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Latest developments on countering international tax evasion
In our previous Hong Kong Tax News Flash (i.e. Issue 3 of March 2009), we reported the call for international collaboration in respect of exchange of tax information by the Organisation for Economic Co-operation and Development ("OECD"), shared our observations of some of the recent developments in the international tax arena on this subject, and reported the steps taken by the Hong Kong Government to seek to modernise the exchange of tax information provisions of the Hong Kong tax legislation.
Since then and following the G20 summit held in London on 2 April 2009, a series of developments in the international arena concerning the use of a special investment vehicle located in places like Hong Kong have taken place. This News Flash provides an update on these latest developments, including the potential impacts of the proposed anti-tax avoidance measures in the US for Hong Kong-based companies and foreign corporations (including Chinese companies) using Hong Kong as a gateway for investing from the US as well as into the US.
Outcome of G20 Summit and OECD's tiered list
A communique was jointly issued by the G20 leaders following the summit in London. Below is an extract from the part of the communique addressing the issue of tax havens:
"...to take action against non-cooperative jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over. We note that the OECD has today published a list of countries assessed by the Global Forum against the international standard for exchange of tax information."
It is obvious that the international community believes that liberal exchange of tax information among different jurisdictions is an effective means to combat tax avoidance. To achieve this goal, it is necessary to call for the cooperation and collaboration of those jurisdictions that have in the past been less open and transparent in this aspect.
The OECD tiered list (or the progress report) first published on 2 April 2009, and subsequently updated on 8 June and 17 June 2009, classifies 84 jurisdictions into three categories depending on their level of cooperation on tax information exchange.
The category relating to territories that "have committed to the internationally agreed tax standard but have not yet substantially implemented it" is split into two sub-categories. There are therefore effectively four lists of jurisdictions, being:
| Category |
Nature |
| 1 |
Jurisdictions that have substantially implemented the internationally agreed tax standard (the so-called "Whitelist") |
| 2 |
Tax havens that have committed to the internationally agreed tax standard but have not yet substantially implemented it (the so-called "Greylist - Tax havens") |
| 3 |
Other financial centres that have committed to the internationally agreed tax standard but have not yet substantially implemented it (the so-called "Greylist - Financial centres") |
| 4 |
Jurisdictions that have not committed to implement the internationally agreed tax standard (the so-called "Blacklist") |
When the list was first published on 2 April 2009, there were four jurisdictions - Costa Rica, Malaysia (Labuan), Philippines and Uruguay in the category of "Jurisdictions that have not committed to implement the internationally agreed tax standard" or the Blacklist. Subsequent to the publication, these jurisdictions had announced their intention to propose domestic legislations to comply with the OECD's standard within 2009. In the updated list published on 8 June 2009, they were moved to the category of "Jurisdictions that have committed to the internationally agreed tax standard, but have not yet substantially implemented it" in the OECD tiered list. Effectively there is now no jurisdiction in the Blacklist. Another notable change in the updated list is that Bermuda has moved from the "Grey List - Tax havens" to the "White List" as the number of agreement of international standards concluded by it has increased to 12. In the Questions and Answers on its Project on Countering Offshore Tax Evasion ("OECD Q&A") published on 17 June 2009, the OECD explains "jurisdictions.... will be identified as having substantially implemented it once they sign 12 agreements that meet the standard".
In a separate OECD announcement on 27 May 2009, Andorra, Liechtenstein and Monaco, which were previously the three remaining jurisdictions on the OECD's List of Uncooperative Tax Havens, were being officially removed from the list by the OECD in light of their commitments to implement the OECD standards of transparency and effective exchange of information and the timetable they set for the implementation. As a result, no jurisdiction is currently listed as an uncooperative tax haven by the OECD.
China is on the Whitelist whereas Singapore is on the Greylist - Financial centres. For Hong Kong and Macao, whilst neither is specifically named in any of the four categories, there is a footnote to the list indicating that China's "Special Administrative Regions" are excluded from being considered to have substantially implemented the internationally agreed tax standard as China has done, and that the Special Administrative Regions have only committed to do so at this stage. This means that Hong Kong and Macao are effectively on the Greylist, along with other financial centres such as Singapore. In the OECD Q&A, the OECD makes it clear that Hong Kong and Macao do not meet the definition of a tax haven.
