The concepts and the practicalities
The distinction between avoidance, evasion and mitigation: an international comparison
The need for a clear distinction in theory and in practice
A theoretical framework
Some practical considerations.
The terms need to be precisely understood – especially by governments and inter-governmental bodies. Taxpayers are entitled to know their position. They need to have the benefits of the law relating to human rights. The growing view that money-laundering applies to foreign fiscal offences requires the individual to know exactly what these are. Politicians are confusing ‘evasion’ and ‘avoidance’. Taxpayers must supply information, but they will always act to reduce this cost – like any other cost. The managers in the Compaq case took steps to reduce tax; the scheme was struck down by the US Court. Did they cross the frontier of the morally permissible? Aggressive tax planning is self-defeating. Tax mitigation and avoidance lie in between the disinterested payer and the fraudulent one. The word “fraud” should be used in preference to “evasion”; it should always require intentional behaviour or actual knowledge. An absence of honest belief is sufficient; it is considered that negligent or even reckless behaviour should not suffice, but statutory provision should replace the common law concept. An attempt to introduce a distinction between “tax mitigation” and “tax avoidance” by reference to the intention of Parliament, in e.g. the Willoughby case is not helpful. A taxpayer is entitled to choose the more tax-efficient form of a commercial transaction. But some forms of avoidance are countered by legislation, or are abusive (as in New Zealand), or ill-advised. Tax mitigation should cover all matters which are not considered abusive or ill-advised tax avoidance.
The advantages of a foreign will for(i) foreign assets(ii) domestic assets
The treatment of foreign testamentary trusts: (i) fixed interest trusts(ii) discretionary trusts
Foreign wills as a medium of tax-free disposition of foreign assets to foreign entities
Many jurisdictions impose a tax on death. Even those which do not have an estate tax as such nevertheless impose a capital gains tax on death. Australia provides examples of cases where a foreign testamentary trust may be advantageous. The global citizen “G.C.” may, at death, be domiciled in one country and resident in another and hold assets in both countries. His death may trigger a tax liability in both countries – see Bath v British and Malaysian Trustees. The end result of that case was advantageous to the beneficiary, but the litigation could have been avoided if the deceased had made a separate will dealing with her New South Wales assets – see the South African case of Jones v Borland. A foreign executor may be liable for tax in the jurisdiction of the deceased’s domicile, but the liability may not be enforceable. Stype Trustees makes it clear that a foreign trustee may be liable for tax arising on the death of the settlor. In Australia, a grant of probate may be made to a syndic on behalf of a corporation. Canada is an example of a country which provides for a deemed disposal on death. A foreign executor may be liable for the tax, though enforceability may a different matter. In Australia, the general rule is that the executor inherits the base cost of the testator: a foreign executor disposing of assets not having the “necessary connection” with Australia (even disposing of them to beneficiaries) is not liable for tax. Land in Australia and shares in private companies incorporated in Australia have the necessary connection. Shares in a listed company (of less than 10%), shares in foreign companies, paintings and trademarks, copyrights etc. do not. A will trust may have tax advantages – e.g. where the trust income is to be attributed to the settlor or grantor. See e.g. s679 of the Internal Revenue Code and ss102AAL and 481(3b) of the Australian Income Tax Assessment Act.
Review of current status of OECD & EU tax harmonisation agendas
The Primarolo Report – next steps
UN “Offshore Forum”
Factors driving the various international initiatives
Reactions/responses to the perceived threats
Need for regulatory and fiscal reform
Polarisation of centres
The issue of tax harmonisation cannot be considered in isolation. Tax and confidentiality are what the wealthy are looking for in offshore centres. Offshore business is growing hugely, but threatened by the concept of the “harmful” in tax competition. The term “Offshore Centres” covers many kinds of jurisdictions – from the classic tax havens to the onshore jurisdictions themselves. Competition is generally accepted to be beneficial: tax “harmonisation” cannot mean equivalence. But even if it did, one cannot focus on business taxes and take no account of social security and other tax-related costs. Nevertheless, there is a fear that the tax base in high-tax countries may be eroded through the impact of technology and globalisation. The Primarolo Report gave Sweden and the UK a clean bill of health, but all other jurisdictions were listed. Member States are to cause dependant territories to comply, but only in accordance with their constitutional arrangement. Discussion on a savings tax directive continues, but agreement does not seem to be in sight. The OECD is also encountering difficulties: a first attempt to identify “harmful” features was riddled with inconsistencies, arbitrary values and political judgements. The Report was essentially rejected by Luxembourg and Switzerland – though they abstained, rather than vetoed. The Tax Havens themselves are of course opposed to the OECD initiative and are highly critical of the Report. There are cost implications to the UK Treasury in taking the dependent territories out of the offshore business. In 1998, the UN expressed the view that offshore banking is beneficial to the world economy. The EU code of conduct and OECD guidelines have some common strands – no discrimination, no zero rate, no ring-fenced regime, open administration, and so on. The US is introducing new withholding rules, which will furnish information to the Revenue authorities. Offshore centres are going to have to change if they are going to survive: they are going to have to reform their tax systems, establish regulatory standards and exchange information. There will in the future be fewer centres in business and global standards of regulation. This will provide even more business for the centres which survive.
