U.S. Companies Flee No-Tax Caribbean Havens After EU Crackdown

(Bloomberg) -- Many U.S. multinational corporations have packed up or are choosing to open subsidiaries in low-tax, rather than no-tax, countries that are seen as more legitimate than the formerly popular island destinations of the Cayman Islands and the Bahamas.

They’re fleeing in response to regulations from the European Union that require them to justify the business purpose for their offshore operations. Low-tax countries that have been attractive destinations for multinationals -- such as Singapore, Ireland and the Netherlands -- are becoming even more desirable, especially as they make changes to show they’re more legitimate.

“The days of picking a holding jurisdiction mainly because of tax are over,” said Allen Tan, head of the tax practice at law firm Baker McKenzie Wong & Leow in Singapore.

American corporations have used tax havens for years to avoid higher levies where they actually earn the income. European countries and the U.S. have teamed up in recent years to stop the use of loopholes and collect more of the tax dollars the companies domiciled within their borders owe.

Facebook Subsidiaries

Insurance firm Swiss Re AG closed one of its Bermuda subsidiaries in 2016. It opened its regional headquarters in Singapore in January. The company said in a statement that it doesn’t use tax havens for the purpose of avoiding tax and that the entities registered in Bermuda are fully taxable in the U.S.

Facebook Inc. has said it plans to almost triple its workforce in Singapore. The social media giant only reports Irish and Singapore subsidiaries, according to a 2017 study by the left-leaning Institute on Taxation and Economic Policy. The company said last year it was overhauling its sales structure so income is booked in the country where it’s earned. Facebook has until 2020 to wind down transactions where it routed income from Irish subsidiaries to the tax-free Cayman Islands. Nora Chan, a spokeswoman for Facebook, didn’t respond to a request for comment.

Countries like Singapore that are more developed and still offer relatively low tax rates are seizing the moment, highlighting their infrastructure, available labor forces and tax agreements with other countries.

Tax experts say the driving force behind the move away from the most flagrant tax havens is a series of requirements from the Organization for Economic Cooperation and Development intended to stop companies from shifting profits abroad. The standards, which have become law in many European countries, require companies to show economic substance -- employees, management teams and sales -- in the countries where they’re earning income.

Tax authorities in OECD countries also have to exchange data annually with each other about how much income companies are earning, how much tax they’re paying and how many employees they have within their borders. The first data swap occurred in June.

‘Income into Ocean’

Two of the most egregious tax moves -- the “Double Irish” and the “Dutch Sandwich” -- that often involve using zero-tax havens as the final destination for offshore income were effectively killed thanks to the OECD rules, though some companies like Facebook have a couple more years to wind down the practice. The U.S. Internal Revenue Service is planning to issue rules soon that would implement some of the OECD requirements.

Alphabet Inc.’s Google had moved 15.9 billion euros ($18 billion) to Bermuda in 2016 using the maneuvers to shield much of its international profits from taxation, according to a 2018 regulatory filing in the Netherlands.

With those transactions “income essentially falls into the ocean because nobody is taxing it,” said Jeffrey Korenblatt, a tax attorney at law firm Reed Smith.

Now, companies in the technology and pharmaceutical industry that were the most frequent users of the tactics are forced to keep that income within the initial European country. In turn, Ireland and the Netherlands are tightening their accounting guidelines and making it more difficult for companies to massage their numbers about where income is earned.

Still, some firms -- such as hedge funds -- are staying put in their Caribbean locations, undeterred by political pressure and facing fewer restrictions since many are private.

‘More Proper’ Subsidiaries

Ireland has always been an attractive destination for large multinationals looking to minimize taxes, but it’s becoming even more desirable in the current environment given its relatively uncomplicated system, consistently low rate of 12.5 percent, European Union membership and educated workforce of relatively low-cost English speakers.

It’s the top pick for many U.S. multinationals more today than ever before, according to Linda Pfatteicher, managing partner of law firm Squire Patton Boggs San Francisco and Palo Alto offices.

The companies being set up in Ireland now have more substance behind them, said Vivian Nathan, an adviser who helps companies form Irish subsidiaries. “Fifteen years ago we would form 500 companies in a month or two. Now we do 10 big projects,” he said. “It’s taken more seriously. It’s more proper.”

Tax ‘Grey List’

The Netherlands has been pushing back on its perception of helping U.S. companies avoid taxes. More than half of Fortune 500 companies reported at least one subsidiary there as of 2016, according to research from the Institute on Taxation and Economic Policy.

The Dutch government is considering a series of proposals to prevent companies from shifting income outside the country, as well as a withholding tax on inter-company debt and royalty payments, which can be used as tools to reduce tax liabilities. The country is also considering reducing its corporate rate -- which at 25 percent is higher than many of its peers.

“I think what’s really wanted is to remain an attractive option for foreign investors,” said Jian-Cheng Ku, a legal director at law firm DLA Piper in Amsterdam.

Other European countries, such as Switzerland, are trying to make sure they don’t become blacklisted. The European Union placed Switzerland on a “gray list” of jurisdictions with questionable tax regimes last year. Now the country is working to overhaul its corporate tax system.

U.S. Companies Flee No-Tax Caribbean Havens After EU Crackdown

Switzerland, which has traditionally been a favorite low-tax jurisdiction for banking and money managers, is at risk of losing some of its market dominance to Singapore or other locations, said Ronen Palan, an international politics professor at the City University of London.

Singapore is becoming a popular destination for headquarters because of its 17 percent corporate rate, lax regulatory network, British-style legal system and large airport making it easy for executives to travel.

The Asian country increased its market share of global assets under management by 12 percent from 2010 to 2017, while assets in Switzerland declined by 7 percent, according to a Deloitte study released in May. Switzerland’s decline follows several years of tax disputes and more than 80 banks reaching agreements with the U.S. to resolve potential criminal activity.

Panama and the Caribbean were the hardest hit, losing 67 percent of their assets because they’re just not as attractive compared to larger, more mature countries, the Deloitte report said.

The next step for European and Asian countries that are attracting corporate operations is to shift their focus to locking in some of the income earned within their borders, said Bret Wells, a tax law professor at the University of Houston. Countries are likely to replicate the U.S.’s base erosion and anti-abuse tax, known as BEAT, a provision in the new tax law that prevents corporations from shifting profits to a lower-tax jurisdiction offshore.

Eventually, traditional zero-tax havens, especially those that are close to Europe -- such as the Isle of Man and Jersey -- may work to shed their bad actor image to keep up with the larger countries, Nathan said. He expects that within five years those countries will be among Ireland’s fiercest competition.

“There has been a political and a public reckoning and this has become a big thing,” said Steve Wamhoff, director of federal tax policy for ITEP. “There were a lot of years where corporations were getting away with murder.”

©2018 Bloomberg L.P.