The United States Virgin Islands (USVI) lies 1100 miles southeast of Miami, Florida - and it's one of the most impoverished jurisdictions under the American flag. But most Americans only know the islands as a vacation venue with beautiful resort hotels, white sandy beaches and blue lagoons.
The three principal islands -- St. Croix, St. John and St. Thomas -- have a population of 108,605. Per capita income in the territory is US$18,652. That's less than half the average in the continental U.S. and US$7,000 less than Mississippi, the poorest state.
In addition to extreme poverty, the U.S. Virgins also have another unusual distinction. They have been, until now, America's very own tax haven. But if the IRS and U.S. Senator Charles Grassley have their way, that won't last for long.
U.S. Created Its Very Own Tax Haven
In 1986, the U.S. Congress created special tax breaks to spur economic development in this poor territory. They allowed the Virgin Islands to offer a major tax deal to Americans who moved there to set up a business. Companies and individuals only had to pay 10% of the income tax and other taxes they paid in the United States. (By law Virgin Islanders pay U.S. tax rates, but the money goes to the local government, not Washington.) To qualify for the 10% tax break, companies had to invest at least US$100,000 in the local economy. They had to hire at least 10 people, with 80% of those employees from the Virgin Islands. And finally, they had to contribute US$50,000 or more to local charities.
The EDC launched an aggressive marketing campaign to attract corporations to USVI. As a result, about 100 companies moved to or expanded on the islands between 2002 and 2004, and employed nearly 3,100 people. The tax benefit program began paying dividends almost immediately after hedge funds were invited in 2001. The islands' tax revenue doubled to US$800 million in a five-year period ending in 2005. The increase erased a US$287.6 million deficit for the territory in 1999. The EDC program was worth about US$100 million annually to the local economy. A USVI Government House spokesman said that the EDC was crucial in lifting the territory from a dire financial crisis seven years ago to the present-day projection of a fiscal year surplus in excess of US$50 million.
One Anonymous Note Brought Havoc to the USVI's Tax Advantages
All went well until 2003 when someone sent the IRS an anonymous letter. The letter included marketing materials advertising the territory's economic program as an easy way to legally reduce taxes while living in a sunny Caribbean climate -- which it was. But U.S. Senator Charles Grassley (R-IOWA) saw this as tax evasion, notwithstanding the fact that the law clearly allowed these tax breaks.
The anonymous letter included a Jan. 15, 2002 memo recommending that an unnamed client obtain a post office box in the territory, open a local bank account with the appropriate balance, get a USVI-issued driver's license and register to vote in the islands. On May 20, 2003, the IRS raided Kapok Management LP, a financial-services firm. The IRS accused Kapok Management of sheltering income for dozens of partners who were living on the U.S. mainland. Afterwards, they arrested exactly one Massachusetts life insurance executive in February 2004 for tax evasion charges in St. Croix.
The events prompted the publicity-seeking Grassley, (who at one time was a major critic of the IRS as being too touch on taxpayers), to charge the IRS wasn't acting fast enough to combat what he called tax fraud. An insurance executive, Gary Payne, of Beverly, Massachusetts, had claimed tax benefits without living in the territory. Payne had registered to vote in the territory, got a driver's license there and rented both an apartment and a condominium. He lived and worked full-time in Massachusetts, according to court documents. Facing five years in prison, he reached a plea agreement in exchange for a lenient sentence, which hasn't yet been handed down.
New Strict Six Month Residency Requirement Scares Away
U.S. Companies, Hedge Funds
The Grassley legislation imposed a strict six-month residency requirement and clarified that the territory's tax benefits apply only to income earned exclusively in the islands. This law was slipped into a major tax bill without any hearings, or without even notice to USVI officials, who were stunned to learn it had become law. Congress's Joint Committee on Taxation estimated in a wild guess that Grassley's legislation would increase federal revenue by US$400 million over a 10-year period, which it hasn't so far.
In a reign of terror the Payne case prompted the IRS to open about 100 audits says Marjorie Rawls Roberts, a St. Thomas-based tax lawyer who has advised about half of all USVI-based hedge funds. Roberts says that even her clients who aren't being audited still have to wrestle with the new residency requirement. Since the new law was adopted, 23 of the 49 hedge funds have either halted their activities temporarily or withdrawn from the islands. An expected finance boom never came. Instead, the IRS and Senator Grassley knocked it out with a combination punch of legislation and subsequent IRS rules that are still unclear.
The old rules required a resident to be on the Islands for 122 days a year on average, over three years, to qualify. The new rules require a resident to spend at least 183 days, or roughly six months, every year. The IRS asserted that it had authority to go back as far as it wanted without regard to the statute of limitations. The number of financial firms that make the Virgin Islands their corporate home has fallen to less than 60 from 100 two years ago.
The IRS also drafted an intrusive new form for island residents it says is needed to prove valid residency. The form requires those who stop filing tax returns with the IRS in order to file them in the USVI to list where their immediate family lives, where their cars are registered and where they hold driver's licenses. The form also asks for a list of memberships in social, cultural, professional and country clubs as well as chambers of commerce and political organizations in which the resident participates.
Frank Schulterbrandt, chief executive officer of the EDC says: "In the states, they definitely see that they are losing taxes when some of their taxpayers move elsewhere. All of the people everywhere are competing for the same business. What's wrong with the Virgin Islands attracting some of those people?"
In fact, the betrayal of the Virgin Islands by the federal government, assures only one thing -- that Americans seeking legal tax breaks will instead find them in secure tax havens such as Panama, Belize, the Channel Islands, Singapore and Hong Kong.
Meanwhile, the U.S Virgins have been had.
© Copyright; Foundation for Economic Growth and various authors. Individual authors retain their own copyright.
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