Hamburg 2003 meeting

Swiss taxes are numerous. There is a federal income tax at a maximum rate of 11.5%. The Cantonal and municipal taxes bring the total rate to 35% – 52%. The Cantons levy a wealth tax of between 0.1% and 0.8%, and there are social security charges. However, there is no capital gains tax (except on local land) – a feature which indicates Switzerland as a “drop off” location. The inheritance and gift taxes are Cantonal. “Canton shopping” is a developed art.
Non-EU citizens need a residence permit. There is a Cantonal quota system. A permit to work is difficult to obtain, but may be granted if a new and desirable business is to be established. There are easier rules for retirees. They must be over 55, show close personal relations with Switzerland and have adequate financial resources. The lump sum tax system – the “forfait fiscale” – is available to them. Exceptionally, “young retirees” may obtain permits. EU residents going to Switzerland to work enjoy facilitated entry treatment, though quotas still apply for a transitional period expiring in 2007. Non-working EU citizens have no restrictions, and a permit is not required, but the applicant must show sufficient resources and a full health insurance policy.

The forfait can apply to all non-working residents, but only to a very limited extent to Swiss citizens. The minimum sum is five times the annual rent of the taxpayer’s residence. This is his notional income. There are Cantonal minima. The Swiss-source income and assets, and treaty-privileged income, should not exceed the lump sum amount. Residents taxed on a forfait basis may be excluded from treaty benefit. The lump sum arrangement does not provide exemption from inheritance or gift tax (except in Vaud).

Trusts do not figure in Swiss tax legislation, but foreign trusts are generally recognised, though their tax treatment is not consistent. Advance rulings are available.

A tax harmonisation programme is in progress, and Cantons which did not have the forfait system are adopting it. The Swiss recognise that foreigners contribute to the economy and prestige of the country. Switzerland is not part of the EU, but it is getting closer and is expected to eventually join.

The 2001/2003 “tax shield” legislation is the first signal of a new climate. It has been very successful. The taxpayer can repatriate assets or report them and continue to hold them abroad. A tax of 2.5-4% of their value can be paid to a financial intermediary, without the need for a tax return. The amnesty does not cover a criminal investigation. If the historical cost of repatriated assets cannot be ascertained, the contemporary value is taken as their base cost. The tax authorities are sometimes prepared to view trust assets as those of an individual taxpayer for these purposes.
The introduction of a wealth tax is unlikely. Gift and inheritance taxes have been abolished; a small donations registration tax remains, subject to a number of exceptions. Existing inheritance and gift tax treaties require revision. The tax rate on most income from financial investments is 12.5%, though some kinds of income and gains are taxed at 27%. A number of reforms are under consideration.

The “harmful tax competition” campaign has essentially resolved itself into a KYC concept. At the same time, we are seeing the growth of an industry of avoiding revelation of information. The need for KYC is universal, though the detail is industry-specific and geography-specific. There are on-line resources.
The design of a KYC system begins with ascertainment of the relevant law or laws and resolution of conflicts between two or more systems. One needs to identify the source of the laws, to interpret the rules, to consider the local restrictions in the gathering or use of information and to stay current. The next step is to develop procedures and protocols. Learning about customers can reveal business opportunities, but there are often necessary restrictions on internal sharing of information. Experience is a guide. Cultural differences need to be taken into account.

In order to execute the compliance system, one must identify the persons concerned. Here one looks to the introducer, to interviews, to referencing, to questionnaires and the terms of the customer agreement. To prove the identity or existence of the subject or assets, to investigate information on the subject and to verify the information provided are further steps. There will always be an obligation to report suspicious transactions. But what is “suspicious”? There is a need to monitor ongoing client relationships.

We are all familiar with the trust which is a device to hold property for the benefit of other people. We shall need to distinguish such beneficiary trusts, with the idea of “equitable” ownership with certain rights – such as putting an end to the trust – from purpose trusts. Discretionary trusts also imply the concept of equitable ownership – it is still possible for all possible beneficiaries to agree and end the trust. They can also agree on the use of a power. But a purpose trust has no beneficiaries. However, beware the “hidden” beneficiary which may make the trust not a purpose trust. A purpose trust has an “abstract purpose”: it may benefit society as a whole, not any specific person.
In English law a non-charitable trust with no beneficiary is generally void. This is the general view, but Baxendale-Walker says that purpose trusts have been around in England for 600 years. He argues that there are valid purpose trusts which are not charitable, and he cites 67 cases as proof. The Baxendale-Walker thesis is that a beneficiary only has the right to complain, and he has no rights against the trustee. So, beneficiaries are “optional” – a trust needs a “complainer” about the trustee’s future to fulfil his duty. Any trust which imposes on the trustee a duty other than a dispositive duty is a purpose trust. This is a very unorthodox view. An accumulation trust, for example, is labelled a purpose trust, so are ESOPs, or trusts to carry on a business.

