At Cayman Finance, we’ve been watching the United States presidential election carefully, and observe the disappointing, though somewhat predictable, distortion of the facts by some US politicians and media, regarding the financial services industry in Cayman.
These two groups are speaking to their domestic audience, and seem reluctant to take the time or trouble to learn about offshore international finance and how it benefits the US economy. At Cayman Finance we try to correct the facts about investing via Cayman as often as we can, and share information with journalists in the US.
As we do on the eve of every US presidential election, it’s important to consider how the 2012 US election might impact that country’s policies regarding Cayman and offshore international finance. This was an important issue in the US Congress before Mitt Romney won the Republican nomination for US president. Now that his investments and taxes have become the central issue for the Obama – Biden re-election campaign, it’s going to be all the more important thereafter, too.
How things are shaping up in the US
International tax reform in the US has moved from being a subject for lawyers, bankers and accountants to a stump speech topic for many members of the US Congress. It took the takeover of America’s most popular brewery, Anheuser-Busch, by InBev to do it, but conservative politicians there are arguing that the US’ worldwide tax system puts them at a disadvantage in the world marketplace. Liberal politicians continue to argue (ignoring FATCA’s enactment) that the rich hide their money in offshore banks, and that taxing it would solve the US budget deficit. They go on to assert that American businesses are evading taxes on their tax-deferred profits overseas, too.
This is occurring with a weak economy, and with numerous temporary US tax policies expiring on 31 December, 2012. New higher rates for individual income taxes, corporate taxes, taxes on investments and estate taxes all go into effect in the US on New Year’s Day, 2013.
All of these issues – the US budget deficit, legitimate tax policy concerns and false claims about offshore tax evasion – are likely to be addressed as part of the major US tax reform effort the US Congress hopes to begin in earnest in 2013. The tax-writing committees of the US Congress have already begun work towards reforming the US international tax system. With the publicity surrounding these issues in the US election, Cayman will likely be in the middle of this tax policy debate, whether we like it or not.
Obama vs Romney
The impact on Cayman from US tax reform will vary depending on the outcome of the November elections. If President Obama remains in the White House, he will seek to impose significant new “earnings stripping” restrictions on the deductibility of outbound interest from the US affiliate to its foreign multi-national parent; require US multi-nationals to pay a minimum tax on overseas profits, especially from intellectual property; defer US interest expense deductions deemed attributable to US multinationals’ foreign earnings until such earnings are repatriated to and taxed in the US; and impose an entity level tax on income of large businesses operated in pass-through form.
Governor Romney’s tax plans are less focused on international issues, but he would broaden the tax base to eliminate “loopholes”, without specifying which provisions he would target. He also would move the US to a territorial tax system, and provide for a repatriation tax holiday.
Chairman Dave Camp of the US House of Representative’s Ways & Means Committee has put a little more thought into these issues. His plan would also move the US to a territorial tax system, and exclude from tax all but 5 per cent of the dividends of a controlled foreign corporation in an active trade or business. The effective income tax rate on new earnings repatriated to the US from foreign operations would thus be 1.25 per cent.
An exception would apply to all existing foreign earnings, which would be subject to a 5.25 per cent effective tax rate upon enactment. Passive, highly mobile foreign income would be subject to current US tax under existing law.
Despite the fact that the rest of the world has operated under territorial tax systems for years, there is a great deal of apprehension in the US that income would shift offshore upon enactment of a territorial system.
Chairman Camp provides alternative proposals to reduce the risk of income shifting under a territorial system. These include an “excess returns” proposal that taxes intellectual property transferred to a low tax jurisdiction at a high rate and a “minimum tax” proposal, which currently taxes in the US under existing US rates all income of a controlled foreign corporation in a low tax jurisdiction.
Tax reform issues
Drafting a new international tax regime for an economy as large and a tax code as complicated as the US’s will be a major undertaking. Several issues remain unsettled. For example, many US-based multi-nationals have millions and even billions of dollars in deferred tax benefits from foreign operations on their books, such as foreign tax credits. If the US moves to a territorial system it is unclear whether these assets will be the subject to accounting write downs or if non-US investors will see any negative impact on their equity.
If Obama is re-elected, we are likely to see more efforts to close so-called loopholes and raise taxes, such as those listed above, and possibly a renewed effort to end deferral of foreign profits for US companies. If Romney wins, revenue will still have to be raised to reduce the deficit, but international tax reform will be more of a competition among industries to avoid new taxes and lower existing taxes.
However, given the controversy over Romney’s investments via Cayman, it’s likely that his administration would be circumspect about providing any benefit that could be construed as favouring Cayman. A Romney administration might instead work to inoculate him against further criticism by adopting the Democrats’ anti-offshore agenda. They could also work to change US tax laws to try to reduce the need for offshore financial centres like Cayman.
For Cayman Finance, the important first step in addressing these proposals is education and engagement in Washington. US politicians can’t make responsible and economically efficient decisions about Cayman without knowing how our financial service industry works, and how their decisions will impact new investments and existing business structures. Both during the election, and thereafter, we will be working to try to better inform Washington how offshore finance works, and how Cayman has created the most transparent, efficient and professional environment to facilitate international business.