There is now a well-trodden road for foreigners to invest in the People’s Republic – generally through the medium of a “joint venture”. The percentage of the profit to which the foreign investor is entitled is a matter for tough and detailed negotiation, but can be unexpectedly high. The members who went to China were impressed by the calibre of the officials they encountered – not only the officials concerned with investment but also those concerned with tax.
China’s income tax legislation was enacted between 1979 and 1982. The statutes are brief and couched in simple terms. Tax on joint venture profits are levied at 33% plus a 10% charge on profits remitted out of China, but this basic charge is subject to a variety of reductions and exemptions for favoured investments.
China’s labour costs are low and industrial strife is virtually unknown. Economic development is held back not so much by lack of capital formation but by lack of knowledge of how to invest capital productively and profitably. The group came away with the impression that foreign investors able to supply such knowledge are likely to establish some very profitable enterprises there in the course of the next few years.
Unlike tax costs, customs costs are rarely obvious; customs planning is commonly neglected. The problem of the movement of goods across frontiers requires to be considered as a whole – excise duties and control of goods as well as customs duties and value added tax. The question of valuation is of prime importance; this question frequently generates contradiction with transfer prices desirable for tax purposes.
Two international codes drawn up under Art. 7 of GATT, are used in valuation – the old Brussels code, which referred to a notional sale between vendor and purchaser at arms length, and the new GATT code, which determines the customs value by reference to the transaction value, subject to adjustment on an objective basis. The quantification of these adjustments – especially in relation to royalties and licence fees – can be difficult and complicated in practice.
Related party transactions do not necessarily require adjustment, but customs officers will scrutinise them closely. It is nevertheless open to the importer to show that the transfer price is valid: he may point to identical or similar goods, or work backwards from their sale price or forwards from production costs.
It is advisable that transfer prices should be set by reference to external factors, but allowances can be made for variables such as size of market, launching costs and other specific outgoings. Royalties, R & D costs and interest charges are sometimes needlessly subject to duty because Customs implications of R & D cost-sharing agreements and of royalty and financing agreements are not taken into account when these agreements are being drafted.
Information (software) stored on tapes or discs increases the value of the tape or disc, even though the information itself can be imported (e.g. by telephone) without duty. EEC countries now charge customs duty only on the value medium itself, provided that value is separately identified, (though the VAT implications still appear to vary between the member states).
The interests of Customs in the country of importation is basically the same as that of the Revenue in the country of exportation: acceptance of a value by one may provide persuasive evidence for the other.
Investors wish to acquire foreign real estate for a variety of commercial and personal reasons. When they make such an investment, they have to recognise that prima facie their income and gains will be subject to tax in the jurisdictions in which the property is situated. Most countries make a distinction between investing on capital account on the one hand and dealing or trading on the other and impose greater tax on dealing profits. Other taxes are material also – e.g. in the United States, Federal estate and gift tax as well as state taxes, and in the United Kingdom, stamp duty, capital transfer tax, local rates and (often overlooked) value added tax.
In assessing the tax consequences of a real estate investment, one needs to consider a number of factors – not only the situs country tax, but the tax in the investor’s country of residence and the interaction between the two; the incidence of withholding tax or similar deductions; whether particular types of real estate enjoy more favourable tax regimes.
Tax in the situs country may be reduced by deductions – expenses of management and repair, interest, depreciation, carry forward (or backward) of losses or deferring or acceleration of income or gains. Gearing or leverage presents many possibilities of effective reduction, but is not without its obstacles – e.g. debt/equity limits in the US and Canada and the imposition by many countries of withholding tax on interest payments to non-residents.
Specially beneficial structures include the Australian property trust, the German silent partnership, the Swiss partnership and the Swiss or Dutch company. In general, an individual should invest through a company – generally a foreign company; borrowing should be maximised; the basis should be stepped up where possible; advantage should be taken of any benefits from inter-group transactions; capital gains are of course preferred to income; the residence of the investor may be changed; a discussion or arrangement with the local tax authorities may be possible; the ultimate profit may be taken by disposal of some other asset – e.g. an interest under a trust; and if tax is inevitable, tax shelters in the situs country may be available to alleviate this.
Canadian companies often used Dutch holding companies to invest in the United States. In July 1984, agreement was reached for the imposition of higher rates of withholding tax on dividends declared by Dutch companies in favour of their Canadian parents. This new convention will also take away the present exemption from Canadian tax on capital gains, and Dutch investors will suffer a higher rate of the tax on interest on mortgage bonds (income on which no Dutch tax is payable).
