To help rein in harmful tax regimes, the Code of Conduct (CoC) Group has posited itself as the ultimate scrutineer – both within the EU and the wider tax community – through its maintenance of the EU List of Non-Cooperative Jurisdictions.

The purported goal of the EU List is to promote improved tax governance globally and to ensure the EU’s international partners respect the same tax standards as EU member states. Under the listing process, jurisdictions are assessed according to three criteria: tax transparency, fair taxation, and Anti-Base Erosion and Profit Shifting measures. Those jurisdictions that fall short of baseline expectations within these criteria are asked to commit to addressing the deficiencies within a set deadline; if the deadline passes before such a commitment is made, the defaulting jurisdiction will be added to the List.

Further, to ensure fiscal justice, EU Member States are required to introduce legislative defensive tax and non-tax measures to deal with blacklisted countries, including restricting development and investment funds from being routed through entities in these countries.

With the advent of COVID-19, pressure on governments to further mitigate the risks corporate tax havens pose to the efforts to handle the pandemic has grown, resulting in the banning of companies operating in so-called “tax havens” from receiving the COVID-19 bailout. In addition, the G7’s recent agreement on implementing a global minimum corporate tax has brought the issues surrounding tax havens and the List to the forefront.

The Case of the Cayman Islands

The Cayman Islands, a jurisdiction notoriously believed to be a tax haven for offshore investors seeking illicit profits, might seem like a natural target for the EU List. However, it was only due to a technical timing issue, rather than substantive non-compliance, that the Cayman Islands was added to the List in February of 2020.

Considering the short duration between the addition and removal of the Cayman Islands from the List, economic ramifications were mostly ephemeral. Notably, this has stimulated two distinct and ongoing debates: one about the consequences that blacklisted jurisdictions face, and the other about the transparency and efficiency of the listing process, which seems to shy away from cracking down on prominent tax havens.

Even though the Cayman Islands was only on the List for a brief period of time, various historical transactions likely became reportable as result, imposing a significant reporting burden on European investors in the country. Blacklisted countries are subject to defensive measures set by EU Member States which include, inter alia, non-deductibility of costs, stringent foreign companies’ rules, withholding tax measures and specific documentation requirements. This may have imposed a significant compliance burden on law-abiding European investors, investment funds and advisors interested in investing in the Caymans; though they could continue to market CIVs or funds under private placement regimes, EU institutional investors or those associated with EU governments may have been deterred from investing in the Cayman Islands’ funds as a matter of policy or governmental pressure.

On the face of it, there seems to be a massive scope for blowback from blacklisting a jurisdiction due to issues other than non-compliance. Most of the blacklisted countries are small and lack the administrative capabilities to deal with the EU’s requests. At the same time, the EU has turned a blind eye towards certain jurisdictions that may have complied with the criteria on paper, while continuing to operate as a tax haven. Thus, the question that arises is whether the List truly serves its underlying objectives.

The Aftermath of Delisting

The EU has received criticism for omitting the most notorious tax havens from the Blacklist and placing them on the ‘Grey List,’ or removing them from the List altogether.  The Cayman Islands costs other countries over USD 70 billion a year, or 16.5 percent of total tax losses.  Notably, the Virgin Islands, Bermuda and Jersey – each of which have also been identified as tax havens – have also been removed from the List.

After the Council’s recent updates to the List, the Chair of the European Parliament’s subcommittee on Tax Matters commented that the List falls short – far short – of its potential, a sentiment that was also noted in the European Parliament’s resolution of January 2021. The asymmetrical pattern of listing and delisting depicts the inefficacy and incertitude that pervades the listing process. The state-of-play calls for restructuring the process, enhancing the selection criteria for identifying List-worthy jurisdictions, and prioritising their screening.

