Exclusion of duties till irreducible core reached
Exemption from liabilities
Gross negligence and ordinary negligence
Can deliberate reliance on exemption clause be dishonest?
Can deliberate breach of trust for benefit of beneficiaries be dishonest?
What must the settlor at outset be advised?
Hayam v Citibank was a Hong Kong case, decided by the Privy Council in London. The executors were expressed in the trust instrument to have no responsibility for the property during the lifetime of two beneficiaries occupying the property. It was held that such an exclusion was lawful. In Armitage v Nurse the UK Court of Appeal held that the irreducible minimum is the duty of the trustee to account to the beneficiary. A trustee may be given power to speculate. Where the trust fund is a substantial share in one company, the duty to diversify may be excluded. A trust instrument may provide that trustees need not interfere with the management of a company in which the trust is invested until they are aware of actual dishonesty. But is this effective? The trustees will always have the power to intervene: the Court may well say that the trustees have a duty to exercise it. The problem may be circumvented by appropriate provisions e.g. in the constitution of an underlying BVI IBC. Or the settlor may reserve the trust management to a company controlled by him. If the trust instrument takes away the right of the beneficiaries to sue during the lifetime of the settlor, there may be no real trust – and the document, if it is to be valid, would in that case require to be executed as a will. In re Murphy’s Trust the settlor was required to disclose to a beneficiary the identity of the trustee. Can the liability of a trustee be limited to cases of actual fraud? The decision in Armitage v Nurse indicates that it can. Liability for negligence can be excluded whether it be ordinary or gross, on the assumption that the two cannot be satisfactorily distinguished. However, there are cases relating to bailment where a distinction is made between negligence and gross negligence, so this has become a grey area in England. In Jersey the distinction has been embodied in the law. If a trustee takes a risk not authorised by the trust instrument, is he accountable? The English decisions appear contradictory, but Armitage v Nurse supports the right of a trustee to do so if he is motivated by a desire to benefit the beneficiaries and not simply in reliance on the exemption clause. The law in this area is in need of clarification. Rattee J attempted to do this in Walker v Stones. Perhaps a one-off breach of trust believed to be the best interest of the beneficiaries may be harmless, but the Court will not tolerate a continuous course of such conduct. The cases on exemption clauses are not easy to reconcile, but while the general drift of the cases is that the court will support an exemption clause, even if the testator or settlor was not offered the opportunity of taking independent advice, a House of Lords decision may well in the future take a stricter view.
The Role of FATF
The Money Laundering Cycle – a Brief Overview
Trends in Money Laundering
What should the Professional Adviser do?
The Consequences of Non-Compliance
“Know Your Client”
The UN report in 1998 branded financial havens as “tailor made” for money laundering. It has become a matter of great concern for tax professionals, not only in relation to offshore transactions. Laundering is said by The Times to be occurring in Monaco; London and New York are much used; institutions in Russia have been involved. Criminals are becoming more sophisticated, and nowadays not only banks but e.g. lawyers, estate agents, company formation agents and trust companies are at risk. “Smurfing” is making deposits of an amount just less than the reporting requirement. This is a form of “placement”. “Layering” is concealing cash behind a web of shell companies. “Integration” is putting the cash back into the economy as ostensibly legitimate funds.The UK law is extensive. The primary law is found in the Criminal Justice Act of 1988, amended 1993. Offences include assistance in dealing with proceeds of criminal conduct, “tipping off” and failing to report suspicion. The Regulations of 1993 require relevant financial business to retain records. The Explanatory Notes of the Institute of Chartered Accountants contain valuable information. “Criminal conduct” includes conduct, wherever it takes place, which would be indictable if committed in the UK: in theory it extends to tax-related offences. This is very wide ranging – and may go further than was originally thought. It is not true that a transaction is not caught by the money-laundering legislation if it takes place abroad. Forced heirship avoidance and foreign exchange control evasion do not come within the scope of the legislation. The US also has far reaching legislation, but – up to now at least – in Germany the confidentiality of the client relationship is paramount. Jersey has brought its law into line with that of the UK, but “criminal conduct” here is conduct which would be punishable by one or more years in prison, and false accounting and cheating the Revenue fall within this category. The Cayman Islands has similar provisions: although they have no income tax, such offences are similarly punished. The Financial Action Task Force has made recommendations, which member countries – including the US, UK France, Germany and Switzerland – have to adopt. There is an EU proposal of 14 July 1999 to update the 1991 Money Laundering Directive, though this is not expected to extend to tax related offences. The adviser needs to verify a new client’s particulars. He will want a recent utility bill, a photocopy of his passport, a tax return and so on.
