Brexit and Trump – a reboot for global tax policy?

What do the electoral shake-ups of 2016 mean for Cayman and other offshore centers?
With Trump now inaugurated and in command of the White House, and the Brexit referendum freeing Britain from the chains of European Union policy, there is a breath of fresh air on both sides of the Atlantic.

But how will this affect Cayman and other offshore finance centers?  Will the old bureaucracy continue to tighten its grip, trying to squeeze more tax money out of global business, or will the new governments adopt pro-investment policies and usher in a new era of global prosperity?

Attitude

There are encouraging signs that the new governments see lower taxes as potentially a good thing.

Trump seems to have the right gut instincts about tax, having openly said that he had been “smart” to reduce his tax bill.  This is a refreshing change from the virtue-signaling David Cameron, who publicly condemned people engaging in tax planning and lectured us on the importance of our paying more taxes to “fund public services,” while having benefited from offshore family tax-avoidance structures himself.

Sadly, it doesn’t seem that Trump has any direct experience of offshore structures.  Although there were some Trump companies listed in the Panama Papers, they seem to be joint venture partners or franchise holders, not companies Trump actually had a shareholding in.  But at least it shows that several of his business associates do understand the offshore world.

More positively, Rex Tillerson, now Secretary of State and responsible for the USA’s international relations, has been director of a Bahamas-incorporated company.  Again, this was part of a joint venture between Exxon and another oil company, so it is not certain whether he was actually responsible for the decision, but at least he will not assume that all offshore operations are suspect.

Sadly, on my side of the Atlantic, the post-Brexit Chancellor Philip Hammond did not take such a robust line when he was accused of reducing his own tax bill by transferring an investment property to his wife.  Instead of Trump’s positive pro-investment response, Hammond issued a statement saying that the transfer had not been done in order to avoid tax, which I suppose might even be true.

Worse, Hammond’s latest budget included proposals to punish professionals for advising their clients on how to reduce their tax bills, an idea that is completely contrary to the rule of law and the right to fair representation.

So a mixed message, but the new governments certainly seem more pro-business and less culturally attuned to tax-grabbing than their predecessors.

A better American tax system?

Trump’s proposal is for a 15 percent tax on business income, but applied to worldwide income for American companies, with no deductions or postponements for offshore income.

That sounds good for American businesses, but could cause problems for international finance centers.  That’s because the current 35 percent corporate tax is not only ridiculously high, but also gives companies the ability to shelter non-U.S. profits so long as they are kept out of the USA.  That gives a big incentive for American companies to use offshore structures, particularly those in Cayman, but that incentive will be reduced under Trump’s proposed tax system.

Although Trump’s plan wouldn’t change what can be done in Cayman, it does mean that the relative advantage of an offshore structure is greatly reduced, because the U.S. tax saved is lower.  Indeed, Richard Murphy, left-wing campaigner for higher taxes and long-term opponent of offshore finance centers, has said of Trump’s tax policies: “Is there a downside? Not that I can see.”

But I wouldn’t get too worried; Trump has to get it through Congress first, and even if his reforms survive that process without being watered down, there will still be plenty of other advantages to offshore structures, such as more sensible regulation and less risk of tax rates being increased in the future.

So we aren’t expecting the sort of all-out assault on offshore finance that Bernie Sanders might have proposed.  Instead, the risk to offshore finance centers from Trump is that he will make American taxes so low and straightforward that offshore finance becomes, comparatively, less attractive.  There are worse problems to have.

Britain – a European Singapore?

On the other side of the Atlantic, Britain has voted to leave the European Union, but that is merely the start of a long, slow progress toward freedom.  As I write this, the government has just got its Brexit Bill through Parliament and announced that they will serve notice on Brussels at the end of March, formally beginning the two-year negotiation on what will happen when we leave.

At the moment the two sides are just starting the opening salvos in what seems likely to be a war of attrition.  But Hammond has responded robustly, announcing that, if Britain is shut off from access to European markets (particularly the City of London’s financial markets), we will abandon the high-tax, high-regulation European-style social model and become “the tax haven of Europe.”  Nor is he alone; Prime Minister Theresa May apparently “stands ready to do so” too.

The disappointment is that Hammond is not proposing to do this anyway.  The U.K. becoming a “European Singapore,” a global hub for trade and investment, is the very thing to make a success of Brexit.  Disappointingly, our Chancellor seems to stick with the failed “European economic and social thinking” that has led to 20 percent and greater youth unemployment.  But at least he seems ready to change to a better model if necessary.

If Hammond is going to properly turn Britain into a successful global economy, he needs to improve our relationships with its associated international finance centers, not just the local ones in the Channel Islands, but also Cayman and the other Caribbean centers.

These links have been strained in recent years as Britain has put pressure on its associated territories to comply with increasingly draconian European Union tax rules, but post-Brexit that can stop.  If Hammond is serious about making Brexit work and attracting inward investment, one of the best sources of capital will be the funds managed in British-connected offshore finance centers.

