The EU Tax Blacklist- Is This the Future for Globalisation?

The blacklist is an ambitious project to impose EU tax policies on more than 60 countries around the world.  Inter-governmental organisations like the Organisation for Economic Development and Cooperation (the OECD) and the Financial Action Task Force (FATF) have pursued cross-border coordination on tax and anti-money laundering rules for twenty years, while the United States’ imposition of the Foreign Account Tax Compliance Act (FATCA) has required many other countries to collect data to assist US tax collections for the US.

In that context, the EU tax blacklist initiative may seem like more of the same.  However, the EU’s aggressive and unilateral demands for change in the domestic laws of other countries marks a key inflection point for the future path of globalisation, and not just in the tax context.

German Chancellor, Angela Merkel has noted that the EU accounts for seven per cent of the world’s population and produces 25 per cent of global GDP, but accounts for 50 per cent of the world’s social spending.  As former US National Security Adviser Zbigniew Brzezinski put it, Europe is “the world’s most comfortable retirement home.”

The EU’s ageing population, low rate of growth, and high public debt makes maintaining its social market economy a considerable challenge in a competitive world.  Against this backdrop, some see EU tax bureaucrats as the ‘new imperialists’, engaged in a drive to stem Europe’s relative decline by requiring other countries to play by its rules.

The EU Blacklist: Unprecedented and Unparalleled

The EU hastily assembled its first tax blacklist in 2015. This list was abandoned following criticism by the OECD, the international policy community, and – surprisingly – even the media.  A relaunch by the EU in early 2016 proposed a more methodical way to judge countries around the world on their compliance with EU criteria for ‘good tax governance’.

The EU has applied three tests to assess good tax governance in other countries:

1. tax transparency;
2. ‘fair taxation’; and
3. compliance with OECD ‘Base Erosion & Profit Shifting’ (BEPS) requirements.

The EU screened 93 countries last year and wrote to 63 jurisdictions seeking commitments to comply with the EU’s criteria. The EU ultimately blacklisted 17 countries in December 2017, although most blacklisted countries were removed from the list in short order after making commitments to change.

Review of the project now is timely as December 2018 is the critical date for the EU’s judgement of ‘grey-listed’ jurisdictions, all of which made commitments to avoid immediate blacklisting last year.  This includes most of the British international financial centres which agreed, in principle, to meet vague EU demands for ‘fair taxation’.  Tax transparency and BEPS compliance are objective standards and all of the British centres were judged compliant with these tests.  However, the notion of ‘fair taxation’ is highly subjective and globally novel, posing myriad definitional and other challenges for countries targeted by the EU on this basis.

The demand for countries with low corporate taxation to adopt ‘economic substance’ – necessitating sweeping changes to local tax, commercial and corporate law – is the most unusual and intrusive aspect of EU plans to impose ‘fair taxation’ requirements on others.  There are precedents to require companies to demonstrate substance in narrow circumstances, for example in regulated financial services or as a qualification for double tax treaty relief.

However, the EU has demanded that companies in designated sectors maintain ‘substance’ in the form of employees, premises and expenditure if they are incorporated, operating in, or tax resident in low or no tax countries. The EU’s current objectives go well beyond the limited areas marked out by precedent.

Blacklist Controversy

Within the EU, the project represents a drive by the Commission (the EU’s executive branch) to centralise control over taxation.  Powers over EU direct tax policy are reserved to Member States, which have historically resisted Commission efforts to interfere in direct tax matters.  The Commission’s call for minimum requirements for tax systems threatens Member States’ autonomy in tax matters. 

Most Member States’ citizens back their governments in resisting Commission encroachment in tax matters, but on ‘fair taxation’ the Commission believes public sympathies are with them.  Not surprisingly, the initiative has been regularly delayed and diverted by the internal tension between Member States and the Commission. The disagreements within the EU have undermined the clarity of the standards and goals demanded in the exercise.

Despite initial promises to ‘lead by example’ in raising tax standards, the EU has exempted its own members from examination in their blacklisting process. Perhaps this was necessary to persuade Member States to back the blacklist project, but it does seem odd that the EU has agreed not to test the compliance of its own Member States while it threatens to blacklist many others, including the United States. 

The EU and the OECD: Collaboration or Competition?

