The trick of tax 'convenience'

Tax authorities are all the same. They want more control - global control - when possible.

Being clever fellows, they know that they must at least pretend to be gracious, and offer something in exchange. That something usually turns out to be convenience. "We'll take more of your money than before", the authorities say. "But we promise to do it in the least troublesome, quickest way possible".

Or, as the OECD put it in a recent classic of a statement about tax havens, "we are not bludgeoning them; we are trying to be helpful".


Why, after all, would a small financial centre be anything but thrilled to surrender its only competitive advantages and follow the standards of big, bloated, high-tax countries?

In any case, these days the "convenience" argument is being plied as rarely before. Consider a tiny piece of the current global tax crackdown story, the new American rules regarding withholding on payments by US-based firms of interest and dividends and other forms of investment income to people living outside America.

These rules, effective in 2001, are being presented and received as "convenient".

And in some ways they are. Payments to non-US based investors were already subject to withholding, sometimes to amounts in the 30 per cent range. Now paper forms that used to be good for only one year will be good for three years or more. This cuts paperwork for the thousands of investors who claim the reductions or exemptions to which many of them are entitled under various statutes or bilateral treaties. Besides, as International Revenue Service (IRS) sympathisers point out, the new American forms may be difficult, but they are not as bad as many tax documents require by other nations' tax authorities.

But here's the big convenience lure: if investors make their investments through a "qualified intermediary", a local bank or brokerage that has been approved by the IRS, then the form-filling will be even easier. Looking for anonymity? In theory you can still have it, merely by signing up with one of these QIs. The intermediaries are not obligated to identify individual investors to the IRS.

But that of course is only part of the story. For these "convenient" rules also give the IRS more control than it had before over investors scattered around the globe. It also enables it to grab those Americans who owe the US government tax on all their income, wherever they earned it.

The first way the IRS gains control is through the Qualified Intermediary Institution itself. In effect, it is forcing German, French, or English financial institutions to make a choice: sign up to become an arm of the US global tax police or be penalised and lose advantages against neighbour competitors who do become QIs. This will have a negative effect on the banking culture generally. Instead of standing for enterprise and returns, the financial institutions will also stand for compliance.

What's more, investors in private securities or partnerships who don't operate through a QI will have to identify themselves clearly to the IRS - or pay higher tax rates than those to which they are entitled. This is new. In the olden days, the same investors could avoid contact with the IRS. In other words, in the name of corralling tax evaders, the IRS is forcing direct investors to give up some privacy.

Finally - surprise! - QI clients won't really enjoy privacy, since QI financial institutions have to agree to periodic audits to retain their coveted QI status.

But perhaps the most important effect of the new rules is to put the squeeze on tax havens. That's because only banks and brokerages in countries that have won a gold star from the IRS - passing a test known as the "know your customer standard" - can serve as qualified intermediaries. Those countries that have failed so far to make the grade - the Bahamas, Liechtenstein and others on an IRS bad boy list - are left out in the cold.* So are their businesses and customers.

In short, the new withholding regs are bad news, at least for people who believe that not every international investor who wants financial privacy is a drug dealer, money launderer or con man. The old patchwork system of different rates, different withholding rules and different tax cultures in different countries may have provided wonderful hiding places for illegal activity. But it also forced healthful tax competition - without the lower-tax US next door in the 1990s, Canada would never be contemplating lower taxes today. And without lower-tax Britain across the Channel, Germany would not be putting through growth-oriented rate cuts now. Absent obstacles, governments will tend to harmonise upward. And without competition, who knows where they'll stop?

* List of Jurisdictions without qualified Know-Your-Customer rules

© Copyright 2001 Financial Times

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