Venice 1990 meeting

It seems that the European Community is uncertain what policy to adopt towards offshore centres, but the Community is likely to retain them insofar as they benefit the member states. Most importantly, free movement of capital is to be encouraged: the offshore centres should have a role to play here. Free competition has always to be encouraged in the Community: common currency and common capital requirements and regulations will apply equally to onshore and offshore jurisdictions. A common currency would remove any remaining adjustments which fluctuating exchange rates have made to the competitiveness of member states.
Common taxation policies have presented greater difficulties. They require the unanimous approval of the Council of Ministers. Proposals are presently before the Council (and have been for some years) on the tax treatment of mergers etc, on the treatment of dividends between parent and subsidiary companies in the Community and an arbitration system between tax authorities of members states. The Commission are to introduce two further proposals: to allow losses of permanent establishments to be set off against the profits of the head office and to abolish withholding tax on inter-group interest and royalties. A committee of experts is to examine disparities of corporate tax rates: will they be eliminated by market forces, or are directives required? They are to examine a range of options for aligning the tax regimes of member states with the principle of free competition.

The Commission wants “aids” (tax and other incentives to industry) to be administered by Brussels. Much of the Commission’s present thinking on Regional Policy is set out in their Memorandum of the 25 April 1990.

Overall, and looking at all the Commission’s policies and proposals, trading and financial and licensing transactions within the Community may cease to be possible or advantageous through the offshore centres, but the centres will continue to be useful for inward investment.

The relationship between the offshore centres and the Community vary from case to case: the position of Luxembourg, Madeira, Gibraltar, the Channel Islands and the Isle of Man, Monaco, San Marino, Andorra, Cyprus, Malta and the Associate countries in the Caribbean and elsewhere need to be looked at separately.

Note The talk was based on the principle that with the harmonisation of taxes in the Community the Commission would be looking for a harmonisation of the tax base before considering the rates and allowances. Nothing much has happened in this direction and the expectation that Madame Scrivener, the Commissioner then responsible, would achieve much resulted in little change. The expectation therefore that the Commission would look at the anomalies existing in the offshore centres within its boundaries or which member state had some influence did not come about as matter of technical adjustments. However, the offshore centres whether independent of the EU or not remain a thorn in their side and recently a different assault has been launched on them with the demand that member states should themselves adopt measures to remove these anomalies either in their own countries or those over which they have influence. This has resulted in an appraisal of the U.K. dependent territories: despite government assurances that their futures as financial centres will continue, the price to be paid for that support has not yet become apparent. Also the British government suddenly launched on some enquiry into the practices of the Channel islands and the Isle of Man, due they say to concern shown by the EU and the United States. This does little more than illustrate the craven sycophancy of the British government to these organisations and suggests that any changes should be in the direction of greater independence. Offshore centres now have reached a stage where the onshore centres probably need them as much as the offshore centres need the onshore centres: a degree of expertise has been reached offshore that their independence and freedom from corruption and folly makes them essential bases for international investment.

