Vienna’s experience with business with Eastern Europe makes it a popular location for a sales office – a branch or subsidiary.
The losses of a branch of a foreign company cannot (in the absence of a “non-discrimination” clause in a tax treaty) be carried forward, but is taxable on its profit.
A subsidiary – generally a GmbH – is taxable as a separate entity. The minimum capital is AS 100,000.
A foreign company will generally choose the medium of a subsidiary: the tax rates are the same for branches and subsidiaries, but the losses of a subsidiary may be carried forward, at least five years. Certain tax advantages are available to a subsidiary which are not available to a branch, and of course a subsidiary – unlike a branch – can take advantage of Austria’s income tax treaties. Austrian treaties mainly follow the OECD model; there are treaties with several Eastern European countries.
A subsidiary is a “resident” company, and taxable on its world-wide income; a branch is taxable only on the profits referable to the branch. Credit for foreign tax is given only in accordance with a treaty. Companies in a group may amalgamate their profits and losses for tax purposes. Corporate tax rates range from 30% to 55% on retained profits. Distributed profits suffer double taxation, but a distribution reduces the rate payable to the corporate level by half.
A variety of tax incentives is available both to branches and subsidiaries.
There is also a capital gains tax of 20%.
Where the Austrian company has belonged for at least 12 months as to 25% or more to a single shareholder the “affiliation privilege” excludes the dividends and capital gains from the taxable gains of the shareholder; relief from withholding tax may be given under a treaty.
There is a business tax, calculated as a percentage of income, net worth and payroll, a turnover tax, a value added tax, a net worth tax, a real estate tax, and some minor taxes.
The staff of a branch or subsidiary – being resident in Austria – will be taxable on their world income, including fringe benefits, after deductions and allowances. The tax is a “wage tax”, withheld by the employer, at a rate rising from 23% to 62%. The top rate is reached at approximately US $110,000. Liability arises if a non-resident does the work in Austria – subject to any contrary provision in a tax treaty.
Austrian exchange control mainly affects dealing in Austrian currency – the Austrian schilling. Non-residents are free to transfer and convert all other currencies. Moreover, Austria has a tradition of bank secrecy similar to that of Switzerland – a tradition recently codified into Austrian law. These factors have made Austria an attractive banking centre.
Austrian banks, unlike those of Switzerland, impose no “negative interest” on deposits denominated in Swiss Francs. Checking accounts, savings accounts and deposit accounts in Austria may pay interest – regardless of the currency in which the account is denominated. Austria levies no withholding or other tax on bank interest earned by non-residents. Austrian banks maintain portfolios of Swiss franc denominated securities, which may be acquired by persons resident outside Austria and Switzerland without restriction.
Luxembourg offers several facilities to the international banking community. A bank established in a tax haven may incorporate a service company in Luxembourg to provide administrative services there: such a company will be taxed in Luxembourg only by reference to a percentage of its outgoings – subject to a minimum annual amount.
Like the UK, but unlike Switzerland, Luxembourg imposes no withholding tax on the payment of interest to non-residents. Similarly, Luxembourg imposes no withholding or other tax on interest payable on certificates of deposit, except interest on bearer certificates with a nominal value under 7.5 million francs (about US $250,000.
Credit is given – subject to certain restrictions – for foreign tax suffered on inward payments of interest, and any surplus may be used for certain other income.
As a rule, the tax treaties to which Luxembourg is a party provide for inward payments of interest from abroad to be made without deduction of foreign tax. The French treaty is an exceptional to this rule: it provides for a 10% withholding on payments from France – any credit which cannot be utilised being treated as a deduction.
Luxembourg banks can arrange “back to back loans”, underwriting and subscription of securities (without any stamp duty or VAT cost) and dealings in currencies and gold.
The tax advantages of the Grand Duchy are only partly the cause of Luxembourg’s success as a banking centre: traditional know how, flexible banking and exchange control regulations, and a self-imposed disciplinary code have also made their contribution.
The infrastructure of Switzerland and its attraction as a location has made Switzerland a popular place for non-residents to do business. There are Swiss banks of many kinds – some are small, some are branches of foreign banks, some have in the past even failed. It can be difficult to open an account for a corporation incorporated under a system of law with which the bank is not familiar.
An agreement – the “Due Diligence Agreement” – Between the central bank and the banks, imposes on the banks the duty to ascertain the beneficial owners of shares in an offshore company.
Switzerland is a place for more conventional banking operations – managing funds for non-residents and dealing in foreign exchange, but little giving of credit to non-residents – unless secured by guarantee from a foreign bank.
