Caribbean Trade Law and Development

Category: corporate tax

  • Global tax reforms and Caribbean countries’ investment policy implications

    Global tax reforms and Caribbean countries’ investment policy implications

    Alicia Nicholls

    As of August 12, all Caribbean Community (CARICOM) Member States have now endorsed the Organisation for Economic Cooperation and Development (OECD) statement on a ‘Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy’ of July 1, 2021. The OECD statement, signed now by 133 member jurisdictions of the OECD/G20 Inclusive Framework, is not a fait accompli per se but has been described as a ‘conceptual agreement’ indicating their ambition for global tax reform. The stated purposes behind this latest phase of the OECD Base erosion and profit shifting (BEPS) initiative, described as ‘BEPS 2.0’, are to ensure that multinational enterprises (MNEs) “pay their fair share of tax” and to stop a “race to the bottom” in countries’ corporate tax rates. As such, pillar one of the two-pillar solution seeks to ensure a fairer distribution of profits and taxing rights among countries with respect to the biggest MNEs globally, in particular large tech companies. Pillar two – and the more controversial for our region – aims to prevent tax base erosion by setting a global minimum corporate income tax of at least 15%.

    The technical details behind this solution remain to be worked out. As the statement notes, a detailed implementation plan and the remaining issues are to be finalised by October 2021. But what does this mean for the investment policies of Caribbean countries, especially in a COVID-19 climate where foreign direct investment (FDI) will be key to sustainable economic recovery efforts?

    In its latest IIA Issues Note entitled “Recent Developments in the IIA Regime: Accelerating IIA Reform”, UNCTAD (2021) devotes several paragraphs to the possible impact that ongoing global tax reform efforts might have for international investment patterns and global and national investment policies and policy-making. UNCTAD (2021) identified several possible implications. One implication is that it would discourage multinational corporations (MNCs) from shifting profits and tax revenues to low tax-countries, and second, stop the race to the bottom among countries’ tax rates which have occurred over the past three decades.

    Let us look at these first two implications. Not all Caribbean jurisdictions have low CIT rates, but some do, particularly those which have large international business sectors. A global minimum CIT, of course, would have implications for those countries (particularly low tax and no-tax jurisdictions) whose favourable tax regimes have traditionally been a key component of their value proposition to potential and existing foreign investors. Contrary to popular opinion, it is not only small island international financial centres (IFCs) which have made a favourable tax environment part of their investment attraction strategy, but some larger countries, including in the EU, such as the Republic of Ireland and Luxembourg.

    The possible loss of business from raising their CIT to meet a possible minimum global CIT of 15% could have implications for the macroeconomic stability of countries dependent on FDI inflows, as well as possible loss of jobs. Governments would need to conduct the appropriate economic analyses to ascertain the potential impacts of raising their tax rates to meet the proposed global minimum CIT, if and when it is decided. The possible socio-economic implications must be considered and weighed.

    A third implication raised by UNCTAD (2021), and what several Caribbean countries are currently undertaking, is the need to engage in a comprehensive review of their tax incentive regimes to attract investment. Indeed, those countries whose tax rate was their main value proposition will be forced to develop other areas of competitiveness which would make them attractive to global business. This, of course, is not a negative thing and could force our countries to build other areas of competitiveness and pay greater attention to accelerating on-going investment facilitation and wider business facilitation reforms.

    A fourth issue raised by UNCTAD (2021), and which must be seriously considered, is the implications for host country obligations under international investment agreements (IIAs) signed. More specifically, should host States decide to raise their tax rates to the proposed minimum standard (once agreed), there is the possibility of legal exposure to investor-State claims brought by investors under IIAs, especially relying on nebulous clauses such as the fair and equitable treatment (FET) standard. This is a real possibility as the majority of Caribbean countries’ bilateral investment treaties (BITs) are older generation treaties with broad investor protections and few, if any, explicit provisions for State regulation in the public interest. Even where a host State ‘wins’ an ISDS dispute, the costs incurred through the need to hire (often foreign) legal representation and the negative press surrounding such a dispute might be just as harmful.  

    While the threat of possible treaty-based investor claims would not be a concern for those Caribbean countries with few or no BITs in force, those whose investment promotion strategies have historically relied on the signing of BITs should pay close attention to this possible unintended consequence as they formulate new tax regimes.

