Character and source of revenues
Permanent establishment issues
U.S. tax considerations for beneficial owners who are U.S. persons
Common structures for business-to-business exchanges
Progress report on global efforts to achieve uniformity in e-commerce taxation
The OECD is playing a significant role in achieving consensus on the taxation of e-commerce. Is the downloading of software a purchase of goods or a transaction giving rise to a royalty? A payment for downloading digital content might be a royalty, a price for sale of goods, a rent or a service fee. The TAG seeks to avoid characterization as a royalty, and to treat income as arising where value is created; the majority view was to treat the transaction as a sale of property. The profits are “business profits” for treaty purposes, though they may be passive income for subpart F purposes. The involvement of e-technology does not make a transaction a delivery of “technical services” for treaty purposes. This approach was favoured by developed countries.
The OECD has tried to apply the Permanent Establishment concept to e-commerce. The presence of computer equipment is indicative. Human presence is not necessary. A server “at the disposal” of an enterprise is a PE. France, Spain and other countries have taken different positions on this issue; the US position is not yet known. Various IFA reports have concluded that a mere server is not a PE. This again is a view which favours the developed countries.
The third issue concerns the allocation of income to a PE. The Business Profits TAG preferred to allocate the income to the home office, so functional analysis is preferred. It is difficult to apply traditional transfer pricing methods to e-commerce because of new concepts and uses.
These e-commerce questions were considered at the 2001 IFA Congress. The basic planning approach is to minimise local presence in market jurisdictions by placing servers in tax haven jurisdictions.
Background – A general social and economic perspective – The free trade blocs – The economic liberalisation and its consequences.
BRAZIL – General data – Profile of external trade – Foreign direct investments – Foreign direct investments by countries – Foreign direct investments by sector.
ARGENTINA – General data – Profile of external trade – Foreign direct investments – Foreign direct investments by sector.
OTHER SOUTH-AMERICAN COUNTRIES – Foreign direct investments – Foreign direct investments by sector.
THE LEGAL TREATMENT OF FOREIGN DIRECT INVESTMENTS IN BRAZIL Registration – Abolition of exchange controls? Taxation of dividends – Double taxation treaties – List of tax havens – Repatriation of capital and the capital gains tax – Anti-trust considerations – Tax litigation and tax reform.
THE LEGAL TREATMENT OF FOREIGN DIRECT INVESTMENTS IN ARGENTINA Registration and taxation – MERCOSUL legislative integration?
CONCLUSIONS – Perspectives for the future.
Foreign direct investment in Brazil has risen spectacularly over the last six years. Spain is the major investor, followed closely by the United States. The year 1999 was a year of high investment in Argentina; it has fallen away since. Investment in Mexico continues to rise; the United States and Canada contribute the largest share. In the mid-nineties, Brazil, Argentina and Mexico liberalised their economies and attracted a much higher level of investment.
In Argentina, a vast body of law and regulation governs inbound investments. Some are prohibited and some require approval, but there are no restrictions on – and no taxation of – outgoing dividends. In Brazil, some areas of investment are still not open to foreign investors, but again profits can be freely remitted abroad, though capital gains are taxed by withholding. Mexico has a regulatory regime for foreign investments: they are actively encouraged, and steps are taken to reduce bureaucratic delay, but certain industries are closed to outside investment. Dividends and profits may be freely repatriated.
The liberalisation and privatisation programmes in Argentina and Brazil were not accompanied by better access to US markets, and they have not been altogether successful. By pegging its currency to the US dollar, Argentina damaged its trading balance with Brazil. Mexico trades extensively with the United States and benefits from remittances from Mexicans working in the United States. Poverty and unemployment are endemic in all these countries and have worsened with the present economic downturn.
Special nuances relating to the Latin American client
Concerns relating to absence of trusts as part of the Latin American tradition
Possible alternatives or palliatives, including foundations, private trust companies, protectors, etc
The influence and pace of change in the Latin American environment.
The price and benefit of migration or, if the client has to pay in either the U.S. or his or her country, he/she may be better off paying in the U.S.
The foreign tax credit as a tax shelter.
The problems of the “blacklist” and the various responses to it.
The continuing interest in the fiscal paradises or following one’s money.
Problems of exchange of information.
The relationship of outsider and home country planning (the problems of having a foot in each camp).
Tomorrow and after (Watchman, how goes the night?).
