Tax Information Exchange Agreements

In light of the current financial crisis, particularly this freedom of movement of capital and the possibility to secure one’s wealth from increasing taxes was a thorn in OECD’s (Organization for Economic Cooperation and Development) side. Although an organization with laudable mission to stimulate economic progress and achieve a rising standard of living in its Member countries, the recession turned OECD into a cartel of indebted, economically stagnant states with high taxes. It is not unreasonable for OECD leaders to worry that if their citizens remain free to choose their tax domicile, then key OECD members will systematically lose their taxpayers to smaller states with more attractive tax systems.

For the last years the OECD paid a lot of attention to analyze tax systems of specific countries to identify the so called ‘tax havens’, whereas the common position of OECD members became a tool to exercise pressure on ‘tax havens’ to limit the tax benefits offered to foreign investors.

In their studies, the experts from OECD developed and codified whole Newspeak for the purposes of tax systems analysis, assuming, not without reason, that control over the language always ensures control over the debate’s result.

In accordance with OECD terminology, countries with alarmingly competitive tax systems against large OECD members have been named as ‘countries engaged in harmful tax competition’, whereas the pressure exercised on states with attractive tax systems were defined as ‘measures to counter the distorting effects of harmful tax competition on investment and financing decisions’.

This kind of Newspeak does not so much describe reality as it shapes it, by making it impossible for language users to make normal choices – after all, would any of us be supporting ‘harmful’ competition or would any of us oppose to ‘limiting distorting effects’?

In April 2009 the OECD published a ‘black list’ and ‘gray list’ of countries, which did not make commitments to exchange of tax information with third countries. Black list included Costa Rica, Philippines and Malaysia, and the gray one dozens of tax havens. The countries evidenced on the two OECD lists have been widely reproved on the international area and were pushed to act defensively in the field of public relations, being absolutely surprised by the scope of OECD activities and the incidental publicity.

These countries however were offered not only sticks but also carrots in the form of the possibility to be transferred to a ‘white list’ provided that they conclude at least twelve tax information exchange agreements (TIEA) with other states. The OECD already prepared special model agreement.

What does the model agreement on exchange of tax information developed by the OECD provide?

Under TIEA the two states parties commit to promote and continue mutual cooperation in tax matters through exchange of information which may be relevant to determine the rate and levy of tax, or for the purposes of debt recovery and tax arrears enforcement, investigations in tax matters or prosecution of tax offenses.

In particular, under TIEA the parties undertake to provide:

• information regarding legal and factual ownership of companies, partnerships, trusts, foundations and other persons including ownership information on all such persons in an ownership chain;
• in the case of foundations – information on founders, members of the foundation council and beneficiaries;
• in the case of trusts – information on settlors, trustees, protectors and beneficiaries.

Without getting involved at this stage in detailed interpretation and clarification of different types of clauses used in TIEAs – which, depending on the arrangements of the parties, may provide for exchange of information upon request, automatically or spontaneously – it should be asserted that this kind of agreements are in many aspects, despite their misleading reciprocity, unilateral acts of unconditional capitulation of ‘tax havens’ vis-à-vis foreign tax administrations.

TIEA not only provide for exchange of information by public authorities of ‘tax havens but also contain a reservation, that if the information in the possession of the competent authority of the requested party is not sufficient to enable it to comply with the request for information, that party shall use all relevant information gathering measures to provide the requesting party with the information requested, notwithstanding that the requested party may not need such information for its own tax purposes.

For the purposes of enforcing TIEAs ‘tax havens’ are obliged to obtain information held by banks, other financial institutions, and any person acting in an agency or fiduciary capacity including nominees and trustees.

On the other hand, the scope of regulation under TIEAs is much narrower than scope of agreements for the avoidance of double taxation (DTA). DTAs are definitely more attractive to foreign investors because they offer various tax benefits related to e.g. rules on payment of dividend, interest, remunerations and gains generated by business activity. Consequently DTAa also necessitate some exchange of information but in vast majority of cases such exchange takes place to a much narrower extent that under TIEAs (although one should note the world trend to renegotiate DTAs with an aim to introduce clauses concerning automatic exchange of information, which results in similar outcome to conclusion of TIEA agreement).

Currently all states examined by OECD have been removed from the ‘blacklist’ which implies that each one of them undertook to conclude the minimum of twelve tax information exchange agreements.

The majority of tax havens attempted to protect their independence by fulfilling the standards through conclusion of TIEAs only between themselves and other countries with secondary meaning. Not less than thirty seven tax havens concluded agreements on exchange of tax information with sixty thousand Eskimos inhabiting Greenland (especially the kinds of tax havens which have not seen a single Eskimo since the mammoths died out). Whereas with the Faroe Islands, a state with such a powerful financial standing, TIEAs were concluded only by twenty three tax havens. Odd chains of agreements were created, on basis of which e.g. Liechtenstein exchanges information with Monaco, Monaco with Andorra, Andorra with the Faroe Islands, and so on.