    Caribbean  IFCs are in uncharted and hostile global regulatory waters, and not for the first time. The ideal response would have been unity among affected countries to contest this latest blatant encroachment on our sovereignty, in particular, our ability to determine our own tax regimes and by extension, investment policies. However, it appears that many countries have decided that it was in their own national interests to sign on to the initiative because of the very realistic possibility of victimisation (through arbitrary blacklisting, for example) and reputational risk at a time when they are already dealing with the impact of de-risking practices by global banks. Another stated reason for joining is the prospect of influencing and shaping the developments from within. Let us hope that by having a seat at the table, we can at least ensure our voices will be heard in an initiative that is likely to be consequential for our Caribbean small island developing States at a time when we most need FDI inflows for a sustainable post-COVID-19 recovery.

    Alicia Nicholls, B.Sc., M.Sc., LL.B. is a trade and development consultant with a keen interest in sustainable development, international law and trade. All views herein expressed are her personal views and should not be attributed to any institution with which she may from time to time be affiliated. You can read more of her commentaries and follow her on Twitter @LicyLaw.

  • What might a global minimum corporate tax mean for Caribbean International Financial Centres (IFCs)?

    What might a global minimum corporate tax mean for Caribbean International Financial Centres (IFCs)?

    Image by Gerd Altmann from Pixabay 

    Alicia Nicholls and Tammi Pilgrim

    Finance ministers of the world’s seven richest democracies (the Group of 7 or G7) have committed to an “at least 15%” global minimum corporate income tax (CIT) rate. This decision in principle has been lauded as a ‘landmark’ deal to ensure big multinational corporations (MNCs) pay their ‘fair share’ of tax. While the details of the proposed tax are still unknown, the decision, if implemented, could potentially have non-negligible implications for no-tax or low-tax jurisdictions globally. This article provides our initial reflections on what this development might possibly mean for Caribbean international financial centres (IFCs), including Barbados.

    What does a global minimum CIT entail?

    The global minimum CIT would require a corporation from a country which implements this floor (the “home country”) to pay taxes on its profits at this particular rate, even if those profits are declared overseas, such as in a lower-tax jurisdiction. It works as a “top up” tax, where the corporation’s home country (Country A) could charge the difference between the tax rate the corporation paid in the lower-tax jurisdiction (Country B). That undermines any advantage of shifting to a lower-tax jurisdiction.

    The idea of a global minimum CIT is not new. The introduction of common global minimum tax rules is presently part of Pillar 2 of the Organisation for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Initiative which aims to stop corporations from exploiting gaps and mismatches in countries’ tax systems to avoid taxes.

    Why is this being proposed?

    Fundamentally, this worldwide minimum CIT seeks to discourage MNCs from moving profits to countries with low CIT rates in order to avoid paying the higher CIT imposed by their home countries. This inevitably results in reduced tax revenue for the home country.

    The OECD argues that “BEPS practices cost countries $US 100-240 billion in lost revenue annually, which is the equivalent to 4-10% of the global corporate income tax revenue”. Large countries, especially certain high tax European countries like France and Germany, blame this tax competition for the erosion of their tax bases and point to the higher rates paid by small businesses and the ordinary taxpayer. However, very little is said about the tax codes of these large countries which generally allow this ‘inequity’ to occur, by permitting corporations to take advantage of various tax loopholes. It also discounts the legal principle espoused by many common law jurisdictions, allowing taxpayers to legitimately arrange their affairs to minimize tax liability.

    Under the Trump Administration’s massive tax reform done pursuant to the Tax Cuts and Jobs Act of 2017, the US statutory CIT rate was lowered from one of the highest in the world at 35% to in the mid-range (21%). However, the Biden Administration initially sought to raise the statutory CIT rate to 28% to help finance its ambitious $2 trillion dollar infrastructure plan to stimulate the US economy. Therefore, the implementation of a global minimum CIT gained renewed traction in April 2021, when US Secretary of the Treasury Janet Yellen called for such a tax at a rate of 21%.

    This “call to action” was enthusiastically greeted by many European countries, the Organisation for Economic Cooperation and Development (OECD) and the International Monetary Fund (IMF). Perhaps not surprisingly, it has not received a similarly enthusiastic response in the Republic of Ireland, which has a CIT rate of 12.5% and is home to the European headquarters of US tech behemoths Apple, Facebook and Google.

    How does this impact Caribbean IFCs?

    Many countries, including Caribbean IFCs, have traditionally attracted foreign direct investment thanks in part to lower CIT rates. Among Caribbean IFCs, there are ‘no-tax’ jurisdictions like the Bahamas and the British Overseas Territories of the Cayman Islands, the British Virgin Islands (BVI) and Bermuda which charge no personal or corporate income tax. Then there are ‘low-tax’ jurisdictions, like Barbados, whose CIT rate (1% – 5.5%) is now the lowest in the world.

