NTJ: a closer look at the OECD’s initiative
As we know from the Paradise Papers, the Panama Papers, and the Pandora papers, the rich, the powerful, and companies can avoid paying their full share of taxes through offshore accounts and shell companies. Around 100-240 billion USD is lost in revenue annually worldwide through base erosion and profit shifting (BEPS) practices. This is equivalent to 4-10% of the global corporate income tax revenue. In response to that, the OECD came up with the BEPS initiatives.
Through the OECD/G20 Inclusive Framework on BEPS, over 135 nations and jurisdictions work together to put the BEPS package into place.
The BEPS package has 15 Actions that give governments the tools they need to stop tax avoidance, both domestically and internationally. They give countries the instruments they need to ensure that earnings are taxed where they are made and where value is created. These tools also give businesses more clarity by minimizing disagreements over how foreign tax rules should be applied and making it easier for them to follow the rules.
What is NTJ?
One of the initiatives for base erosion and profit shifting is substantial activities in no or only nominal tax jurisdictions (NTJ), also known as economic substance. It is included under Action 5 of the BEPS package and is generally used by systems in the jurisdictions the OECD identified as low or no tax jurisdictions. If incorporated in one of these jurisdictions, you must report certain information to your local tax authority. For example, are you an intellectual holding company? Are you involved in one of these highly mobile activities? The tax authority would then decide whether it needs to be reported to the ultimate beneficial owner’s countries or not.
What the OECD is trying to find with this initiative within the BEPS initiatives is if companies are being set up in no or only nominal tax jurisdictions for the sole purpose of reducing their tax burden.
What are no or only nominal jurisdictions?
No or only nominal tax jurisdictions were referred to as “tax havens” in the 1998 OECD report “Harmful Tax Competition: An Emerging Global Issue”. This document describes four key factors in identifying tax havens:
- no or only nominal taxes,
- lack of effective exchange of information,
- lack of transparency, and
- no substantial activities.
Today, there are 12 jurisdictions listed as no or only nominal: Anguilla, Bahamas, Bahrain, Barbados, Bermuda, British Virgin Islands, Cayman Islands, Guernsey, Isle of Man, Jersey, Turks and Caicos Islands, and the United Arab Emirates.
On March 2021, the 12 jurisdictions began their first tax information exchanges under the Forum on Harmful Tax Practice’s (FHTP) global standard on substantial activities. To ensure the effectiveness of NTJ, the FHTP carries out annual monitoring of the regulatory compliance of the 12 jurisdictions. You can find the results on the map below by clicking on each jurisdiction.
What types of companies are set up in no or only nominal tax jurisdictions?
The companies set up in these jurisdictions generally fall into two categories.
1. Intellectual property
When that property is licensed, the licensing or royalty fees will get paid to that offshore company. So it won’t be subject to the taxes in that corporation’s home country or the individual that is the ultimate beneficial owner of the property.
2. Highly mobile activities
There are specific activities that you can move around relatively easily, and you could place that part of your business, or your entire business, in one of these tax jurisdictions to avoid paying your total share of taxes.
How does NTJ work?
Let’s say a French and German chemist paired up to create a new chemical process which they patented. The scientists could transfer that patent to one of these 12 countries for tax avoidance.
Whenever an industry or company worldwide wants to use that process, that industrial process, they would have to license it from that holding company that these two individuals created, meaning that the royalty payments or licensing payments would end up getting paid to that company in that low tax jurisdiction.
The purpose of NTJ would be for that company to get reported back to the tax authority in Germany and the tax authority in France so that they would know that there was an ownership structure in the low tax jurisdiction that this patent had been transferred to, which is receiving royalties. It may be that in France and Germany, those two company owners would need to be paying taxes on those royalties or licenses.
The mechanism would be that the company in the low tax jurisdiction, or the company service provider on behalf of the German and French citizens, would report that information to their tax authority. They would see that it’s high risk and intellectual property must be exchanged. They would then exchange a copy of it to Germany and a copy to France to notify those tax authorities that this company exists and is receiving royalties or licenses.
The OECD defines the actual mechanism. It’s called the Common Transmission System, and it’s a transmission protocol between tax authorities. It’s a secure transfer mechanism, and it’s used for many different types of data, not just NTJ. So, for example, all the credit data goes there, as well as several other data exchanges under the base erosion and profit shifting initiatives.
What are the problems with NTJ?
First of all, it requires a fair amount of reporting.
- Every company needs to fill out an economic substance test, or the company service providers would fill it out on your behalf.
- These forms must be collected and contain information about the company and its activities.
- Answers to the management test also need to be collected.
- There’s also a validation of intellectual property to determine if it needs to be exchanged or not exchanged.
- Then there’s baseline information about the revenues and the employees.
And that’s to name a few. Each company in the 12 jurisdictions needs to collect all of this information and evaluate it every year. That’s a lot of information for the tax authority to digest and decide whether it’s adequate or not adequate.
This brings another problem, which is “adequate”. For example, are there adequate resources? Is there sufficient expertise on the board of directors? But, again, those are difficult decisions that would have to be made and are not easily quantifiable by the tax authority.