A Swiss bank will not generally hold for clients shares in an offshore company, or foreign real estate. A bank will not usually allow the client to choose his own broker, or specify a foreign correspondent. A bank will not want to engage in any operation, however, risk-free, which has no business substance.
To effect an international transfer, it is desirable to ensure that the transferor and transferee are correspondents. If one starts with a branch, one adds an additional step to the transaction. A transfer consists of a large number of steps, each of which have to be checked: all this takes time. The most efficient method of transfer is to have the accounts of both parties at the same bank.
Opening a letter of credit on a back-to-back basis can present problems. One may use a transferable letter of credit – it is cheaper, faster and safer, but reveals the identity of the original issuing bank. Banks will generally refuse to split letters of credit – eg to take the commission element out of a transaction.
The effectiveness of bank secrecy cannot be judged by the length of the jail sentence. The only provision in Swiss law relating to bank secrecy is article 47. A Swiss court has power in civil proceedings to order bank books to be opened up. The Swiss federal and cantonal authorities have very limited powers to obtain information about taxpayers and therefore have little information capable of being exchanged under a tax treaty. In the case of a tax fraud, the powers of obtaining information are much more extensive; but in Switzerland, a tax fraud requires some actual falsification – as opposed to mere neglect to report income. Germany has made some very blatant attempts to gain access to information from the Swiss tax authorities, on the basis that a criminal fraud had been committed.
A captive insurance company owned by a group, used to insure risks of companies in the group. The name is new, the practice well-established. They are generally used to insure more cheaply than the market, or to insure uninsurable risks. They may also convert contingent reserves into tax-deductible premiums. Further, they serve to encourage a more competitive attitude from the regular market. Captives have important cash flow advantages, as well as tax-deferral and foreign exchange advantages.
An insurance company maintains a separate “fund” for each class of business and for each underwriting year: premiums are paid into it and claims met out of it. At the end of the underwriting year, unearned premiums and unpaid claims are taken as reserves: previous year’s reserves are brought forward. Underwriting income is taxed in arrear, investment income on a current year basis.
In some countries – notably in the Netherlands – self insurance “reserves” are allowed as a deduction. Outside such countries the use of a captive converts the reserve into a premium. By locating the captive offshore, the net profit may remain substantially tax free.
The US tax a captive’s income under Subpart F, except the underwriting profit on non-US risks. Ruling 77-316 sets out IRS practice in disallowing deduction of premiums – on the grounds that there is no shifting of risk. Ruling 78-339 provides that premiums may be allowed when paid to a mutual insurer where not more than 5% is owned by one participant. The IRS approach is likely to be followed by other tax authorities.
A captive must have enough premium, a spread of risk, a good loss experience, and good loss control. The object of reinsurance is to shed excess risk: there are several types of reinsurance – facultative, quota share, surplus (excess line), excess loss and stop loss. In a feasibility study, one must look at the premiums, the spread of risk, the loss experience, the loss control, reinsurance, location (domestic or offshore) and management (internal or outside) – administration, underwriting, accounting, taxation, documentation and legal claims.
Essentially, a captive involves taking a risk. If the risk is good, a captive should offer cheaper insurance – even a modest operation should show a 25% saving.
An individual taking up residence in a new country requires to establish outside that country a structure to hold his assets so that he is free to leave it again is he wishes. He may for example establish a discretionary trust in Liechtenstein for the benefit of a large and fluctuating class; the trust fund may be invested in North America and elsewhere; the individual goes to live in Great Britain. The haven – Liechtenstein in this example – should have little tax, no exchange control, competent professional, and good communications; it should recognise trusts and have an economic interest in maintaining arrangements of this kind.
The only safeguard against confiscation or similar acts in the countries of investment, is to spread investment among a number of countries. The country of residence could confiscate the individual’s own assets, but cannot act against the trust property.
The trust should contain a provision requiring the trustee to give notice to the original owner before taking certain steps – eg distribution of trust property, in default of which the trustee shall be personally liable to make good any loss to the trust fund. The original owner should have power to remove trustees (without the necessity of communicating with the trustee) and the right to appoint a new trustee (perhaps not extending to a right to appointing a trustee resident where the appointor is resident). The trust should also contain a power to transfer the trust fund to another settlement.
To avoid problems in the haven, one may choose an alternative trustee in another jurisdiction, eg Bermuda, and create a similar trust there; the Liechtenstein trustee empowers the original owner to transfer specific trust assets to the new trustee. If it became desirable to do so, the original owner appoints the Bermudian trustee of the Liechtenstein settlement and exercises the power of attorney to transfer the trust assets to him; the Bermudian then exercises the power to transfer the trust property to the Bermudian settlement.
