Offshore Attack of Tax Havens by OECD

Still in the Line of Fire

By Matt Blackman

This article appeared in Shore to Shore Magazine - Spring 99 - (Full article)
AND
was the basis for an article entitled In the Line of Fire in Offshore Finance Canada Magazine Nov/Dec 98.

The Edwards Report

A report commissioned by the British Home Office into business practices in the Channel Islands, authored by Treasury servant Andrew Edwards, had an unscheduled early release in September. The 200-page document appeared on a web site hosted by an accounting association almost two months before it was scheduled for official release causing uproar in government circles. The recommendations and abuses identified in the report should serve as a wake-up call to all offshore financial centres, multinational companies, high net worth individuals, offshore investment advisors and entrepreneurs.

Entitled a Review of Financial Regulation in the Crown Dependencies the report makes a number of recommendations. Edwards identifies areas of concern that will put increased pressure on the islands of Jersey, Guernsey, Sark and the Isle of Man to put an end to "tax dodging" if the reigning U.K. government endorses the report.

Edwards estimates that the islands are home to as much as £400 billion. This is a mighty tempting target, especially for the left-winged Labour government that has already made a number of fiscal changes aimed at tightening the tax net on the entrepreneur and high-net worth individual.

Edwards identifies what he believes to be abuses, including:

a refusal to help foreign tax authorities investigate tax evasion on Jersey.
the use of thousands of secretly owned unsupervised companies on the Isle of Man.
the use of fictitious nominee directors in Guernsey and Sark.

Some sweeping changes recommended by Edwards:

Forcing the estimated 100,000 offshore companies to make public account filings.
Ownership disclosure of the offshore companies to the islands regulators.
A crackdown on professional offshore advisors and tough new regulations to control those assisting with company formation as well as other "sucker fish" who make a living from tax havens.
Stricter supervision of lawyers and accountants in both dependencies and onshore involved with offshore structures and services.
Strict action against trust companies offshore with pressure for greater transparency and documentation of trustees and beneficiaries.
More strict regulations (in addition to those already in place) to address money laundering.
Mandatory cooperation with British Inland Revenue.
He notes a drastic increase in the use of offshore trusts, which will undoubtedly make them a target.

Edwards also accuses Sark of using nominee directors for offshore companies without knowing the true owners thus allowing them to combine secrecy with tax-free status.

The report follows a similar investigation earlier in the year into the Dependent Territories in the Caribbean by the British Foreign Office headed by Robin Cook that established a deadline for the islands to follow a compliance checklist and to assist regulators investigating financial irregularities.

Taken individually, these investigations could be viewed as a simple attempt to control abuse of the lax regulation in the British Dependent Territories. However, when taken in context with the recent action taken by the Organization for Economic Cooperation and Development (OECD), a disturbing trend emerges.

In April 1998, the OECD released a report entitled Harmful Tax Competition: An Emerging Global Issue which identified "harmful tax practices in the form of tax havens and harmful preferential tax regimes in the OECD countries and non-member countries and their dependencies." It defined factors to identify harmful tax practices and 19 recommendations were made to counteract the problem.

The U.K. is not the only nation to have made recent overt attempts to stem the use of offshore jurisdictions. Since May 1996 when the study into harmful tax competition was initiated by OECD ministers, the U.S., Canada and Australia have also announced sweeping changes aimed at reducing tax haven use. For the international investor, businessperson and offshore practitioner watching these developments unfold, little time has been wasted by these high-tax nations in following and instituting recommendations made in the report.

The OECD Problem

"Globalization in one of the great economic events on the 20^th century. It is the process which breaks down economic barriers between nations and leads firms to develop global strategies…But globalization has also raised the challenges for governments…It has also widened the opportunities for evasion and avoidance…If nothing is done, governments may increasingly be forced to engage in competitive tax bidding to attract or retain mobile activities. That "race to the bottom," where the location and financing decisions become primarily tax driven, will mean that capital and financial flows will be distorted and it will be more difficult to achieve fair competition for real economic activities."

Exactly what the ministers mean by "real economic activities" is not explained in the report but it would appear to refer to activities that generate large tax revenues to governments.

"There is no reason why taxpayers that do not or cannot take advantage of harmful tax practices should have to pay the taxes avoided by those who have easy access to tax havens and harmful preferential tax regimes." The report sites a five-fold increase between 1985 and 1994 to more than $200 billion flowing to tax havens in the Caribbean and South Pacific, "a rate of increase well in excess of the growth of total outbound foreign direct investment."

Until recently governments have acted independently to combat the problem but the report calls for a unified effort. "Developments within the G7, the EU, the OECD and beyond suggest that the political climate is now ripe for a common approach against harmful tax practices."

