India is a large and stable democracy – large in population, industrialisation, economy and growth in numbers and consumers. It has technical manpower and a developed business infrastructure. It has never defaulted on international debt. It has a food surplus. It is a major software development base. There is a large English-speaking population. It is a rich country full of poor people.
Since 1991, India has moved from a closed to an open economy – permits, tariffs, inflation and tax rates have gone down and foreign exchange reserves and foreign direct and portfolio inward investment have gone up. Exchange control has been relaxed and is expected to be abolished. There has been growth in information technology, privatisation and globalisation.
Foreign direct investment is now virtually free. Some sectors still require approval, but the list is getting shorter and a Government body exists to help approval to be obtained. A special export scheme is required for a major stake in a small company. Approval is required for a second company. Mauritius has played an important role in facilitating direct investment in India. There are various portfolio investment schemes: Foreign Institutional Investors can – since 1992 -invest on the ‘Indian stock exchanges and this indirectly enables foreign individuals and corporations to do so. They may also invest through offshore funds. Non-resident Indians (widely defined) have special privileges – including the right to buy property. There are general investment limits. Overseas corporate bodies cannot invest in secondary markets. There is a new scheme for NR1’s to have dual citizenship.
The recent budget has bought back 20% withholding tax on dividends. This is reduced to 5% under the Mauritius treaty, which also exempt Mauritius-resident investors from capital gains tax in India.
Suppose a revolutionary idea, requiring a viable solution for the individual (Mr X) and his company (NewCo). Relevant factors are the residence of Mr X and NewCo, the economic, commercial and personal needs and the tax objectives of both. Should Mr X change his residence? The United Kingdom, Switzerland and Austria may be considered; specific problems need to be addressed – the number of days, any departure tax or prolongation of tax liability, the place of management of NewCo. Units of NewCo – know-how, production, sales – may be in different places. Development of know-how may generate useful losses, but ultimately know-how is best located in a low-tax jurisdiction. Where do sales profits arise? Will there be a PE in a taxing jurisdiction? Corporate tax optimising requires consideration of financing and the group holding structure. The combination of the needs of Mr X and those of NewCo needs to be considered as a whole, taking into account the tax cost of repatriation of profits and the CFC rules.
For example, an individual resident in the UK but not domiciled there may interpose a Jersey holding company between himself and a UK PLC. He may have a Liechtenstein trust to hold the Jersey company. A German resident may migrate to Austria and hold his German investments through an Austrian company. A traded US company may invest in Europe via a Netherlands BV, holding a Swiss Domiciliary Company. These are only examples: every case is different.
Of the thirteen countries under review, some are little developed (e.g. Moldavia), some have development potential held back by political instability or lack of economic diversification (e.g. Turkmenistan) and there are “big players” – Azerbaijan (whose capital is Baku, a city of some six million with a developed service industry), Kazakhstan (which has a reasonably diversified economy, as well as oil and mineral extraction activity) and Estonia (which is about to enter the EU).
There is no uniform system of customs duties or VAT. The Baltic countries have a VAT system similar to that of the EU. In other countries imports from non-CIS countries generally carry VAT, but imports from another C1S county carries VAT in the exporting country. Setting up a branch carries with it a number of problems – the definition varies from one country to another. Branch profits are generally subject to income tax; an additional branch profits tax is levied in some of the countries. A subsidiary pays income tax on its profits, but international accounting standards are not universally applied. The exception is Estonia, which taxes distributions only. Dividends from other resident companies are generally exempt. Operating losses are generally carried forward. Tax rates range from 200/0 to 30%. Investment incentives have mostly been abolished. Dividends, interest and royalties carry a withholding tax of 100/0 – 15%; treaties reduce or abolish these and other withholding taxes.
A foreign employee becomes a resident if he stays for 183 days, but Georgia has a special regime. Fringe benefits are taxable; there are social security contributions; capital gains are taxed as income.
Some of the former USSR treaties remain in force. There are recent treaties, based on the OECD model. There is a new treaty between Russia and Cyprus, and the old ones apply to other former USSR countries to the extent that they consider themselves successor countries of the USSR. Cyprus may be used as a tax planning base, though changes are on the way. Estonia may also be used: it has a small treaty network; it taxes distributions only and this may be reduced by treaty. The Netherlands is also useful: a Dutch subsidiary may have an operational branch abroad whose profits are exempt from tax under domestic law.
