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EU AND OECD TAX INITIATIVES – RECENT DEVELOPMENTS

Colin Powell

This year decisions can be expected to be taken in respect of European Union (EU) and Organisation for Economic Co-operation and Development (OECD) tax initiatives which will have a significance for the Island. It is an appropriate time therefore to provide an update on these initiatives and to examine where Jersey stands in relation to them.

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 should be highlighted; business taxation, taxation of savings income and 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 and to determine which could be considered ‘harmful’.

In December 1999 the Helsinki European Council agreed that a High Level Working Group should provide a report to the Council on possible options in relation to on the issue of taxation of savings income, the Code of Conduct and the Directive on interest and royalties as a package, and that the Council should report to the European Council in June 2000 at the latest.

At the Feira European Council meeting[2] in June 2000 the Council endorsed the report on the tax package by the ECOFIN[3] Council. It endorsed the timetable set out, which will follow a step by step development towards realisation of the exchange of information as the basis for the taxation of savings income of non-residents. The European Council also requested the ECOFIN Council to pursue with determination work on all parts of the tax package so as to achieve full agreement on the adoption of the directives and the implementation of the tax package as a whole as soon as possible but in any event no later than by the end of 2002.

Directive on the taxation of savings income

At the Feira Council meeting the Council agreed that the proposed Directive on the taxation of savings income (“the Directive”) should be based on the following key elements:-

(a) With a view to implementing the principle, set out in the Helsinki European Council Conclusions, that all citizens resident in a Member State of the EU should pay the tax due on all their savings income, exchange of information, on as wide a basis as possible, should be the ultimate objective of the EU in line with international developments.

(b) In the meantime, Member States should exchange information on savings income with other Member States or, subject to point (d) below, operate a withholding tax. Member States which decide to operate a withholding tax should agree to transfer an appropriate share of their revenue to the investor’s state of residence.

(c) In order to preserve the competitiveness of European financial markets, as soon as an agreement has been reached by the Council on the substantial content of the Directive and before its adoption, the Presidency and the Commission should enter into discussions immediately with the United States and key third countries (Switzerland, Liechtenstein, Monaco, Andorra and San Marino) to promote the adoption of equivalent measures in those countries; at the same time the Member States concerned committed themselves to promote the adoption of the same measures in all relevant dependent or associated territories (including the Channel Islands, Isle of Man, and the dependent or associated territories in the Caribbean). The Council should be informed regularly on the progress of such discussions. Once sufficient reassurances with regard to the application of the same measures in dependent or associated territories and of equivalent measures in the named countries have been obtained, and on the basis of a report, the Council will decide on the adoption and implementation of the Directive no later than December 31st, 2002, and do so by unanimity.

(d) The Commission should report regularly on Member States’ experience in relation to the application of the systems referred to under point (b) above, as well as on international developments concerning the access to bank information for tax purposes. When the Council decides on the adoption and implementation of the Directive on the basis of paragraph (c ) above, with the consequences that follow for dependent or associated territories, any Member State operating a withholding tax shall agree to implement exchange of information, as soon as conditions permit, and in any case, no later than seven years after the entry into force of the directive.

At the Nice ECOFIN Council meeting in November 2000 the Council agreed the essential content of the future Directive on the taxation of savings income.

This Directive will not apply to Jersey because Jersey is not part of the EU’s fiscal territory. If any aspect of the EU Directive on the taxation of savings income is to be mirrored in the Island it will only be through a decision of the Insular Authorities, in the same way that the application of equivalent measures by Switzerland or any other non-EU jurisdiction will be a decision for that jurisdiction.

The Directive will seek to ensure that savings income in the form of interest payments to beneficial owners who have their residency in a Member State is subject to effective taxation. The Directive will define what is meant by a “beneficial owner”, and it is expected that the Directive will apply to any individual who receives an interest payment for his own benefit or any individual for whose benefit an interest payment is secured. Companies and trusts appear likely to be outside the scope of the Directive.

