Tax Havens and Exchange of Information in the Era of Global Fiscal Transparency

Dr. Pasquale Pistone, Head of the Academic Committee of the IBFD, Wirtschaftsuniversitat Wien & University Salerno

The article is devoted to tax havens and problems of global fi scal transparency. The author provides the defi nition of tax havens and an overview of their evolution from the 1980-s until the most recent events. Exchange of information (EoI) is the key to fade out tax havens. Various legal instruments, including European conventions, and international standards are used for exchanging information at the international level.

Key words: tax havens, global fi scal transparency, exchange of information, OECD Model Tax Convention, tax and non-tax instruments for exchanging information, the 1988 open Multilateral Tax Convention on Mutual Assistance, International Standards on Transparency and EoI, a peer-reviewing procedure

1. Introduction: From tax havens to non-cooperative fiscal jurisdictions in the era of global fiscal transparency. In the 1980s, the International Fiscal Association (IFA)[1] and the Organization for Economic Co-operation and Development (OECD)[2] defined tax havens as low tax jurisdictions attracting foreign capital through ring fenced (off-shore) preferential tax regimes, which were not available to their residents, and a strong protection of banking secrecy. Such definition does not automatically turn purely territorial tax jurisdictions into tax havens, whereas their lack of interest to conclude a tax treaty was to a major or minor extent tolerated in relations between such jurisdictions, considering that the latter would give relief for any double taxation on a unilateral basis. Furthermore, banking secrecy was for long respected on the international scenario, especially in countries which considered this as a fundamental expression of the right to privacy.

Over several decades tax havens offered a safe shelter for international capital to escape liability to tax in high-tax jurisdictions and have it replaced by lower or no taxation. It was perhaps for such reasons that other languages expressed the same concept by using terms sounding like “tax heavens” (paradis fiscaux, paradise fiscali, paraísos fiscales), or “tax oasis” (Steueroasen).

However, the strong international consensus for global transparency has turned such heavens into true hells, considering that the current legal uncertainty as to their boundaries and destiny deprive them of sheltering functions, while forcing international tax planners to radically revise their strategies.

I will now provide an overview of such evolution from the 1980-s until the most recent events.

Perhaps, the true core of the notion of tax havens currently no longer lies in just sheltering income under a zero or low taxation preferential regime, but rather in depriving a State from its effective exercise of taxing jurisdiction due to the absence of information on a cross-border situation. From this perspective, I believe we should carve out the constellation of abusive practices which to some extent overlap with this topic whenever abuse is carried out by making use of tax havens and will not be addressed hereby.

The engine of the Copernican revolution in the global shift to fiscal transparency was (and is being) soft law (which I will address in a separate section of this conference). Along a pattern designed by the OECD in order to call for a global voluntary compliance with standards in exchanging information, it should enable tax authorities to exercise their own tax jurisdiction on cross-border situations on the basis of sufficient facts concerning income and capital falling under their sovereignty. It would not be incorrect to affirm that soft law succeeded where other measures had previously failed, especially considering that several events (including the UBS[3], HSBC Geneva and Liechtenstein bank tax diskettes, as well as the fight against money laundering and terrorism) have remarkably affected the current international scenario.

In connection with the establishment of the Global Forum on Fiscal Transparency, supported by the OECD General Secretariat, almost all countries of the world (including Caribbean islands, which were regarded by tax literature as classic examples of tax havens) have thus dramatically reverted their international tax policy in order to show their commitment to comply with such enhanced standards. Accordingly, countries lacking a treaty network with clauses on a broad and effective exchange of information (hereinafter also: EoI) have rushed to conclude either general or exchange of information treaties, in order to be regarded as co-operative jurisdictions within the Global Forum on Fiscal Transparency[4]. I will provide an overview of this evolution.

1. Exchange of information (EoI) as the key to fade out tax havens: general tax and policy issues. This frantic evolution is giving rise to a number of legal and tax controversial issues which are being studied by international organizations, as well as in tax literature and practice, in order to set the ground for a fair peer-reviewing activity by the Global Forum on Fiscal Transparency over the next years. Following an approach that combines theory and practice (including case-studies), we will critically revise such issues with a view to removing the uncertainty that still surrounds tax havens and the scope of exchange of information for tax purposes on the international scenario.

