The last decade has seen many changes in the ever evolving global taxation landscape. Globalization, as well as economic and political pressure, have caused the OECD to reassess their position on the taxation of multinational enterprises (MNE) in respect of the profits that they derive from their cross border operations. To this end, the OECD has devised a multistage process to address this situation. One such stage involves a more coordinated approach to the issue of Base Erosion and Profit Shifting (BEPS).
The OECD has stated that
“BEPS refers chiefly to instances where the interaction of different tax rules leads to some part of the profits of MNEs not being taxed at all. It also relates to arrangements that achieve no or low taxation by shifting profits away from the jurisdictions where the activities creating those profits take place.”
The OECD has developed an Action Plan, which identified fifteen action items that countries should implement to address and eradicate instances of BEPS. Of the fifteen identified action items, there are two in particular that are likely to have an impact on the Barbados international business sector. These are Action items 5 and 6 which deal with measures to counter harmful tax practices and tax treaty abuse respectively.
In essence, these particular Action items will have an impact on holding, finance and licensing companies that seek to obtain benefits under Barbados’ double taxation agreements. For example, it is not uncommon for a Canadian company to establish a Barbados International Business Companies (IBC) to own its shares in its Chinese subsidiary that is carrying on an active business. Dividends derived by the IBC from the Chinese subsidiary would benefit from a reduced withholding tax in China to 5% under the Barbados/China double taxation agreement (“China DTA”), a saving of 5%.
In 2009, the Chinese Tax Administration issued Circular 601 where it stipulated that a non-resident recipient of passive income China, such as the IBC in the above example, must demonstrate that it has sufficient substance, such as staff, premises, business operations, to qualify for treaty benefits. Therefore, it is no longer enough for the IBC to demonstrate that it is resident in Barbados under the central management and control test to qualify for the reduced withholding tax under the China DTA.
Recently, China introduced new measures designed to deny income tax deductions for certain services and royalties paid by Chinese companies to their overseas affiliates that do not undertake functions and risks and/or lack economic substance.
Mexico’s tax reform provisions in 2014 introduced a number of provisions that address BEPS issues directly including a provision that allows the Mexican tax authorities to ask a foreign taxpayer that carry out activities with a Mexican related party, in connection with which treaty benefits are being claimed, to prove the existence of “legal double taxation” by way of a sworn statement signed by the taxpayer’s legal representative.
The above examples demonstrate some of the measures that countries have introduced into their domestic legislation that are in conformity with the BEPS initiative. Other examples can also be found in recent changes introduced in Canadian domestic legislation and it is expected that this trend will continue in other countries. International business entities established in Barbados will be required to demonstrate to relevant foreign tax authorities in addition to the exercise of central management and control being located in Barbados that their business activities carried on from Barbados have sufficient substance, by means of employees, office facilities, etc., to justify the profits generated by such activities.
In this regard, the fact that traditionally many of the international business entities operating in Barbados are owned by residents of Canada is helpful for the reason that such entities have typically needed to have a certain level of substance in Barbados to satisfy the Canadian tax rules.
As a result, service providers in Barbados have developed a significant level of experience in assisting their clients in creating the required substance by, for example, offering services such as finding or providing office space; providing or assisting in the search for employees to carry out a range of duties, including negotiating contracts, generating purchase orders, invoicing and banking as well as acting as directors. The implementation of BEPS will pose many challenges for Barbados’ future as an International Financial Centre (IFC) . However, it will also provide opportunities for Barbados to leverage its strengths, such as its large network of DTAs, well-educated work force, highly developed support infrastructure and maturity as an IFC, to expand is reach into new markets, such as Africa and certain countries in Latin America.
In this ever-changing world sometimes only the fittest will survive. Barbados has all the basic attributes to survive the challenges that the BEPS project is expected to pose for small international financial centres. However, this will require both the Government and the private sector to display a greater willingness to implement the necessary changes in focus and strategy in order for Barbados to not only survive but succeed as an IFC.