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EU And OECD Proposals On Harmful Tax Competition
Colin Powell
The Insular Authorities over the past year have been giving further active consideration to the possible impact on the Island of the EU/OECD proposals on harmful tax competition. The President of the Policy & Resources Committee made a statement on these matters to the States on December 2nd, 1998, and an update was presented to States Members and distributed widely to the institutions within the Island’s finance industry in July 1999.
On December 10th/11th, 1999 the European Council met in Helsinki and agreed a “tax package”, and in November 1999 the OECD Forum on Harmful Tax Practices completed its initial technical evaluation of whether various jurisdictions met the criteria for being a “tax haven”. It may be timely therefore to undertake a further update of the Island’s position in respect of both the EU and OECD proposals on harmful tax competition.
International interest in “offshore” jurisdictions
In reviewing the position vis-à-vis the EU and OECD proposals it may be helpful for the reader to know that other international bodies are also focusing attention on the offshore world of which the Island is considered to form a part.
· The G7 countries (Canada, France, Germany, Italy, Japan, United Kingdom, USA) issued a communiqué in May 1998 which referred to the actions of tax havens in encouraging tax evasion and money laundering, and lent support to the OECD initiative on harmful tax competition which seeks to distinguish between tax havens and preferential tax regimes.
· The international Financial Action Task Force, set up to combat money laundering, in pursuing a global commitment to its 40 recommendations, is seeking to define non co-operative jurisdictions which it is thought would include a number of offshore centres;
· The United Nations Office for Drug Control and Crime Prevention has set up an Offshore Forum which is engaged in “an Offshore Initiative” focusing on ways of generally raising standards among offshore centres;
· A G7 sponsored Financial Stability Forum has been set up with three Working Groups, one of which is looking at offshore financial centres. That Group is focusing on ways of raising international standards within offshore centres generally, both in the area of financial regulation and anti-money laundering measures.
This general interest in offshore centres has not been without its benefits. By focusing on offshore centres the international community has become much better informed about them, and has recognised the need to distinguish between those centres such as Jersey that are working to international standards on financial regulation and anti-money laundering, alongside and often ahead of EU and OECD Member States, and those centres that show little regard for complying with those same international standards.
In responding to all these international initiatives the Insular Authorities have made it clear to those concerned that -
· they have independence of decision making on fiscal policy within their jurisdiction;
· they will, in common with other countries, act to protect their economic interests, whilst recognising the need to co-operate with other countries in the pursuit of those engaged in serious crime;
· they are committed to carrying on business having proper regard for international standards of financial regulation and anti-money laundering measures;
· they are prepared to enter into a dialogue on ways in which harmful tax competition is dealt with, providing this is done on an international level playing field basis.
The emphasis on an international level playing field is of paramount importance, not only to the Island but also to the United Kingdom (and the City of London in particular) for both benefit greatly from the Island’s role as an international finance centre. If the Island’s fiscal attractions were to be affected adversely vis-à-vis other jurisdictions engaged in the provision of offshore financial services - which it must be emphasised is not something that is in prospect - the funds presently attracted to the Island from the world at large could be expected to move to other jurisdictions that generally speaking are far less well regulated, and have far less regard for international standards. There would also be far less likelihood of European capital markets benefiting from the money flows as they do at present.
EU tax proposals
The Council of the European Union in December 1997 adopted a resolution on a Code of Conduct for Business Taxation[1]. The Council concluded that in the spirit of comprehensiveness of approach, three areas were particularly highlighted: business taxation, taxation of savings income and the issue of withholding taxes on cross-border interest and royalty payments between companies. That resolution also provided for the establishment of a Code of Conduct Group with a remit to assess the tax measures that may fall within the Code.
Of equal interest to the Island is the draft directive on the Taxation of Savings Income. Both are concerned with the co-ordination of the tax position within the Member States in support of the Single Market and Economic and Monetary Union. The European Union, however, has indicated that it is keen to see the principles of the Code and of the directive extended to the dependent and associated territories of Member States and to European non-EU territories such as Switzerland, Andorra, Monaco and San Marino.
The Code of Conduct, which is a non-legal instrument, in referring to discussions to be entered into with the dependent and associated territories, includes the words, inserted at the request of the Insular Authorities, “within the framework of their constitutional arrangements.” The draft directive on the Taxation of Savings Income makes no reference to the dependent and associated territories but reference is made in an annexe to the directive. Again the phrase “within the framework of their constitutional arrangements” is used to qualify the reference to the discussions to be entered into with the territories concerned.