In particular, the goal is to ascertain - from a legal, tax and policy perspective - how an effective EoI is the key to the fading out of tax havens within a global strategy of fiscal transparency.

At present, Article 26 OECD Model Tax Convention provides for a broad-type of EoI clause, which requires exchange of information to apply regardless of the subjective and objective scope of bi- and multilateral tax treaties that include it. However, considering that the European Union, currently the largest financial donor in the world, has recently shown its willingness to require an effective exchange of information among the conditions of good governance (to which it subordinates its donations to developing countries)[5], it is also investigated to ascertain whether and how the EU-OECD cooperation perspectives may positively affect the future of the Global Forum on Fiscal Transparency and beyond.

Further legal instruments are used for exchanging information at the international level. They may be grouped into the following two categories.

The first category includes tax instruments for exchanging information. In addition to Article 26 OECD MTC, the 1988 open Multilateral Tax Convention on Mutual Assistance by the Council of Europe currently allows for exchange of information and is in force among 14 countries (Azerbaijan, Belgium, Denmark, Finland, France, Iceland, Italy, Netherlands, Norway, Poland, Sweden, UK, Ukraine, US). Furthermore, two EU directives allow for mutual assistance within the EU Internal Market, namely Directive 77/799/EEC on exchange of information, which the EU Commission proposed in 2009 to update in order to ensure a more stringent legal framework within the European Union[6], and the directive on mutual assistance, recently upgraded through Directive 2010/24/EU.

The second category includes non-tax instruments that allow exchanging information that is normally not available to tax authorities, such as in respect of treaties against money laundering and international criminality. Both of the latter types of measures should be more carefully analysed within the international tax community, for the purpose of understanding whether and to what extent they may enhance the new approach of international tax law to tax havens. Attention should be paid in particular to measures such as the obligations for banks to require the identification of their account holders and disclose them in tainted cases, but also to the use of such instruments by the European Union secondary law and international agreements on the taxation of savings.

1. The International Standards on Transparency and EoI under Article 26 OECD MTC. With the quantitative requirement based on the number of tax treaties with broad exchange of information only as the starting point of a process that will use peer-reviewing in order to ascertain the effectiveness of such exchange as a way to give evidence of the good faith in applying tax treaties, we will now focus on whether and to what extent the possible limits in gathering information set by domestic law of a State may harm the effectiveness of its commitment to exchange information at the international level through a clause contained in a tax treaty.

I In particular, I would like to address the technical issues that concern the interpretation and application of Article 26 both within OECD countries and in relations with and between other countries worldwide.

The first issue arises as to the scope of EoI clauses in tax treaties.

Information can be exchanged through broad, narrow and very narrow clauses. The first category corresponds to the one allowed under the current drafting of Article 26 OECD MTC, i.e. regardless of the subjective and objective scope of a treaty for both purposes of securing the correct application of the treaty and domestic law of the (other) Contracting State(s). The second category includes clauses that allow for exchange of information only to the extent that is needed in order to secure the correct application of the treaty and domestic law of the (other) Contracting State(s) within the boundaries of the subjective and objective scope of the applicable treaty. Finally, the third category only allows for exchange of that information, which is needed to secure the correct application of the treaty in respect of its subjective and objective scope. In the presence of a treaty not including an exchange of information clause, the same type of information may also be exchanged on the basis of unilateral declarations, often acknowledged by the other Contracting State, though giving rise to a more discretionary framework within which any obligation arises.

Several interesting results came out of a brief survey carried out over the past few months with a small research group[7] across tax treaties of OECD countries in 2009 to be distributed upon completion at the Seminar to be held in the framework of the 2010 Congress of the International Fiscal Association in Rome.

Carving out Swiss tax treaties, the first category of clauses (i.e. broad clauses, modeled after the 2000 version of Article 26 OECD MTC) seems to be almost the general rule (with just above twenty exceptions) in treaties signed from 2000 onwards between OECD countries, whereas the second category was generally accepted (with less than thirty exceptions) in treaties concluded between the same group of countries before then. Surprisingly, however, the highest number (and percentage) of clauses of the first type (i.e. of broad clauses) are included in tax treaties of OECD countries with non-OECD countries: an outcome that can find different motivations, including the ones based on the more recent date of conclusions of such treaties and on the likely stronger negotiating powers of OECD Member States.

