Cannes 1997 meeting

Meeting Summary
  • Dividends and Capital GainsRichard Rees-Pulley
    • How can, for example, a Cayman Islands trust make an investment in a high-tax country? Without any planning, the trust would suffer full withholding taxes on dividends and capital gains tax where applicable (not the US or UK). A suitable structure must minimise intermediate taxes, should not be too expensive, should preferably follow well-trodden paths and will take advantage of tax treaties.
      The use of a Netherlands holding company, with an Antilles company on top, is classic. The Netherlands has a large number of treaties and binding rulings are available. The overall tax cost is around 10%, but this can be reduced by debt financing at both levels. However, the Netherlands appears currently not altogether happy with the low tax level of the Antilles.

      The Luxembourg SOPARFI is not dissimilar to the Netherlands holding company. A 1929 holding company is normally used if participation exemption is required on dividend flows. Use of Madeira still appears to be untested, as is the economic zone in the Canary Islands. Cyprus is used in relation to Eastern Europe. Hungary may perhaps be used for dividends, but in practice is used for royalties. The UK holding company can be used in appropriate cases.

      Australia imposes withholding tax only on unfranked dividends. Treaty companies may escape tax on capital tax by invocation of the “business profits” article. Barbados is used to avoid capital gains tax in Canada; dividends are more difficult, but some relief may be obtained by debt financing. French withholding tax is 25% and capital gains tax of the order of 16%. France has anti-treaty-shopping and anti-Directive-shopping in its code. As with German investment, a strong commercial reason for the Netherlands or other holding company is needed. German withholding tax is also 25% and there is a capital gains tax on disposal of significant holdings.

      Italian withholding tax is 32.4% and Italy has a similar capital gains tax. Again, the Netherlands structure should work, if economically justifiable. A trust for an Italian resident may make use of this; the individual may be comforted by retaining voting shares. Japanese withholding tax is 20%; their code contains no anti-shopping provisions. Spain imposes a 25% withholding tax and tax on capital gains; here the UK may be considered,. the treaty setting aside the Spanish debt/equity rules; the Netherlands route is classic.

      The United Kingdom has no withholding tax as such and imposes no capital gains tax on non-resident investors. There may be changes in the July budget.

      US withholding tax is 30%. An LLC may invest into the target company; the parties elect for consolidation; debt-financing of the LLC may give rise to tax free portfolio interest.

  • InterestLes Falk
    • Minimising source tax is only interesting if the recipient country imposes less (or no) tax. Interest is normally tax-deductible; a loan can normally be repaid without tax consequences; a loan can be denominated in any currency; debt generally avoids stamp duties; debt may be converted to equity (and not the other way round).
      Sometimes relief is obtained twice – e.g. where a loan is made to company 1 which takes equity in company 2, which lends to company 3. Contrariwise, interest is not always deductible. Or it may (as in the UK), be allowed on an accruals basis. Thin capitalisation rules can present problems – the regimes differing in different countries; most companies (except the UK) have safe harbours – 1.5:1 in France, 9:1 in Germany; parent company guarantees and back-to-back arrangements are treated in various ways.

      Under the US earning-stripping rules, the interest must not exceed 50% of income nor must the debt/equity ratio exceed 1.5:1; but any excess may be carried forward and is not treated as a dividend. These rules only apply where the interest is paid to a treaty country. The general thin capitalisation rules are understood to permit a 3:1 ratio, but the IRS can recharacterise debt as equity.

      In Germany, the allowed ratio for an operating company is 3:1; any excess disallowed is treated as dividend – even if the company is making losses. The ratio for hybrid debt is only 0.5:1.

      Interest suffers no withholding tax – subject to certain conditions – in France, Germany and Spain. The UK imposes 20%, the US 30%. The OECD favours a 10% maximum.

      Australia, Italy and Japan have no anti-treaty-shopping rules. Many other countries do – notably the US, beginning with the Aiken Industries case, and domestic rules override treaties. Many UK treaties contain an exclusion for debt created to take advantage of the treaty, but its effectiveness is largely untested. The Danish treaty excludes interest payable to a Danish company owned by shareholders resident elsewhere.

