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Businesses face dual challenge in low-tax jurisdictions

Multinational companies based in low-tax jurisdictions are facing the prospect of more transparency and higher substance requirements than ever before.

After pressure from the EU, UK crown dependencies Jersey, Guernsey and the Isle of Man have put into place far-reaching substance requirements. EU finance ministers have responded by taking Jersey and Guernsey off the ‘grey list’ as a result.

The European Commission has blacklisted 17 countries and territories over tax avoidance and a lack of financial transparency. This is just as the world is moving towards much greater financial transparency and information exchange.

“All crown dependencies believe these companies have a substantial presence, but substance is not codified in common law,” said Geoff Cook, consultant at Mourant in St. Helier, Jersey. “We believe we do things the right way, so we will pass new legislation to codify best practices.”

The substance requirements are not coming into force in isolation. At the same time, the UK has plans to open up the registers of beneficial ownership in these jurisdictions. Places such as Jersey have arrangements with the UK to provide information to the authorities, but that information is not public yet.

One tax director at a pharmaceutical company confirmed their fears of what transparency can mean. “We’re very wary about transparency because your arrangements can end up on the desk of a newspaper if you’re not careful,” the tax director said.

However, one vice president of tax at an energy group suggested that greater transparency is far less of a problem than other tax professionals think.

“I see three different threads in international tax right now,” the vice president said. “There’s transparency, the definitional changes around transfer pricing, and the fundamental changes to how things are taxed.”

“The definitional TP, and fundamental, changes around digital tax are far more serious than transparency,” he suggested.

Some observers suggested the drive towards substance was partly due to the UK’s efforts to make the registers public, but this is not the only view.

“It’s much more to do with the EU’s dissatisfaction with the lack of progress on taxing the digital economy,” Cook said. “They’ve got particularly exercised with issues around intellectual property.”

“US companies have been selling large quantities of goods to European consumers and paying fairly low effective corporate tax rates,” he added.

A banker by profession, Cook was the CEO of Jersey Finance for 12 years. Prior to that he oversaw wealth management and financial planning at HSBC Bank for two decades. In Cook’s view, the substance requirements will not mean much change on the islands.

“We don’t want to attract business to Jersey with low-substance investment because it doesn’t create jobs and doesn’t contribute much to the local economy,” he said.

Out of Jersey’s working population of 55,000 people, approximately 14,000 work in financial services and around 4,500 to 5,000 of those people work in banking and insurance; so it’s possible to establish a presence on the islands beyond paperwork.

Critics are still sceptical of Jersey’s commitment to substance. “I suspect all of these requirements are gestures,” said Richard Murphy, director of Tax Research. “And there is no way business is leaving.”

“So what will the compromise be?” Murphy asked. “I would call it very light-touch enforcement.”

The firing line

The crown dependencies are playing their part in responding to international trends, but they are far from alone in the world of low-tax jurisdictions. British overseas territories like the Cayman Islands and theBritish Virgin Islands (BVI) are rolling out their own new standards.

Unlike the Channel islands, the Cayman Islands and the BVI are applying much more strictly OECD modeled standards. The requirements may be broad in scope, but it will likely be much narrower than in Jersey.

“The draft legislation looks like it could apply to any function that a multinational sources to the Cayman Islands,” said Friedemann Thomma, chair of the international tax group at Venable.

“The list of potential targets could include trademark portfolios, treasury functions, cash assets and hedging arrangements,” he told TP Week. “It’s still open to interpretation. It could be reasonable or it could be ridiculous.”

The Cayman Islands and the BVI have to draw a clear line to distinguish between structures that are within OECD guidelines and those that are clearly outside those guidelines. This means either unwinding or building up substance where necessary.

The problem is that there will inevitably be structures in a grey area, neither completely in line with OECD standards nor completely outside of them. This is why some people think there will have to be compromises and carve-outs, but others are optimistic that the standards are realistic.

“The Cayman Islands will be fine because there is substantial industry there,” Cook said. “The BVI will make the commitments to substance, but it will be harder for them to meet those standards.”

“If you factor in the size and scope of the challenge, the BVI is a smaller jurisdiction with fewer people and far less assets,” he explained.

It is possible that it will be easier to build up substance in places such as Jersey than in the BVI. Even while trading on tax neutrality, the Channel Islands have a far more conventional economic model than the overseas territories.

“You find a much more conventional tax system in places like Jersey than you would in an overseas territory,” Cook said. “Overseas territories by and large have registration fee models instead of traditional taxes.”

For example, American businesses have often used structures in Bermuda and Ireland as part of their IP strategy. This is a key difference with the Cayman Islands and the BVI, where companies are more likely to station their trademark portfolios than set up structures just for IP holdings.

Bermuda has implemented its own substance requirements in a bid to get off the EU’s blacklist. This may mean that US multinationals will have to open up research and development (R&D) centres in Bermuda to justify the IP structures. The only other option is to move the IP onshore or find another low-tax jurisdiction.

“Most companies are still taking the wait and see approach for now,” Thomma said.

“There are many companies out there with structures that will fall squarely into the purview of these substance requirements,” he explained. “Some of these companies will just unwind those structures, but I don’t believe there will be many of them.”

Learning from the past

Some companies have less to fear than others. The wave of tax avoidance scandals have forced multinationals to reconsider their practices. Bad publicity is a serious deterrent given the damage it can have on a company’s reputation.

TP Week spoke to the European tax leader at an S&P 100 company that had been hit by such scandals in the past.

“You won’t have seen our company in the newspapers as frequently as you would have in the past,” the tax leader said. “We do our best to stay out of the news these days and we’ve achieved that by changing a lot.”

The risk of not abandoning controversial practices can expose a company’s balance sheet in the end. Consumers can vote with their wallets and boycott a business if they do not like what the brand stands for anymore.

This has led to the rise of what IFAPresident Murray Clayson calls “tax morality”. The idea of a ‘fair share’ might seem far too woolly for the lawyers and accountants of the tax world, but it is increasingly an important part of the picture for businesses.

“Many companies still haven’t learned the lesson yet,” one head of tax at an Asian chemical company said. “There are certain industries out there that have not realised they have reputational concerns too.”

“What was done in the past was perfectly acceptable and legal,” the head of tax said, adding, “but times have changed.”

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