New Bermuda Corporate Tax: Details & Analysis
Bermuda, long celebrated for its pristine beaches and offshore financial services, is embarking on a journey to recalibrate its tax mix. Spurred by the OECD’s Pillar Two initiative, the island will introduce its first-ever corporate income tax in 2025. At first glance, supporters of the OECD’s global tax deal may see this development and declare the battle on tax havens won. However, the economic consequences of the proposal could impact larger economies well beyond Bermuda’s borders.
Changing Bermuda’s Tax Structure: A Preliminary Win for the OECD
At the heart of the OECD’s initiative lies a drive to curtail tax avoidance through tax havens, safeguarding countries from losing revenue to low-tax—or in Bermuda’s case no-tax—jurisdictions. Bermuda’s decision to implement a corporate income tax shows the initial success of the OECD’s supposed objective: ensuring that income is taxed at a minimum rate around the world.
However, a corporate tax in Bermuda will likely alter investment flows, corporate structures, and economic dynamics.
Bermuda is set to lose its tax advantage and suffer from the investment diversion effects of Pillar Two. Even if the introduction of a corporate income tax would generate some revenue, the consequences of the proposal will be felt by the island. Businesses facing this tax increase from 0 to 15 percent will re-evaluate their global tax strategies and potentially shift income away from the island. This doesn’t necessarily make Bermuda a winner from Pillar Two.
But Bermuda’s decision to embrace a corporate income tax is pragmatic and primarily stems from the fear of “top-up” taxes. Other countries could impose these taxes by applying Pillar Two rules on income earned within its borders if Bermuda’s effective corporate tax rate is below 15 percent. The choice for Bermuda in this scenario appears straightforward: either tax corporate income or risk losing the income to other jurisdictions. This was the exact trade-off architects of Pillar Two hoped to create for Bermuda and other tax havens alike.
A Win for the OECD but a Loss for Its Member Countries?
However, what initially looks like a success story for the OECD may come with a less-discussed consequence that will likely affect its own members the most. Primarily, this is due to a ripple effect on global investment dynamics.
Over previous decades, an intricate financial web between tax havens and high-tax countries has developed. On one hand, offshore financial centers like Bermuda are often used to route money from high-tax jurisdictions to low-tax jurisdictions—this is the profit shifting the OECD is trying to tackle.
On the other hand, these profits are usually reinvested into the higher tax jurisdictions, bringing jobs and economic growth. Without these financial centers, companies would have less capital to invest, and foreign direct investment (FDI) flows would be affected.
First, the amount of FDI stock is considerable. UNCTAD estimates that the “value of the FDI stock at stake” in these offshore financial centers would be large, ranging from $4 trillion to $12 trillion.”
Second, the changes in FDI flows would affect other countries. UNCTAD predicts that there would be major disinvestment of the FDI stock from these offshore financial centers, hampering FDI flows. Indeed, researchers have found that multinational firms use tax haven affiliates to reallocate taxable income away from high-tax jurisdictions and that the ability to use tax havens facilitates economic activity in non-haven countries. In other words, countries that have high inward FDI flows, such as France, Germany, and the United States, benefit in part from tax havens and might witness a decrease in FDI as a result of other jurisdictions’ implementation of Pillar Two.
For example, imagine a French company that uses offshore financial centers—in this case, Bermuda—to optimize the taxation of its profits. Then it returns to France, a higher tax jurisdiction, and re-invests them. When Bermuda decides to impose a corporate income tax, the French company’s profits from Bermuda are reduced due to the tax. This time around, when the French company wants to return to France and re-invest some of its profits, it has less money to do so. It might choose not to re-invest because it doesn’t have enough profits or perhaps decide to simply invest somewhere else with a lower tax burden than France. In the end, the French economy is negatively affected.
This effect occurred when the U.S. closed off some tax strategies that U.S. companies were deploying through Puerto Rico. As the taxes on Puerto Rican activities were increased, businesses reduced their investment and employment.
So, in the End, Who Wins?
The OECD’s objective of reducing profit shifting is clear and appears to be succeeding in pushing low-tax jurisdictions to adopt policies that align with the project. However, the effects of Pillar Two go well beyond a given country’s borders.
As implementation of the global tax deal evolves, policymakers should continually assess whether their policies align with sound tax principles. What might appear to be an achievement for global tax negotiations may have negative consequences when viewed through a wider lens.
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