Investments for development: derailed to tax havens

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I spoke at the launch of a new report I have written last evening in Bergen, Norway.

The report is entitled ‚ÄòInvestments for Development: Derailed to Tax Havens’. The report focuses on the use of tax havens / secrecy jurisdictions as investment conduits by Development Finance Institutions (DFIs). They are state owned companies located in European companies that invest their capital in developing countries for the express purpose of advancing development in those places by promoting investment in local business. The best known in the UK is CDC plc, formerly the Commonwealth Development Corporation. DFI activities can be compared to that of the European Investment Bank (EIB) and International Finance Corporation (IFC) – a part of the World Bank. At the end of 2008 the DFIs that were members of the European Development Finance Institutions network (EDFI) had combined funds invested of about €16.7 billion.

The report argues that DFIs should encourage three things:

1. Business activity in developing countries – but consistent with the relief of poverty

2. Distribution of the benefit of that business activity within those countries, or their development objective is not fulfilled

3. As publicly funded agents for change they have to be transparent and accountable about all they do and be seen to promote the highest standards of social, environmental and governance policy compliance.

In that connection the report also argues that the DFIs have a duty to maximise their economic footprint in the countries in which they invest and that means they have a duty to pay tax in those places if they are to pay tax anywhere. I stress, the argument is that they should actually seek to pay tax there, support the tax systems of those countries, and encourage the development of those tax systems if necessary. This is an explicit component of the development agenda.

We argue they don’t do that. They invest in two ways. The first is directly, holding minority stakes in companies in developing countries. But increasingly they invest via funds in private equity style, often partnering with private equity partners. In both cases they use secrecy jurisdictions, either as intermediate holding companies or as the location in which funds are located.

DFIs argue this is necessary, to avoid double tax, to pool capital, to use legal infrastructure and to provide legal certainty.

The report does not agree with this. We argue there are seven reasons why investment in developing countries through tax havens is harmful. They are:

—Contributes to the loss of tax revenues by developing countries.

—Contributes to maintaining tax havens

—Contributes to supporting structures that facilitate illicit financial flows, even though there is no suggestion DFIs engage in such activities

—Contributes to the misallocation of investment funds

—Contributes to the risk that investments fail to meet governance criteria

—Contributes to the risk that DFIs are not democratically accountable

—Contributes to development ineffectiveness

Summarised, apart from the clearly inappropriate action of supporting tax haven behaviour that is demonstrably harmful to developing countries there is also the straightforward problem that the opacity of the arrangements into which DFIs enter – often made even more opaque by the now common tiering of structures through tax haven locations – makes governance harder and increases risk as a consequence. If risk is increased the rate of return required is increased to compensate. That increases the hurdle rate at which investment takes place so the volume of investment falls and the diversity of activity diminishes – often with consequence for the very poorest in developing countries and as a result aid effectiveness is diminished. That is not an unfortunate side effect of tax haven structuring, it is a foreseeable and inevitable consequence, I argue.

This inevitable consequence requires a radically different approach to tax havens / secrecy jurisdictions from that recently adopted by the DFIs. According to a new code of conduct they have adopted they can use an secrecy jurisdiction if it is OECD compliant, in effect, and does actually exchange information under Tax Information Exchange Agreements. But as was forcefully, and appropriately, argued at the Task Force on Financial Integrity and Economic Development conference in Bergen yesterday, these OECD standards are the absolute minimum level of acceptability. It is absurd, I argue, for organisations that are meant to be exemplars of good practice to simply be required to accord with minimum levels of compliance: this is the wrong standard to use.

It is for that reason that I and the organisations that published the report, are arguing for a new Code of Conduct for DFIs. Under that Code each DFI would be expected to say:

1. Our investment activities will be transparent and accountable;

2. We will discharge our public duty to promote investment in the interests of development on the assumption that all we do might be subject to the glare of publicity in all locations in which we operate;

3. We will ensure that all our activities, and the activities of all funds in which we invest and all companies and other entities in which we invest are disclosed in all locations in which we operate, to at least the standard required in our parent jurisdiction of incorporation, without exception. If the entities in which we invest do not do so in the location in which they are incorporated we shall publish this information in our own country of incorporation instead;

4. When the funds and entities in which we invest are controlled by a combination of DFIs, whether directly or indirectly, we will make that clear so that this is known to all who engage with that entity in the interests of transparency, accountability and good governance being evidenced in practice;

5. We will seek to ensure that all entities in which we invest are tax compliant by which we mean that they will seek to pay the right amount of tax (but no more) in the right place at the right time where ‚Äòright’ means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes. In furtherance of this goal we shall ensure that each entity in which we invest makes full disclosure of all taxes paid on profits it makes, and to the greatest degree possible, all other revenue payments that it makes to the government of the jurisdiction in which it is incorporated whether that payment is made by it as principle or as an agent for others;

6. We shall seek, quite openly, to avoid double taxation of any transaction in which we are engaged as actively and as publicly as we will seek to avoid non-taxation of any transactions in which we engage;

7. Whenever we need to use a tax haven / secrecy jurisdiction to fulfil this objective we will be explicit about reasons for doing so, shall state what double taxation charge we are seeking to avoid and shall lend our support to reform of the taxation system of the states whose law might give rise to double taxation charges to ensure that a more open and transparent tax system arises for the benefit of all market participants, states and investors in that location;

8. We shall, wherever and whenever possible seek to ensure that the funds in which we invest are located in those places in which they in turn onward invest on our behalf. Where that is not possible we will be explicit in explaining our reasoning and will seek to remove those obstacles that stand in the way of investing in the way we desire, including by offering training, legislative support and technical advice to the governments of the jurisdictions in question to overcome the obstacles to inward investment within their domain that we have identified.

9. We shall account on a country-by-country basis for the activities that we undertake – taking into account the substance and not the form of the transactions we undertake, and shall publish reports according to the principles of country-by-country reporting in each and every country in which we operate and will demand country-by-country reporting of DFI backed companies when they form part of multinational companies.

This Code puts the requirement to be transparent at the forefront of DFI obligations. We believe that committing to this obligation, is a fundamental necessary step in order to achieve the goal of openly and accountably enhancing the investment opportunities in those jurisdictions in which DFIs invest.

That is why we believe this code should be adopted now.