The countries removed from the first list were added to a larger, secondary list of countries that have agreed to work toward meeting criteria set by Brussels by the end of 2018 or 2019 (the latter deadline is for certain developing countries without financial centers).5 If they fail to meet these goals — as well as abandoning what the EU considers their harmful tax practices (such as not charging any tax at all or offering lower rates to foreign companies than domestic ones without ensuring they don’t encourage artificial offshore structures that lack real economic activity) — they too could find themselves on the blacklist.
A new approach
Some EU Member States previously maintained their own list of blacklists determined by their own criteria. The new EU list replaces that patchwork system. It follows in the footsteps of another tax-fairness plan that has amounted to the biggest global overhaul of tax practices in decades.
In 2012, members of the G20 asked the Paris-based Organisation for Economic Co-operation and Development (OECD) to come up with a plan to combat harmful tax practices. The OECD in 2015 presented its base erosion and profit shifting (BEPS) Action Plan, which contains 15 actions to address gaps in country-level tax laws that the OECD says lead to tax revenue losses of as much as USD240 billion6 each year.
The BEPS plan has grown into a global movement with 111 countries now pledged to implement some or all of its reforms. Its aim is to tax corporate profits where real economic activity occurs instead of in low-/no-tax environments where companies have insufficient workers, assets or sales to support the business being reported.
The EU list took more than a year to develop, with the process kicking off in September 2016 with the selection of 92 countries for review after an initial preselection process. The EU used an existing peer-review mechanism, in which tax professionals from EU countries used a suite of predetermined criteria to evaluate tax systems elsewhere.
Just 20 of the 92 countries selected were deemed to have satisfactory tax practices,7 while the rest were contacted with follow-up questions and to encourage reforms. The EU held bilateral meetings with country representatives to inform them of the findings and allow for rebuttals or the presentation of reform plans for consideration.
Requested reforms include the following: increasing transparency through another OECD program in which information regarding taxpayers is exchanged between countries; a substantive economic activity requirement for companies instead of on-paper arrangements that shift profits to low-tax environments that were generated by real economic activity elsewhere; the elimination of other harmful tax practices; and the implementation of the BEPS plan.
Among the jurisdictions put on notice and subject to close monitoring by the EU on the secondary list are Switzerland, Lichtenstein, Mauritius and Hong Kong, and British territories including Cayman Islands, Bermuda, Isle of Man, Guernsey and Jersey.
The UAE, Tunisia and Bahrain are among countries that have pledged to implement reforms, according to reports from Reuters8 and the Financial Times9 — which in part has resulted in the UAE, Tunisia and Bahrain also being moved to the second listing.
“With its removal of some jurisdictions, the EU has shown that it is willing to move quickly,” says Rob Thomas, a Washington, DC-based director in our tax policy practice.
Those jurisdictions that remain on the noncooperative jurisdiction blacklist could face consequences in terms of EU-country relationships, as well as bilateral moves by EU members. Countries on the list lose eligibility for development funding through the EU’s European Fund for Sustainable Development (EFSD), European Fund for Strategic Investment (EFSI) and External Lending Mandate (ELM).
The European Commission is considering other potential consequences, encouraging members to agree on coordinated sanctions and suggesting defensive measures to protect their tax bases, such as demanding extra documentation and withholdings from companies who operate in countries on the list.
New risks for companies
For companies, the EU’s move creates several new risks. Multinationals with operations in the countries on the blacklist could see EU jurisdictions apply more scrutiny and withholding, and that may mean a reexamination of financial flows and the development of plans to move some operations from countries that are likely to remain on the list.
Reputational risk may intensify for all companies in those countries, even domestic ones that have nothing to do with the type of aggressive tax planning targeted.
“It’s important to know where your company stands on the risk spectrum,” says Mat Mealey, our EMEIA International Tax Services Leader. “If governments are going to reform their systems, you’ve got to know the effect the changes will have on your organization and communicate concerns to governments if you believe the effect is unreasonable. Companies’ audit risk might be much higher.”