Cayman Island Companies – Split the baby! President Obama’s Tax Proposal
By Ron Cohen, CPA, MST
Partner
Greenstein, Rogoff, Olsen & Co., LLP
Further related to President Obama’s Corporate Tax
Proposal of May 4, 2009:
(See:
http://media.npr.org/documents/2009/may/whitehouse_taxhavens.pdf)
May I suggest there are
two types of Offshore Holding Companies – in the Cayman Islands, Bermuda, the
Netherlands, and others, but let’s stay with the Cayman Islands for this Blog.
The President has
repeatedly pointed out:
“In the Cayman Islands, one
address alone houses 18,857 corporations, very few of which have a physical
presence in the islands.”
I’m sure that is accurate.
But let’s break it down.
“Bad” Cayman Company
Prior to 2004, the Cayman Islands did not share tax information on income of its resident individuals, corporations or
trusts with the I.R.S. or any other tax authority.
(See: The Cayman Islands are Becoming "Transparent" for Tax Purposes)
Therefore, individuals and
companies use the laws of the Cayman Islands to establish corporations and
trusts to exploit these so-called “privacy” rules. They open a bank account or
make other types of investments and do not report the income from these
investments to their home-country tax authority.
This is often clear tax
evasion. No one, including the most aggressive (legal) tax advisors, favors or
encourages this arrangement, as it is unfair to all U.S. taxpayers for some to
hide their income.
We fully encourage the I.R.S. to find the people involved in such
transactions and enforce the tax laws with collection action and, where
appropriate, criminal prosecution.
There is no reasonable
argument to encourage “Bad” Cayman Companies.
“Good” Cayman Company
But, there are good, legal
uses of a Cayman Island Company.
For example, assume a U.S.
parent company is doing business in Germany. The U.S. company incorporates a
German subsidiary. (Local laws in Germany force the U.S. parent company to do
so, trust me on this.) The German subsidiary earns a profit and is ready to
pay a dividend. The German subsidiary has already paid +30% German corporate
income tax on the German-based profits.
Let say the U.S. parent
company wants to build a new factory in France. Again, trust me, the U.S.
company will be forced to establish a French subsidiary that will own the new
factory, sales, marketing, finance, admin, and other activities required to run
a business in France.
Can the German subsidiary
just give its profits to the French subsidiary to use to build the factory?
NO! U.S. tax law says that transaction is a taxable dividend payment, first, to
the U.S. parent company and, second, a contribution of funds from the U.S.
parent company to the French subsidiary. This is known in the tax world a
“round-tripping” and has bad tax consequences.
Let’s analyze what happens with round-tripping.
The U.S. parent company is taxed on the dividend from Germany. Up to a
35% U.S. tax is imposed (less a credit for a share of the German tax paid on the
same income -- it gets complex. IRC Sec. 902).
Simplistically, if the German
tax rate is about 30% and the U.S. rate is 35%, the difference of
5% (it is
actually more due to withholding taxes paid to Germany and allocations under
U.S. tax law [Reg. 1.861-8] ) is lost
money, just for the right to send the
money back out to France to build the factory.
Therefore, the better answer is to create a Cayman Island holding company and
move (referring to the subsidiaries only by their country) Germany and France to
become subsidiaries of Cayman. A dividend from Germany to Cayman (of
“active” business income – not investment income earned in Germany) escapes U.S.
taxation as no cash arrives in the U.S. parent company bank account.
Cayman now contributes the dividend cash from Germany to France which then
builds the factory. The round-trip is through tax-free Cayman and
not the U.S. The corporate tax rate in Cayman on the dividend is zero.
It is still not a complete free-lunch due to withholding taxes imposed by
Germany on payments to Cayman. That’s why the Netherlands is used, because
the withholding tax under the tax treaty between the Netherlands and Germany on
a dividends paid to the Netherlands from Germany is less….but let’s stick with
Cayman for now.
Warning: Don’t go off and
move existing subsidiaries under Cayman without good tax advice. Large U.S.
taxable events can result.
The reason this so-called
“deferral” structure has evolve is, as the Wall Street Journal wrote on May 6th:
“The
current tax-deferral system is a clumsy attempt to deal with the fact that most
countries don’t tax their companies’ overseas profits. A Germany firm doing
business in Ireland, say, pays no German income tax on its Irish profits but it
does pay Ireland’s corporate income tax at its 12.5% rate. The U.S. company
competing with the German business in Ireland by contrast, pays Ireland the same
12.5% on its profits – and it then pays Uncle Sam up to 35% minus a credit for
what it paid the Irish.”
The German company in the WSJ example NEVER faces additional tax on the Irish
income, no matter what it does with the related cash dividend.
On the other hand, the U.S. company faces incremental U.S. tax if that cash ever
touches a U.S. bank account of the U.S. parent company or U.S. related
parties…or is deemed, under the tax law, to have round-tripped through the U.S.
parent company, as in my earlier example. What a legal mess.
So, the long-held deal Congress made was to avoid the U.S. tax as long as the
money was never “repatriated” to the U.S. parent company, and, further never
distributed as a dividend to the shareholders of the U.S. parent company.
Fair Deal!
Hence, intermediary tax-haven holding companies are used to move cash around
outside the U.S. to allow multi-national businesses to build, expand and
compete outside the U.S. Just what a good tax policy should encourage, aye!
GOOD Cayman, Bermuda,
Netherland holding companies, etc. are just a tool to do what Congress intended
and is in the best interest of U.S. based multi-nationals, and, may I say, the
U.S. voters they employ.
Capital, intellectual property
and human resources are movable. A pseudo patriotic view that “these companies
can’t just up and leave” if deferral structures become illegal or severally
limited, is naïve. Just arrange a visit to any Silicon Valley Board of
Directors meeting to see what I mean.
The I.R.S. would find itself
in endless court battles regarding outbound transfers of technology…assuming
they have the resources and expertise to even identify and develop the issues.
When the “crown jewels” of a
company, in terms of intellectual property, can be transmitted anywhere in the
world with a few clicks of a mouse, I submit that deferral structures are – as
Martha Stewart would say -- “a good thing.”
The GOOD CAYMANs should be
encouraged!
So, please Mr. President,
split the baby. Go get the bad Caymans and encourage the Good Caymans.
I can always be reached for
comments or questions at (510) 797-8661 x237.
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