Offshore Survey ? September 2006 by Christopher Owen
EC demands repeal of Luxembourg?s 1929 holdings regimeThe European Commission decided, on 19 July 2006, that the preferential tax regime in favour of Luxembourg?s Exempt, Milliardaire and Financial Holdings of 1929 violates EC Treaty state aid rules. It requires the scheme to be repealed by the end of 2006, while its effects for the existing holdings are to be eliminated by the end of 2010. Under the 1929 law, exemptions from direct business taxation are granted to Luxembourg holding companies providing certain financial and capital-intensive services to related and unrelated business entities within a multinational group. The Exempt 1929 Holdings are companies that are exclusively engaged in holding the stocks of companies, managing collective investments, providing financing and licensing intangibles to related entities within a group. The Milliardaire and Financial Holdings entities are both subgroups. Revenues earned by all three categories are tax-exempt and distributions are free from withholding taxes. In June 2003, the Council of EU Finance Ministers considered that the exemption from dividends constituted a harmful tax measure under the EC Code of Conduct on business taxation because it was not conditional upon the payment of a sufficient tax by the distributing company. It recommended that Luxembourg eliminate this harmful legislation by 31 December 2010 at the latest. On 21 June 2005 Luxembourg amended its 1929 Law to abolish the exempt status for holdings receiving more than 5% of their yearly dividend income from participating companies that were not subject to a tax comparable to the one applied in Luxembourg. But for Exempt Holdings existing at the time of entry into force of the new law on 1 July 2005, the potential loss of the exempt status would apply only as of 1 January 2011. In parallel, the Commission had initiated a review under state aid rules and, on 21 October 2005, it proposed certain measures. These were rejected by Luxembourg and, in February this year, the Commission opened an in-depth investigation to verify whether the tax exemptions granted to the 1929 holdings constituted state aid and were compatible with the Single Market. The Commission concluded that the scheme granted unjustified tax advantages to providers of certain financial services in Luxembourg. It distorted competition and trade by altering the level playing field between financial undertakings and induced them to create dedicated structures in Luxembourg to reduce their current tax liabilities. The modifications introduced in June 2005 narrowed the scope of the scheme but the regime still constituted state aid because the tax advantages remain unchanged. The Commission has set strict conditions for the phasing-out of the scheme because the tax exemption was not linked to any specific investments and its beneficiaries cannot therefore have acquired legitimate expectations about its permanent nature. This was confirmed by the EU Court of Justice in a judgment of 22 June on a similar tax scheme concerning Belgian coordination centres. The Commission decision requires the scheme to be repealed by the end of 2006, while its effects for the existing holdings must be completely eliminated by the end of 2010 to enable existing beneficiaries to exit from the structures without incurring tax penalties. As the scheme is existing aid, the Commission?s decision is only for the future and the beneficiaries need not repay aid received until its final elimination. The decision does not affect Luxembourg SOPARFIs, which are ordinary taxable Luxembourg companies. Competition Commissioner Neelie Kroes said: ?The decision to eliminate a scheme providing sizable tax advantages to Luxembourg?s financial holdings will help to restore a level playing field in the EU?s financial services industry.? The Luxembourg Minister of Justice announced that the government would comply with the decision and would be proposing alternative tax structures for private wealth and asset management purposes.Malta to end ?preferential? tax regimesThe European Commission announced, on 12 May, that the government of Malta had agreed to amend its preferential tax treatment of international trading companies (ITC) and companies with foreign income (CFI) by the end of 2010. In March, the Commission had deemed these tax regimes to be in violation of the state aid rules of the European Union. Competition Commissioner Neelie Kroes said: ?I welcome the abolition of Malta?s preferential regimes as a further important step towards eliminating selective tax incentives that significantly distort the location of business activities in the Single Market.? Under the agreement, existing ITC and CFI schemes will be effectively abolished by 1 January 2007 and replaced by a new refundable tax credit system that it does not discriminate in favour of foreign-owned companies. The ITC regime will not be available to Maltese-registered