Tax defensive measures implemented by European states against non-cooperative jurisdictions

The fight against harmful tax competition and aggressive tax planning has been high on the European Union (EU’s) agenda in the past few years. Following calls from both Member States and the European Parliament, the European Commission (EC) included in their January 2016 Anti-Tax Avoidance Package a proposal for a common EU external strategy for effective taxation. The objective of this initiative was to coordinate the fight against base erosion threats from third countries by replacing the various national tax haven or white lists with a single EU listing system.

The outcome was the adoption on December 5, 2017, of the initial EU list of non-cooperative jurisdictions for tax purposes (the “EU List” – Annex I to the Council conclusions on the EU list of non-cooperative tax jurisdictions). The document was the result of an in-depth screening and dialogue process between the EC and 92 non-EU countries that were assessed against EU criteria for tax good governance. The current screening criteria are founded upon tax transparency, fair taxation, and the implementation of the Organisation for Economic Co-operation and Development (OECD) anti- base erosion and profit shifting (BEPS) measures. For more details, please refer to Euro Tax Flash Issue 367. In line with the aim of the initiative, the screening exercise only covers third countries.

Jurisdictions that do not comply with all of the criteria, but that have committed to reform by bringing domestic legislation in line with the standards required by the EU, are initially included in a state of play document, the so-called “grey list” (Annex II), and monitored for compliance. Jurisdictions that fail to meet the EU’s requirements within the agreed upon deadlines are deemed non-cooperative and moved to Annex I. The EU List is an ongoing project and is regularly updated and revised, with the next revision expected in February 2022.

The most recent EU List became effective on October 12, 2021, and comprises American Samoa, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands and Vanuatu.

As a result of the October revision of the list, the following countries and regions are currently on the EU “grey list”: Anguilla, Barbados, Botswana, Costa Rica, Dominica, Jamaica, Jordan, Malaysia, North Macedonia, Qatar, Seychelles, Thailand, Turkey, Uruguay and Hong Kong (SAR), China. Among others, the update reflects the results of the recent Code of Conduct Group (COCG) screening in respect to foreign source income exemption (FSIE) regimes. For more details, please refer to Euro Tax Flash Issue 457.

Consequences of being placed on the EU List

As a general rule, EU Member States are free to choose the type and scope of measures applied against jurisdictions on the EU List, in line with the framework of their national tax systems. However, Member States have committed to applying both administrative and legislative tax measures against listed jurisdictions based on a number of recommendations from the EC. The commitment only refers to countries listed on the EU List and the measures do not target countries included in Annex II.

In short, administrative measures include reinforced monitoring of transactions, increased risk audits for taxpayers who benefit from listed harmful regimes, as well as increased risk audits for taxpayers using structures or arrangements involving listed jurisdictions​.

In regard to tax defensive measures, the EC’s menu gives Member States a choice of one or more of the following measures:

  • Limiting the deductibility of costs;
  • Controlled foreign company (CFC) rules;
  • Withholding tax measures; and/ or
  • Limitation of participation exemption on profit distribution.

Member States had committed to introducing one or more such defensive measures by January 2021. Countries encountering difficulties to enact the measures due to institutional or constitutional issues triggered by the national process of implementing the rules benefited from a six-month extension. The body mandated to review harmful tax practices, i.e. the COCG (Business taxation) – has undertaken a review of the defensive measures applied by Member States and a summary (https://data.consilium.europa.eu/doc/document/ST-14230-2021-INIT/en/pdf) of the measures was published in late November 2021.

The inventory of restrictions continues to develop, with recent EU-wide legislation explicitly referring to the EU List of non-cooperative jurisdictions, including:

  • EU mandatory disclosure rules (DAC 6): Reporting requirements in respect of cross-border arrangements involving listed jurisdictions.1
  • General framework for securitization (Regulation (EU) 2021/557): Amendments in force since April 2021 now s refer to the EU List. Specifically, in the context of investments in third countries through Securitization Special Purpose Entities (SSPEs), SSPEs should not be established in a listed jurisdiction, while notification requirements apply in cases where an investor intends to invest through an SSPE based in a grey list jurisdiction.
  • EU public country-by-country reporting rules: Additional disclosure requirements related to countries on the EU List, i.e. data has to be disclosed separately for each jurisdiction included on the EU List or on the “grey List” for two consecutive years, as compared to aggregated reporting for other third countries.

The EU List also impacts areas other than tax. Member States were invited to take the EU List into account when developing their foreign policy, as well as in their economic relations with third countries. The EU itself restricts access to several EU funding instruments, if channeled through entities based in a listed jurisdiction.

