Will transparency on transactions, legal structures and tax lead to the death of IFCs?
Transparency is THE word used these days, especially since access to information, facilitated by technology, has never been easier. Afterall one needs to be able to access information in order to “see” thereby creating a transparent situation. In the world of tax, first the authorities have to agree to a set protocol on information sharing, and when facilitated by technology, transparency is then easily established.
Someone once said, this new exchange of information protocols amongst nations (for example, the Common Reporting Standard or CRS), is almost like a Facebook for competent authorities! When considered in their abstract form, one can see their resemblance.
All this transparency has led to more questions on the levels of activity, be it operations or management being carried out in jurisdictions where entities have set up their legal presence. In effect, transparency in the tax affairs of a legal entity has naturally brought about questions on the operational/management activities of the jurisdiction where the tax is paid.
It’s after all a logical line of enquiry. “What are your operations in the countries/jurisdictions your entities are set up?” Except of course, historically there hasn’t been much economic or operational activity conducted in the jurisdiction these entities call home.
Someone once said, this new exchange of information protocols amongst nations (for example, the Common Reporting Standard or CRS), is almost like a Facebook for competent authorities! When considered in their abstract form, one can see their resemblance.
All this transparency has led to more questions on the levels of activity, be it operations or management being carried out in jurisdictions where entities have set up their legal presence. In effect, transparency in the tax affairs of a legal entity has naturally brought about questions on the operational/management activities of the jurisdiction where the tax is paid.
It’s after all a logical line of enquiry. “What are your operations in the countries/jurisdictions your entities are set up?” Except of course, historically there hasn’t been much economic or operational activity conducted in the jurisdiction these entities call home.
Welcome to the concept of economic substance!
The scenario above describes in a simplistic manner the background that has led to some quarters decreeing the death of International Financial Centres (IFCs). However, we believe that this new “operating model” which is now being accepted globally, only enhances the credibility of IFCs and in no way bring their demise.
IFCs have long been a focus of concerted measures proposed by international and supranational organisations to combat tax avoidance and evasion, with the collection and sharing of tax information on investors in these jurisdictions being a key element. The push for greater transparency has come from several fronts. The United States passed the Foreign Account Tax Compliance Act (FATCA) in 2010, a unilateral regime aimed at detecting US taxpayers who use accounts with offshore financial institutions to conceal income and assets from the Internal Revenue Service. Financial institutions that do not report information on accounts with American connections face a substantial 30% withholding tax.
Meanwhile, the OECD and G20 driven initiative on base erosion and profit shifting (BEPS), which started in 2013, has continued to shine a spotlight on the weaknesses in the international tax regime, with many of the recommendations highlighting BEPS opportunities popularly associated with low-tax (or zero-tax) regimes. And although BEPS will be applied via the adoption of domestic legislation, it’s take-up has been almost universal. Clearly, the possible clawing back of taxes unpaid is great encouragement!
The BEPS project consists of 15 action plans, organised around three main pillars - coherence of corporate tax at the international level, realignment of taxation and substance, and transparency - with four minimum standards agreed to by all participating countries who have committed to implement them under the Inclusive Framework. Two of the four minimum standards i.e. Actions 5 (Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance) and 13 (Transfer Pricing Documentation and Country-by-Country Reporting), clearly have transparency in mind.
IFCs have long been a focus of concerted measures proposed by international and supranational organisations to combat tax avoidance and evasion, with the collection and sharing of tax information on investors in these jurisdictions being a key element. The push for greater transparency has come from several fronts. The United States passed the Foreign Account Tax Compliance Act (FATCA) in 2010, a unilateral regime aimed at detecting US taxpayers who use accounts with offshore financial institutions to conceal income and assets from the Internal Revenue Service. Financial institutions that do not report information on accounts with American connections face a substantial 30% withholding tax.
Meanwhile, the OECD and G20 driven initiative on base erosion and profit shifting (BEPS), which started in 2013, has continued to shine a spotlight on the weaknesses in the international tax regime, with many of the recommendations highlighting BEPS opportunities popularly associated with low-tax (or zero-tax) regimes. And although BEPS will be applied via the adoption of domestic legislation, it’s take-up has been almost universal. Clearly, the possible clawing back of taxes unpaid is great encouragement!
The BEPS project consists of 15 action plans, organised around three main pillars - coherence of corporate tax at the international level, realignment of taxation and substance, and transparency - with four minimum standards agreed to by all participating countries who have committed to implement them under the Inclusive Framework. Two of the four minimum standards i.e. Actions 5 (Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance) and 13 (Transfer Pricing Documentation and Country-by-Country Reporting), clearly have transparency in mind.
The Common Reporting Standard
In 2014, the OECD developed the Common Reporting Standard (CRS) for the automatic exchange of information (AEOI) between countries, which has had a widespread impact on how countries share and obtain information. Facilitated by the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information (CRS MCAA), the CRS has created a superhighway of tax information, corporate information and personal details.
Substance requirements
The second pillar of the BEPS actions addresses substance, and Action 5 contributes to this as well as to transparency. The first part of Action 5 relates to transparency through the compulsory spontaneous exchange of certain taxpayer-specific rulings between tax administrations, facilitated by the “building” of this new superhighway of tax information via CRS.
The other part relates to preferential tax regimes, whereby a peer review of preferential tax regimes in all Inclusive Framework members is undertaken by the Forum on Harmful Tax Practices (FHTP) to identify features of regimes that have the potential to unfairly impact the tax base of other jurisdictions.
Countries are expected to comply with the standard on harmful tax practices, including ensuring that their preferential regimes align taxation with substance, be it operational or management activity. In effect, the Inclusive Framework has very elegantly created a new standard for substantial activities requirements for all activities conducted in a jurisdiction.
