Jurisdictions
Regions
Industry Sectors
04/07/19
From Sector Research
Tax Competition and Liberal Principles
This article, and all other articles in this feature, is an extract from IEA Current Controversies 67: ‘All at Sea: The Misguided War on Offshore Financial Centres’, written for the Institute of Economic Affairs by Jamie Whyte (March 2019). Jamie Whyte is a journalist. He has previously been a Director of Research at the Institute of Economic Affairs, leader of the ACT Party of New Zealand, a management consultant with Oliver Wyman and the Boston Consultant Group, and a philosophy lecturer at Cambridge University, where he also gained his PhD.
The tactics now used to prevent tax competition undermine the rule of law in at least two ways. The first is to give discretionary power to tax collectors. The UK’s general anti-avoidance rule (GAAR), introduced in 2011, allows Her Majesty’s Revenue and Customs (HMRC) to collect not the amount of tax you owe according to the letter of the law but according to the spirit of the law. Your tax arrangements, including those using OFCs, may be entirely within the law. But that is no defence. If HMRC deems your tax arrangements to be tax avoidance, then it can collect the amount of tax you would owe if you hadn’t made them.
If the difference between legitimate tax planning and tax avoidance were clear, this might not undermine the (degree of) legal certainty that is required for the rule of law.
The legal uncertainty this creates is not merely an affront to general principles of liberalism; it imposes another deadweight cost on society. By increasing the uncertainty of companies’ post-tax returns, it increases the pre-tax returns that investors will demand. In other words, it increases the cost of capital and thereby reduces investment.
Recent attempts to limit the use of tax havens also violate important principles of liberal societies. In 2018, the UK government required its 14 overseas territories, including the British Virgin Islands, Bermuda and the Cayman Islands, to publish lists of the beneficial owners of all the companies registered in them (through an amendment to the Sanctions and Anti-Money Laundering Bill.) This may exceed the powers of the UK parliament. Some critics have even complained that it amounts to a revival of colonialism. But, let us assume that the UK parliament acted within its powers. It is still a regrettable law.
To see why, we need only consider the justification provided by its main sponsors, the Labour MP Margaret Hodge and the Conservative MP, Andrew Mitchell. According to Ms Hodge:
“That [landscape of OFCs] allows, whether it’s a tax avoider or a tax evader, a kleptocrat, a criminal, gangs involved in organised crime, money launderers, or those wanting to fund terrorism … [The public register] will stop them exploiting our secret regime, hiding their toxic wealth and laundering money into the legitimate system, often for nefarious purposes …Transparency is a very powerful tool. With open registers we will then know who knows what and where, and we will be able to see where the money flows”.[i]
The police already have access to the information that this new law will make public. If they suspect someone of using OFCs to launder money acquired through criminal activity, they can gather any relevant information about the beneficial owners of companies registered in the Overseas Territories (and Crown Dependencies) within 24 hours.
The crime fighting justification is thus specious.
I hope authoritarianism has not made so much progress that this proposal will still strike readers as reasonable. Liberal societies require privacy. You can give it up voluntarily, as when you reveal your life on Facebook, or you can have it removed against your will when you commit a crime. But the idea that you should lose your privacy because you could use it for wrong doing is wholly inconsistent with the legal principles of the UK and other free societies.
Now consider the EU’s blacklist of ‘non-cooperative tax jurisdictions’.[ii] This violates two generally agreed principles. One is that sovereign governments are free to design their own tax policies. The criteria for blacklisting make it clear that changing other countries’ tax policies is the goal. There are three criteria which must be satisfied to avoid blacklisting (European Commission 2017):
- Transparency: Countries must comply with international data sharing standards.
- Fair Tax Competition: Countries should not violate the EU and OECD principles concerning tax competition. More specifically: ‘Those that choose to have no or zero-rate corporate taxation should ensure that this does not encourage artificial offshore structures without real economic activity’.
- BEPS implementation. Countries must implement the OECD’s Base Erosion and Profit Shifting (BEPS) minimum standards.
Most Overseas Territories and Crown Dependencies pass the transparency and BEPS tests. It is the Fair Tax Competition criterion that is meant to catch them. It does this by specifying that a common feature of incorporation around the world – namely, that it need not be accompanied by ‘real economic activity’ by the company (or substance, as it is sometime known)[iii] – fails the test when combined with a particular tax policy: namely, no or zero-rate corporate tax. Every advanced economy would fail the test if it stopped taxing corporate profits.
The Overseas Territories and Crown Dependencies are not rogue states. They are stable democracies committed to the rule of law. EU politicians have no proper business meddling in their domestic policies. Calling this interference colonialism may be overstating the case. But the interference displays a remarkable contempt for the sovereignty of their governments and a willingness to use force against legitimate and peaceful jurisdictions. The second principle violated is that justice is blind – or, in other words, that the same rules apply to everyone. The European Commission applies the criteria for blacklisting only to ‘third countries’, exempting EU countries from the same scrutiny and the possibility of being blacklisted. It justifies this by saying that, within the EU, it uses ‘different tools’ to ensure fair and transparent tax (see European Commission 2017).
Perhaps it does. But that is irrelevant. Let us suppose sanctions are warranted by failing to meet the blacklisting criteria listed above. Why is membership of the EU exculpatory? The European Commission’s argument is preposterous. You might as well argue that the criminal law need not apply to members of the aristocracy, because aristocrats have other reasons for behaving well. There is no evading the fact that the EU applies standards to third countries that it does not apply to its own member states.
[i] Theresa May changes course on tax havens after facing Commons defeat’, Sky News, 4 May 2018, https://news.sky.com/story/theresa-may-changes-course-on-taxhavens-after-facing-commons-defeat-11355052
[ii] Blacklisted countries are subject to sanctions that ban funds from EU development agencies being transferred through them. And companies with activities in blacklisted countries are subject to stricter reporting requirements than companies with no such activities.
[iii] Tests for substance might include having offices and staff in the country of incorporation or, perhaps, engaging in trade within that country. It is currently unclear how burdensome the EU means to make the substance test.
Jamie Whyte
Jamie Whyte is a journalist who was previously Director of Research at the IEA. He holds a Ph.D. from Cambridge University and is former leader of the ACT Party of New Zealand. No Company.
