Cayman Islands is situated in Caribbean Sea, 480 miles southwest of Miami, USA. The three islands are spread over 101 square miles, have a population of 65,000 and gross domestic product (GDP) of $5.5 billion, slightly more than that of the Union Territory of Puducherry.
Still, it was the third-largest contributor of equity foreign direct investment (FDI) in India in the first six months of FY21 ($2 billion). Only Singapore ($8.3 billion) and the US ($7.13 billion) were ahead. The tiny British Overseas Territory even bettered Mauritius, traditionally the biggest source of FDI into India.
The emergence of Cayman Islands as India's biggest FDI source is not a one-off event triggered by the Covid-19 pandemic. The trend had been taking shape for the last two-three years, but became more visible only in FY20 when the island became the fifth-largest source of FDI ($3.7 billion). It had entered the top 10 (sixth rank) only in FY18. While it topped countries such as France, Germany, the UK and Japan in the last three years, if trends for the current financial year hold, it may outflank Mauritius, traditionally the number one FDI source, in FY21.
Why is a country half the size of Puducherry emerging as one of India's biggest FDI contributors? Is it the new Mauritius - a typical no-tax, low-compliance jurisdiction, which investors take advantage of to route ill-gotten money into India? Or is there more to it than meets the eye - a China connection, may be?
The rise of Cayman Islands went parallel with both Mauritius and Singapore losing their tax advantages after India modified its tax treaties with these two countries. The new India-Mauritius and India-Singapore tax treaties that came into force from April 1, 2017 took away some of the tax advantages of routing investments through these jurisdictions. Cayman Islands, on the other hand, does not have a tax treaty with India but only a Tax Information Exchange Agreement, signed in 2011. This could have meant double taxation for investors but for the fact that Cayman Islands does not impose income, corporate, capital gains or other direct taxes such as payroll and withholding taxes. According to the The Organisation for Economic Co-operation and Development (OECD), Cayman Islands has had tax treaties with just 10 countries, of which only eight were in force in the first half of 2020. So, is it gaining at the cost of Mauritius and Singapore?
Amit Jindal, Co-founder of chartered accountancy firm Felix Advisory, says Cayman's no-tax territory status is a big reason for investors shifting there. "Unlike most countries, Cayman doesn't have corporate tax, making it an ideal place for multinational corporations to base subsidiary entities to shield some or all of their income from taxation," he says.
Akhilesh Ranjan, former member of the Central Board of Direct Taxes (CBDT), who was also in charge of the administration of international taxation and transfer pricing in India, says there was a shift from Mauritius to Singapore after the amendment in the Mauritius treaty. "Though both the treaties were amended at the same time, Singapore already had a Limitation of Benefits clause, which specified some objective parameters. So, there was an element of certainty in Singapore, which was not there in Mauritius, which is why substantial investments shifted from Mauritius to Singapore," he says. However, he refuses to say that the surge in FDI from Cayman Islands is only due to low tax rates there. "There are no clearly identifiable reasons. Of course, it is a low-tax jurisdiction, but so are others," he says.
Virendra Nath, Managing Director, APC Partners of Hong Kong, which has a Cayman Islands-based FPI (APC Prestige Fund) registered in India, says Cayman is preferred not because it is a tax haven, but because it offers a tax neutral jurisdiction. "Our investors are from different territories. If I put the fund in Hong Kong, I will benefit certain investors (from countries which have tax treaty with Hong Kong) and not certain others (from countries which have no tax treaty with Hong Kong). So, I have to put my fund in a place that is neutral to all." As Cayman is a no-tax jurisdiction, investors do not have to worry about being taxed twice if their country has not signed a tax treaty with it. He tries to dispel what he calls is a 'misconception' associated with tax havens by saying that even if an entity based in Cayman Islands does not pay tax, investors in the fund pay tax wherever they are supposed to. "Our fund is based out of Cayman Islands, and when I am investing in India, I am paying taxes (in India). So, where is the question of tax haven?" he says.
Tax rates for foreign investors in India are specified in tax treaties with their countries, but as Cayman Islands does not have a treaty with India, investors have to pay tax in India - short-term capital gains at 15 per cent and long-term capital gains at 10 per cent.
A total of 339 Cayman Islands-based FPIs are registered with the Securities and Exchange Board of India; these invest only in listed securities. The purpose of their investments is not management control.
At the height of tension with China at the Ladakh border last year, the Indian government issued a press note on April 17, 2020, putting restrictions on investments from border countries, including China. The aim was to curb unchecked Chinese investments. The sharp jump in equity FDI from Cayman Islands in the April-September 2020 period set tongues wagging that Chinese investors might be routing money through Cayman. Is this true?