The OECD has played the leading role in coordinating cross-border tax policy and information exchange over the last 20 years. The OECD’s BEPS project concluded in 2015 and reflects remarkable OECD success in driving a global tax agenda.

With EU Member States dominating OECD membership and playing a key role in OECD tax policy, the EU claims that its blacklist is merely building on the OECD’s work in Action 5 of the BEPS project. However, in going beyond OECD standards, the EU is setting an independent, more aggressive agenda, and directly competing with the OECD as a global standard-setter.

EU exemption for its own members has stirred controversy. At the outset of its ‘harmful tax practices’ programme the OECD proceeded with similar deference to its own member countries in avoiding judgement on whether its  members were taking the medicine it prescribed for others. The OECD lost credibility as a result. It later repaired that gap by adopting ‘peer reviews’ for all countries, including its own members. This helped the OECD to gain the trust and confidence of well over 100 countries now participating in the OECD Global Forum. The EU may have a lesson to learn here. 

Assessing the Future Impact of the EU Blacklist Project

The underlying political rationale for the blacklist project is that European public finances are harmed by unfair tax competition from others. Despite the centrality of this narrative in the blacklist project, the EU has not conducted or published any empirical research evidencing this assumption.  Sensational news reporting may have political resonance, but it is a weak basis for policy making, particularly where it abrades EU relationships with scores of countries. 

Remarkably, most EU countries have not even conducted fundamental ‘tax gap’ analysis to assess tax leakages insofar as who evades or avoids which taxes and how. The UK is nearly alone in the EU in conducting analysis of this sort – across all taxes and from both domestic and international sources. This basic research is essential to properly target resources to stem evasion and avoidance.

Also, the EU has not assessed the economic, geopolitical and diplomatic consequences of disconnecting EU markets from the world’s financial centres. These analytical gaps pose risks for the EU project as follows:

• There could be less foreign capital flowing to the EU: The EU benefits from massive inflows into its capital markets, which fund infrastructure, reduce insurance costs and provide liquidity to financial institutions. Money goes where it is welcome, so the EU risks disrupting these inbound flows.
• Targeted countries could tilt to the US or China: Countries that are disenfranchised by the EU will likely direct their focus elsewhere, so the EU will lose out to the US or others further afield, like China. China’s ‘Belt and Road’ initiative will require plenty of friends, including financial centres that can efficiently intermediate the large investments required.
• There could be damage to the EU’s role as a standard-setter: Reducing the centrality of EU capital markets is likely to degrade the EU’s leadership in global regulation-setting too. By imposing the blacklist now, it may effectively cede influence to other players later.

What are the risks of the project to targeted countries? While most are focused on the short-term goal of avoiding inclusion on the blacklist, the most important consequences are long-term. The EU has indicated that its blacklist project is set to become a multi-year process.  Those countries that have accepted EU dictation on design of their domestic laws to avoid being blacklisted now have a foot on the escalator – the EU will be back for more next year, and in the years following.

The Future of Globalisation

Finally, what does the EU blacklist project mean for the future of globalisation? The OECD has championed a consensual and cooperative approach to tax policy development over the last decade. Are we now moving towards a more confrontational approach, where dominant players – like the EU – impose politically-driven domestic policy on others without consultation?  If so, will the US, China, and other power blocs stand back while the EU builds global standards to suit its own interests?  If other powerful countries engage in similar tactics, who will adjudicate when standards inevitably diverge?

The rising power of the nation state was a key theme of the closing centuries of the last millennium.  As our politically-segmented world becomes more economically integrated, national governments are having to work together. The EU’s unilateral blacklist approach follows a different model from that pursued by OECD, posing a vital question on the future of globalisation:  will it proceed through cooperation between countries, or conflict between them?

Richard Hay
Richard Hay is a Stikeman Elliott London partner specializing in international tax law, and head of the London office's International Private Banking and Financial Regulation Group. Mr. Hay advises financial institutions and private clients on tax, regulatory and political risk aspects of cross-border estate planning structures for high net worth families, including those in Canada, Latin America, Asia and Europe. Mr. Hay also advises IFC Forum (www.ifcforum.org), banks and private clients on financial regulation and the information exchange initiatives conducted by the G-20, the OECD, the EU, FATF and the IMF. Mr. Hay is also Co-chairman of the London based International Committee of the Society of Trust and Estate Practitioners, a member of the International Bar Association and the International Tax Planning Association.