Uproar over Romney's finances highlights the world's most unlikely financial capital

The island has been garnering a lot of publicity this week, not the good kind, thanks to the scrutiny of presidential candidate Mitt Romney's tax returns, which include millions of dollars in foreign investments. According to ABC News, Romney has as much as $8 million invested in 12 Cayman Islands funds. (The governor has money parked in Bermuda, Ireland and Luxembourg as well.)

Romney's Cayman riches aren't actually a new story. The LA Times reported in 2007 that the former Massachusetts governor was listed as a general partner and investor in BCIP Associates III Cayman, a fund set up by his old employer Bain Capital. Bain has as many as 138 funds registered in the Caymans, according to ABC. The BCIP fund is registered at P.O. Box 908GT in George Town, the Caymanian capital. This is the address of Walker House, the local office of international law firm Walkers. It's also, on paper at least, home to dozens of other companies, including Del Monte Fresh Produce Inc., the global food giant physically headquartered in Coral Gables, Florida.

Walker House is just one of a number of addresses in downtown George Town used by corporations, including Coca-Cola, Oracle and Intel, to minimize taxes or cut out the red tape in international transactions. The vast majority of these companies are legally prohibited from doing business in the Caymans themselves. The most famous of these addresses, located just down the road at 335 South Church St., is Ugland House, a five-story office building that is home physically to law firm Maples and Calder and, on paper, nearly 19,000 companies.

President Barack Obama called out Ugland House specifically in a 2009 speech, saying "either this is the largest building in the world or the largest tax scam in the world." Legally speaking, it's neither. A 2008 GAO report found no evidence of illegal activity by Maples and Calder or any of the entities registered at Ugland House, about half of which have billing addresses in the United States. But, particularly in the case of hedge funds and private equity funds like Bain's, about 38 percent of Ugland's "tenants," the building makes a mockery of the US tax system.

As Romney's campaign has repeatedly stated, investors in these funds do pay US taxes on their income. But there are significant financial incentives in having a Cayman address. First of all, the British territory has no direct taxes, and makes it exceptionally easy to set up a new company; doing so costs only about $600. A fund with a Cayman address also allows foreign investors to invest in US-run funds, such as the bricks-and-mortar incarnation of BCIP Associates on Huntington Avenue in Boston, while avoiding double-taxation in both the United States and their home countries.

A managing partner of Maples and Calder told Bloomberg in 2009 that "having a registered office address in the Cayman Islands is driven by commercial considerations, not by tax avoidance," but there are tax advantages for US investors. Under US tax law, a person is taxed on all foreign income. But a foreign corporation is not taxed on foreign income until it is distributed to shareholders, meaning greater returns for investors like Romney. The Caymans also allow US non-profit entities like pension funds and university endowments to invest in hedge funds without paying the "unrelated business income tax," which could be as high as 35 percent if those funds were based in the United States.

There are also concerns that the complexity and lack of transparency in Cayman Islands transactions can make tax evasion and money laundering easier, though there's no evidence that Bain or Romney were involved in these activities and the vast majority of Cayman Islands transactions are entirely legal.

This is not to say they're popular. The organization Citizens for Tax Justice estimates that the US federal government loses as much as $100 billion per year in revenue due to tax havens. Sen. Carl Levin has proposed legislation that would treat foreign-registered, US-based corporations as American companies for the purposes of tax law. Legislation to shut down the Caymans as a tax haven has been proposed in the British parliament. Given the nearly $5 trillion held by US corporations and individuals in tax-haven countries, though, these motions are likely to face some stiff, and well-funded, resistance.

As for Romney, he argues, "I don't think you want someone as the candidate for president who pays more taxes than he owes." Fair enough, but it will be up to voters to decide what the definition of the word "owes" is.

*Joshua E. Keating is an associate editor at Foreign Policy. © The Washington Post 2012