Growing Political Opposition to OECD Initiative Causes US to Rethink Its Role to Stop “Harmful Tax Practices”
For those of you who have followed the OECD’s developments in its “Harmful Tax Haven” initiative over the past three years, skip to the section below entitled “Where Are We Now?” For the rest of us, a simple overview will put the OECD actions into context.
In 1997 the OECD (Organization for Economic Cooperation and Development), which comprises the wealthiest nations of the world, embarked on a project to end what it referred to as “harmful tax practices” in some 35 developing and tax haven countries of the world. The former Clinton Administration was one of the leaders of the initiative.
OECD Director-General Donald Johnston described the initiative as being narrowly targeted to special tax regimes that allow the “evasion or abusive avoidance of tax in other countries.” These countries would be put on the infamous “black list” if they failed to meet one of the general standards unrelated to taxation including transparency, effective exchange of information or non-discrimination in favor of non-resident investors or investment.
While the US itself meets this definition, it was not put on the OECD blacklist (except for the US Virgin Islands which was included). Other OECD members including Switzerland and Luxembourg were also given special exemption from the blacklist.
It seems that countries with no taxes in place such as the Caymans, Bermuda, etc., could have a “harmful tax system” while some of the OECD member nations charge their own citizens tax rates in excess of 70% of their income. Which group of countries seems more harmful?
Nevertheless, the OECD developed its framework and coerced a number of traditional tax haven countries including the Caymans, Bahamas, Bermuda, Cyprus, Isle of Man, Malta, Mauritrus, The Netherlands Antilles, San Marino and The Seychelles to change their tax and financial privacy policies or face financial protectionism from the OECD nations. Under the Memorandum of Understanding, drafted by the OECD in late 2000, there are a series of progressive steps to be implemented between the countries as outlined below:
By December 2001: Each party will adapt a detailed plan indicating how, by December 2005, it will achieve transparency and effective exchange of information for all tax matters, and eliminate any regimes that attract businesses without substantial business activity.
By 31 December 2002: Each Party will ensure that its regulatory or tax authorities have access to information regarding beneficial owners of companies, partnerships and other entities organized in its jurisdiction, including collective investment funds, and to information on the identity of the principal (as opposed to agent or nominee) of those establishing trusts (settlors) and foundations under their laws and those benefitting from trusts and foundations.
By 31 December 2003: Each Party will have in place a legal mechanism that allows information to be provided to the tax authorities of OECD countries upon request for the investigation and prosecution of criminal tax matters. This mechanism will include a means to ensure that information could be given to tax authorities of OECD countries in response to a request if the information may be relevant to the investigation of a criminal tax matter.
Each Party will also remove any restrictions on the ability of entities qualifying for preferential tax treatment to do business in the domestic market (although a preferential tax rate need not be extended to domestic business until 2005).
By 31 December 2005: Each Party will have in place a legal mechanism that allows information to be provided to the tax authorities of OECD countries upon request for the investigation and prosecution of criminal tax matters and for the determination, assessment, collection and enforcement of all other tax matters (hereafter referred to as civil tax matters).
In the case of information requested in the context of a civil tax matter, the Party will provide the information without regard to whether or not the Party has an interest in obtaining the information for its own domestic tax purposes.
So basically, a gun was put to the heads of the tax haven countries with the demand that they comply with big government’s ideas of what is or is not a harmful tax practice, or the OECD would pull the trigger. The tax haven countries themselves basically fell into two categories. The first group were the countries listed above, which are basically highly evolved tax haven (i.e Bermuda, Caymans) that had enormous financial ruin to contemplate if they didn’t comply. Their offshore industry comprised numerous international and multi-national banks, brokerage houses, insurance companies, mutual funds, etc, which were largely unaffected or only minimally affected by the OECD actions. Because so much of their income comes from these non-affected international and multinational companies, it was much easier for them to agree to the OECD’s demands.
The second group of countries, however, saw more financial ruin to the tax haven industry by compliance with OECD demands and nothing to replace the lost income. Countries prominent in this group include Belize, Anguilla and Panama. Belize, for example had less than 5,000 IBC (International Business Companies) registered in its jurisdiction by 1999, but that number has now swelled to over 20,000 as companies and individuals have left the OECD compliant jurisdictions in droves. Since Belize has few multinational corporations actively engaged in business in Belize, it had little to win and much to lose by narrowing or eliminating the small business or a “mom and pop” oriented IBC industry prevalent there. The migration of IBCs from more traditional jurisdictions to Belize is proof that the offshore financial industry will regard countries willing to stand up to the US and the OECD and it will penalize those countries that give in to that pressure. This point is particularly well made by the number of lawyers, accountants and other offshore practitioners who are leaving jurisdictions such as the Bahamas and migrating themselves to Anguilla, Panama and Belize.
