1. International Tax Proposals and Their Implications for Cayman Gary Clyde Hufbauer Reginald Jones Senior Fellow Peterson Institute for International Economics Cayman Finance Summit May 6, 2010

2. 2 International Tax Reform Proposals The fiscal 2011 budget blueprint, released February 2010, proposes to raise about $122 billion over the next 10 years by increasing taxes on MNC income earned abroad. The international tax proposals in this year’s blueprint are downscaled from last year (then projected to raise about $210 billion over 10 years)  Remaining: proposals to tighten the foreign tax credit and curtail deferral, limit “earnings stripping”, prevent equity swaps to avoid dividend withholding taxes, repeal the 80/20 and dual-capacity rules, and combat under-reporting of income.  Dropped: proposals to revise “check-the-box” rules for foreign entities.  Newly Added: provisions to curtail intangible property transfers and disallow the deduction for excess non-taxed reinsurance premiums paid to foreign affiliates.

3. 3 Obama’s International Tax Reform Proposals Include: Defer deduction of interest expense related to deferred income Determine the foreign tax credit on a pooling basis Prevent splitting of foreign income and foreign taxes Tax excess returns from intangibles transferred to offshore entities Limit shifting of income through intangible property transfers Disallow deduction for “excess” reinsurance premiums Limit earnings stripping by expatriated entities Repeal 80/20 company rules Prevent equity swaps to avoid dividend withholding taxes Modify tax rules for dual capacity taxpayers Combat under-reporting of income by offshore entities

4. 4 Extend Subpart F to Intangibles The 2011 budget dropped a proposal to abolish “check- the-box” rules which allow US MNCs to shift income from high-tax countries to affiliates in low-tax countries. However, new proposals would expand Subpart F anti- deferral rules with respect to the transfer of intangibles.  Under the proposal, the “excessive return” earned by a CFC “subject to a low effective tax rate in circumstances that evidence excessive income shifting” in connection with intangibles transferred by a US MNC would be treated as Subpart F income and taxed currently.  The new proposal takes aim at the transfer of licenses, patents, and trademarks to subsidiaries in low-tax countries.  These changes, if enacted, will hamper US MNCs compared to foreign MNCs. The core idea is to impose a US tax on income earned in low- tax jurisdictions, without the need to show an improper transfer price.

5. 5 Implications: MNCs and Low-Tax Countries A January 2009 GAO report noted that of the 100 largest US corporations, 83 have subsidiaries in “tax havens” – defined as low-tax countries.  In Cayman, one address houses 18,857 corporations, few of which have a physical presence. Nothing wrong with this, but such statistics excite antagonists. It’s good news for MNCs and Cayman that the check-the-box limitation was dropped, but the proposal to extend Subpart F is worrisome.  The extension of Subpart F is motivated by three forces: [a] the need for revenue; [b] the difficulty of proving improper transfer pricing of intangibles; [c] academic research which guesstimates that US MNCs avoid about $60 billion of US taxes annually by concentrating income in low-tax jurisdictions. The denial of a deduction for “excess” reinsurance premiums raises important tax discrimination issues.  If this measure passes, it will be challenged in the WTO and under bilateral tax treaties. The EU has registered strong objections.

6. 6 Cayman’s Answer: Transparency + Exchange of Information  On March 25, Cayman announced that will conclude a further 16 tax information exchange agreements with several G-20 jurisdictions of economic significance, on top of the 14 agreements already in place.  Senators Baucus and Grassley support a beefed-up information exchange approach (the HIRE act). When enacted, this will put to rest fears that Cayman banks are a vehicle for tax evasion by US citizens and residents.  The exchange of information approach could become a model for US tax relations with low-tax countries around the world.

7. Financial Regulation = Opportunity for Cayman If US financial regulation separates proprietary trading from commercial banking (the “Volcker rule”), Cayman should make every effort to attract proprietary traders. This would be a golden opportunity, akin to what the Interest Equalization Tax of the 1960s did to create the Eurodollar market in London. 7