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EU Warns Watchlist Countries That New Regimes Are Still Harmful

POSTED ON Feb. 6, 2019

The EU has informed the governments of six countries that legislation recently enacted to avoid the EU’s blacklist of noncooperative tax jurisdictions fails to eliminate the harmful features of prior law.

In a series of letters dated February 1, the EU Code of Conduct Group (Business Taxation) warned government officials of Barbados, Belize, Curaçao, Mauritius, Seychelles, and St. Lucia that recent reforms will not be sufficient to keep their countries off the 2017 EU blacklist. In exchange for recommending that the country not be included in the blacklist, the letters ask for a commitment to end the harmful practices identified and comply with the blacklist criteria by the end of 2019, with no grandfathering provisions. Each of the six countries appears in the blacklist’s Annex II, which sets out a watchlist of countries with harmful tax regimes that commit to abolish or amend their regimes in line with EU standards.

Barbados and St. Lucia were among 17 countries that appeared on the original blacklist, but were removed during 2018 after committing to comply with EU tax good governance criteria. Those standards, which appear in Annex II, include commitments to transparency through automatic information exchange and administrative assistance agreements and compliance with the four minimum standards of the OECD base erosion and profit-shifting project.

To remain off the blacklist, countries must also meet “fair taxation” standards by not offering harmful preferential regimes or facilitating structures that attract profit without real economic activity. According to the letter to Barbados, the low and regressive corporate tax — which falls to 1 percent for income over BBD 30 million ($15 million) — that recently replaced the country’s preferential regimes still facilitates offshore profit-shifting arrangements because of the absence of adequate economic substance standards. “Barbados needs to comply with the requirements under criterion 2.2, including by ensuring that legal mechanisms do not exist that enable the granting of advantages only to nonresidents or in respect of transactions carried out with nonresidents and that sufficient substance is required for entities doing business in or through your jurisdiction,” the letter says.

The letters to BelizeCuraçao, and Seychelles say the abolition of preferential regimes identified by the EU was followed by enactment of an exemption for foreign income with similar harmful features. The exemptions, which are similar to the participation exemption available in many countries but lack antiabuse measures, effectively ring-fence the domestic economy, the letters say.

“The Code of Conduct states that antiabuse provisions or countermeasures contained in tax laws and in double taxation conventions play a fundamental role in counteracting tax avoidance and evasion. In past assessments, the Code Group has taken into account, in the overall assessment of various regimes, the existence of appropriate antiabuse rules,” the letters say. “Such measures would include [controlled foreign corporation] rules or a switchover clause, in line with the agreed Code Guidance and previous assessments."

In its letter to Mauritius, the council criticized the new 80 percent partial exemption system for foreign-source dividends, profit attributable to a foreign permanent establishment, interest and dividends from local or foreign sources, and financial services. The measure’s lenient treatment of outsourcing could be used to circumvent its substance requirements, the letter says.

“The outsourcing of core income-generating activities is only permitted to occur within the jurisdiction concerned,” the letter says. “In addition, the primary entity should have the capacity to properly supervise and control the work of the entity to which the core functions have been outsourced; and the substance of the outsourcing provider (employees, expenditure, and premises) should not be used multiple times by multiple primary entities that outsource to the same outsourcing provider.”

According to the letter to St. Lucia, its version of an exemption for foreign income is a clear case of ring-fencing.

In December 2017 the EU Council approved its conclusions on the EU list of noncooperative jurisdictions for tax purposes. The blacklist instructs EU member states to take at least one of three administrative defensive measures: reinforced transaction monitoring, increased audit risk for taxpayers benefiting from the regime, or increased audit risk for taxpayers that use arrangements involving the jurisdiction. It also recommends — but does not require — legislative measures, including CFC rules, withholding taxes, restrictions on deductibility of costs, and special documentation requirements.