A Tax Haven - OECD Definition

The report defines a tax haven that conducts harmful tax competition as:

Any nation that imposes nominal or no tax on income.
Any nation offering preferential treatment to certain types of income at no or low tax rates.
Any nation that offers or is perceived to offer non-residents the ability to escape taxes in their country of residence.

Further activities that identify a tax haven are:

Practices which prevent the effective exchange of relevant information with other governments on taxpayers benefiting from a low or no tax rate.
General lack of transparency.
The absence of a requirement that the activity be substantial (investment that is purely tax driven.)

The report elaborates on these characteristics and outlines a series of other factors and considerations that are useful in identifying harmful tax practices. However, it is careful in not suggesting a minimum tax rate for member and non-member countries thus allowing "friendly" tax competition between member nations.

OECD Recommendations

In total 19 recommendations are put forward to deal with harmful tax practices. They are listed under the following categories:

I. Recommendations concerning domestic legislation and practices.

Controlled Foreign Corporations (CFCs) - Countries that do not have CFC rules consider adopting them.
Foreign investment fund or equivalent rules - Countries that do not have such rules adopt them to entities covered by practices considered to be harmful tax competition.
Restrictions on participation exemptions and other systems of exempting foreign income in the context of harmful tax competition - Countries that apply the exemption method to eliminate double taxation of foreign source income consider adopting rules that would ensure that foreign income benefiting from harmful tax competition practices does not qualify for the application of the exemption method.
Foreign information reporting rules - Countries that do not have rules concerning reporting of international transactions and foreign operations of resident taxpayers consider adopting such rules and that countries exchange information obtained under these rules.
Advanced rulings - Countries offering advanced rulings concerning the particular position of a taxpayer make public the conditions for offering or denying such rulings.
Transfer-pricing rules - Countries follow the guidelines set out in the OECD 1995 guidelines on transfer pricing and not promote harmful tax competition.
Access to banking information for tax purposes - Countries review their laws, regulations and practices which govern the access to banking information with the view to removing impediments to the access to such information by tax authorities.
II. Recommendations concerning tax treaties.
Exchanges of information - Countries should undertake programs to intensify exchange of information concerning transactions in tax havens and preferential tax regimes constituting harmful tax competition.
Entitlement to treaty benefits - Countries consider including in their tax convention provisions aimed at restricting the entitlement to treaty benefits for entities and income covered by measures constituting harmful tax practices.
Clarification of the status of domestic anti-abuse rules and doctrines in tax treaties - That the Commentary on the Model Tax Convention be clarified to remove any ambiguity regarding the compatibility of domestic anti-abuse measures with the Model Tax Convention.
List of specific exclusion provisions found in treaties - The Committee should prepare a list of provisions used by countries to exclude from the benefits of tax conventions certain specific entities and types of income.
Tax treaties with tax havens - Countries consider terminating their tax conventions with tax havens and consider not entering into tax treaties with such countries in the future.
Coordinated enforcement regimes (Joint audits, etc.) - Countries consider undertaking joint enforcement programs such as simultaneous audits and examinations, in relation to income or taxpayers benefiting from practices constituting harmful tax competition.
Assistance in recovery of tax claims - Countries should review the current rules applying to the enforcement of tax claims of other countries for the addition to tax conventions.
III. Recommendations to intensify international cooperation in response to harmful tax competition.
Guidelines and a forum on harmful tax practices - Member countries endorse the guidelines set out in the following list (see Guildelines below) dealing with harmful preferential tax regimes.
Produce a list of tax havens - The Forum mandated to establish within one year of the first meeting of the Forum, a list of tax havens on the basis of factors identified in this report.
Links with tax havens - Countries that have links to tax havens ensure that these links do not contribute to harmful tax competition and in particular, that countries with dependencies that are tax havens ensure that the links with these territories are not used to promote or increase harmful tax competition.
Develop and promote Principles of Good Tax Administration - The Committee be responsible for developing and promoting a set of principles to guide tax administrations in the enforcement of guidelines in this report.
Associating non-member countries with the Recommendations - The Forum engage in dialogue with non-member nations to promote these recommendations.

Guidelines for Dealing with Harmful Preferential Tax Regimes in Member Countries

The report goes beyond identifying tax havens as culprits in stealing away tax revenues from the high-tax member nations. It adopts further measures designed to "level the playing field" between member nations to allow continued expansion of global economic growth and "to avoid an aggressive competitive bidding by countries for geographically mobile activities."

