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Four main factors are used to determine if a preferential tax regime is harmful:
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The regime imposes low or no taxes on the relevant income (from geographically mobile financial and other service activities). Although a low or zero effective tax rate is the necessary starting point of an examination of a preferential regime, it alone is never sufficient to find harmfulness. The OECD recognises each country’s right to determine its own tax rate.
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The regime lacks transparency;
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There is no effective exchange of information with respect to the regime;
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The regime is ring-fenced from the domestic economy.
Transparency ensures that there is an open and consistent application of tax laws among similarly situated taxpayers and that information needed by tax authorities to determine a taxpayer’s correct tax liability is available (e.g., accounting records and underlying documentation).
With regard to exchange of information in tax matters, the OECD encourages countries to adopt information exchange on an “upon request” basis. Exchange of information upon request describes a situation where a competent authority of one country asks the competent authority of another country for specific information in relation to a specific inquiry, generally under the authority of a bilateral exchange arrangement between the two countries. An essential element of exchange of information is the implementation of appropriate safeguards to ensure adequate protection of taxpayers’ rights and the confidentiality of their tax affairs.
A regime is ring-fenced if a country insulates its core tax base from the effects of providing the preference. For example, if a country offering a preferential tax regime denies that regime to resident taxpayers or domestic activities, it means that it is not willing to bear the cost in lost revenues with respect to its own tax system.
There are also a number of other factors to be considered in evaluating whether a preferential tax regime might be harmful, including the extent of compliance with the OECD Transfer Pricing Guidelines. Any evaluation requires an overall assessment of each of the above factors and once a regime has been identified as potentially harmful the economic effects would, where necessary, have to be examined (see also consolidated application notes which were developed to assist countries in applying the criteria to preferential tax regimes).
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