Barbados' H Wayne Lovell discusses what is a very difficult balancing act for IFCs -- preserving an attractive business environment while complying with BEPS and EU initiatives.
In recent years, international tax issues have been high on the political agenda of most countries, as the integration of national economies and markets has increased substantially, challenging the effectiveness of international tax regulations. Weaknesses in current rules create tax-planning opportunities to defer, avoid, or, in extreme cases, evade taxation, resulting in what is now referred to as Base Erosion and Profit Shifting (BEPS). Policy makers in the OECD and G20 countries have made bold moves to restore confidence in the global system and to ensure that profits are taxed where economic activities take place and value is created. Barbados, as a well-known and respected jurisdiction for international business and financial services, is responding to these initiatives in order to ensure that the country maintains its standing as a jurisdiction of choice.
The G20, OECD countries and the European Commission all collaborated on the BEPS project. 15 Action items were adopted which focused on three key pillars: coherence in domestic rules that affect cross-border activities; substance requirements; and transparency.
The 15 action items are:
Action 1- Digital economy: Identify and address the main challenges that the digital economy poses for the existing international tax rules.
Action 2- Hybrids: Design domestic rules to prevent hybrid mismatch arrangements from being a source of ‘double non-taxation’.
Action 3 - Controlled foreign corporations: Strengthen controlled foreign company rules to prevent the creation of affiliated non-resident taxpayers, and the routing of income of a resident enterprise through the non-resident affiliate to reduce or avoid taxation.
Action 4 - Interest deductions: Limit domestic law tax deductions to restrict base erosion via interest and other financial payments.
Action 5 - Harmful tax practices: Identify and counter harmful tax practices, taking into account transparency and substance (must be adopted).
Action 6 - Prevent treaty abuse: Enhance domestic rules to prevent the granting of treaty benefits inappropriately (must be adopted).
Action 7 - Permanent establishment (PE) status: Redefine the threshold to avoid creating artificial PE status to prevent BEPS.
Actions 8 to10 - Transfer pricing: Ensure that the imputation of value for tax purposes is consistent with the economic activity generating that value.
Action 11 - BEPS data collection: Establish procedures to collect and analyse data on BEPS and the actions to address it
Action 12 - Disclosure of aggressive tax planning: Aggressive tax planning arrangements must be disclosed
Action 13 - Transfer pricing documentation: Develop rules regarding transfer pricing documentation to enhance transparency for tax administration (must be adopted).
Action 14 - Dispute resolution: Improve the effectiveness of dispute resolution mechanisms to address issues that prevent countries from resolving treaty-related disputes under mutual agreement procedures (must be adopted).
Action 15 - Multilateral Instrument (MLI): Develop a MLI to enable jurisdictions to implement measures developed in the course of the work on BEPS and to amend bilateral tax treaties.
The BEPS package of measures, therefore, represents the first substantial renovation of the international tax rules in almost a century. Tax planning strategies that rely on outdated rules, or on poorly coordinated domestic measures that encourage BEPS, will be rendered ineffective. These BEPS action items, while challenging, are not insurmountable and definitely not beyond Barbados’ capacity to implement.
The OECD Forum on Harmful Tax Practices (FHTP) conducted a review process on countries which was intended to identify preferential tax regimes (PTRs) that can facilitate BEPS and therefore have the potential to unfairly impact the tax base of other jurisdictions.
The OECD’s framework for determining whether a regime is a harmful PTR involves three stages:
• determining whether the regime is within the scope of work of the FHTP and whether it is a PTR
• determining whether the PTR is potentially harmful by considering 12 factors under the framework, including low or no tax, ring-fencing, exchange of information, transparency and substance, among others
• considering the economic effects to determine whether a potentially harmful regime is actually harmful
The framework states that for a regime to be considered potentially harmful, the first key factor (of the following) must apply:
• The regime imposes zero or low effective tax rates on income from geographically mobile financial and other service activities.
• The regime is ring-fenced from the domestic economy.
• The regime lacks transparency.
• There is no effective exchange of information.
The first key factor – low or zero effective tax rates on relevant income – is a gateway criterion to determining those situations in which an analysis of the other key criteria is necessary. However, the presence of a low, or zero, tax rate alone does not make a PTR harmful.
Barbados was deemed to have a number of PTRs on the agenda of the FHTP under BEPS Action 5 (Harmful Tax Practices). These were in relation to specific legislation, particularly, the Fiscal Incentives Act (FIA). The FIA and Shipping Regime were deemed out of scope pending certain commitments from Barbados.