The withholding tax to be introduced by the new treaty with the Antilles will doubtless stimulate creative tax planning – redeeming shares in the BV rather than declaring dividends, substituting interest for dividends, using a branch of the Antilles company to own the shares of a Dutch holding subsidiary.
The Dutch have refused to accept an anti-treaty-shopping article in negotiating a new treaty with the US; the I.R.S. are now looking very critically at structures involving Netherlands or Antilles companies.
In the light of the Aiken case and recent revenue rulings on interest payments via the Antilles, may Denmark become a substitute for the Netherlands in connection with the Antilles? This seems theoretically possible at the present time, but treaty changes may be on their way, and there are exchange control problems in Denmark.
Presently German dividend withholding taxes to the Netherlands are reduced from 25% to 15% by using the “quintet” structure, i.e. five Dutch holding companies each owning less than 25% of the capital of the German company. The treaty will be renegotiated in an attempt to reduce the present 25% withholding rate to 15% for shareholdings of more than 25% and possibly to obtain a payment of the Germany tax credit to Dutch portfolio investors.
A new treaty with Italy has been signed but not yet ratified. In general, it will be less favourable than its predecessor. (The zero rate of dividend withholding will be replaced by a 5% rate).
Negotiations with Switzerland are expected to take place in September. The present treaty has an anti-abuse provision: this is currently being invoked, though in what appears to be a random way. It is hoped that the new treaty will introduce greater certainty and consistency in this area.
The French treaty may be amended to cover the French wealth tax.
The protocol with the UK has diminished the ACT refund formerly generally available to Netherlands companies. It is understood that a revision of the definition of “permanent establishment” as regards operations in the North Sea, and provision for credit for Dutch Petroleum Revenue Tax, are the subject-matter of present negotiations with the UK.
Revision of several other treaties and the making of new treaties is in progress with several other countries. In general, the outlook for the use of Netherlands treaties is by no means gloomy.
It appears that all future tax treaties to which the United States is a party will include a provision limiting its benefits to residents of the treaty partner country. Corporations will not be treated as residents for this purpose unless they are substantially owned by resident individuals. The interposition of an entity in a treaty country between a US source of income and the ultimate recipient of the income, resident in a non-treaty country, constitutes “treaty-shopping”. An important motivation for the policy of the US Treasury to eliminate treaty shopping is to facilitate the negotiations of new treaties. For example, the United States had great difficulty in negotiating a new treaty with Canada, because Canadian companies were able to invest in the United States via a Netherlands company and reduce thereby the withholding tax on dividends to 5% – an advantage which was never available to US corporations investing in Canada.
Since 1981, treaties with the United States have invariably included an anti-treaty-shopping article, generally as article 16. Since 1979, the IRS has required strict compliance with any requirement that a company claiming the benefit of a treaty should not be created or maintained for the purpose of taking advantage of the treaty. In a 1984 ruling, the IRS ignored an Antilles subsidiary of a Swiss corporation functioning as an intermediate lending company and treated the loan made to a US subsidiary as made directly by the Swiss parent. The present practice of the IRS is to require large amounts of information from companies seeking to take advantage of certain treaties (notably that with the Antilles); how far the Service intends to look behind foreign companies to the residence of their ultimate shareholders is not yet known.
Curiously, an Article 16 is so far in force in only four treaties – in the treaties with Jamaica, Australia and New Zealand (not countries commonly associated with treaty shopping) and, in a much truncated form, in the treaty with Canada.
Anomalies in tax treaties still afford opportunities for a kind of treaty shopping. The denial of treaty benefit to dual resident companies in the US/UK treaty left the way open for dual resident companies with negative income to obtain relief in both jurisdictions. The tie-breaker rules in the UK/Canada treaty have opened up the way for a company incorporated in a Canadian province whose domicil is transferred to a US state to qualify as a Canadian resident for treaty purposes while remaining a US corporation for domestic purposes.
Tim Urquhart spoke on foreign investment in French real estate. The French government’s attack on foreign companies owning residential property began in 1977: foreign companies which do not collect and pay corporation tax on a market rent suffer a tax on three times the rental value of the property. The present government instituted a wealth tax on individuals; partly in order to prevent non-residents from avoiding this tax by owning their French real property through foreign companies, a 3% tax was imposed on the net worth of such companies and disclosure of the ultimate beneficial owners was required. Some tax treaty companies are exempt from this tax. In the discussion session which followed, interest centred on the possible use of a UK-resident company which changed its residence to the Netherlands before disposing of the property.
