“Countries such as Barbados that offer investors the benefits of low taxation together with a wide network of DTAs will generally continue to enjoy a strategic advantage over countries that offer a combination of zero taxation and a network of TIEAs.”
On 29 June 2011, the Barbados Government signed a Tax Information Exchange Agreement (“TIEA”) with Denmark, the Faroe Islands and Greenland. On the same date it also initialled a Double Taxation Agreement (“DTA”) with Iceland and Protocols to the existing DTAs with Finland, Norway and Sweden.
Prior to this, the only TIEA that Barbados had concluded was that with the United States in 1984. However, in that case, the TIEA was accompanied by a comprehensive DTA with the US and brought with it significant benefits for Barbados. Since then Barbados has pursued a policy of entering into DTAs and not TIEAs.
However, in the last three years, following the onset of the global economic crisis, there has been a rush by many international financial centres in the Caribbean and elsewhere to conclude TIEAs in order to meet the OECD standard on exchange of information.
The question has been asked as to whether the initialling of the TIEA with Denmark signals a change in the Barbados Government’s policy of entering into comprehensive DTAs as its preferred method of complying with the new OECD standard on transparency and exchange of information.
It is understood that, while there may be other circumstances in the future in which it may be important for Barbados to enter into a TIEA with a particular country, maybe as a precursor to entering into a DTA at a later date, the Barbados Government has not abandoned its stated policy of expanding its network of DTAs as its main strategy for growing its international business sector.
The reasons for this can be found in a close examination of the differences between TIEAs and DTAs. So what are those differences?
Double Taxation Agreements v Tax Information Exchange Agreements: The Main Differences
Double Taxation Agreements
DTAs have a long history, dating back to the early part of the 20th century. The primary objectives of a DTA are:
- to promote cross border trade;
- the avoidance of double taxation; and
- the prevention of fiscal evasion.
There is no doubt that DTAs have played a significant role in developing cross border trade and investments over the last century. However, it is also clear that, in recent times, TIEAs have grown in importance as a result of the emphasis placed by a number of international organizations, such as the OECD and the G20, on the prevention of tax evasion through exchange of information. Nevertheless, it is widely accepted that TIEAs in their current form cannot replace DTAs in relation to the important role of facilitating cross border trade and investments. The main reasons for this are examined below.
For the investor, DTAs offer the following benefits:
- Certainty of tax treatment in relation to the income and gains derived from their cross border investments.
- Reduced withholding taxes in the source country in respect of certain types of income, such as dividends, interest and royalties, derived from passive investments.
- The assurance that in general the income from their investments will not be subject to less favourable tax treatment in the source country than the investments of residents of that country.
- A means of eliminating the incidence of double taxation of income accruing on their cross border investments through the use of foreign tax credits.
- The ability to effectively manage the burden of the tax costs associated with their cross border trading and investment activities.
From the point of view of the countries that enter into DTAs, the benefits are:
- The ability to ensure that the taxing rights in respect of income derived by a resident of one country from sources in the other country are fairly allocated between the two countries.
- A mechanism for the settlement of disputes that may arise between taxpayers and the tax authorities and also between the tax authorities themselves, for example in the area of transfer pricing.
- The ability to obtain tax information in order to combat tax evasion and avoidance.
Tax Information Exchange Agreements
Given the advantages to investors and to the countries that have concluded DTAs outlined above, why do countries such as Bermuda and the Cayman Islands choose to enter into TIEAs? The answer of course lies in the fact that, as a matter of policy, many OECD countries and some of the larger developing countries, such as China, generally refuse to enter into DTAs with countries that do not levy income taxes. However, in an attempt to combat tax avoidance and evasion by their taxpayers, they are keen to enter into TIEAs with such countries.
Therefore, in order for jurisdictions such as Bermuda and the Cayman Islands, to meet the OECD standard on exchange of information, they have little choice but to enter into TIEAs. Unlike DTAs, the sole purpose of TIEAs is to “promote international cooperation in tax matters through exchange of information”.
TIEAs offer cross border investors no protection from double taxation and, as a result, they make little or no contribution to the encouragement and facilitation of international trade and investment. However, they are simple to negotiate, which is one of the reasons why the OECD member countries prefer to enter into TIEAs, rather than DTAs, with small international financial centres.
In general, TIEAs offer small international financial centres very little benefit. Instead, they are likely to present such countries with significant challenges because of the limited resources available to them with which to deal with information requests.
Some countries, such as France, Canada and the UK, have offered incentives to countries to enter into TIEAs with them.
Perhaps the most significant incentive is that offered by Canada. In a 2007 budget measure, the Canadian Government extended the scope of the exempt surplus rules to enable Canadian companies that have foreign affiliates in countries that have concluded TIEAs with Canada to benefit from the exempt surplus treatment in respect of dividends derived from the active business income of such affiliates. Previously, such tax treatment was reserved for dividends derived from foreign affiliates that are resident in a country, such as Barbados, that has a DTA with Canada.
Concern has been expressed that this development will result in Barbados losing its competitive advantage in the Canadian market over “zero tax” jurisdictions, such as Bermuda, that have concluded TIEAs with Canada. Although there could be some fall out in the Canadian market as result of this development, it should be borne in mind that an investor’s choice of a suitable international financial centre in which to establish operations is based on a number of factors.
In many cases, because of the significant advantages offered by DTAs compared to TIEAs highlighted above, the existence of a wide network of DTAs that provides an opportunity to effectively manage from one location the tax costs, as well as the tax risks, associated with their trading and investment activities in multiple jurisdictions is of paramount importance to all investors, whether from Canada or elsewhere.
For this reason, countries such as Barbados that offer investors the benefits of low taxation together with a wide network of DTAs will generally continue to enjoy a strategic advantage over countries that offer a combination of zero taxation and a network of TIEAs.