Why Europe's new tax initiative is a big deal

By Ronen Palan, City University London

Public outcry over revelations in the Panama papers about global levels of tax dodging has led to political action. Europe’s five largest economies – the UK, France, Germany, Italy and Spain – have agreed to new transparency rules, which will require banks to identify the ultimate beneficial ownership of assets.

If properly implemented, these rules could seriously dent the game that individuals and companies play to evade tax or adopt aggressive tax avoidance planning. As shown, among other revelations in the Panama papers data leak, companies and individuals use strings of shell corporations, set up offshore, in order to avoid detection from their domestic tax authorities.

The new rules will require banks to identify the ultimate beneficial owner of these strings of companies and information on the ultimate beneficial owners will now be automatically exchanged. This removes an important layer of opacity that had been used to evade taxes.

Chasing the footprint

Tax planning schemes typically involve a number of jurisdictions. Each provides its own unique contribution – a bundle of laws, regulations and taxes – which, when linked to other entities in other jurisdictions, serve to minimise a corporate or individual’s tax footprint.

One famous method used is the “double Irish”, where companies set up an office in Ireland, through which they register much of their income from international operations. Only this Irish outpost is structured in such way that it does not meet the threshold of Irish tax residency law. The entity is therefore not subject to taxation. It would typically be controlled by another Irish outfit, this time managed from an extremely low-tax jurisdiction elsewhere, say, Bermuda. This is subject to Irish tax residency, only that it does not have many assets or profits that would be taxed. In this way, Apple managed to avoid paying nearly any tax on its non-US income.

In my career studying tax dodging, I’ve long-complained that regulatory efforts do not cope well with the way these schemes are multi-jurisdictional. So the decision for these five major countries to work together and share information is a significant step.

Will it work?

The system probably will work – and we have a precedent for it. Although we still do not have much detail on the new European scheme, the rules are reminiscent of the US Foreign Account Tax Compliance Act (FATCA), which my colleague Duncan Wigan at Copenhagen Business School and I have studied. Announced by the US in 2010 and implemented in 2014, the philosophy behind FATCA is as simple as it is powerful.

Instead of seeking to persuade each and every tax haven to change their laws and policies in a process akin to herding cats, the US targets financial intermediaries through FATCA. It deploys the carrot of access to the large US market by insisting that institutions that operate or invest in US markets must automatically exchange information with the Inland Revenue Service on US accounts. This is irrespective of domestic laws in their place of registration, which may or may not prohibit the exchange of this information.

The FATCA rules and the new transparency rules announced by the five European countries address head on the game of multi-jurisdictionality. What took so long? I do not know, but at least they got there. Better late than never. This is a step forward. The net is clearly closing. But, we need to remain vigilant. Vested interests and various lobbies may be able to derail the new rules or evacuate them of content by the time the new rules are in place in early 2017. More information about the details of the new initiative is needed.

Ronen Palan, Professor of International Politics, City University London • This article was originally published on The Conversation. Read the original article.