The Directive will refer to the arrangements for the automatic exchange of information between Member States, other than where a Member State has opted for the withholding tax alternative during a transitional period of seven years after the date of entry into force of the Directive. Belgium, Luxembourg and Austria have indicated that they will take this option which will require the levying of a withholding tax at a rate of 15% during the first three years of the transitional period and 20% for the remainder of that period. The countries concerned will agree also to transfer 75% of the revenue collected to the Member State of residence of the beneficial owner of the interest. It will be possible however for individual beneficial owners to request that rather than be subject to a withholding tax, information should be exchanged.

The Directive is expected to include a “grandfather” provision whereby, during the transitional period of seven years, the Directive will not apply to interest on domestic and international bonds and other negotiable debt securities, whether held directly or indirectly by individuals, for which the issuing prospectuses had been approved before March 1st, 2001.

As noted above the Directive on the taxing of savings income is seen by the EU as part of a total tax package. Indeed Austria and Luxembourg declared at the Nice Council meeting in November 2000 that they would agree to the Directive on the taxation of savings income only when there had been a binding decision on the roll - back of the so called ‘harmful’ tax measures identified within the framework of the Code of Conduct on Business Taxation.

The position of Jersey on the taxation of savings income is that any discussions with the EU, through the United Kingdom Government, should not take place until the Insular Authorities have had an opportunity to study closely the proposed Directive and until it is known what other non- EU jurisdictions, in particular Switzerland, are going to do in response to the EU proposal.

The Swiss appear to be of the view that they do not want to facilitate “avoidance” of any measures agreed by the EU Member States, but at the same time they are determined to preserve the privacy of law abiding citizens. Accordingly the Swiss, if they agree to join the EU in seeking to establish a sound system of taxation of savings income, will not adopt the exchange of information and will broaden the present Swiss withholding tax to one that applies to interest payments to individuals resident in an EU Member State. The Island may wish to consider in due course whether a similar approach to that likely to be adopted by the Swiss would be in the Island’s best interests, rather than follow the United Kingdom Government’s decision to opt for the exchange of information rather than a withholding tax.

The Swiss may have geopolitical reasons for wanting to work in harmony with the EU. This is far less the case with the USA which is likely to be much more difficult to convince that its interests would be served by the adoption of measures equivalent to those to which the Directive will refer. The recently reported comments of US Treasury Secretary Paul O’Neill in relation to the OECD initiative would seem to underline that position.[4]

The United Kingdom Government has taken some steps towards implementing the requirements of the EU Directive, as it is expected to be, through the Finance Act 2000 which provides for automatic reporting by banks to the Inland Revenue of information on interest payments to residents of “reportable” countries who hold accounts with banks in the United Kingdom. Jersey is included in the list of “reportable” countries, and so a Jersey resident with a bank account in the United Kingdom can expect information on interest received to be passed to the Inland Revenue and possibly through the latter to the Jersey tax authorities. The United Kingdom Finance Act has no application in the Island and the Insular Authorities have no plans to introduce equivalent legislation. A complication for the banks in the United Kingdom is that they are now faced with implementing an arrangement whereby they will need to separate those customers resident in “reportable” countries from those who are not. It is expected that some customers who are resident in the “reportable” countries will respond by requesting their accounts be transferred out of the United Kingdom.

EU code of conduct

The Code of Conduct Group (the Primarolo Group) continues to review the implementation of the removal or “roll back” of the so-called ‘harmful’ tax measures identified in the Group’s report[5] of November 1999. This report covers the UK dependent territories. Of the measures listed, four refer to measures in Jersey (tax exempt companies, international business companies, international treasury operations and captive insurance companies).

The November 2000 ECOFIN Council agreed that the deadline for removal of the effects of the so-called ‘harmful’ measures listed should be the end of 2005. The Council further agreed, however, that the 2005 deadline could be extended in exceptional circumstances.

Jersey’s position in relation to the work of the Code of Conduct Group is that before non- EU jurisdictions are asked to participate, the EU Member States should first get their own houses in order. The Primarolo Group’s report includes a large number of footnotes reflecting the extent to which Member States were in disagreement with the listing of certain individual tax measures and wished to enter reservations. For example, there was no apparent agreement on how the Dutch and the Danish holding company regimes, or the Belgian co-ordination centres, were to be dealt with.

