Tax Transparency – Exchange of Information

As the commercial world becomes more closely knit and globalised, there is an urgent need for the tax administrations in each country to ensure that taxpayers pay the right amount of tax for income that arise in their jurisdiction. Cross border operations are now the norm. Where the flow of goods was dominant in the past, the flow of services and intangibles are now equally important. The role played by tax havens in facilitating cross border transactions has increased over the years.

This has given rise to a phenomenon called base erosion and profit shifting (BEPS). This essentially means that with “aggressive” tax planning taking into account the global nature of the operations of a MNC, profits are made to ‘disappear’ where it was earned or generated or shift to a lower tax base where it pays little or no taxes overall. The tax strategies used are in many cases within the law. This gives the MNCs an unfair advantage as compared to SMEs due to their global reach. As these global companies operate in multi tax jurisdictions, it is virtually impossible for a single country to address this issue.

The Organization for Economic Co-operation and Development (OECD) provides the lead that is required to tackle this situation and the larger issue of exchange of information between countries in essentially plugging the international tax loopholes.

After the G20 meeting in London in 2009 the OECD published a “black” list of tax havens and stated that those tax havens had to sign with other jurisdictions at least 12 bilateral tax information exchange agreements (TIEAs) in order for them to be taken out of the list.

The TIEAs called for an exchange of information on request. This meant that the requesting country could request for information based on well founded suspicion. This move was hailed by the OECD as a step in the right direction for the sharing of information between jurisdictions and at the same time protects the individual’s right to confidentiality. In practice, the bar of “well founded suspicion” was a difficult hurdle to clear and their claims were made that the process of obtaining the requested information was difficult.

Tax havens on the other hand felt that the actual aim of the TIEAs was to erode their ‘attractiveness’ and advantages. There were expectations that there would be a massive outflow of capital from the tax havens. In reality, the overall level of funds remained constant in the tax havens. Increasingly claims were made that the concept of request for information was not working and that a transparent tax system in information and automatic exchange was required.

The big push in this direction came in the form of the Foreign Account Tax Compliance Act (FACTA) in the USA in the year 2010. This act essentially requires all foreign financial companies (including banks and other financial institutions) to identify American nationals who hold accounts with them. Should the foreign financial companies not comply with the request for information on these American nationals, under FACTA a 30% withholding tax will be imposed on the income earned by these foreign financial companies in the USA. The FACTA rules will be imposed in stages starting from 2014.

What started out as a unilateral move by USA in expanding its tax net has morphed into what an OECD official calls “a remarkable leap forward for transparency”. USA has signed or is close to signing or negotiating bilateral agreements with more than 50 countries who in return will accept some of the terms of FACTA.

Other countries are already jumping on the bandwagon with many of them drawing up their own version of FACTA. It is now acknowledged that automatic exchange of information primarily for tax purposes will become the global norm. How it actually works in practice is yet to be seen. Will this then be the beginning of the end of offshore tax havens?

How will the above developments and particularly the implications of the exchange of information affect Singapore and Singapore registered companies. This will be discussed in another post.

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