Amsterdam 2010 meeting

The Isle of Man is a self-governing Crown Dependency. It is not part of the EU, but participates in EU free trade and is part of the European Customs Area. The law is based on the principles of English Common Law, and the Privy Council is the final court of appeal. Income tax is based on the Act of 1970. There is a cap of £115,000. Presently, corporation tax is 0%, but there is pressure for change. Banks and property transactions are taxed at 10%. There are no death taxes, capital gains tax or wealth tax. Trusts are transparent, so that trusts with non-resident beneficiaries pay no tax on foreign income. Partnerships are tax-neutral. Residence of individuals and companies is governed by rules similar to those in the UK. The Island is part of the UK for customs, excise and VAT; this facilitates the use of an Isle of Man company for importing to the EU, the middle-man profit arising there. There are four tax treaties and 17 TIEAs. There are now companies on the BVI IBC model – the “2006 Company”, LLCs on the US model, partnerships, limited partnerships and trusts on the English model – plus purpose trusts.
The Isle of Man is a popular offshore jurisdiction for property holding companies. It has a thriving space industry, an aircraft registry for private planes, shipping registries for yachts and merchant ships, online gambling and a film industry (aided by the Media Development Fund). The Financial Assistance Scheme helps the establishment of local businesses. Recent developments include discussions with the European Union on the Zero/10 tax and plans for a Foundations Bill.

Trusts have had a long and successful history. Their very success has stimulated governments to institute anti-avoidance measures. Foundations, on the other hand, have not been so long in existence, and may therefore afford opportunities for tax saving no longer available to trusts.
A beneficiary of a foundation may have – in contrast to the beneficiary of a trust – few or no rights. A Jersey foundation is a body corporate. It has a charter and regulations, and has a council (of which one member must be a Jerseyman). It has a guardian to enforce the duties of the council, but no-one has any remedy if he fails to do so.

The uses of the foundation in relation to UK tax may indicate its uses in other jurisdictions. For inheritance tax, the ideal (but rare) situation is to begin with a start-up. For the non-domiciled or the owner of the business, there is no problem; for others there are various ‘value-freezing’ and ‘value-shifting’ strategies. The foundation, however, offers a path to freedom from inheritance tax. It is considered that a foundation is not to be equated with a trust. It is probably going to be a close company, but discretionary beneficiaries are not participators. Foundation distributions should be of property situated abroad.

Steps can be taken to ensure that transferring appreciated assets into a foundation has no capital gains tax consequence, so long as the founder is not ‘connected’ with the foundation.

The offshore trust anti-avoidance provisions for capital gains tax (section 86) are draconian, but they do not apply to a foundation. Section 87 attributes gains to beneficiaries when they get a benefit; it applies to a ‘settlement’, which may include a foundation. The problem may be solved by proceeding in two stages. The gains of non-resident close companies can be apportioned to participators, but – again – discretionary beneficiaries are not participators.

The income tax provisions relating to transfer of assets abroad may be relevant. If the founder excludes himself and his spouse or civil partner, the liability only arises when the beneficiary gets a benefit.

The best form of offshore tax planning is to make a gift to an individual who does not die, lose capacity, become insolvent, divorce or behave dishonestly. Of course, the donor wants his wishes to be carried out, but giving the intended beneficiaries rights may expose them to a tax liability. The foundation is one way to – partially at any rate – bridge this gap.

Bank-owned trust companies are increasingly averse to high-risk investments. The trustee has a duty of care – the “prudent man of business” test, expanded in the UK by the 2000 Act. There have been actions against trustees for failure to take proper care – Bartlett famously, and more recently Gregson v HAE. Modern portfolio theory minimises risk by diversification. It was approved in Nestlé v National Westminster Bank PLC. Settlor-directed investments are typical hot potatoes, and trustees asked to hold them will want an Anti-Bartlett clause in the trust instrument, though this will not eliminate the overall duty of care. One solution to the problem is the private trust company. The foundation or VISTA trust may reduce the level of duty of care, but there are some uncertainties. Trustees need to consider the terms of the trust and examine any possible breaches of trust by former trustees. Jasmine v Wells & Hind is a case of an invalid appointment of trustee. Bank-owned trust companies need to be aware of self-dealing issues. Exemption or exoneration clauses can be effective, but will be strictly construed; they need to be brought to the attention of the settlor; STEP does not approve of them; not all jurisdictions will give effect to them. How far trustees should pay attention to the wishes of the settlor can be a very difficult question. Reserved powers are viewed differently in different jurisdictions. Trustees are well advised to communicate with beneficiaries and to be aware of the extent and limitation of their powers.

