The European Union and Offshore: A Review of the Year 2000

by Jeremy Hetherington-Gore, Tax-news.com

01 January 2001

In January the conspiracy against offshore which had been hatched between the OECD's finance ministers back in 1996 was nearing maturity: the Financial Stability Forum, the Financial Action Task Force (FATF) and the OECD had all nearly completed the studies which were going to result in the issue of the famous - or infamous - lists of 2000; while for its part the EU expected 2000 to see a denouement on two crucial parts of its Savings Tax Directive - the imposition of a withholding tax on cross-border interest payments, and the outlawing of almost all the 'harmful' tax practices in its member states, but more particularly in their offshore dependencies and territories.

Elsewhere in the Commission, other initiatives with negative consequences for offshore were also expected to come to fruition in 2000. The long-running saga of the USA's Foreign Sales Corporation (FSC) legislation (which encourages US corporations to establish offshore sales subsidiaries for exports into Europe) would surely result in victory for the EU, and even more importantly, a way would be found to impose VAT on the growing volume of untaxed e-commerce imports from outside the Union.

For three of these four dossiers, the Commission's hopes of a successful outcome were probably dependent on achieving agreement on qualified majority voting for fiscal affairs - only the FSC dossier could be resolved without unanimity as a trade matter affecting the single market. And so it has proved: each of the three fiscal measures has run into the sand, even if the EU is pretending otherwise, while the FSC affair seems likely to end with a result which is bad for offshore, whether or not it is bad for the USA.

The EU's most shameful failure has surely been the collapse of the Savings Tax Directive, as it is called. Alongside the two key anti-offshore components, it also contains a number of quite sensible measures which tidy up various loose ends in the cross-border taxation of royalties and interest, and these can now go into force. But in order to get it through, smoke and mirrors had to be employed to make it seem as if agreement had been reached on the Code of Conduct and the withholding tax - in fact neither one has been agreed.

The Code of Conduct Committee

The Code of Conduct (for avoiding harmful fiscal practices) was developed by a Committee chaired by Dawn Primarolo, British Paymaster-General (junior Treasury minister). Its initial list of several hundred harmful practices (say 'tax break' in ordinary English) was pruned down to a mere 66, and the list finally published at Easter-time. One thing you could say for it was that it was indiscriminate - no country got off lightly, onshore or offshore, and virtually every worthwhile tax dodge in Europe was on the list, from Belgian headquarters companies to 'designer' tax regimes in several offshore dependent territories.

The very completeness of the Code of Conduct list has been its downfall. Countries may be happy enough to sign up to notions of 'unfair tax competition' when it comes to bashing tropical islands, but when it comes to their own interests, you're talking jobs, pennies onto income tax and so forth, and, no, they don't want to play this game any more. Plus the Committee blandly ignored the fact that Europe's tax havens are almost all quasi-independent nations: during the last 100 years, Europe's moneyed and powerful classes have built up the polite fiction of independence for these territories in order that they could put their own loot safely out of the reach of the taxes they wanted to impose on us huddled masses. Now they want to stop the rot, they find they haven't any power to do so: who will be the first to send paras into a poor (ok, rich) little country with white-washed cottages and an army consisting of 24 semi-retired militiamen in 18th century uniforms?

So the publication of the Code of Conduct list was greeted with a shocked silence, and after a decent interval it was interred by unanimous agreement that it should go into effect on a voluntary basis. Please! What a waste of time and money! But imagine, if there had been QMV on fiscal affairs, the Code of Conduct would have been a massive bargaining chip at Nice: it still wouldn't have gone into effect, but would have been a powerful weapon against those countries, like the UK and Luxembourg, which were standing out against the withholding tax.

The Savings Tax

The battle of the savings tax has been a little like Waterloo: the Grande Armee (in the shape of successive presidencies) has sent wave after wave of veteran troops against the thin red line of the British and their Luxembourgeouis auxiliaries, only to be thrown back by the unyielding No! of perfidious Albion. It pays back General de Gaulle for that 'Non!' although it may be stretching things a bit to liken Gordon Brown to the Duke of Wellington. Perhaps the bulge-bracket banks should club together to give him an estate in Jersey? The Duke of St Helier? On condition he goes and lives there.

By now it is hardly interesting to track the tangled history of negotiations on the savings tax during the year: the end result is an agreement to agree, which is rather unlikely ever to happen. The directive originally included a choice between a withholding tax or an exchange of information (ie, an EU financial institution will send information on interest payments to the recipient's home country tax authority). The majority was always ready to impose a withholding tax, but the Brits successfully defended their eurobond issuing business by just refusing to go along with the tax.

