The positive effects of Caribbean tax information exchange agreements

Offshore taxation demystified (Part 2)

This column tries to bridge the gap between the hardship of tax information exchanges and the chances of an adjusted legal environment. The aim is to preserve the traditional benefits from Caribbean financial centers, even in an era in which banking secrecy is equalized with tax banditry. 

The Rationale for Tax Information Exchange

Agreements for the avoidance of double taxation have advantages, but also downsides. The positive effect is that they assure that profits are taxed only once and not in both countries involved. This avoids a subsequent taxation of offshore profits in high tax countries and, therefore, is beneficial for Caribbean countries with tax rates down to 0%. 

The country with the higher tax rate grants this benefit not for free. In return, it expects the exchange of tax-related information to assure that the taxpayer does not act fraudulently and hides income which is taxable in the high tax jurisdiction. It is evident that the low tax country has no economic interest to obtain tax information from the high tax country. It accepts such clauses to get the benefit from the avoidance of double taxation only.

Needless to say that such an explanation is highly simplified and makes no claim to describe the peculiarities of double taxation. However, it shows the direction. A tax information exchange clause without the double taxation avoidance clause does not meet the economic interests of both parties. 

An unbalanced information-only tax agreement results in a win-lose-situation. It provides tax information which is beneficial only for high tax countries and denies the benefits which would result in benefits for the low tax country. In other words, in a fair negotiation, no one would expect a jurisdiction in the Caribbean to sign such a stripped tax treaty. It would be similar to turkeys voting for Christmas.

The motivation for signing can be explained very easily. The rich OECD countries announced to the world’s tax havens that they will be treated as tax pariahs if they are not willing to sign. This made an offer the Caribbean countries can’t refuse. 

Convinced by strong economic pressure of the high tax countries and a clever exploitation of the recent financial, political and religious disruptions, the low tax countries could not resist to “be committed to international standards of anti-money laundering legislation and practice, counter terrorist financing legislation and financial regulation and international efforts to combat financial crimes.” Aggressive propaganda like “the war on tax piracy“ shows the lack of real arguments. 

These stripped tax treaties are marketed under the term Tax Information Exchange Agreement (“TIEA”). Surely they do not provide a balanced “exchange” in both directions but are definitely a one-way street.

The rush of TIEAs

The Cayman Islands signed in August 2009 its 12th TIEA with New Zealand and moved onto the “white list” of countries that have substantially implemented the OECD’s defined tax standard. Other “good boys” are British Virgin Islands, Anguilla, Turks & Caicos and Bermuda. The press celebrates the triumph of the OECD’s efforts to end international tax competition. In fact, it might terminate the era of banking secrecy as a shield for tax evaders. 

However, it will not at all be the end of the tax-haven era. Instead, it will be decisive whether the coming TIEAs are negotiated in a clever way and that the offshore jurisdiction does its homework in establishing a beneficial legal environment. In that case, it will remain a favorable spot for investments by honest taxpayers to make use of lawful tax avoidance schemes and tax optimized wealth management. Maybe we will see a new offshore model whose time has come.

Experience will show that even under a TIEA, black sheep cannot be avoided by any Caribbean country. Besides legitimate and lawfully cross-border tax planning, there will remain a wide scope of unlawful tax evasion schemes involving the Caribbean and other low tax jurisdictions. Those “in the know” will easily get around any legislation. The latter is not subject to the following explanations.

The bad and the worse TIEAs

Information exchange agreements between independent countries are not identical. They follow more or less the model convention of the OECD. These small differences can be of great importance.

Some of the new information-sharing agreements are weak. Well-advised countries benefit from tailor-made agreements instead of copying the saucy proposals made by the Paris-based bureaucracy. Therefore, it is worth noting the differences and gaps which are left open for tax planning considerations. To distinguish between a hard and a soft, a strong and a weak TIEA, it is helpful to concentrate on the following five criteria:

1. For which purpose is information exchanged? A double tax treaty is usually restricted to income taxes. Information may be requested to enforce the tax treaty only or, in addition, any tax law of the contractual country. Typically aged tax treaties have chosen the restricted exchange clause, while newly agreed tax treaties implement an extended, but not unlimited information exchange.

TIEAs are broader than double tax treaties and typically comprehend the determination, assessment, enforcement and collection of all taxes. Besides, it may cover the investigation or prosecution of criminal tax matters. It might even go beyond this and open the door to each type of law enforcement and the application of civil and public laws, regulations and decrees. 

2. Tax information can be submitted on request or exchanged automatically. Automatically would mean, for example, that any opening of a bank account, any bank transfer of a particular scope, any registration as an agent, or any identification as a trustee or beneficiary would result in an information transfer. Typically the TIEA guarantees that a jurisdiction is not obliged to provide information that has not been explicitly asked for by the other jurisdiction. 

In a briefing paper published by the government of the British Virgin Islands (International Affairs Secretariat) dated June 2009, it is stated: “The BVI signed a TIEA with the United States of America seven years ago in 2002 and till rodaz the USA has made only one request for information to the BVI. The BVI has made none.” This clearly illustrates the advantage of an “on request only” limitation in the TIEA.

