The EU's Tax Haven Blacklist - Will the U.S. Eventually be Added?

Yesterday (December 5), EU finance ministers finalized a list of 17 jurisdictions that the EU regards as non-cooperative for tax purposes – a tax haven blacklist by any other name. 

This was the culmination of a process that began in January 2016 when the European Commission produced a strategy document addressing “external challenges” to the tax base of Member States, “given the global nature of harmful tax competition and aggressive tax planning”. As part of that strategy, the Commission announced that it was working “towards the goal of a common EU system for assessing, screening and listing third countries . . . with a clear and coherent EU approach to identifying third countries that fail to comply with good governance standards”. Such an approach, it added, “must be fair, objective and internationally justifiable”, as well as “compatible with EU commitments under multilateral or bilateral international agreements”.

To that end, work commenced on establishing the criteria that non-EU jurisdictions would have to meet to avoid listing (EU jurisdictions, it should be noted, were specifically excluded from the listing process, even though tax campaigners argue that the tax regimes of some Member States do not bear close scrutiny). Three such criteria were agreed by the EU Council of Ministers in November 2016 – tax transparency, fair taxation and implementation of anti-BEPS measures. Each of these criteria itself consists of a number of sub-criteria or tests.

The Blacklist Criteria

The first set of criteria, relating to tax transparency, is as follows:

  • Criterion 1.1 – with respect to the OECD Automatic Exchange of Information (AEOI) standard (the Common Reporting Standard – CRS), a jurisdiction should have
    • committed to the CRS and started the legislative process to implement it effectively, with first exchange in 2018 at the latest; and
    • have arrangements in place to be able to exchange information with all Member States, by the end of 2017, either by (a) signing the Multilateral Competent Authority Agreement on automatic exchange of financial account information or (b) through bilateral agreements;
  • Criterion 1.2 – a jurisdiction should at least possess a “Largely Compliant” rating from the Global Forum on Transparency and Exchange of Information for Tax Purposes (the Global Forum) with respect to the OECD Exchange of Information on Request (EOIR) standard;
  • Criterion 1.3 –
    • a sovereign state jurisdiction should either
      • have ratified, agreed to ratify, be in the process of ratifying, or committed to the entry into force, within a reasonable time, of the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters (the Convention), as amended; or
      • have a network of exchange arrangements in force by December 31, 2018 that is sufficiently broad to cover all Member States, effectively allowing both EOIR and AEOI;
    • a non-sovereign jurisdiction should either
      • participate in the Convention, as amended, which is either already in force or expected to enter into force for it within a reasonable time; or
      • have a network of exchange arrangements in force (or have taken the necessary steps to bring such exchange agreements into force within a reasonable timeframe) which is sufficiently broad to cover all Member States, allowing for both EOIR and AEOI.

 At an unspecified “later stage”, a fourth sub-criterion, dealing with beneficial ownership, will be added “in view of the initiative for future global exchange of beneficial ownership information”.

There are two important points to note about these transparency criteria. First, in 2018 Criterion 1.1 will be replaced with a new provision, requiring a jurisdiction to possess at least a “Largely Compliant” rating from the Global Forum “with respect to the AEOI CRS”. Secondly, until June 30, 2019, a jurisdiction can be regarded as compliant on tax transparency if it fulfils only two of the three transparency criteria, though that provision does not apply to jurisdictions rated “Non-compliant” on Criterion 1.2 or which have not obtained a “Largely Compliant” rating on that criterion by June 30, 2018.

As regards the second main criterion (fair taxation), a jurisdiction will be considered compliant if it

  • has no preferential tax measures that could be regarded as harmful according to the criteria set out in an EU resolution of December 1, 1997 on a code of conduct for business taxation (Criterion 2.1); and
  • does not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction (Criterion 2.2).

To satisfy the third main criterion (implementation of anti-BEPS measures), a jurisdiction should commit, by the end of 2017, to the agreed OECD anti-BEPS minimum standards and their consistent implementation. Once the Inclusive Framework for Tackling Base Erosion and Profit Shifting (the Inclusive Framework), a multi-national group under OECD auspices, has completed a review of the minimum standards, Criterion 3 will be replaced with a new provision requiring the jurisdiction to receive a “positive assessment” in relation to the effective implementation of those standards.

Who’s on the Blacklist?

