Tax competition
Tax competition generally refers to competition between different tax jurisdictions to encourage businesses and individuals to locate in their areas. At one extreme tax holidays may be granted, which mean that companies or individuals meeting certain criteria are granted favourable tax treatment for a period following their move into a new country.

There are conflicting views about tax competition: some believe that it has beneficial effects: for example, in encouraging governments to keep tax rates down. Other feel that it is damaging to the world economy because of the ensuing misallocation of resources.

In 1998, the OECD established a forum on Harmful Tax Practices, a subsidiary body of its Committee on Fiscal Affairs. The Forum produced a report that identified harmful tax practices and guidelines which asked member countries to identify preferential tax regimes and practices.

In 2000, the Committee on Fiscal Affairs identified 47 preferential tax regimes in nine categories of ‘potentially harmful’ areas (insurance, financing and leasing, fund managers, banking, headquarters regimes, distribution centre regimes, service centre regimes and miscellaneous activities).

So what, in the view of the OECD, is a harmful tax regime? The preferential regime criteria are those where:

1. low (or no) taxes are imposed on the relevant income
2. the regime is ring-fenced from the domestic economy
3. the regime is not transparent, in that details are not clear or there is inadequate financial disclosure; and
4. there is no effective exchange of information.

A further self review was performed by members in 2004, which entailed providing descriptions of regimes with reference to the above criteria.

Following this process, and its accompanying peer review, 18 regimes have been abolished, 14 amended to remove their harmful features, and 13 found not to be harmful.

In addition to the work being done by the OECD member countries, a number of countries and jurisdictions not within the OECD have committed themselves to adopt greater transparency and information exchange. By the end of 2003, 33 jurisdictions, in partnership with OECD member countries, had developed a model Agreement on the Exchange of Information on Tax Matters. An Informal Contact Group has been established comprising OECD members together with participating partners.

A meeting of the Informal Contact Group in Ottawa, Canada in October 2003 attended by representatives of 40 jurisdictions agreed that a level playing field has not yet been achieved and requires participation from those financial centres not currently part of the process.

Exchange of information for tax purposes is a laudable practice, but it will only be effective when the information available for exchange is reliable, which means that it is important for the countries entering into such agreements to have appropriate standards governing the maintenance and accessibility of accounting records.

A small number of countries and jurisdictions have chosen not to participate in the move towards greater transparency and information exchange, identified in a list of ‘Uncooperative Tax Havens’. In December 2003 these were:

• Andorra
• the Principality of Liechtenstein
• Liberia
• the Principality of Monaco
• Republic of the Marshall Islands

The Committee on Fiscal Affairs appreciates the limitations of traditional bilateral and unilateral measures to address harmful tax practices, and has examined a number of possible measures that could be adopted including denial of tax deductions or credits for payments to residents of countries that engage in such behaviour, and reporting requirements for residents transacting with persons in this sort of jurisdiction.

 

The description ‘harmful tax practices’ raises the question – harmful to whom? Certainly not to those trying to avoid tax!

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