Charles Lubar investigated the possibilities of establishing tax haven investment companies which would not be “controlled” for US, German and Swiss tax purposes. He took as an example an Isle of Man non-resident company; a Manx exempt company may now be used for this purpose.
Malcolm Finney spoke about the new tax regime for non-domiciled individuals working in the United Kingdom. The privilege of the “remittance basis” will not now apply to employments where duties are performed in the United Kingdom, but non-domiciled individuals still enjoy the remittance basis on salaries from overseas employment and on passive income and capital gains arising from assets situated abroad. The rules governing the special status of non-domiciled individuals resident in the United Kingdom are easily stated, but any change in domicil requires careful attention to practical aspects.
The last three topics at this meeting were grouped under the title “The Limits of Tax Planning”. In the UK, the decision in Furniss v. Dawson announced the death of a previously flourishing tax avoidance industry; in the US the doctrine enunciated in the Aiken case in 1971 has inspired an attack on “treaty shopping”; in France, some limits on tax avoidance are imposed by the concept of abus de droit.
The principality of Monaco has recently seen the establishment of many new banks. It is too early to say whether Monte-Carlo will become the “Hong Kong of Europe”; the regulations of French exchange control constitute a serious obstacle to such development.
Business between Eastern Europe and Western countries – especially the EEC – has expanded rapidly. In parallel, there has been an increase in east-west tax treaties – Bulgaria has 3, Czechoslovakia 15, the GDR 1 (with Cyprus), Hungary 16, Poland 23, Romania 23, the USSR 6 and Yugoslavia 8. Tax authorities in socialist countries are not concerned with treaty shopping, so that businesses and investors established outside Cyprus may be able to take advantage of the six tax treaties now in force with Eastern Europe. The Netherlands has somewhat similar advantages.
The Cyprus “Offshore Company” – incorporated and managed and controlled in Cyprus, but owned by non-residents and doing its business abroad – pays tax at the rate of only 4.25%, but is nevertheless (unlike the Luxembourg Holding Company) entitled to the benefits of most of the treaties to which Cyprus is a party, including all treaties with Eastern Europe.
In these treaties, business and shipping profits are exempt from tax, following the OECD model. Four of the treaties (those with Bulgaria, Hungary, Romania and the USSR) extend the exemptions to profits arising from road transport. In the Bulgarian, Czech, Hungarian and (with qualifications) Russian treaties, an assembly project is not treated as a permanent establishment. Exemption or relief for interest is provided in all six treaties. Similar treatment is accorded to royalties – an item of great importance, since the non-treaty rates of withholding on royalties can rise, in Eastern European countries, to very high levels.
Hungary, Romania and Bulgaria permit joint ventures with Western investors, but the reliefs for dividends in these treaties are not very significant – bearing in mind that no credit for foreign tax is available to Offshore Companies in Cyprus.
The general feeling in Hong Kong was that the imminent agreement with China would be beneficial, and that, although the implementation of the agreement would not be without difficulties, Hong Kong would function as the shop window and financial centre for the People’s Republic.
Alan Smith spoke on new developments in Hong Kong company law. Hong Kong company law is based on the UK ct of 1929: a good deal of modernisation was plainly necessary, but the new legislation has left a number of grey areas. Up to 1982, the Hong Kong budget was in surplus: government was able to sell land and use the proceeds to meet the expenses of administration. This has been much curtailed by the agreement with China and in consequence the raising of more money by taxation has become necessary.
Marshall Langer spoke about new US treaties. The new treaty with Australia contains a number of provisions less than usually favourable to the taxpayer. He also outlined the new rules defining residence for US tax purposes, and mentioned the new draft treaty with Barbados, implementing the Caribbean Basin Initiative.
Brian Norris’s talk covered the wide topic of investment in the Western Pacific. The size of investment and the tax treatment of income and profits naturally vary greatly from one country to another but the investment climate is generally favourable. Since the seminar, New Zealand and Australia have made several changes – with the broad effect of liberalising the rules affecting foreign investment.
Richard Edmonds and Peter Edwards together discussed the development of the concept of “substance and form”. Since the seminar, the Court of Appeal in Australia has declined to follow the UK case of Furniss v. Dawson and in a case concerning sales tax judgement has been given in favour of the taxpayer – the Revenue’s invocation of the UK Ramsay case not being referred to in the judgement
Sidney Rolt gave a broad review of taxation in S.E. Asia. There is a general trend to increase the tax burden on non-resident investors.
