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Cayman Islands, U.S. reach pact to fight tax evasion

By Patrick Temple-West

WASHINGTON (Reuters) - The United States has cut a deal with the Cayman Islands that will smooth implementation in the Caribbean island nation of a new U.S. anti-tax evasion law, while pressuring other low-tax and no-tax countries to follow suit.

Criticized by President Barack Obama and others as a tax haven, the Cayman Islands said it has agreed to cooperate with the Foreign Account Tax Compliance Act (FATCA), enacted in 2010 and set to take effect in July 2014.

The Caymans and the United States have initialed an inter-governmental agreement (IGA) to that effect. The pact is expected to be signed soon, government officials said.

The IGA "will provide certainty to Cayman's significant fund industry with respect to FATCA implementation," Robert Stack, the U.S. Treasury Department's deputy assistant secretary for international tax affairs, said in a statement on Tuesday.

FATCA requires foreign financial institutions to tell the U.S. Internal Revenue Service about Americans' offshore accounts worth more than $50,000. It was enacted after a Swiss banking scandal showed U.S. taxpayers hid substantial fortunes overseas.

The Cayman Islands is one of the world's most popular destinations for investment funds to organize for tax purposes. The island nation of 53,000 people has no income tax and is frequently labeled a tax haven by critics.

In his 2008 presidential campaign, Obama called the Cayman Islands a tax haven.

Banks, funds and other financial institutions that fail to comply with FATCA face a 30-percent withholding tax on their U.S. source income, a penalty that could effectively freeze them out of U.S. financial markets.

With the Cayman FATCA deal in place, Americans "can't use it as a place to hide their money," said Michael Hirschfeld, a tax lawyer with Dechert LLP.

The IGA will ease the FATCA compliance burden on the country's thousands of hedge funds, private equity and mutual funds, which favored an IGA to preserve their access to U.S. markets, said Adrienne Baker, also a tax lawyer with Dechert.

The pact will pressure other low-tax countries, including Luxembourg, Bermuda and the British Virgin Islands, to negotiate FATCA deals with the United States to stay competitive with the Cayman Islands for investment fund business, she said.

The Treasury Department said last November it was exploring IGA deals with a number of low-tax jurisdictions. Ireland and Switzerland, two of the world's favorite low-tax destinations, completed FATCA deals in January and February, respectively.

In all, the Treasury has signed nine IGAs with foreign governments, but is struggling to complete deals with China and Canada, leaving two potential holes in the FATCA dragnet, tax experts said.

The Treasury last month postponed the start of FATCA to July 2014 from January 2014, in part to give U.S. negotiators more time to sign IGAs before the law started.

Other world financial centers are working to comply with FATCA. The Singapore Finance Ministry said in July it was working to finish an IGA. Australia is also close to finishing an IGA, said a tax lawyer familiar with the negotiations.

On August 19, a new registration website is scheduled to open for banks to sign up with the IRS and ensure they are complying with FATCA. Businesses will need to register on this public website by April 25, 2014, to avoid the FATCA penalties.

(Editing by Kevin Drawbaugh and Leslie Adler)

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