To avoid any uncertainty about what the phrase “their constitutional arrangements” means, the United Kingdom Government, again at the request of the Insular Authorities, tabled a statement on the Island’s constitutional relationship which was referred to in the statement made by the President of the Policy & Resources Committee on December 2nd, 1998 in the following terms-
“The United Kingdom Government is responsible for the defence and international relations of Jersey, and the Crown is ultimately responsible for its good government. However, the people of Jersey cannot vote in the elections for the United Kingdom Parliament and it would be unprecedented for the United Kingdom to implement legislation in Jersey on taxation and other domestic matters without the agreement of the Jersey authorities. Legislation on taxation matters has always taken the form of Laws enacted by the Island’s legislature”.
As far as the Insular Authorities are concerned, the main plank of their response to the EU tax proposals is that, as the Island is not part of the European Union, such proposals (which are designed to regulate the position within the Member States) are not directly relevant to the Island. The proposals are simply matters that can be considered by the Insular Authorities in the same way that they can be considered by other non-EU countries. It has been made clear that such matters must be considered in the context of a truly international level playing field.
The Tax Code of Conduct Group has produced a report which was presented to ECOFIN[2] on November 29th, 1999 and to the European Council meeting in Helsinki on December 10th/11th, 1999.
That report includes a list of potentially harmful tax measures for the Member States and their dependent and associated territories. In relation to Jersey, reference is made to exempt companies, international business companies, international treasury operations and captive insurance companies. However, it must be emphasised that the process of including in the report of the Code of Conduct Group a factual statement regarding these measures does not alter in any way the position of the Island in relation to the European Union, or the Island’s independence of action in responding to whatever views may ultimately be expressed by the Council of the European Union.
The view of the Insular Authorities is that before Jersey or any other non-EU jurisdiction should be asked or should agree to give any consideration to the principles of the Tax Code of Conduct or the draft Directive for the Taxation of Savings Income, it should be able to see very clearly what is to be accepted and fully implemented in the Member States. Particular attention should be focused, for example, on what action is to be taken by the individual Member States to remove their own harmful tax practices and over what timescale.
In the face of the decision of the United Kingdom Government not to agree to the Directive for the Taxation of Savings Income unless Eurobonds were exempt, in order to safeguard the interests of the City of London and the United Kingdom economy, the Helsinki European Council summit meeting agreed a “tax package” as follows -
· all citizens resident in a Member State of the European Union should pay the tax due on all their savings income;
· in examining how best the European Union could pursue the application of this principle, the European Council has agreed that a high level Working Group will consider specifically how the principle can be implemented most effectively, and whether, as a starting point for these considerations, the paper of December 7th, 1999 put forward by the Presidency and the Commission offers a way forward;
· it will also consider the proposals put forward by the United Kingdom, including proposals for exchange of information;
· in its consideration the Working Group will take account of all decisions of the Council including the approaches set out in the paper of November 29th, 1999;
· it will provide a report for the Council with possible solutions set out above and on the Code of Conduct and the Directive on Interest and Royalties as a package, and the Council will report to the European Council in June 2000 at the latest.
There is a lack of clarity in the first bullet point. However, it is understood that it is intended to mean that savings income in third countries and territories of which a citizen resident in a Member State of the European Union is a beneficiary is expected to bear a withholding tax. It is understood that “citizens” means individuals who have their residence for tax purposes in a Member State, and that the position of a non-EU national living in a Member State, who may legitimately not be liable to tax on savings income arising outside the EU unless it is remitted to him in his present country of residence, will not be affected.
Furthermore, as the European Union Directive on the Taxation of Savings Income refers to individuals, and not to companies or trusts, there would seem to be no certainty that, if non-EU countries/territories agree to withhold tax in respect of savings income to be paid directly to EU “citizens” resident in a EU Member State, this would be at all effective. Indeed, the view of many commentators in the City of London is that the draft Directive of the Taxation of Savings Income is extremely poorly drafted and, even if the principle is accepted, considerable redrafting and clarification will be required.
The Insular Authorities accept that in due course they, in common with other non-EU jurisdictions in Europe, may be invited to consider taking action similar to that to be taken by the Member States themselves. However, all concerned recognise that non-EU countries, including the Dependent Territories, cannot be compelled to follow suit and would need to be persuaded that it is in their best interests to introduce whatever measures ultimately come out of the European Union deliberations regarding the position within the Member States. What can be stated is that the Insular Authorities, in responding to any request to enter into discussions, will maintain their view on the importance of an international level playing field and will wish to see how other non EU territories such as Switzerland respond to equivalent approaches from the European Union. The Swiss Authorities for example have made a number of public statements to the effect that the exchange of information between tax authorities is not on their agenda.