Steven Lang dealt with change of fiscal residence. “Double dipping” and similar devices illustrate an increasing interest of tax planners in this area: by change of trustees or emigration of individuals from a high-tax to a low-tax area substantial savings may be achieved.
Jeffrey Sharp gave an account of the possibilities of the use of Australia as a financial centre. Since the seminar, a number of licences have been granted to foreign banks to open branches in Australia, and there seems some possibility that Sydney may acquire some of the business now handled in Singapore and Hong Kong.
Meanwhile Singapore has introduced legislation permitting the establishment of Asian Currency Units and similar legislation is expected in Taiwan.
In the last session of the seminar, Ray Moore vehemently attacked the introduction of “unitary tax” in the United States. It seems that international opposition to this tax will eventually ensure its demise.
There have been many changes in the last ten years – not only in legislation but also in jurisprudence and the policy of the tax authorities. The Dutch Company was commonly used to receive dividends at low rates of withholding tax and where it could claim the “Participation Privilege”, no Dutch tax was suffered on the dividend income. The Participation Privilege still exists, but the tax authorities now adopt a more strict attitude to its application, and in some cases treaty revisions have reduced (or future revisions may reduce) the extent of freedom from or lower rates of withholding tax (see Art. 16 of US treaty, Art. 10 of UK treaty and Art. 9 of Swiss treaty). The new Realm Act is expected to impose 7.5% tax at source on dividends paid by Dutch companies to Antilles parents (reduced to 5% if the Antilles increases its tax rate to 5.5%), and the concept of “residence” of the OECD model treaty is to be introduced to determine the fiscal domicil of Antilles companies.
These changes, however, will not abolish the advantages of the Netherlands /Antilles route, but it will cost more in tax terms (a cost which may be capable of reduction by converting dividends into interest at the Netherlands and/or at the Antilles level).
The Netherlands still levies no withholding tax on royalties and interest and has the benefit of a large network of tax treaties. In general, the Netherlands continues to have many attractions, though some of them have become (and others may in the future become) more limited.
When the private limited company (“BV”) was introduced in 1972, many partnerships were converted into BVs, but the partnership form is nowadays often used for a joint venture with two or more participants. Partnership law is very flexible: a partnership may be formed in such a way that the I.R.S. will give a private letter ruling that it is to be treated as a corporation for US tax purposes.
For Netherlands tax purposes, a partnership, whether general or limited, is transparent – the partners being liable for tax (if any) on their apportioned share. Thus, a Dutch resident is liable to the usual taxes and exemptions as regards his share of partnership profits. If the Dutch activities do not constitute a permanent establishment, a partner resident in a treaty country is exempt from Netherlands tax. If the partnership business is not carried on in Holland at all, a non-resident partner is not liable to any Dutch tax on his share of the partnership profits. The passive receipt of royalties does not constitute a business, and a partnership engaged in such activity suffers no Dutch tax (though it may nevertheless obtain treaty benefits). Experience with the Dutch tax authorities to date suggests that a favourable ruling will be given so long as there is sufficient Dutch tax payable.
In a fast-moving world, Luxembourg moves very slowly. It is a small country, with a population of some 370,000. In 1929, the law governing holding companies was enacted and the stock exchange established.
Luxembourg is party to fifteen treaties – the older ones being the most valuable from a planning point of view. The absence of withholding tax on bank and bond interest makes the “Luxembourg Sandwich” attractive for several jurisdictions. The Luxembourg Holding Company is always excluded from treaty benefit, but may always become a tax-paying company if treaty benefits are required. The Holding Company continues to be much used: it may hold shares, but may lend only to companies in which it holds shares. Its accounts must be audited. The 0.02% tax on its capital may be abolished. A non-resident UK company may be treated as a Holding Company in Luxembourg.
The law of 30th August 1983 provides for the establishment of mutual funds – the open-ended fund or the variable capital fund. They suffer an annual tax of 0.06% on their capital; the 1% capital tax of the EEC is not levied, but a single tax of Lux. Frs. 50000 is imposed on formation.
Finance companies and banks appear to make most use of Luxembourg’s treaties. The law of 24th February 1984 provides for the establishment of re-insurance companies and “captive” insurance companies. With a view to making Luxembourg attractive to the international insurance industry, the tax treatment of such companies is generous. This new regime is already attracting new business to Luxembourg.
