Hedge Fund Havens Weigh Taxes as Caribbean’s Debt Rivals Greece

Date: Thursday, October 25, 2012
Author: Eric Sabo, Bloomberg

From the Cayman Islands to the Bahamas, hedge fund havens are considering a surprising remedy for widening deficits -- higher taxes.

The Bahamas is planning a town hall to debate a tax overhaul that may include the nation’s first income and sales tax. In the Cayman Islands, which has the highest number of hedge funds in the Caribbean, Premier McKeeva Bush vowed to increase registration fees for the industry after foreign workers balked at a tax on their earnings. Antigua & Barbuda is targeting self-employed workers for tax evasion, with the Finance Ministry calling it “high time” to go after cheats.

Hedge funds and other financial companies such as Bain Capital LLC, co-founded by U.S. presidential candidate Mitt Romney, have invested in the region to help themselves and their clients lower their taxes. Yet widening deficits and debt burdens that rival Greece are causing some Caribbean governments to reconsider the strategy they used to lure investors in the first place.

“They are in a Catch-22,” said Carl Ross, managing director of investments at Oppenheimer & Co. in Atlanta. “If they start raising taxes on expats and trying to extract more blood out of the stone, they make it much less attractive to go there.”

Many countries may not have a choice, said Therese Turner- Jones, deputy division chief of the Caribbean for the International Monetary Fund. At least five Caribbean island nations -- including Jamaica, Antigua & Barbuda and St. Kitts & Nevis -- have undergone debt restructurings since 2004. Grenada missed a Sept. 15 payment on $193 million of bonds before paying investors within a 30-day grace period.

‘Quite Serious’

“The debt dynamics are becoming quite serious for a number of these countries,” said Turner-Jones. “I don’t think anything is off the table in the current environment.”

Low savings rates relative to other emerging markets and a high reliance on external debt after the 2008 financial crisis have taken a “heavy toll” on the region, Standard & Poor’s said in a May 22 report. Economic growth in the region will reach 0.9 percent this year, up from a 0.1 percent contraction in 2011 yet less than the 3.2 percent forecast for Latin America and the Caribbean as a whole, the IMF said Oct. 12.

Cayman Islands Premier Bush withdrew his plan for a 10 percent income tax on foreign work permit holders in August after protests erupted on social networks, with opponents saying the move was discriminatory. Just over half of the 38,000 people working in the territory are foreigners and financial services account for 9.7 percent of jobs, according to the nation’s statistics agency.

Tax Shelters

In addition to serving as a base for hedge funds, the Caymans has also attracted companies such as Facebook Inc. and Medtronic Inc., which use subsidiaries based there to lower U.S. tax obligations.

“It went against everything the Caymans stand for,” said 27-year-old Casey Goff, a local who co-founded the group Caymans United to rally opposition to Bush’s so-called expat tax. “With all these major companies that are registered here, when you start taxing employees that allow that registration to be possible, why come to the Cayman Islands instead of Bermuda?”

The Cayman Islands was home to 10,979 funds as of Sept. 30, up from 9,258 in 2011, according to the country’s monetary authority. The government cites its “tax neutral” policies for fueling growth in the financial services sector. Bush, 57, is now seeking to raise registration and work permit fees to offset a fiscal deficit of about $17 million in the first quarter.

Island Expenses

Peter Hughes, managing director of Apex Fund Services Ltd, said he staffs a small office in the Cayman Islands with local workers to avoid permit fees that cost 70 percent more than his headquarters in Bermuda.

“Cayman is a good place to do business, but it’s more expensive,” said Hughes, whose company manages $23 billion, in a phone interview from Hamilton, Bermuda. “When you’ve got to pay these big work permit fees it makes a massive difference to your cost of hiring.”

The Cayman Islands remains the preferred domicile for hedge funds because of its history of friendly regulation, helping prevent an exodus of money managers naturally averse to new taxes, said Richard Coles, the chairman of Cayman Finance, a trade group.

Cayman Competitors

“The financial world is a realist about this and they understand that Cayman is in a similar revenue squeeze like every other country in the world,” Coles, who was the nation’s attorney general when it enacted laws in 1993 to attract hedge funds, said in a phone interview. “The Caymans has to raise fees, but odds are even our competitors are going to have do exactly the same.”

Cayman Islands dollar bonds have returned 5 percent this year, compared to an average of 15.9 percent for emerging markets, according to JPMorgan Chase & Co. indexes. Dollar debt sold by the Bahamas has returned 9.4 percent over the same period.

With a deficit of $504 million in the 2011-2012 budget, almost double what the government had forecast, the Bahamas also needs to overhaul taxes to boost revenue, Prime Minister Perry Gladstone Christie said in his 2013 budget proposal.

“Our tax system is inadequate to finance a 21st century public administration,” Christie, who was elected May 7, said in his first budget statement. At 19 percent of gross domestic product, the nation’s tax revenue “pales in comparison to that in many other countries, where the ratio is in the mid-20 percent to 30 percent range,” he said.

Credit Rating

S&P lowered its credit outlook on the Bahamas to negative Sept. 24, saying the island’s lack of an income or value-added tax was limiting the revenue base. The country’s BBB rating, the second-lowest investment grade ranking, puts it in a category with Mexico and Russia.

Bahamian officials, who created a Ministry of Financial Services to promote the country as a destination for investment, expect resistance to a proposed income tax when debate begins, said James Smith, a former finance minister who advises the prime minister. The town hall, scheduled for today, was delayed because of Hurricane Sandy.

“We should look at all taxes,” said Smith, chairman of the Nassau-based CFAL investment group. “But historically we shy away from direct taxes on income, so I don’t think we can get a consensus on that.”

Elsewhere in the Caribbean, St. Lucia’s 176,000 inhabitants started paying their first sales tax this month. In Jamaica, the region’s third-largest economy, the government began taxing phone calls after the debt-to-GDP ratio climbed to 140 percent in June, according to the IMF.

Greek-level Burden

St. Kitts & Nevis had the distinction of carrying the Caribbean’s heaviest debt burden last year at 154 percent of GDP, the IMF reported. That compares to 161 percent for Greece, according to a May report by the European Commission. The island nation this year agreed to give hundreds of acres of land to creditors in exchange for canceling $333 million in domestic debt, equal to about 45 percent of GDP.

As a result of the Caribbean tax debate and tighter regulations in the U.S., more hedge funds are inquiring about relocating to Bermuda, said Cheryl Packwood, the head of Business Bermuda, a promotion agency.

Bartenders and Accountants

Marla Dukharan, an analyst with RBC Financial Caribbean Ltd in Trinidad & Tobago, said that Caribbean countries should consider sales taxes over payroll or income taxes for raising revenue since almost 40 percent of workers are employed in the informal sector.

Higher taxes alone may not dissuade hedge funds or other financial companies from investing in the region. Christopher Gregory, a 30-year-old investment manager at Republic Bank Cayman Ltd., said proposed taxes on foreigners are more likely to affect expatriate accountants, hotel workers and bartenders than hedge fund managers.

Nevertheless, countries should be wary of taxes that give funds an incentive to move their business elsewhere, said David Marchant, founder of OffshoreAlert, a newsletter that tracks the offshore financial industry.

“There are only two pillars to the economies of your typical official financial center -- tourism and international business,” he said in a phone interview from Boulder, Colorado. “And international business is only there because of the financial incentive.”