The Flaws and Fallacies in the Listing Process

The List, at the vanguard of international tax good governance, is not devoid of criticism. The European Parliament has expressed concerns regarding the current process and requested to strengthen the List through increased transparency and consistency, stricter and more impartial listing criteria, and concrete defensive measures against tax avoidance. Marek Belka, a Member of the European Parliament (MEP), argues that it is not proven that the List hurts tax havens; paradoxically, it might serve as a vade mecum, or guidebook, for wrongdoers seeking secrecy and low tax rates. The List currently emphasizes tackling tax abuse and unfair tax competition, rather than eliminating tax havens, provided they comply with the criteria provided. However, the existence of tax havens tilts the playing field against poorer countries and emerging market economies, as tax havens are often utilized to escape paying tax on large-scale projects based in developing countries.

Most MEPs note that the CoC Group appears to have consistently failed in effectively identifying non-cooperative jurisdictions and have called for using ‘very low or zero-tax rates’ as a primary criterion for automatic blacklisting. This is further underscored by the fact that only  two out of 13 countries with a zero percent corporate tax rate have been blacklisted, while the other 11 all manage to remain compliant with the CoC’s requirements despite their incredibly low tax rates. But addressing this seemingly inconsistent application of the List is easier said than done.

There are major stumbling blocks that stand in the way of change. While European public opinion supports strict norms, backroom discussions are rife in the process, with insufficient explanations provided to the general public. Paul Tang, Chair of the Subcommittee on Tax Matters, said it best when he stated, “While the list can be a good tool, it is currently lacking an essential element: actual tax havens. Countries on the list account for just 2% of corporate tax avoidance! EU member states currently decide in secret which countries are tax havens, and do so based on vague criteria with no public or parliamentary scrutiny. This needs to change.”

Reputational damage is at the core of the List’s power, as is the EU’s ability to deploy a diplomatic offensive against listed countries. Undeniably, the EU has provided explanations, clarifications, and technical advice to these jurisdictions, but so too is there a focus on punishment for the non-compliant; this is evident in the European Commission’s recommendationto not grant COVID-19 financial support to entities with links to countries on the List.

While attention has turned to changing and improving the EU List, perhaps it would be more fitting for the EU to first practice better upkeep in its own backyard. The transformative potential of the List – and all of the compliance measures it promotes globally – will likely only be realized if the EU Member States practice what they preach. The Netherlands, Luxembourg, Ireland, Hungary, and other Member States are responsible for one-third of global tax avoidance. In 2019, Luxembourg had Foreign Direct Investment (FDI) levels that were 67 to 100 times bigger than its economic weight, which hardly reflects brick-and-mortar investments in the small economy. Some Member States have allowed corporations to artificially reduce their tax base, resulting in a redistribution of wealth at the expense of EU citizens.

Conclusion

In theory, the List’s twin objectives of promoting good international tax governance and protecting Member States serve a common goal: curbing harmful tax regimes. However, in practice, the EU is imposing a “naming and shaming” policy on some countries, while choosing not to target the most significant perpetrators of tax fraud – notably the world’s most renowned tax havens – or the Members in its own backyard.

A potential solution ascertained from the plenary debate of the European Parliament is twofold: first, adopting a country-specific approach based on recovery and resilience; and second, omitting political considerations by increasing international dialogue and transparency.

Portugal, which currently holds the presidency of the EU Council, has reached a provisional political agreement with the European Parliament’s negotiating team on public country-by-country reporting to ensure transparency by setting common reporting standards for EU and non-EU entities. This approach would promote a better-informed public debate concerning multinational companies, while it would help regain the trust of EU citizens in their own national tax systems.

For a jurisdictional approach, it has been suggested that excessive profit tax and wealth tax in tax havens would considerably benefit the global tax system. In addition, the 5-pronged ‘bail or bailout’ test to ensure tax transparency from bailout recipients would prove to be effective in eliminating loopholes in tax rules. Indeed, the international tax governance regime must ultimately sculpt a fair society and a robust economy while upholding the social contract and the rule of law.

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Hamna Viriyam is a third-year law student at The National University of Advanced Legal Studies in Kochi, India. She is keenly interested in International Economic Law, Energy Law, and Intellectual Property Law.