Czechoslovakia Czechoslovakia is in the throes of changing to an open market economy. It has been possible since 1985 for Western companies to establish joint ventures: there are now regulated by the law of 9th November 1988. There is no limit on the share of the venture held by the foreign partners: in principle, the law seeks to preserve the contractual freedom of the partners and is designed to give all possible encouragement to foreign investors. The beginning of a tax regime for privately-owned business can be discerned in the taxes devised for joint ventures. There is a flat rate of 40% corporation tax, with a discretionary power to grant tax holidays of up to 2 years. There is also a flat 50% social security contribution on wages and salaries (a lower rate of 20% is applicable to service companies). Withholding tax on dividends is 25%, reduced to a minimum of 5% in the tax treaties – of which there are presently 17. The withholding tax on royalties is 30%, though copyright royalties carry only a 25% withholding tax, and tax treaties provide lower rates. There is also a quasi-withholding tax of 5% on service payments. Interest payments carry no withholding tax, but this may change. New laws are in the pipeline to make possible a wider range of investment in Czechoslovakia by foreign investors.Cyprus The Cyprus treaties with Eastern Europe are of great importance to Western companies doing business with Eastern Europe. Cyprus has treaties with Bulgaria, Czechoslovakia, the GDR, Hungary, Romania, USSR and Yugoslavia, as well as treaties with the principal developed countries in the West. Comecon countries do not have anti-avoidance and anti-treaty shopping provisions, and the use of treaties in conjunction with an offshore licensing company in Cyprus can effect substantial reduction in the tax burden of Eastern European business. The greatest advantage is obtained by the Cyprus company where it is owned by a resident of a zero-tax jurisdiction in the Middle East or elsewhere, or by a zero-tax company established in a tax haven, or by a company established in a country which will impose no or reduced tax on dividends declared by the Cyprus company – eg Austria, Denmark, Italy, Luxembourg, Hong Kong or Greece (in this last case because of tax sparing credit provisions in the relevant Treaty). Most countries – including Ireland, Switzerland and Singapore and West Germany (so long as the subsidiary is not a sham company – impose no tax on undistributed profits of foreign subsidiaries. Sweden accords this treatment to a Cyprus company because of the tax treaty between the two countries. One the other hand, some countries – like Australia, Belgium, Canada, France, Japan, United Kingdom and the United States – do have provisions in their law to impose tax on undistributed profits, but in some cases some exception may be made for companies resident in a treaty country. France, Switzerland and Denmark do not tax the profits of foreign branches; Cyprus offers tax exempt status to an offshore banking unit – ie the Cyprus branch of a foreign company. Construction and assembly sites obtain favourable treatment under the Cyprus treaties with Eastern European countries. Comecon enterprises use Cyprus to register ships on which loans are to be raised from Western banks.

Multinationals have become expert in reducing tax levels. This may be the clue to their competitive edge.
Taxpayers may play the avoidance game, the evasion game or the lobby game. Countries play games to cheat their treaty partners – notably by lowering the base: e.g. the Netherlands will take a slice to enable the taxpayer to reduce its tax in the United Kingdom.

The fundamental game for the taxpayer is to remove the connecting factor between the potentially taxable person or event and the taxing jurisdiction. At its simplest, a Bermudian manufacturer manufactures in Bermuda and sells in the Bahamas. Early trusts removed property from succession duties; the substantial history of trust taxation is one of counter-avoidance by governments and counter-counter-avoidance by taxpayers. At a more sophisticated level, multinationals are constantly revising their structures so as to achieve foreign presence without foreign tax. Where business profits threaten to constitute a source of income in a country, the multinational will look to use a treaty company with no permanent establishment there (and a low or nil rate of tax at home) – e.g. a Swiss company with an Isle of Man branch. This arrangement will often involve paying the “carte de visite” – reaching an agreement with the federal authorities in Switzerland about the percentage (20% or 30%) of the profit which is to be attributed to head office and about effectively distributing profits by way of expense payments (not suffering the 35% withholding). Licensing via a Netherlands “stepping stone” has a similar effect. Where the “stepping stone” is related, the Dutch expect a turn of 7% on the first 2 million guilders down to 2% on amounts exceeding 10 million guilders. On film royalties a standard 6% turn is expected. Where the parties are not related, there is no fixed tax base.

Tax treaties must be interpreted both in the light of public international law and in the light of private international law – “conflict of laws”. This distinction has not always been observed. Articles 31 and 32 of the Vienna Convention has codified rules of interpretation in public international law. The 1986 U.S. Tax Reform Act introduced an anti-treaty-shopping provision (now 884 (e) of the IRC); TAMRA 1988 (s 7852 (d)) confirms that domestic law may override the provisions of treaties. An injured State has no remedy. It cannot go to the International Court without the consent of its treaty partner; the remedy of termination can do more harm than good.
Tax treaties have in practice been interpreted in the light of the domestic law of taxpayers affected, though the courts are now inclined to refer to the Vienna Convention and the principles of public law, Nevertheless, the potential conflict between the plain meaning of the words and the perceived intention of the parties is likely to persist.

