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A matter of substance: we must not get the short end of the EU stick

Fighting for position: offshore financial centre provide tax competition to EU member countries

It is a well-known truism in economics that you cannot control both the price and the supply of an item at the same time — you can control the price (price controls) but the supply will self-adjust. You can also control the supply, but the price will self-adjust.

There is an apparent similar maxim in the area of national tax policy, except it contains three elements instead of two. The three elements are:

1, National tax policy

2, Free movement of capital

3, No tax competition

The rule is that you can have any two of the three, but not all three. The European Union, through its Code of Conduct Group, is mightily trying to have all three. They already have a national tax policy and free capital movement. The way they are trying to accomplish this is to eliminate a source of tax competition that they see as being the weakest one: ie, offshore financial centres, of which Bermuda is one of the most successful. The elimination of important tax competition will make it easier for EU countries to maintain their high tax rates without losing capital to other lower-taxation jurisdictions.

Offshore financial centres provide significant tax competition to EU member countries, as does the United States, Britain and many other countries. But, typically, offshore financial centres are small countries with very limited political clout on the world stage — unlike the US — and therefore can be bullied into cutting their own throats. And, make no mistake, blacklisting and other such extrajudicial actions are indeed state-sponsored bullying.

This is the context that is required to understand the rationale behind the EU Code of Conduct Group’s actions.

The Bermuda Government has committed to co-operate with the Code of Conduct Group as it relates to companies registered in Bermuda that have a “lack of substance”.

First of all, what does this phrase mean? Well, it apparently has not been defined yet. The danger for Bermuda is how this is defined. The most important thing for Bermuda is that any “substance” definition be universally applicable. This means that the definition will apply to us as well as them — no double standards, please. So if rules are applied to companies that “lack substance”, the definition doesn’t give similar EU companies an escape hatch.

Here is what they are driving at: they would like to say that a Bermuda company, which, say, was a holding company whose only assets are patents and other intellectual property, lacks “substance” because it does not employ anyone or trade locally. Of course, such assets could be worth billions, but if you define substance as employing people or trading locally, then that definition would be highly discriminatory and will cause great harm to Bermuda’s international business sector.

The thing is, the holding or owning of assets by a company, whether intellectual or physical, is a legitimate and, dare I say, “substantial” economic purpose.

But the key thing is that whatever definition you have applies to them as well. So, if we cannot have holding companies that do not employ people or trade locally, then they cannot have such companies, either.

There is some notion that holding companies, referred pejoratively as “shell” companies, are unique to offshore financial centres. They are not. Holding companies are found everywhere, including the EU. So we must avoid agreement to a definition of “substance” that is designed to hurt us and not them.

While such companies may not directly and individually employ people in Bermuda, collectively, the administration of such companies does indeed employ many, many Bermudians and results in the collection of millions of dollars in tax revenues by the Bermuda Government.

Therefore, the wise and careful handling of this issue by Bermuda is essential to the island’s economic success going forward.

Bob Richards was the Minister of Finance and Deputy Premier of Bermuda from December 2012 to July 2017