What is also considered to be a reasonable position for the Island and other non-EU jurisdictions to take is that, before any consideration is given to a request to respond to any particular tax measures, evidence should be forthcoming that those measures have been fully implemented by all the Member States.
OECD tax proposals
The OECD in its report on harmful tax competition, published in May 1998, proposed that countries that satisfy certain criteria set out in the report should be included in a list of tax havens, while others would be categorised as having preferential tax regimes. It was envisaged in the report that those jurisdictions categorised as tax havens would be subject to some form of action taken by the Member States of the OECD.
The OECD Committee on Fiscal Affairs established a Forum on Harmful Tax Competition which in turn set up study groups to help determine which jurisdictions should be considered tax havens, and a member of each study group was given a jurisdiction to assess. The OECD included 47 jurisdictions in a provisional list of tax havens, and Jersey was included in that number. The list was drawn up on an apparently subjective basis, and a number of jurisdictions providing financial services on a similar basis to that of Jersey, such as Switzerland, Luxembourg, Hong Kong and Singapore, were not included.
The Insular Authorities in May 1999 were given the opportunity to make an oral presentation to the Forum. The objective of that presentation was to convince the Forum that -
· Jersey is not a tax haven, having regard to the criteria used in the OECD report;
· Jersey is fully prepared to co-operate in working towards the elimination of any harmful preferential tax regimes, providing this is done on a truly international level playing field basis.
The Forum members were informed that the Island’s constitutional relationship with the United Kingdom left responsibility for taxation matters with the Island’s legislature. It was also pointed out that throughout the centuries the Island has been a relatively low tax jurisdiction and that this position has been maintained through sound economic policies. The Forum was informed that the Island had not changed its standard and maximum rate of income tax of 20%, set to meet the revenue requirements in 1940, for nearly 60 years. It was indicated that this is evidence, if it is needed, that the Island has not sought to manipulate its tax structure to attract business. It was pointed out that the same argument can be extended to the exempt company provision which essentially is also unchanged since 1940. What changes have occurred have been designed not to change the tax regime but to bring these companies under stricter regulatory control.
The Insular Authorities in their representations to the OECD Forum have relied upon the wording of the OECD report and in particular paragraphs 40, 42, 43 and 44.
The Insular Authorities’ understanding of paragraph 40 is that a country which collects significant revenues from tax imposed on income at the individual or corporate level, but which has a tax system that includes preferential features allowing the relevant income to be subject to low or to no taxation, is to be distinguished from a tax haven which is a country that generally imposes no or only nominal tax on income from geographically mobile activities.
Paragraph 42 reinforces this distinction between the two categories of country. It is implicit from paragraph 42 that a tax haven is a country that is able to finance its public services while levying no or only nominal income taxes, and which offers itself as a place to be used by non residents to escape tax in their country of residence. Countries which raise significant revenues from their income tax but whose tax systems have features constituting harmful tax competition are separately considered.
In paragraph 43 it is suggested that the “tax haven” country has no interest in trying to curb the “race to the bottom” with respect to income tax and for this reason is considered unlikely to co-operate in curbing harmful tax competition. By way of contrast, countries in the second category referred to in paragraphs 40 and 42 have a significant amount of revenues which are at risk from the spread of harmful tax competition and therefore are considered more likely to agree on concerted action.
This analysis is further confirmed by paragraph 44 which states “this report distinguishes between jurisdictions in the first category, which are referred to as tax havens, and jurisdictions in the second category, which are considered as countries which have potentially harmful preferential tax regimes”.
The Insular Authorities believe, on the basis of the OECD report, that by showing that Jersey raises significant revenues from income tax and has a significant amount of revenues that are at risk from harmful tax competition, the Island cannot be considered a tax haven. This view is reinforced by the wording of a procedural note issued by the OECD in November 1998. In paragraph 15(a) of that note it is stated that the identification of letter recipients considered to be tax havens would be based upon an analysis of the collected information. This list of letter recipients would refer to those “whose tax regime is considered to meet the key criteria in paragraph 52 and which is also a tax regime within the meaning of paragraph 42 of the report”.
Paragraph 15(c) of the procedural note applies to the identification of letter recipients who have a large number of harmful and preferential regimes that are significant and pervasive relative to their overall economies, and which subject to continuing discussions may also be considered to be tax havens.