Leaving just in time

It is just as well Britain is leaving the European Union because in the last few months the EU has started another tax squeeze on businesses, with a package of measures designed to increase the tax take and make it more difficult to invest or trade in Europe without suffering swinging taxes.

I intend to write more on this in future issues, but the bureaucrats’ plans include exit taxes (a fiscal Iron Curtain around Europe to trap business inside), extending Europe’s tax net to catch non-European subsidiaries, and a return to the infamous, often rejected, “Common Consolidated Corporate Tax Base” (CCCTB), effectively a centralized European corporation tax system under which the European Union, rather than national governments, will centrally set what deductions, allowances and exemptions companies can claim.

This is a power-grab by the EU’s Brussels bureaucracy.  Tax is one of the few areas where their control is limited, with national governments having jealously guarded their tax-raising powers.  But with European governments, as Margaret Thatcher warned, “running out of other people’s money,” and desperate to prop up their unreformed, out of control spending, the bureaucrats are promising that if they are given the power, they will “stop tax avoidance” and get more money flowing into the national coffers.

The EU’s proposal are designed to make it more difficult for multinational groups to take advantage of legitimate offshore structures, such as group financing companies, captive insurers and IP holding companies, many of which are based in Cayman and other Caribbean jurisdictions.  By leaving the EU, Britain can keep its companies out of that tax cartel and enable them to continue to use offshore structures to help their international expansion.

The problem is that a centralized tax system means that there is no room for innovation, reform becomes almost impossible (because it will need all national governments to agree) and it is a near-certainty that in time, once businesses are locked in to the EU tax net, the rates will increase.

And in the long term it won’t bring in more money; as the tax system tightens, business and investment will stay away from the European Union, wealth and employment opportunities will reduce even further, and Europe’s decline will continue.

It looks like Britain is getting out just in time.

The rest of the world

So America is to be made great again through low taxes, encouraging businesses and employment to stay in, or even move back into, the USA.  And Britain is apparently going to rediscover its global role in business and turn its back on European bureaucracy and protectionism.

But what of the bigger picture?  How will Brexit and the Trump presidency affect the rest of the tax world, and what impact will they have on Cayman?

The European press has generally been presenting both Brexit and Trump as part of a wider move to isolationism.  Brexit they see as Britain cutting itself off from Europe, while under President Trump, they claim, the USA will look after itself alone and retreat from the rest of the world, with both abandoning free trade areas.

But how accurate is this?

Brexit could be portrayed as isolationist, Britain turning its back on Europe, but if it is done well it will actually be an internationalist, globalizing move.  Although the European Union has (sometimes rather fitfully) encouraged a “Single Market” of goods, services, people and capital, it is only an open market within its own borders.  As regards the rest of the world, the European Union adopts a “Fortress Europe” mentality, shutting itself off through tariffs and regulations.

Once Britain is out of the European Union it can forge its own trade deals with other countries, which is not allowed within the EU, where all trade policy is controlled centrally by the Brussels bureaucracy.  The hope is that Brexit will see Britain reopen its trading and investment links with the rest of the world, instead of being trapped inside a declining Europe.

As for Trump’s America, the fears of future American policy do seem to be rather exaggerated.  It is true that significant American isolationism would be a retrograde step, but there is little sign that this is happening.

On international trade, it is true that TTIP, the U.S.-EU trade deal (the “Transatlantic Trade and Investment Partnership”), is probably dead.  But it was dead anyway.  Protectionism did indeed kill it off, but protectionism by the EU rather than the USA.  Look at the fuss Europe made over the far less controversial EU-Canadian trade deal, which was almost scuppered when one of the Belgian parliaments voted it down in a fit of protectionism.  There is no way a decent U.S. trade deal would have got past the EU, which is another good reason for Britain to regain control of trade policy from Brussels.

So withdrawing from the flawed TTIP does not make Trump a dangerous isolationist.  Nor does he seem to be opposed to all international trade agreements; he was quick to offer the U.K. one after the Brexit referendum.

So, no, I’m not terrified; I don’t expect international trade to end.

One international system to leave

But just because international trade and global free markets are beneficial, that does not mean that all international organizations are forces for good.

If President Trump is looking for international systems to withdraw from, and Britain wants to advertise its post-Brexit pro-growth policy, I have a good suggestion – abandon the OECD and its tax-grabbing “BEPS” project.

Initially the OECD did good work, helping restore the world economy after the ravages of the Second World War and, through its model tax treaty, reducing the double taxation that discouraged international business.  Sadly, over the decades it has lost its original purpose and is now acting as a tool of the high-tax, high-spending European governments, and rather than growing wealth and opportunity by encouraging international business, it is now propping up bloated governments and helping them squeeze more tax out of their moribund economies.

