Overview: the regulatory system, taxation, exchange control- Recent developments in Labuan- Use of Malaysia and Labuan in international structuring Exchange control and the Anwar affair have made Malaysia an unpopular location. This is unfortunate, for the country offers tax planning opportunities. The Labuan tax regime is simple: one can elect for the fixed tax of MR$20,000 or 3% tax, but investment income is exempt. Domestic companies pay tax at 28%, but foreign source income is not taxed. Malaysia has had exchange control since 1953. It was re-introduced in the wake of the economic crisis. The move was criticised, but appears now to be useful. The Malaysian banks could not compete with Singapore: a way had to be found to repatriate money deposited in Singapore. There is a foreign currency exempt account which enables foreign-source income to flow freely in and out of the country. Foreign investors can convert their Ringgit dividends into foreign currency through such an account. The system works smoothly. A withholding levy was introduced to discourage repatriation of profits on realisation of Malaysian investments. The rate is 10% of the gain. The levy can be circumvented via Labuan. Labuan was established in 1990. Originally, it was effectively cut off from the rest of Malaysia, but this has gradually been relaxed and a degree of interaction with domestic companies is now permitted – notably in the insurance field. The Central Bank and Malaysian Government attitude to inward investment is in fact more open than it sometimes appears. The Dutch announced that Labuan companies would be excluded from treaty benefit; but the ASEAN countries generally allow Labuan companies to benefit. Elsewhere the present situation is obscure. Malaysia has a new and very favourable treaty with Taiwan; it is expected that Labuan companies will not be excluded. The insurance industry grows rapidly. A virtual exchange for financial instruments and funds is to be established. Changes are under consideration. Foreign company administration will be made easier. Labuan companies may establish branches in Malaysia. A form of IBC is to be introduced. Labuan is being used for holding companies, transfer pricing and leasing. Interestingly it can now be used as a base for investment in Malaysia proper. A dividend route out of the Netherlands to Labuan via Malaysia is now possible at a zero tax charge. Labuan companies commonly utilise the banking services of Hong Kong and Singapore. There appear to be many opportunities for avoiding Malaysian tax through Labuan: the Malaysian Government will probably clamp down on these.
Singapore non-resident companies- Singapore-Mauritius double tax treaty- Changes to Singapore trust legislationSingapore is an independent country, but provides naval facilities for the US Navy. Non-resident companies have the advantage that they do not advertise their tax-free status. Singapore is not, for example, on the Mexican blacklist. The United Kingdom and now Ireland have put an end to their non-resident companies. This has encouraged clients to look at Singapore as a base for business of this kind. It is a serious jurisdiction, with a legal system based on English law and with active and efficient courts of law. Section 2 of the Income Tax Act equates residence of a company with control and management of its business – following the principles enunciated in the English De Beers case. In practice, the Revenue will treat a company as resident where the directors hold their meetings – so long as true control is exercised outside Singapore. It is wise to have a majority of the board resident outside Singapore, though the secretary and auditors must be resident in Singapore. Resident companies pay tax at 20% and have an imputation system for dividends. But there is a franking charge if the dividend is not paid out of taxed profits. These rules do not apply to the non-resident company. Residents do not pay tax on unremitted foreign income; s.12 provides machinery for apportioning tax liability on mixed source income. To come within the exemption, a resident company must show a clear source of profits abroad. Again, these provisions have no application to the non-resident company. The potential liability to estate duty on shares in the Singapore-resident company needs to be taken into account. A foreign branch share register may provide a solution to this problem. A trust may alternatively offer a solution, but s.8(1) of the Estate Duty Act needs to be taken into account, and the deceased must not have had a beneficial interest in the shares. Singapore now has a useful tax treaty with Mauritius. A Mauritius company may function as a holding company for a Singapore company; interest payment passing tax-free to Mauritius.
