INTRODUCTION
When taxes become the subject of dinner-table debates, there's usually a political or macroeconomic issue below the surface. Today's conversations about international taxation are no exception. Ever since the financial crisis, governments around the world have been exploring ways to shore up revenues, and for many, cracking down on cross-border activity by corporations and investors seems the obvious route to healthier budgets. News-making actions mainly involve global multinationals like Apple, Google, and McDonald's, which are criticized for locating operations outside the US with the goal of paying no—or very low—income taxes.
Investment flows through offshore financial hubs may get fewer headlines. But tax-neutral domiciles like the Cayman Islands are coming under increasing scrutiny, some of it politically motivated. Allegedly, by helping investors minimize taxes on returns from capital, offshore financial centers rob the investors' home countries of needed revenues.
Tax neutrality is key to efficient financial flows. If citizens of Country A had to pay taxes twice when they made an investment in Country B, they'd likely keep their assets at home.
Do such allegations have merit? To find out, To find out, Cayman Finance commissioned Oxford Economics and the International Tax and Investment Center to closely analyze tax rates in the EU, with the goal of determining whether its member states lose significant revenue when their investors use Cayman-domiciled funds. Our research shows that treaties and elaborate domestic rules in the European Union effectively lower taxes on cross-border investments far below official published rates.
Furthermore, while offshore jurisdictions like Cayman offer one route to tax neutrality, it is by no means the only route. EU member governments have developed complex—and often considerably less transparent—mechanisms to achieve the same objective. In fact, the EU is growing more and more concerned about such complex maneuvers, as evidenced by its Council Directive 2011/16, known as DAC6. The directive requires detailed reporting of cross-border tax arrangements, with the aim of achieving transparency in the complex structures facilitated by tax treaties.
Tax neutrality is a fundamental principle of free[1]market economics. In essence, it says investors shouldn't make decisions solely on the basis of tax consequences. It is easy to see how letting the tax tail wag the economic dog can lead to market distortions—for example, an unnatural concentration of capital in jurisdictions whose only merit is low taxes, or capital flight from an economically robust but high-tax location. Thus, tax neutrality is key to efficient financial flows around the world, and it underpins the vast global network of tax treaties: If citizens of Country A had to pay taxes twice when they made an investment in Country B, they'd likely keep their assets at home.
For fund investors, tax neutrality means the country where a fund is registered does not add a third layer of taxes onto those already imposed in the investor's home country and in the countries where the fund invests its assets. Tax-neutral does not mean tax-free. In fact, it's arguably more difficult to avoid taxes in a tax-neutral jurisdiction like Cayman, which doesn't participate in tax treaties and therefore does not affect other countries' taxing rights, than in the often opaque system of domestic and international onshore rules governing double taxation.
Offshore investment hubs like Cayman play an important role in helping global investors aggregate and access funds— one of of capitalism's signature goals.
Efficient capital allocation is a cornerstone of economic health, and international tax policy can help support it. But for most governments, achieving a fair, sustainable fiscal policy that strikes a balance between raising revenues and encouraging investment is a struggle. On the one hand, a national government needs to protect its domestic tax base; on the other, it can't risk alienating foreign investors. It's little wonder this balancing act can get politicized.
We hope that, by shedding light on the taxes actually paid when money moves from one jurisdiction to another, our study will allow policymakers to make objective, data-based comparisons between tax regimes. When they do, they are likely to conclude that tax-neutral offshore investment hubs like Cayman play a unique and important role in helping global investors aggregate and access funds—one of capitalism's signature goals.
Published: July 14, 2021
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