5(6) applies even though it is closely related to the foreign enterprise on behalf of which it is acting.”

On this point it adds that “as a matter of policy, where the activities that an intermediary exercises in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise should be considered to have a taxable presence in that country unless the intermediary is performing these activities in the course of an independent business.”

The report also addresses the exceptions titled Article 5(4) above and notes that there have been dramatic changes in the way that business is conducted since their introduction as outlined in detail in the report on Action 1. The report goes on to say that depending on the circumstances, activities previously considered to be merely preparatory or auxiliary in nature may correspond to core business activities. In order to ensure that profits derived from core activities performed in a country can be taxed in that country, the PE rules will be modified.

The modification will ensure that each of the exceptions included therein is restricted to activities that are otherwise of a “preparatory or auxiliary” character.

The report noted that BEPS concerns related to Article 5(4) exceptions also arise from what is typically referred to as the “fragmentation of activities.” It points out the ease with which multinational enterprises (MNEs) may alter their structures to obtain tax advantages. In light of this, it is important to clarify that it is not possible to avoid PE status by fragmenting a cohesive operating business into several small operations in order to then argue that each part is merely engaged in preparatory or auxiliary activities that benefit from the Article 5(4) exceptions.

Finally, it noted that the exception which applies to construction sites has given rise to abuses through the practice of splitting-up contracts between closely related enterprises.

It is rules like this and others, mainly the ones on transfer pricing, that allowed American MNEs like Apple Inc, Starbucks Corporation, Amazon, Google and others to minimize their tax obligations legally. The purpose of this article is not to debate the merits or demerits of the behavior of these companies, but I mention this to set the context of what drove the OECD and G20 starting in 2013 to launch this project.

In light of all this, the new proposals call for a change in the definition of what constitutes a PE. The first one deals with ending commissionnaire arrangements exemptions. It requires that where a person is acting in a contracting state (in the context of a DTT) on behalf of an enterprise and in so doing, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without major modification by the enterprise, and these contracts are:

  1. In the name of the enterprise or;
  2. For the transfer of the ownership of, or for the granting of the right to use property owned by that enterprise of that the enterprise has the right to use or;
  3. For the provision of services by that enterprise, that enterprise shall be deemed to have a permanent establishment in that state in respect of any activities which that person undertakes for the enterprise.

The second change relates to the Article 5(4) exceptions listed above. The proposal is to remove the wording which is highlighted in the exceptions in subparagraphs 5 and 6 and insert the following text after item 6: “provided that such activity or, in the case of subparagraph (f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.”

When read together, this means that these exceptions which allow physical locations used for storage and the maintenance of goods etc, not to qualify as PEs, will only apply where the said locations and maintenance of goods are being used for activities that are preparatory or auxiliary in character. This will be different from what happens under the current regime where MNEs are using physical locations which are engaged in these activities to conduct business, while at the same time being allowed to avoid the PE requirements and thus paying taxes in the states where these activities occur and locations are situated.

To avoid MNEs using the new proposals to avoid the PE rules by splitting up activities into many different steps, isolating them into various locations and claiming that each is preparatory in nature, a new anti-fragmentation rule has been proposed. The rule says that the exceptions which are set out in Article 5(4) above shall not apply to a fixed place of business that is used or maintained by an enterprise. However, only if the same enterprise or a closely related enterprise carries on business activities at the same place or at another place in the same contracting state and:

  1. That place or other place constitutes a PE for the enterprise or the closely related enterprise under the provisions of Article 5; or
  2. The overall activity resulting from the combination of the activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, is not of a preparatory or auxiliary character. This is provided that the business activities carried on by the two enterprises at the same place, or by the same enterprises or closely related enterprises at the two places, constitute complementary functions that part of a cohesive business operation.

Finally, to address the issue of splitting up contracts to get around Article 5(3) above, the Principal Purposes Test (PPT) rule will be added to the OECD Model Tax Convention as a result of the adoption of the report on Action 6 mentioned earlier to address the BEPS concerns related to such abuses. The report does not give a definition of the test but instead provides a model scenario in the commentary that accompanies the report.

