Menu
Tax Notes logo

EU Tax Haven Blacklist Hamstrung by Politics, Critics Say

Posted on Oct. 6, 2021

One of the EU’s most heralded weapons against tax avoidance and evasion falls prey to political whims, is applied arbitrarily, and lacks transparency, according to tax observers and lawmakers.

The EU blacklist of noncooperative jurisdictions for tax purposes — a soft-law tool used to name and shame non-EU jurisdictions with laws and policies that facilitate tax avoidance — faces criticism from members of the European Parliament, scholars, and other tax observers, who allege that the mechanism falls short of curbing the tax avoidance and evasion that drains the EU’s coffers.

Critics argue that the blacklist, which was created in 2017 by the EU Council’s Code of Conduct Group (Business Taxation), suffers from a secretive jurisdiction selection process, inadequate and inconsistently applied listing criteria, and the imposition of EU sociocultural norms on other nations.

In January the EP approved a resolution demanding the reform of the blacklist by the end of 2021. MEPs from all areas of the political spectrum — from the progressive Greens to the conservative Identity and Democracy group — endorsed the resolution. It says the blacklist has failed “to live up to its full potential, [with] jurisdictions currently on the list covering less than 2 percent of worldwide tax revenue losses.”

The EP resolution calls for expanding both the geographic and policy criteria for inclusion on the list, toughening requirements that screened jurisdictions must meet to get off of it, and making the Code of Conduct Group's decisions about the list more transparent. Recommendations include the inclusion on the list of all countries with a 0 percent tax rate, the screening of all non-EU (or "third") countries — including major EU trading partners — under the listing criteria, and the formalization of the blacklist as a legally binding instrument by the end of 2021.

Facing political pressure, the Code of Conduct Group started work in April to expand the geographic scope and harmful tax criteria of the Code of Conduct, which sets the guidelines for a jurisdiction’s inclusion on the blacklist.

The secrecy regarding the Code of Conduct Group's work has led to scrutiny of the group's decisions to drop the Cayman Islands — which has a 0 percent corporate income tax rate — from the blacklist and to omit EU member states from the list.

Johan Langerock, a policy adviser for the Greens/European Free Alliance who coauthored the EP resolution, said the blacklist has failed to limit the risk of tax avoidance or to establish fairer standards of tax competition in the global economy. A key misstep with the blacklist, he said, was the European Commission’s inclusion in 2018 of economic substance guidelines, which target jurisdictions that give advantages to companies that lack any real economic activity within their borders.

In theory, substance requirements are a good idea, Langerock said, but without further criteria that list jurisdictions with 0 percent tax rates or tax rates below an acceptable threshold, they allow jurisdictions like the Cayman Islands to slip through regulatory cracks.

“You know why [the Cayman Islands] left the list. They respect the substance guidelines," Langerock told Tax Notes. "The only thing we don’t know is whether these guidelines will be effective or be followed up.” The Cayman Islands "are given years to comply, but these are years of possible tax avoidance,” he added.

A council source said the Cayman Islands is not on the blacklist because it mostly houses investment funds, which are not subject to EU economic substance guidelines.

But some scholars say a minimum tax rate requirement — outside of a voluntary global agreement — would violate countries’ sovereignty to decide their own corporate tax rates.

Steven Dean, a professor of law at Brooklyn Law School, pointed out that blacklisting countries based on 0 percent tax rates has led to inequities in the past. The OECD’s 2000 list of tax havens — which was widely regarded as a blacklist because of economic sanctions imposed on jurisdictions that did not take corrective action — included Liberia, which did not have a corporate income tax but was also recovering from a brutal civil war, Dean said. The exclusion of Switzerland — whose banking secrecy laws had been known to facilitate tax evasion — further cemented the unequal and seemingly arbitrary application of the criteria, he said.

“It’s just a very odd thing that in tax, after 2000, it became a legitimate exercise in governance to threaten to impose sanctions on . . . states without an income tax,” Dean said. “There’s nothing wrong with not having an income tax.”

