OECD report on ‘level playing field’ imminent

The release of the Organisation for Economic Co-operation and Development’s (OECD) seminal report on tax-information collection and exchange practices is imminent. The report, which has taken nearly two years to prepare, will be a definitive statement of information collection and exchange practices in the 82 countries surveyed.

The controversy over comparative standards for information exchange is not an arid debate over arcane regulatory policy; big money is at stake. At US$10tn and growing rapidly, the market for cross-border financial services is one of the most dynamic and lucrative businesses in the global economy. International financial services are highly mobile, and will readily shift jurisdictions in response to regulatory arbitrage opportunities. The new report will influence the odds for jurisdictional success or failure in a critical sector of the global economy.

This paper considers the controversial background for the OECD programme on international tax information exchange in anticipation of the report’s release.

The story so far

A longstanding principle of international law limits taxing rights to those which a country can enforce without the need for assistance from others. The OECD, an exclusive Paris-based club of thirty rich countries, launched a campaign in April 1998 to co-opt the assistance of non-member jurisdictions (tax havens[1]) and help its sovereign members by reversing this rule. The OECD’s 1998 report, entitled ‘Harmful Tax Practices:

An Emerging Global Issue’, proposed an ambitious jump in global tax-enforcement capability through:

Government access (around the world) to beneficial ownership and financial data;

Cross-border exchange of such data to tax authorities, everywhere.

The OECD demanded formal commitments from small non-member financial centres to proactively assist with its programme for global ‘transparency’ (financial surveillance). These demands were backed by threats to shut non-cooperating international financial centres out of the world’s banking and securities markets. Tempting hubris, the OECD launched its programme for enhanced surveillance without effective means of ensuring participation from key countries within its own membership.

Switzerland and Luxembourg, OECD states with substantial offshore financial services business, both formally dissented from the 1998 report. They have continued to reject any participation in the OECD information-exchange programme. Portugal and Belgium, also OECD members, dissented from the project in 2001 and retain reservations.[2]

Non-member commitments to the OECD project

The Cayman Islands made an advance commitment to the OECD in May 2000, which avoided its inclusion in the OECD’s initial list of uncooperative tax havens published in the OECD’s 2000 Report. The text of the advance commitments was not published in full. The Cayman Islands was also instrumental in the preparation of ‘Towards a Level Playing Field’, published in September 2001, which foreshadowed the imminent OECD Report with a survey of information access and exchange practices in thirteen OECD and non-OECD countries.[3]

By 2002, most of the smaller offshore centres had agreed, under duress, to support the OECD project for tax information exchange. This process was slow initially, because these traditional offshore centres found that clients were migrating elsewhere in anticipation of those commitments. They were moving to take advantage of the more relaxed standards available, particularly in Switzerland and the US[4].

Led by an early Isle of Man commitment in December 2000, the smaller offshore centres accordingly took the precaution of conditioning their commitments on a ‘level playing field’ – a requirement for the adoption of similar obligations by OECD countries. The traditional offshore centres were apparently willing to co-operate on the basis that all financial centres would work together.

The Bahamas committed to the OECD project in March 2002, subject to the level-playing-field commitment, following an extensive re-regulation of its financial-services environment. Although the introduction of eleven new pieces of financial-services legislation in response to Financial Action Task Force pressure at the end of 2000 was a painfully quick adjustment for the Bahamas at that time, it has translated into The Bahamas being widely regarded as the leading Caribbean centre for international wealth planning.

EU Savings Tax Directive skewers the OECD

The OECD’s lack of success in extending its programme to its own members became embarrassingly conspicuous in 2004, when the European Union (EU) moved to adopt its own parallel programme for tax-information collection and exchange, the Savings Tax Directive[5]. Unlike the careful management of the OECD initiative (where the key debates were conducted behind closed doors), the EU argument over the competitive and financial costs of compliance became a highly public confrontation between the EU and Switzerland[6].

Although all fifteen members of the EU at the time were also OECD members, the EU exempted four OECD members[7] from information-exchange obligations until 2010.

The US flatly refused to discuss involvement in the EU programme and was (disingenuously) declared to be in compliance with the information exchange demanded by the EU.

Cayman challenged its inclusion in the Directive in the European Court of Justice (ECJ) on the grounds that the EU enjoys no constitutional authority to unilaterally impose rules on Cayman. The ECJ agreed and dismissed the action on the basis that the EU (and by extension the ECJ) had no competence on the issue.

In the process, the ECJ noted that inclusion of the UK-dependent territories (including Cayman) in the Directive was a matter which should be addressed under Cayman’s constitutional arrangements with the UK. In the event, Cayman preferred to negotiate rather than litigate with the UK government and subsequently announced its agreement to participate in the Directive in exchange for UK promises to enter into negotiations with Cayman on a double-tax agreement.[8]

Cayman, Anguilla and Montserrat have opted to participate through automatic exchange of information. The UK Crown Dependencies (the Channel Islands and the Isle of Man), as well as the British Virgin Islands, Aruba and the Turks and Caicos Islands have all opted for withholding tax. Note that EU-resident clients with interest payable from a withholding tax jurisdiction are generally given the opportunity to opt into information exchange, but the reverse does not apply.