The scenario is not all inclusive and it appears that the report basically will leave it up to individual jurisdictions to use the scenario, which I have set out below, with necessary modifications, to apply the test. The objective is to apply the test to cases where contracts are being split to assess whether or not this is being done simply to take advantage of a treaty benefit or whether or not there is an economic rationale for the split.

RCo is a company resident of State R. It has successfully submitted a bid for the construction of a power plant for SCO, an independent company resident of State S. That construction project is expected to last 22 months. During the negotiation of the contract, the project is divided into two different contracts, each lasting 11 months. The first contract is concluded with RCO and the second contract is concluded with SUBCO, a recently incorporated wholly owned subsidiary of RCO resident of State R.

At the request of SCO, which wanted to ensure that RCO would be contractually liable for the performance of the two contracts, the contractual arrangements are such that RCO is jointly and severally liable with SUBCO for the performance of SUBCO’s contractual obligations under the SUBCO-SCO contract.

In this example, in the absence of other facts and circumstances showing otherwise, it would be reasonable to conclude that one of the principal purposes for the conclusion of the separate contract under which SUBCO agreed to perform part of the construction project was for RCO and SUBCO to each obtain the benefit of the rule in paragraph 3 of Article 5 of the State R-State S tax convention. Granting the benefit of that rule in these circumstances would be contrary to the object and purpose of that paragraph as the time limitation of that paragraph would otherwise be meaningless.

Substance in the context of the PE rules focuses on the physical location where activities occur and the actual facilities which are used to conduct them along with the persons who conduct the activities irrespective of the legal arrangements involved. The concept is now grounded in the idea that where value is created is the nexus for where taxes are to be levied and gimmicks like splitting up contracts to take advantage of the 12-month rule and setting up different entities to argue that each entity is doing a separate activity that is preparatory in nature will no longer apply.

In the second part of the article, I will focus on the proposals related to transfer pricing which will further elucidate the concept of substance.

Primeo v HSBC: Uncharted territory


This case concerns the efforts of the liquidators of a Madoff feeder fund to recover losses suffered as a result of fraud from service providers to the fund, in this case the administrator and the custodian. As explained below, the recent judgment handed down by Justice Andrew Jones QC in the Grand Court of the Cayman Islands addresses a number of novel legal issues and takes the law into unchartered territory.


As is well-documented, Bernard Madoff, the former NASDAQ Chairman, perpetrated the world’s largest known Ponzi scheme and was eventually sentenced to 150 years in prison for securities fraud. Prior to his arrest in December 2008, Madoff purportedly managed money and traded on behalf of clients across the globe. Primeo Fund (in official liquidation) was one such client.

Primeo was incorporated in the Cayman Islands in 1993 and, until 2007, invested directly in Bernard L Madoff Investment Securities LLC (BLMIS). Thereafter, Primeo continued to invest in BLMIS indirectly, primarily through another Cayman-domiciled investment fund, Herald Fund SPC (in official liquidation). As explained below, that change in investment structure became the focal point in the judge’s mind at first instance.

Members of the HSBC Group, Bank of Bermuda (Cayman) Limited (BoB Cayman) and HSBC Securities Services (Luxembourg) SA (HSSL) (together, the HSBC defendants), acted as administrator and custodian to Primeo. Having been placed in liquidation, Primeo initiated proceedings against the HSBC defendants in February 2013. Broadly, Primeo alleged that the HSBC defendants had been grossly negligent in performing their respective functions as administrator and custodian and, by their breaches of duty, had caused Primeo’s underlying investors to suffer very substantial losses.

The trial commenced in early November 2016 and concluded in late February 2017. During the course of the trial, the Grand Court heard evidence from 10 factual witnesses, including former Primeo directors and senior HSBC executives, and 17 expert witnesses ranging from investment management consultants to a former director of the FBI.

Last month, Justice Jones held that the HSBC defendants breached various ongoing duties in their capacities as administrator and custodian to Primeo. However, despite those findings, the HSBC defendants escaped liability at first instance as a result of a number of novel legal findings. Those findings have been appealed and will now be determined by the Cayman Islands Court of Appeal.

