William Byrnes' Tax, Wealth, and Risk Intelligence

THE OECD FORUM REGARDING HARMFUL TAX COMPETITION[1]

Over the past several weeks, I have written a series of blogticles addressing issues of tax information exchange.  I will now pull back to circle around this subject, touching upon several forums, reports, and initiatives that either led up to or occurred during the OECD Forum.  Recognizing that the Forum has obtained steam due to the global financial slump – I will address current initiatives and impacts after the historical annotation.  Importantly, I will need to research and address the most recent OECD Forum in Mexico wherein Dr. Dan Mitchell, a press commentator for the Cato Institute, reported that the OECD is attempting to resuscitate the debunked arguments for capital export neutrality.[2]

1998 HARMFUL TAX COMPETITION: AN EMERGING GLOBAL ISSUE (OECD)

Let us begin this look back with a review of the seminal 1998 OECD Report .  In 1998, the Organization of Economic Cooperation and Development (“OECD”) presented its seminal report Harmful Tax Competition: An Emerging Global Issue [“1998 OECD Report].[3]  The 1998 OECD Report addressed harmful tax practices in the form of tax havens and harmful preferential tax regimes in OECD Member countries, but primarily in non-Member countries and their dependencies.  The 1998 OECD Report focused on geographically mobile activities, such as financial and other service activities.  The Report defined the factors to be used in identifying harmful tax practices and regimes, proposing 19 recommendations to counteract such practices and regimes.  Because Switzerland and Luxembourg abstained from the Report, these two OECD members are not bound by its recommendations.  The OECD has followed the 1998 Report with progress reports regarding implementation of the recommendations.

The OECD listed as four key factors to determine whether a tax regime was harmful:

1. Whether there are laws or administrative practices that prevent the effective exchange of information for tax purposes with other governments on taxpayers benefiting from the no or nominal taxation.
2. Whether there is a lack of transparency regarding revenue rulings or financial regulation and disclosure.
3. Whether there is a favourable tax regime applying only to certain persons or activities (ring fencing).
4. Whether there is an absence of a requirement that the activity be substantial, which would suggest that a jurisdiction may be attempting to attract investment or transactions that are purely tax driven.

The 2000 follow up report downgraded the 1998 factor of whether the jurisdiction imposed a minimal level of tax from a determinative factor to only as an indicative factor of tax haven status that would lead to further investigation into the four determinative factors.

Was the 1998  Forum Influenced by Geo-Politics at the Expense of Neutrally Developed Outcomes?

The list of tax havens determined to have harmful regimes included many of the traditionally targeted, primarily uni- and micro-economy[4], international financial centres on OECD member blacklists i.e. The Bahamas, British Virgin Islands, and Cayman Islands.[5]  Notably though, the list did not target jurisdictions such as Hong Kong and Singapore.  Their absence from the list constituted disparate treatment, alleged the micro-economies, resulting merely from the micro-economies lack of diplomatic importance.

Also, the 1998 OECD Report, in line with general OECD member trade negotiation policy, did not address its members’ ring-fenced tax policies that created harmful effects to the developing world, but rather only addressed the tax competition issues that affected the developed States.  By example, the 1998 Report did not address the US tax ring-fenced policy established in 1984 of exempting from withholding tax non-resident’s portfolio interest that led to the capital flight from Latin America of US$300 billion to US banks.[6]  The 2000 Report listed the British overseas territory Virgin Islands as a targeted jurisdiction but did not list the US ring-fenced policy favourable toward the US overseas territory Virgin Islands, and most of the US’ other dependencies, that allows an exemption from US taxation on non-US source income for US taxpayers resident in the dependencies.[7]  This factor, alleged the micro-economies, illustrated the disingenuousness of the Report.  The pro-micro economy commentators alleged an OECD discriminatory cartel against non-members, and in line that the Report was merely self-serving of the cartel’s interests.

Enforcement Measures

The OECD proposed counter-measures to be applied against listed uncooperative, such as:

• Restricting the deductibility of payments to tax havens;
• Withholding taxes on payments to tax havens; and
• Application of transfer pricing guidelines.

In order to be removed from the targeted list, the micro-economies had to issue Letters of Commitment to engage in effective provision of information for criminal tax matters for tax periods starting from 1 January 2004 and for civil tax matters for tax periods starting from 2006.    All Caribbean States and territories were targeted by the OECD and succumbed to commitment letters.[8]  The States and Territories that have issued these Letters of Commitment have based their commitment on at least two quid pro quos: (1) a diplomatic seat at the table for future discussions regarding the issue of tax competition, and (2) a level playing field wherein the OECD obtains commitment from its members to implement its recommendations.

My Commentary: Pro and Con

My commentary on the criticism of the OECD Report has been very detailed, and addresses the policy issues raised by the Report from a complex perspective.

First, the OECD States have democratically chosen government that democratically set the tax rates and rules that apply to their residents.[9]  If the residents do not like the rates or the rules, then the residents must either use the democratic process to change the rates and rules or move to a different jurisdiction.[10]  Thus, the often heard justification that OECD residents are justified in ‘hiding income’ because the OECD welfare States require high tax rates is not legitimate.  Evasion, in the OECD, is a democratically established crime with legitimate sanctions. 