      The OECD report recommends that interest on participation and convertible bonds should be treated as interest unless the lender effectively shares in the risks of the borrower; most treaties provide for interest on hybrids and should be treated as such, but the position is not always clear. Zero-coupon deep discount bonds are generally treated as giving rise to deductible interest; in the UK it is free of withholding tax; the discount is treated in Japan as “other income”.

      Outbound US investment may utilise a Dutch finance company to invest in e.g. France, Germany, Italy and Spain.

      For US inbound investment, if a UK company capitalises a haven company which lends to a US company, the present situation is that the US company may be treated as paying interest to the UK company. But this is to change from next January. But query, will it still work if an LLC replaces the haven company? With a German GmbH and Co KG or other “hybrid” a workable structure may be created. A “silent” partnership (eg in Holland) may be used to lend to Japan.

  • OverviewConrad McDonnell
    • The Internet is a network of computers all over the world. Its main uses are e-mail and the World-Wide Web. An intranet is a smaller version, within a single organisation. Both are growing in popularity very rapidly. The Internet is like a large telephone system connecting computers.
      E-mail is a way of sending text messages very quickly from computer to computer. It is especially useful for sending a computer file, which would otherwise have to be placed on a disk and transported physically. It is cheap and reliable, but not secure unless cryptographic techniques are used. An e-mail message is often short and informal and users are inclined to use the system a good deal.

      The World-Wide Web carries a huge amount of information, not all of which is very useful. But the system is easy to use: it is compatible to computers of all kinds and no special expertise is required. It provides a very cheap way to disseminate information. It is useful for advertising products and for market research since its reach is global, although only a portion of society sees it: the typical user is a young person with college education. Publicly funded bodies may find it useful as a way of distributing information to the public. Train and aeroplane times, shareholder information and pre-launch testing of computer software are all examples of commercial uses of the Web. A corporate website will typically have an opening page in graphic form, with a facility to click on buttons to access further information.

      Tax practitioners may find the Web useful for research – eg from websites maintained by the large firms of accountants. Such information is variable in quality, since of course it is free. There are also paying sites – like that of the ITPA. Such sites are only available to subscribers. Others are paid for by credit card – notably those offering pornography.

      People find that new business comes through having a presence on the Internet. The net is also a source of substantial advertising revenue in certain cases; sometimes the net can produce revenue directly when sales are made over it.

      To create a website is not expensive, but it is important first to think of useful content. Web space needs to be rented, although this is often offered free by an Internet Service Provider. Optimally, a “domain name” can be registered for about $200 for two years: registration is effected on a first-come first-served basis. It is important that a website should be simple, attractive and informative.

      To connect to the Internet, a computer and a modem and a telephone line are required: there is now a faster X2 standard modem. An alternative to a modem is an ISDN line. This is usually offered by the telephone company and has other uses also; including video-conferencing. An ISDN line is superior to a normal telephone line: a basic rate interface is roughly twice as expensive but around four or five times as fast for Internet access.

      Video-conferencing is essentially the combination of television and telephone. It saves travel costs, since meetings that would previously have been conducted face-to-face may be held over video-conferencing systems instead. It has already been used to conduct litigation in the UK, one of the two parties remaining in his own city rather than travelling to court for the hearing.

      These new technologies have a role to play in tax planning: the Internet may facilitate cross-border selling without any physical presence in a country; video-conferencing may facilitate management of a company from an offshore base.

  • Personal ServicesStephen Gray
    • A US company acquired a UK company. A well-paid individual had to spend a lot of time in the US. He might become a resident for federal, state and city purposes. But he was able to reduce the number of days spent in the US and thereby limit his US tax liability to remuneration for services rendered there. Point one is to avoid resident status, if possible.
      The loan-out company route generally does not work. A stock option or phantom stock may be realised to produce capital gains or be tax free after residence has ceased. If it is advantageous, the option or stock may be in a parent or affiliate. In the US, the value of stock received may be fixed so as to compute income.

      Personal service may be converted into other sorts of income. Acceleration or deferral of income can be effective.

      Split contracts work well for non-domiciled residents of the UK – who are not taxed on services performed outside the UK. Italy and Japan have a similar rule. Allocation of income away from locally-performed services – to eg endorsement royalties – can be effective if done ahead of time. The residence of the service-performer may be changed eg to Ireland, Switzerland or the UK: the allocation should then be properly provided for in the contract. This line of tax planning in the US derives from the decision in the Sierra Club case: royalties for use of image, name and signature are not personal services income.