This started in the 1990s with the OECD’s “harmful tax competition” initiative.  Tax competition is the process by which governments improve their tax systems in order to encourage and attract more business and investment; it is a beneficial action that promotes economic growth and boosts jobs.  Unfortunately, some governments see it as a challenge to their desire to squeeze as much tax out of business as they can, regardless of the negative effects on their population.

Those governments that persisted with their inefficient, uncompetitive old tax systems soon found themselves losing out to those more dynamic countries that had made improvements, not just international centers such as Cayman but also the more dynamic European economies (yes, there are a few) such as Ireland and Estonia.  But rather than improving their tax systems to encourage business and investment, they labeled tax competition as “harmful” and tried to force their failed policies onto other countries.

Sadly, the OECD, to some extent, went along with this and attempted to force low-tax countries to change their tax systems to make them less attractive, and made it more difficult for businesses to use offshore centers. Now this is going further through the OECD’s current initiative, “BEPS.”

Time to leave BEPS

BEPS stands for “Base Erosion and Profit Shifting,” reflecting the OECD’s claim that companies, primarily multinationals, are “shifting” their profits away from high-tax countries and are thereby reducing their taxable profits, known as their “tax base.”

This is aimed primarily at successful multinationals, particularly American-owned ones; Google, Apple, Starbucks, Amazon have all been pilloried in the media, and by governments, for not paying as much tax as governments would like.  Never mind that they are providing services that people want, and much-needed employment in Europe’s stagnating economies; to many governments the only purpose of business is to pay taxes.

The OECD’s BEPS project is aimed squarely at allowing European governments to extract more tax from businesses such as those.  And to add insult to injury, those OECD bureaucrats pushing for businesses to pay more tax enjoy tax-free salaries themselves, thanks to the French government granting diplomatic status to the Parisian palace that is the OECD’s headquarters.

The OECD’s plan, enthusiastically supported by the high-tax European governments, is to change the international tax system so that tax authorities will be able to ignore certain legitimate business costs for tax purposes.

If a company has sales of £100 million and costs of £80 million, it has profits of £20 million and pays tax on that.  But if the tax authority ignores, or “disallows,” £10 million of those costs, suddenly the taxable profit is treated as being £30 million and the company’s tax bill becomes one and a half times what it was.

Worse, the OECD’s primary targets are vital features of the new knowledge economy.  The main costs that they are seeking to disallow are royalties or other payments for intellectual property, and interest or other financing costs.

The European Union is also pushing through its own version of BEPS, which seems likely to be even more restrictive and damaging.

Innovation has been the vital driver of Western economies, and payments for the use of intellectual property, for the right to exploit inventions and new ideas, are what underpin that growth.  But the OECD and European Union do not seem to be worried about the damaging effect their proposals will have on job creation or improving living standards for their citizens; instead their sole worry is that when companies pay royalties for the right to use an invention, there is less profit for them to tax.

Over-taxing intellectual property is like eating the seed potatoes; it may help this year, but it causes far more problems next year.  As we all know, and have known for centuries, if you tax something you get less of it, and the more you tax it the less of it you will get.  But somehow the governments that enthusiastically make that argument about smoking seem surprised when it also has the same effect on innovation.

The problem for offshore finance centers is that the assets being attacked by BEPS – intangibles such as intellectual property and finance – are the ones often held by companies in their jurisdiction.  The BEPS initiative is intended to make it more difficult for companies to take advantage of offshore structures.   If, after Brexit and the Trump victory, Britain and the USA will be less favorable to these harmful tax cartels, the world will benefit.

Britain and the U.S. should set their own tax policy

The OECD’s BEPS project is a retrograde, harmful process that is trying to shore up inefficient European governments and their uncompetitive tax systems, and is doing so by attacking business innovation.

Britain is just escaping from the European Union’s anti-innovation restrictions, and that will hopefully help rebuild its relationship with its related offshore finance centers.  It would be folly for them to escape one draconian tax system merely to plunge straight back into the OECD’s version.  And this is certainly one international system that the USA should withdraw from, for the sake of its own businesses and to save the rest of the world from European governments’ folly.

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Richard Teather

Richard acts as a tax policy consultant, including advising the Jersey parliament on their recent tax reforms, is a Fellow of the Adam Smith Institute. and is an editor or member of the editorial board of various journals. His book, “The Benefits of Tax Competition”, is published by the London-based Institute for Economic Affairs. His work has been the subject of a debate in the UK Parliament and quoted in government studies in the UK, EU and Australia, and hit the national press when the UK government tried to suppress its own civil servants favourable comments on it.Richard TeatherSenior Lecturer Tax LawBournemouth UniversityChristchurch House C206Poole, BH12 5BBUKT: 01202 961870E: rteather@bournemouth.ac.ukW: bournemouth.ac.uk 
 

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