The other part relates to preferential tax regimes, whereby a peer review of preferential tax regimes in all Inclusive Framework members is undertaken by the Forum on Harmful Tax Practices (FHTP) to identify features of regimes that have the potential to unfairly impact the tax base of other jurisdictions.
Countries are expected to comply with the standard on harmful tax practices, including ensuring that their preferential regimes align taxation with substance, be it operational or management activity. In effect, the Inclusive Framework has very elegantly created a new standard for substantial activities requirements for all activities conducted in a jurisdiction.
The death of IFCs?
Thus, amid all the emphasis on transparency and substance, it’s not surprising that IFCs are facing the impact of increased scrutiny, bringing with it the core fundamental question as to why these jurisdictions have been utilised in the first place.
The answer is clear and simple: IFCs are by default intermediation points for businesses, risk, assets and wealth. By design, they are meant to lessen the natural friction which occurs when the legal and tax systems of two countries collide. IFCs – well executed – are meant to erase the friction caused by a globalised world, creating a fiscal, legal and currency neutral “home” for cross-border transactions.
So, will transparency on transactions, legal structures and tax lead to the death of IFCs? This is hugely dependent on the individual IFC, and how each IFC measures up in this massive global review on the usability of IFCs. So as it stands, instead of tax savings being the sole aim of using a jurisdiction, considerations now have evolved into more substantive questions such as location, efficiency, scalability, range of legal structures, reputation and compliance to international standards, with the last two considerations essentially being two sides of the same coin.
The answer is clear and simple: IFCs are by default intermediation points for businesses, risk, assets and wealth. By design, they are meant to lessen the natural friction which occurs when the legal and tax systems of two countries collide. IFCs – well executed – are meant to erase the friction caused by a globalised world, creating a fiscal, legal and currency neutral “home” for cross-border transactions.
So, will transparency on transactions, legal structures and tax lead to the death of IFCs? This is hugely dependent on the individual IFC, and how each IFC measures up in this massive global review on the usability of IFCs. So as it stands, instead of tax savings being the sole aim of using a jurisdiction, considerations now have evolved into more substantive questions such as location, efficiency, scalability, range of legal structures, reputation and compliance to international standards, with the last two considerations essentially being two sides of the same coin.
Malaysia and Labuan IBFC’s Response
As part of Malaysia, Labuan IBFC has always been party to all the international conventions ratified by Malaysia including the commitment to OECD and other multilateral organisations, with the anti-money laundering rules that apply to onshore Malaysia also applicable to Labuan IBFC.
This is one of the reasons why historically Labuan IBFC has always been perceived as somewhat of a laggard amongst IFCs. The fact is the jurisdiction should have never been bucketed together with the more “traditional” IFCs. Labuan IBFC is in fact a midshore IFC, marrying the efficiencies of a traditional offshore centre with the robust legal and regulatory framework of an onshore centre. It is effectively a hybrid jurisdiction that believes in the proportionality in regulation, operated by a globally recognised one-stop pro-business Regulator.
Will Labuan IBFC continue to adhere to the ever-evolving global standards of transparency? Yes, we will. And at the same time, ensure that our IFC remains competitive via the legal structures and the cost-efficient substance propositions that we offer.
After all, any Asian entity looking for a friction-free environment to house their regional/global hub would do well to consider Labuan IBFC in ensuring all its global reporting responsibilities are met, without having to endure the threat of reputational damage.
This is one of the reasons why historically Labuan IBFC has always been perceived as somewhat of a laggard amongst IFCs. The fact is the jurisdiction should have never been bucketed together with the more “traditional” IFCs. Labuan IBFC is in fact a midshore IFC, marrying the efficiencies of a traditional offshore centre with the robust legal and regulatory framework of an onshore centre. It is effectively a hybrid jurisdiction that believes in the proportionality in regulation, operated by a globally recognised one-stop pro-business Regulator.
Will Labuan IBFC continue to adhere to the ever-evolving global standards of transparency? Yes, we will. And at the same time, ensure that our IFC remains competitive via the legal structures and the cost-efficient substance propositions that we offer.
After all, any Asian entity looking for a friction-free environment to house their regional/global hub would do well to consider Labuan IBFC in ensuring all its global reporting responsibilities are met, without having to endure the threat of reputational damage.
Benefitting from the flight to quality
In the new era of transparency, IFCs need to mould themselves into a business facilitator rather than just mere locations for entities looking to operate in low-tax countries for tax advantages. Taxpayers need to appreciate that taxes now come with a burden of morality, respectability and fairness. At the same time, all Governments continue to juggle tax policies with national economic interest, under the ever-watchful eye of supranational organisations hosting an ever-growing appetite for transparency and along with that, substance.
Without a doubt, Labuan IBFC will continue to offer global businesses with Asian connections a pro-business environment, while focusing on its strengths and comparative advantages – specifically on it being a substance enabling jurisdiction located in the middle of Asia that is well supported by the large Malaysian hinterland, and a dynamic and skilled work force boasting strong ties to key Asian powerhouses like China and India.
And yes the flight to quality jurisdictions is real – just have a look at our report card for 2018 here.
Having said that, there are challenges to be faced and changes to adapt to for all IFCs, but as always along with change comes opportunity!
Without a doubt, Labuan IBFC will continue to offer global businesses with Asian connections a pro-business environment, while focusing on its strengths and comparative advantages – specifically on it being a substance enabling jurisdiction located in the middle of Asia that is well supported by the large Malaysian hinterland, and a dynamic and skilled work force boasting strong ties to key Asian powerhouses like China and India.
And yes the flight to quality jurisdictions is real – just have a look at our report card for 2018 here.
Having said that, there are challenges to be faced and changes to adapt to for all IFCs, but as always along with change comes opportunity!