The true growth industry of the Grand Duchy since 1970 has been banking. This sector continues to grow with astonishing momentum. Unlike Switzerland, Luxembourg levies no tax on bank interest or tax on movements in securities. Gold sales are free of VAT and stamp duty. At the end of 1984, there were 112 banks in Luxembourg.
The Stock Exchange provides a useful and cheap way for a Luxembourg or foreign company to obtain a quotation, although the market itself it not a very active one.
Board meetings of a foreign company may be held in Luxembourg without exposing the company to local tax, so long as the day-to-day management of the company’s business is not conducted there.
|The message from our Swiss speakers was that Switzerland was no multi-purpose tax haven, but nevertheless has some interesting features. Peter Bratschi spoke about the “lump sum” tax payment which may be agreed for new residents, over the age of 60 and -more importantly – with a real link with Switzerland. The tax base is fixed at 5 times the annual value of his residence – amounting in practice to an amount in the order of Swiss Francs 100,000-150,000. Estate and gift taxes are not covered by such agreement.The advantages of the Swiss domiciliary companies, said Thomas Bär, are waning. The 1962 anti-treaty-shopping legislation and the distribution charge on liquidation have been adverse factors for some time; the reluctance of the Federal authorities to permit the use of the Netherlands treaty to allow dividends to be paid free of withholding tax is a further disadvantage.
A branch of a foreign company may remit to head office without incurring the 35% withholding tax. (If the company is Dutch, relief will generally be available in the Netherlands for its foreign income) Companies resident in Barbados, BVI or Antigua may take advantage of the permanent establishment / business profits provisions. Swiss partnerships continue to have advantages under the UK and Irish treaties.
There has been a growth in trust administration in Switzerland: the practical stability, absence of exchange control and high level of professional services are undoubted attractions.
The second day of the seminar was spent in Liechtenstein. Six forms of entity on the Liechtenstein “menu”: the A; the GmbH; the Anstalt; the Stiftung; the Treuunternehmen and the Treuhnderschaft. Their features are set out underneath:
LIECHTENSTEIN ENTITIES (Holding Companies and Domiciliary Enterprises)
|NAME||ANNUAL TAX ON CAPITAL RESERVES||COUPON TAX ON DISTRIBUTIONS||PUBLIC REGISTRATION||AUDITED ACCOUNTS|
|Aktiengesellschaft||0.1% (minimum Sfr 1000)||4%||Yes||Yes|
|Anstalt||as above||n/a unless capital divided into shares or parts||Yes||Only if commercial activity (See 1.)|
|Stiftung||as above. (See 2.)||n/a||(See 3)||n/a|
|Treunternehmen||as above||n/a unless capital divided into shares or parts||Yes||Only if Commercial Activity (See 1)|
|Treuhnderschaft||as above||n/a||See 4.||n/a|
1) Establishments and Trust Enterprises which have no commercial activity must submit annually to the Public Registrar a declaration signed by their Liechtenstein board member confirming that a statement of assets and liabilities for the previous year is available and that the entity did not engage in a commercial activity during the preceding business year.
2) For Foundations the Capital Tax is reduced to 0.075 % where capital and reserves exceed Sfr 2 million and to 0.050% where they exceed Sfr 10 million.
3) A Family Foundation need not be registered in the Public Register, but its statutes must be deposited with the Court of the Principality. Where, however, the Foundation conducts an enterprise within the frame of its non-commercial purposes, it must be entered in the Public Register.
4) Where the Trust Settlement has a duration exceeding 12 months and at least one trustee is resident in Liechtenstein the following information must be recorded in the Public Register: name of trust, date of creation, duration, name and address of the trustee. Alternatively a copy of the trust deed is deposited with the Public Register but is not available for public inspection.
To what extent do countries in Continental Europe recognise a trust. There have been a few cases in France and Switzerland, where foreigners who were beneficiaries under trusts took up residence in their countries. These indicate that the civil law court will give some recognition to an English-style trust. As regards taxation, the French have issued regulations in the context of the France-US treaty, and in certain Swiss cantons rulings have dealt specifically with the issues involved. A French citizen is entitled to establish a trust governed by a law which is not French. A New York court has upheld a trust made by a French citizen resident in the State of New York; the validity of a New York trust made by a non-domiciled settlor is reinforced by a local statute.
The Final Act of the Hague Conference will clarify the position: the 32 countries who are parties to the Convention will be required to recognise trusts in the manner set out in the Convention, but it may take some time before the Convention is signed and ratified by all parties.