In many countries, concessions are given to expatriates employed by foreign businesses; after-tax income of the executive may be maximised by also taking advantage of concessions and reliefs available in his base country. The US is a special case: US citizens are taxed on their world income, but are entitled to reliefs relating to cost and hardship of country of work and to credit for foreign tax payable.
The UK affords deductions for salaries paid for working abroad – 100% for a 365-day period, 25% for a 30-day period. French nationals working overseas are, under law 76-1234, exempt from tax where foreign tax rate is at least two-thirds of the French rate or where certain construction, extraction or export activities are concerned. The Dutch expatriate’s foreign source income is exempt in Holland if it is subject to foreign tax (at whatever rate). He may therefore have a contract with a Cyprus company – the Cypriot rate rising to a maximum of 6%.
Australian residents are exempt from tax on foreign earnings so long as they are not exempt in the country from which the income is derived. Belgium’s reliefs extend to foreign executives working in Belgium: 30% of his income is exempt in any case, but 50% if he works less than half the year in Belgium. In Holland, foreigners are deemed non-resident for 5 years and entitled to a deduction of 35% of their income.
In the UK, non-domiciled executives of foreign businesses are charged on 50% of their income (75% after 9 years) from duties performed in the UK. A salary for duties performed abroad is taxable only if remitted to the UK.
It will often be advantageous to separate the executive’s overseas duties from his home duties. Deferred remuneration, tax equalisation plans, and “fringe benefit” may form part of the remuneration package. The tax liability of the executives may be an important factor in locating eg a headquarters. The effect of tax treaties requires to be taken into account – eg an individual working for a UK company in various European countries may deliberately become resident in the UK.
The main change in the field of international tax planning since 1974 has been the finalisation of the OECD Model treaty and the increased awareness of the importance of interpreting and using tax treaties accurately. There have been over 100 cases and rulings on the definition of “permanent establishment”. A modification to the U.K./Swiss treaty now prevents avoidance of U.K. tax on North Sea profits. The U.K. external trust, the société simple, the stille Gesellschaft – have all become popular alternatives to mere subsidiaries or branches. There has been much anti-avoidance legislation and, more particularly, extensive discussions on increased exchange of information under tax treaties. Four attempts by U.S. corporations to avoid having a “controlled foreign corporation” for Subpart F of the IRC have been unsuccessful in the court, though one has been successful. Canada has enacted the FAPI legislation. Dividends from some countries may however be tax-free: these include U.K., Ireland, Cyprus, Barbados, St.Vincent. Japan has enacted the equivalent of Subpart F. Australia has an exchange control screening process to counter tax avoidance.
In the field of intercompany pricing double taxation of “overlapping” profits has become more common: the new OECD Model does not eliminate this problem. The difficulty of establishing a method of intercompany pricing is illustrated by the “safe haven” interest rate of 6-8% under s.482 IRC in the U.S. – apparently regardless of the currency of the loan. In the Dupont case, the U.S. government witnesses compared the profits of the Swiss company with like enterprises.
Export incentives tend to increase – a feature of the growth of protectionism. In financing, stepping stone transactions and “treaty shopping” have become more common. The intermediary’s tax credit for foreign tax withheld on interest may shelter the whole of its “turn” – and, in some cases, other income as well.
Extracting profits in the form of service fees has become more difficult: on the contrary, the difficulty now is to obtain an adequate deduction for proper headquarters expenses.
There has been a spectacular growth of leasing, especially in the U.K. – with its system of first-year allowances.
Captive insurance has proved most attractive, but is not without its disadvantages. A plethora of material appeared in the U.S. on captives: the IRS retaliated with rulings in 1977 and 1978 – a U.S. parent may be able to deduct premiums paid to a captive where the captive writes only group risks. However, ruling 78/338 permits deduction of a premium paid to an “industry captive”.
Holding companies in the U.K. became unattractive with the introduction of ACT. Some companies have re-organised themselves; others declare only stock dividends. Some declare tax-free cash dividends out of a share premium account.
An acquisition of a U.K. company by offering convertible shares may avoid both capital gains tax and the “dollar premium”.
Joint ventures and merges have become more sophisticated – see the Rothmans merger.