China’s tax treaty practice and its impact on foreign investors- Treaty-shopping- Unique position of Hong Kong- The future?China has 61 tax treaties – generally following the OECD or UN model, beginning with the treaty with Japan. The tax treaty area is only mainland China and covers the Unified Income Tax of FIE’s and FE’s (Foreign Invested Enterprises and Foreign Enterprises). Other taxes – e.g. commercial tax and VAT – are not covered. China has no capital gains tax. Tax is levied on residents, on permanent establishments (PE’s) and on services rendered in China. There are some disparities in the PE definition in domestic law and in the treaties. A 20% withholding tax (reduced by treaty) is levied on interest, royalty or dividends. Payments by Foreign Invested Enterprises do not suffer withholding tax. China has a system of credit for foreign taxes, and the Ministry of Finance and State Administration of Taxation issues guidance notes. There are no international anti-avoidance rules, but in practice, Foreign Invested Enterprises have a limit on the debt/equity ratio allowed. Hong Kong’s tax regime is based on the One Country Two Systems principle. Hong Kong investors continue to enjoy the benefits offered by China to foreign investors. There are problems of double taxation affecting taxpayers performing services or doing business in the Hong Kong SAR and in mainland China. The Arrangement addresses these problems in a way similar to that provided by a tax treaty. But there is no relief for Mainland withholding tax on payment to a Hong Kong resident, nor is there provision for tax sparing or exchange of information. The Business Tax in China is not covered by the Arrangement but it may be deductible for Hong Kong tax purposes. It has been suggested that one effect of the Arrangement may be to introduce the concept of residence into the Hong Kong tax regime. The 50/50 rule may not be logical, but it has practical value. Foreign investors will be able to acquire State Enterprise debt. Consideration is being given to replacing tax incentives with a unified tax rate for foreign investors. The conclusion of the agreement between China and the United States for the entry of China into the WTO opens up many new opportunities.
Its present role as a base for international business:- Hong Kong’s general tax regime- Hong Kong as a finance and banking centre- Hong Kong as a trading and manufacturing centre – Double taxation arrangementsHong Kong is, from a practical point of view, little changed since the handover. Its connection with Britain began in 1841, when it was a “barren island”. It was involved in the opium trade, prospered in many trades and acquired further territories, public services and a huge increase in population. It is now a major centre for shipping, tourism, banking and international trade. It suffered occupation during the Second World War and absorbed many immigrants in the years after the War. Negotiations for the handover began in 1983; it was agreed that there should be “one country two systems.” The Basic Law is the constitution of Hong Kong; it provides essentially for domestic affairs to be controlled by the local government. Article 107 requires the government to aim for a “fiscal balance” – continuing the former British policy. Land sales account for 23% of government revenue, profits tax for 20%.The Inland Revenue Ordinance is short. It provides for various taxes – salary tax, property income tax, estate duty, stamp duty and profits tax. There is no capital gains tax. Three conditions are required for a liability to profits tax: carrying on a business in Hong Kong, profits arising from the business, and the profits arising in or being derived from Hong Kong. As to carrying on a business, the principles are to be found in the Bartica case. A repetitive activity is not required. As to the location of the source of profits, the Hang Seng case is illustrative: the Privy Council looked at where the profit-making activity was carried on. The Revenue practice is to look at the place where the contracts are made, but where manufacturing and banking profits arise partly abroad, the taxable amount may be arrived at by apportionment. Hong Kong takes no account of residence, and a company may therefore be resident with no exposure to tax, so long as the source of profit is abroad. This may suit China very well, and no change in this regime is foreseen. No tax treaties had been negotiated before the handover. Negotiations are now afoot with the Netherlands and an Arrangement on the lines of the OECD Model has already been agreed with China.