State of play of defensive measures

Given the increased significance of the EU List and recent commitments for additional measures made by several countries in their Recovery and Resilience Plans, we endeavored to summarize progress made by EU countries in implementing the EU’s recommendations. The challenge with this exercise, as with any other EU-wide initiative that is not binding on Member States, is the disparity in local implementation and approach. A tracker of tax defensive measures is therefore a useful tool for anyone attempting to understand the impact of being placed on the EU List has for a non-EU jurisdiction.

Our comments herein are based on an internal KPMG survey coordinated by KPMG’s EU Tax Centre, with the participation of KPMG firms based in Europe (the EU, Iceland and the UK). The information was initially collected in July 2021 and, where potential changes were noted, reconfirmed in December 2021.

Relevance of the EU List

In summary, most EU Member States have implemented or are in the process of adopting at least one type of tax defensive measure from the list provided by the EC.

While some Member States refer directly to the EU List in their domestic legislation, others have added jurisdictions listed by the EU to their national lists of tax havens or have excluded listed jurisdictions from domestic lists of countries that are exempt from defensive measures.

In mid-July, Spain reformed its rules tackling tax avoidance and has introduced new listing criteria for its national “tax haven” list (which has also been renamed as the “list of non-cooperative jurisdictions for tax purposes”). In practice, this represents a shift from the previous list (not linked to the EU exercise) to new criteria similar to the ones used by the EU for assessing potential harmful tax regimes.

A few countries – including Greece, Italy, Latvia, Lithuania and Poland – have not connected their national tax haven lists with the EU List. Nevertheless, even in the case of these countries, a significant number of EU-listed jurisdictions are still captured by their national tax haven lists.

For an overview of the applicability of the EU List across the Member States, please refer to the map below:

Applicability of the EU list

Source: Defensive measures against non-cooperative jurisdictions for tax purposes, KPMG International, January 2022

Given the different approaches to the listing criteria taken by Member States, taxpayers should monitor and analyze the list of non-cooperative jurisdictions operated by each Member State in order to capture all impacted non-EU jurisdictions, i.e. including those that are not listed by the EU but are relevant for specific Member States.

Timing aspects

The differences in the types of defensive measures adopted are compounded by fact that changes to the EU List do not always have immediate effect. Some EU countries make reference to the EU List applicable at a certain moment in time (e.g. the end of the previous tax year), while in others, changes made to the EU List require the adoption of an implementation act to become effective for domestic purposes.

The timing of implementing defensive measures also varies among Member States, with several countries amending their rules in 2021, including:

  • Denmark and Germany, which enacted defensive measures in 2021; and
  • Cyprus, which enacted in December 2021 legislation introducing defensive measures, i.e. withholding tax on certain outbound dividend, interest and royalty payments, which will enter into force on December 31, 2022.

Tax measures applied

If we look at the specific tax provisions applicable, the most popular measures seem to be introducing or extending existing controlled foreign company rules (to limit artificial shifting of profits to group entities in low-tax jurisdictions), increased withholding taxes for transactions with entities in listed jurisdictions and the non-deductibility of payments to countries on the EU List.

Most Member States have implemented a subset of measures from the EC’s list (see below for details), with only four countries among those that responded to the survey – Germany, Latvia, Lithuania and Portugal – having implemented all suggested legislative tax measures.

In contrast, a suite of countries limited their reaction to only one type of measure:

  • Non-deductibility of costs (Greece and Romania);
  • CFC rules (Czech Republic, Finland, Hungary and Ireland);
  • Withholding tax measures (Italy); and
  • Participation exemption restrictions (Malta).

Nevertheless, Malta has committed in its recovery and resilience plan to analyze and potentially introduce additional defensive measures to be implemented by September 30, 2024.

In the particular case of Ireland, a consultation took place in November and December 2021 on whether additional defensive measures are required, which could include the denial of deductions or the imposition of withholding taxes. If additional measures are introduced, they are expected to take effect from 2022 at the earliest.

In France, transactions with listed jurisdictions could lead to a significant increase in the tax burden – a 75 percent withholding tax applies on payments of dividends, royalties, interest, capital gains and employment income towards listed jurisdictions (the standard rate is 26.5 percent). The increased tax rate applies automatically, unless the originating company proves that the payments are not motivated by tax avoidance. The provisions of the relevant double tax treaties should also be considered.

Administrative measures

In addition to the above, almost all EU countries have introduced or are planning to adopt administrative countermeasures or other types of non-tax restrictions. Based on the review performed by the COCG,2 24 Member States apply at least one administrative countermeasure, i.e. reinforced monitoring of certain transactions and increased audit risks.

