The Cayman Islands is a United Kingdom Overseas Territory located in the Caribbean Sea south of Cuba and northwest of Jamaica, with a total land area approximately 1.5 times the size of Washington, D.C., and a population of 47,862. While geographically small, the Cayman Islands is a major offshore financial center (OFC) with no direct taxes that attracts a high volume of U.S.-related financial activity, often involving institutions rather than individuals. Although not easily defined, OFCs are generally described as jurisdictions that have a high level of nonresident financial activity, and may have characteristics including low or no taxes, light and flexible regulation, and a high level of client confidentiality. The Cayman Islands reports that in 2008 it had 277 licensed banks, over 80,000 registered companies, more than 9,000 registered investment funds, and 760 captive insurance companies. According to the Department of the Treasury, U.S. investors held approximately $376 billion in Cayman-issued securities at the end of 2006, making it the fifth most common location for U.S. investment in foreign securities. As of September 2007, U.S. banking liabilities to the Cayman Islands were the highest of any foreign jurisdiction, at nearly $1.5 trillion. As of June 2007, U.S. banking claims on the Cayman Islands stood at $940 billion, second only to the United Kingdom. The international law firm of Maples and Calder, with its associated businesses - Maples Corporate Services Limited and Maples Finance Limited - is the sole occupant of Ugland House. Its business is to facilitate Cayman Islands-based international financial and commercial activity for a clientele of primarily international financial institutions, institutional investors, and corporations. Similar to corporate service providers in the United States, Maples Corporate Services Limited provides registered- office services, using Ugland House as a registered address, to entities it establishes. Registered-office services include activities such as maintenance of certain entity records and filing of statutory forms, resolutions, notices, returns, and fees. Cayman Islands law requires company-service providers like Maples and Calder to adhere to specific Anti-Money Laundering (AML) and Know-Your-Customer (KYC) requirements. For example, they must verify and keep records on the beneficial owners of entities to which they provide services, the purpose of the entities, and the sources of the funds involved. Very few Ugland House registered entities have a significant physical presence in the Cayman Islands or carry out business in the Cayman Islands. According to Maples and Calder partners, the persons establishing these entities are typically referred to Maples by counsel from outside the Cayman Islands, fund managers, and investment banks. As of March 2008 the Cayman Islands Registrar reported that 18,857 entities were registered at the Ugland House address. Approximately 96 percent of these entities were classified as exempted entities under Cayman Islands law, and were thus generally prohibited from carrying out domestic business within the Cayman Islands. Maples and Calder senior partners told us that approximately 5 percent of the entities registered at Ugland House were wholly owned by U.S. persons, while 40 to 50 percent were related to the U.S. in that they had a billing address in the United States. A U.S. billing address does not necessarily imply ownership or control. According to the partners, U.S. persons associated with Ugland House registered entities are often participants in investment and structured-finance activities, including those related to hedge funds and securitization. Entities associated with these activities are not generally directly owned or controlled. For instance, investment-fund entities are often established as partnerships and are essentially owned by the fund’s investors. Structured-finance entities are not typically carried on a company’s balance sheet, and ownership can be through a party other than the person directing the establishment of the entity, such as a charitable trust, or spread across many noteholders or investors, such as in deals involving securitization. The entities created by Maples and Calder that are directly owned or controlled include corporate subsidiaries, such as those used by multinational corporations to conduct international business. U.S. persons who conduct financial activity in the Cayman Islands commonly do so to gain business advantages, including tax advantages under U.S. law. Although such activity is typically legal, some persons have engaged in activity in the Cayman Islands, like other jurisdictions, in an attempt to avoid detection and prosecution of illegal activity by U.S. authorities. The Cayman Islands may attract U.S-related financial activity because of characteristics including its reputation for stability and compliance with international standards, its business-friendly regulatory environment, and its prominence as an international financial center. For instance, because the Cayman Islands’ legal and regulatory system is generally regarded as