Jersey has made it clear that any discussions on taxation matters affecting the Island must be within the framework of the Island’s constitutional arrangements, and acknowledge the Island’s fiscal autonomy and the exclusion from the EU fiscal territory under the terms of Protocol 3[6]. The United Kingdom Government has confirmed that this view has been communicated to and is fully understood by all EU Member States.

The Insular Authorities also have pointed out that they were given no opportunity to discuss with the Code of Conduct Group the measures that the Group considers to be “harmful”. Nor has the Island, as an independent fiscal authority, had the same opportunity as the Member States to argue the case for the non-inclusion of a given measure, or for qualifications or provisos to be entered in the Group’s report.

In responding to the EU tax initiatives Jersey has made it clear that it supports the principle of fair tax competition, but is not prepared to make commitments which would leave Jersey competing for the provision of financial services with other relevant jurisdictions on an un-level playing field.

It is to be noted that the Code of Conduct on Business Taxation does not place legal obligations on Member States. The implementation of the Code is stated to be required to enable Member States to benefit fully from the Single Market and to support the development of the Economic and Monetary Union, to neither of which is Jersey committed under the terms of Protocol 3. While EU Member States see the need to act in unison in removing what they perceive to be harmful tax measures to ensure the effective functioning of the goods, services, capital and labour markets in the EU, so Jersey sees the need for an inclusive global response to so called harmful tax measures if its economic interests are to be safeguarded.

The EU Member States, in considering the tax package, have recognised the importance of having a level playing field embracing non-EU jurisdictions. Jersey sees a level playing field as a necessary pre-condition before any action is taken in this area. It is unclear as yet whether the EU will make any progress in its talks on the tax package with non- member countries such as Switzerland and the USA[7], or the extent to which such countries will seek to broaden the discussions to embrace other areas such as better access to the EU financial markets, which also could be of interest to the Island’s finance industry.

OECD

Over the last three years Jersey and Guernsey have sought to engage constructively with the OECD in its initiative on “harmful tax competition”, which was enshrined in the OECD’s 1998 report “Harmful Tax Competition: an Emerging Global Issue”.

The Islands have indicated their willingness to enter into a political commitment to the three broad principles that the OECD has stated are the key to a global approach to removing “harmful tax practices”; that is:

· Effective exchange of information

· Transparency

· Non discrimination

It is assumed that this commitment will be shared by all OECD member countries and by those non- member jurisdictions with which Jersey is in competition in the provision of cross-border financial services.

In 1998 the OECD produced a list of 47 so called “tax havens” which, without any apparent logic or reason, included Jersey, Guernsey and the Isle of Man but did not include Switzerland, Luxembourg, Hong Kong or Singapore which are similarly engaged in the provision of financial services to non-residents. Following representations, six jurisdictions were removed from the list and in June 2000 the OECD published a report entitled ‘Towards Global Tax Co-operation’ which set as one of its objectives the identification of those ‘tax haven’ jurisdictions that were considered “non co-operative” with a view to listing those jurisdictions by the end of July 2001 and recommending a common framework of so-called defensive measures be taken against them. To avoid being listed, jurisdictions are required to enter into a commitment to make changes in support of the OECD’s ‘harmful’ tax initiative. Jersey is confident that it will not be listed as non-cooperative not least because the Island has no need to make any changes to existing legislation to be in line with the OECD’s proposals for exchange of information on criminal tax matters to be implemented by the December 31st, 2003. The Island also can readily satisfy the OECD’s requirements on the availability in the Island, in response to appropriate requests, of information on the beneficial ownership of companies, partnerships and other legal entities, and accounts for such entities.

A willingness has been indicated to engage in discussions with a view to their full participation in the OECD’s partnership programme towards the development of a model exchange of information instrument concerning ‘civil tax matters’, and its effective adoption and implementation by both OECD member and representative non- member jurisdictions.

Jersey has also signalled its willingness to participate in a process which includes an open dialogue between the OECD and non- member jurisdictions, a process required if the level playing field which is so essential to the continued expansion of global economic growth is to be achieved. Such a dialogue must enable non-member jurisdictions to become increasingly integrated into the process of setting new international tax standards and in the detailed implementation of both existing and new international standards on ‘harmful’ tax practices.