Cayman has always been a favourable jurisdiction from the perspective that regulators there do not ask for investor details, says Nischal Arora, Director, Nangia & Andersen India. "China and all neighbouring countries got banned in April 2020. They had to find a way to come in. Not everyone could have waited for their applications to be cleared. They had to find different avenues," he says, insinuating that Chinese investors might be using the Cayman Islands route.
Since there are no strict guidelines by Sebi and RBI on screening Chinese investors, some banks are strictly screening all Chinese investments, while others may be going by the 10 per cent or 20 per cent ultimate beneficial ownership checklist, adds Arora. Smaller holdings (less than 10 per cent) might still be getting approved despite the government order.
According to Dhaval Jariwala, a Mumbai-based chartered accountant, who works with a few Cayman Islands-based funds, the ban is more from the perspective of Chinese investors taking controlling stake in Indian companies. "The government is not closely looking at FPI investments from China. FPIs cannot invest more than 10 per cent in a company, and the moment they cross this, they have to characterise their investments as FDI," he says. The government won't be too closely looking at Chinese investors putting money in a Cayman Islands-based vehicle registered as FPI as their intent is not to have a controlling stake, he adds.
Virendra Nath of APC Partners rejects any such insinuation. "(To say that) Chinese investors are sneaking in through Cayman Islands is totally wrong. Sebi has issued licence (to FPIs), and that should lay all other questions to rest," he says.
A fund, in order to invest in India, needs Sebi approval, he adds. "Sebi looks at a lot of things - whether the fund has an independent money laundering reporting officer and an independent administrator, whether the fund follows see-through requirements. The underlying investors have to be known."
Ease of Doing Business?
None of the experts BT talked to attributed the rising FDI from Cayman Islands to zero-tax jurisdiction. Most point towards its easier and low-cost compliance regime and relaxed regulatory norms that allow investors the much-needed secrecy.
The mutual evaluation report on Cayman Islands published by the Financial Action Task Force (FATF), the global money laundering and terrorist financing watchdog, says the territory is the worlds sixth leading global financial services centre. It says the majority of financial services are targeted towards non-residents, particularly high-net worth individuals and institutions, from a variety of jurisdictions, not all with robust measures against anti-money laundering or financing of terrorism. The financial services sector accounts for approximately 40 per cent GDP of Cayman Islands and employs 3,424 persons or 8.4 per cent of the workforce. Banking, securities and investments and, to some extent, insurance industries dominate the financial landscape, says the report. Jariwala says a number of investors in Europe and the US get comfort from the fact that it's a British territory. "European or US investors looking for a pooling vehicle prefer Cayman Islands as they are pretty much familiar with rules, regulations and documentation," he says.
Low cost of setting up funds and compliance are also big pull factors. "Lower cost of operations and compliance requirements make Cayman Islands attractive. There has been a dip in FDI from Mauritius and Singapore and Cayman Islands, with its low operating cost, is increasingly replacing the two," says Divakar Vijayasarathy, Founder and Managing Partner, DVS Advisors LLP. Increasing regulations and costs in Singapore and grey-listing of Mauritius have been key triggers for the rise of Cayman Islands.
According to an estimate by Jariwala, setting up a fund in Singapore costs anywhere between $90,000 and $1,00,000, while the annual compliance cost is $60,000-80,000. In comparison, the cost of setting up a fund in Cayman Islands is $70,000 and annual compliance cost is around $30,000. Cost of compliance is lower in Mauritius, though.
Though Cayman Islands is rated largely compliant by the FATF based on its 40 Recommendations - a set of counter-measures against money laundering - the anti-money laundering global body says in its report that "a portion of the securities sector is subject to limited supervision and not subject to monitoring for anti-money laundering and CFT (counter financing of terrorism) compliance or risk assessment." This, says the FATF report, is a potential source of money laundering and terror financing risks.
Could these lax supervisions be the reason for investors looking for a veil of secrecy? Akhilesh Ranjan, former CBDT member, says, "Now, the thrust is on transparency and tax rates are not so much an issue, so people are looking at jurisdictions that are more opaque than others."
However, Virendra Nath of APC Prestige says Cayman is favoured because it is more compliant. "The reason is that it is FATCA compliant, which Mauritius is not as of now. FATCA is all about anti-money laundering regulations, and when it comes to these regulations, Cayman is no different from Hong Kong or any other FATCA-compliant countries," he adds.
The Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions and certain other non-financial foreign entities to report on foreign assets held by their US account holders or be subject to withholding tax.
Though there are no definite answers for the reasons for the surge in investments from Cayman Islands, the trend will certainly be keeping the government on its toes. Meanwhile, December quarter FDI numbers may dispel the mystery shrouding the FDI numbers.