The Council of the European Union confirmed on Tuesday, 18 February 2020 that the Cayman Islands, a British overseas territory, has been added to the European Union’s ‘blacklist’ of non-cooperative jurisdictions for tax purposes.

In this alert, we explain the background to the European Union blacklist and some of the specific tax and non-tax impacts for businesses that have transactions or structures that involve the Cayman Islands.

Key Takeaways

The Cayman Islands has been added to the European Union (“EU”) blacklist of non-cooperative jurisdictions for tax purposes.

The Cayman Islands is known for not imposing direct taxes on corporations, levying no withholding tax on payments of dividends or interest, and having a minimal tax administration regime. For these reasons, the Cayman Islands is a popular jurisdiction in international tax planning.

The Cayman Islands’ addition to the blacklist means that businesses in Member States of the EU (“Member States”) may now impose additional compliance measures on businesses that have a nexus to the Cayman Islands.

While the additional compliance measures are encouraged, Member States are not obligated to implement them and we are not aware of any significant application of the compliance measures to date.

This Client Alert is relevant for any business that has transacted, or is considering, transacting with, or using structures that involve, the Cayman Islands.

Background

The Council of the European Union (the “Council”) adopted the first list of non-cooperative jurisdictions for tax purposes (the “List”) in December 2017. The initial List of countries was compiled by the Code of Conduct Group on Business Taxation (the “Group”), which took into account criteria such as a country’s commitment to tax transparency, fair taxation, and implementation of anti-Base Erosion and Profits Shifting (BEPS) measures.

From its inception, the List has contained an Annex 1 (the ‘blacklist’), which lists countries that are considered to be non-cooperative jurisdictions for tax purposes, and an Annex II (the ‘grey list’), which lists countries that are identified as being of concern but have committed to addressing these concerns and to becoming compliant with EU criteria. The Cayman Islands was previously grey-listed on the basis that it had been identified by the Group as having a tax regime that facilitated offshore structures which attracted profits without real economic activity. The Cayman Islands committed to address these concerns and enacted the International Tax Cooperation (Economic Substance) Law, which went into effect on 1 January 2019. In spite of this, the Caymans Islands has now been added to the blacklist of countries that do not effectively cooperate with the EU. The Cayman Islands joins American Samoa, Fiji, Guam, Oman, Samoa, Trinidad and Tobago, the U.S. Virgin Islands and Vanuatu, with Palau, Panama and the Seychelles also being added to the blacklist.

The reason for blacklisting the Cayman Islands given by the Council was that the “Cayman Islands does not have appropriate measures in place relating to economic substance in the area of collective investment vehicles.”

To be removed from the blacklist, a country must take steps to effect positive changes in the area of non-cooperation that has been identified by the Group.

What Are The Implications of Being Blacklisted?

The tax impacts include both administrative measures and specific legislative measures.

Administrative tax measures

Following a Council report in December 2017, Member States agreed to apply at least one of the following administrative tax measures, which aim to prevent using the legislation, policies and administrative practices of listed jurisdictions for aggressive tax planning, evasion or abuse:

• Reinforced monitoring of certain transactions;
• Increased audit risks for taxpayers benefiting from the regimes at stake; and
• Increased audit risks for taxpayers using structures or arrangements involving these jurisdictions.

Legislative tax measures

From January 2021, Member States may apply at least one of the four following specific legislative tax measures in their dealings with blacklisted countries, which may be implemented along the lines of the following examples:

• Non-deductibility of costs: The deduction of costs and payments that would otherwise be deductible for the taxpayer are denied when these costs and payments are treated as directed to entities or persons in listed jurisdictions.
• Controlled Foreign Company (CFC) rules: The income of an entity resident, or a permanent establishment situated, in a listed jurisdiction is included in the tax base of the taxpayer.
• Withholding tax measures: Withholding tax is applied at a higher rate when payments (such as interest, royalties, service fees, or remuneration) are treated as received in the listed jurisdictions. We question how Member States may implement this measure in practice, given that most double tax treaties are not governed by domestic law.
• Limitation of participation exemption on profit distribution: The exclusion or deduction of dividends or other profits received from foreign subsidiaries are denied or limited if such dividends or profits are treated as received from a listed jurisdiction.

The non-tax impact of being on the blacklist is the imposition of so-called ‘defensive measures’ which can reduce a country’s access to certain financing and investment under:

• The European Fund for Sustainable Development;
• The European Fund for Strategic Investments; and
• The general framework for securitisation.

Funds from these instruments cannot be channeled through entities in listed countries.

To date, the legislative tax impacts have not been implemented by the Member States and the non-tax impacts are unlikely to be of consequence to commercial entities that do not rely on EU funding.

How does this affect businesses that engage with the Cayman Islands?

These measures are only directed at Member States, and will only be relevant where businesses have a nexus with the Cayman Islands. The measures which each Member State decides to impose will vary among Member States and, because of this variance, the implementation of the measures (and the countries which are added and removed from the List during this time) should be monitored closely between now and January 2021. For a Member State imposing the withholding tax measures, for example, a corporate that is tax resident in a Member State making interest or royalty payments to a Cayman Islands holding company may need to consider whether additional withholding tax on interest payments should be levied. For another Member State imposing the limitation of participation on profit distribution, the repatriation of profit by way of dividend from a Cayman Islands subsidiary to its parent in that Member State may no longer be exempt. In addition to the identified measures, the reputational ramifications of doing business with a blacklisted country may also need to be considered.

Morrison & Foerster tax associate, Kirsten Banks, assisted in the preparation of this client alert.

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