Federica Casano, a researcher and PhD candidate at Leiden University who is studying the blacklist's effectiveness in tackling harmful tax competition and tax avoidance under the advisement of harmful tax competition scholar Martijn Nouwen, agreed that the EU’s practice of holding low-income and developing nations to standards that they did not create — such as the two-pillar plan to modernize corporate tax rules under action 1 of the OECD’s base erosion and profit-shifting project — is unfair. Many blacklisted countries are not part of the inclusive framework on BEPS, she noted, and thus do not have any input on international standards to combat tax avoidance.

A Political Process

Sources within the Code of Conduct Group and the EU government confirmed to Tax Notes that deciding which jurisdictions to put on the blacklist is a political exercise determined by the EU’s relationships with the third countries the group screens.

The list adopted by the council October 5 includes American Samoa, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, the U.S. Virgin Islands, and Vanuatu. Anguilla, Dominica, and the Seychelles — which had been on the February 22 blacklist for noncompliance in exchange of information on request — were all moved to the gray list, which comprises jurisdictions that are subject to increased supervision and progress review, according to an October 5 council release.

The EU said the blacklisted countries either did not make a commitment to address the stated concerns about their tax laws, did not deliver their written commitment to change their tax laws on time, or had major transparency issues.

Turkey was not included in the blacklist for the second time,  despite its lack of agreement to exchange information on financial accounts with EU member state Cyprus.

In its February 22 blacklist conclusions, the council had asked Turkey to “fully commit on a high political level” by May 31 to effectively activate automatic exchange of information (AEOI) relationships with six member states — Austria, Belgium, Cyprus, France, Germany, and the Netherlands — by June 30. It also asked Turkey to send all member states information for fiscal 2019 by September 1, and to send  information for fiscal 2020 and 2021 by September 30, 2021, and September 30, 2022, respectively, in accordance with the OECD calendar for AEOI with all member states.

On May 19 Turkey committed to effectively activate AEOI relationships by June 30 with all member states with which it has diplomatic relations. Turkey does  not have diplomatic relations with Cyprus, which is still divided by a wall separating the north of the island (known as the Turkish Republic of Northern Cyprus) and the south, which is part of the EU.

The February council decision to allow Turkey more time to comply with AEOI standards frustrated many MEPs, who felt that Turkey's exclusion from the blacklist weakened the tool’s effectiveness.

Several MEPs think that Turkish President Recep Tayyip Erdogan is manipulating the EU regarding refugee policies, which infringes on Europe’s sovereignty, said German MEP Sven Giegold, spokesman for the Greens/European Free Alliance.

However, some member states “want to limit conflict with Turkey rather than insisting that European and international tax law is implemented to its full [extent],” Giegold said.

Turkey was given until December 31 to “urgently begin or to continue bilateral technical work with member states and solve outstanding technical issues to effectively exchange data,” according to the October 5 council conclusions.

The council acknowledged that its treatment of Turkey is unusual, given that “the effective exchange of information with all Member States is a condition for Turkey to fulfil criterion 1.1 of the EU list,” and that “the progress made by Turkey is still not fully in line with the commitments required” in the council conclusions from February 2020 and February 2021. In a September 24 report, the council said that while Turkey has taken steps to activate the exchange of data with 26 member states, further engagement and technical work is required to meet international standards and fully comply with the February 22 council conclusions.

The council’s concessions for Turkey came amid political tensions between that country and the EU and its allies. The United States issued sanctions against Turkey in December 2020 over its July 2019 purchase of an S-400 air defense system from Russia. Meanwhile, some EU member states — including Cyprus and Greece — have been locked in a years-long disagreement with Turkey over eastern Mediterranean maritime boundaries and energy resources.

EU sources said that from the blacklist's inception, member states have worked to protect the EU's relationships with its allies and trading partners, including the United States. When the council was first developing criteria for the blacklist, member states wanted to make sure that the screening method would not evolve, “because nobody wanted to blacklist the U.S.,” said a commission source.

There is "a clear difference" under the U.S. Foreign Account Tax Compliance Act between the obligations of the United States to EU countries and those of EU countries to the United States, Giegold said.