Based on the information received from KPMG firms, additional popular measures include:

  • Stricter transfer pricing documentation requirements (Cyprus, France, Lithuania, Poland and Slovakia);
  • Disclosure or reporting obligations (Belgium, Germany, Luxembourg and Poland); and
  • No or limited access to COVID-19 relief (Austria, Denmark, Germany and Spain).

In addition, in Luxembourg, companies need to indicate in their annual corporate tax return if they carry out transactions with related entities in a listed jurisdiction. This allows an enhanced control by the Luxembourg tax authorities on top of other anti-abuse provisions in this respect.

An overview of applicable defensive measures as of December 2021 can be found below:

Most EU Member States have implemented at least one defensive tax measure against countries on the EU List.

ALT

Source: Defensive measures against non-cooperative jurisdictions for tax purposes, KPMG International, January 2022

Note 1: Bulgaria, Norway, Slovenia and Sweden were not included in the survey. For details on the administrative measures implemented by Member States please refer to the COCG’s “Revised state of play of the implementation of the 2019 Guidance on Defensive Measures by EU Member States” 
Note 2: Enacted in December 2021, and will enter into force on December 31, 2022
Note 3 : Certain costs related to countries on the EU List are subject to CIT
Note 4: CFC rules applicable to individuals (but not to companies). Restrictions to deductibility of costs in place for low tax countries, but not directly linked to the national tax haven list.
Note 5: No CFC exemptions apply for non-EEA states (and consequently also for countries on the EU List

Note 6: Iceland and the UK have not introduced defensive measures based on the EU List / a national tax haven list
Note 7: Under Ireland’s worldwide system of taxation, Irish taxation of foreign dividends provides the protection that would be offered by a limitation of the participation exemption. Separately, public consultation is being undertaken to determine if additional defensive measures are required.
Note 8: Payment for certain services/royalties to residents of tax heavens may increase the amount of ‘minimum income tax’.
Note 9: Information valid as at July 2021. 

What can we expect next?

As mentioned above, the next update of the EU List is expected in February 2022 and would include the results of the assessment of third countries based on the compliance with the country-by-country reporting criteria introduced in 2019.

A reform of the mandate of the COCG, which is currently under discussion at the council level, may also lead to changes in the listing process. The reform was delayed due to the COVID-19 pandemic and is now further delayed because the Economic and Financial Affairs Council (ECOFIN) did not reach agreement on the new mandate at their December 7, 2021 meeting. While the draft document3 outlining the revised mandate for the COCG submitted to the council for approval did not cover changes to the screening criteria, Paolo Gentiloni, the European Commissioner for Economy, referred to it as an “initial reform of the Code of Conduct Group”4 . Gentiloni’s statement suggests that further changes are expected.

The European Parliament is also a strong advocate for this reform and for updated listing criteria.5 The geographical scope, as well as the screening criteria used for assessing countries, could be broadened. Changes could potentially include the introduction of the pending fourth transparency criterion with respect to the exchange of beneficial ownership information (already on the COCG’s agenda but postponed due to COVID-19), new criteria which would lead to the automatic listing of jurisdictions with a zero percent or a “very low” corporate income tax rate and of jurisdictions which do not meet a minimum level of economic substance (changes requested by the Parliament).

Lastly, another area to watch closely is the interaction of the EU List with the recent OECD/G20 Inclusive Framework on BEPS agreement on a Two-Pillar Solution. As an example, it would be interesting to see how the denial of deductions, if implemented as a defensive measure, would interreact with the Global Anti-Base Erosion (GloBE) Rules for “low-taxed” jurisdictions, which are also included on the EU List. As announced in the EC’s Communication on Business Taxation for the 21st Century, it intends to propose the adoption of Pillar Two as a new criterion used for assessing third countries.

KPMG’s EU Tax Centre will continue to monitor developments related to the EU List and its impact, and report on events via our publications.

Authors:

Raluca Enache, Director, KPMG's EU Tax Centre

Ana Puscas, Manager, KPMG’s EU Tax Centre

1For the purpose of this article, listed countries/jurisdictions refer to the countries included in Annex 1 of the list of non-cooperative jurisdictions for tax purposes.
2
For details on the administrative measures implemented by Member States, please refer to the COCG’s “Revised state of play of the implementation of the 2019 Guidance on Defensive Measures by EU Member States”.
3
Draft Council conclusions (https://data.consilium.europa.eu/doc/document/ST-14354-2021-INIT/en/pdf) on fair and effective taxation in times of recovery, on tax challenges linked to digitalization and on tax good governance in the EU and beyond, dated November 26, 2021.
4https://ec.europa.eu/commission/presscorner/detail/en/SPEECH_21_6502
5For more details, please refer to KPMG EU Tax Centre’s Euro Tax Flash Issue 440 – European Parliament resolution on reforming the EU list of non-cooperative jurisdictions.

  

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