The tax “octopus” may expose an individual to tax for any one of eight reasons:
Residence a concept which varies from one country to another;
Domicile – an English concept not found in civil law jurisdictions;
Citizenship – a criterion of taxability in the Philippines, South Korea, Liberia and the United States;
Marital status – which does not in itself affect taxability, but may affect domicile and community property;
Source of income;
Location or situs of assets;
Timing so that e.g. a tax exile will generally try to postpone accruing or receiving income until he is no longer a taxpayer;
Status of beneficiaries who may not themselves become tax exiles.
The tax exile has a wide choice of locations to take up residence or domicile. Where the “remittance basis” applies (e.g. in Barbados), the exile will avoid acquiring domicile there. The U.S. exile however needs to acquire a foreign residence and domicile.
Suitable destinations for tax advantages in the Caribbean include the Bahamas, Bermuda, Cayman, Netherlands Antilles and Turks and Caicos. But U.S. citizens need to change their citizenship. Government statistics show that between 1962 and 1993 the numbers of renunciations of citizenship have varied between 0 and a few hundred, but this probably understates the true numbers. For new citizenship, Ireland and Cape Verde Islands merit consideration; in the Caribbean, the best programme presently is that of St. Kitts and Nevis.
It has been usual to use corporate vehicles for investment in the United States. Generally a foreign parent company has a U.S. subsidiary: this avoids the branch profits tax and insulates the foreign shareholder from U.S. gift and estate taxes. Corporate rate on income (say 38%) is a little below the top rate for individuals (39.6%) but its capital gains tax rate is some 10% higher. However, a corporation suffers a second tier tax on dividends; this is often avoided e.g. on liquidation (a route which may, however, be closed).
The limited liability company and partnership are “passthrough” vehicles. The big advantage lies in the lower tax on capital gains. For estate tax, it appears that an interest in a foreign partnership or LLC is foreignsitus property. A favoured structure is a foreign limited partnership owning a U.S. limited partnership. Cayman, Bermuda, Bahamas, Turks and Caicos and other jurisdictions have enacted legislation to provide such vehicles.
The United States recognises two types of trust: the grantor trust (where the grantor is treated as the owner) and the nongrantor trust (where the grantor excludes himself from benefit and control). The non-grantor foreign trust has some tax advantages with a 5:1 debt/equity, engaged in U.S. trade or business. The interest is deductible and tax free but it has not in practice proved popular. It appears that a U.S. trust can achieve a similar advantage.
Grantor trust income is attributed to the grantor even when he is a nonresident alien; this phenomenon is currently regarded as abusive by the IRS.
The IRS has many and powerful weapons for obtaining information legislative, judicial and diplomatic measures, including treaties.
The Tax Information Exchange Agreement began in the Caribbean. It offers certain benefits, notably U.S. deduction for convention costs and qualification for a FSC (e.g. in Barbados and U.S. Virgin Islands). It is an expanded version of the treaty article. It does not require ratification by the U.S. Senate. The information is to be used for tax purposes only.
The right to privacy is generally overridden by the taxing requirement of the U.S. Government, to the point that concept nowadays hardly exists in practice.
Provisions for exchange of information are found in income tax and estate and gift tax treaties, and in the newer ones in a wider form. But the information is supposed to be limited to tax matters. The new NAFTA agreement provides for some sharing of information with customs authorities. This may indicate a new trend. The new protocols with Mexico provide also for enforcement another possible trend. The proposed protocol with Canada provides for collection assistance with respect to former (by as much as 10 years) citizens and residents.
Only 10% of the information routinely received by the IRS is usable. Spontaneous exchange is little used. Treaties provide for specific requests, but again these provisions are little utilised. But the IRS uses all its summons powers to obtain information required for exchange; some, but not many, defences have succeeded. The courts have generally upheld summonses to obtain general information from banks even where the individuals are not specified or the relevant foreign jurisdiction forbids disclosure. Congress has substantially increased the reporting requirements on U.S. taxpayers. Since 1970, transactions of over
US$ 10,000 require to be reported, but Treasury does not exchange this information (yet).
The present trend is for more and more extensive exchanges of information. There is now even an agreement between the United States and Switzerland.
