Tax and Regulatory Competition Make the Caymans an Ideal Home for Hedge Funds

The New York Times has a detailed story showing how good tax policy and a sensible approach to regulation have made the Cayman Islands the world’s premier domicile for hedge funds. The irritates politicians in Washington and other national capitals, but the article correctly notes that Cayman funds and American investors and managers are obeying all U.S. laws. This leaves two options for politicians. They can engage in fiscal protectionism and try to criminalize free trade in financial services, or they can improve the tax and regulatory environment in America. Sadly, it does not take a political expert to know which route is more likely:

…lucrative tax breaks and fabled financial secrecy have made this British territory a magnet for hedge fund managers. “All of the offshore jurisdictions are competing against each other to provide the most hospitable regulatory landscape, and the Caymans are really coming on strong,” Mr. Grayson says. …In as little as two weeks, and for about $35,000 in fees, hedge funds can set up shop in the Caymans — just a fraction of the time and up to one-tenth the price of incorporating a fund in drearier climes like Delaware. While speed and bargain prices are big attractions, the real draw, say analysts and Congressional investigators, are perfectly legal Caymans-based corporations and partnerships that allow major investors to avoid taxes of up to 35 percent that the Internal Revenue Service levies on unearned business income. Cayman tax laws also help American fund managers legally defer domestic taxes on their personal profits by channeling them offshore through their funds. …it is the corporate home for what the Cayman Islands Monetary Authority estimates to be three out of every four of the world’s hedge funds — more than anywhere else — thanks to its friendly tax and regulatory regimes, as well as an army of foreign bankers, tax lawyers, accountants and fund administrators who make it all work. …foreign individual investors and tax-exempt American investors — like pension plans, hospitals and university endowments — are allowed to put their money into another section of the fund that is registered offshore, in the Caymans. The American institutions have that option because, while they are tax-exempt under American tax law, a United States tax on unearned business income would apply if they invested in a domestic fund. …Some 8,500 investment funds are registered in the Cayman Islands, according to the agency — a near-tripling since 2001.