    These countries are now at risk of losing that business and the benefits that come along with it, as the global minimum CIT might act as a disincentive for companies to stay in no/low tax jurisdictions. While empirical data is limited, the global or international business sector is an important source of foreign exchange and direct employment in the Caribbean, while also providing spill-over benefits through skills transfer, corporate rental income and being a vital income source for corporate services providers. Corporate tax receipts from the global business sector comprise the lion’s share of Barbados’ CIT revenues and have proven resilient even in the face of the COVID-19 pandemic. Any negative impact on the global business sector at this time could inflict even greater economic devastation on these countries’ vulnerable economies.

    Aside from the potential loss of business and tax revenues, Caribbean IFCs may also be exposed to significant international pressure (including reputational damage) to conform to the global norm. Although the ability to levy taxes is a sovereign right flowing from statehood, Caribbean IFCs would not be unreasonable to fear they might be strong-armed into adopting the global minimum CIT rate through tactics such as blacklisting or denying corporations from receiving deductions on income earned in a jurisdiction which has not adopted the minimum CIT.

    Barbados, for example, lowered its CIT rate from 30% to the current low rate in response to the OECD’s allegations of ring-fencing, since international business companies (now abolished) then enjoyed a lower CIT rate than that imposed on domestic companies. Barbados also passed significant economic substance legislation requiring companies to demonstrate that they are carrying on their core income generating activities in the countries in which they declare profits. This has made it even harder for jurisdictions to compete for investment simply on tax rate.

    Finally, Caribbean IFCs following these developments might find it increasingly necessary to pivot to alternative methods of boosting their investment appeal. Indeed, a look at Invest Barbados’ “why Barbados” page reveals that Barbados has increasingly based its value proposition on non-tax factors, including facilitating businesses of substance, its human resources, lifestyle and tax treaty network

    Barbados’ response to this latest initiative seeks to attract more businesses to headquarter here where they would be taxed as Barbados companies. As stated by Advisor to the Barbados Government, Professor Avinash Persaud, at a recent business forum “America and the UK may decide to have a global minimum tax rate… they can decide how they tax a Barbadian subsidiary of a British company, but they cannot determine how they tax a Barbados-headquartered company. So we need to bring these companies to Barbados to do real business in Barbados and be headquartered here”.

    What happens next?

    The commitment in principle by G7 countries on a global minimum CIT is a major decision, but not yet a ‘fait accompli’. Talks will continue in the Group of 20 (G20) and OECD with the aim to reach a consensus by July. However, the fact that the G7 communique utilizes the wording “at least 15%” speaks to possible disagreement, even among proponents, on whether the rate should indeed be 15% or even higher. There are, of course, other issues that are yet to be resolved, such as to which companies would this tax be applicable.  

    Since the G7’s announcement, further dissension has come to light. The City of London (UK), as well as Hungary and Poland, have signalled their intention to seek carve outs (from the global minimum CIT rate) for financial services companies and income derived from a company’s substantive activities within a jurisdiction, respectively. It is possible that such exemptions might be necessary in order to achieve international consensus.

    The issues raised by the introduction of a global minimum CIT rate are complex. They bring sharply into focus the friction between the competing needs of a home country (to retain tax revenue) versus those of another country (to attract foreign direct investment), usually with the shared aim of promoting their own development and achieving their respective economic and social goals. Without doubt, therefore, the issue of MNCs paying their “fair share” in taxes is one which needs to be addressed multilaterally. However, arguably, this discussion should be occurring in a forum like the United Nations where all the world’s countries – big and small, developed and developing – are at the table, to avoid the perception that rich countries are setting the rules, changing them at will and moving goal posts, based on their own narrow political interests and economic exigencies.  

    Moreover, as too often happens, in seeking to go after the ‘big fish’, it is the little ones – small IFCs – which will likely feel the brunt of any economic fall-out. Caribbean IFCs should, therefore, strategize on how best to tackle this latest onslaught. One possibility might be to join forces with other similarly situated IFCs internationally, to voice objection to this proposal and demand a seat at the table. As Barbados is currently doing, they must also implement alternative strategies to attract investment if this latest proposal achieves ‘global’ agreement.

    Alicia Nicholls, B.Sc., M.Sc., LL.B. is an international trade consultant and founder of www.caribbeantradelaw.com. Tammi C. Pilgrim is an Attorney-at-Law, specializing in resolving commercial disputes by arbitration, litigation and mediation. She is the lead partner for arbitration at Lex Caribbean, Barbados, and is admitted to practice in Barbados, St. Lucia, New York and St. Kitts and Nevis. The views expressed in this article are solely those of the authors and do not necessarily represent the views of any entities with which they might be affiliated.

    This article also appeared in the Barbados Business Authority (Barbados’ leading business magazine) and Barbados Today.