Changes in Ireland and Puerto Rico affect investment incentives. France has become an attractive headquarters location: others are Monaco, Jordan and the Philippines. It may be dangerous for a house in France to be owned by a foreign company. Shipping is in the doldrums – several tax havens are nevertheless keen to establish shipping registers. Offshore funds are still suffering the aftermath of the Cornfeld/Vesco era. Currency changes are giving rise to problems – notably in the U.K., where currency losses may not necessarily be matched to currency gains. People have become more aware of political risk: Netherlands Antilles, New Hebrides and Nauru have changed their laws with a view to further enabling people to forestall political problems.
In the field of executive compensation, the effect of treaties must be studied closely. Ireland offers attractions to individual residents; commodity straddles may be utilised to reduce income or capital gains. There have been few changes in capital markets.
Switzerland continues to display xenophobic tendencies. The growth of the B.V.I., Cyprus and St Vincent, the increasing difficulty in forming U.K. non-resident companies and reforms in Liechtenstein, have been features of recent years.
US real estate has become a popular investment of foreigners. A treasury report was published on May 7th; the report indicates how non-resident aliens invest in US real estate with minimal tax exposure – eg via the Netherlands Antilles or British Virgin Islands. The advantages of a treaty country are (i) that the election under the relevant tax treaty to be taxed on a net income basis may be made annually, and it is not made for the year of sale (ii) there is an exemption from the “second withholding tax”. Under the domestic law, and under the newer treaties – following the US model treaty, the election once made cannot be freely withdrawn.
The “net income” basis generally results in no tax, because of generous depreciation. The Treasury report identifies five ways in which US tax is avoided by investors in US real estate. (1) An instalment sale is made – a small instalment being received when the investor is engaged in trade or business in the US, the remainder being received in a year when the investor is no longer so engaged. (2) An exchange of domestic property for foreign property of a like kind is tax free. (3) A foreign company may be liquidated into the hands of the individual shareholder: the tax is escaped both at the corporate and shareholder level. (4) The shareholder may sell shares in the foreign company which owns the US real estate: it may be difficult to find a purchaser, though a purchaser has the advantage of being able to take a higher base cost for the property. (5) The investor may take advantage of a tax treaty annual net election.
A Bill has been introduced in the US Senate to subject farm land and “rural” land to tax on capital gains in the hands of non-resident aliens; the tax is to be collected by withholding: the Bill is expressed to affect transactions from 28 February 1978.
An intermediary – sometimes called a “stepping stone” – is a company which is able to receive from a high-tax country interest and royalties gross under a tax treaty and to pay out a corresponding royalty to a zero-tax country gross by virtue of its domestic law. The stepping stone may be a subsidiary or associate of the paying company but in general an independent stepping stone is to be preferred. The Netherlands and Luxembourg are commonly used: a stepping stone operation via Canada or the U.K. would have advantages of a “cosmetic” nature.
The Netherlands may be used for interest and royalties, Luxembourg for interest on short-term borrowing but not royalties, the United Kingdom for interest and some royalties (but not U.K. patent royalties or U.K. copyright royalties except for video and film) and Canada and Denmark for copyright royalties. An onward payment of royalties is not always required: the Stepping Stone company may be able to erode its taxable income by writing down the cost of the rights giving rise to the royalty.
Exchange Control legislation requires to be examined in very much the same way one approaches a taxing statute: if route X is impossible, can the same economic objective be reached by route Y?. A person may be forbidden to subscribe money for shares in a foreign company, but may nevertheless receive the shares as a gift or take a similar benefit under a trust. Exchange control legislation will generally forbid transfers of money but permit transfers of intellectual property.
The trust has proved to be a most useful instrument in exchange control planning – especially the “thin trust” – the trust which, while retaining the form of a settlement, has the economic effect of beneficial ownership.
Close study of the legislation and of the various consents is fundamental to exchange control planning – see for example the narrow concept of “control” in s.30 of the UK Act, but the wide consents requisite to allow the London art market to exist or to permit UK – based business to operate abroad.
Rulings are an important aspect of all tax planning. In the Netherlands, the authorities are in general willing to give a ruling. It is an information document written by the taxpayer, which is returned – after a few days or a few weeks – approved by the tax inspector. It will not be binding if the law is changed, or if there is a contrary court decision, or if the facts prove to be inaccurate.
Finance rulings, royalty rules and holding rulings are familiar examples: a finance ruling will generally provide for a “turn” of one quarter of one per cent, but for intercompany positions, the turn is 1/8 and according to a scale the turn may be as low as 1/32 or even less per cent. The ruling will also provide for currency gains and losses to be ignored – a treatment which is actually contrary to the law. Rulings may also deal with profit allocations between activities in Holland and abroad.
