* Cayman Islands has $82 mln shortfall in revenue
* UK refused to bail out Cayman Islands, blocked loan
* Suggests overseas territory imposes taxes
* Cayman Islands mulls gambling, increasing tax on alcohol By Lorraine Turner
LONDON, Sept 3 (Reuters) - The UK government's move to block loans to the Cayman Islands is designed to disadvantage a competitive rivalry in financial services at a time when the UK sector itself is under threat, said the head of the islands' regulatory agency on Thursday.
The Cayman Islands, the Caribbean overseas territory which is domicile to the majority of the world's hedge funds, failed to gain approval from the UK government last week to extend its borrowing to plug a government deficit of $82 million.
"We believe there is another agenda, which seems to have more to do with the competition for financial services and concern that unreasonable tax rates in G20 countries will cause an exodus of people and financial services companies," said Anthony Travers, head of the Cayman Islands' Financial Services Authority CIFSA.
Up to three banks had been lined up to lend $275 million to the Cayman Islands, he added. The nation is predominantly self-governing but needs the British government's permission if it increases borrowings above a certain threshold.
"I need to be absolutely convinced that there is a sustainable medium term plan for turning round the public finances and paying off debt before being able to consider any extension of borrowing," said Chris Bryant, Foreign Office Minister in a letter dated August 27 to McKeeva Bush, leader of the Cayman Islands.
He recommended the introduction of measures such as a property tax or lowering expenditure to tackle the ballooning debt, caused by overspending on public infrastructure projects and the global financial crisis.
"It would be unwise, I suspect, to rely too heavily on a rapid improvement in trust fund income or to expect that the Cayman Islands' prosperity can presume on an off-shore tax haven status," he added.
Overseas territories such as the Cayman Islands have suffered from increasing pressure from G20 governments which have vowed to crack down on so-called "tax-havens".
Last month, Switzerland agreed to hand over details of some 4,450 UBS AG UBSN.VX (UBS.N) bank accounts to U.S. tax investigators [IB:nLJ718259] [ID:nN19479123]
"It is unfair, what the government seems to be doing, it is associating tax havens with tax avoidance and this isn't necessarily the case," said Vimal Tilakalapa, UK tax partner at Allen & Overy.
Nonetheless, the future of offshore locations remains uncertain. Hysteria surrounding tax havens is likely to die down in the long term, analysts said, but not without denting new business flow to offshore locations.
This comes as a further blow to jurisdictions such as the Cayman Islands which are reliant on financial services and tourism, both of which have been hit heavily by the financial crisis.
Travers said income from hedge funds on the Cayman Islands has dropped by up to 40 percent, bringing it to similar levels seen in 2005.
This has lead to many offshore locations reviewing their long-term business models.
Jersey said it can still win business by focusing on its Trust business, while Travers said the Cayman Islands is looking to bulk out its service providers on the islands through cutting red tape and encouraging an inflow of talent.
But in the short term, the government of the Cayman Islands is focused on plugging the deficit gap.
Travers said the government is reviewing a number of options which include public finance initiatives due to much of the debt burden stemming from the overrunning of two large school projects.
Other measures include reviewing the introduction of gambling or a lottery, and increasing taxes on tobacco and alcohol, as talks continue between the UK government and the Cayman Islands, he added. (Editing by Rupert Winchester)