companies after 31 December 2006, but existing ITCs may continue to operate under the current regime until 31 December 2010. The number of new ITCs that can be incorporated before the 31 December 2006 shut-off is to be limited to the average number of ITC companies registered annually over the last five years. The government published, on 5 August 2006, a pre-Budget document for calendar year 2007. Entitled ?Securing Our Future?, it contains an analysis of the Maltese economy and sets out a programme of action, together with details of the proposed changes to the tax system as agreed with the European Commission (EC). It also sets out a number of proposed changes to Malta?s corporate tax system in a supplementary paper entitled ?Streamlining Company Taxation?. As a full imputation system that treats residents and non-residents in the same way, the Maltese system is non-discriminatory and compliant with EU law. The only feature that requires amendment is to extend a credit for foreign underlying corporate tax to individuals, as well as to companies, where such a credit is already available. Other changes are necessary to reflect the agreement that Malta reached with the Commission in respect of International Trading Companies and companies operating a Foreign Income Account. This proposal, to be implemented with effect from 1 January 2007, extends the refundable tax credit system to dividend payments made by all Maltese companies to all their shareholders. For further details, see the Offshore Survey September 2006 Supplement.Cadbury Schweppes wins partial victory in CFC appealThe establishment by a parent company of a subsidiary in a low-tax jurisdiction is not an abuse of freedom of establishment, said the Advocate-General (A-G) of the ECJ in the Cadbury Schweppes case. Publishing his opinion on 2 May 2006, Philippe Leger said that the UK?s controlled foreign corporation (CFC) rules were in breach of the EU principle of freedom of establishment when they sought to tax the income of subsidiaries set up in low-tax jurisdictions. But, he added, the UK could apply its controlled foreign corporation rules to ?wholly artificial arrangements the purpose of which is to circumvent national law?. In Cadbury Schweppes v Commissioners of Inland Revenue, the UK drinks and confectionery group had set up two companies in the International Financial Services Centre in Dublin (IFSC) to raise finance for subsidiaries in rest of Cadbury Schweppes. The IFSC provides favourable tax treatment for group treasury companies. On the basis of its controlled foreign corporation (CFC) rules, the UK issued Cadbury Schweppes with a tax bill of almost £9 million on the profits of Cadbury Schweppes Treasury International, one of the IFSC companies, for the year to the end of 1996. Cadbury Schweppes appealed to the UK Special Commissioners, claiming that the UK?s CFC rules breached the EC Treaty rules on freedom of movement. The UK?s CFC rules seek to tax the profits of a foreign subsidiary controlled by a UK tax resident where the tax rate in the country where the subsidiary has been set up is much lower than the UK rate. Control is taken to mean a stake of 50 percent or more. The A-G said: ?Articles 43 EC and 48 EC do not preclude national tax legislation which provides for inclusion in the tax base of a resident parent company profits of a controlled foreign company established in another Member State where those profits are subject in that State to a much lower level of taxation than that in effect in the State of residence of the parent company, if that legislation applies only to wholly artificial arrangements intended to circumvent national law. ?Such legislation must therefore enable the taxpayer to be exempted by providing proof that the controlled subsidiary is genuinely established in the State of establishment and that the transactions which have resulted in a reduction in the taxation of the parent company reflect services which were actually carried out in that State and were not devoid of economic purpose with regard to that company?s activities.? The A-G proposed that evidence of legitimate operations might come in the form of ?the degree of physical presence of the subsidiary in the host State; secondly, the genuine nature of the activity provided by the subsidiary and, finally, the economic value of that activity to the parent company and the entire group.? If the ECJ follows Advocate-General Leger?s opinion that the UK?s CFC rules breach the EC Treaty, the case will have an impact in other EU member states other than the UK. A final decision is expected in the autumn.Indofood decision reversedA recent UK Court of Appeal decision could have significant consequences for existing securitisation structures and other financial transactions that involve the use of offshore SPVs to receive income free of withholding tax under a tax treaty. In Indofood International Finance v JPMorgan Chase Bank, the Indonesian parent company, the