So Where Are We Now?
Has President Bush assembled his economic team this past January, the OECD continued on with business as usual in pressuring countries and setting the deadline of July 31, 2001 for the tax haven countries to comply with their "framework."
By early February, however it became clear that the US was reconsidering its own position vis-a-vis the OECD framework. At a meeting in February of the OECD / tax haven working group, in Barbados, the US took an unusually low profile in the talks. By late February the Wall Street Journal reported that Treasury Secretary Paul O’Neill had expressed “skepticism about the Organization for Economic Cooperation and Development’s three year old campaign to blacklist un-cooperative tax haven countries and territories – currently 35 of them.”
At a meeting of top economic officials of the G - 7 in Italy, Mr. O’Neill again took a low profile in commenting on the OECD’s work but did raise European suspicions that the US would not support the final push by the OECD to force compliance by the tax haven jurisdictions. After the G - 7 meeting, Mr. O’Neill said in a prepared statement “It is critical to clarify that this project [the OECD initiative on harmful tax practices] is not about dictating to any country what should be the appropriate level of tax rates.” Mr. O’Neill’s predecessor, Mr. Summers viewed the initiative as an important tool for combating tax evasion particularly by US companies that shift profits to secretive low-tax jurisdictions to cut their tax bills back home.
This shift in attitude has been seized upon by both proponents and opponents of the OECD’s work. In a press conference last month Mr. O’Neill was again asked whether the US and President Bush supported the OECD’s drive to force low-tax jurisdictions to change their tax regimes. Mr. O’Neill’s artful response was as follows:
“I guess I would take a pass at the moment on whether or not we [the United States] as an independent entity, want to be strictly allied with what the OECD has said.”
In the last two months, a dozen Congressman and Senators from both sides of the aisle have written to Mr. O’Neill, publicly urging him to remove the administrations support for the OECD initiative and instead oppose it. We have reproduced verbatim the letters sent by Senator Don Nickles, as well as Representative Dick Armey; the Chairman of the House Ways and Means Committee. I trust that you will find the letters interesting in shifting the debate away from what is good policy for the big-governments of the OECD member countries, to what is good for the US tax payers.
March 16, 2001
The Honorable Paul O'Neill
Secretary of the Treasury
Department of Treasury
1500 Pennsylvania Avenue
Washington, DC 20220
Dear Secretary O'Neill,
Recent news reports indicate that you are wisely reevaluating the United States involvement in the OECD's "harmful tax competition" initiative. This project, which was supported by the Clinton Administration, is fatally flawed and contrary to America's national interests. I stand ready to assist you in seeking a far more productive way to address important international tax issues.
I encourage you to act quickly to reverse the previous administration's misguided policy. Many low tax nations, facing a threat of financial protectionism as early as this July, are under tremendous pressure to comply with the OECD's demands. As the world's largest economy, but also as the nation that symbolizes freedom and entrepreneurship, we have a moral obligation to come to the aid of these persecuted regimes.
It is my understanding that career personnel are urging you to support the Clinton Administration viewpoint on the grounds that the OECD initiative is needed to reduce tax evasion. This is a red herring. A global network of tax police is the wrong approach.
Instead, the U.S. should shift entirely to a territorial system the common sense notion that countries only tax income that is earned within their borders and also, eliminate the double taxation of income that is saved and invested. This approach is consistent with sound tax policy, protects financial privacy, and preserves fiscal sovereignty. Moreover, the incentive for tax evasion would be eliminated. At the same time, economic growth would be enhanced because a territorial system and proper tax treatment of savings and investment would stimulate business activity here at home and attract investment from overseas.
Bad economic policy is not the only reason to reject the OECD's initiative. Countries that are being persecuted for having attractive tax policies will have little incentive to cooperate in the prosecution of drug dealers, terrorists, and other international criminals. Indeed, the OECD proposal likely will cause an increase in crime since some people may seek illegal income from things like money laundering to offset the legitimate income lost as a result of the OECD's attack against tax competition.