The United Kingdom charity
The United Kingdom corporation
United Kingdom resident thin trusts
United Kingdom resident alchemist trusts
The UK has a number of tax advantages for resident non-domiciled individuals – which are advantages beyond the scope of this talk. There are, however, opportunities for non-residents to make use of the UK. They must bear in mind that the transaction has, and can demonstrate, substance. The UK charity has extensive exemptions from tax (though it is liable to VAT), and can take advantage of the UK’s tax treaties. It must be a genuinely philanthropic entity, concerned with poverty, religion or education (or with some other activities for the “public” benefit). Registration with the Charity Commissioners is generally required. A charity may take the form of a trust or company: the appropriate form may be decided upon, in the light of the consequences of insolvency and the applicability of any relevant tax treaty. A charitable corporation is undoubtedly the “beneficial owner” of its income; it is considered that a charitable trustee is also – for tax treaty purposes. A wholly-owned company, making payments to the parent charity, may be used for obtaining relief on trading profits or so as to obtain benefit of e.g. Art VI of the UK/German treaty. The UK-resident company (whether or not incorporated there) pays tax at a rate between 10% and 30%. There is no withholding tax on dividends and non-residents are in general exempt from capital gains tax. Interest and “annual payments” (e.g. royalties) are in principle deductible; if they are not to be taxed, they need to have a non-UK source or the benefit of a tax treaty. The “thin trust” is useful for eliminating the capital gains tax liabilities of resident but non-domiciled individuals. It may also be used to take advantage of the capital gains article in a tax treaty. The Alchemy Trust is used to convert UK taxable income into non-UK taxable income or income of a third state into non-taxable income. The outgoing income needs an appropriate treaty – e.g. with Austria, Barbados or Israel, but not the US.
New wealth – new estate plans
Civil law trusts – common law foundations
Substantial fortunes have been made in the last ten years. The newly wealthy do not necessarily plan to hand the whole of their wealth to the next generation: changes in family pattern has eroded the dynastic convention. At the same time, “forced heirship” rules constrain testators in civil law countries. The “disposal” portion varies from country to country. The anti-forced-heirship laws in some offshore jurisdictions have yet to be fully tested. Such a client may wish to consider charitable giving – not in the Carneigie style but more in the form of foundations run more on business lines. Some such charities are onshore, some offshore – enjoying fewer constraints than the onshore equivalent, e.g. in a purpose trust or Liechtenstein Foundation. The client wants to keep his hands on the levers of power: there are risks, here, of sham or invalidity, but a Protector or private trust company may be effective, and powers can be reserved to the settlor (an ability confirmed by statute in Cayman, Bahamas and Bermuda). Trust laws exist in civil law countries – in Panama (which also has a Foundation, modelled on the Liechtenstein Foundation) and in Liechtenstein (since 1926 – but shortly to be revised). Switzerland is expected to codify the law relating the Fiducie and ratify the Hague convention; the assets of the foreign trust of a new resident may be excluded for Swiss wealth tax purposes (a circumstance which may also be helpful in the Netherlands). The Stichting and Stiftung have proved useful in civil law countries: a similar vehicle is on its way in the Bahamas, and may be on its way in Anguilla. A “collapsible” company is one where the client retains control during his lifetime, but the shares held by the next generation acquire value on the death of the client. Such a structure may be a fraud on creditors or require probate on the grounds that the arrangement is testamentary. Probate is not generally available to an estate of a person not domiciled in the jurisdiction. But Jersey offers such a facility, as does Cayman, Bermuda and to some extent the UK. A joint bank account is a simple way of passing benefit without probate, though it will not override the interests of civil law heirs. A more interesting use of this feature is this. An offshore joint account with X Co., on which the client can sign solely. X Co. is settled on trust. When the client dies, the only signatory is X Ltd. The general trend is towards a reduction in estate tax; the Hague Succession convention is not yet in effect, but will in due course facilitate cross border inheritance planning: the wealthy are becoming more mobile – going to Verbier, Belgium and the UK.
