On Dec. 5, the EU Council agreed, after long debate, haggling and horse trading, on a blacklist of 17 countries that the European finance ministers consider uncooperative in tax matters. They also voted on a commitment list of 47 countries that would be deemed uncooperative, according to the EU’s own criteria, had they not agreed in writing to remedy their shortcomings by the end of 2018.
The reaction could not have been more diverse.
Blacklisted countries expressed their “sadness” and “dismay.”
NGOs like Oxfam and the Tax Justice Network, who in the week before their announcement had released their own, much longer tax blacklists, lamented the omission of European countries and the absence of “the most notorious tax havens” on the EU list.
The EU Commission, in the person of Tax Commissioner Pierre Moscovici, called the list an important but insufficient first step.
Toomas Tõniste, minister for finance of Estonia, meanwhile noted on behalf of the EU Council that the initiative was already proving its value because numerous countries had made commitments to change their tax regime based on EU criteria to avoid the blacklist.
And the countries on the commitment list described their “graylisting” as a seal of approval, certifying that unlike the non-cooperative countries on the blacklist, they were in fact “cooperative.”
The Isle of Man, for instance, “welcomed” its graylisting as a decision not to place the island on the blacklist. Bermuda said it reaffirmed its status as a cooperative tax jurisdiction. Jersey considered itself “cleared” from inclusion on the blacklist. And Cayman said the EU recognized it as a cooperative jurisdiction.
However, while it is clear, based on the criteria employed by the EU, that a blacklisting of any offshore jurisdiction had become increasingly likely – Bermuda’s former Premier Michael Dunkley went as far as calling it a “foregone conclusion” – desscribing the graylisting, which may require as yet undefined changes in local tax practice and legislation with unclear economic consequences, as an outright success might be a step too far.
In November 2016, the EU Council established three criteria that meant the examined jurisdictions had to be considered compliant on tax transparency, fair taxation and the implementation of measures to prevent tax base erosion and profit shifting (BEPS), a term for the loss of tax revenue due to tax evasion and aggressive tax avoidance by multinational companies.
Cayman’s government emphasized that the EU lists confirmed Cayman’s compliance with the required tax information exchange regime, the implementation of BEPS and its lack of preferential tax mechanisms that treat foreign companies differently than local ones. But much like Bermuda, Guernsey, the Isle of Man, Jersey and Vanuatu, Cayman had not met the EU’s fair tax criterion, which stipulates that jurisdictions should not facilitate offshore structures that attract profits without real economic activity.
Lack of substance
How the six jurisdictions are supposed to change their tax regime or legislation to meet the fair tax objectives of the EU is uncertain. Yet, in an apparent effort to buy time, they have all committed to doing so.
While the EU appears to expect changes in tax law, with a European Commission document stating Cayman had committed to “introduce substance requirements,” Cayman’s government aim appears to be to keep the conversation going and educate EU officials about Cayman structures.
Exempted companies in Cayman do rarely have staff on island and under the law they are not allowed to trade with any person or business locally, except to further the business of the exempted company carried on outside the Cayman Islands.
This means that exempted companies can, and some do, have substance but often they are mere legal structures, a fact that may be at odds with the EU’s desire to ensure that jurisdictions do not facilitate letterbox companies.
Premier Alden McLaughlin acknowledged that the majority of Cayman’s companies “are not bricks and mortar,” but he insisted, “they also are not letterbox companies” in the sense that they are solely used to avoid certain tax obligations rather than pursue economic objectives.
Instead he stated, “they are financial instruments that pool investment capital and facilitate international transactions.”
Taking into account the transparency regime that shares information with foreign tax authorities, including all EU member states and G20, the premier noted, “there is no interest in setting up these companies to circumvent tax obligations.”
Tim Ridley, former chairman of the Cayman Islands Monetary Authority, said the substance requirement could be an opportunity to bring more economic activity to the island.
In a speech at the annual STEP Caribbean conference last May, he highlighted the economic activity criteria inherent in the EU blacklist and BEPS initiatives to recommend that offshore jurisdictions encourage economic activity in their jurisdictions to thrive.
“Having warm bodies in cool offices making real decisions,” is part of what Tim Ridley called the long game that offshore centers must play to survive.
The economic benefits would undoubtedly be greater than for the mere corporate services of registering and administering legal structures. But to encourage companies to relocate staff, offshore centers must also put in place attractive packages, encompassing little red tape in terms of immigration and business services and cost-effectiveness, he noted.
Others are more skeptic. Tony Travers, senior partner at Travers Thorpe Alberga, warned in a speech in November that “substantial activity doctrine” in the BEPS initiative, which advocates that profits can only be taxed in the jurisdiction where substantial activities are undertaken, was in fact a Trojan horse.
In Cayman and other overseas territories, he said, it is highly unlikely that a sufficient substantial presence can be developed, “given the current immigration rules and particularly, with regard to the rollover policy and the manner of its application which make it highly improbable that skilled financial professionals would consider a long-term career in an offshore financial center.”
The Crown dependencies in the British Channel, in contrast, indicated they are prepared to change their laws to introduce legal substance requirements and made bullish statements how this would be an opportunity to grow their local economies.
Howard Quayle, the chief minister of the Isle of Man, said his government had a constructive dialogue with the EU’s Code of Conduct Group, which developed the tax criteria, about their concern “relating to a potential lack of substance, which it highlighted may be due to the absence of legal substance requirements for entities doing business in, or through, the Isle of Man.”
Mr. Quayle said his government will create an island of enterprise and opportunity: “We have a strong and diverse economy which we will grow, alongside encouraging a skilled workforce to relocate to the island. We can do that while ensuring we meet our EU and international commitments.”
Jersey’s Chief Minister, Sen. Ian Gorst, said his government’s discussions with the Code of Conduct Group may include changes to Jersey’s legislation on economic substance.
“We have already begun the necessary preparations, having regard to the Code Group requirements and Jersey’s best interests. I am committed to ensuring that, working with the finance industry, this process will be completed by the end of 2018,” he said.
Process not over
That the process is far from over is evident in the statements of Commissioner Moscovici who said, “the countries that have taken commitments must change their tax laws as soon as possible.”
To keep them on the straight and narrow, EU finance ministers should quickly agree on sanctions.
“We must not accept unfair tax competition and opacity,” he said. “Tax havens must not slip off Europe’s radar screen. As a European citizen, I share the expectations of those who hoped for more. I say to them, let us take this list for what it is: a first step. And let us keep up the pressure together, on the member states and on third countries.” Countries that are not on the blacklist, he added, “will only be fully off the hook once they have fulfilled their commitments.”
To assess jurisdictions under the fair tax criteria, the EU Code of Conduct Group will apply any guidance it has developed over the years.
The most pertinent assessment criterion from a Cayman point of view is whether any tax advantages are granted without any real economic activity and substantial economic presence.
This analysis will take into account the “adequate” level of employees, “adequate” expenditures, physical offices and any activities such as investments that are undertaken in the jurisdiction.
EU documents show that a jurisdiction can only fail the assessment if its offshore structures that attract profits without real economic activity “are due to rules or practices, including outside the taxation area, which a jurisdiction can be reasonably asked to amend.”
The introduction of a corporate income tax system or a specific income tax rate “is not amongst the actions that a third country jurisdiction can be asked to take in order to be in line with the requirements under this test, since the absence of a corporate tax base or a zero or almost zero level tax rate cannot by itself be deemed as a criterion for evaluating a jurisdiction as non-compliant,” the EU Council Outcome of Proceedings document stated.