The protagonists in the Six Fiscal Fables are individuals who arrange their affairs in a tax-efficient manner. Mr. Smith – a UK resident – increases the base cost of his shareholding in a new company; Mr. Shah – resident but not domiciled in the United Kingdom – frees his estate from inheritance tax on his UK home; Mr. Lee uses twin trusts to support UK-resident beneficiaries; the Englishman Abroad finds that he does not have to go to a zero-tax jurisdiction in order to pay no tax, but needs a “window” between his two residences. Their stratagems relate to provisions in the UK tax code, though this may have application elsewhere. The procedures adopted by Jack and Nigel, however, may be of more general use – Jack’s transaction exploring the possibilities of assets which, taken separately, have no value, but taken together have considerable value, and Nigel’s transaction looking at the use of liabilities with similar characteristics.

A family office manages the family investments: the management is under family control and not given to a trust or management company. It brings various administrative activities under one roof; it is the modern version of the ‘Estate Office’. A typical structure is based offshore, but must nevertheless be able to take advantage of the onshore advice of the protector or his equivalent. The protector has fiduciary duties and responsibilities. He has few rights – unless the trust instrument provides them. Instead of appointing an individual to be the protector, the structure may use as trustee a private trust company (‘PTC’) of which the individual is the director. Shares in the PTC may be held by a purpose trust, or perhaps by a foundation (to be known in the Bahamas as an Executive Entity).
The letter of wishes has shortcomings. The risk of family conflict reduces the value of the family company. Family governance requires a binding structure just as a business does, setting out purposes and procedures so that power is exercised responsibly.

UK holding companies have been widely used, but before 2002, the tax regime was essentially unfavourable to the holding company. Statutes and the influence of the EU law have made changes. A ‘small’ UK company may be used by non-residents as an investment vehicle, investing in a treaty country and obtaining treaty benefits. There is a GAAR in the rules. The rules for larger companies are more generous. With a medium-sized company there are five classes of exemptions, the most important of which are dividends from controlled companies. The substantial shareholder exemption is a separate exemption for capital gains: the provisions are formulaic and not altogether satisfactory. There is a non-statutory clearance procedure. After Cadbury Schweppes, the CFC rules are applicable to an EU subsidiary only if the arrangement is wholly artificial. The ‘thin-cap’ rules may be similarly curtailed.

Fundamental to transfer pricing questions is the arm’s length principle. The guidelines fall into two categories: traditionally, comparables are used, but a functional analysis may point to the use of alternative pricing methods. The comparative method can be very difficult to apply in practice. The functional analysis looks at the functions performed by each party to the transaction, with a view to ascertaining how the mutual benefits are shared. The economist begins by looking at the market, at the market level of return, at the scarcity of the product and at the bargaining power of the parties, and asks what is the alternative: risk and reward will normally correspond.
The Dixon case shows these processes at work. The retailer sold warranties to customers and re-insured its liabilities with a Manx subsidiary. Its case focused on the insurance aspect. But HMRC looked at the retail market: it was a parent that the seller of the goods was familiar with risks and had the best opportunity to sell a warranty to the purchaser, and accordingly a large share of the warranty profit should accrue to the retailer. The decision largely adopted the HMRC argument, allowing a normal (and lower) profit to be attributed to the Manx insurer.

Beneficial ownership is the key to unlocking treaty benefits. Articles 10, 11 & 12 require beneficial ownership: the received wisdom is that this requirement is intended to curb treaty-shopping. The expression originated in the 1966 protocol to the UK / US treaty: it was substituted for ‘subject to tax’, in order to extend treaty benefit to pension funds and charities. It was embodied in the 1977 OECD model and has subsequently been seized upon by tax authorities in order to fight treaty-shopping. The expression has a narrow meaning in English law, which distinguishes between legal ownership and beneficial ownership. The international fiscal meaning is derived from the OECD commentary: this seeks to prevent nominees and conduit companies benefitting from a treaty. Indofood is an unsatisfactory decision of the English Court of Appeal: it was held that an interposed Dutch company in a chain of lending would not be the beneficial owner of the interest, and that the expression should have an international fiscal meaning. In Prevost, the Canadian court held that a Dutch company which received and paid a dividend was the beneficial owner of the incoming dividend, since there was no pre-determined flow of the dividends. In the Indonesian case of PT Transportasi Gas, on facts similar to Indofood, the court came to the opposite conclusion, distinguishing Indofood on the basis that the Dutch SPV in that case was designed to receive the interest. In the Danish case of Company X, it was held that the Luxembourg Company in that case was not a conduit company. There is a lot to be said for allowing national courts to adopt their own meaning of ‘beneficial ownership’, but the cases to date appear to favour the adoption of an international meaning. The OECD proposal treats a widely-held collective investment vehicle as the beneficial owner of its income. Perhaps over time we shall move to an international consensus on the scope and meaning of the term.