OECD releases 2022 update on peer review of preferential tax regimes and no or only nominal tax jurisdictions

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29 July 2022

The updated results cover new decisions on 12 preferential tax regimes. As reported, the total number of tax regimes that have been reviewed, or are under review, is 319.
This Alert summarizes the updated conclusions of the preferential tax regimes review.
The release of the updated results provides information to taxpayers on the status of preferential regimes in jurisdictions in which they may operate. It also informs the assessments made by the European Union Code of Conduct Group, which in turn may have a direct impact on taxpayers.

Executive summary

On 27 July 2022, the Organisation for Economic Co-operation and Development (OECD) released an update on the results of the peer reviews of jurisdictions’ domestic laws under Action 5 (harmful tax practices) of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project. The results were approved on 7 June 2022 by the Inclusive Framework on BEPS.

The updated results cover new decisions on 12 preferential tax regimes. According to the press release, the total number of tax regimes that have been reviewed, or are under review, is 319. The reviews were undertaken by the Forum on Harmful Tax Practices (FHTP). Two regimes of Armenia and one of Pakistan were classified as “potentially harmful” and will be subject to further evaluation by the FHTP. The remaining nine regimes on which new decisions were announced have been abolished, are being amended, are under review or are considered to be “not harmful.” The FHTP will continue its reviews and will provide periodic updates.

Additionally, the Inclusive Framework concluded its first annual monitoring process for the effectiveness of the substantial activities requirements in previously identified no or only nominal tax jurisdictions. With respect to 8 out of 12 jurisdictions, issues have been identified and recommendations provided.

Detailed discussion

Background

On 5 October 2015, the OECD released its final report on Action 5, Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance (the Action 5 Report) under its BEPS Action Plan.¹ The Action 5 Report covers two main areas: (i) applying the “substantial activity” criterion when determining whether tax regimes are harmful; and (ii) improving transparency. The Action 5 Report also includes a strategy to expand the review of preferential regimes to third countries beyond the OECD/G20 countries.

This expansion has been executed through the Inclusive Framework on BEPS, which currently has 141 member jurisdictions.²Each of the member jurisdictions has committed to the 2015 BEPS package and its effective implementation, including fulfilling the minimum standard under Action 5. This means that the preferential tax regimes of Inclusive Framework member jurisdictions have been, are being or will be reviewed based on the Action 5 criteria, including the new criteria on substance and transparency.

The OECD published the 2017 Progress Report on Action 5 in October 2017.³ Since then, the FHTP has continued its work on the review of preferential regimes within the scope of BEPS Action 5:

In May 2018, the OECD released updates to the results of the reviews of 11 preferential tax regimes.
On 15 November 2018, the OECD released updated results covering the assessment of 53 preferential tax regimes. On the same date, the OECD also released guidance on the application of the substantial activity requirement for “no or only nominal tax” jurisdictions.⁴
On 29 January 2019, the OECD released the 2018 Progress Report, reflecting the FHTP’s review of 255 regimes in total since the start of the BEPS project.⁵
On 23 July 2019, the OECD released an update to the results of the reviews for 56 preferential tax regimes.⁶ This update also includes, for the first time, the results of the review of 12 identified no or only nominal tax jurisdictions. The FHTP concluded that the legislative frameworks of 11 jurisdictions are not harmful. For the United Arab Emirates (UAE), the FHTP concluded that as of June 2019 there was one technical point outstanding and the legislation was reported as “in the process of being amended.”
On 23 November 2020, the OECD released an update to the results of the reviews for 49 preferential tax regimes.⁷Additionally, the OECD released updated conclusions on the review of the substantial activities factor for no or only nominal tax jurisdictions in connection with the domestic laws of the 12 jurisdictions that were identified by the FHTP as being a no or only nominal tax jurisdiction.
On 5 August 2021, the OECD released an update to the results of the reviews for 18 preferential tax regimes.⁸
On 24 January 2022, the OECD released an update covering new decisions on nine preferential tax regimes.⁹

Updated conclusions of the preferential tax regimes review

On 27 July 2022, the OECD released an update to the results of the reviews for 12 preferential tax regimes and the conclusions on no or low tax jurisdictions as approved by the Inclusive Framework on 7 June 2022. According to the updated results of the regimes reviewed, two regimes of Armenia (free economic zones and information technology projects) were regarded as “potentially harmful” due to the implications of ring-fencing and lack of substantial activities requirement. The “export regime on IT” of Pakistan also was classified as “potentially harmful.” At this time, there is no immediate consequence for these jurisdictions from their regimes being classified as “potentially harmful” but this classification could lead other jurisdictions to decide to impose defensive measures against these jurisdictions (e.g., non-deductibility of costs or withholding tax). The FHTP will continue its assessment of these regimes at its next meeting.