FATCA has been a source of friction between the EU and the United States because it requires foreign banks to give the U.S. government tax information on accounts held by American citizens but does not mandate that American banks give foreign tax authorities similar information on their citizens' accounts. “The OECD doesn’t dare to touch the issue, and the EU doesn’t dare to touch the issue either,” Giegold said. Recently, however, EU officials have raised concerns about the law — including the tax treatment of so-called accidental Americans — in conversations with the Biden administration.

Giegold said the blacklist is used against some countries but not others, with little explanation. That disparity is illustrated, he said, by the fact that the EU regards the United States as compliant on transparency in the exchange of tax information. The blacklist is “not unpolitical,” he said.

(Non-)Members Only

Many critics, including some European lawmakers, also object to the blacklist's application to only non-EU countries, saying it ignores member-state tax havens. For example, another council source said EU member states took no action when France “refused for years” to change its patent box regime — which provided a 15 percent tax rate for intellectual property assets — even after the Code of Conduct Group determined in 2017 that the regime was noncompliant. France’s new patent box regime — adopted in 2019 — provides for a 10 percent tax rate (compared with the 25 percent general corporate tax rate) for income derived from IP assets, including software.

MEPs from a broad political spectrum demanded in their resolution and subsequent reports that the council address harmful tax competition within and outside the EU by widening the geographic scope of the Code of Conduct, expanding the criteria to include more harmful tax practices, and making the council’s process and decisions more transparent. The commission’s Annual Report on Taxation 2021 says the EU loses an estimated €36 billion to €37 billion in corporate income tax revenue annually because of tax avoidance.

A July 20 Committee on Economic and Monetary Affairs report from French MEP Aurore Lalucq of the  Progressive Alliance of Socialists and Democrats asks that the Code of Conduct Group “look into all aggressive tax planning indicators by [a] Member State, including the general characteristics of a tax system, to determine whether its legislation comprises harmful tax measures.” The report also requests that the commission employ binding legal instruments to fight harmful tax practices and consider the use of article 116 of the Treaty on the Functioning of the European Union to allow qualified majority voting when a member state has applied harmful tax practices that distort competition in the internal market.

Justification for using the Code of Conduct to hold member states accountable for harmful tax practices is contained in its founding document. The code was developed in 1997 as the EU’s primary instrument to prevent harmful tax measures “which affect, or may affect, in a significant way the location of business activity in the Union, and which provide for a significantly lower level of taxation than those that generally apply in the member state concerned,” according to Lalucq’s report.

The possibility that the blacklist could target EU countries has long prompted worries among some member states. Former European Commission President Jean Claude Juncker faced pressure to kill the blacklist from opponents in Luxembourg who feared that the Grand Duchy would be screened under its criteria someday, the commission source said.

To Casano, though, the reason member states are excluded from the blacklist is as simple as it is intractable. “To approve the list, you need unanimity,” she said. “You would never get that from including EU member states on the list.”

One change that could implicate some EU countries is the proposed expansion of the Code of Conduct's prohibitions to some transfer pricing and tax exemption regimes, Casano said. EU member states have broad discretion to determine how to apply the arm’s-length principle in any part of transfer pricing legislation, which creates issues within the market, she said. If member states decide to include transfer pricing regimes within the category of preferential tax regimes that could land non-EU countries on the blacklist, they should apply the same standard within the EU, she said.

Commission officials have publicly disputed the idea that the blacklist is unfair to non-EU countries. The commission “never ask[s] third countries to do things that would not be asked to our member states first,” Benjamin Angel, the commission’s director of direct taxation for the Directorate General for Taxation and Customs Union, said in a March 25 interview on the Tax Notes Talk podcast.

Angel said at the time that the Code of Conduct Group was working to broaden its mandate to include regimes that produce harmful effects. He described the discussion as “difficult” and said member states would be working to reach consensus for many more months.

Langerock said the political nature — rather than the objective or technical nature — of the Code of Conduct Group and blacklist criteria means that any revision should be a political exercise undertaken by a “high-level political working group.” He said the structure and scope of the list have persisted for so long because the group can agree more quickly on policies that affect non-EU countries rather than member states.