There are aspects of a trust which are similar to the features of a contract. A trustee does not have to serve; he consents to serve. Settlors and trustees negotiate about the terms on which he will do so. Is that not a contract? But there are differences between trust and contract – different legal histories and courts. Beneficiaries can enforce the trust; the settlor cannot. There do not need to be two parties – one can unilaterally declare a trust. No issues of fundamental breach justify bringing the trust to an end. Trustees do not get paid if trust funds run out. The courts monitor trusts, not contracts. Any claim against a trustee is not for damages, but for restitution. Trust funds are separately held, safe from creditors of the trustee. The beneficiaries’ rights are vested, not promised (as under a contract). Trust assets can be inalienable for a long period – which raises social policy issues. There is no rule against perpetuities in the contract area. Trusts and contracts are fundamentally different.

Offshore jurisdictions provide for a “non-owned” vehicle. A corporate form was rejected. Designer legislation – the 1989 Bermuda model and the 1996 Jersey model – set the stage. These embody different approaches. Both provide for trusts for a non-charitable, lawful purpose to be enforceable. The trust funds must be “consumed” in serving the purpose. Without this, the trust is invalid. There is no need for these vehicles under UK law. There is no real demand for them. And it may be noted that there is no requirement of privity of contract anymore, due to the effect of Contracts (Rights of Third Parties) Act 1999. A third party can enforce the contract.

The Cayman Islands STAR is a separate, distinct regime. It disconnects enjoyment and application of income and capital from enforcement. There needs to be a separate “enforcer” – he is not a beneficiary. So a STAR trust can benefit people, who have no right to complain. The STAR trust is similar in some ways to a civil law fiduciary contract and foundation. The STAR legislation permits the court to cure any form of uncertainty, plus there is a “non-charitable” cy-près jurisdiction. Very useful improvements. One may ask whether a STAR is really a trust at all. In 1998, Lord Millett, in Armitage v. Nurse, said that there is no trust if beneficiaries have no enforceable rights. Is the STAR trust against public policy? Is it recognisable under The Hague Convention? This is not clear.

Popular literature says purpose trusts can be used widely. Is this correct? The assets really are separated and can be used in many private ways. Five are listed in the working papers, e.g. cross-border securitisation, foreign agencies, private trust companies etc.

But purpose trusts present problems. Do purposes go too far and create hidden beneficiaries? Does the enforcer become a beneficiary? Who controls the trust? Is it a sham? We need to be weary of the trust as product, a “trust to go”. There is commercial pressure to expand the frontiers of the trust. But the fundamentals of the trust cannot be altered.

THE WORLD-WIDE RESPONSE TO THE HARMFUL TAX COMPETITION CAMPAIGN – Philip Baker
The EU proposed “tax package” was agreed in June, 2003. The OECD focussed on “harmful tax regimes”. 47 were identified. 9 have been excluded. 32 have made commitments. There remain 6 “uncooperative” jurisdictions. There was never any assessment of what was harmful: the original focus on low rates of tax and ring-fencing has shifted to transparency and exchange of information. The campaign has subjected different jurisdictions to different levels of pressure. The EU and OECD member states were affected by both campaigns. Ireland responded by lowering its tax rates for everybody to 12.5% and abolishing the Dublin and Shannon regimes. The other OECD countries, which are not EU members did not come under the same pressure. The 10 EU candidate countries, due to join in May 2004, have had little pressure, but have used the opportunity to make their tax regimes more attractive, following the Irish example. A lot of pressure has been applied to the dependent and associated territories of EU and OECD members. The 32 committed jurisdictions have as yet done little, except enter into tax information exchange agreements. The “uncooperatives” are under great pressure. The excluded jurisdictions are under no pressure. It is strange that Hong Kong, Labuan, and Singapore were never on any list.
What is a “non-harmful tax regime” – what is acceptable tax competition? A uniform low or zero rate is acceptable. What are the other sources of corporate revenue? Are “special regimes” still allowed? For some activities, like shipping, yes. For local financial services, perhaps no. For utilities, maybe. Holding company regimes are well entrenched and will be hard to dislodge; Italy is introducing one later in 2003. Some regimes, like the participation exemption, are likely to survive. Some exemption methods, like capital gains tax relief, appear to be non-harmful. Can there be a special regime for expatriates or non-domiciliaries? Is this harmful? This is not clear, but they must be limited in time. Tax breaks for industrial development are allowable. So are some ruling procedures. But lack of transparency and absence of exchange of information are per se harmful. There is now an actual duty to gather information for purposes of exchange.