The Insular Authorities, with regard to paragraph 42 of the OECD report and paragraphs 15(a) and (c) of the procedural note, have submitted to the OECD that Jersey is a country that raises significant revenue from income tax, that the domestic tax base is significantly greater than the nil or nominal tax base, and that any harmful and preferential regimes are not significant or pervasive relative to the overall economy. Jersey should not therefore be included in any list of tax havens.
The Insular Authorities have also contended that Jersey does not meet the criteria for a tax haven as set out in paragraph 52 of the OECD report which cover “no or nominal tax”, “effective exchange of information”, “transparency” and “substantial activities”.
No or nominal tax
Information presented to the OECD shows that Jersey does not generally impose “no or nominal tax” on geographically mobile activities. The standard rate of tax of 20% provides 90% of the Island’s tax revenues. The Island raises significant revenue from its income tax and it is on this revenue that it depends to fund its public services. Over 60% of income tax revenues arises from the taxing of companies and some 50% of income tax revenues arises from the taxing of banks and financial institutions that are engaged in what the OECD is understood to mean by geographically mobile activities.
It has been pointed out to the OECD that the Jersey tax structure is a relatively simple one with limited tax allowances compared with other jurisdictions. The result is that the average effective rate of tax for companies, charged at the tax rate of 20%, is 19%. This is higher than the effective rate of tax for companies in other jurisdictions, particularly in regions where considerable fiscal inducements are given to encourage investment. One international bank stated recently that the average rate of tax that it pays for its business in Jersey is almost twice that which is paid in a comparable jurisdiction within the European Union. These comparisons also do not take account of the significant elements of state aid that are available to companies within Member States of the European Union which are not similarly available to those companies that are established in the Island.
The Insular Authorities have accepted that the Jersey tax system has some preferential features which allow income from some geographically mobile activities to be subject to no or nominal taxation. This situation however equates with that of many other jurisdictions, including OECD member countries, and would appear to be consistent with the wording of the second category in the OECD report. This would place the Island in the category of countries with a harmful preferential tax regime and not in the category of tax havens.
Exchange of information
On the question of information exchange it has been pointed out to the OECD Forum that, unlike many other jurisdictions, including some OECD countries, the Island has no bank secrecy laws. There is a common law duty of confidentiality, but that barrier can be overcome and information may be obtained in all circumstances where there is evidence of criminal conduct. The legislation enacted to deal with all money laundering crimes is equivalent to the legislation in the United Kingdom and is more extensive than the legislation in many OECD member countries.
Transparency
The OECD Forum has been informed that there is no lack of transparency in the operation of the legislative, legal or administration provisions of the tax regime in the Island. It has been pointed out to the Forum that in 1998 the Island was subject to a comprehensive review of its regulatory systems, through the Edwards Report, from which it emerged as a well regulated international finance centre. A Financial Action Task Force type mutual evaluation of the Island’s anti-money laundering activities has been also taken by evaluators who included officials from OECD member countries. It was also pointed out that the regimes in respect of exempt companies and international business companies are the result of published criteria.
Substance of activities
Responding to the issue of the substance of the activities carried on in the Island, the OECD Forum has been informed that the Island’s financial service activities employ over 10,000 people or some 20% of the Island’s work force. A substantial proportion of the income tax revenues are derived from taxing geographically mobile finance centre activities that are resident for tax purposes at the 20% rate of tax. It was also pointed out to the Forum that with regard to financial service activities generally there are difficulties in defining substance, particularly with the development of e-commerce. In any international finance centre it is frequently the case that the legal, accounting and financial skills that the centre offers are attractive to those who wish to establish a legal identity there even if the economic activity in terms of physical trading or direct employment is located in another jurisdiction.
It has been pointed out to the Forum that Jersey has an interest in trying to curb the “race to the bottom” in respect of income tax. The prospect of a general 12.5% corporate tax rate in the Irish Republic is expected to put pressure on the Island’s tax rate of 20%. It is for this reason, among others, that the Insular Authorities are prepared to participate in a dialogue on curbing harmful tax competition, providing this is undertaken on an international level playing field basis.
While the individual non resident investors who place their funds with Jersey banks, fund management companies, trust companies etc. may not be subject to tax, in common with the position in most other jurisdictions, the institutions that provide the services - the banks, the fund management companies, the trust administrators, the lawyers and accountants - are taxed at 20%. They have the opportunity to relocate to other jurisdictions if a more attractive tax regime presents itself. There is plenty of evidence to confirm that relatively small changes in cost levels, of which tax is a part, will persuade individual institutions to relocate their activities to other jurisdictions, including OECD Member States. Thus Jersey has in the past lost fund management business to Luxembourg and Dublin on these grounds.