It was obvious from the beginning that London's bond business, and Luxembourg's offshore sector, would be washed away if the EU adopted either a tax or information-sharing, so the 'agreement to agree' stipulates that other key financial centres must adhere to a similar regime before the directive comes into force. This surely kills it? The deadline for agreement is the end of 2002, and can anyone imagine that Switzerland, Jersey and the US (to pick three of the 'key' financial centres) will agree to such a thing? The truth is that all the world's financial centres have to agree before an information-sharing regime can work. One day they will; but not this time around, not with a Republican President and Congress, and with national treasuries bulging with money.

The E-Commerce VAT Directive

Well, non-Directive, to be precise, because there isn't one yet, and there may never be. The Internet and E-Commerce were heaven sent to make fools out of Governments, especially incoherent ones like the EU's clunky legislative apparatus.

This year the Commission, the Commissioners and the Council have deluged us with high-minded declarations about the future of e-Europe. If it is true that good intentions pave the road to perdition, then that is where the EU is going, at least as far as e-commerce is concerned.

The curious thing is that while the EU's and the OECD's finance ministers had the wit to see that e-commerce could undermine a nation's power to tax, because so many parts of the production chain become cyber-portable, their response, instead of being to compete to welcome e-commerce, has been to compete to legislate it away. The US has got this much more right than Europe, by exempting e-commerce from tax while it grows. First fatten the chicken, then eat it, or get it to lay eggs.

The EU proposal to collect VAT on cyber-imports is a classic piece of stupidity, or to be more fair to Frits Bolkestein, the Commissioner for Taxation, who is not a stupid man, the handling of a wrong-headed proposal by the EU has been stupid and has turned a mistake into a disaster.

As originally proposed, the tax attempted to remedy the fact that digital supplies within the Union, which were classed as services even if they were digital representations of physical goods (eg compact discs) are taxed if they originate within the Union, but are untaxed if they originate outside the Union. The brave and wise thing to do would have been to free internal digital supplies from taxation, to put Europe's e-commerce businesses on a level footing with their overseas competitors; instead, the EU predictably tried to impose VAT on digital imports.

Having made the initial mistake, the EU then logically (but fatally) suggested that an external e-commerce business could register anywhere in the EU, and would be able to supply throughout the Union based on that registration. The bonanza that would have given to the country with the lowest rate of VAT (Luxembourg, Madeira or the Isle of Man) provoked screams of greedy outrage from the countries with high VAT rates, and the whole thing has degenerated into a farce, with the most recent ECOFIN Council agreeing a messy compromise which the Commission now has to try to turn into a Directive.

In a way, it doesn't matter to offshore what the result is, if there ever is one, because any Directive can bind only the member states of the Union, while e-commerce firms outside the Union will be free to supply their e-goods to consumers inside the EU with impunity. How is the EU going to know that a teenager in Cracow has spent $10 on his offshore credit card to download Madonna's latest album from a Bermudian server to the laptop he bought on a visit to Hong Kong?

In fact, there may not be an outcome for a number of years. If a Directive emerges, it will be subject to the unanimity requirement, which will make sure firstly that it takes ages to come into effect, and secondly that it will be so complicated as to be unworkable. As with information exchange, there will one day be taxation of e-commerce, but the EU should focus first on generating some e-commerce, and only then worry about co-operating internationally to agree a sensible taxation regime which will apply to all countries.

Foreign Sales Corporations

The antecedents of the FSC spat between the EU and the US are not related to offshore, except incidentally. This is a trade matter, and those offshore jurisdictions (mostly in the Caribbean) which benefit from the presence of thousands of US exporters' subsidiary sales companies are innocent victims in the cross-Atlantic line of fire.

The rights and wrongs of the affair are tangled, but what matters to offshore is that the US has agreed to change its FSC rules so that the tax benefit (equivalent to about 5% of sales value) accruing to US exporters can be claimed back at home. Whether the tax break stays or goes, it can't help offshore any more, and it has to be assumed that many or most of the offshore sales subsidiaries that currently exist will be discontinued, once the WTO reaches a final conclusion, which may be during 2001.

It's not easy to estimate the value of the FSC sector to offshore, and even harder to guess what proportion of it will disappear. The value of the tax break to US companies is said to be about $5bn a year, based on export turnover of about $100bn, all of which passes through the offshore companies concerned, of which there are perhaps about 6,000. It is not an insignificant business, and the three main countries concerned - Barbados, Bermuda and the US Virgin Islands - can't be happy about the situation.

Conclusion

The EU has been largely a paper tiger for offshore in 2000, very loud and fierce, but with no claws. Under the surface, trends in EU affairs are if anything highly positive for offshore. The tax burden in most EU countries rises every year, even at a time of fiscal surplus, and will doubtless continue to do so. Even without the magic of e-commerce, increasing hordes of rich EU citizens and companies will want to get out from under the Colbertian superstate - and offshore is their escape route. Then, in a few years' time, imagine how the populations of Eastern Europe will react to the iron embrace of Brussels, the acquis communautaire and VAT.

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