A round-up of recent developments Harmful Tax Competition continues to be a live issue. The Forum has prepared a provisional list of jurisdictions said to be engaging in such competition. Not all the territories have responded to an invitation to communicate with the OECD; but by next June we should have the final list. In the EU, the Code of Conduct Group has reviewed the practices of the member states – some 250 practices were under review; the Group has identified some 90 undesirable practices and the Report is due to be presented on the 29th November. In the course of the review, the UK Government has declared that it would be “unprecedented” for the London government to legislate for Jersey and Guernsey in its internal affairs. Money Laundering Do the money laundering rules apply to the proceeds of fiscal offences? The opinion is now growing that they do, and UK Government officials take this view. The Financial Action Task Force has recommended that the “fiscal excuse” is not a reason for failing to report suspicious transactions. The European Commission proposes to widen the money laundering directive: the obligation to report is to be extended to e.g. estate agents, lawyers and others who do not actually handle money; the proposal will also extend the directive to all organised crimes and may include fiscal offences. OECD developments The OECD Model tax treaty is to be updated in March. The Independent Personal Services Article (Art 14) is to be deleted. Provision is to be made for the treatment of partnerships. A report on banking secrecy is to be published. Five working groups are working on the taxation of e-commerce. E.U. Developments The EU has published draft directives on savings income and on interest and royalties. The UK Government wants an exemption for eurobonds: unless the UK position changes by December, this proposal will effectively die and may not be resurrected for the next five to ten years. This may increase the growing role of the European Court of Justice. The Court has issued a judgement in the Saint Gobain case. Branches are entitled to the benefits of tax treaties: consider a UK branch of a Luxembourg 1929 company. X AB and Y AB, Eurowings and Vestergaard will be important decisions. The UK A pre-Budget statement was made in the UK. The deferral of capital gains tax on gifted shares is to be abolished, but taper relief for shares is to be increased, so that the tax is reduced to 10% after five years. The Law Commission in the UK has published a report proposing modernisation of the rules relating to trust administration. Mareva Injunctions The Jersey Court has granted a free-standing Mareva injunction, but the Bahamas has refused to do so. The US Supreme Court has decided that US Federal Courts could not grant a Mareva injunction.Asset Protection TrustsUS Courts have sent to prison settlors of asset protection trusts for contempt of court, requiring them to repatriate trust funds. The Isle of Man courts have upheld a trust not intended to defraud creditors.
International tax planning through Australasia – Trusts for non-resident beneficiaries- Combining trusts with treaty relief – Group regional office tax relief – All-service tax havens in the Pacific- Aftermath of the Wine Box inquiryIn most cases, a New Zealand trustee who accumulates foreign income pays no tax so long as the settlor is a non-resident. Trusts are not separate taxable entities: they have no residence. A resident trustee is a taxable person. Liability for tax on trust income falls in principle on the beneficiary in respect of distributions and on the true settlor in respect of accumulations. In respect of foreign-source income accumulated by the trustee, liability for tax depends primarily on the residence of the settlor. If the settlor is non-resident the trustee does not bear tax even if the trustee is resident in New Zealand. The exemption conferred on New Zealand trustees where settlors and beneficiaries are non-resident is not an accident, nor is it designed as a tax haven rule; it is inherent in the system. Is a New Zealand resident trustee entitled to treaty relief? Is the trustee “resident”? And is the trustee the “beneficial owner”? These are questions of foreign law. Art 4(1) of the OECD Model defines a resident as a person liable to tax by reason of residence. A trustee is liable for tax on income he receives personally: he may be like two persons, but he in fact only one person. The US treaty is different and a trustee does not qualify as a resident in respect of trust income with a US source. For passive income, the recipient must be a beneficial owner. The OECD commentary arguably suggests that a trustee is a beneficial owner – being more substantial than an agent or nominee. In the Canada agreement (and some other agreements with Commonwealth countries) the trustee is to be treated as a beneficial owner where subject to tax as a resident: the inference is that a New Zealand resident trustee is not actually a beneficial owner. Under other treaties the question appears to be an open one. For capital gains, the argument in favour of treaty relief is stronger. In practice, relief appears to be given on both active and passive income. The New Zealand offshore trust industry is not large. But New Zealand is omitted from the Mexican blacklist. And a New Zealand trust is useful in superannuation schemes and other structures whether or not they are designed to obtain treaty relief. Unit trusts do not in general come within these provisions, but there may be exceptional cases – notably for those investing in debentures.