This kind of peculiarities should not divert us from observing some crucial tendency – that is a clear division of tax havens into two groups.

The first group consists of the oldest and richest tax havens, originating from former British colonies such as the British Virgin Islands, Cayman Islands, Bahamas, Bermuda, Jersey, Guernsey or Isle of Man. Although their tax systems have not been subject to any major transformation and they still offer complete freedom from income tax to investors, or very attractive methods of CIT levy, yet they have established cooperation with governments of OECD countries in terms of tax information exchange and disclosure of ultimate beneficial owners of corporate structures.

Tax havens from the first group do not refrain from concluding more than twelve TIEAs, they willingly enter into further agreements. This happens even in situations where conclusion of such agreements violates the fundamental standards of not only decency but also human rights. For instance, the British Virgin Islands, Bermuda, Bahamas and the Cayman Islands concluded tax information exchange agreements with the People’s Republic of China, surprising dozens of thousands Chinese businessmen who were protecting their wealth against attempts of the people’s government with their decisions.

At the same time, ‘tax havens’ from this group enforce gathering of a lot of data on the client from the local banks and company administrators (the scope and particularity of such information by far exceeds similar requirements of Polish banks, lawyers and accountants) and make the collected data easily available upon request of foreign authorities.

It is true that these countries still offer a very high level of judiciary; however tax information exchange agreements are drafted in a way which makes it impossible for a foreign taxpayer to defend himself against the unlawful acts of authorities by seeking assistance of local courts in the tax haven. Typical TIEA clauses provide that a request for information shall not be refused on the ground that the tax claim giving rise to the request is disputed. TIEAs also specify that information shall be exchanged without regard to whether the conduct being investigated would constitute a crime under the laws of the requested party if such conduct occurred on its territory. In turn, the rights and protective measures guaranteed to persons by the legislature and administrative practices of the requested party shall still be applied, as long as they do not over restrain or delay effective exchange of information.

The second group of ‘tax havens’ consists of countries which conclude agreements in accordance with OECD standards but they are not capable to (or not willing to) provide any information on the companies’ activities and their ultimate beneficial owners, because the procedures relating to collection and processing of such data do not exist or are not effective. These include, inter alia, Marshall Islands, Anguilla, Samoa, Costa Rica, Panama, Guatemala, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and Grenadines, Cook Islands.

But in particular this group includes traditional American corporate havens such as the State of Delaware or the State of Wyoming.

It is also worth noting that many jurisdictions were not subject to OECD examination at all and as a result they are not on the ‘blacklist’, even though they have not undertaken any commitment to exchange of tax information. There are also some territories which offer financial and corporate services to foreign investors but they are unable to even conduct negotiations with OECD due to their complicated international position (e.g. the Turkish Republic of Northern Cyprus, the Pridnestrovian Moldavian Republic). Under normal circumstances it is difficult to treat these offers seriously, taking into account the political and legal instability and lack of credible and independent judiciary, with the exception of Anjouan – the autonomous territory of the Union of Comoros – which offers a very well-developed sector of offshore services.

Although due to the world trend to conclude TIEAs the future of tax expats does not look bright at all, in reality TIEAs remain at this point a plan rather than a ready-for-use tool. Probably, even in case of tax havens from the first group, a move from the planning stage to implementation stage should not be expected earlier than in a dozen years.

Most importantly one must be aware that only a few tax havens have enough information on companies’ finances to be capable of answering the upcoming questions in a substantive way, while according to TIEAs, the state party requested for information is not obliged to provide details which are not in possession of its authorities; are not in possession of persons remaining in their territorial jurisdictions or cannot be accessed by these persons.

Moreover, with some exceptions the rule is that TIEAs do not place any duty on the requested Party to provide legally protected information or information disclosing and trade, economic, industrial or professional secrets or any mode of company activity.

Furthermore, a competent authority of the requested Party may decline it, for instance where the requesting Party has not pursued all means available in its own territory to obtain the information, except those that would give rise to disproportionate difficulties or where disclosure of the information would be contrary to public policy.

All of this gives rise to the current situation, where almost no exchange of specific, relevant information in tax matters is conducted. On top of that, appropriate structuring of corporate mechanisms with the use of entities from more than one tax haven may effectively prevent the possibility to access and extract any information under TIEA in the future.

Author: Robert Nogacki – Legal Advisor, Founder of Skarbiec Law Firm