Article by Wendy Dorman ACA, Tax Director, and Jane Wickham, ACA, AITI, Tax Manager - Deloitte & Touche, Channel Islands. The article was published in the November 2002 issue of Tax Adviser. KEY POINTS
- Tax Havens are increasingly under attack partly because of concerns over their link with organised crime and partly because their low tax regimes are seen as a threat by high tax countries
- The relationship between domestic economies has changed greatly in recent years due to the globalisation of trade and investment, and international trade agreements
- Tax harmonisation is not gaining support on the international agenda
Tax havens have grown rapidly over the 1980s and 1990s and their success has provoked closer scrutiny by the international community. This community has become less tolerant of the type of competition offered by tax havens and increasingly concerned that tax havens conceal proceeds of organised crime. Never before has the pressure on tax havens been so intense. This article looks at the current position, explores the driving forces behind current attacks, outlines initiatives taken by the international community, and assesses the future prospects for tax havens.
What defines a tax haven?
Tax havens are typically used to shelter income and gains from taxation or to defer the imposition of taxes. They offer an ideal location for taxpayers to manage and dispose of capital and provide an environment for the tax efficient structuring of international trade. Tax havens can be integral to arrangements that stretch territorial limits of high-tax countries so as to minimise the burden of corporate, income, capital gains and inheritance taxes for taxpayers. They attract the financial industry and other mobile service activities and are often used by holding companies, banks and investment companies, captive insurers and shipping companies.
Commonly utilised tax havens are characterised by some or all of the following:
- low or no taxes on at least one important source of income;
- political and economic stability enabling certainty, confidence and corporate security in business dealings;
- a comprehensive selection of legal, tax and accounting expertise;
- advanced communication facilities;
- internationally recognised standards of regulation and supervision of business;
- suites of company and tax legislation that caters for a diverse range of international business requirements; and
- confidentiality and privacy regarding clients’ business transactions.
Why are tax havens being challenged?
The low tax environments offered by tax havens are seen as a threat to high-tax countries, and recognition of countermeasures imposed by the fiscal authorities of high-tax countries have always been a feature of doing business in tax havens. Recently, there has been increased focus on tax havens on an international level due mainly to pressure from both the European Union (EU) and the Organisation for Economic Cooperation and Development (OECD). This interest can be attributed in part to the globalisation of the trading world, but is also a key element in international efforts to combat organised crime.
On the domestic front, many high-tax countries have acted to curb both the legitimate use and the abuse of tax havens over the years, first and foremost to prevent erosion of their tax base. Measures are designed to ensure domestic laws are complied with, non-compliant cross-border transactions are deterred, legally due taxes are collected, and the use of tax havens is proper and disclosed.
Apart from protecting tax revenues of high-tax countries, other reasons to challenge the use of tax havens have been put forward, particularly by the OECD. These include:
- the use of tax havens undermines the fairness and social acceptance of domestic tax systems;
- the use of tax havens by residents of high-tax jurisdictions re-shapes the desired level, distribution and mix of taxes (direct or indirect) and public spending; and
- the measures that fiscal authorities must put in place to prevent the erosion of their tax bases have increased the complexity of domestic tax systems and put greater burdens and costs on tax administrators as well as compliant taxpayers.
What countermeasures are imposed?
Tax legislation in high-tax countries now includes a wealth of anti-avoidance provisions with specific legislation in many such jurisdictions serving to eliminate the tax advantages of undistributed income held offshore. Controlled Foreign Company legislation has been widely introduced and refined to reduce the attractiveness of tax deferral possibilities afforded by the use of foreign personal holding companies and controlled foreign operations.
Aside from amendments to domestic tax legislation, fiscal authorities of high-tax countries have imposed other general measures such as:
- refusing to enter into tax treaty negotiations with tax havens. The lack of a tax treaty network reduces the attractiveness of the tax haven for many businesses and individuals;
- transfer pricing arrangements whereby fiscal authorities examine cross-border transactions to ensure they are transacted on an arm’s length basis, thereby limiting any artificial shifting of income from high to low tax environments;
- statutory interpretations, for example substance over form principles, enabling a fiscal authority to overturn schemes by ignoring intermediate transactions as artificial and solely undertaken to avoid a tax charge; and
- shifting the burden of proof for tax compliance matters from the relevant fiscal authority to the taxpayer.
Why the spotlight now?
Until recently, the interaction of domestic tax systems was relatively unimportant, given the limited mobility of capital. Decisions as to the mix of tax, nature of tax incentives and level of public spending were primarily based on domestic concerns and effects on other economies were generally limited. The relationship between domestic economies has changed greatly in recent years due to the globalisation of trade and investment, and international trade agreements, notably the integration of European national economies into the EU. These developments have increased the potential impact that domestic tax policies have on other economies. This combined with growing worldwide concern that loosely regulated tax havens shelter the proceeds of organised crime has lead to a concerted attack by international organisations on tax havens and ‘harmful tax practices’ in non-tax haven countries. The EU and the OECD have led the main initiatives in this area.
In December 1997, the EU Council introduced a package of measures to tackle harmful tax competition in order to help reduce distortions in the Single Market, to prevent excessive losses of tax revenue (to locations outside the EU) and to develop tax structures in a more employment friendly way.
The package consists of a Code of Conduct on business taxation, a directive on the taxation of savings income and a directive on withholding taxes on cross-border interest and royalty payments between companies. It was decided from the outset that, although the Package relates to the EU Single Market, it should include dependent territories of member states and in certain aspects key third countries such as Switzerland and the United States of America (USA). This seeks to avoid restrictive measures in the EU resulting in a flight of capital out of the EU.
The main areas for action are the Code of Conduct and the taxation of savings.
Code of Conduct
The Code of Conduct is an agreement to eliminate potentially harmful tax practices in business tax, emphasising geographically mobile industries. The key principles are that member states should commit themselves to:
(1) examining their existing laws with a view to beginning the process of eliminating harmful measures; and
(2) not to introduce new tax measures that are harmful. The code does not define what is harmful but sets out criteria by which measures are to be evaluated. Such criteria includes:
November 2002 by