A separate and more complex analysis is instead required for Swiss tax treaties, whereas the replacement of the traditional narrow exchange of information clauses through broad clauses (along the pattern of the 2000 version of Article 26 OECD MTC) started as of 2002[8] (in several cases by means of a protocol amending the existing treaty), including it in twenty-four treaties or protocols signed by December 2009. In particular, the exchange of information in tax treaties à la Suisse raises a number of interesting points, considering that banking secrecy has been preserved, whereas the sentence added in Article 26.5 to exchange information breaks up in fact the traditional consistency of such clause with Article 26.3 OECD MTC. Furthermore, one may wonder whether consensus at the international level exists as to the circumstance that banking secrecy may be preserved without harming the compliance with the standards of fiscal transparency that are required in exchanging information by Article 26.5 within the OECD.

A more general point also arises as to situations not covered by Article 26.5 OECD MTC that may hinder, harm or negatively affect EoI through the escape clause contained in Article 26.3. Among others, the attention should be focused on exemptions (for instance on State securities and bonds) and procedural requirements under domestic tax law. This analysis should provide some additional guidance as to the type of information that can be effectively exchanged, not being the mere compliance with quantitative (or formal) requirements – such as the number of tax treaties including a broad type of exchange of information - per se sufficient to ensure the effectiveness required by the standards of fiscal transparency that should be the object of peer-reviewing mechanisms within the Global Forum in the near future. Possible examples of such problems are, among others, the cases in which tax authorities either do not dispose of the powers to obtain a specific type of information on the basis of their domestic law, or have administrative or regulatory practice (for instance due to ne bis in idem preventing the re-opening of tax examinations despite the presence of new elements that seriously indicate a possible problem of compliance, or time-limits problems or other) that prevents them from carrying out controls in line with the standards required by the Global Forum in order to pursue fiscal transparency.

Likewise, problems of this type could arise whenever the domestic (administrative or judicial) procedures of the requested State on the right of taxpayers to avoid undue supplies of confidential information could be substantially in conflict with the right of the requesting Contracting State to obtain a timely satisfaction of its right to obtain the information that is necessary to a proper application of the tax treaty or its domestic law. The same problem could be seen also in the light of preclusions set by domestic law in respect of information that has not been legitimately obtained (an issue that emerged in the Liechtenstein affaire in respect of information illegally purchased by Germany and made available also to other States around the world). Further issues of confidential information may also arise in respect of the scope of Article 26.3.c OECD MTC for persons that handle information in the framework of an activity that at least partially enjoys the privilege of confidentiality.

Possible applications of these criteria are likely to lead to a dramatic increase of the volumes of information exchanged, especially in the short term, for instance, in fields like transfer pricing. Specific problems can also arise in countries like Switzerland that currently still preserve banking secrecy. Especially insofar as broad EoI clauses are becoming frequent also in treaties with developing countries, one may, however, not exclude that flows of information will take a unilateral direction and have some remarkable budgetary implications for such countries. Such problems should be addressed within a more general framework concerning the principle of reciprocity, in order to determine whether some special measures (including fees for information exchanged, including the type that is currently in force under the EU-Switzerland Agreement on the Taxation of Savings and the equivalent regime applicable to payments made by agents domiciled in Austria, Belgium and Luxembourg to beneficial owners that are resident in other EU Member States, or even revenue sharing mechanisms) could/should be envisaged.

It is also important to critically evaluate whether and to what extent arguments based on the lack of proportionality (between the request of information, its cost for the requested State and its use by the requesting State) could/should constitute possible reasons to reject the EoI, or to consider it not foreseeably relevant in the meaning of Article 26.1 OECD MTC, having due regard to the fact that EoI should by no means turn into the first and main resource available to tax authorities for collecting information on cross-border situations, as well as to the arguments and limits indicated in Article 26.4. For the purpose of conveying the analysis within the boundaries of legal criteria that may commonly arise in the international tax practice, it is appropriate to address these issues on the basis of case-studies that depart from the wording of Article 26.1 and the words “necessary” and “foreseeably relevant”, respectively included in the 1977 and 2005 version of the OECD MTC. Due to the limited number of years that have passed since the amendment, only just above one hundred of the bilateral treaties of OECD Member States in force, 32 of which Exchange of Information Agreements, follow the wording of the 2005 OECD MTC.