Choosing a jurisdiction- For a group holding/finance/licensing company- For an operating company – local v. branch- For an investment holding company for high net worth individuals- For a trustee company- For specific type companies The choice of jurisdiction of incorporation is determined by the purpose of the company and by what a particular jurisdiction has to offer. A jurisdiction where incorporation does not constitute residence may be required: the choice is now less wide than it was. Vehicles other than companies may in some cases be more appropriate. Australia will tax most trusts as companies after 2001; offshore trusts are no longer viable for Australian residents. The domestic use of trusts may come to an end shortly. Why has the expression “tax havens” become unfashionable? The OECD Report uses it in a perjorative sense, but it is foolish for the jurisdictions which have been known as tax havens for years to try to hide behind euphemisms. Denmark nowadays presents itself as a highly favourable jurisdiction for a holding company. The subsidiary must not be in a low-tax jurisdiction and have “financial” income; a minimum 25% holding is required; and – most importantly – there is no tax on outgoing dividends so long as the parent has held at least 25% for one year; there is no capital gains tax on disposals of holdings held for more than three years. Luxembourg is an interesting alternative. A 10% holding is sufficient for exemption from tax on dividends, but 25% is needed for freedom from tax on a capital gain. Luxembourg imposes a 25% withholding tax on outgoing dividends – which may be relieved by treaty or under EU rules. Luxembourg may sometime be preferred: the holding period of only one year is required for tax freedom on capital gains. One solution to the problem of tax on outgoing dividends is to use two Luxembourg companies, one above the other and liquidate the top Luxembourg company, forming a fresh subsidiary to restore the structure. The tax cost of taking dividends out of a Dutch company is lower by using Denmark than by using the Antilles. The Netherlands is pre-eminent for the finance company, where the new rules provide for 80% tax-free reserves, bringing the effective tax rate down to 7%, though the company may achieve a greater rate if its domestic CFC rules require. The reserves may be released over five years at a 10% tax cost. There is a capital duty of 1%. New Zealand’s offshore trust regime is very attractive. Is the trustee “beneficially entitled” to the income for the purpose of treaties? The question is arguable; but probably yes. Guarantee and hybrid companies are being used as alternatives to offshore trusts – notably by Australian residents. A limited partnership can achieve a “double dip” for interest on borrowed money, which does not fall foul of double dipping rules applicable to dual resident companies.
Choosing a jurisdiction- For the classic trust- To meet special requirements- For treaty-shoppingMore or less everything I know about the offshore trust is condensed into Part 3 of my book on offshore business centres. These pages were reproduced in the Working Papers and are appended to the transcript of my talk on the website. There are a few gaps, and some things I have learnt since. I included these in my talk in Hong Kong. I drew attention to the provisions of s.79 of the Cayman Trusts Law, which enable a settlor to confer benefit on children or adult beneficiaries of unsound mind or weak personality or on individuals he thinks may turn out to be greedy or grasping, without giving them any right to apply to the Court or otherwise make nuisances of themselves. I referred to the Trust Casebook and observed that the offshore trust business is not for the faint hearted. The offshore trust business requires personnel of high calibre and at the same time it is increasingly under pressure to keep down costs. I discussed the office of Protector: not only do the beneficiaries look to the Protector to ensure that all claimants to the income and capital of the trust fund are dealt with fairly, but the offshore trustee will generally look to the Protector for accurate and disinterested advice. I spoke about choosing a location for the trust, about asset protection trusts and about “Thin” trusts, with special reference to the United Kingdom and Ireland and the possibilities for “treaty shopping” there.
Several countries now aggressively tax emigrants and expatriates- Securing residence and work permit- Residence programs and citizenship programs- Practical aspects of using a new passport- Some countries that don’t overtax you if you become resident, domiciled or a citizen Tax is based on residence, domicile or citizenship of the income recipient and on the source of the income. The key to tax planning lies in cutting the connection with those criteria. Nowadays, rules preventing individuals from taking advantage of such manoeuvres, are being introduced in several countries. The US has had such rules since the 60’s and Canada since the 70’s. New US rules came into force in 1996, but no departure tax was introduced and the ten year tax liability applies only to US income. The Reed amendment, under which tax exiles may be prevented from ever returning, has never been used and has loopholes. New proposals are currently before the House of Representatives to tighten the rules further: portions of them appear to be unconstitutional. Green cards expose the holder to the same rules as those applicable to citizens. In 1998, France introduced an exit tax. It applies to individuals who have been resident for six out of ten years. The emigrant is deemed to dispose of his shareholdings. In the Pavarotti case, the Italian Court ruled that the singer was not resident in Monaco but in Italy. Following this case, new legislation catches Italian citizens who emigrate to a tax haven. A list of tax havens has been published. Perhaps the solution is first to move to the UK, and move to the tax haven later. Spain took a similar course in 1988. It has a blacklist, and taxes the emigrant for five years as a deemed resident of Spain. Similar rules also exist in Denmark, Finland, Germany, the Netherlands and Sweden. Curiously, the criterion for the application of many of these rules is citizenship. Shopping for economic citizenship is increasingly common. Instant citizenship in Ireland is only available to those with Irish ancestry. Citizenship programmes now exist in Belize, St. Kitts and Nevis, Dominica and Grenada. Of these, Grenada is the most popular. An investment of around $45,000 is requisite. It can be used as a stepping stone to citizenship in Ireland. Travel between the two countries requires no visa, and it is therefore easy to become resident. After five years residence, citizenship is obtainable. A Grenadian citizen can obtain an E2 visa for the United States, thanks to the Bilateral Investment Treaty between the US and Grenada, if he makes a business investment of around $250,000. This contrasts with the $1 million or $1/2 million options for the investors wanting a green card; the E2 visa is to be preferred unless US citizenship is wanted – it allows a whole family to enter the US, and become taxpayers only if they remain there for over 120 days a year; the E2 visa does not make the holder domiciled in the US for estate and gift taxes or liable to the expatriation rules. Although the US legislators do not appear to recognise it, practitioners are discovering that people are leaving for non-tax reasons.