3. An important issue is whether the information exchange is effectively limited to a case-by-case basis. Otherwise “fishing expeditions” would be possible, similar to a dragnet investigation.

Equal relevance has the minimum application requirements. The request must be specific; the nature of the information being sought and a description of the specific evidence being sought must be outlined in the request. A good standard would require that the tax authorities have to name names and details, which might not be readily ascertainable.

Besides, no request for information should be allowed that is unlikely to be relevant to the tax affairs of a given taxpayer. Such limitation is contained in either the text of the TIEA itself or in a formal letter that is exchanged upon the signing of the TIEA.

4. If would not be unfair to restrict information requests to cases of proved tax offenders from sufficient case-by-case specification. However, the OECD model convention goes far below. Information has to be foreseeable relevant tax-wise only. It has to be exchanged without regard to whether the conduct being investigated would constitute a crime under the law of the requested country. There is neither a single nor a dual criminality and even not a probable cause requirement.

5. For the taxpayer, confronted with an agreed TIEA or even the vague chance that a TIEA will be concluded in the future, it is of utmost importance at which point in time such agreement will enter into force. Typically, it will come into effect concerning criminal tax matters much earlier than regarding all other issues covered by the TIEA.

The Scope of Flexibility

It is not surprising if the OECD will look of the quality of the agreements rather than just counting the quantity. Twelve TIEAs is the magic number in determining whether a jurisdiction is removed from the gray list. This list contains those countries that have announced to follow the OECD requests but are not performing yet in the implementation of such statements.

However, a broad scope of flexibility remains possible, including alternative approaches. One of the recent and famous examples is the tax agreement between Liechtenstein and Great Britain, concluded on August 11, 2009, which has the appearance but not the outcome of a TIEA.

Under this agreement, financial institutions of Liechtenstein are required to ask British customers for proof and evidence that they are in communication with the British tax authorities. If the customer can provide the documentation to prove that the British government is aware of his tax status, then the bank can continue with its customer’s relationship.

If the customer can’t or doesn’t want to, he has to find another offshore location to put his money. Otherwise, the Liechtenstein bank will close his account in 2015. The bottom line is that Liechtenstein will not be required in any instance to hand over names of the customers to the United Kingdom.

A Broken Business Model or a Big Chance?

Dishonest tax players might lose the ability to hide assets and income in Caribbean bank accounts easily. Honest tax players will be disgusted to see their privacy freely disclosed to an indefinite scope of persons and entities. In the worst case, the game is already up for offshore financial centers.

However, from the point of view of the Caribbean location, passive income from banking activities, highly automated and computerized, has never made a substantial contribution to the development of the economy. Therefore, even if the banking business model is broken, this does not mean the end of the offshore benefits.

It is no secret that bank accounts are not the only place to put wealth out of reach and out of sight from the tax man. A TIEA is restricted to banks and other financial institutions on the one side, and the ownership of companies, trusts and other legal entities on the other side. There is no information exchange regarding the ownership in other movable and immovable property. Therefore, landowners in the Caribbean are not directly affected by the TIEA.

Why shouldn’t we use this great opportunity? Investments in commercial and private property are discreet and close-lipped. They are a smart and sound investment. If the switch from a financial investment at a bank to an investment in Caribbean land and infrastructure succeeds, a bright future can be expected.

It is evident that such switch can be successful for a certain percentage only. However, this would be overcompensated by the enormous positive side effects in comparison to a money transfer to a bank.

One clear obstacle is the lower fundability and interchangeability of land in comparison with a bank account that can be transferred very easily. This issue cannot be significantly influenced but may be a problem merely for smaller investment amounts.

Which legal environment is required to give the stranded money a safe home? Three aspects are outlined below, other have to be discussed later:

  1. As a starting point for any structuring, the traditional secrecy and confidentiality rules for bank accounts can be utilized for land ownership. There is no need for a public land register. Any independent country has the right to allow its landowners to skulk in the shadows.
  2. The right to land ownership should be opened to foreigners and foreign companies. This would make international corporate and private structures possible.
  3. The national constitution should explicitly guarantee the unlimited and undisturbed land ownership. This gives the foreign investor more comfort and significantly reduces the fear of being dispossessed and expropriated.

Needless to say, these three points are just the first step in creating a legal environment which attracts bank customers to invest the funds in real estate rather than transfer them to supposed secure alternative offshore locations. Another gap in the TIEA, which might be used for a restructuring, is the perpetuation of the attorney’s rights of confidentiality and secrecy (legal privilege limitation). It should be noted as well that the requested country is typically not obliged to provide information which is neither held by its authorities nor in the possession or control of persons who are within its territorial jurisdiction.

The future of the Caribbean offshore business depends on the ability to revaluation, adjustment, and assimilation. The coming years will see winners and losers in the Caribbean offshore arena.


This article had been published in October 2009 in the Caribbean Property Magazine.
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