In 1984, Anguilla enacted eight new Acts and introduced several further measures. Antigua published three new Bills and proposed some residency law changes. Bahamas amended its IBC Act, introducing Limited Life Companies; several Bills are pending. Barbados now has a new Protocol to its Treaty with the United States; an investment treaty with Venezuela was signed and a tax treaty is imminent; additional proposals are in the pipeline. Belize proposes to update its IBC Law. Bermuda has opened the door to the asset protection trust with its Conveyance Amendment Act.
In the British Virgin Islands, the new Trustee Act came into force; other proposals for new laws were published. Cayman regulated mutual funds. New tax treaties were made by Cyprus. Gibraltar provided for the registration of EEIG’s. The Company Law is under active review in Guernsey. Hong Kong provided for increased disclosure requirements for directors. Ireland has proposed to permit single shareholder companies.
Changes in Jersey herald the establishment of offshore insurance. Luxembourg has a new treaty with Switzerland. Madeira has widened the class of business which can take advantage of its offshore facilities. Malta has been overhauling its entire system: possibilities of treaty shopping are opening up there. Mauritius enacted an IBC Act and proposed a Financial Services Act. The new NetherlandsU.S. treaty came into effect. The new Trust Act in Nevis allows for asset protection trusts on the Cook Islands pattern.
Niue is a new jurisdiction with 4 new laws. Panamanian lawyers are now obliged to “know their client”.
In Switzerland, beginning 1 January 1995, VAT at 6.5% will be imposed on many goods and services, including financial services.
In Turks and Caicos, amendments to the Companies Ordinance, introduced on February 8th of this year were subsequently adopted. These amendments make the use of an “objects clause” permissive rather than mandatory a company may carry on any business not prohibited by law. Companies may now have classes of members each with different liabilities (hybrids). It has now been clarified that a sole director can also be the secretary of a company so, one person companies are possible. An exempted company may now have its name in any language (with an English translation). The $300 annual renewal fee for a company formed in the second half of the year is now not due until January of the second year after registration. Very substantial discounts are available for prepaying the annual renewals 5 or 10 or 20 years in advance.
The U.S. Virgin Islands is not usually thought of as a tax haven because it is a U.S.-unincorporated territory. But Bill 20-0396, which passed the U.S. Virgin Islands legislature at the end of September amends the exempt companies law to include exempt mutual funds and U.S.owned insurance companies. Under the amended law, a mutual fund can carry on the activities which a mutual fund normally performs in its business without becoming subject to Virgin Island law.
The law passed last year in Uruguay, regulating insurance and reinsurance companies, became effective 25 May 1994.
Even though Vanuatu is just digesting the IBC and Financial Services Acts adopted last year, proposals have been made for a Trust Act, International Trust Act and a Companies Management Act.
A resident company is taxed on its world income. The passive income of a subsidiary or other controlled foreign affiliate (“FAPI”) is taxable to the Canadian shareholder. The rules have been tightened to include income from property unless a financial institution or securities trader, or real estate developer etc. To come outside these rules, at least six employees are now required; nonarm’s length trading, insurance, leasing and factoring are to be generally excluded (though factoring by a nonCanadian subsidiary is not excluded).
Dividends from a foreign subsidiary carrying on an active trade and situated in a listed country (e.g. a Barbados IBC) are “exempt surplus” and taxexempt in the hands of the Canadian parent. Active business income may extend to that of an interposed holding company.
Becoming nonresident of Canada is becoming increasingly difficult. Revenue Canada issues a form, full of searching questions. It is not compulsory and should not be completed. The assets of the emigrating individual are revaluated and any gain taxed.
A Canadian trust is taxed at a flat rate e.g. 54% in Ontario. When the beneficiaries emigrate, the trust assets may be distributed to a “mirror” trust elsewhere.
An overview of 28 territories in the Caribbean and neighbouring areas shows a number of tax treaties, many of them extensions of U.K. treaties some of which – e.g. those with Switzerland and Japan – are still in force. Art. 7 of the Swiss treaty deals with royalties; article 8 is a capital gains tax article (useful e.g. with Barbados). The JapanB.V.I. and JapanMontserrat treaties are still in force; they include a capital gains tax article. Many of France’s treaties extend to Guadeloupe and Martinique.
U.K. treaties exempt royalties if taxable in the hands of the recipient. Tax credit on U.K. dividends can be claimed by a resident of Belize. The Barbados treaty has a capital gains article, even though Barbados imposes no tax on capital gains.