Ending the Relationship but Keeping the Assets
Transfer pricing rules and related customs rules
Definition of related parties
Avoiding organisations “owned or controlled directly or indirectly by the same interests”
Using trust declarations to destroy ownership and control
Using employment and/or management agreements, as well as retirement plans, to retain the economic benefits
Variation on a Theme
Transferring intellectual property out of the wrong jurisdiction tax-free
One Old Problem: One New Solution
Selling U.S. Real Property Interests Tax-free
Where goods are manufactured outside a high-tax jurisdiction but sold inside such jurisdiction, how can the taxable profits be minimised? The use of a local subsidiary will involve transfer pricing problems. One approach is to use an offshore trust to control the manufacturing company through a holding company which remunerates the client: the link of common control is broken and the parties cease to be related for transfer pricing purposes. A variant is to place the intellectual property in the hands of an offshore employees’ trust, but giving the clients remuneration as consultants. Again, ownership is replaced by contract. The United States imposes capital gains tax on disposal of US real property. This may be avoided by standing an anti-avoidance rule on its head. The vehicle is the charitable remainder trust.
Identifying the problem
Locating the treaty benefit
Exemptions and credits
Distribution: dividends, interest, liquidation
The starting point of this topic is a company located in Bermuda or other zero-tax location, which plans to acquire a significant shareholding in an operating company located in a high-tax country, and needs to consider whether it should invest directly into the operating company or should interpose a holding company. This is an exercise in treaty shopping, but does not appear to be regarded by the European Union as abusive. First, the holding company needs to be able to get dividends out of the operating company free of withholding tax or at a lower rate of withholding tax, by virtue of a tax treaty or under the European Parent/Subsidiary Directive and to be able to dispose of its investment in the operating company without any liability to capital tax or its equivalent in the operating country. Secondly, there needs to be in the domestic laws of the holding company jurisdiction some provision which wholly or largely exempts such dividends and capital gains from local tax. And thirdly, the zero-tax company needs to have the ability – and this, traditionally, has been the most difficult step – to take dividends out of the holding company without giving rise to any charge to tax at the holding company level. These features are to be found, to a greater or lesser extent, in Belgium, Cyprus, Denmark, Hungary, Luxembourg, Madeira, Malaysia, Mauritius, the Netherlands, Singapore, Spain and the United Kingdom.
International Tax and the Fashion Model
US tax issues
Employee or self-employed status
Treatment as artiste
Employment via UK company
International Tax and the IT contractor Global employer leasing company
Social security contributions
International Tax and the Entertainer
OECD model treaty article 17
Locally incorporated companies
Intermediary conduit companies
VAT and other taxes
Other Members of Entourage
Successful tax planning nowadays calls for a degree of “substance”. A mere name or label is not sufficient: artificial transactions will not do, and management must actually be exercised. Sara is a model. She is resident in the UK but not domiciled there. She has a contract of employment with a Danish company. Is the Danish company entitled to receive its US fees free of US tax? One must look first at Sara’s position and the UK/US treaty: if she is self-employed, she is not exempt from US tax, and the US model agency is liable for the tax. If she is employed, and does not stay in the US for more than 183 days, she will be exempt from US tax. It would be different if she were an “artiste” – which she probably is not. And she will only be an “employee” if the company determines her movement and pays a fixed salary. Exemption from US tax on self-employed profits requires remittance to the UK. Suppose a UK company under an offshore trust is the employer – with the attributes of a true employer: the company takes advantage of the business profits article and UK tax applies to its profits – after payment of Sara’s salary and contribution to her pension scheme. A global employee-leasing company can present a more “substantial” option; single-employee companies have problems in many countries – e.g. Germany and the UK. Entertainers and sportsmen generally have a special – and disadvantageous – treatment. A cancellation fee is generally not taxed, but the presence of an individual for even a few days can give rise to a tax charge on gross earnings – even though he will not usually benefit from the social security etc. which the tax pays for. An entertainer earns income of many types – from performances, endorsement, sponsorship, merchandising, recording etc., and design logos and trade marks. Art. 17 of the OECD Model extends to income from personal services as such : this will cover a bonus, profit participation, prize, sponsorship and “up-front” fees. A locally incorporated company can generally receive the income without withholding tax and can reduce its profits by providing pensions, charging expenses – e.g. for providing a fully equipped show. Other income may not fall within the “as such” category – endorsement, some kinds of sponsorship, merchandising and royalties from intellectual property rights. (Royalties may be passed through an intermediary licensing company). The earnings of other members of the entourage do not fall within Art. 17.