A round-up of recent developments
The EU Code of Conduct Group has produced a report, which lists the 66 harmful tax practices. Holding companies, participation exemptions, exemptions from capital gains tax and exemptions for profits from offshore activities were regarded as to some extent harmful. Dutch and Danish holding companies, practices in Gibraltar favouring non-residents and similar practices in the Channel Islands are particularly targeted. The EU tax package includes the potential Savings Tax Directive: the present impasse may be penetrated by a focus on the provision of information, but unanimity may not be reached, and the work of the Code of Conduct Group may be discontinued. There is also a perceived lack of enthusiasm in the UK for rolling back the tax practices of the overseas territories: the dependent territories are heavily dependent on the offshore business, but a KPMG review is expected to be conducted by June. Changes are being and have been made in Ireland, Germany and Italy, and more may follow. The OECD report presented to the Committee of Fiscal Affairs is not yet publicly available: it is thought that most tax havens will be categorised as “in dialogue” with the OECD. April is the deadline for self-review and June for dialogue with non-OECD members. Changes have been made in the Bahamas, but no direct tax is proposed there (government revenue relying on indirect tax). New Multi-national Enterprise guidelines have been published in draft. A recent G7/8 meeting was held in Japan: the OECD’s attempt to curb harmful tax competition was encouraged. The FATF report on money laundering is available on the OECD website. It focuses on the vulnerability of on-line banking and the need for financial institutions to know and identify their clients, on alternative remittance systems and the need to regulate them, on company formation agents and making use of the information they have an on trade-related activities as cover for money laundering. The UN Offshore Forum will meet in the Cayman Islands in March; Austria is required to change its provisions for anonymous passbook accounts. The Droit de Suite, a tax on sales of art, is to be introduced in the EU; it is expected to shift a considerable slice of the art market to jurisdictions outside the EU.
Tax Planning Opportunities
The objective is to move profits with little or no withholding tax to a low-tax jurisdiction. Art. 12 of the OECD model contains a definition: it extends to payments in kind and it derives from a licence, not a sale. Withholding tax is generally levied: rates vary from zero in Scandinavia to 30% in the U.S; 25% is the usual rate. The treaty generally prevails, but domestic anti-avoidance provisions may negate the treaty benefit.Residence definition, limitation of benefits, relief from double taxation and business profits provisions need to be considered, as well as the royalty article. That article generally gives the recipient the primary taxing right, but may reserve a taxing right to the source country.The objectives of a royalty structure include deduction for royalty paid, minimisation of withholding tax and beneficial taxation of the recipient. Beneficial ownership is required. The German tax authorities argue that a conduit company fails this test. Some treaties contain specific anti-avoidance provisions – e.g. in the UK/Netherlands requirement of “business purpose.” US treaties generally have limitation of benefit (“LOB”) provisions. Some treaties have specific exclusions – e.g. the exclusion of 4¼% companies from the benefit of the UK/Cyprus treaty. The special relationship article applies a transfer pricing test to royalties as to other payments.Examples of anti-avoidance provisions are found in the US anti-conduit rules, the treaty-shopping rules in Germany – s.50(d) and CFC or subpart F provisions.A conduit company must have an extensive treaty network, be entitled to deduction for payments made and suffer no withholding tax on outgoing royalties – e.g. UK, Netherlands, Ireland, Denmark. An arms length margin is around 10%. The UK law is under review. A branch may be used to accumulate royalties – e.g. a real and active branch of a Dutch company in Jersey and taxable there. This does not work for group arrangements. Deductions for interest and depreciation may wash royalty income – e.g. use of fully-taxed Cyprus company licensing to UK, bringing the eventual tax rate down to or below the 4¼% rate paid by offshore companies. Tax sparing provisions can be used to give a credit for tax not actually paid – e.g. with a Dutch company licensing to China. These routes can be combined – e.g. avoiding the US conduit rules by a Hungarian company and relying on an arbitrage between Hungarian and US definitions of debt and equity.