In February 2017, three months after the criteria were agreed, the EU was reported to have informed 92 jurisdictions that they would be “screened” for compliance with the criteria. Although the identity of those jurisdictions was not disclosed, it is widely thought, on the basis of a “scoreboard” published by the EU in September 2016, that one such jurisdiction was the United States.

As the EU made clear at the time, the scoreboard was not intended to be a draft blacklist, but simply a means of identifying those countries that were “of most relevance for screening in greater detail against tax good governance criteria”. Nor was it meant to be a “pre-judgment of countries’ cooperation on tax matters”. Thus a country’s inclusion in the screening process was not necessarily an indicator that it would find itself on the blacklist.

Sure enough, when the list was agreed yesterday, it contained only the following 17 jurisdictions:

  • American Samoa
  • Bahrain
  • Barbados
  • Grenada
  • Guam
  • Macau
  • Marshall Islands
  • Mongolia
  • Namibia
  • Palau
  • Panama
  • Saint Lucia
  • Samoa
  • South Korea
  • Trinidad and Tobago
  • Tunisia
  • United Arab Emirates

This is a substantially smaller list than seemed likely just a month or so ago. According to a November 8 Bloomberg BNA report, the EU originally informed 53 jurisdictions that they were in breach of its criteria. Other reports suggest that this list was subsequently reduced to around 25 to 30 jurisdictions, but last-minute haggling between finance ministers of the Member States whittled it down further to just 17.

A Political Fix?

The document agreed by the ministers contains no specific sanctions against the listed jurisdictions, but instead provides a list of “effective and proportionate defensive measures” that “could be applied” by the EU and Member States. These include non-deductibility provisions, withholding taxes and limitations on participation regimes. The implementation of such measures has been left to the competence of Member States. In addition, the document “invites” EU institutions and Member States to take the blacklist “into account in foreign policy, economic relations and development cooperation with the relevant third countries”.  

The ministers also agreed a “gray list” of 46 jurisdictions that have given commitments to take the steps required to comply with the EU criteria. Those jurisdictions include Bermuda, Cayman Islands, Guernsey, Hong Kong, Isle of Man, Jersey, Liechtenstein, Switzerland, Taiwan and Turkey. Screening of a number of Caribbean jurisdictions severely affected by recent storms, including Bahamas and British Virgin Islands, was put on hold until February 2018.

Tax campaigners were unimpressed by the blacklist. “The EU has today missed a great opportunity to tackle the real issues lying behind the large-scale tax avoidance and tax evasion that is bleeding EU countries dry”, said Alex Cobham, chief executive of the Tax Justice Network. “Rather than have a list of tax havens based on an objective set of criteria, as originally envisaged, the list appears to be a political fix with EU members picking their least favourite countries to name and shame. The result of the flawed blacklisting process is a politically led list, that includes only the economically weak and politically unconnected.”

Cobham was also scathing about the absence of any sanctions from the blacklist. “It is completely pointless to have a blacklist with no sanctions”, he said. “Tax avoiders, and the countries that sponsor them will all be letting out a sigh of relief today.” 

In contrast, Luxembourg’s finance minister, Pierre Gramegna, said that blacklisting was a motor for change in itself. If someone wants additional sanctions, they can talk about it”, he observed. “But one should not underestimate the effect of a black list."

No Appetite for a Fight

According to the November 8 Bloomberg BNA report, the U.S. was not among the 53 jurisdictions that the EU originally warned were in breach of its criteria. At first sight, this may appear rather surprising. For the U.S. plainly fails to satisfy the Criterion 1.1 requirement of being committed to the CRS and having started the legislative process to implement it effectively, with first exchange in 2018 at the latest. As is well-known, the U.S. is the only major jurisdiction not to have committed to the CRS. It escapes blacklisting on this point only because, as we saw earlier, the EU has decreed that fulfilling just two of the three transparency criteria is sufficient until June 30, 2019. On that score, the U.S. gets home on Criterion 1.2 and Criterion 1.3.

Cynics might suggest that the “2 out of 3 rule” was deliberately crafted to park the issue of U.S. non-participation in the CRS until the second half of 2019. By then, as we also saw earlier, the current Criterion 1.1 will have been replaced by a new version, requiring a jurisdiction to possess at least a “Largely Compliant” rating from the Global Forum “with respect to the AEOI CRS”. In other words, the EU will then pass the buck to a multi-national group that operates under the auspices of the OECD – an organization that those self-same cynics might also suggest is unlikely to pick a fight with its most important member, the U.S.