world?s largest noodle maker Indofood, wished to raise capital by issuing loan notes on the international market. It set up a special purpose vehicle in Mauritius to issue US$280 million in bonds in order to benefit from the reduced rate of withholding tax (10% rather than 20%) that was available under the existing Indonesia/Mauritius tax treaty. The issuer lent the funds on to Indofood, which also guaranteed the loan notes. One of the conditions under which the loan notes were issued was the provision that the notes could be redeemed earlier than the specified date if there was a change in Indonesian law which resulted in the withholding tax on interest paid by Indofood to the issuer exceeding 10%. On 24 June 2004, Indonesia gave notice to terminate the Mauritian tax treaty with effect from 1 January 2005. On 24 August 2004, the issuer gave notice to JPMorgan, the trustee, of its intention to redeem the balance of the loan notes stating that there was no reasonable measure that the parent could take to avoid the liability to deduct a higher rate of withholding tax. The trustee refused consent on the ground that reasonable steps could be taken to avoid this increased liability. In particular, it suggested that a company could be incorporated in the Netherlands and interposed between the parent guarantor and the issuer. In this way, advantage could then be taken of the existing tax treaty between Indonesia and the Netherlands and withholding tax would remain at 10% or less. The UK High Court judge found in favour of the trustee. Indofood appealed. The Court of Appeal, on 2 March 2006, reversed the decision, holding that the interposition of a new Dutch company would not have prevented Indonesian withholding tax from being incurred at the higher rate. Its decision was based largely on the interpretation of ?beneficial ownership?. For the tax treaty with the Netherlands to apply, the proposed new company would have to be the ?beneficial owner? of the interest paid or payable by the parent. The Court referred to commentary provided by the OECD Model Tax Convention which states that ?a conduit company cannot normally be regarded as the beneficial owner if, through the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties.? The Court of Appeal held that the position of the new company would equate to that ?of an administrator of the income?, and noted that in practical terms it was impossible to conceive of any circumstances in which either the issuer or the new company could derive any ?direct benefit? from the interest payable by the parent guarantor. This decision may have a wider application, both in the United Kingdom and in other OECD countries.US Senate issues report on tax haven abusesA report entitled ?Tax Haven Abuses: the enablers, the tools and secrecy? was released by the Permanent Subcommittee on Investigations of the US Senate Homeland Security & Governmental Affairs Committee on 1 August 2006. The report, based on a 12-month investigation, examines tax havens, detailing case histories that give insight into how they function and including recommendations for reducing their influence. The business of promoting, developing, and administering offshore financial services, said the report, has become a massive and complex industry. The range of services and products available offshore now parallels what is available domestically, but offshore service providers typically advertise a level of secrecy and tax avoidance that cannot be found onshore. The Report presents a number of case studies to illustrate the roles played by offshore promoters and service providers, the products and services they offer, and how they interact with US persons to hide assets and shift income offshore. For further details, see the Offshore Survey September 2006 Supplement.Guernsey Parliament approves ?zero-ten? tax packageGuernsey?s parliament passed, on 28 June 2006, a set of economic and taxation changes that includes a ?zero-ten? corporate tax regime and the capping of personal tax at £250,000. Wealth taxes such as inheritance tax and capital gains tax will not be introduced. The principal measures will come into effect from 1 January 2008. The package of measures includes: ? a zero rate of income tax on company profits, except for specific banking activities which will be taxed at 10%; ? Guernsey residents continue to pay tax at 20% on assessable income; ? personal tax capped at £250,000 on non-Guernsey income and investment income; ? taxation of Guernsey-resident shareholders on distributed company profits only. Chief executive of GuernseyFinance Peter Niven said: ?Firstly, this decision provides the industry and its clients with certainty going forward and secondly, the set of measures agreed will further enhance the environment for doing business in the island.? The proposals are intended to maintain competitiveness with similar jurisdictions ? the Isle of Man introduced a zero-ten percent corporate tax regime on 