Estonia suggests itself as a location for a holding company. Rulings in former Soviet countries (except Kazakhstan) are not available. Estonia has CFC legislation – which is surprising. None of the countries distinguish thin capitalisation. Transfer pricing rules are prevalent but not uniform.
Russia has exchange control; outbound investment is very new. Before January of this year there was a large tax base and high tax rate, the tax treaty with Cyprus was much used, some interest was non-deductible, there were few transfer-pricing rules, “domestic tax havens” existed, there was political and economic uncertainty and black cash deals prevailed. There has now been a major tax reform, the economy is stronger, currency control is relaxing, corporates desire to “go white” and anti-money laundering legislation has been introduced. There is an appetite for legitimate, sophisticated international tax planning. The corporate rate is 24%, VAT is 20%, the individual rate is 13%, non-residents pay 30%. There is a large treaty network. There are basic transfer pricing rules and some thin capitalisation rules. Domestic “havens” have been abolished.
Business may be done through a branch or local company. Cyprus is still a preferred location for in-bound structuring: dividend withholding tax can now be as low as 5%, which is creditable in Cyprus. Many “normal” transactions still require Central Bank consent; a branch of a foreign entity has a more liberal regime. Maintaining a non-taxable presence requires scrupulous adherence to the rules. Pre-2002 structures need to be reviewed. The tax administration is becoming more sophisticated, but a good deal of tax avoidance is still permitted. Russian individuals are now able to invest limited sums abroad, and many have become aware of the advantage of respectability.
The tax system in Ukraine is less advanced. There is a new Land Code, prohibiting foreign-owned companies from owning land, although foreign companies may still own buildings and lease land. A new Civil Code and Commercial Code appear to be on the way, and reforms have introduced a level playing field between local and foreign companies. Cyprus is not included on the blacklist. Licensing, management services agreements and transactions with offshore companies are typical tax-planning transactions. Ukraine has a network of tax treaties.
Islam requires its followers to earn income by halal means. Some activities are Karam – prohibited. interest is regarded as forbidden usury. Islamic finance requires an asset backing.
The laws were laid down over 1400 years ago. They have often been ignored in the past, but have been much more widely observed from the 1970’s onwards. There are now over 200 Islamic banking companies or departments, and new products have been devised – e.g. a replication of the call option. Investment is forbidden in gambling, alcohol, banking, insurance, pork and arms, and interest is forbidden also, but investment is permitted in a company which has e.g. a small amount of interest. In such a case, the investor will donate to charity a corresponding part of the dividend.
Banks have come to recognise the investment needs of their Muslim clients; they have devised new products for the purpose and their business has grown in consequence.
A halal trading transaction requires an exchange of tangible goods – e.g. a bank may buy a car and sell it to the client at a higher but delayed price – the marabaha transaction. Such transactions have been approved and audited by Sharia scholars over the last 25 years. Apart from the marabaha, there are Islamic currency swaps, leasing, global equity funds, marabaha/trade financing funds, property funds and capital preservation funds, and there are future product development plans and plans to create a capital market product. Deferred payment is the basis of the marabaha transaction.
The GAAR is not unique to Australia. The UK Court has developed rules of construction which have a somewhat similar effect. is a statutory or case-law GAAR to be preferred? in Australia, the effect of the legislation has been a degree of uncertainty; some commentators have criticised the UK judge-made law for the same reason.
The standard design features of a modern GAAR include defining “tax avoidance” – usually by reference to purpose, form, or both, but with qualifications to provide safe harbours and protection against the unintended application of the rule. The rule needs to define the indicia which trigger its operation. It must also provide for the consequences of its application ; which gives tax effect to a hypothetical transaction.
The Australian rule is uncertain in its application to a given case. It has always been used by the Revenue in terrorem. The purpose of the legislation was to counteract schemes of a blatant, artificial or contrived kind, but the Courts have construed the enactment much more widely – notably in the Peabody and Spotless Services cases. The avoidance purpose of a taxpayer’s professional advisor may be attributed to the taxpayer, but recent cases (at the lower appellate level) have shown that a taxpayer is not bound to choose the transaction which achieves his economic objective in the least tax-effective way. The law does not contain a definition of an avoidance transaction – a shortcoming which has played a great part in generating the present uncertainty. There is a 500/0 penalty, reduced to 25% if the taxpayer has a “reasonably arguable” case.
