International Policy Digest

World News /24 Jul 2020
07.24.20

International Initiatives can Convince Tax Havens to Turn Over a New Leaf

The coronavirus pandemic has not only taken a sledgehammer to the global economy, but it has also whittled away the patience some decision-makers had for tax havens and the firms that exploit them to cheat the public purse. The European Commission recently recommended that its member states withhold any coronavirus aid funds from companies linked to listed tax havens, while a number of pundits have suggested that cracking down on secrecy jurisdictions could plug the holes that the pandemic has left in national budgets. There’s clearly an appetite for finally doing something about tax dodging—in June, a large majority of European lawmakers voted to establish the EU’s first permanent subcommittee on tax avoidance.

Given that some countries which the EU currently identifies as tax havens, such as Panama or the Cayman Islands, have built entire industries out of helping firms avoid the taxman, the prospects of convincing them to clean up their act might seem slim. A recent working paper by the Brookings Institution found that the EU’s review of jurisdictions—and the prospect of being put on its black or grey lists—was a strong motivator for countries to improve their tax governance. Indeed, there’s a number of encouraging precedents of countries which were whitelisted by the EU after they signed up to international initiatives like the OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI/BEPS) and made substantial progress reforming their tax policies.

Mauritius, for example, had become well-known in the 1990s for its liberal economic regime. In October 2019, however, the EU endorsed it as a compliant jurisdiction for tax matters—the culmination of years of work on Port Louis’s part to fall in line with international best practices of tax governance.

Among the steps which allowed it to earn the EU’s stamp of approval, Mauritius signed up to the MLI/BEPS, allowing it to efficiently transpose OECD recommendations into its existing network of bilateral tax treaties. In a sweeping finance bill passed in 2019, the island nation introduced Controlled Foreign Corporation (CFC) rules aligned with similar rules in the EU’s anti-tax avoidance directive. The same finance bill also ushered in economic substance requirements to ensure that firms that are tax residents in Mauritius are carrying out genuine economic activity there, and restricted the eligibility for a partial tax exemption to companies that conduct their “core income-generating activities” in Mauritius. The country also became one of the first African nations to sign a multilateral agreement for the automatic exchange of tax information in order to crack down on tax evasion.

Mauritius isn’t the only one to have radically improved its tax governance in recent years. Belize, a frequent fixture on lists of the world’s most notorious tax havens, was moved from the EU’s blacklist to its greylist in November 2019 and delisted entirely in February 2020 after Brussels found that the Caribbean nation had carried out the necessary reforms to improve its tax framework.

Belize’s removal from the EU’s tax havens list came after it, like Mauritius, joined the MLI/BEPS and passed legislation to bring its tax regime in line with international norms. The most critical of the six laws Belize implemented was an amendment to the International Business Companies Act. The reform, among other things, expressly granted companies falling under Belize’s International Business Companies (IBC) regime the option to conduct business activity within Belize as long as they meet certain physical presence requirements. The amended legislation also altered the tax regime applying to IBC companies, taxing any part of their income which was earned in Belize and requiring IBCs conducting business activity in Belize to file financial statements.

Indeed, countries like Mauritius and Belize have shown more willingness to reform their tax policies than some EU member states. Dutch PM Mark Rutte recently received his fair share of criticism for playing Mr. Frugal and nearly torpedoing a deal on the EU’s coronavirus recovery fund—while the Netherlands’ lax tax regime costs EU countries some $10 billion a year in lost corporate tax.

The notorious “Dutch sandwich,” in which companies move royalties and interest payments from where they’re actually turning a profit through “special financial units” in the Netherlands into offshore tax havens, is one of the most famous loopholes which companies exploit to reduce their financial liability. These Dutch subsidiaries are often little more than shell companies, meaning that the Netherlands serves as a “backdoor” through which taxes owed to other EU member states seep out.

Brussels has had ample evidence that concerted pressure, such as the possibility of being blacklisted by the bloc, has induced countries abroad to adopt best practices in tax governance. It’s also seen how instruments like the MLI/BEPS, which a number of EU member states have yet to ratify, have handed countries the tools to improve their standing in the international community. The EU has nevertheless been reluctant to take a hard line with its own member states. It’s likely no accident, for example, that the Cayman Islands—an autonomous British Overseas Territory—were only added to the EU’s tax blacklist after the UK left the EU.

With national coffers running low on cash amidst the pandemic and patience with tax avoidance running low, will the EU finally learn from encouraging examples abroad and stamp out tax loopholes within the bloc?