Photo Source: Stefan Rousseau, AP
As the G7 meetings concluded in Cornwall, England, one outcome was an agreement on a global minimum tax. This initiative will further squeeze the Caribbean just as it is struggling to recover from the harm the COVID-19 pandemic wreaked on tourism, the region’s main economic sector.
May 20, 2021, represented somewhat of a turning point in this regard. The United States Department of the Treasury proposed a 15 percent rate as a starting point for the Organization of Economic Cooperation and Development (OECD) negotiations on a global minimum corporate tax regime, as part of its efforts to modernize the international tax system. The U.S. Treasury announced its position in meetings with the Steering Group of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) as part of the OECD/G20 international tax negotiations. Until that point, the U.S. Treasury had opposed key aspects of the BEPS initiative, championing the sovereign right of each government to arrange its own tax architecture.
OECD initiatives against tax havens
Since 1998, the OECD has promoted initiatives against small jurisdictions that attract investment by offering tax incentives. In 1998, the OECD issued a report on harmful tax practices by so-called “tax havens.” The OECD defines “tax havens” as jurisdictions with (1) no or nominal taxation on financial or other service income; (2) a lack of effective exchange of information with other countries; (3) a lack of transparency in the operation of legislative, legal or administrative provisions; and (4) the absence of a requirement that investor activity be substantial in order to receive tax incentives. The OECD said governments should blacklist and impose countermeasures on tax havens that did not change their ways.
On July 18, 2001, then U.S. Secretary of the Treasury Paul O’Neill, in testimony before the Senate Committee on Governmental Affairs Permanent Subcommittee on Investigations, expressed concern that the OECD was trying to interfere with countries’ tax architecture and stifling tax competition among nations. Secretary O’Neill expressed concern about the potentially unfair treatment of some non-OECD countries, the lack of clarity in the initiative, and the focus on the requirement that investors must undertake substantial activities in a given jurisdiction in order to receive tax benefits.
The Global Forum on Transparency and Exchange of Information arose from the OECD’s harmful tax practices initiative. (Due to substantial criticism of the initiative, the OECD formed the Global Forum to include countries from within and outside the OECD, and focus on the goal of ending bank secrecy and tax evasion through international tax exchange and cooperation.) The Forum aims to ensure compliance with the relatively recently implemented standards on tax cooperation through its monitoring and peer review activities.
A major part of the 1998 initiative directed OECD countries to consider imposing defensive measures to persuade noncompliant jurisdictions (i.e., tax havens) to cooperate with its provisions. Initially, the OECD put countries not compliant with so-called international tax information exchange standards on a blacklist. In reality, however, the OECD used the initiative to try to develop new soft law standards and coerce compliance through the threat of blacklisting.
Eventually, the Global Forum started publishing a report on peer reviews of the compliance of nations with the international tax cooperation standards, which established the following ratings: compliant, largely compliant, partially compliant, and non-compliant.
The Global Forum still counsels its members to apply countermeasures against uncooperative countries. Similarly, the G20 has also endorsed defensive measures against these jurisdictions. When the Global Forum gives a partially or non-compliant rating to a Caribbean jurisdiction, especially when that same jurisdiction has recently appeared on other tax or money laundering lists, it is liable to suffer from a loss of reputation, de-risking, and defensive measures.
BEPS II: Global Anti-Base Erosion Proposal (“GloBE”) – Pillar Two
On April 4, 2021, U.S. Secretary of the Treasury Janet Yellen announced her support for global coordination on an international minimum tax rate that would apply to multinational corporations regardless of where they locate their headquarters. Yellen’s speech referred to U.S. President Joe Biden’s proposal to raise U.S. corporate tax rates to 28 percent and increase the international minimum tax rate that American companies pay on their foreign profits to 21 percent.
The Biden administration has reversed not only on O’Neill’s promise that the U.S. will not interfere in the tax policy decisions of other countries, but also O’Neill’s opposition to the “no substantial activities” criterion of determining whether or not a jurisdiction is deemed to be “uncooperative.” In recent years, this has been a major criterion for putting countries on the black or grey lists of both the OECD and the European Union, which has emulated the OECD’s tax practices initiative.
The G20 and support for the BEPS initiative
The fact that the G20 has supported the BEPS initiative poses a significant political problem for small jurisdictions in the Caribbean. The G20 has directed the OECD’s Global Forum’s Inclusive Framework to continue its work on the issue. In January 2019, members of the Inclusive Framework decided to review the tax reform proposals in two pillars. In October 2020, the OECD’s report on Pillars One and Two explained that Pillar Two is focused on a global minimum tax. Pillar Two will help ensure fairness and equity in tax systems and fortify the international tax framework in order to better enable tax authorities to cope with changing business models. In addition, Pillar Two will emphasize the stabilization and sustainability of government finances.
In its Pillar Two consultation, the OECD used a 12.5 percent minimum corporate tax rate. However, the final rate for the GloBE may increase as a result of the Biden administration’s announcement of his new corporate tax plan featuring a 28 percent tax rate.
GloBE operates in order to enable a country to recoup tax revenues when a company offshores its profits to a low tax jurisdiction that operates below the minimum international standard. (These revenues are known as income inclusion for under-taxed income.) Hence, countries have a mechanism to safeguard and supplement their tax revenues in the event that not all countries in the world (i.e., low tax jurisdictions) agree to the proposal.
EU Code of Conduct tax haven list
In 1998, the Council of the EU adopted a resolution on a Code of Conduct for business taxation, with the goal of curbing harmful tax competition. In particular, the EU labelled as harmful tax measures that result in a significantly lower effective rate of taxation, including zero taxation, than tax rates of EU member states. Under such criteria, the EU has listed at least thirteen Caribbean jurisdictions as non-cooperative.