Other Madoff feeder funds have also brought claims against HSBC entities and are likely to be encouraged by this decision. Without a technical legal argument specific to the way in which Primeo’s investments were restructured in 2007, which does not apply to other funds, the HSBC Defendants would have been found liable for Primeo’s losses.

Serious breaches

The judge was satisfied that the HSBC defendants owed and breached their duties to Primeo in various ways from 2002 to 2008. In particular, he concluded that:

  • the custodian was in breach of its ‘on-going suitability’ and ‘most effective safeguards’ duties by not recommending safeguards to protect Primeo’s assets;
  • the custodian was also in breach of contract when it failed in August 2002, June 2003, March 2004, March/April 2005 and February 2007 to give any consideration or make any recommendations to Primeo about effective safeguards which were readily available;
  • the administrator did not exercise reasonable care and skill in calculating the net asset value after April 2005. It was grossly negligent to continue to produce valuations based on single-source information received from Madoff at the end of each of the following months;
  • the unqualified audit opinion for Primeo was based, to a material extent, upon the custody confirmation issued to the auditors by HSSL, acting as Primeo’s custodian. The judge found that HSSL had no proper basis for confirming the existence of the assets, in circumstances where the assets were supposedly held by BLMIS and HSSL had taken no steps to verify that they existed; and
  • faced with various concerns and the other background information, a reasonably competent custodian should have given notice for resignation and explained its reasons for doing so. Although there was no legal duty to do so, it would have been commercially unrealistic for the custodian to resign without providing an explanation.

The judge found that Madoff would have refused to implement any measures suggested by the HSBC defendants, due to the risk of the fraud being uncovered. Accordingly, the judge held that, when faced with a refusal from Madoff in these circumstances, any competent custodian would have either resigned or sought to re-negotiate terms with Primeo to limit its functions and liability.

By 2005, it was held to be grossly negligent for the HSBC defendants to continue to produce a NAV based on single-source information, i.e. information received only from Madoff acting in three capacities as sub-custodian, broker and investment manager.

The judge also held that, by virtue of entering into a sub-custody agreement with BLMIS in 2002, HSSL became strictly liable to Primeo for BLMIS’ defaults as sub-custodian. This is important because it means that in relation to that cause of action Primeo does not have the burden of showing that HSSL caused Primeo’s loss.

The judge labelled the evidence of a number of former and current senior HSBC executives as “contrived” and “not credible.” The judge found that they had held “wholly untenable” views, and ignored the serious consequences of their actions. Certain HSBC executives were found to have been “indifferent to obvious risk,” having acted with such serious disregard of the risks as to be guilty of gross negligence.

The effect of the 2007 switch

Nevertheless, despite the damaging findings referred to above, in determining the ultimate issue of liability, the judge focused on Primeo’s 2007 restructuring from direct to indirect investment in BLMIS. This restructuring is the sole reason that the HSBC defendants escaped any liability at first instance.

It is not disputed that BLMIS misappropriated and misused Primeo’s money and perpetrated fraud on a massive scale. The judge accepted that HSSL was strictly liable for the willful defaults of BLMIS as sub-custodian. However, the judge held that Primeo suffered no relevant loss as a result of BLMIS’ defaults. He decided that, notwithstanding that Primeo did not receive any cash as part of the 2007 transaction and rather received potentially worthless shares in Herald (which had invested all its assets with BLMIS), Primeo realized the full value of its assets through the switch into Herald. For that reason, the judge found that there was no relevant loss for which HSSL was strictly liable.

Similarly, the judge held that Primeo’s claim for the loss of its investment is barred by the rule against reflective loss. The rule against reflective loss operates where a company suffers loss by requiring any claim for the loss to be brought by the company, and not by shareholders in the company. The shareholders’ loss is said to be reflective of the company’s loss, with a view to preventing multiplicity of proceedings, potential multiple recovery and possible prejudice to the company as a result.

