According to the Wall Street Journal, offshore hedge-fund investors could be the next target of the Internal Revenue Service (IRS) and US lawmakers after last week’s agreement between the United States and Swiss governments over secret Swiss bank accounts held by US citizens.

This means that US investors in Cayman Islands hedge funds, who have failed to report earnings to the IRS, will likely be the next target of US tax authorities.

At issue here are two factors: a failure by US taxpayers to report income and the secrecy in the offshore jurisdictions that allows US citizens to think they can get away with such non-reporting.

Indeed, the thrust of the “Stop Tax Haven Abuse Act”, currently before the US Congress is the identification of so-called “offshore secrecy jurisdictions” and imposition of far-reaching sanctions against them.

Needless to say, the Cayman Islands is one such “secrecy jurisdiction” listed in the draft legislation.
The UBS case at the root of the matter has been making waves in financial circles for quite a while now and the ramifications are likely to be felt further and further afield.

Briefly, the IRS’s agreement with the Swiss government and UBS AG will result in thousands of Americans who thought they had a secret Swiss bank account having their names and account details turned over to US tax authorities.

Thus the celebrated Swiss banking secrecy turned out to be not so sacrosanct after all and the misguided activities of UBS bankers in reliance on such secrecy have led to all sorts of recriminations in Switzerland itself.

As one Swiss commentator puts it: “These people dragged UBS from being a flagship bank into a basket case requiring a government bailout that threatened to pull down the entire national economy.”

Inevitably, the Cayman Islands always seems to get a mention: “In [court] documents, UBS shows every sign of being a criminal organization, helping tax cheats move money surreptitiously skimmed off of transactions conducted in the United States by way of the Cayman Islands.”

Having followed in the footsteps of Switzerland in terms of adopting strict banking secrecy, perhaps we should now be learning from the Swiss experience instead of waiting until we are forced to do so by the US.

Cayman has earned a reputation as a “secrecy jurisdiction”, largely as a result of the Confidential Relationships (Preservation) Law and, as we have pointed out in recent months, this particular piece of legislation has, first, outlived its usefulness and, second, may now be counterproductive to what the country is trying to achieve in terms of its reputation as an international finance centre.

The latest developments in the UBS saga serve to reinforce our view on this issue.

Anthony Travers, Chairman of the Cayman Islands Financial Services Association (CIFSA), had called for a prompt full or partial repeal of the Confidential Relationships Law prior to the general elections in May. However, the government at that time wanted to wait and assess the impact of such amendment or repeal.

A subsequent proposal by the Cayman Islands Monetary Authority (CIMA) to make available an online public database of hitherto unpublished details of managers, investment strategies, etc., of locally established and administered hedge funds resulted in the difference between privacy and secrecy being highlighted in the debate that followed.

In particular, some of the local fund managers sounded a note of caution that any such disclosure may well infringe the contractual or otherwise reasonably expected right to privacy on the part of individual clients.

Further, the Leader of Government Business and Minister for Financial Services, Hon. McKeeva Bush, also expressed the view that it may not be in our best interests to introduce such a change.

As we pointed out, there is a big difference between privacy and secrecy and, in throwing out the bathwater of secrecy; we don’t want to make the mistake of also throwing out the baby of privacy.

Furthermore, the nature of the proposed disclosures was unlikely to provide the kind of transparency sought by the US authorities. The IRS will simply be interested in the identities of any US taxpayers.

Perhaps this is a subject that will be discussed at the local “economic summit” due to be held today at the Ritz Carlton this Thursday, but who knows. In any event, it would behoove all stakeholders to address the secrecy jurisdiction issue while at the same time preserving reasonable privacy, before we become as UBS has been described – a “basket case”.