Further, if this undercutting continues, business location and financing decisions could become primarily tax driven and real economic factors would take a backseat in business decisions.

The impact of these developments has already been quite significant. For example, foreign direct investment by G7 countries through low-tax jurisdictions, increased to more than US$200 billion over the period 1985-1994 and the rate of increase is well above that of total outbound foreign direct investment by the G7.

Overview of proposed actions by OECD
An increasing need is being felt across the borders for actions to protect the tax bases of productive economies from erosion due to tax-induced distortions in capital flows. However, in this new global environment, such actions by the individual nations would yield little results unless reinforced with multilateral co-operation. To provide co-ordinated action for the elimination of harmful tax practices, the OECD in May, 1998 issued a report on 'Harmful Tax Competition'.

The report created a forum on harmful tax practices, set forth guidelines for dealing with harmful preferential regimes in member countries, and adopted a series of recommendations for combating harmful tax practices. As part of this work, the forum has engaged over the past two years in extensive factual review and dialogue with a number of jurisdictions initially identified for review as possible tax havens. The work is focused on the concerns of OECD and non-OECD countries, which both experience significant revenue losses as a result of harmful tax competition.The OECD issued recently a report that sets out the progress made in identifying and curtailing harmful tax practices both within and outside the OECD.

The report identifies potentially harmful preferential regimes in member countries; identifies jurisdictions meeting the criteria for being tax havens. The OECD identified 47 preferential tax regimes of member countries as potentially harmful. Key factors used in identifying and assessing harmful preferential tax regimes were a) no or low effective tax rates; b) 'ring fencing' of regimes; c) lack of transparency; and d) lack of effective exchange of information.

Harmful tax regimes are mainly categorised under various financial and service sectors like insurance, finance and leasing, fund managers, banking, headquarters, distribution centre, service centre, shipping and miscellaneous activities. Holding company regimes and similar preferential tax regimes are not included in the report for the time being in view of the complexities involved therein, requiring greater efforts.

The preferential tax regime OECD countries are committed as per 1998 report to remove the harmful features of preferential tax regimes by April 2003 and not to adopt new or strengthen existing measures constituting harmful tax practices.

The report also identifies 35 jurisdictions as tax havens, which includes amongst others - Bahrain, Liberia, Maldives, Marshall Islands, Monaco, Netherlands Antilles and Panama. The main factors for being a tax haven are a) no or only nominal effective tax rates; b) lack of effective exchange of information; c) lack of transparency; and d) absence of a requirement of substantial activities.

The report incidentally does not name those tax havens, which have made high level political commitment to eliminate harmful tax practices ('an advance commitment'). These tax havens are Bermuda, Cayman Islands, Cyprus, Malta, Mauritius and San Marino.The tax havens are given the opportunity to determine over the next 12 months whether or not they wish to work with OECD to eliminate harmful features of their regimes by the end of 2005. OECD is developing a general framework within which member countries can implement a common approach to tackling harmful tax competition. This will include defensive measures that countries will consider applying to uncooperative tax havens non-committed to eliminate harmful tax practices.

These possible defensive measures would include amongst others the following significant disincentives on transactions with uncooperative tax havens: a) Disallowance of deductions, exemptions, or other allowances. b) Comprehensive information reporting rules. c) Denial of the foreign tax credit or the participation exemption. d) Withholding taxes on certain payments to residents of uncooperative tax havens. OECD has also endorsed the development of the guidance (application) notes, which will assist member countries in determining which of their potentially harmful regimes could be actually harmful, and then in determining how to remove the harmful features of these regimes.

The application notes also will assist tax havens and other non-member economies in eliminating their harmful tax practices, and will assist the forum in verifying that member countries and co-operative jurisdictions have met their respective commitments to eliminate harmful tax practices within established timetables.Bearing in mind that association of non-member economies is critical for the success of these efforts, OECD has also initiated a dialogue on harmful tax competition with non-member economies.

Most of these economies share the concerns of member countries on the spread of tax havens and other harmful tax practices. OECD has endorsed a work programme to encourage these economies to associate themselves in these efforts and to encourage them to take positive steps to remove any harmful features of their preferential tax regimes. In the June 2000 meeting in Paris organised by the OECD, an emphasis was laid on the need for improved cross-border co-operation amongst tax authorities and with other law enforcement authorities as no country alone can combat these issues.

India specific issues
Developing nations like India are also not unaffected of these developments. A significant portion of the foreign institutional and foreign direct investments are structured through low-tax jurisdictions resulting in loss of revenue especially in form of capital gain taxes. This is evident in the ongoing controversy of applicability of beneficial provisions of India's treaty with certain low-tax jurisdictions, where enterprises investing in India are availing these benefits merely by registering themselves in such jurisdictions without having any substantial presence.

In this regard, it is pertinent to note the proposed amendments in tax laws of Mauritius (being one of the countries which has made an 'advance commitment'), whereby with effect from 1st July 2000, the tax rate for all offshore corporations will be flat 15% as against optional tax @ 0-35% on all offshore companies incorporated before July 1, 1998. Further, the deemed foreign tax credit of 90% is proposed to be reduced to 80% and may be reduced even further in future.

Conclusion
OECD accepts that the necessary changes for removal of harmful tax practices may adversely affect the economies of some of these jurisdictions. The OECD with other interested international and national organisations will examine how best to assist co-operative jurisdictions in restructuring their economies. Nevertheless, the initiative and the efforts taken by OECD towards curbing harmful tax practices are commendable and could go a long way in future in eliminating the harmful tax competition in the form of harmful tax practices by certan nations.

-- The authors are Mumbai-based chartered accountants