Does the G20/OECD's minimum tax spell the end of tax havens?

(This blog was first published in Swedish on 15 August, 2021. It is published "as is" with no amendments made because of subsequent events)

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1. Background

It is easy to get the impression that tax havens have only been on the defensive for the past 20 years. Both the OECD and the EU have gradually added new standards in the area of taxation and money laundering, which has forced tax havens to introduce new legislation, in particular with regard to transparency and the exchange of information.

However, from the point of view of tax havens, this process has not been only negative. By meeting these requirements, they have acquired a legitimacy that they did not previously have, which has resulted in the multinational industry increasingly using various structures in tax havens for tax planning purposes.

Because despite all new regulations, the tax havens maintain many advantages that most other states cannot offer, such as minimal regulations, tailor-made company and trust solutions and - of course - zero income tax.

Somewhat simplified, it may be argued that tax havens - at least to some extent - sacrificed the less profitable and more risky tax evasion industry and replaced it with the more profitable and (in principle) legitimate tax planning industry. Since the clients of the latter category are mainly multinational enterprises and so-called "high net-worth individuals", many tax havens today derive government revenue from the offshore sector that they could only have dreamed of 20 years ago.

2. The Impact of the Minimum Tax on Tax Havens

The G20/OECD minimum tax proposal of 15% (pillar 2) is going to adversely affect tax havens. In fact, the introduction of a minimum tax risks making some of them obsolete overnight. If a tax haven chooses to keep the zero tax rate, in-scope MNEs' offshore subsidiaries located therein will be taxed currently at a rate of 15% in the MNEs' home countries. If tax haven instead introduces a corporate tax rate of 15%, the whole point of establishing offshore companies would become obsolete.

3. The Substance Carve-out

The tax havens are now engaging in damage control by insisting that exceptions should be made from the minimum tax requirement insofar as they meet requirements for "economic substance".

Pillar 2 (in the version now proposed) actually allows in-scope companies to exempt 7.5% of both the book value of tangible assets and the sum of wage costs from the minimum tax base. However, this economic substance carveout is of no use to tax havens because no real activity is (or ever will be) conducted there.

Both the OECD (BEPS) and the EU (Code of Conduct) have since 2015 required that tax havens implement minimum standards for economic substance. The tax havens therefore argue (not without justification) that their haven activities should be exempt from the minimum tax rules. The tax havens have implemented such rules on the assumption that companies would be able to satisfy such substance requirements via "accounting engineering". However, the current minimum tax proposal completely disregards both BEPS' and the EU's substance requirements, which means in practice that the OECD ignores its own work in this area.

4. The Inherent Limitations of the Minimum Tax Proposal

So would the introduction of a minimum tax spell the end of tax havens? Well, it's probably not that simple. First of all, the proposed rules only cover large companies with revenues of at least USD 750 million. Small and medium-sized companies can therefore continue to use tax havens for tax planning purposes without restrictions. Furthermore, traditional evasion activities are still carried out in tax havens. However, the transparency and exchange of information requirements (both automatically and on request) have made it both more complicated and costly to circumvent such rules in order to maintain full anonymity. Havens probably derive less state revenue from evasion activities today.

Paradoxically, the most sophisticated tax havens such as Switzerland, Luxembourg, Singapore, Hong Kong and the Channel Islands are likely to be hardest hit because they have almost completely prioritized the development of low or zero-taxed structures tailored for tax planning purposes.

5. All rules can be circumvented

However, it is unlikely that these or other states in a similar situation will submit unconditionally to the new rules. Switzerland published on June 5 a press release following the G7 agreement on the global minimum tax. It is not difficult to read between the lines of that press release:

“For over a year now, in discussions with the cantons, academia and the business community, the Federal Department of Finance (FDF) has been examining the possible transposition of an international standard into Swiss law, as well as internationally accepted measures that will safeguard Switzerland's appeal as a business location (min understryk). This work by the FDF will be intensified in the coming months in close cooperation with the Federal Department of Economic Affairs, Education and Research and other departments concerned.”

All rules, minimum standards and other principles adopted by the G20/OECD may be manipulated. The same day that global minimum tax rules are agreed, both tax havens and tax and audit firms around the world will start looking for ways to undermine or circumvent the new rules. Beyond death, this is the only thing that is absolutely certain.