Dividends, interest, royalties, capital gainsSome of the more common uses of tax treaties in international tax planning include:- obtaining reduction in withholding tax on dividends, interest and royalties; business profits planning, taking advantage of Art. 7 (or its equivalent) and avoiding a “permanent establishment” -e.g. by utilising a commissionaire or restricting the right of the host country to tax branch profits e.g. as in National Westminster Bank v US (1999); capital gains tax planning, utilising Art. 13 – i.e. where the state in which the alienator is resident either imposes no tax on capital gains (e.g. Mauritius or Belgium) or imposes a capital gains tax on a narrow base (e.g. by taking advantage of the “uplift” for new residents in Denmark and elsewhere); employee renumeration tax planning – taking advantage of Art. 15; pension planning under Art. 18 – e.g. for the UK resident who retires to Malta; using the non-discrimination article (Art. 24) – e.g. on inter-group transfers, obtaining group relief even though one company does not meet the domestic criterion. Treaty access is restricted to those entitled to its benefit. The treaty must be in force. The tax must be covered by the treaty. The vehicle must be “resident”, and not specifically excluded (like the Luxembourg 1929 companies): it is often useful to look at the use of a vehicle other than a company. The entity must be “liable to tax”; this extends to charities and other entities enjoying a specific exemption. Arts. 10,11 and 12 refer to “beneficial ownership”. There is no precise guidance on the meaning of this expression. The Guidance Notes make it plain that a mere nominee or agent does not fall within this category. Some entities are specifically excluded from benefit – but not always from all Articles. Art. 22 of the US model contains very extensive limitation of benefit provisions. Does treaty benefit override a domestic anti-avoidance provision? In France, the taxpayer has been successful in three out of the four cases. In the UK, Bricom was decided in favour of the Revenue, but may not have been rightly decided. The OECD plans to clarify this issue.
Offshore opportunities after the work of G7, EU and OECD I have put into the Working Papers, and I have appended to the transcript of my talk, passages from my book on eight jurisdictions which are not on the OECD list – Hong Kong, Hungary, Jordan, Labuan, Lebanon, Montenegro, Ingueshetia and Uruguay. I mentioned also the zero-tax facilities offered by the African State of Anjouan and by the free zone of Abu Dhabi in the United Arab Emirates. I referred back to what David Chong had said in Hong Kong about companies incorporated in Singapore but resident elsewhere (i.e. in the jurisdictions indicated in the book, Zero-tax Management). Other jurisdictions – jurisdictions, that is to say, which are not under attack – offer the possibility of incorporation of non-resident companies – e.g. Botswana, Malaysia and Swaziland, and perhaps also several other jurisdictions which have derived their tax law from that of the United Kingdom. Some high-tax countries need to be mentioned in this context – e.g. New Zealand, for its tax exempt trust, the United Kingdom and Ireland, for their capital gains tax exempt trusts and “thin” trusts, the United States for its LLC, and the United Kingdom itself for a number of vehicles – notably its nominee company, its holding company and its limited partnerships. I speculated that some international tax planning would survive in the Netherlands, even though it was on the OECD List and in Switzerland which – curiously – was not.