Sometime in 2014, I was called to the office of a prominent member of the UK Parliament to discuss the commotion around what was the start of a growing trend in tax transparency and perceived multinational corporate tax ‘avoidance’. Because I had a reputation as both a tax structuring specialist and innovation leader (quite an unusual combination back then), the conversation quickly turned to different ways for governments to tackle the global tax structuring/avoidance debate. As this was well before the days of Brexit, it was clear this was an EU-driven agenda.
The MP’s aim was to find a holistic system, which would ensure profits were taxed where they arose, whilst shining a light upon those territories whose laws supported a system where taxable profits could be diverted from economic generators of those profits. I politely suggested that, in time, surely we should end up with one tax collection agent for the whole of the EU single market? This would (surely), not only leave it to governments to distribute tax collected but would also reduce the generally large inefficiencies in tax policing and collection processes by central and local governments. That way, the established models for matters such as transfer pricing would be done between the governments themselves (which would be the most transparent and thus ‘fair’ system).
“Aha,” said the MP, “but how would you then allocate the taxes collected back to individual countries?” My response was that this could be done based upon country population size as one suggestion. “But what about those countries who currently collect more in tax per capita than the EU average?” the MP queried. “Haven’t you just defined a tax haven?” I politely offered.
Having the benefit of several years of hindsight, I would now reflect that on tax matters, and in its context, we are heading towards a world not far away from my original suggestion. Where effectively global governments are working together to agree principles for dividing profits of global corporates between the various tax hungry countries of the world.
How did we get here? Well you see, there are more than a few problems underpinning the current global tax system.
Most global tax systems are built for the commercial landscape of the mid-20th century – a time when businesses manufactured, sold and made profits on their products (often locally, but almost always domestically). This activity could be clearly articulated and pointed to, but most importantly, it was easy to identify which country profits arose in and which country could collect the tax.
The situation is markedly different today. We now live in a truly globalised and digital society. And with this shift, an increasingly large proportion of balance-sheet value is in the form of intellectual property, which is not only hard to define, but difficult to pin down when it comes to value transition between countries.
How on earth can something be taxed which cannot be identified, let alone decide which country it’s based in and thus where those profits arise?
Add to that the fact that different countries apply a different basis for their respective tax systems, meaning that transactions across borders could be taxed differently, be taxed twice or (much worse for tax authorities) untaxed in either jurisdiction.
Not to worry – here comes the Base Erosion and Profit shifting project (BEPS) to put things right.
Under BEPS principles, most multinationals are being gently encouraged to allocate profits across multinational groups, in accordance with value driving activities. And, even if we still end up with some countries generating more tax per capita than average – if that’s because those parts of the business are generating more economic value, so be it.
In principle, we would have a global system aligning the key principles of taxation for multinationals, which every country tax system can adhere to.
However, with the end game clear, the journey to get there seems a little, if not significantly more arduous. It will mostly be done in a lethargic global economy, which will provide the most uncertainty. The problem is that we haven’t really got time to stop the world whilst BEPS is implemented and governments have other things going on. So we may feel the effects more than others in the Caribbean as governments play catch up.
Most governments in the Caribbean, despite the very best of intentions, are only just starting to grapple with what this means by way of changes to local legislation. And I can tell you that most international tax experts are struggling to keep pace with the scale of legislative change facing us. So I have nothing but sympathy for boardrooms whose currency is typically certainty, when so much uncertainty is baying at the door. It looks likely that the ambiguity surrounding tax matters will take years to resolve, and as far as perfect solutions to complex global problems go, my earlier proposal to that UK MP is still my best answer.
How Does US Tax Reform Impact the Caribbean?
When we focus on the Caribbean, it is apparent that a number of structures commonly seen in the region will need to be re-examined with the recent US tax reform changes, particularly those with US ownership or affiliates.
The recent US tax reform effort culminated with the enactment of the Tax Cuts and Jobs Act (HR1) in December 2017. HR1’s underlying principles include the simplification of the US tax code for individuals and makes US-based businesses more competitive in the global market by lowering the corporate tax rate and moving to a ‘territorial’ tax system.
