Interview with Jeff Short & Keiran Hutchison – Although introduced a few years back, Financial Interpretation Number 48 (FIN 48) has recently become a high priority focus for Cayman fund managers involved in the liquidation of their fund(s). “Initially people were uncertain as to whether or not cheques would need to be written to various tax authorities around the world,” explains Jeff Short (AM partner) Ernst & Young.
But that is now becoming reality. Continues Short: “As they wind down their funds, investment managers and directors don’t want to find themselves exposed to potential off balance sheet tax liabilities at a later time and are consequently looking at FIN 48 much closer now.”
FIN 48 was created in 2006 to establish a framework requiring businesses to analyze and disclose all income tax risks that are less than certain. For managers, this is especially important when they choose to wind up the fund.
Of current concern is an area of legal ambiguity embedded in Cayman law and how it relates to FIN 48.
Keiran Hutchison, restructuring partner, Ernst & Young, explains:“Under Section 139 subsection 2 of the Companies Law there is a provision that says that foreign taxes are only admissible to prove to the extent that they are enforceable in accordance with the Foreign Judgments Law (FJL) in Cayman. The general principal in Cayman is that foreign tax liabilities are not claimable because the island is a corporate tax-free jurisdiction and foreign taxes are not applicable. However, what this provision says is that if another country has been given recognition under the FJL then it is possible that that tax could be enforced although the provision itself contains an inconsistency.”
To date, the only country to register under the FJL is Australia. However, mindful of the need to attract alternative investments, the Australian government has enacted a law to restrict the liability of foreign investment.
Of wider concern is that tax authorities in European jurisdictions like Spain are getting more proactive. Hutchison says that in one or two recent cases where Ernst & Young has been liquidating a fund, the Spanish tax authorities have written to them highlighting that the fund had traded Spanish securities and was therefore on the hook for accrued tax liabilities. Furthermore, despite technically not being able to enforce a judgment in Cayman, the Spanish authorities pointed out that not only were the fund’s directors liable for tax, but the liquidator also.
“This is bad news because no fund director is going to want a tax debt hanging over their head. This has all sorts of implications for their ability to conduct business in Spain in the future,” says Hutchison.
If Spain adopts this approach, what’s to stop other European jurisdictions doing the same? However, it’s not all doom and gloom.
“In one case we agreed with the fund managers that we would negotiate with the Spanish tax authorities to settle the tax liability which we were able to do quickly and conclude the fund’s liquidation.
“In another case involving the Spanish tax authorities they failed to claim under the process so we decided we could distribute the fund. If the tax authorities were to try to pursue a claim in the future they would have no standing as they had failed to respond to a recognised proving procedure.
“This shows that we can use the Cayman liquidation process to our advantage to bring about a successful resolution.”