The EU initiative mandates that a jurisdiction should not facilitate offshore structures or arrangements which do not reflect “real or substantial economic activity” in the jurisdiction. Caribbean jurisdictions have had to enact new laws, under strict deadlines, with detailed requirements for investors to meet in order to verify such substantial economic activity and receive incentives.
Anti-money laundering efforts
An additional challenging dimension with respect to the status and sustainability of Caribbean financial services has been, concurrent with the tax haven blacklisting, that many of the same countries have also found themselves on anti-money laundering lists produced by the Financial Action Task Force (FATF) and the EU. FATF now calls countries included on such lists “high-risk countries and countries in need of additional monitoring.”
In February 2021, FATF’s list of countries with deficiencies included Barbados, the Cayman Islands, and Jamaica. In February 2020, FATF had listed the same three countries, plus the Bahamas.
The EU keeps its own anti-money laundering blacklist with distinct criteria. On May 7, 2020, the EU listed the Bahamas, Barbados, and Jamaica.
Impact on the Caribbean
A problem with the evaluation and listings of the OECD, FATF, and EU is the lack of a level playing field. The powerful countries that dominate the OECD and FATF, such as the U.S. and some EU member states, do not have to worry about being listed, even though some have been evaluated non-compliant with two or more areas of the standards. For instance, the FATF found the U.S. non-compliant with gatekeeper and entity transparency standards in 2006 and 2016. Significant private wealth has been flowing to South Dakota, Wyoming, Nevada, and Delaware since July 15, 2014, when the OECD Common Reporting Standard (i.e., worldwide automatic exchange of information) was agreed upon, with the U.S. declining to participate. In the EU, Ireland, Cyprus, Malta, the Netherlands, Luxembourg, and Austria continue to serve as major tax planning jurisdictions for multinational corporations. The biggest money laundering scandals in recent years have occurred through Danish (i.e., Danske Bank) and Swedish (i.e., Swedbank) banks in the Baltic states, Cyprus, and Andorra. Caribbean jurisdictions have a problem with BEPS Pillar Two and the GloBE because they would eliminate the advantages of having a tax rate of zero (which is the case in the Bahamas, the Cayman Islands, and the British Virgin Islands) or low tax rates for jurisdictions attracting international business companies and societies with restricted liability. In the latter case, Barbados has used a top rate of 2.5 percent, which decreases as corporate earnings increase. The GloBE and the Biden administration proposals are directed at the tax competition, and particularly the tax advantages, of small Caribbean jurisdictions. Historically, the Caribbean has counted on the U.S., under the Republican administrations of former presidents George W. Bush and Donald Trump, to mitigate the harm caused by aggressive initiatives of the OECD and the EU against the Caribbean international financial services sector.
A continuing result of the above-mentioned initiatives is de-risking, whereby international banks in their respective metropoles, serving as correspondent banks to local financial institutions, limit or terminate their correspondent banking relationships (CBRs) with these local or regional banks (respondent banks) in response to crackdowns on low tax jurisdictions.
An important result of de-risking is the loss of business for many banks in the Caribbean, the inability of certain sectors (such as international financial services) to do business, and difficulties in making remittances for the Caribbean diaspora, which are critical to many low-income families and countries in the region. Another consequence in a region suffering from financial exclusion is that fewer people can access the formal economy, in part, because there exist fewer financial institutions. As the number of financial institutions declines and international transactions become more difficult, the remaining financial institutions raise their rates and become increasingly inaccessible.
Caribbean regulators are working to help local banks engage in customer due diligence more effectively and raise their compliance with tax transparency initiatives, AML/CFT, and economic sanctions. However, these regulators struggle to keep pace with the ever-changing rules of the OECD, FATF, EU, and the U.S., especially since Caribbean jurisdictions do not have a seat in any of these bodies and each organization uses different criteria and standards. Therefore, the Caribbean cannot anticipate the changing standards, and has limited capacity to undergo regular evaluations and engage in the inevitable task of responding to the deficiencies found in such assessments. Because of their comparatively limited political power, the inability to quickly correct gaps in standards will land small jurisdictions on black or grey lists. In contrast, the U.S., as mentioned above, has been non-compliant with FATF’s gatekeeper and entity transparency rules since 2006 and has still failed to be included on any lists, despite the windfall of private wealth investment enjoyed by the U.S. due to its noncompliance with the FATF and OECD standards.
On June 9, the Caribbean Community (CARICOM) Secretary General Irwin LaRocque said that Caribbean countries must be concerned about the G7 announcement of an agreement of a global minimum tax. He urged the CARICOM countries to take a unified position with respect to the minimum global tax in various international fora.
The Caribbean is in a precarious position economically, having suffered a brutal pandemic-induced economic downturn that has left high unemployment, massive fiscal deficits and difficult-to-service debt obligations in its wake. Unintentionally, the proposed global minimum tax is much like kicking someone when they have already fallen. Caribbean leaders need to move quickly on this issue, formulating a unified response and pushing hard on key players, including the Biden administration. While Central America is to set receive USD $4 billion in U.S. assistance, the U.S. is in effect taking money away from the Caribbean with its support for global minimum tax initiatives. This is not a good start to the Biden administration’s engagement with the Caribbean.
Bruce Zagaris is a partner with the Washington, D.C. law firm of Berliner Corcoran & Rowe LLP, founder and editor of the International Enforcement Law Reporter, and former lecturer at the Law Faculty of the University of the West Indies at Cave Hill, Barbados.