1 April ? and are designed to meet international obligations, particularly the European Union?s Code of Conduct on harmful business taxation. Legislation will be required to give effect to the proposals.EC requests Belgium, Spain, Italy, Luxembourg, the Netherlands and Portugal to end discriminatory taxation of outbound dividendsThe European Commission has sent, on 25 July 2006, formal requests to Belgium, Spain, Italy, Luxembourg, the Netherlands and Portugal to amend their tax legislation concerning outbound dividend payments. These six Member States tax dividend payments to foreign companies more heavily than dividend payments to domestic ones. They have national rules that provide for no or only very low taxation of domestic dividends, while outbound dividends are subject to withholding taxes ranging from 5 to 25%. The Commission considers that these rules are contrary to the EC Treaty and the EEA Agreement as they restrict both the free movement of capital and the freedom of establishment. The request is in the form of a ?reasoned opinion? under Article 226 of the EC Treaty. If the Member States do not reply satisfactorily to the reasoned opinion within two months the Commission may refer the matter to the European Court of Justice. EU Taxation and Customs Commissioner László Kovács said: ?It is a basic rule of the Internal Market that the Member States cannot tax companies of other Member States more heavily than their own companies. While most Member States respect this rule, the Commission will actively ensure that the others do so too.? Outbound dividends are, in this case, dividends paid by domestic companies to companies in other States. Domestic dividends are dividends paid by domestic companies to other domestic companies. For Belgium, Spain, Italy, the Netherlands and Portugal, the discrimination concerns outbound dividends paid to Member States and to the three European Free Trade Association (EFTA) countries ? Iceland, Liechtenstein and Norway ? that are parties to the European Economic Area (EEA). In the case of Luxembourg the discrimination only concerns these last three countries.New Isle of Man income tax regime gains Royal AssentBoth the Income Tax (Amendment) Act 2006 and the Income Tax (Corporate Taxpayers) Act 2006, introducing the new ?zero-ten? tax regime for companies, received Royal Assent on 11 July. The ?zero-ten? tax regime for companies is now in force and has effect from 6 April 2006; that is, for the 2006/07 and subsequent years of assessment. The distributable profits charge and the corporate charge are also in force from 6 April 2006. An accounting period basis of tax assessment for companies will be introduced with effect from 6 April 2007. South Korea designates Labuan as a tax havenSouth Korea?s Ministry of Finance and Economy announced, on 27 June, that it had designated Labuan as a tax haven, allowing the Korean tax authority to levy taxes on profits of Labuan-based foreign funds in accordance with revised tax rules. Deputy Finance and Economy Minister Bahk Byong-won said investors investing in Korea would be subject to special monitoring and screening and subject to Korea?s new withholding tax rules due to take effect on 1 July. The rules enable the Korean government to oblige non-resident foreign investors based in tax havens to deposit in a local bank in advance an amount equal to the potential tax capital gains liability. Under this system, Labuan-based investors must pay 25% of the interest or dividend profits realised to the Korean government, and either 25% of capital gains from stock transactions or 10% of total stock sale price, whichever is smaller. But if investors receive prior approval from Korea?s National Tax Service, Korea will apply a lower tax rate stipulated under the tax treaty between Korea and Malaysia. The Ministry did not designate Belgium as a tax haven. It had been considering the move to enable it to impose withholding taxes on the US-based private equity fund Lone Star which is set to realise a US$3.85 billion profit from the sale of its controlling stake in Korea Exchange Bank (KEB), the country?s fifth-largest lender. Lone Star made all investments in the KEB via its Belgian holding company LSF-KEB Holdings, taking advantage of Korea?s tax treaty with Belgium. Korea also sought to prove that LSF-KEB Holdings was a paper company.Uruguay proposes to end SAFI regimeThe Uruguay government has sent to parliament a Bill for a comprehensive tax reform on under which Financial Investment Corporations (SAFI?s) would be brought under a new general tax regime, and then phased out by 2010. Under the proposals, various taxes would be abolished and a new dual-rate personal income tax system would be introduced, with progressive rates of tax from 10% to 25% on earned income, and a 10% flat rate on capital income. The existing corporate and agricultural tax regimes would be replaced by a single ?economic activities? tax under which: ? the tax rate on business