The Bahamas is, of course, an independent sovereign state and as such is not subject to the terms of the Savings Tax Directive. Accordingly, onerous withholding tax or information-exchange requirements imposed under the Savings Tax Directive do not apply to EU residents receiving interest from Bahamian sources.

The exemptions from tax-information exchange granted in the EU Savings Tax Directive stunned the traditional financial centres. For several years, including through their commitment process, those centres had been steadily losing business to OECD countries lagging behind their efforts. The OECD kept their project on foot through continuous (though ineffectual) promises of decisive action on the derelictions within its own membership.

The exemptions granted by (and for) OECD countries in the EU initiative tore the lid off the Pandora’s Box of defaults by OECD countries. Such countries were demanding onerous information collection and exchange from others, but were refusing to bear the costs of implementation at home. The OECD’s credibility in insisting that changes in its own membership to match progress elsewhere were imminent was severely damaged by the outcome under the EU Savings Tax Directive.

The smaller centres saw their role as early movers (and regulatory arbitrage losers) as having been the dupes of a hypocritical OECD membership, keen to receive information, but reluctant to give it. The firestorm of protest prompted by the exemptions granted under the Savings Tax Directive crippled the OECD project for information exchange.

More serious problems for the OECD have arisen from the ambivalent position of the US in its initiative. The US federal government provides funding9 and officer staffing for the OECD, and the Clinton administration enthusiastically supported the OECD’s financial surveillance program when it was launched in 1998. However, US officials did not advise the OECD that most of the new data-tracking commitments fell outside federal competence, and instead within state legislative jurisdiction. In the event, US states have completely ignored OECD demands to identify and collect information from foreigners establishing US companies.

In her celebrated trial for tax evasion, Leona Helmsley, heiress to a US hotel fortune, infamously remarked that “Taxes are for the little people”. In a similar manner, the smaller financial centres were wondering whether it could be right that the proposed data tracking and exchange obligations were just for the small countries.

By mid-2004, OECD insurrection was in the air. The OECD was under serious pressure to show decisive and swift action on their constant promises to remedy the defaults in its own membership. It was time to prepare a report. Two years later, release of that report is now imminent.

Eight years on from the launch of the OECD’s project, it is time to move away from a model where one group proposes to capture all the benefits of regulatory change, leaving the other with only the costs. Will the OECD’s report bring about concrete action on a level playing field, and promote free(er) trade in international financial services?

References

1. Now more politically correctly referred to as the small ‘international financial centers’.

2. The OECD’s Project on Harmful Tax Practices: The 2001 Progress Report, footnote 1 reads as follows:

“Belgium and Portugal abstain from this Report. Luxembourg recalls its abstention to the 1998 Report, “Harmful Tax Competition: An Emerging Global Issue,” which also applies to the present Report and regrets that the 2001 Progress Report is further away from the goal of combating harmful tax competition with respect to the location of economic activities. In addition, Switzerland notes that its 1998 abstention applies to any follow up work undertaken since 1998.” Portugal and Belgium expressed further reservations in the 2004 Progress Report, and Switzerland and Luxembourg continued their dissenting position.

3. That report showed that three years after the launch of OECD’s program for tax information exchange in 1998 most of the principal OECD states competing for offshore services significantly lagged behind the progress on “transparency” in the smaller centres. The 2001 Towards a Level Playing Field Report was sponsored by the Society of Trust and Estate Practitioners and a grouping of smaller financial centres (the “International Tax and Investment Organisation”). It was researched by fourteen leading professional firms and prepared by Stikeman Elliott LLP. That report is available at www.stikeman.com.

4. Ironically, the tax evasion business that OECD sought to drive out of the smaller centres was not disappearing, but instead migrating to OECD countries with low data collection standards.

5.The Directive became operational in July 2004. It requires automatic reporting of cross-border interest payments on savings income paid from an EU or other participating jurisdiction to EU resident individuals. Switzerland, Austria, Belgium, Luxembourg and most UK Overseas Territories and Crown Dependencies will levy withholding tax, in lieu of exchanging information, until 2010.

6. See “ECOFIN Bolkestein urges ministers to ‘stick to their guns’ on Swiss tax deal”, AFX News Limited, 9 March 2004 and “Swiss failure to agree savings tax angers EU”, Financial Times, 9 March 2004.

7 The four exempted jurisdictions were Austria, Belgium, Luxembourg and Switzerland.

8 ‘Cayman Islands yield to European Union’, Caribbean Net News, 17 February 2004.

9 The United States bears 23% of the OECD budget, and bears influence commensurate with this substantial funding.