Why does Mitt Romney have money in the Caymans? Two potential reasons.

Mitt Romney’s official residence is Belmont, Mass., a suburb of Boston. But at least a part of his money resides in the Cayman Islands, best known to many Americans as a nice place to escape winter.

Mr. Romney says he reports his income from there and pays his taxes – and will prove it in April or whenever he releases his taxes – assuming he does.

But why was it there in the first place?

The Cayman Islands used to be known as a “tax haven,” a place where people could set up an account with a friendly banker whose lips were sealed. However, tax experts, say in 2009 the Caymans agreed to exchange tax information with at least a dozen IRS-type organizations around the world. Suddenly, it became more difficult to hide assets or income and some banks actually shut down their operations on its sunny shores.

But there could be other reasons to use the Caymans to store millions, other than the discreet bankers.

One of the reasons could relate to Bain Capital, which Romney founded and ran from 1984 to 1999. The company could have been trying to attract foreign investors who did not want to deal with the US tax code. A Cayman Islands-based company could invest in US companies and then move their profits offshore.

“A company that is set up in the Caymans would not subject their foreign investors to US taxation,” says Seth Cohen, a principal in the accounting firm WeiserMazars in New York.

But Romney is a US investor and must report his income to the IRS, which he apparently has done. “Because he [Romney] is reporting this we know he is obeying the law,” says Mr. Cohen. “If we did not know about his Cayman’s investment that would be a problem.”

However, some other tax experts think Romney may have had a different reason for having money in the Caymans.

While Romney says he paid taxes on his Bain investments, Daniel Shaviro, a professor of taxation at New York University Law School, says Romney may have been trying to avoid paying a specific tax on investments made by his Individual Retirement Account (IRA).

Mr. Shaviro thinks Romney may have invested some of his IRA money in “super high performers.” But Romney wanted to increase his return on investment by getting his IRA to borrow so that he could buy even more of the stocks. However, under IRS rules Shaviro says, nonprofits such as IRAs that borrow to hold investments face something called the Unrelated Business Income Tax (UBIT).

Shaviro hypothesizes that to avoid paying that tax, Romney’s lawyers set up a separate Caymans entity, which would borrow and buy the stocks. Romney’s IRA invested in that entity.

“Congress is sort of aware of this but has not changed the law,” says Shaviro. “It is not a top secret tax planning trick but it is a common end-run around the purpose of the law.”

If Shaviro is correct – that the funds are accumulating tax-free – in the Cayman Islands, Romney may have no reason to repatriate them to the US. “It’s not as if he needs the money back here to pay his rent,” says Shaviro. “Plus, if he did the same thing using a US entity, then it would face US corporate tax on the income.”

Shaviro points out that Romney’s Cayman Islands stash is likely to be debated politically. “If I was thinking of working with someone in business and I heard they had done this, I would not be upset,” he says. “You could say he did something that any clever and savvy investor would do.” But, he adds, “If you believe that someone who is running for President should live by a higher standard, then you could take offense at it.”

UPDATE: In response to this article, Romney campaign press secretary Andrea Saul sent the following email:

The Romneys' investments in funds established in the Cayman Islands are taxed in the very same way they would be if the Romneys held their shares of the fund investments directly in the US rather than through a Cayman fund.

Nothing is changed from four years ago in relation to these funds. Governor and Mrs. Romney's assets are managed on a blind basis. They do not control the investment of these assets. The assets are under the control and overall management of an independent trustee.

Furthermore, only the sponsor of the fund decides where it is established. That responsibility is totally outside the control of a passive investor like Gov. Romney or the trustee of this blind trust.

Also, in regards to the Unrelated Business Income Tax: Governor Romney’s IRA is tax deferred, just like the IRA’s of every other American. Its investments are in compliance with rules created to keep it tax deferred, just like it was intended to be.