Work for whom? Someone usually benefits.
Fraud? Where it works, but not for the client.
Idleness? When it works from sheer inertia.
Conmanship? Which works for the conman and the client never knows.
Ignorance? When nothing works and everyone knows.
Absurdity? Which works out of astonishment.
Conclusion? The baddies get the girl in this game!
The offshore world has changed. Tax offences used to be merely civil matters. This is no longer so. Revenue authorities have invoked the criminal law. Sections 18-20 of the UK Theft Act lists offences which may arise from offshore transactions. Some people believe that there are jurisdictions where their tax evasion will not be found out. This is unlikely to be true. Facts often emerge on the death of a taxpayer. Carelessly structured situations can have unexpected results – e.g. what appears to be a company’s income may in truth belong to the individual “behind” it; problems of VAT, forced heirship and money laundering may arise. Reality is more important than appearance: behind a purpose trust or asset protection trust can be a simple evader who “only wants” not to pay some tax. Unfortunately, there are many intermediaries who will persuade taxpayers to set up evasive structures to which fraudulent investments are sold: the victim does not complain, lest the tax authorities find out. There are many kinds of fraud. Con-men are numerous; clients are gullible. Trusts are often a mere façade, behind which is a tax fraud.
A practitioner’s reminiscence
The attraction of practice in the tax field lies in the good rewards, the opportunity to meet people and the intellectual challenge. It seemed especially attractive in Britain of the mid 70’s: taxes were inordinately high and exchange control was strict. That epoch seems very strange to us nowadays – telex and tippex were in use, capital transfer tax and development land tax were new and important, offshore trusts were rare, exporting trusts seemed dangerous. The Vestey decision of 1980 established that offshore income could only be attributed to transferors: income tax, and then capital gains tax, could be deferred until such time as the taxpayer took the benefit. Then came Margaret Thatcher, the abolition of exchange control and a new prosperity: offshore trust work prospered. The decade 1981 – 1991 was a golden era for UK taxpayers to use offshore trusts. There have been many adverse changes since then, but have been countered by devices invented by tax professionals – e.g. the “flip flop”, the use of a tax treaty to protect a gain or provide temporary residence: the capital gains tax is still largely a voluntary tax, and provides a surprisingly low yield. Back duty has been a profitable source of work, with interesting facts. Negotiation with the Revenue can be satisfying, if full of surprises. Litigation is notoriously uncertain, but has its lighter side. Practice at the tax bar introduces you to many people of various kinds. An unhappy trend (seen in Cunningham and Dimpsey cases) has been the criminalising of tax offences. The criminal courts have little understanding of e.g. the rules determining the residence of a company. VAT has become a complex subject. Regulation has increased hugely: it is often far too complex for the people charged with the duty of administering it.