By every possible criterion, the OECD's effort is misguided. It is designed, in effect, to create a tax cartel for the benefit of a small handful of high-tax nations. These countries are seeking to impede the flow of global capital, and the U.S. economy B with its comparatively attractive tax system B will suffer if they succeed. I look forward to working with you to stop the OECD's initiative and to adopt, instead, common-sense proposals that will maintain tax competition and the sovereignty of all nations.
Member of Congress
February 6, 2001
The Honorable Paul H. O'Neill
Secretary of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220
Dear Secretary O'Neill:
In today's global economy, tax policy is an important part of a nation's competitiveness. The U.S. economy has prospered in part because we are attracting savings, investment, and entrepreneurial talent from other nations. Indeed, this is one more reason why President Bush's tax cuts are desirable.
With this in mind, I want to express my deep concerns with an initiative sponsored by the Organization for Economic Cooperation and Development (OECD). Several years ago, the OECD launched a "harmful tax competition" project to pressure dozens of low-tax nations to change their tax and financial privacy policies or face financial protectionism from OECD nations. The previous administration supported this effort.
I believe it is contrary to America's economic interests to restrict tax competition, a phenomenon that keeps politicians in check and enhances economic growth potential. Our relatively low-tax status has fueled economic growth and enabled our economy to draw investors and savings from many of our high-tax European competitors. Those competitors will eventually use the OECD initiative as a weapon to undermine our sovereign right to enact pro-growth tax policies.
It does not make sense for the United States to participate in an effort that is inconsistent with our long-term tax agenda. I encourage you to review the OECD initiative and reconsider American support for it.
Thanks for your attention on this
Other groups, however such as the non-partisan (but union funded) Washington Research Group, “Citizens for Tax Justice” have come out and strongly urged the Bush administration to follow through in its support for the OECD initiative. According to their director, Robert McIntyre the US Treasury loses tens of billions of dollars a year because American companies report profits as coming from low-tax jurisdictions. According to McIntyre “It would be a shame if the Bush Treasury were to decide that they’re in league with the people who want to manipulate the tax laws.”
Union funded research groups are not the only ones urging the US to comply. The Japanese and the European Union have also urged Washington to tow the OECD line. According to Gabriel Mahhlouf, Chair of the OECD Committee on Fiscal Affairs, “There has been no indication that the US position has changed” in a recent press conference in Tokyo.
So Where Are We Now, Really? From all of the conversations with lawyers, accountants, bankers and government officials in both the US and abroad, a picture is starting to emerge:
First, the US did not want to criticize the work of the OECD. These are the US’s most important trading partners and the US helped start the initiative in the first place.
Secondly, the new administration is far closer to Dick Armey’s view on international taxation than it is willing to let on to its European allies. The administration also understands that forcing small developing countries out of the tax haven business will only exacerbate the financial stability of those countries and the arguments for tax harmonization may be eventually used against the US to force us into harmony with Japanese and European rates.
Finally, on May 10, Secretary O’Neill issued a statement that ended the fence straddling. In it, O’Neill clearly took the side of free market tax competition among nations instead of the Clinton “harmonization” approach, advocated by the OECD. He also expressed concerns about the “direction of the OECD initiative”. He was “troubled by the underlying premise that low tax rates are somehow suspect and by the notion that any country, or group of countries, should interfere in another country’s decision about how to structure it’s own tax system.”
The United States, according to O’Neill “does not support efforts to dictate to any country what it’s own tax rates or tax system should be, and will not participate in any initiative to harmonize would tax systems.”
Pretty conclusive language that the major thrust of the OECD’s work was now dead. The end of the press release however addressed the issue of specific tax evasion and utilizing the OECD as a “framework for exchanging specific and limited information necessary for the prosecution of illegal activity. The release concluded however, “that in it’s current form, the project is too broad and is not in line with this Administration’s tax and economic priorities”.
At this point, I would still avoid offshore structures, including trusts and IBCs in the group one countries mentioned above. These countries have shown their willingness to work with US tax authorities and those authorities are still clearly willing to pursue bilateral and multilateral agreements that are more limited in their scope. Existing structures in those countries are all right as long as the financial accounts for those structures are moved out of those jurisdictions by December 31, 2001. After that date, your financial privacy may be compromised to any OECD member country including the US.
Copyright 2002 Nagel & Associates, LLC