Most rulings are issued by the tax inspector. They are generally for 4 years in the first instance. A ruling has no legal basis: a court should override a ruling which is not in conformity to the law. But is it the practice of the tax authorities to abide by rulings – especially if they are clear and unambiguous, and if they ever fail to do so, an aggrieved taxpayer may obtain redress from the Ministry of Finance.
Holland has, like other countries, regulations – issued by the Ministry of Finance. The decided cases have held that the principle of proper government has an important role in affording protection to the taxpayer. One of these principles in the doctrine of the “inspired trust” – the tax administration must meet the expectations which it has inspired. A ruling is not a regulation, and it would be interesting to know whether the taxpayer is protected by a ruling in the same way as he is by a regulation; but a case has never come to court – which indicates the degree to which the parties involved feel bound by the terms of the ruling.
What is said about Holland applies mutatis mutandis to the Netherlands Antilles.
Switzerland still has a role to play in international tax planning – quite outside the familiar fields of holding companies and domiciliary companies.
The primary authority for direct taxation is the Canton, but the Federal government imposes the defence tax and anticipatory tax. The Cantonal and Federal authorities are most approachable – the Cantonal authorities even advertising the tax advantages of their particular Canton.
In certain Cantons, new residents can be taxed on a “lump sum” tax basis – arrived at either by reference to expenditure or by reference to rent or rental value. However, income from Swiss sources or foreign income relieved from tax under a treaty, also requires to be taken into account. This treatment applies for Federal tax too.
An intending resident (who must be over 60) must be sponsored by the Commune and the Canton – and they will tend to sponsor those whose tax yield will be significant.
The Canton of Geneva may give a ruling for a foreign-owned company to be taxed at 9% in the Canton (which results in approximately 18% tax overall) – its base being in Geneva, but its business being carried on mainly abroad.
A “service” company – one which merely renders management or other services to other members of its group – will be taxed on a notional profit of 10% of its general expenses. In Fribourg or Zug there is no Cantonal tax on such profit, but Federal tax is chargeable, as well as Federal tax on distributions (at the treaty rate, if applicable). Such a company may be used to employ personnel: the salaries of the personnel (if non-residents of Switzerland) suffer no Swiss tax or Swiss social security deductions.
All tax planning is concerned with the saving of resources.
A person’s domicil is the country which he regards as his permanent home. In the U.K., a foreign domicil has several tax advantages; an individual with business or other interests in the U.K. may therefore be careful to acquire or keep a non-U.K. domicil. A person with a permanent home in France may well be a resident of France under the Treaty; he may then acquire a French “domicil” for U.K. purposes. After 3 years, a former U.K. domiciled person may be free of U.K. capital transfer tax; without waiting for the expiry of the 3-year period, he will enjoy the “remittance basis” for non-U.K. income and capital gains.
A £2,000 a year exemption for U.K. capital transfer tax adds up to a considerable sum over the years: in this field, tax planning cannot begin too early – e.g. in paying premiums on an insurance policy for the benefit of children.
[By 1998 capital transfer tax has become inheritance tax but the annual exemption has increased only to £3000]
High taxpayers should consider ways of converting income into capital. Industrial buildings and warehouses purchased give rise to a 54% allowance in the first year and 4% thereafter – the allowance being on the construction cost, interest on any borrowed money being allowable as a deduction for tax. Woodlands may be acquired out of income but sold for capital.
[By 1998 all of this has become less important as the higher rates of income tax and capital gains tax have become more or less equal. Allowances are also not as attractive.)
Much information has been published about the Netherlands Antilles, but not all the basic information is well known. Tax rates are high and tax is effectively administered. But offshore legislation was enacted in 1953. There are tax benefits for specific businesses – insurance, shipping and aviation, new industries and hotels, land development and activities in the duty-free zone. Tax advantages in the holding financing and investment sphere are to be found in Articles 13,14, 14A and 8A of the Profits Tax Ordinance: Article 13 provides for relief for dividends from a “qualifying participation”; Article 14 provides a 2.4-3% tax rate on dividends, interest and royalties, capital gains being tax free, reasonable expenses being deductible, and no withholding tax being chargeable on dividends; Article 14A provides a similar freedom from tax on capital gains; Article 8A permits Antilles companies to pay higher rates (15% on dividends 24-30% on interest and royalties so as to take advantage of treaties – expenses being allowed in arriving at the income to be taxed at this rate. The former U.K. and US treaty no longer apply.
There are also tax benefits for offshore traders: a ruling may cover captive insurance, offshore banking, dealing in U.K. property – the tax rate in these cases is 9.8-8.6%.