Six guidelines are put forward to encourage and insure compliance of all nations to adhere to the recommendations of the report. They are:

an agreement to not adopt harmful taxation measures,
a review of existing harmful tax measures,
the removal within 5 years of the harmful feature of preferential tax treatment,
an examination by member countries of any measures that are considered to be harmful tax competition,
coordination of a forum to discuss such practices,
and the use of the forum to promote non-member nations to associate themselves with the guidelines.

Switzerland and Luxembourg participated with the OECD in discussions leading up to ratification of the report but both abstained from ratifying the document.

Discussion

This move by the OECD to attack what they believe to be harmful tax competition has moved forward, unopposed to date from either the offshore service providers or the offshore financial centres themselves. The growing cost of tax compliance with new laws designed to counter transfer pricing and the use of tax treaties has caused a steady growth in the need for professional legal and accounting services. It is these service providers as well as the offshore financial centres themselves that will bear the brunt of the attack. Not only will the cost of compliance soar for companies involved in international trade, the pressure on professionals engaged to assist such entities will also increase.

There are more than 68 offshore financial centres world-wide, the majority of which are 'have-not' countries that rely on financial services to provide them with much needed employment and tax revenues resulting from foreign company registration, bank services and trust management. A concerted effort by the developed nations to curtail these activities will most certainly hamper these developing nations in their effort for financial autonomy and political sovereignty.

Offshore financial centres serve a multitude of purposes. They offer a much-needed neutral platform from which to conduct international trade and finance. Studies show that lower tax regimes allow multinational companies to offer their products in all nations at more competitive prices than would otherwise be possible if not for the ability of these companies to operate in lower tax environments. (Corporations are flow-through entities. Taxes are simply passed on to shareholders, many of whom are pensioners, and customers.) Thirdly, offshore centres serve as a taxation safety valve to prevent governments of their high-tax counterparts from charging onerous tax rates unabated. One has to wonder what would the tax rates be in high-tax nations today had it not been for offshore centres?

It is this third factor that has caused the high-tax nations of the OECD to conspire to remove this competitive force, this factor they label "harmful tax competition."

Such a document put forward by a group of competing national or multinational companies in any free-market would most certainly be viewed as a clear violation of anti-competition legislation and would be attacked by government watchdog agencies in much the same manner that Microsoft has been targeted in the United States. The question is, do citizens of both developed and emerging nations care that their governments plot to control taxation rates, ganging up on those nations that would attempt to better the standard of living for their people by attracting new investment?

When put in context with recent political trends in Europe and North America, there is little doubt that a move is afoot to garner governments greater freedom to raise taxes and increase spending as they see fit. They are intent on stemming the tide of capital on the move to offshore safe havens away from ever-increasing tax hungry bureaucracies. With this threat safely stowed, what mechanism will keep taxes in check?

Within the European Union, 12 of the 15 governments are left-winged who view corporations and the wealthy as sources of infinite tax revenues to be more vigorously tapped. The newly appointed Social Democrats in Germany under the reigns of Mr. Schroeder and finance minister Lafontaine have wasted no time in drafting laws to increase taxes for corporations and the well-heeled. This move will set an example for other governments to follow.

In the U.S., the Democrats under Bill Clinton have increased income taxes to their highest levels since the early 1980 pre-Reagan days and attempts to lower taxation by the House of Representatives have been quelled. Offshore trusts have come under increasing attack and there are scant signs of any tax relief on the horizon.

Canada's Liberal government has passed 43 tax increases and a flurry of laws aimed at restricting the flow of capital out of the country since coming to power in 1993. Although Canadians pay some of the highest taxes in the industrialized world, there is no relief in sight. The new law requiring the reporting of virtually all foreign assets with original value of $100,000 CAD or greater whether or not they produce income was ratified in spite of vehement opposition from business groups and the New Democratic government of British Columbia. Real incomes in the country have been dropping since 1989 but taxes continue to rise yet so does government spending.

Offshore centres serve a highly useful purpose in promoting international trade, financing overseas operations and investments and providing a livelihood for citizens of developing nations. It is time that offshore financial centres, service professionals, multinational companies, international entrepreneurs and medium to high-net worth individuals stood up to be counted and express their opposition to this control and subjugation of the free-market spirit offshore. If the member states of the OECD have their way, we will be left to the whim of high-tax bureaucracies able to increase tax burdens unabated without concern that citizens have an alternative.

To read the 200 page Edwards Report on the Channel Islands please go to http://visar.csustan.edu/aaba/jersey.htm

If this site is no longer functional I have also posted the information at http://www.goldhaven.com/ioi/Edwards.htm

Your comments and questions are welcomed at info@goldhaven.com

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Guidelines for Dealing with Harmful Preferential Tax Regimes in Member Countries