However, the rule operates where the shareholder is a shareholder in the company at the time the loss is suffered. The rule has never been applied to prevent someone who suffered loss before they became a shareholder from pursuing a claim simply because they subsequently became a shareholder in a company which suffered a similar loss under an entirely different set of contractual arrangements and did not even exist at the time the shareholder accrued certain claims. The judge’s finding in this regard is unprecedented in the common law world and, if upheld on appeal, would substantially enlarge the rule against reflective loss.

The judge also found that, for the rule against reflective loss to apply, it was only necessary for HSBC to show that Herald had a claim that had a real prospect of success, namely a claim that would survive an immediate strike out application but was thought to have less than a 50 percent chance of success (and which was therefore likely to fail). Again, it is difficult to understand why the fact that Herald may have a poor claim against HSBC should operate to deprive Primeo of the good claims that it had prior to investing in Herald.

In the absence of these inter-related legal findings in relation to events in 2007 (i.e. long after the HSBC defendants first breached their respective duties), Primeo’s claim against the HSBC defendants would have been successful. Accordingly, these issues will be key issues for the Court of Appeal to consider.


The judge held that the causes of action which accrued against the HSBC defendants from February 2007 are not statute barred. This would allow Primeo to recover for those claims but not for claims which accrued earlier.

However, he rejected arguments made by Primeo that the HSBC defendants deliberately concealed their wrongdoing so as to extend the limitation period. For the purposes of the law, deliberate concealment does not require intentional concealment of the breach of duty, rather it is sufficient if a defendant knowingly commits a breach of duty in circumstances where that breach is unlikely to be discovered for some time. Primeo argued that this was the case here, because the HSBC Defendants had known since 2002 that they were unable to verify the existence of the underlying assets and were therefore unable to comply with their obligations to safe keep the assets and to determine the value of them.

Although the judge found that the HSBC defendants had breached their obligations, he said that they did not knowingly breach their obligations but were instead reckless (i.e. not caring) as to whether they had complied with them. The judge did not accept that recklessness is sufficient. As a result, despite his other findings, for example, that senior HSBC executives “did not apply their minds to and failed to consider whether any safeguards, or any more effective safeguards, could or should be implemented,” the judge said that causes of action which had accrued before February 2007 were time-barred.

Again, these issues will be important issues for the Court of Appeal and may affect the amount of damages that Primeo can recover.


Although causation is not relevant to Primeo’s strict liability claim, it is relevant to the claims for breaches of the administration and custodian duties. The law requires that the breach is one of the elements that caused the loss, but not that it is the sole or most effective cause of the loss. Nevertheless, the judge held that Primeo had not established that the HSBC defendants’ serious breaches of contract caused Primeo’s losses.

Primeo called three former directors of Primeo, two of whom reside in Austria. Primeo also served a number of hearsay notices in relation to transcripts of evidence given by former Primeo directors in Austria and Primeo’s liquidators obtained thousands of contemporaneous documents from multiple sources, including former directors. However, on the facts of the case, the Judge found that there was “no evidence from any of those who would actually have made the decision” to withdraw Primeo’s investment.

As many readers will be aware, liquidators are in a uniquely challenging position in relation to evidence gathering. They often have no power to compel individuals to give evidence and have no entitlement to documents falling outside the realm of their statutory powers (in Cayman, sections 103 and 138 of the Companies Law). Even where there is a clear entitlement, third parties will often fight to restrict access to documents. By way of example, the HSBC defendants, as key service providers to Primeo, resisted the Primeo liquidators’ early attempts to gather information and documentation.

This may be a dangerous precedent which, if not over-turned, may make it almost impossible for liquidators to prove the causation element of breach of duty claims. In this litigation, due to the Judge’s findings on strict liability, it may not be necessary to succeed on causation on appeal. However, often causation will be an essential element of any claim and this part of the Judge’s decision is particularly problematic for liquidators.