Analysis based on the wording of Article 26.1 OECD MTC is required in order to determine the actual boundaries of the so-called “fishing expeditions”, i.e. requests for information that are not specifically based on the outcome of internal examinations, but are rather aimed at general acquisition of relevant elements through authorities of the other Contracting State. This situation would in fact be tantamount to shifting the (also financial) burden of fact-finding on the Contracting State other than that which needs the information. Such case-studies could be drafted on the basis of the following five examples that involve bank accounts, namely (i) all bank accounts held in the Contracting State by all residents of the other Contracting State; (ii) all bank accounts held in the Contracting State by one resident of the other Contracting State; (iii) all bank accounts held at one single bank in a Contracting State by all residents of the other Contracting State; (iv) all bank accounts at one single bank in a Contracting State by all residents of the other Contracting State; (v) one bank account at one single bank in a Contracting State by one resident of the other Contracting State. The first case-study is clearly a fishing expedition and the last one is certainly not. However, the issue of whether the dividing line should be situated remains unclear, especially when for the requesting State, such as under the new clauses contained in the Swiss treaties with France and the US, it is not compulsory to specify the request with all relevant details when they are not available to the requesting State.

A particularly interesting problem also arises as to whether information exchanged under Article 26 should also be extended to tax years preceding the year in which the clause entered into force. The affirmative answer seems in line with the need to ensure effective compliance from the moment in which the State undertook its obligation to comply with the standards of fiscal transparency, but also with the criteria that were included in the OECD Commentaries, including paragraph 14 on the OECD Commentary on Article 27. However, the opposite view was held by the Swiss Federal Supreme Administrative Court in its decision of January 21, 2010 on the basis of the need to protect taxpayers’ rights and the rule of law. From such perspective, one may wonder whether the correct solution to such a problem could be to apply a grandfathering period that ensures taxpayers’ protection in respect of the exceptional situation connected to the global switchover to fiscal transparency, which in certain countries determined a major revolution.

1. The next steps of global fiscal transparency: peer-reviewing and the destiny of tax havens. The need to secure effective standards of fiscal transparency should characterise standards of peer-reviewing within the Global Forum of Transparency that combine a supply of information based on interpretation in good faith by any Contracting State (essential to comply with criteria set by the Vienna Convention on the Law of Treaties – hereinafter also VCLT) with the respect of the foundations of its tax law and policy, on the one hand, and the fundamental rights of taxpayers, on the other hand.

The output of analysis carried out in the previous sections should now briefly focus on the possible content and standards for the peer-reviewing of national systems to be carried out in the years to come under the auspices of the Global Forum on Fiscal Transparency. From such perspective, I believe that experiences of sharing data and practices by some countries (such as, for instance, JITSIC, but also the automatic exchange of information in the EU and under the US-Canada DTC) and expert groups (such as for the FISCO Group in the European Union), also in other tax fields (such as for the VIES mechanism successfully used in the field of value-added tax within the European Union) can be relevant in order to determine the content and shape of a permanent worldwide peer-reviewing procedure for sharing information and best EoI, or fiscal transparency practices at the supranational level, as well as providing a technical and impartial monitoring of their interpretation and application.

Furthermore, it is also important to address the role of legal instruments and defensive measures that may frame an effective exchange of information within a new shape - including a possible model EoI multilateral convention (taking into due account the role of the 1988 multilateral convention on mutual assistance), or remain as expressions of soft law – and the freedom of each State to determine the tax policy goals that best correspond to its needs[9], provided that compliance with the standards of global fiscal transparency is effectively secured. This may not exclude the relevance of alternative measures, such as collection of tax at source and remittance to the State of residence, as under the EU-Swiss Agreement (and transitional regime of the corresponding EU Directive) on the taxation of savings.

Hopefully, the synergies between the OECD, the EU and other key international players within the Global Forum on Fiscal Transparency will be able to catalyse in the near future an evolution that replaces tax havens with tax jurisdictions that coordinate the exercise of their prerogatives, while allowing for a healthy and fair tax competition worldwide.