Bridgetown – January 11, 2021– Two University of the West Indies Cave Hill (The UWI Cave Hill) researchers, Dr Ronnie Yearwood and Alicia Nicholls have critiqued the premise of the European Union (EU)’s concept of economic substance as applied to Commonwealth Caribbean international financial centres (IFCs). The critique forms part of a paper recently published by the authors in renowned academic journal Bulletin for International Taxation.
Economic substance rules seek to ensure that profits are taxed where actual value creation occurs, thereby minimizing the ability of companies to evade or avoid their tax burden by shifting profits to low or no-tax jurisdictions where they have little value-creating activity.
Both the Organisation for Economic Cooperation and Development (OECD) through its Base Erosion and Profit Shifting (BEPS) Action 5 project and the EU through its Code of Conduct Group has sought to ensure IFCs pass economic substance legislation to eliminate harmful tax practices that they claim hurt the tax bases of onshore jurisdictions.
Yearwood, a Lecturer in Law in the Faculty of Law and Nicholls, a trade specialist and researcher with the Shridath Ramphal Centre for International Trade Law, Policy and Services, compared the economic substance laws passed by The Bahamas, Barbados, Bermuda, British Virgin Islands and the Cayman Islands to assess their compliance with the EU’s test of substance under its Criterion 2.2. While showing that the legislation passed by the five jurisdictions studied complies with the EU Criterion 2.2, the authors refute the erroneous premises on which the EU’s argument is based.
For one, the authors argue that the concept of economic substance, as advocated by the EU, does not consider the growing importance of global value chains (GVCs) which means that no single jurisdiction may be able to make a full and legitimate claim as to being the main source of value creation for a particular good or service.
They also demonstrate the impracticality of the EU-mandated test for economic substance, especially in light of social distancing and travel restrictions imposed to mitigate the spread of the novel coronavirus disease (COVID-19).
Indeed, because of the latter, the tax authorities of each of the jurisdictions studied were obliged to release guidance notes on how to still meet the test of substance in spite of these restrictions.
Yearwood and Nicholls instead argue, through resort to settled case-law, that the English common law already contains an arsenal of legal principles, such as control and residence of a company and shams, for addressing tax avoidance and determining substance in economic activity.
The authors propose, therefore, that the EU’s flawed test of economic substance be rejected in favour of these more established common law principles.