In addition to the publication of the OECD's tiered list, the G20 leaders also made a declaration on strengthening the financial system (the "Declaration") on 2 April 2009 following the G20 summit in London. Tax havens and uncooperative jurisdictions are among the various issues covered in the Declaration. The Declaration stated that the G20 stand ready to take agreed action against those jurisdictions which do not meet international standards in relation to tax transparency. The Declaration also mentioned the G20 have agreed to develop a toolbox of effective counter measures for countries to consider. Some examples of such counter measures are:
- Increased disclosure requirements on the part of taxpayers and financial institutions to report transactions involving uncooperative jurisdictions
- Imposing withholding taxes in respect of a wide variety of payments
- Denying deductions in respect of expense payments to payees residing in a uncooperative jurisdiction
- Reviewing tax treaty policy
Actions proposed by the European Commission
Building on the recent G20 conclusions concerning uncooperative tax jurisdictions, the European Commission adopted a Communication on 28 April 2009 identifying actions that European Union ("EU") Member States should take to promote "good governance" in the tax area (i.e. more transparency, exchange of information and fair tax competition). Among other things, the Communication considered the particular tools that the EU Member States may have at their disposal to promote good governance internationally. In particular, the Communication calls on the EU Member States to adopt a coordinated and coherent approach in the promotion of good governance principles towards third countries, including, where appropriate, coordinated action against jurisdictions that refuse to apply good governance principles in the tax area. One of the concrete actions mentioned in the Communication is to discuss with Member States the content and eventual use of the toolbox of effective counter measures suggested in the G20 Declaration towards uncooperative jurisdictions.
Latest developments in the US
On 4 May 2009, the Obama Administration released its proposed international tax changes entitled "Leveling the Playing Field: Curbing Tax Havens and Removing Tax Incentives for Shifting Jobs Overseas". On 11 May 2009, the US Treasury issued its so-called "Green Book" which provides general explanations of the proposed international tax changes. The majority of the corporate tax proposals are targeted at US multinationals and their foreign subsidiaries; however, many proposals could also affect foreign-based multinationals and their US subsidiaries. The international tax changes announced by the Obama Administration are proposed to take effect in 2011. Below is a highlight of some of the changes:
- Requiring US-based multinationals generally to defer deductions for expenses (except for R&D expenses) properly allocated and apportioned to foreign income until the deferred foreign income is repatriated.
- Imposing new limitations on foreign tax credits. Specifically, the proposal would restrict foreign tax credits to the average rate of total foreign tax actually paid on total foreign earnings.
- Revising the so-called "check-the-box" entity classification rules to disallow disregarded entity treatment for certain foreign subsidiaries established by US businesses and treat these subsidiaries as separate corporations for US tax purposes.
Before the Obama Administration announced these proposed changes, there have been moves by the US senators to tackle perceived abusive uses of tax havens to inappropriately avoid US taxation. Early March 2009, Senator Carl Levin reintroduced the Stop Tax Haven Abuse Act (the "Levin Bill"). In brief, the Levin Bill has blacklisted 34 offshore secrecy jurisdictions ("OSJs") including Hong Kong and Singapore (the "US Blacklist"). The Levin Bill also contains, inter alia, provisions and rebuttable presumptions that have broad implications on tax planning and transactions involving offshore entities. One of the proposed provisions is treating foreign corporations managed and controlled in the US as domestic corporations for US tax purposes. The management and control provision would apply to publicly traded foreign corporations as well as foreign corporations with assets of US$50 million or more, but exclude controlled foreign corporations ("CFCs") of a US corporation that has substantial assets held for use in the active conduct of a US trade or business. In addition, the Levin Bill clarifies that the intent of this provision is to include foreign corporations with assets that are primarily managed on behalf of investors and the investment decisions regarding these assets are made in the US (for example alternative investment funds).