The South American private investor is anxious to preserve what he has. Like other investors from civil law countries, the South American is not drawn to trusts. Kidnapping, corruption and unclear and poorly enforced laws are prevalent. Change, however, is on its way. There is a new emphasis on criminal enforcement of taxes, a move to worldwide taxation and – in Mexico – an information exchange agreement which appears to be working. The United States plans to make available information about bank deposits. Mexico has a blacklist, designed to prevent residents from sheltering passive income by incorporating in a zero-tax or low-tax jurisdiction. It has been copied in Brazil, Venezuela and elsewhere. Mexican residents have used entities not established in a blacklist jurisdiction but in fact free of tax; changes are on foot to bring these into the same category as entities established in blacklist jurisdictions. A similar change seems to be on its way in Venezuela and perhaps also in Brazil.
The Singapore corporation may provide a solution to the problem. Barbados is not on the Venezuela blacklist, and it also has a treaty with Venezuela; a private bank in Barbados may lend to a Venezuelan enterprise. Other possible vehicles are the Scottish partnership, the Delaware single-member LLC and the Dutch CV. Trusts which may be useful are the transnational Canadian trust and the New Zealand trust – at any rate for the time being. A wholly discretionary and irrevocable trust falls outside the anti-avoidance legislation, but it may not be favoured by the South American client. A policy of life assurance is another possibility. Other opportunities include equalising tax rates, tax arbitrage and taking advantage of residence rules or tax credits.
Many changes are afoot, and the professional advisor is going to need to guide his client on a careful path, bearing in mind that information gathered for money-laundering purposes is bound to be available, as a practical matter, to the tax authorities in the client’s home country.
Complying with international standards
How does this affect your clients?
The Bahamas has a long record of supervision of offshore transactions. It has enacted in 2000 a raft of supervisory legislation: it now has Qualified Jurisdiction status from the United States, it has been removed from the FATF list, it has had the FinCen advisory dropped and it has met the FSF requirements.
The new IBC Act repeals the 1989 Act. There are new requirements, a widening of permissible activities and a prohibition against the issue of bearer shares. The new Central Bank Act repeals the 1974 Act. It confers on the Bank a limited power to co-operate with overseas regulatory authorities. The new Bank and Trust Companies Regulation Act repeals the Acts of 1909 and 1965 and confers regulatory powers on the Inspector of Banks and Trust Companies. He has power, on behalf of a foreign authority, to investigate the procedures of a bank or trust company (but not the affairs of its customers).
There is now a Financial Intelligence Unit Act. This is essentially an international co-operation and anti-money-laundering measure. Certain financial and corporate services now require a licence under the Financial and Corporate Services Providers Act. The Financial Transaction Reporting Act provides a framework for financial institutions to “know your customer” and monitor transactions. The Bahamas government expects to enter into a tax information agreement with the United States: the new Criminal Justice (International Co-operation) Act confers power on it power to do so. A new Proceeds of Crime Act repeals the Acts of 1986 and 1996 and extends the meaning of “criminal conduct”. Managed banks will no longer be permitted.
The events of September 11th stimulated a review of all accounts in the Bahamas. Terrorist funds are to be frozen.
The Netherlands Antilles is to abolish the offshore regime it has had for many years (though “grandfathering” existing offshore companies). The new fiscal framework will facilitate the expansion of tax treaties. There will be a flat rate profits tax of 34.5% and a participation exemption. The exemption will be of three kinds. All of them will require a minimum of 5% of capital or voting or an acquisition price of one million NA florins. The first exemption is 100% for domestic companies and the second 95% for foreign ones. The third kind applies to dividends from Dutch subsidiaries with a 25% holding: in this case the Netherlands withholding tax will be 8.3% and capital gains exempt.
There will also be a 95% exemption for a permanent establishment. Fiscal unity of companies whose seat in the Netherlands Antilles will be possible. There will be a new Exempt Company (NA BV): its activities must be restricted to investment and financing. It will not be able to take advantage of the Kingdom Tax Arrangement (“TAK”). It may facilitate the use of loan capital to reduce the tax cost of routing through the Antilles distributions of a Netherlands company.
It is expected that this new regime will take the Antilles out of the category of “tax haven” in the eyes of the OECD.
Why the OECD is a “win/win” organization for the United States both government and taxpayers
Non-tax projects of interest to ITPA
Some of the OECD tax projects which the US and taxpayers should find beneficial – – transfer pricing –double tax agreements–anti-bribery convention–electronic commerce
OECD projects of particular interest to ITPA members — harmful tax competition — bank secrecy
The importance of the OECD’s Business Industry Advisory Council
The future of the OECD
US policy towards the OECD: why the US should participate fully and effectively in all OECD projects.
The present US administration’s policy goes further than the OECD initiative in the field of information gathering. The events of September 11th have emphasised the importance of international co-operation. The earlier isolationist tendencies of the Bush administration have been abandoned. Mr O’Neill was badly advised, and some back-pedalling was evident even before September 11th. The US should and does support many OECD activities, including its publication of economic data and its campaign against corruption, as well as its work on e-commerce and corporate governance. The provision of a model treaty and commentaries has for many years been a useful contribution of the OECD.
