The World Bank has published a policy paper dated 12 March 2019 on Low Tax Jurisdictions and Preferential Regimes: Policy Gaps in Developing Economies. The paper reviews recent international initiatives and domestic policy developments aimed at helping countries to protect their tax base against erosion by individuals and companies that allocate assets to or route income via low tax jurisdictions. The paper highlights the benefits and limitations of existing policy instruments from the perspective of capital-importing developing economies. Focusing on two common policy gaps for developing economies, options are explored for:
- introducing necessary charging provisions to ensure effective taxation of individuals, and
- an anti-diversion rule tailored to reflect developing economy contexts and administrative constraints.
These proposals include a possible definition of excess profits in low tax jurisdictions and options for distribution keys to reallocate profits to countries where there is “real” economic substance and activity. The measures discussed could also address the diversion of profits to entities benefitting from preferential regimes in countries with high nominal tax rates.
The paper concludes that developing economies need an effective charge on the income and gains of wealthy individuals who make use of offshore structures and low tax regimes to minimize their tax liabilities. Existing practices in a number of countries provide a useful template to follow in implementing effective tax provision.
The paper also concludes that an anti-diversion rule can complement transfer pricing regimes in developing economies. To make such a rule commensurate with limited administrative capacity, it needs to be mechanical and targeted at the main abuse risks. Such an approach may appeal to countries that are less comfortable with anti-avoidance rules that require the exercise of judgement and discretion, whether that is because they are more familiar with rules-based approaches, or because they are concerned that too much discretion increases the risk of favoritism, or corruption. By incorporating the proposed rule in the design of the CIT, countries can ensure it is subject to treaty obligations to avoid double taxation and that the tax is creditable. To address the concerns of foreign direct investors that have lowly taxed entities that are unrelated to activities in developing countries, an anti-diversion rule could be subject to rebuttal.