From theory to practice: development finance institutions and Global Forum peer reviews

There are two big ‘policy coherence’ issues when it comes to taxation and the way that development assistance works. The first is the way donors often demand tax exemptions for aid-funded projects. If you think about how aid can be quite a large share of GDP in some low-income countries, these are large sums at stake, so I’m pleased that this is back on the agenda of the UN tax committee.

The second area is the way that development finance institutions (DFIs), which use aid money to invest in private sector projects, often make investments that are structured through tax havens. While DFIs vocally defend this practice, NGOs have been complaining about it for a while, arguing that such structuring is often aggressive tax avoidance, and that it builds, rather than reduces, the role of offshore jurisdictions with respect to developing countries. But NGOs’ position has always been weakened by the absence of an authoritative ‘blacklist’ of jurisdictions to be avoided.

That changed last week with the publication of the OECD Global Forum on Transparency and Exchange of Information’s long awaited peer review results.Here we have a list of four jurisdictions (The British Virgin Islands, Cyprus, Luxembourg and the Seychelles) that are officially ‘non-compliant’ with OECD standards, and two more (Austria and Turkey) that are only ‘partially compliant’.

This put me in mind of a Guardian article earlier this year in which Luxembourg was one of the six offshore jurisdictions through which Britain’s DFI, the Commonwealth Development Corporation, makes its investments. According to that article, “DfID said it will ensure CDC only invests via jurisdictions deemed to have substantially implemented tax standards, according to the OECD global forum on tax and transparency.”

So, what does Luxembourg’s ‘blacklisting’ mean for CDC? Will it cease to invest through Luxembourg? And what of its “new long-term financial commitment” through this country?

A more detailed policy is that of the World Bank’s International Finance Corporation [doc], which states:

IFC will not submit to the Board for approval any new IFC Investment in any IFC Investee Company organized in an Intermediate Jurisdiction, or controlled by an entity organized in an Intermediate Jurisdiction, that has not met international norms for tax transparency by reference to the published results of the Peer Review Process. An Intermediate Jurisdiction will be deemed not to have met international norms for tax transparency if, subject to paragraph 9 below:(i) a Phase 1 review has been completed and, based on a report publicly issued as part of the Peer Review Process, the Phase 2 review is deferred because the jurisdiction does not have in place crucial elements for achieving full and effective exchange of information; or

(ii) a Phase 2 review has been completed and, based on a report publicly issued as part of the Peer Review Process, the overall assessment of the jurisdiction is “partially compliant” or “non-compliant;”

The outcomes of the policy are summarised in the following table:

Summary of the IFC's tax transparency policy
Summary of the IFC’s tax transparency policy

So it seems to me that investments made through those six jurisdictions that were labelled partially or non-compliant in their phase 2 reviews are now off the cards for the IFC. But it also looks from the policy wording like the 14 jurisdictions that did not progress to phase 2 (Botswana, Brunei, Dominica, Guatemala, Lebanon, Liberia, Marshall Islands, Nauru, Niue, Panama, Switzerland, Trinidad and Tobago, the United Arab Emirates and Vanuatu) should also be excluded.

There is some language about how these outcomes can be ‘rebutted’, “if the World Bank Group is satisfied that the jurisdiction is making meaningful progress.” So it will again be interesting to see how the IFC’s policy, which up until now has been largely a theoretical exercise, holds up in practice.

Postscript: If we wind back to the OECD’s classic 1998 definition of tax havens, information exchange is neither a necessary nor sufficient criterion: the core criterion is low tax rates, and then other things such as economic substance requirements and tax treaty networks, as well as information exchange, come into it as secondary criteria. So we can’t say that, by not using these jurisdictions, a DFI would definitely not be engaged in aggressive tax planning or supporting the ‘tax haven’ industry. We don’t have a list for that. But this is a start at least!