Certainly, the OECD has shown no appetite for such a fight so far. For the last couple of years, it has maintained a list of jurisdictions committed to AEOI under the CRS. In the early days, the OECD also maintained a “naughty boy” list of jurisdictions that had not committed to the CRS despite being asked to do so. The U.S., uniquely, wasn’t on either list. Instead, it formed a class of its own – or rather a footnote to the list of committed jurisdictions. This read as follows:

“The United States has undertaken automatic information exchanges pursuant to FATCA from 2015 and entered into intergovernmental agreements (IGAs) with other jurisdictions to do so. The Model 1A IGAs entered into by the United States acknowledge the need for the United States to achieve equivalent levels of reciprocal automatic information exchange with partner jurisdictions. They also include a political commitment to pursue the adoption of regulations and to advocate and support relevant legislation to achieve such equivalent levels of reciprocal automatic exchange.”

That cryptic footnote is still in place, even though there has not been the slightest sign that the commitment it refers to will ever amount to anything more than words. FATCA remains, as it always has been, entirely one-way traffic.

A Non-BEPS Compliant U.S. Patent Box?

The FATCA footnote is a fig-leaf, designed to obscure the uncomfortable truth that the U.S. has opted out of the nascent global regime for mutual automatic exchange. For a while last week, it looked as if even that flimsy covering was about to be ripped away. Last Thursday (30 November), as the U.S. Senate prepared to vote on its tax reform bill, Senator Rand Paul (R-Kentucky), a long-time opponent of FATCA, tabled an amendment for its repeal. But that amendment never made it into the final version of the bill, passed by the Senate in the early hours of Saturday morning (December 2). So, for the time being at least, the OECD (and by extension the EU) will be able to maintain the dubious proposition that the FATCA regime renders the U.S. at least “largely compliant” with global AEOI requirements.

But that is not the end of the story. As we saw earlier, the EU’s Criterion 3 requires a jurisdiction to commit, by the end of 2017, to the agreed OECD anti-BEPS minimum standards and to their consistent implementation – a provision that will eventually be replaced with one requiring a jurisdiction to receive a “positive assessment” from the Inclusive Framework as regards the effective implementation of those standards.

One of the minimum standards, accepted by the U.S. in common with all other parties to the BEPS project, is Action 5 – Countering Harmful Tax Practices. A major focus of Action 5 is preferential IP regimes, such as patent boxes. As part of the moves to align taxation with substance, Action 5 provides that such regimes must require a “direct nexus between the income receiving benefits and the expenditures contributing to that income”.

When the Obama Administration signed up to Action 5, the “nexus” requirement was essentially a non-issue for the U.S. because it had no patent box regime. But the tax reform bill passed by the Senate last week provides for the introduction of a U.S. patent box in all but name – a 37.5% deduction (21.785% for taxable years beginning after December 31, 2025) on part of a U.S. corporation’s “foreign-derived intangible income” (FDII). This produces an effective rate of 12.5% (15.625% for taxable years beginning after December 31, 2025) on such income compared to the new general corporate tax rate of 20%. And guess what – the proposed new quasi-patent box regime contains no explicit “nexus” requirement.

Intellectual Gymnastics

The next stage in the U.S. tax reform process is the reconciliation of the Senate’s bill with the measure passed by the House of Representatives on November 16. There is therefore still opportunity for a “nexus” requirement to be added to the FDII regime. But if it is enacted without such an amendment, is it possible for the new regime be compliant with BEPS Action 5? If it isn’t, how will the Inclusive Framework be able to give the U.S. a positive assessment on implementing the BEPS minimum standards? And if it can’t, wouldn’t that make it impossible for the U.S. to satisfy Criterion 3 of the EU’s blacklist criteria?

Given the hoops that both the EU and the OECD have gone through to avoid putting the U.S. on the naughty step, it may not be beyond their ingenuity to find a way of accommodating the FDII deduction, even if it remains bereft of a “nexus” requirement. But if they do, it will require a feat of intellectual gymnastics that puts their previous efforts into the shade.

By Dr Craig Rose, Technical Editor, Bloomberg Tax


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