The regimes of Costa Rica (free trade zone), Greece (tax patent incentives), Kazakhstan (Astana international financial centre and special economic zones) have been classified as “not harmful” because they were designed taking into account the substance requirements developed under BEPS Action 5.

The updated results conclude that the “special economic zones” regime of Eswatini is in the process of being amended. Likewise, the “free zones (ZOLI)” and “employment and economic development zones (ZEDE)” regimes of Honduras are “in the process of being eliminated/amended.”

The regime “Maio special economic zone” of Cabo Verde is “under review.” Lastly, the regime “taxation of income from intangible assets” of Italy has been abolished.

Taking into account this update, the FHTP has reviewed a total of 319 tax regimes. The conclusions are:

One regime is currently harmful (“special economic zone” regime of Trinidad and Tobago).
Eight regimes are potentially harmful but not actually harmful.
Five regimes are potentially harmful.
128 regimes are not harmful.
16 regimes are in the process of being eliminated or amended.
Three regimes are not operational.
112 regimes have been abolished.
39 regimes have been found to be out of scope.
Four regimes are still under review.
The remaining three regimes relate to disadvantaged areas.

Substantial activities requirement for “no or only nominal tax” jurisdictions

In November 2018, the Inclusive Framework adopted a standard on substantial activities that would apply to jurisdictions that do not impose a corporate income tax. It would also apply to jurisdictions that are considered to impose only nominal corporate income tax. The FHTP has identified 12 “no or only nominal tax jurisdictions” with the necessary domestic legal framework to meet the substance standard, namely Anguilla, the Bahamas, Bahrain, Barbados, Bermuda, British Virgin Islands, Cayman Islands, Guernsey, Isle of Man, Jersey, Turks and Caicos Islands and the UAE.

To monitor the implementation of the standard on substantial activities requirements, the FHTP undertakes an annual monitoring exercise to assess the effectiveness of the standard in practice. The FHTP started this exercise in 2021 and has now released the results of the first monitoring year. For Anguilla, the Bahamas, Barbados and the Turks and Caicos Islands, areas were identified that need to be substantially improved by the next annual monitoring. Bahrain, Bermuda, the British Virgin Islands and the Cayman Islands were identified as the jurisdictions for focused monitoring in specific areas. No issues were identified for Guernsey, Jersey, the Isle of Man and the UAE.

Next steps

The FHTP will continue its reviews of the tax regimes that have been identified and may identify additional regimes to review. The FHTP will also continue its annual monitoring on specific aspects of regimes. The next review update is expected to take place during the second half of 2022.

Implications

The updated results of the review of preferential tax regimes reflect the continuing focus of the Inclusive Framework on jurisdictions’ implementation of the BEPS Action 5 minimum standard notwithstanding its ongoing work on other substantial international tax projects, including the work on the two-pillar solution to addressing the tax challenges of the digitalization of the economy under the so-called BEPS 2.0 project. The release of the updated results provides information to taxpayers on the status of preferential regimes in jurisdictions in which they may operate. It also will inform the assessments¹⁰ made by the European Union (EU) Code of Conduct Group, which in turn may have a direct impact on taxpayers (e.g., through updates to the EU list of non-cooperative jurisdictions for tax purposes and the tax measures that refer to such list). An updated EU assessment is expected in October 2022.

The FHTP will continue its work, including monitoring and review of preferential tax regimes that are in the process of being amended to conform to the Action 5 minimum standard or are being eliminated. Businesses should monitor any potential legislative changes with respect to regimes that may be reviewed by the FHTP and that are relevant to them.

Finally, the interaction of the proposed global minimum tax rules under BEPS 2.0 Pillar Two with preferential tax regimes or “no or only nominal tax” jurisdictions will become relevant for those Multinational Enterprise (MNE) groups that are in scope of Pillar Two rules when those rules are implemented by individual jurisdictions. MNEs doing business in no or low-tax jurisdictions or making use of preferential regimes should monitor developments with respect to Pillar Two and begin assessing the potential impact on their tax profile.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Belastingadviseurs LLP, Rotterdam