Regarding the work of the OECD, the EU wanted to go further, and embarked on an ‘External Strategy for Effective Taxation’ by adopting the following three-stage approach to listing:
• Pre-assessment of all ‘third country’ jurisdictions to determine their risk of facilitating tax avoidance, on the basis of a scoreboard of ‘indicators’.
• Member states to agree on a short list of third country jurisdictions and launch the screening process and dialogue with these jurisdictions. Third countries should be screened against clear and intentional recognised good tax governance ‘criteria’.
• Following the screening/dialogue process. The European Commission will recommend third countries to be backlisted, and explain why.
The following good tax governance criteria are used to screen jurisdictions with a view to establishing the EU list of non-cooperative jurisdictions for tax purposes:
• Tax transparency
• Fair taxation
• Implementation of anti-BEPS measures which are assessed cumulatively.
As a ‘largely compliant’ jurisdiction, Barbados has already committed to the Common Reporting Standard (CRS), with first exchanges in 2018 at the latest, and has signed onto the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters, as well as, the Multilateral Competent Authority Agreement for the Automatic Exchange of Information. Having fulfilled these requirements, Barbados was recently ranked highly on the list of countries with respect to tax transparency.
The criteria for fair taxation are very similar to BEPS Action Item 5, which discourages harmful tax practices and the facilitating of offshore structures not engaged in real economic activity. Barbados has traditionally sought to encourage business of substance through its extensive tax treaty network. Additionally, Barbados signed the Multilateral Convention for the Implementation of BEPS in January 2018, indicating the country’s commitment to the agreed OECD anti-BEPS minimum standards and their consistent implementation. These minimum standards are:
• Action 5: Harmful Tax Practices
• Action 6: Prevent Treaty Abuse
• Action 13: Country by Country (CbC) Reporting
• Action 14: Dispute Resolution
Is Tax Competition Dead?
One of the factors that has contributed to Barbados’ success as a respected international financial centre (IFC) is its variety of regimes and corporate vehicles which afford flexibility to investors and multinational enterprises. While most of these regimes/structures have been identified as PTRs, the Barbados authorities have been actively engaging the OECD to address the areas of concern and are working towards a speedy resolution.
Most countries, including Barbados, will seek to maintain an attractive business environment while complying with BEPS and EU initiatives by:
• providing broad-based tax relief (e.g. lower tax rates)
• reducing (or eliminating) withholding tax under domestic laws
• increasing the use of, or adjustments, to local incentives, e.g. research and development credits, Foreign Currency Earnings Credit (FCEA)
• reducing (or eliminating) other tax burdens not addressed by BEPS
Factors that may be important in the future are:
• Economic Substance - principal purpose test (PPT) and increased focus on non-tax reasons for using holding and financing companies. In other words, to be eligible for treaty benefits, businesses will be required to demonstrate a substantial purpose and economic effect, other than the reduction of taxes. The PPT (Article X (7) of the OECD Model tax convention) states that benefits under this Convention will not be granted if the main purpose for entering an arrangement or transaction was to secure a more favourable benefit/treatment, unless it can be established that granting that more favourable treatment is in accordance with the object and purpose of the relevant provisions of the Convention.
• Impact on disclosure requirements
• Focus on general tax relief over more specific tax exemptions – tax arbitrage
• Shift in expectations, e.g. accepting higher effective tax rates and increased focus on avoiding double taxation.
Barbados as the Jurisdiction of Choice
Barbados has robustly engaged the OECD FHTP at every stage of the review process in order to retain, in particular, the FCEA regime. Consultations are continuing with all stakeholders to arrive at a solution that allows Barbados to retain some key provisions/benefits.
Other factors to consider are:
• Transfer Pricing: for example, a deemed fair market-value interest expense on non-interest-bearing loans would be helpful.
• Substance: Foreign currency earnings should, for example, be carefully defined to provide that the income be earned by a Barbados corporation with substantial operations in Barbados from arms-length customers located outside of CARICOM. This arms-length requirement is important because it really says that this provision discourages shifting of profits within a corporate group through inter-company charges.
It is likely that Barbados’ appeal as an IFC will be further enhanced through:
• the retention of the FCEA regime;
• the introduction of transfer pricing legislation; and
• reinforcement of substance requirements with consequences for non-compliance.
Global investors, tax payers, tax advisors and tax administrators must stay up-to-date with all new tax developments that may impact holding and financing companies.
H Wayne Lovell Independent Tax Adviser, Barbados