      Personal services income may be converted into a pension: this may achieve tax deferral in eg the US, but after the pensioner returns to reside in the UK or Ireland the pension may come free of tax or be surrendered for an untaxed capital sum. A UK resident may build up a pension and then go eg to Antigua or Malta and receive his pension free of tax under the treaty.

      Dependent and independent personal services may be protected by the treaty with the country of performance, but the price is payment of the home country tax. A “Rabbi” trust has IRS blessing in the United States and may be effective in the UK and elsewhere.

  • RoyaltiesRoy Saunders
    • In a case involving licensing video programmes, the interposition of a Dutch company between the UK and Polish company reduced Polish withholding tax from 10% to 0%. Patents, designs, trade marks, franchises, copyrights, know-how etc give rise to “royalties” for treaty purposes. “Showhow” – which requires physical presence – generally gives rise to business profits. A capital payment for the use of intellectual property will not be a “royalty”. A royalty is essentially a payment related to usage.
      The royalty article in a treaty may or may not include film rights . In the UK, a payment for film rights suffers no withholding tax. A treaty may contain anti-abuse provisions – e.g. the UK/Dutch treaty. The UK does not charge withholding tax on foreign patent royalties: a UK intermediary may be interposed e.g. between Germany and Jersey. The UK company should use a foreign bank account and be administered abroad and the agreements should be made under foreign law.

      The US imposes 30% withholding tax. Anti-abuse provisions in US domestic law and treaties prevent the use of a conduit company. Canada imposes no withholding tax on copyright royalties (except film). Germany has a 25% withholding tax rate; it is reduced by treaties but the recipient must be engaged in business or be owned by persons who themselves would be entitled to treaty benefit – but a Dutch company may be used nevertheless if commercially engaged in business. The rate in Spain is 25%: the Hungarian treaty provides for a zero rate. The Italian rate is effectively 22.5% to 30%; Japan 20%.

      The classic plan for royalties begins with the vesting of the rights in an offshore entity. The price will generally have to be market value: future rights may have small value.

      As regards intermediary licensing companies, the Netherlands has a large network of treaties, mostly providing for 0% withholding tax on royalties; it permits a spread of 7% reducing to 2%; it levies no tax on outgoing royalties. In one case, a UK company was buying film rights for foreign programming; the payments it received were royalties where the amount depended on usage – hence the interposition of the Dutch company.

      The Swiss domiciliary company has an effective tax rate of 4.5%, but 25% must be paid out as dividends with a withholding tax of 35% if the 1962 Federal Decree on Treaty Abuse is relevant. Film licensing through Ireland is effective: Irish treaties do not generally have an anti-abuse provision (though a new treaty with the US is on its way); there is no withholding tax on outgoing film royalties; withholding tax on other royalties may be eliminated by the use of Cyprus. Cyprus offers a good route to Eastern Europe: there is no withholding tax in Cyprus on foreign-source royalties referable to use outside Cyprus.

      Hungary may be used for all royalties from Korea and cultural royalties from Japan. The Hungarian tax is 3%, but there is also a local tax of a minimum of 0.15% of turnover and VAT is chargeable (and takes a long time to recover, during which an exchange loss may be incurred).

      Conduit royalty transactions may be attacked on the ground that the intermediary is not truly resident or that the intermediary is not beneficially entitled to the royalty. The intermediary should take some risk – eg by paying a fixed sum for the rights it acquires, and the performance of its head licence should not be totally dependent upon the performance of one of its licencees only.

  • Surveillance and CommunicationsKevin Mirecki
    • Interception of information threatens the basic confidentiality of the client relationship: advisers, trustees, businesses, exporters and many others present targets of surveillance. The techniques were developed by the US and other governments during the Cold War; it is now being applied by private enterprises. Information can be collected and stored in huge quantities by super-computers. Intelligence is gathered in many ways. All forms of communication are vulnerable – e.g. telephone wires, wireless signals. Facsimile messages are insecure, as are e-mail messages.
      Web sites log users. The older systems are more secure – e.g. the post, courier services.