At this stage, it is uncertain whether the Obama Administration's international tax proposals and/or the Levin Bill would be passed in the US, and if so, when that might happen and what their final forms would be. Moreover the practical implications of these proposed changes will not be clear until they are enacted, and it may take a while for the US Internal Revenue Service to issue additional guidance to implement those changes.
PwC observations
Potential impacts for Hong Kong-based companies and foreign corporations
So far as the OECD's "Greylist" and the development of the toolbox of counter measures against uncooperative jurisdictions are concerned, it has yet to see the next steps taken by the international community to implement the proposed actions and the progress in completing such implementation. However, one clear message, as indicated in the OECD Q&A, is that the OECD and its members will closely monitor the progress of these jurisdictions in their liberalising the exchange of tax information.
Revising the so-called "check-the-box" rules suggested in the Obama Administration's proposed international tax changes aims to eliminate loopholes for "disappearing" offshore subsidiaries. The current so-called "check-the-box" rules allow a US corporation to treat a subsidiary in one jurisdiction (for example China) as the same entity of another subsidiary in another jurisdiction (for example Hong Kong or any other jurisdictions), permitting the US corporation to shift income between the two subsidiaries without reporting the income or paying any US tax until it is repatriated. This will change if the rules are revised as suggested.
Referring to the Levin Bill in the US, one significant impact is that with the wide-ranging proposals attempting to attack a variety of transactions, the proposals in the Levin Bill could bring unexpected and/or unintended consequences to these transactions. Also, if a foreign corporation (such as a Hong Kong company or a company incorporated in a jurisdiction outside the US) has its management and control in the US, it is possible that this foreign corporation could be considered as a US corporation and subject to US tax on its worldwide income. Relying on the place of incorporation would no longer be sufficient to determine the residence of a corporation and there is a need to examine and determine where the management and control of a corporation take place.
Steps forward
As mentioned in our Hong Kong Tax News Flash Issue 3, March 2009, the 2009/10 Hong Kong Fiscal Budget contains a proposal to amend the existing provisions in the Hong Kong tax legislation for accommodating a more modern requirement for exchange of tax information (which has already been acknowledged positively by the OECD). While Hong Kong is heading towards the right direction, it is important that the necessary amendments be completed as soon as possible. Undue delay in the process could seriously harm Hong Kong's standing as a world financial centre, if sanctions are to be imposed by her trade partners. There are signs that the Hong Kong Government is fully aware of the urgency of implementing such proposal and is stepping up its effort to push for the passage of the related proposal in the 2009/10 Fiscal Budget within the current legislative year. Meanwhile it is necessary for the Hong Kong Government to reflect, via the adequate channels, to the US Congress/Administration, the fact that Hong Kong is not an uncooperative tax haven or OSJ, and should be fairly treated as such.
The legislative amendments will position Hong Kong to meet the internationally agreed tax standard and show its commitment to implement it. At the same time, this will allow Hong Kong to enter into more bilateral tax information exchange agreements endorsed by the OECD. It is expected negotiations of double tax agreements will also be expedited after the legislative change.
Despite the importance of observing and respecting the principles of transparency and exchange of tax information, we are keen to see adequate provisions governing the tax information exchange in order to deter "fishing expeditions" i.e. exchange of tax information should be based on specific and legitimate requests. For example, the requesting tax administration has to demonstrate a grounded suspicion that a tax resident in its jurisdiction has committed or involved in tax fraud or evasion, and it has to first explore its domestic sources of tax information, etc.
Concluding remark
The situation in this area is still evolving at the present stage and new developments are expected to take place. It is too early to predict what the exact consequences of being named in the OECD's Greylist and what the final form of the Levin Bill / tax reform proposals in the US will be, and even whether Hong Kong will be in the final US Blacklist. However, Hong Kong based companies and foreign companies having investments in or doing business with any of the so-called uncooperative jurisdictions should keep an eye on the latest developments on this matter.
These companies should assess the potential impacts to them if any sanctions are to be imposed or any changes are to be made in the tax reporting requirements in respect of these jurisdictions, and plan ahead of what possible actions can be taken to minimise the impacts for their investments and business operations.
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