It is today an increasingly difficult (and risky) world for trustees, whose task is difficult already. It is important, however, to keep a sense of proportion. Proper care in the drafting of trust documents is vital. Advance thinking is the key. You need to be sure that an intending settlor understands what a trust means. A particular difficulty arises where the settlors comes from a civil law background and is unfamiliar with the concept of the trust and with its limitations. You also need to understand what the settlor wants to achieve and, if necessary, guide or manage a settlor in his expectations. Both settlor and trustee need to know what information and what trust documents a beneficiary is entitled to see. A recent UK Privy Council decision may have created difficulties for trustees, with its emphasis that it is not so much a right as a matter for the court’s discretion in the circumstances. Many settlors wish to retain control to a greater or lesser extent. There is nothing wrong with this in principle, unless the level of control clashes with the “certainty” requirement and that it is a trust that the settlor did intend to create. An area of concern here may be some difference of approach between common law and civil law jurisdictions; but in any case it is important that the nature of the control is understood from the beginning and is clearly set out in the trust document.
Exoneration or liability exclusion provisions for trustees is another area where care is required in the drafting. There must be no internal conflict: such provisions are always construed against the person relying on them. This applies particularly to professional trustees, where there is increasing pressure that they should accept liability for misconduct or negligence, because a higher standard of care is expected from them. One needs to watch carefully for differences of approach between jurisdictions. If a serious mistake through oversight or failure to take advice, trustees (and beneficiaries) may find protection in the developing Hastings-Bass principle: you made a mistake, so you never did what you actually did do. It is likely that the protective features of this decision may soon be limited by the courts. For example, a recent UK decision has confirmed that the mistaken action is not actually void but voidable, so that the application of the principle is always subject to the courts discretion.

VAT is a tax, with its own jargon found in the 6th VAT Directive, such as “taxable supplies” of goods and services. Art. 2 says the tax applies to a taxable person (or business). Art. 4 defines a taxable person as one who carries out an economic activity in any place. There is no need for a profit motive. VAT is also levied on imports to the EU. The trader pays the tax; the consumer bears the burden. There are exempt businesses, e.g. insurance, medical care, etc. – see Art. 13. There is a public benefit exemption, plus others over which Member States have some choice. Exemption may not be a good thing. One can be partly taxable, partly exempt. An exempt person cannot recover the tax. There are varying rates. The standard rate is 15%; this will be reviewed in 2005. The EC Treaty (Art. 93) directs harmonisation of tax. This was started in 1967, under the First and Second Council Directive. Domestic legislation implements VAT, and Member States have their own rules. It is not a European tax, in contrast to the customs system and the common agricultural system, but each State sends some of its VAT to Brussels. “Output tax” is the UK expression for the tax which a trader pays on the supplies he makes. “Input tax” is the converse – a deductible tax. They are offset to determine the amount payable to the fisc. Exemption permits no offset – a circumstance which used to be a problem for charities.
Planning involves four areas – strategies (avoiding the system altogether, e.g. by e-commerce, cash-flow (mitigating the cost of VAT by the timing of charges/collection), exemption (can it ever be beneficial?) and side-stepping the rules.

The location of the business determines the place of supply. Art. 9 sets forth the rules. The supply is made where the business is “established”, even though the customers are elsewhere. AOL charges no UK VAT: it is not established in the UK. Freeserve does pay UK VAT and it has challenged HMC&E on the AOL decision. Freeserve may move to another location. For telecommunications companies, the law changed in 1999, and the rules for e-commerce are to change. The old rule was that VAT applied to the place where the supplier belonged. The new rule, applied by 2002/38/EC as of 1 July 2003 is that the place of supply is where the customer is. This means that local VAT is charged to local consumers. So US service providers are supposed to charge VAT and register in each jurisdiction. This is ridiculous, so there is a special scheme: one can account in one place electronically, and that Member State will divide the VAT collected pro rata, based on customer lists. The governments must sort this out themselves.

Cash flow planning depends on the fact that the right to deduct arises at the time of invoice receipt not of payment. On exemption planning, there is an aggressive UK scheme. Retailers allocate part of their charge to servicing rather than sale of goods. That is an exempt output for VAT purposes. So, 17.5% of 2% is saved. The Customs hate this. The UK rule that only 50% of VAT is recoverable on leased cars may be side-stepped by leasing via a German loan company, paying German VAT and making an 8th Directive reclaim from Germany. Long term leasing in Germany is zero-rated, which can give an even better result. There are also opportunities in cross-border transactions: VAT is due on personal services to non-EU persons by an EU business, but there is an exemption for lawyers, consultants etc. One needs to bear in mind that special rules apply to the Isle of Man and Monaco, which are deemed part of the VAT system of UK and France, respectively.

What is the attitude of the ECJ going to be to aggressive VAT planning? There is little guidance as of yet. A number of UK cases are in the pipeline. VAT tax is not a community tax, so the EU general abuse doctrine should not apply. It seems, therefore, that only local law should apply.