stable and compliant with international standards, U.S. persons looking for a safe jurisdiction in which to place funds and assets may choose to carry out financial transactions there. Additionally, establishing a Cayman Islands entity can be relatively inexpensive—an exempted company can be created for less than $600, not taking into account service-provider fees. Further, U.S. persons may also be attracted to the Cayman Islands because it is proximate to the United States, operates in the same time zone as New York, and is English speaking. Another frequent reason for doing business in the Cayman Islands is to obtain tax advantages, such as through reduction or deferral of U.S. taxes. For instance, U.S. tax-exempt entities, such as university endowments and pension funds, may invest in hedge funds organized in the Cayman Islands in order to avoid the unrelated business income tax (UBIT). The investment income of U.S. tax-exempts may be subject to UBIT if earned by an investment vehicle organized as a U.S. partnership, a formation common among U.S.-based hedge funds. However, tax-exempts that invest in hedge funds organized as foreign corporations in jurisdictions like the Cayman Islands can be paid in dividends, which are not subject to UBIT. Additionally, some U.S. persons may use Cayman Islands entities to defer U.S. taxes. For example, a U.S.-based multinational business may create a Cayman Islands subsidiary to hold foreign earnings, which are not generally taxed in the United States unless or until repatriated. Because the Cayman Islands, like some other OFCs, has no direct taxes, Cayman subsidiaries do not incur additional taxes owed to the Cayman Islands government. One indication of the extent to which U.S. companies use Cayman entities to defer taxes is their reaction to a recent tax law. In 2004, Congress approved a received dividend reduction for certain earnings of foreign subsidiaries of U.S. companies repatriated for a limited time. Approximately 5.5 percent of the nearly $362 billion repatriated between 2004 and 2006 came from Cayman Island controlled foreign corporations. Lastly, as with other offshore jurisdictions, some U.S. persons may establish entities in the Cayman Islands to illegally evade taxes or avoid detection and prosecution of illegal activities. The full extent of illegal offshore financial activity is unknown, but risk factors include limited transparency related to foreign transactions, and difficulties faced by U.S. regulators and the courts in successfully prosecuting foreign criminal activity. Voluntary compliance with U.S. tax obligations is substantially lower when income is not subject to withholding or third-party-reporting requirements. Because U.S.-related financial activity carried out in foreign jurisdictions is not subject to these requirements in many cases, persons who intend to evade U.S. taxes are better able to avoid detection. Persons intent on illegally evading U.S. taxes may be more likely to carry out financial activity in jurisdictions with no direct taxes, such as the Cayman Islands, because income associated with that activity will not be taxed within those jurisdictions. Individual U.S. taxpayers and corporations are generally required to self- report their taxable income to the Internal Revenue Service (IRS). Similarly, publicly owned corporations traded on U.S. markets are required to file annual or quarterly statements with the Securities and Exchange Commission (SEC). When an individual or corporation conducts business in the Cayman Islands, there is often no third-party reporting of transactions, so disclosures to IRS and U.S. regulators are dependent on the accuracy and completeness of the self-disclosure. Cayman Islands financial institutions are often not required to file reports with IRS concerning U.S. taxpayers. This makes it more likely that there would be inaccurate reporting by U.S. taxpayers on their annual tax returns and SEC required filings. In addition to the information that both IRS and SEC receive from filers of annual or quarterly reports, the U.S. government also has formal information-sharing mechanisms by which it can receive information from foreign governments and financial institutions. In November of 2001, the United States signed a Tax Information Exchange Agreement (TIEA) with the government of the United Kingdom with regard to the Cayman Islands. The TIEA provides a process for IRS to request specific information related to taxpayers. IRS sends TIEA requests to the Cayman Islands based on requests from inside the agency. In addition to the TIEA, the U.S. government and the Cayman Islands also entered into a Mutual Legal Assistance Treaty (MLAT) in 1986. The MLAT enables activities such as extraditions, searches and seizures, transfer of accused persons, and general criminal information exchange, including in relation to specified tax matters. Since the TIEA began to go into effect, IRS has made a small number of requests for information to the Cayman Islands. An IRS official told us that those requests have been for either bank records of taxpayers or for ownership records of corporations.