      Surveillance includes bugging and eavesdropping; it is generally illegal. Menwith Hill intercepts information on a large scale. Sophisticated intelligence-gathering is not publicly acknowledged, but is widespread. Methods include parabolic microphones, telephone bugs, cellular scanners, automatic telephone recorders, bugging devices, laser eavesdropping.

      The US National Security Agency can monitor every telephone communication. Menwith Hill monitors one billion telephone conversations a year and other similar installations exist all over the world. Streams of business information are being captured: no one knows how much nor to whom it is conveyed.

      The US has RSOC ground stations in various parts of the world which exist to obtain and process information. Two thousand Americans are employed at Menwith Hill and no information about its activities are released. The UK has a site at Morwenstow in Cornwall: tapping or other unlawful spying is believed to be undertaken on its behalf by the US sites. The ECHELON intercepts all forms of electronic communication: it monitors intelstats and undersea cables. The system extracts important information from a mass of intercepted communications: it is sensitive to “key words” in all major languages. In a UK television programme a former GCHQ employee said that information was being intercepted which had nothing to do with intelligence.

      It is possible to encrypt e-mail messages and scramble telephone conversations. But the NSA can monitor despite any device exported from the US. Everyone of us needs to be aware of these surveillance systems.

  • Taxation IssuesHoward Levine
    • The traditional factors of taxation do not fit Internet transactions – e.g. permanent establishment, place of sale etc. This presents both a problem and an opportunity. The IRS have realised that the Internet can be used by US taxpayers to avoid subpart F income. Business can be conducted through the Internet with a significant US content without exposure to US tax.
      The US Code charges tax on a seller who is engaged in trade or business in the US. Traditionally, this depends on continuous activity in the United States – e.g. regular sales. Mere solicitation into the US is not sufficient, but if combined with demonstrations may be enough to amount to trade or business in the US. A seller selling through a website maintained by a server in the US may not be carrying on trade or business, if the server is outside the US, the argument is stronger. A secondary server outside the US makes it virtually impossible to identify where the sale is effected.

      Treaties provide that a fixed place of business constitutes a permanent establishment: a local server probably does not amount to a PE, though an ATM machine may constitute a PE of a bank, as may gaming or vending machines. Sales of software over the Internet may be treated similarly.

      The very lack of clarity which may be advantageous to taxpayers may lead to double taxation: the question is likely to be addressed by future treaty negotiation.

      Services are taxed in the US in the place of performance. The IRS seem less keen to tax sales of services; in any case the place of performance of services provided on the Internet (or by video conferencing) can be virtually impossible to identify. This is also true of global trading.

      The Internet is offering US taxpayers the opportunity to conduct business offshore through an offshore company – e.g. in gambling (whose profits do not constitute subpart F income).

      Foreign entities are selling books, software, online information, healthcare information, stocks, offshore banking etc. without the need to have any distributor or other establishment in the US. The IRS white paper is surprisingly favourable to taxpayers, but the Service has announced that the matter is under review.


  • The Technology and its ApplicationIan Bebbington
    • Users of the Internet include financial services; it serves to expand markets and improve customer services. Sites have become much more interactive: this increases communication with the customer and creates an ongoing relationship with the customer. Customised software delivers customer-specific information: this makes an effective marketing tool – the “push technology” sends tailored information responsive to a customer’s specific needs.
      A website is cheap and can be easily updated. The sites attracting most interest are those where no physical delivery is involved – providing information and services – e.g. travel services. The best web site strategy is to tell the potential customer the problems he is going to encounter and the solutions available. There are now 300,000 web sites and 10,000 are added each week. Some 50,000 are providing on-line sales. An annual US$ 6 billion by the year 2000 is forecast. Sales are direct, cutting out the middle man: online booking is offered by hotels, airlines, banks, brokers and others.

      The user base is educated and relatively high earning. Software is available to tailor information to specific classes of customers. The volume of commerce is much larger than the size of the value-passing transactions will suggest. But new software is enabling the user to acquire a token currency which can be spent on the web. A “digital signature” will enable the Internet user to establish his identity: SET identifies all the parties and operates through visa and mastercard. Value transfer via the Internet is already very secure: enhanced encryption codes and protocols will make them more secure still.

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