Negotiation and Litigation
The title to this talk may evoke bitter memories: the settlor finds that the assets he has worked so hard to earn are in the hands of a hostile stranger. The problem arises in civil law as well as common law jurisdictions, but settlors rarely think about it in advance. The trustee may prove to be “unwanted” by one or more of the other persons involved in the settlement – the settlor, protector, beneficiaries or even other trustees. The circumstances are diverse: there may have been negligence, or the “chemistry” of the relationship may no longer be functioning. Most trust instruments contain power to dismiss a trustee – generally exercisable by the settlor or someone in his confidence. If the power has been exercised, but the trustee refuses to comply, the Court will take steps to remove him and vest the trust assets in a successor. Statute and Rules confer specific powers on the Court, and the Court’s inherent powers are wide – see the English cases of Letterstedt v Broers  AC 371 and Wrightson v Cooke  Ch 789, which tell us that the overwhelming consideration is the welfare of the beneficiaries. The Court will exercise its powers where the settlement is administered within its jurisdiction, even if the settlement is governed by some other law: Chellaram v Chellaram , All ER 1043. The Court will act quickly and radically: Clarke v Heathfield  ICR. But an application to the Court may not be necessary or desirable, and a settlement may be reached with the departing trustee by negotiation. Disputes with trustees can be bitter, but a trustee will often back down in order to avoid adverse publicity, or because he cannot obtain a Beddoes order entitling him to recover his costs from the trust fund. Litigation, or the threat of it, is the most powerful weapon for achieving a settlement.
An update of Dutch and Antilles legislation
What’s new in Dutch ruling policies
The competitive position of the Netherlands vis-à-vis the newcomers
What lies in store
1999 saw changes in the Netherlands Antilles. In the 70’s and 80’s the Antilles was very popular: the treaty with the US and the agreement with the Netherlands were very favourable. The US cancelled its treaty into the mid-80’s; at the time over $150 billion of eurobonds were outstanding. Other countries followed suit and the agreement with the Netherlands was changed. The offshore business declined: Luxembourg and Denmark came to be more advantageous locations for a holding company for Dutch companies.The new provisions in the Antilles have been enacted, but will be brought into force only when agreement has been reached with the Netherlands. But the provisions introducing a zero-tax company are already in force: the disclosure requirements are stringent. There will be advance rulings – both standard ones and ones particular to the applicant.There will be no withholding tax on interest and royalties. There are “grandfathering” provisions, which do not extend to shelf companies: they protect the position of holding, financing and leasing companies until 2020, and other provisions apply to other companies until 2010. The new provisions will apply without “grandfathering” to offshore companies incorporated after 31st December 1999, from the date the new regime becomes effective.The new tax will be at 34.5%, but the participation privilege applies to 95% of income arising from foreign companies in which at least 5% is held. There is a dividend withholding tax of 10%, but interest payments are exempt, as are – more importantly – liquidation proceeds (though a tax up to 5% can apply if that represents treaty protected income) and distributions to any foreign company holding at least 25% of the shares of the Antilles company.The Netherlands continues to be an attractive holding company location: the treaty network is extensive and favourable. Denmark has the signal advantage of exemption from withholding tax on outgoing dividends, and Denmark levies no capital contribution tax. But Denmark has CFC legislation and requires a “waiting period” before income and capital gains are exempt: the upshot is that any subsidiary of a Danish holding company must either suffer a comparable tax or have income from active trading. Denmark offers fiscal consolidation; its advance ruling system is tedious; the debt to equity rate cannot exceed 4:1; the holding company is on the Primarolo list. The Luxembourg SOPARFI has a capital contribution tax, but has no debt/equity requirement, and the 25% dividend tax does not apply to liquidation or partial liquidation or share redemption. There is a participation exemption, for which there are detailed requirements. Dividends are exempt if either the shareholding represents a 10% interest or its value equals or exceeds LUF 50 million (approximately 1,115,000 euros). Capital gains are exempt if the shareholding represents an interest of 25% or a value of at least LUF 250 million (approximately 5,575,000 euros). Minimum holding periods apply to both.In comparing holding company jurisdictions, the different features of the tax regimes in the various jurisdictions will generally lead to different optimal structures for different groups, depending on the particular objectives or characterisation of the group concerned.