In Australia, the Lower Court judges in Thiel took Article 3 of the Swiss treaty as requiring them to apply Australian law in arriving at the meaning of carry on an enterprise. This seems contrary to the purposes of a treaty, which foresees that the meaning of the text will be arrived at in the context of the treaty as a whole, domestic definitions having evolved in a totally different environment. [Note: In line with these comments, and Editorial in the The International Tax Treaties Service, the full High Court then unanimously overruled both Lower Courts.]

In Canada, the judges in Melford held that domestic legislation could only override the terms of a treaty if it expressly says so. Is the meaning of words in a treaty “ambulatory” – does it change with changing domestic laws? Treaty words must be capable of evolution – but their original meanings cannot radically change. [Note: This approach was then essentially adopted in the 1995 OECD Model.] This is illustrated in some estate tax decisions in the US – e.g. Burghardt of 1983. Other approaches have been adopted elsewhere.

Austria’s geographical position in Europe, its political stability and its history make it a natural centre for East-West trade. Its tax system makes Austria a suitable base for licensing and holding companies; such companies are not excluded from the benefit of the 40 tax treaties to which Austria is a party. The 1988 tax reforms reduced the level of corporation taxes on companies and encouraged the use of holding companies. Austria has no extensive anti-avoidance legislation. All companies pay 30% corporation tax; business companies pay an additional 15% trade tax. There is also a 1% property tax on shares, and a further 0.5% inheritance tax equivalent on shares held by foreign investors. Withholding tax on dividends is levied at 25% – reduced by treaty to 5-15%. Subject to certain conditions, a holding company with participating shareholdings in foreign companies is exempt from corporation tax and trade tax on income and capital gains derived from the foreign holdings. Distributions suffer withholding tax, but there are no minimum debt-equity ratios and some treaties provide lower rates for interest. The 40 tax treaties – with countries in Comecon as well as Western countries – broadly follow the OECD model. Apart from treaties, withholding tax on interest is 10% and on royalties 20%. Some exceptions are made for foreign holders of bank deposits and bonds. For the form of company the choice is between the limited partnership (GmbH) and limited company (AG). The limited company is more complicated and has a higher minimum capital requirement, but its shares can be quoted. Austria’s banking system offers a high level of secrecy: foreign investors enjoy total anonymity and effective freedom from exchange control, but anonymous holders generally suffer 10% withholding tax on interest.

A free trade zone is free of customs duty. A system of “drawback” is less satisfactory: it is prone to red tape, it ties up the operator’s money, and the drawback is not always 100% of the duty paid. In a zone the operator can often enjoy freedom from quotas and lower shipping, insurance and security costs. Many zero-tax jurisdictions provide zones – e.g. Aruba, the Bahamas, Bermuda, Gibraltar, Madeira, Western Samoa. Cyprus, Dubai, India, Malaysia, Sri Lanka, Shannon in Ireland and Taiwan offer the most attractive holidays and investment incentives and are among the most successful.
Zones are encouraged by the European Community; they have proved to be successful in the United States, Central America and the Near and Far East also. The USSR and other Comecon countries plan to have zones.

Operating in a free trade zone is generally simpler and better than using a bonded warehouse: there is no 3-month or other limit of time to comply with; Customs officials are not on the premises and goods are not locked up, sometimes for months, until customs make inspections; office – as well as factory space will be available; and countries do not generally regard operations in a zone as constituting a “permanent establishment” for tax purposes.

In some countries, operation in a zone is a condition for permitting a foreign investor to own 100% of the equity of a company – e.g. in China. In choosing a zone, the operator should be aware of such advantages and should look for such things as good management of the zone, the co-operation of government, political stability, ability to install computer systems, transport (a sea or river-harbour is generally desirable), labour which is cheap, available, co-operative and skilled, and a minimum of red tape – often achieved by a system of “one-stop processing”.

[Note: Walter Diamond has not been able to update this summary but the reader’s attention is drawn to his article “Offshore Trading and Financial Services in Eastern Europe” in the Library on the Association’s website.]