HR1 includes significant changes to the manner in which the US taxes international business. The change from a global tax system to a territorial tax system requires a ‘cleanse’ of the historic global system via the ‘toll tax’, which triggers a deemed repatriation of all untaxed foreign earnings for certain US owners of applicable foreign corporations. The toll charge carries a reduced tax rate from the historic 35 per cent corporate rate (and post-2017 corporate rate of 21 per cent) and can be paid over a number of years beginning in 2017; however, these untaxed earnings were often indefinitely reinvested in the foreign country and thus would not be subject to US tax until repatriated.
HR1 introduced the Base Erosion and Anti-Abuse Tax (or BEAT), which targets US tax base-eroding payments to non-US affiliates with a minimum tax. Another new tax enacted by HR1, the Global Intangible Low-Tax Income (GILTI) tax, operates similarly to the Subpart F income regime and has a significant impact on US-owned foreign entities with limited, to no trade or business assets.
Additionally, HR1 includes changes to the historic Controlled Foreign Corporation (CFC) and Passive Foreign Investment Company (PFIC) rules, which cast a wider net over US-owned foreign corporations. The CFC rules have evolved with a change to the definition of a US shareholder, from a 10 per cent or more ‘voting power’ owner to a 10 per cent or more ‘vote or value’ owner. The PFIC rules, as they relate to a non-US insurance company, now include a ‘bright line’ test for being available to avail itself of the ‘active insurance exception’ to the PFIC rules.
Because of these changes, US owners of Caribbean entities will need to determine if they are subject to the toll tax on any untaxed earnings of said entities. Payments from US affiliates to entities domiciled in the Caribbean, which hold intellectual property (IP), including patents, trademarks, etc. or provide reinsurance to the US entities, may now be subject to the BEAT.
Additionally, such Caribbean entities which are US owned may cause the US shareholders to be subject to the GILTI tax. The use of ‘voter cutback’ rules or the issuance of non-voting preference shares, which historically limited a US person’s voting power in a foreign entity, no longer mitigates the risk of the foreign entity being a CFC. Additionally, US-owned foreign insurance companies prevalent in Bermuda, Barbados, Turks & Caicos and the Cayman Islands will now be subject to new rules and may be treated as PFICs under HR1.
Caribbean industries will need to remind the public why their jurisdiction was sought after in the first place. Possibly, it is the clarity in the regulations, the history of that sector in the region, or the vast amount of local financial expertise available. Your country’s unique selling proposition will not change due to the new US tax law.
Corporate Services in the Caribbean in a Post-BEPS Environment
Remember I said the BEPS principles are here to put things right? Well, whether the US embarks on major tax reform, or other statutory or regulatory changes, US-based companies with operations in the Caribbean must still comply with BEPS-related changes in the local tax laws of the countries in which they operate. So, let’s focus on the adoption of certain recommendations contained in the BEPS Action Plan.
Caribbean jurisdictions, for instance, offer business structures that seek to enable corporations operating in their territories to implement substance, value creation and effective corporate governance. The current position of Bermuda and the Cayman Islands, regarding economic substance, attests to this fact. They have introduced the Common Reporting Standards and country-by-country reporting regulations and guidelines. Corporate service providers in these territories understand and promote the importance of adding value creation to corporate structures, as value creation will be aligned with the transfer pricing assessments that are to be exchanged in line with BEPS Action Plan 13.
However, Barbados provides for legislation and standards of practice that require corporations to implement certain levels of substance. For example, Barbados imposes a fiduciary duty on directors and makes them responsible for the direction of the management and affairs of the corporations, with the purpose of having them involved in the decision-making process. Corporate service providers play an important role by re-enforcing the value of effective central management and control of corporations from Barbados.
These service providers are also making a positive impact across the region by incorporating international best practice in the operations of corporations. They assess and benchmark existing governance practices against international best practice and the requirement of current regional codes and guidelines. These regional codes and guidelines allow them to provide advice and support around the creation and implementation of policies and procedures that will enable corporations to adhere to best practice.
With the emphasis on business substance and the current focus on the BEPS framework, investors and tax planners understand the importance of having efficient corporate service providers involved in the implementation and maintenance processes of their corporate structures in the region.
David Prestwich Regional Tax & Legal Services Leader
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