“When you reform the EU listing criteria, you’re close to reforming [EU members’] criteria as well,” Langerock said. “We don’t know how much appetite there is to reform some member states’ criteria. There are some countries that really compete with each other based on tax policies. We have very little intelligence.”

Jumping to Sanctions

While critics have been troubled by the blacklist's inclusion criteria, the question of how to penalize blacklisted countries has proven even more divisive. In a heated January 20 exchange between EU Tax Commissioner Paolo Gentiloni and MEPs, the commissioner said that if member states do not apply effective penalties to countries on the blacklist, the commission will intervene with a legislative proposal.

That exchange came a few months after the commission recommended in July 2020 that member states withhold financial support — especially in the context of the coronavirus pandemic — to companies with connections to blacklisted countries.

For the blacklist to be effective, Casano said, member states need to apply uniform sanctions to listed countries. Weak defensive measures make the list weaker, while the threat of economic sanctions could force real change in a country’s tax policies, she said.

While Langerock agrees that developing common sanctions could “be interesting in further developing anti-tax-avoidance rules,” he thinks the listing criteria should be revised first. “What’s the point of having penalties" if the right countries are not on the blacklist, he said.

But the commission has already taken steps to address tax avoidance facilitated by tax havens. It announced in May that it is preparing a legislative proposal for new monitoring and reporting requirements to address aggressive tax planning linked to shell companies. The commission said it plans to publish the initiative, which calls for new monitoring and reporting requirements for shell companies, December 22.

Several proposals in the commission’s communication on business taxation also aim to address tax avoidance, including a re-imagined common consolidated corporate tax base under a plan called “Business in Europe: Framework for Income Taxation.”

But the biggest shake-up to the blacklist may be yet to come. Pillar 2 of the inclusive framework's plan to modernize corporate tax rules would establish a global minimum effective tax rate of at least 15 percent. Pillar 1 of the plan would reallocate a portion of residual profits — often tied to intangible trade — that the 100 largest, most profitable multinational enterprises make in the jurisdictions in which they have sales.Most of the 139 countries in the inclusive framework reached agreement on key elements of the two-pillar plan July 1. Countries are hoping to work out technical details and finalize the agreement in October.

A global minimum tax rate would enable participating countries in which large multinational corporations are headquartered to collect a top-up tax on those companies’ subsidiaries in lower-tax jurisdictions, up to a yet-to-be-agreed effective minimum tax rate, which could limit the appeal of doing business in those jurisdictions. If a minimum tax regime comes to pass, it may render a blacklist largely moot.

Some low-tax and formerly blacklisted jurisdictions are part of the inclusive framework and have signed on to the two-pillar agreement, including the Bahamas, the Cayman Islands, Guernsey, and Jersey. Barbados — a recent holdout — agreed to join the two-pillar plan August 12. Still, three EU member states in the inclusive framework have not signed on: Estonia, Hungary, and Ireland — all notable for corporate income tax rates below 15 percent. While Ireland may join if the minimum rate stays at 15 percent, Hungary fundamentally opposes a global minimum tax rate, and Estonia disagrees with the scope and structure of the pillar 2 proposal.

The inclusive framework agreed that the core of pillar 2, known as the global anti-base-erosion (GLOBE) mechanism, will have a “common approach” status, meaning that it must secure the support of a majority of countries but that countries are not required to adopt the GLOBE. If they do, they must implement and administer it in accordance with the pillar 2 plan. The EU plans to immediately propose a directive to implement pillar 2, but will require pillar 1 to be converted into a multilateral convention before proposing an EU directive to transpose it into EU law. However, the EU requires unanimity among member states to approve both proposals.

Dean said the two-pillar plan still risks hurting low-income countries, like Liberia, because of blind spots in its design. He said he finds the idea of a minimum tax drafted and imposed by mostly wealthy countries troubling because, as currently designed, it would allow the typically wealthy countries where multinationals are headquartered to collect a top-up tax in jurisdictions that have low or no income taxes.

Global solutions that put low-income countries at the forefront should account for real differences — in economics, politics, and tax system structures — across jurisdictions and should work with those differences instead of punishing them as the EU blacklist does, Dean said.

Elodie Lamer contributed to this report.

Copy RID