Some Caribbean territories (notably the B.V.I.) are a source for the provision of companies of the IBC type. Hybrid companies can be incorporated in Anguilla and Turks and Caicos. Bermuda is pre-eminent in insurance and stands high as a location for trusts. Asset protection legislation has been introduced in several jurisdictions. The Bahamas and Cayman have attracted banks and mutual funds.
S.249 of the Finance Act 1994 made possible the reappearance of the U.K. nonresident company, though its purpose was to curb the use of dualresident companies. The Inland Revenue view, much debated, is that only the OECDstyle tiebreaker brings the section into effect; this limits the usable Caribbean jurisdictions to Barbados, Trinidad and Jamaica.
Reinvestment relief was widened in scope in 1994. The taxpayer must reinvest in unquoted shares in a qualifying company i.e. with a qualifying trade. The trade does not have to be carried on in the United Kingdom, nor must the company be a U.K.resident company. The nondomiciled taxpayer may thus escape the capital gains tax altogether.
The IRS is the collection agency for the U.S. Treasury. The U.S. Congress first focussed on tax haven transactions in 1921. Legislation followed, a major attack on such transactions being made by the Revenue Act of 1962. The Bank Secrecy Act was passed in 1970 and the Foreign Trust Act in 1976. In 1979 and the early 80’s, the “tax haven” hearings were held; these were followed by the extensive and informative Gordon Report of 1981 and the Tax Havens in the Caribbean Basin report of 1983. The Tax Haven Offshore Bank Project of 1983 was an information-gathering project. In 1983 Congress, held further hearings under the heading Crime and Secrecy: the U.S. Use of Offshore Banks and Companies.
The IRS recognises as legal uses of tax havens for avoiding currency control restrictions and banking controls, for confidentiality, for obtaining higher bank interest etc. But the Service regards as illegal hiding true beneficial ownership; the use of “accommodating ” settlors, of nonlicensed banks, and of apparently unrelated parties for transfer pricing schemes; money laundering etc.
The IRS regards as non taxmotivated the use of branch banking and avoiding currency controls and expropriation. Certain transactions are regarded as legal but taxmotivated e.g. use of flags of convenience. Taxavoidance planning includes captive insurance and factoring companies. The Service regards as evasion double trust schemes, sales to related parties, use of unlicensed banks, hiding ownership, hiding corporate receipts and slush funds.
The Caribbean Basin Recovery Act of 1983 requires Treasury to obtain information on taxhaven and criminal activities in the Caribbean. In that year, Treasury published Tax Havens in the Caribbean Basin, identifying the Bahamas, Bermuda, Cayman, the Netherlands Antilles and Panama as satisfying all the criteria. A territory signing a Tax Information Exchange Agreement obtains certain benefits notably the convention tax benefit, the FSC benefit and the loans from Puerto Rico for development projects. As of 31 July 1994, 6 TIEA’s are in force and Belize is in negotiation.
The IRS Manual gives an overview of the characteristics of a tax haven (as of 1985). It gives the Examiner the primary audit tools: much depends on the ingenuity of the Examiner. It directs the Examiner’s attention to typical transactions e.g. in transfer pricing. It discusses the question of substance versus form, the sham theory. It lists 31 tax havens, of which 13 are in the Caribbean. The IRS also has a Student Manual.
Information gathering is not easy for the IRS. They utilise forms, bank information, a major computer, overseas examinations, letters rogatory, tax treaties etc. The IRS have also come to use some coercive techniques, such as the compelling of witnesses and documentary evidence of U.S. citizens and residents in the United States and abroad.
Insurance presents many opportunities in international tax planning. It is a rapidly growing industry. The client base is expanding notably in Asia. Practitioners in this field need to know about the uses of insurance. Pure risks include property risks, risk of tortious liability, risks to personal wellbeing, including death taxes. The United States takes 40% of what an individual makes during his lifetime and 55% of what is left on death and generally more, because of the difficulty in ascertaining market value.
Risk management requires first of all identification of the risk, then an evaluation of its importance, selection of the technique required and finally an implementation which includes periodic review. Risk management techniques include risk avoidance, risk control, risk retention, risk transfer and various combinations of these.
Insurance depends on large numbers: statistics result in predictability in many fields commercial general liability, professional liability, workers’ compensation, transportation, credit, life.
A life policy can be used to provide liquid funds to pay death taxes, income for family expenses, family capital, credit building, funding continuance of business. Accumulation by an insurance company in the United States is tax free: the value of a policy grows correspondingly faster.
Insurance techniques in combination with other planning techniques can create quite dramatic financial and tax results.