The GAAR in Australia has not eliminated the mass marketing of tax planning schemes. The US has proposals to counteract corporate tax shelters: they rely, not on purpose or form of the transaction but on an objective view of the tax benefit obtained from it. This approach appears more certain and more effective in reducing marketing of schemes.
Property is cheap, there is no exchange control for non-residents, interest is exempt, but hell is on the streets. For residents, the tax system has been massively changed, a world-wide basis replacing a source basis, and a new tax on capital gains being introduced; the general quality of the tax administration has declined. There are hit squads and name-and-shame campaigns and cruel and inhuman sentences; there has been some transfer of wealth to a small black group; the currency has lost much of its value – halving itself in three years. Exchange control is severe and has recently eased for individuals making investments abroad. The world-wide basis requires individuals to disclose foreign investments which yield income; this poses a serious problem to those who have committed exchange control offences in the past. It has also created a demand for non-income yielding investments.
There is an “ordinary residence” rule and a new 91-day test for individual residence. A company or trust is resident if formed in South Africa or has its place of effective management there. The tax base has been enlarged, with exemption for income suffering sufficient tax in designated countries (including Mauritius) CFC rules (called “CFE”) and a number of new and prolix provisions, including those applying to non-resident trusts.
Investments which are tax-efficient for South African residents include single-premium policies, and under 100/o in a protected cell company, a roll up fund.
Hong Kong is a very well-established financial centre; Labuan and Brunei have been established more recently. Labuan has a one-stop agency LOFSA; the Development Authority is responsible for the physical development of the centre. The relevant legislation dates from the 1990’s. Offshore companies are rapidly incorporated; there is no exchange control; Malaysia has a number of tax treaties, of which the one with South Korea is the most commonly used. Labuan offers trusts and trust companies.
Brunei is situated in Borneo. The government is diversifying away from oil to financial services. The country has strong ties and a tax treaty with the United Kingdom. It offers an 1BC at modest cost, but it is very discriminating as to its clientele; foreign companies may register as a foreign 1BC. Dedicated cell companies are available, as are banking, trust companies, limited partnerships, mutual funds, trusts, purpose trusts and “special trusts”, enforced by an “enforcer.”
Hong Kong has taxes of many kinds – on salaries, property and profits; it has duty on estates, stamp duty and excise duties; all are on a territorial basis. Profits tax is charged on taxpayers whose profits arise locally. Hong Kong offers companies (whose audited accounts are given promptly to the Revenue); they cannot be re-domiciled. It also offers Trust Companies and trusts. Hong Kong taxes are going to have to rise – perhaps via General Sales Tax.
Mauritius created an Offshore Business Centre in 1992. Seychelles did the same in 1994. The Maldives and Zanzibar have not so far been successful in so doing. Anjouan created an Offshore Centre in March 1999. It has an 1BC law. It offers banks and insurance companies. Unfortunately the state is not internationally recognised; practitioners should steer well clear of its facilities.
Seychelles offers fast and economic 1BC incorporation. There are several trust companies, but so far it has no offshore banking, mutual funds or insurance industries. It has made a commitment to the OECD and is not on the FATF list. lts 1BC may have bearer shares and beneficial owners need not be revealed: this will no doubt have to change. There are tax treaties with China and ‘Indonesia. Holding company and limited partnership legislation is on its way. Like Mauritius, Seychelles is subject to the 1MF assessment programme.
Mauritius has some 16,000 companies doing international business, about half of which access tax treaties – especially the treaty with India. Mauritius needs to avoid “ring-fencing”: it seems likely that tax rates will drop significantly and apply equally to domestic and international business. Global Business Company 2 will be tax-exempt. GB Co. 1 will be taxable and have access to treaties. Strict “know your client” rules are in force. Mauritius is not on the FATF list and is no longer on the OECD list; its treaty network is extensive, those with India, China, Indonesia, South Africa and Luxembourg being particularly interesting. Offshore banking is established in Mauritius and there is a stock exchange. The future seems unclear: but the Indian Ocean Islands are committed to the developments orchestrated by the OECD.