entities would be reduced from 30% to 25%; ? income of non-resident entities would be taxed at a rate of 10%; ? the carry forward of losses would be extended from three to five years; and ? the concept of permanent establishment and transfer pricing rules would be adopted. SAFI?s, which are offshore entities currently subject to a sole tax of 0.3% on their fiscal equity, would be included in the general tax regime. Existing SAFI?s would need to apply the general tax regime before 31 December 2010. New SAFI?s would not be permitted as from the effective date of the tax reform law.OECD Global Forum on Taxation issues progress reportThe OECD Global Forum on Taxation issued on 29 May a progress report, entitled Tax Co-operation: Towards a Level Playing Field, to review the legal and administrative tax systems in the 82 participating OECD and non-OECD countries. The Forum was set up to include 33 jurisdictions that the OECD originally classified as tax havens under its Harmful Tax Practices initiative but which then made commitments on transparency and information exchange. It enables them to work together with OECD members to ensure common standards on transparency and information exchange for tax purposes so as to permit fair competition between all countries. All the OECD and non-OECD participating countries and territories in the Forum have endorsed these principles and agreed to their legal and administrative frameworks being reviewed. Other significant non-OECD economies ? Argentina, China, Hong Kong, Macao, the Russian Federation and South Africa ? have also endorsed these principles and agreed to work with the Global Forum. For further details, see the Offshore Survey September 2006 Supplement.Jersey parliament approves Trusts Law amendmentThe States of Jersey approved the Trusts (Amendment No. 4) (Jersey) Law on 25 April 2006. It now awaits Royal Assent and is due to be brought into force later this year. In addition to a number of more minor changes, the Law introduces four major changes to the Trusts (Jersey) Law 1984: ? introduction of statutory provisions for reserved powers for trust settlors; ? new provisions permitting the courts in Jersey to ignore foreign law claims in relation to trust disputes; ? introduction of trusts with unlimited duration; ? repeal of provisions that gave directors of trust companies personal liability.IRS wins appeal over ?abusive tax shelter?The US Court of Appeals for the Federal Circuit ruled, on 12 July 2006, that although a claimed capital loss fell within the literal terms of the tax code, the underlying transaction lacked economic substance and therefore must be disregarded for tax purposes. In Coltec Industries, Inc. v United States, the appeal court overturned a lower court?s ruling of 2004, which said that Coltec was entitled to an $83 million refund from the IRS for losses generated through a continent liability shelter, structured by Arthur Andersen. The IRS barred this form of shelter in 2001. Coltec, a maker of aerospace and industrial products, bought the shelter to protect itself from US$375 million in asbestos-related liabilities. In 1996, through a series of transactions, Coltec shifted a US$375 million promissory note to a subsidiary to insulate itself from the asbestos liabilities. The subsidiary then sold US$500,000 in stock to investors, and in 1996, Coltec claimed a loss of more than US$375 million, on the basis that the subsidiary?s worth should take into account asbestos liabilities. The IRS disallowed the loss, and assessed Coltec a tax bill of nearly US$83 million. In 2000, Coltec sued for a refund in the US Court of Federal Claims in Washington, which, in 2004, upheld its claim. The IRS appealed. Reversing the decision, the Court of Appeals held, as the IRS had argued, that the assumption of contingent asbestos liabilities by a Coltec subsidiary in consideration of a US$375 million intercompany note lacked ?economic substance,? notwithstanding that there may have been a business purpose to use the subsidiary to manage the group?s asbestos liabilities In the ruling, the judges wrote that ?the law does not permit the taxpayer to reap tax benefits from a transaction that lacks economic reality?? and that ?a lack of economic substance is sufficient to disqualify the transaction without proof that the taxpayer?s sole motive is tax avoidance.??Australian court clears use of evidence of tax fraudThe Australian Crime Commission (ACC) was granted leave by the Federal Court of Australia on 30 June to use information gained from the notebook computer of a Swiss accountant. The ACC found the computer contained correspondence naming celebrities and business people suspected of sending millions of dollars to offshore tax havens to avoid tax. The Australian Taxation Office (ATO) is investigating some 500 people for up to A$300 million in unpaid tax. The ACC is likely to lay criminal charges before September 2006, which will reveal the names of those accused.