It has been made clear that implementation of Jersey’s commitments in the light of agreed international standards will be subject to the necessary legislative and policy decisions being approved in due course by the States. The necessary proposals for those legislative and policy decisions will be presented when it is clear that equivalent measures are to be adopted by OECD members, and by non- member jurisdictions which are materially in competition with the Island in the provision of cross-border financial services.

Because the Island cannot on any objective and fair analysis be considered a “non co-operative” tax haven it does not expect to be subject to any of the so- called defensive measures which the OECD has indicated will be recommended for application to those jurisdictions that appear on the list of non co-operative “tax havens”.

The Insular Authorities have made it clear that they will be as determined as they expect OECD member and non- member jurisdictions to be in protecting their economic interests, and their fiscal autonomy.

In considering the impact of the OECD tax initiative, it is important to note that the OECD 1998 report is concerned solely with geographically mobile financial and other service activities. Attention also needs to be drawn to the statements made by two OECD member countries, Luxembourg and Switzerland, in abstaining from endorsing the 1998 report largely on the ground, among others, that it was so restricted in its application.

It is submitted that fair tax competition in all area of business activities is of benefit to the world economy and is not to be discouraged. The OECD has come under increasing pressure from a number of quarters, most particularly from the United States, on the need to facilitate tax competition. Comfort can also be drawn from the fact that the OECD has now accepted the continued existence of non- discriminatory zero tax regimes both generally and in their application to specific financial and other services. The Insular Authorities have expressed confidence that they can satisfy, by the end of 2005, the OECD requirements in respect of the removal of any discriminatory tax regimes, providing this is done on an international level playing field basis, without detracting from the Island’s competitiveness as a low tax jurisdiction.

Conclusions

The author is confident that the Island will not be on the OECD list of non co-operative ‘tax havens’ published at the end of July 2001. It is suggested that there is nothing in the EU or OECD tax proposals which might jeopardize Jersey’s future as an international finance centre.

Jersey will continue to be attractive for the following reasons:-

· relatively low rates of taxation - acceptance by the OECD of zero tax regimes, providing they are non discriminatory, is as good an indication as one could hope for that there is a future for tax differentials;

· more responsive to market needs - the greater speed with which offshore financial centres can enact legislation which meets the needs of the international financial market place will remain;

· its record of political and fiscal stability;

· the confidentiality offered to those engaged in legitimate business and who have legitimate reasons for protecting their privacy;

· the greater flexibility of small jurisdictions;

· the quality of the services provided and the expertise available.

There will be more international co-operation in the pursuit of those engaged in fiscal fraud and other criminal activities, and this will manifest itself in requests for more exchange of information in support of criminal investigations and prosecutions. However, there is no reason why countries engaged in legitimate business should face fewer opportunities to take advantage of international tax differentials, nor should investors engaged in legitimate activities fear for any loss of the privacy they have a right to enjoy, and which they will be able to call upon human rights legislation to defend.

No one is suggesting that the financial centres of Zurich, Geneva, Luxembourg, Dublin, Singapore, or Hong Kong, are at risk of disappearing. What is important for Jersey’s future is the existence of a level playing field on which the same obligations attach to all such centres. Indeed, there is litle prospect of obtaining an effective response to the international tax initiatives generally unless the major centres engaged in the provision of cross- border financial services act in unison. It is clear that this will be far from easy to achieve, but Jersey has already indicated that it is prepared to join in a truly international dialogue to work towards this objective.

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] Santa Maria Da Feira European Council - June 19th and 20th, 2000

[3] ECOFIN - The Economic and Finance Council of Ministers

[4] Mr O’Neill has been reported as stating that he was troubled by the idea that a group of countries should interfere in the tax systems of other jurisdictions and should concentrate instead on the suppression of tax evasion. Financial Times, May 11th, 2001.

[5] EU Code of Conduct (Business Taxation)/ Primarolo Group Report to ECOFIN Council, Annex A (Description of listed measures)

[6] Protocol 3 to the Treaty of Accession of the United Kingdom to the European Community

[7] But see footnote 4