A realistic approach to the viability of a tax plan takes into account that the facts may have to be explained to a tribunal. Advisers may therefore be cautious, but the experience of clients in the United Kingdom is that advisers are capable and honest. Taxpayers not in a position to disclose all the facts to their advisers and if necessary to the Inland Revenue should not base their activities in the United Kingdom. Nor should those apt to ride roughshod over the technical requirements of UK tax law.
The Court in the UK will collapse a pre-ordained series of transactions not entered into for commercial reasons. This doctrine was classically stated in Furniss v Dawson; in the last few years it has become clear that the Court is not minded to extend this doctrine – but the personalities in the higher courts will change and so may this attitude.

It is always necessary to ensure that everything has been done properly and that it can be proved by credible witnesses subject to cross-examination in the UK that everything has in fact been properly done.

The Alchemist Trust converts UK taxable income into non-UK taxable income. The UK has a schedular system, and the trust operates by converting one type of income in the hands of the trustees into another type in the hands of beneficiary – a type exempt under a treaty. Suppose trustees resident in the UK carrying on a trade make “annual payments” out of the profits to a discretionary beneficiary resident in a treaty country.

Treaties do not expressly refer to “annual payments” but these may be included in the article affecting income “not expressly mentioned elsewhere” – eg the treaty with Austria, Barbados or Israel – and exempted from UK tax accordingly. The effect of TA 1988 s 686 and s 687 is that there is no tax burden. Note that this structure (i) must not fall foul of anti-avoidance provisions, (ii) can only escape capital gains tax if the settlor is non-resident and (iii) is prone to inheritance tax on UK-sited assets if it lasts for 10 years.

The Alchemist company uses the UK as a “stepping stone” – receiving income from foreign state A under the protection of the UK treaty with state A and making payments of interest royalties or annuities (qualifying as “annual payments”) to a resident of state B either under the protection of the UK treaty with that state or by structuring the payments so that they do not have a UK source.

The problem derives from common law rules on pre-bankruptcy dispositions. Insolvency legislation seeks to undo such transfers. The prime example is found in England (Insolvency Act 1986) but civil law systems have rules of similar effect.
The Butterworth case establishes the general principle that a person about to engage in a hazardous activity cannot put his assets beyond the reach of his creditors – even though at the time of the disposition there are no present creditors.

The “sham” doctrine also applies to strike down dispositions where there is no true intention to transfer beneficial ownership. Generally, one country’s courts will not recognise a foreign bankruptcy judgement, but in a number of Commonwealth or ex-Commonwealth territories, the reciprocal enforcement of bankruptcies would mean that, for example, a Bahamian court might assist in insolvency proceedings commenced in England.

US Courts offer an even greater assistance to foreign receivers in bankruptcy, without requiring reciprocity.

Can an asset protection trust assist in safeguarding assets against the claims of creditors? Suppose a professional wishes to protect his assets against the adverse effects of his insolvency, and thus the trust provides for a life interest for the settlor for so long as he remains solvent, but in the event of his insolvency then the trustees hold the assets upon wider discretionary terms – would that stand against creditor claims?

The situs of the assets placed into such a trust will be an important consideration. Assets within the United States will obviously be vulnerable to US receivership action.

Suppose, however, that freely movable assets are first transferred to a Cayman Island company for full value and the shares are then placed in a Cayman trust. This will ensure that neither the assets nor the trustees are vulnerable to action in this settlor’s home jurisdiction. The appointment of a Protector (resident in an appropriate jurisdiction) can give extra security.

On a practical note, it is evident that a Receiver in Bankruptcy will have regard to the cost effectiveness of any recovery action, and by placing assets outside the home jurisdiction, the Receiver’s task will be made costly and time-consuming – with no guarantee of success.

Some 18 jurisdictions have now enacted helpful legislation in this area: the first few were Gibraltar, Bahamas, Cayman and the Cook Islands.

The common feature is that unless a creditor is a creditor at the time of the disposition, he will not be protected by the law.