So the amount of effort and time needed to collect and evaluate the information for NTJ and the loose and undefined terms like ‘adequate’ and ‘sufficient’ is indeed a problem.
There are also some things around the structure that could be improved. For example, what’s a reasonable price if you sell a logo or a trademark to a company in one of these jurisdictions? If you sell it for a dollar, is that reasonable? If you sell it for $1,000,000, is that reasonable?
Finally, some loopholes could be used to get around some of these economic substance tests to ensure that information doesn’t get exchanged and the actual ownership structure doesn’t get back to the tax authorities in some of the more highly taxed jurisdictions.
What are the strategies to solve the NTJ problems?
Low or no income tax jurisdictions employ two strategies to adhere to this NTJ scheme.
1. Require annual economic substance forms
Providing an annual form and collecting all this information each year can be an effective strategy as it’ll catch any circumstances change. For example, if there’s a change in ownership structure or the company has entered a new line of business. But, with a large number of companies incorporated in many of these jurisdictions, it creates a bottleneck for the tax authority to be able to process, evaluate and exchange that information.
2. Require updated centralized database
Another strategy would be to collect that information once. It may be a one-time collection in the jurisdiction, and then any new companies, as they get registered, would be filling out these forms. The tax authority would then require companies to either review and say nothing’s changed or ask companies to update the information in the database if circumstances change.
Once it’s been evaluated by the tax authority, they can say whether it’s exchangeable or not and assume that the status carries over from year to year. If it is exchangeable, you would have to get the latest financials, the number of employees and other information needed to have an accurate exchange of information.
Generally, the beneficial owners don’t differ from year to year, and most companies don’t go into new lines of business. So once the tax authority has made that evaluation (which would have been a tremendous effort to go through and evaluate all the companies, which in some of these jurisdictions can sum up to a number in the tens of thousands or even 100,000 companies), you’ve identified the subsets that are potentially exchangeable. So then, it’s just a matter of categorizing any new companies that come on board or reevaluating any companies that have a change of circumstance that may warrant looking at the status again; perhaps the company goes from exchangeable to not exchangeable or vice versa, or they enter a new line of business, and now you do want to exchange that information. So that would reduce the burden on the tax authority of having to evaluate every year. But it does open the possibility that a change of circumstance doesn’t get logged and recorded, and you miss some companies that may need to be exchanged.
What can the OECD do to improve NTJ?
It’s undoubtedly commendable what the OECD is trying to do. They’re trying to shed some light onto some of these shell companies that may have been created for tax avoidance. To create awareness with the tax jurisdictions in more highly taxed countries that this may be occurring is certainly applaudable. However, I think the way they went about it is not well-defined enough to be especially useful and efficient. So the OECD would probably need to rethink this a little bit, come up with better definitions, and make it easier to do reporting and exchange of information across the board, and for this, I propose three improvements.
1. Talk to the receiving jurisdictions
I encourage the OECD to talk to the tax jurisdictions receiving this data and find out how they’re using it and where it is being used. These jurisdictions might give a better idea of the set of data. For example, are they getting the right data points? Are they getting too much data? Would a different dataset work better? What’s being done with it? Is it being used at all?
2. Talk to the reporting jurisdictions
The second improvement would be to talk to the jurisdictions doing the reporting—the other side of the equation. Tens of thousands of companies have to fill out economic substance tests every year, and it takes a lot of time and effort. The same thing happens with the tax authorities, who are trying to evaluate and determine if these need to be exchanged. So the OECD needs to verify if there are any ways that this process could be streamlined to become more effective and not such a burden on these 12 jurisdictions and all the companies registered in those jurisdictions.
3. Check for overlap in the information
As a third improvement, consider whether some of this information is already being collected and exchanged. For example, the NTJ system aims to identify those holding companies or companies that have moved some of those highly mobile activities into a low or no tax jurisdiction to avoid taxes. The way you would do that is to have an account held by a financial institution. But financial institutions are already reporting the ultimate beneficial owners under CRS. So, is there an overlap between NTJ and CRS? Or is there some value added through NTJ that’s not already being realized by CRS or even some other initiatives under the BEPS umbrella?
What is Trans World Compliance doing to help with NTJ?
The No or Nominal Tax Jurisdictions (NTJ) module provides a fully automated system to support tax authorities’ implementation of the BEPS initiative Action item 5. It includes the requirement for the 12 jurisdictions to collect and exchange information on companies in their jurisdictions that either hold high-risk IP, are pure holding companies, and/or participate in certain Core Income Generating Activities.
The NTJ or economic substance module is part of Trans World Compliance’s Tax Authority Compliance Software (TACS), which provides a comprehensive modular platform to automatically exchange FATCA and the OECD’s CRS, CbC, NTJ, MDR, and ETR data types. TACS was created to support all 24 OECD BEPS data exchange types through the OECD’s Common Transmission System (CTS 2.0).
Although the data collected for exchange is only needed in the 12 jurisdictions, all CRS member countries will need a mechanism to receive, decrypt, and download these reports. NTJ is a bi-directional module and can be used in a completely automated fashion to both send and receive NTJ information.