Secondly, in the OECD, taxpayers have a jurisprudentially long-established right to arrange their affairs so as to incur the lowest incidence of tax.  This is known as tax avoidance planning.  Planning involves characterisation of income and transactions, timing of income, arranging activities that create value in the income value chain with a system and among systems, leveraging definitional and interpretative anomalies within a system and among systems, to name the basics.

Democratically elected governments may, even perhaps a duty to their welfare state societies, to protect their tax bases.  Thus, these governments may change the tax rules to impose tax on transactions that previously avoided tax.  On the other hand, retroactive regulatory changes are an affront to the jurisprudential principle of certainty and the Rule of Law.  Retroactive changes have been enacted, albeit very rarely, and Courts need to be vigilant in maintaining the Rule of Law and the principle of certainty by striking down retroactive application in these situations.

The groundwork is thus set for a conflicting claim: the government for revenue and the taxpayer (assisted by tax lawyers, accountants, and consultants) to minimize taxation.

Another principle policy established by and binding upon the OECD members is free trade, albeit in mitigated application.  The OECD preaches the freedom of movement of goods, services, and investment capital.  The free movement of persons which was once an international norm, lost favour amongst the members, but at least amongst the EU trade bloc, has regained its principle status.  The principles of free trade and the principle of taxation may create conflicting claims, both legitimate, upon taxpayers (tax subjects) and upon the chain of events that create income (tax objects).  I will not go into further detail on this argument, but leave it for the lecture and our discussions in our program.

Parting question for this week

Finally, this Report and the subsequent OECD Report on Banking that will be briefed in later blogticles both address the Exchange (“provision” because it is one way) of Information.  I leave you with this issue to consider: Does Public International Law or international jurisprudence or the jurisprudence of our respective jurisdictions establish a right against retroactive application of a change in revenue department policy or attitude toward previously accepted norms in tax planning?

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[1] The Forum has changed names since 1998 from “Harmful Tax Competition” to Harmful Tax Practices”.

[2] http://www.freedomandprosperity.org/memos/m09-09-09/m09-09-09.shtml. In potential support of Dr. Mitchell’s investigative press report is that the OECD Forum now uses the language in its communiqués “encourage an environment in which fair competition can take place”, sounding very similar to the industrial arguments promoting trade protectionism and barriers through countervailing dumping duties against States with low labour and materials costs.

[3] You may obtain this Report without charge in PDF on the OECD website at http://www.oecd.org/.

[4] The traditional micro-economies had previously been uni- agriculture economies, many exporting to their colonial parent under favourable import regimes to either counter OECD agricultural subsidy policies or as a subsidy in itself to the former/current colony to assist it with foreign exchange earnings that in turn could be used to meet the colonies trade deficit in goods.  Many of the uni-economies diversified into tourism services to mitigate the trend of their lack of agricultural competitiveness.  Eventually, the colonies entered the international financial services sector to mitigate against their dependency on tourism and to increase their local inhabitants standard of living.  

[5] See Toward Global Cooperation, Progress in Identifying and Eliminating Harmful Tax Practices, OECD (2000) at 10.  Forty-seven jurisdictions were initially targeted by the OECD, approximately a quarter of the world’s States and jurisdictions.

[6] The US imposes tax upon its taxpayers’ interest income.  See Globalization, Tax Competition, and the Fiscal Crisis of the Welfare State, Reuven Avi-Yonah, 113 HVLR 1573, 1631 (May 2000) wherein he addresses this policy in the context of President Reagan’s administration’s efforts to attract foreign capital to fund the ballooning US deficit.

[7] The US imposes tax upon her citizens on the basis on their nationality.  Thus, regardless of residency, a US taxpayer is subject to the full impact of US domestic taxation.  This tax policy’s application to her own citizens is maintained in her tax treaties through the savings clause.  The US grants two exceptions to this policy.  The first is a exception limited to a ceiling of US$80,000 of employment income for US taxpayers resident in a foreign jurisdiction that remain outside the US at least 330 days.  The second is the more egregious ring fence policy that allows an unlimited exemption from US tax on non-US source income for US taxpayers resident in the US Virgin Islands.  The Virgin Islands, in turn, grants a generous tax subsidy benefit if the taxpayer’s activity is conducted through an approved investment incentive vehicle.

[8] By example, in June 2000, all members of the Organization of Eastern Caribbean States were listed by the OECD as tax havens.  Under the threat of the OECD sanctions being implemented by its members against the Caribbean States, all issued Letters of Commitment to the OECD.

[9] I start with the democratic argument in order to ground my arguments in public international law.  All OECD members are members of the UN (Switzerland having only recently joined).  The OECD and UN principles hold high regard for democratic processes.  Democratic participation is held up to the level of being a fundamental human right.

[10] Several OECD States have enacted anti-emigration tax statutes that continue to subject former residents (nationals in the case of the USA) to tax.  I strongly disagree with this anti- free trade policy, in this case, that impacts the free movement of persons. This policy creates export barriers to low tax jurisdictions that seek to compete for the immigration of person with capital, such as retirees and entrepreneurs.