Jersey therefore has indicated to the OECD that it would benefit from a general reduction in harmful tax competition. If nil or nominal taxation were removed worldwide in respect of geographically mobile financial and other service activities, and if Jersey were to adopt a single corporate rate of tax on the same basis as the Irish Republic at a level required to continue to fund public services of a standard equal to that found in OECD Member States, it is to be expected that Jersey would attract a considerable amount of business from those jurisdictions that presently benefit most from engaging in harmful tax practices.
The Insular Authorities consider that the logical interpretation of the OECD report is that Jersey is not a tax haven in that it can show it has a substantial domestic tax base and, as it is at risk from harmful tax competition, it can be expected to co-operate in finding ways to reduce that competition on an international level playing field basis.
If, notwithstanding the logic of the argument that it should not be included in a list of tax havens, Jersey is included for reasons of political expediency, it must be assumed that all 47 jurisdictions in the provisional list of so-called “letter recipients” would be similarly included. To draw no distinction between the jurisdictions on that list however would be to fly in the face of reality.
The OECD Forum meeting in November 1999 has undertaken an initial technical evaluation of whether each of the 47 jurisdictions initially approached meets the criteria for being a tax haven as set out in the 1998 report. These preliminary findings are to be considered by the Committee on Fiscal Affairs, the OECD’s senior tax policy body, at its meeting at the end of January 2000. The conclusions of the Committee will then be submitted to the OECD Council of Ministers for consideration in June 2000.
The Forum, having submitted the results of its preliminary work to the Committee on Fiscal Affairs, will maintain a dialogue with the jurisdictions under review, and it is not expected that any findings will be published until after the June 2000 OECD Ministerial meeting. The report to Ministers is expected to distinguish between unco-operative tax havens and those jurisdictions that have chosen to commit themselves towards eliminating the harmful aspects of their tax regimes.
At the same time as the Forum has been considering the position of the 47 jurisdictions included in the initial list of potential tax havens it has been undertaking work reviewing the preferential tax regimes of OECD member countries. The 1998 report foresaw that the member countries would complete a self review of their preferential tax regimes by April 2000 and recommended that they eliminate any harmful features of such regimes by April 2003. The results of this work are also expected to be presented to Ministers in June 2000. In addition a high level meeting is to take place with countries outside the OECD in an effort to engage them further in the fight against the spread of tax havens and the use of harmful preferential tax regimes for financial and other geographically mobile services.
The Insular Authorities consider that, as has been the practice with other international groups such as the Financial Action Task Force, the Basle Committee on Banking Supervision and the G7 Financial Stability Forum, the distinction that should be drawn is not between onshore and offshore centres, or tax havens as the latter are often described, but between co-operating and non co-operating jurisdictions. A distinction should be drawn between those jurisdictions that are working to international standards and those that are not. If this distinction is not made the conclusion must be drawn that the exercise has been based on a predetermination of which territories should be described as tax havens, rather than any objective and logical assessment of the circumstances surrounding the individual jurisdictions. This would also be in conflict with the reputation of the OECD for adopting a professional approach to its responsibilities. It should be recognised that the Channel Islands and the Isle of Man, in their tax structures and general compliance with international standards, can and should be equated with Luxembourg and Switzerland which were not included in the initial list of potential tax haven jurisdictions. In the author’s view the Insular Authorities have reason to remain confident, having regard to the wording of the OECD report of May 1998, that the logic of the arguments they have advanced in defence of the view that Jersey is not a tax haven will be fully recognised.
Conclusion
Whatever the outcome of the EU or the OECD tax proposals in due course Jersey can expect to be asked to consider in what way it would wish to participate in an international movement to reduce harmful tax competition. As a pre-requisite to any such considerations however there must be general agreement on what is meant by “harmful”, and any moves to reduce harmful tax competition must take place on an international level playing field basis. If the approach to reducing harmful tax competition is objective, constructive, and global the eventual outcome can be expected to be positive for the Island, as a centre providing financial services to international standards, and Jersey can be expected to remain a relatively low tax jurisdiction.
Colin Powell OBE was Economic Adviser to the States of Jersey between 1969 and 1992 and was Chief Adviser to the States of Jersey until December 1998. In 1999 he was appointed Chairman of the Jersey Financial Services Commission.
[1] OJC 002/1, January 6th, 1998
[2] ECOFIN – The Economic and Finance Council of Ministers