As the title of this article suggests, the first instance judgment takes this case into uncharted legal territory. The issues relating to whether the 2007 transaction cured all Primeo’s loss, reflective loss and limitation are all very important and novel legal issues which will now have to be determined by the Court of Appeal, and in due course possibly by the Privy Council in London. They could set legal precedents with far reaching implications across the common law world.

STEP Cayman: Providing a global perspective

STEP Cayman hosted the “STEP Cayman Forum” on Sept. 7 at the Institute of Directors in London.

A key component of the effective operation and continued growth of the local financial services industry is the promotion of the Cayman Islands for what it is: a modern and sophisticated international financial center that is a key contributor to the global economy. For those in the wealth management sector, marketing on this front is a business imperative and obtaining the support of professionals located outside the jurisdiction is critical.

Recognizing this, the Cayman Islands Branch of the Society of Trust and Estate Practitioners (STEP Cayman) hosted the “STEP Cayman Forum” on Sept. 7, 2017 at the Institute of Directors in London. Focusing on wealth planning in international financial centers, the aim of the Forum was to provide an opportunity for leading figures in the trusts industry outside the Cayman Islands to discuss openly the challenges faced generally in the wealth management industry, while highlighting the Cayman Islands as a leading jurisdiction in addressing those challenges. The Forum attracted high attendance from industry professionals across London, the Channel Islands, and Switzerland.

The Forum began with a presentation by Timothy Ridley, former senior partner of Maples and Calder and current member of the Cayman Islands Anti-Corruption Commission. Ridley explained how the Cayman Islands has developed into an international wealth structuring center of excellence and responded to the current challenges faced by all international financial centers.

Richard Wilson QC, a leading silk from barristers set Serle Court, with extensive experience in international trust litigation, including appearances before the Grand Court of the Cayman Islands, gave an informed view on the importance of an effective and reliable court system when selecting a private wealth jurisdiction. Wilson confirmed that the quality and breadth of expertise of practitioners in the Cayman Islands, which he has personally observed whilst litigating in the Cayman courts, is very high and that the jurisdiction compares favourably to its competitors in this regard. His presentation was followed by that of John Riches, a consultant with the leading London-based private client team of RMW Law. He provided the audience with an in-depth analysis of global transparency issues and the balance to be struck in respect of an individual’s right to privacy when considering the requirements now imposed by FATCA and the OECD under CRS, as well as the beneficial ownership registers which are now being implemented.

The Forum then moved into a panel discussion format, comprising the above speakers with George Hodgson, the chief executive of STEP who is responsible for managing STEP’s relationship with major external stakeholders such as governments, regulators and international organizations, including the OECD and the FATF. The panel was completed by Richard Hay, the head of Stikeman Elliott’s London-based private client group and counsel to the IFC Forum, who is a well-known speaker at international financial services seminars.

The panel was moderated by the well-known British television political commentator and journalist Andrew Neil. He took the opportunity to probe into the validity of perception of the Cayman Islands held by some members of the public, which he referred to as the “John Grisham effect.” All of the panelists were able to highlight the difference between this perception and the practical reality of their professional interaction with the jurisdiction. Members of the panel noted that the Cayman Islands could be considered a victim of its own success: arguably, had it not risen to become such a prominent international financial center, this perception would not have arisen in the first case or continued for such a prolonged period of time. The panel noted that although there is the continual tabloid reputation, professionals who use the Cayman Islands know and appreciate the compliant environment in place in the Cayman Islands, coupled with the expansive expertise of the professionals based in the jurisdiction.

What became clear from the discussions held during the Forum was the extent of the work which has been undertaken within the Cayman Islands to create a compliant and effective jurisdiction in which to establish wealth planning structures.

The Forum follows on from similar successful events held by STEP Cayman in previous years both in London and in New York. In addition to providing an opportunity for the promotion and marketing of the jurisdiction generally, the Forum allowed those Cayman Islands practitioners present to engage in discussions directly with their international counterparts about the issues surrounding trusts and wealth management globally. By growing these relationships and educating the audience about the ongoing evolution of the wealth management industry, STEP Cayman continues to play a key role in fostering a positive global perspective of the Cayman Islands.