The “harmful tax competition” project generated a quite unexpected degree of controversy. But the OECD has been at pains to listen to the problems of the jurisdictions affected, and the terms of the project have been considerably modified. The OECD is presently examining the relevant legislation of member countries. This initiative is not about tax harmonisation.
The new US money-laundering legislation provides for assistance to jurisdictions affected. It is an example which the OECD will want to follow. The UN has proposed a new body to reach solutions to international tax problems.
Privacy has to give way to the need to control terrorist funds. Practitioners and organisations like the ITPA must take steps to ensure that they are not being used to facilitate the movement of terrorist funds. New money-laundering legislation in the US and the activity of FATF are strengthening the power of governments and agencies to fight terrorist financing. The Bahamas and the Cayman Islands have recently been removed from the FATF “blacklist”. The US government has new (and controversial) powers to limit attorney-client privilege in relation to terrorist offences. IRS agents will be used to follow terrorist and money-laundering funds. Sanctions will be imposed on non-compliant countries. Offshore jurisdictions will have to explore alternative sources of income.
Current negotiations with the United Kingdom and Japan
Treatment of dividends
The US has begun negotiations for a new treaty with Japan and preliminary exploration of a new treaty with Israel. A new treaty with Italy has a “main purpose” clause: the US Senate reserved this, and the future of the treaty is uncertain. More attention has been paid to the drafting than to the implementation of treaties: the mutual agreement procedure can drag on for several years, and advance pricing agreements can take far too long to be agreed. Canada, India, Korea, Japan and other countries have been the source of the problems in this area. There have been difficulties in implementing the s.894 rules relating to hybrid and “reverse hybrid” entities: the regulations are designed to deny treaty benefits to recipients attempting to take advantage of differing transparency rules to obtain relief from US tax without paying tax in the treaty partner jurisdiction. There are new withholding rules under s.1441, providing for Qualified Intermediaries. A recent decision has come down heavily against a Canada-Netherlands scheme. A forthcoming regulation will prevent avoidance by a US corporation continuing in another country without abandoning its original incorporation.
The US model differs somewhat from the OECD model. It contains a “limitation of benefits” article, as well as a “saving” clause, which reserves the right to tax the domestic taxpayer as if the treaty had not been made. The US is no longer simply a capital-exporting country; treaty policy reflects this change.
The new US/UK treaty has a number of new provisions. A major development is the zero withholding on dividends. In addition to expansive limitation of benefit provisions there is a provision aimed at “conduit arrangements”: they are very broadly defined. The treaty also incorporates a provision looking through transparent vehicles, and on this provision there are many pages of notes. The treaty denies UK credit on a repo transaction, so as to prevent arbitrage between the different domestic treatment of a sale and a repurchase. The notes refer to the OECD transfer pricing rules and the attribution of capital to branches. The limitation of benefit provisions of the US/UK treaty are echoed in the new US/Australia treaty.
A joint venture in a zero-tax jurisdiction offers a tax-transparent vehicle. This facility encourages economic activity onshore, and it attracts the kind of public support which other kinds of offshore activity may not.
A joint venture may take the form of a partnership, a company or a simple contractual relationship. As a zero-tax jurisdiction, with a legal system based on English law and its own stock exchange, Cayman is a natural home for the joint venture. The Companies Law easily accommodates the requisite provisions in a joint venture company. The provisions of the memorandum and articles may require to be supplemented by a shareholders’ agreement. The venture may terminate by the company selling its assets or by a sale of shares in the company either to a third party or by one shareholder to the other shareholders.
The absence of limited liability makes a simple partnership generally less attractive, but a limited partnership may be used. The partnership agreement will provide for capital contributions, profit distribution, termination and so on; management is restricted to the general partner. A limited partnership may be used for a private equity fund. Contractual arrangements in various forms are commonly used for short-term ventures.
An offshore trust may hold a share in a joint venture. The settlor will often want to have access to trust capital and to have practical control over the trust property, and the trustee will generally not have the time or expertise to supervise the business of the venture. The trust must not be a sham, and the trustee must be at liberty to exercise proper supervisory duties (while wishing to curtail its responsibilities and limit its liability) and to be able to be accountable to the regulatory authorities. The terms of the trust must make provision for the trust to make such a “concentrated” investment, but the trustee still has inescapable duties and potential liability to third parties on constructive trusteeship principles – see Agip (Africa) v. Jackson.
The trust instrument may vest investment powers in some other party, a “Star” trust may be used or a private trust company may be incorporated. The underlying company may have a split-share capital structure, or the trustee may invest in the limited partner’s share in a limited partnership. The split-unit unit trust is a unit trust equivalent of the split-share capital company.