The EU's recent removal of three jurisdictions from its "blacklist" of uncooperative tax jurisdictions prompts thoughts about whether such lists perform any valuable function at all.

A few days ago the European Union removed three jurisdictions from its “blacklist” of supposedly un-cooperative tax jurisdictions, with 12 remaining. The production of these lists is always controversial and some practitioners suspect a level of political motivation and even covert protectionism.  

In this article, Mark Davies who is managing director of Mark Davies & Associates, a specialist in the taxation of non-domiciled residents and internationally exposed clients, talks about the EU’s decision, and the implications for the future. The editors of this news service are pleased to share these views; they don’t necessarily endorse all opinions of guest contributors and invite responses. Email the editor at tom.burroughes@wealthbriefing.com

The Economic and Financial Affairs Council of the European Union has recently announced that Aruba, Barbados and Bermuda will be removed from the EU blacklist of non-cooperative tax jurisdictions. 

The list consists of 17 jurisdictions, including the United Arab Emirates, Oman, the three US territories of American Samoa, Guam and the US Virgin Islands, Belize, Fiji, the Marshall Islands, Vanuatu, Dominica, Samoa, and Trinidad and Tobago. They were blacklisted for failing to cooperate with the EU by not agreeing to change their domestic laws, particularly on financial reporting transparency, harmful tax practices and the requirement for economic substance. Aruba, Barbados and Bermuda have now agreed to change their domestic laws. The purpose of these new laws is to inform the international tax authorities where offshore structures with little substance are being used to avoid tax by declaring profits in low tax jurisdictions. 

Such structures were exposed by the former US President Barack Obama, who referred to a building in the Cayman Islands that was the registered office for 18,000 offshore companies. He joked: “Either this is the largest building in the world or the largest scam in the world”. 

Those still on the blacklist risk a damaged reputation. However, to date, no sanctions have been imposed on them.

The EU substance rules require certain tax resident companies to meet a series of economic substance tests. In summary, each company has to be managed and controlled from the jurisdiction in which it is tax resident. Also, the profits subject to tax in that jurisdiction have to be proportionate to the activities being carried out there, and furthermore, the company has to have adequate levels of activity in the jurisdiction.

For example, does the company employ staff and rent office space or is it just a “brass plate”? If it is just a brass plate, then information is exchanged with the tax authority of the owners. 

These rules on substance apply to certain activities, including banking, insurance and fund management, finance and leasing, headquarters and holding companies, shipping, intellectual property holding and distribution and service centres. These rules are most likely to have an impact on multi-national businesses rather than on UHNWs. An ultra-high net worth individual’s passive investment company holding equities would not be caught by the substance rules. In addition, many of the jurisdictions left on the list simply do not have sophisticated banking industries that would appeal to UHNW individuals. However, the re-joining of Bermuda and Barbados does offer some opportunities to private clients as these jurisdictions do have some blue-chip banking institutions. It is important that those choosing to use these offshore centres must be very diligent in ensuring that their chosen jurisdiction has sufficient expertise to demonstrate economic substance. 

However, the overall impact is expected to be largely an administrative burden as there will be a scramble to hire “adequate” staff, premises etc. to meet the substance test in order to avoid reporting. An interesting question is “when is an amount of activity adequate?” For example, “how many staff do you need to maintain a server? Who decides?”

These changes are unlikely to be effective in the modern world where long supply chains are commonplace and increased automation is prevalent, because it is difficult to establish where profits ought to be recognised and tax authorities are each competing for a larger slice of tax. However, the increase in costs needed to be compliant and a sense of the prevailing wind might persuade multi-nationals to relocate their offshore business to mid-shore or onshore. 

The lack of sanctions on those blacklisted undermines the list’s practical effectiveness and points to an underlying political motivation. Naturally, the EU rules on substance do not apply to EU companies and Gibraltar. Perhaps this is an instance of criticising others for what is lacking in oneself. The use of companies located in Ireland, Luxembourg, the Netherlands and Malta will undoubtedly remain popular. Indeed little substance is required in the US in states such as Delaware, and although the former president may point the finger at the Cayman Islands, he did little to stop the use of US corporations in tax avoidance in his own backyard.