There’s nothing like a party to cheer us all up, and our Landmark party did just that for all who attended it.  I really want to thank not only everyone who came along, but also the literally hundreds of emails from clients and colleagues all over the world who couldn’t come but sent warm wishes to us all.  As I said in my speech, It hasn’t been an easy year for any of us, but the strength of relationships is tested when the going gets tough, and these have not proved wanting.   My thanks also go to Sweet & Maxwell, my publishers of International Tax Systems and Planning Techniques, and to Opus Group for their joint sponsorship.

This Issue, our last Newsletter for 2008, reviews the way in which the US intends to formulate its future fiscal policy under Barack Obama, which bears remarkable similarity to the way in which the UK has announced similar ideas in the November Pre-Budget Report.  It seems that discouraging entrepreneurs at a time when they are so badly needed is the misguided link between both regimes and gives further credence to the way in which the UK is seen as the US’ puppet in world affairs.  

In fact, the oldest puppet traces its roots back to the 16th century with the Punch and Judy shows travelling around England; the name Punch was derived from the Italian Pulcinello (subsequently anglicized to Punchinello) who was a manifestation of the Lord of Misrule figure of deep-rooted mythologies. Sounds like Gordon Brown and Alastair Darling combined?  Well read on…

The Lord of Misrule was known in Scotland as the Abbot of Unreason – so we certainly have the Scottish connection.  The Lord of Misrule was generally a peasant or sub-deacon appointed to be in charge of Christmas revelries, which often included drunkenness and wild partying, in the pagan tradition of Saturnalia. While mostly known as a British holiday custom, the appointment of a Lord of Misrule comes from antiquity. In ancient Rome, from the 17th to the 23rd of December, a Lord of Misrule was appointed to overturn the ordinary rules of life, so that in a topsy-turvy fashion, masters served their slaves, and the offices of state were held by slaves.

Unfortunately, our Lords of Misrule are unlikely to preside over any revelries this year, and also unfortunately, their term of office is going to extend beyond the 23rd December.  And their topsy-turvy ideas of discouraging entrepreneurialism by soaking the rich are so out-dated, and precisely what will foster the recession that everyone fears.  

By comparison, our country review each month takes us to the Middle East in this Issue, where we highlight the changes in the Israeli tax system designed to encourage immigration and provide tax incentives for a ten year period for those taking up Israeli tax residence. I can see the headlines – “Israel welcomes those pushed out by Obama and Brown”.

So now we are coming up to the end of a year which has been for many their annus horribilis, as Her Majesty The Queen coined the term in 1992, when she said:

“1992 is not a year on which I shall look back with undiluted pleasure. In the words of one of my more sympathetic correspondents, it has turned out to be an ‘Annus Horribilis’. I suspect that I am not alone in thinking it so. Indeed, I suspect that there are very few people or institutions unaffected by these last months of worldwide turmoil and uncertainty”.

Fortunately, we are not aware of major catastrophes amongst the IFS client base, although I am sure we have all suffered losses on the values of our savings and investments.  In any event, I would like to take this opportunity of thanking our clients and colleagues for their support this year, to pledge our support to them in the coming year, and to wish everyone a happy and relaxing Christmas and a successful and above all healthy New Year.

Roy Saunders

Tax Policy of the Obama Administration

“If you were more liberal in your card playing and more conservative in your politics, we’d get along much better.”  This comment by one of President-Elect Barack Obama’s former sparring partners within the Senate sums up some popular sentiment; beyond ”change”, do the fiscal cards Mr Obama  hold contain a joker in the form of a radical fiscal agenda?

The headline policy consists of the intention to reverse the Bush tax cuts of 2001 and 2003 on the top two rates of income tax, replacing the present rates of 33% and 35% with new rates of 36% and 39.6%.  Complementing this is a commitment to restore the phase-out of personal exemption (the PEP provision) for high-income taxpayers, together with enforcing stricter limitations for certain itemised deductions.  Finally, Mr Obama proposes to introduce a new Social Security payroll tax of between 2 – 4% on wages in excess of $250,000. This has the hallmark of a “headline grabber” as most people reporting adjusted gross income (AGI) in excess of $250,000 per year receive the bulk of their income in forms other than wages or salary.  The IRS further estimates that little more than $1 billion is earned in wages by persons with annual gross income exceeding $250,000; as such, the proposed additional levy of between 2 – 4% might be at least partially considered as a political exercise in smoke-and-mirrors.  

These new proposals bear striking similarity to those of the UK government.  In the UK’s 2008 Pre-Budget Report, major tax rises were proposed for high earners (to take effect from April 2011).  These measures include a new 45% tax rate and the removal of the personal allowance for individuals with an annual income of more than £150,000. In addition, the tax free personal allowance is to be halved for individuals earning between £100,000 and £140,000.   Again, it is not anticipated that such proposals will raise any significant revenues for the Treasury, but they mark a definite move, alongside the US, to target the highest earners, many of whom may feel inclined to move themselves and their wealth to more tax-friendly jurisdictions.

The US has, however, pledged to provide some measures of tax relief for entrepreneurs (notwithstanding the protests of “Joe the Plumber” during the election campaign). Mr Obama has said that he will eliminate capital gains tax for start-ups and small enterprises, although the definition of what will constitute one of these entities remains vague.  Other significant policy proposals affecting entrepreneurs include a refundable credit of $3,000 for firms that hire additional US citizen workers during 2009 and 2010.  Note that this echoes a similar scheme previously enacted with limited success by the Carter Administration in 1977.  Domestic US based entrepreneurs  should also benefit from an additional “Making Work Pay Credit” of up to $500, which, though available to all workers, will particularly help alleviate the current ‘double-tax’  suffered by self-employed small business owners who are required to pay both the employee and employer side of payroll taxes.  A small business health tax credit, providing a refundable credit of up to 50% of employer contributions made on behalf of their employees is also in the policy pipeline.

Partners and owners of flow-through businesses – sole proprietorships, partnerships and S. corps – will see their tax burden rise.  As these sources of business income are not subject to corporation tax, but instead ‘flow-through’ to the owner’s individual income tax return, so they will become subject to the proposed new top graduated rates of 36% and 39.6%.  In addition, Mr Obama’s tax agenda advocates the closure of the current loophole surrounding publicly traded partnerships (PTPs) that are presently exempt from corporation status by virtue of generating in excess of 90% of their income from passive sources.  Reclassification of these entities as C. corps raises the spectre of double-taxation, as income is taxed both at the entity level and subsequently at the individual level after distribution.  

Long Term Capital Gains and Qualified Dividend tax rates are also set to rise.  These are likely to rise from 15% to 20% for those earning in excess of $200,000 from 2011.  Similarly, the top rate on qualified dividend income is set to lose its current special status, and become taxable at marginal rates.  There are also proposals to change the tax treatment of “carried interests” received by private equity fund managers to ordinary income as opposed to capital gains.  Although this policy shift is likely to cause problems for fund managers, the net gain to the US Treasury is likely to be small in terms of the economy at large.

Mr Obama has in the recent past shown support for specific legislation targeting perceived abuses using non-US “offshore” tax havens and entities.  The evocatively named “Stop Tax Havens Abuse Act” sponsored by Mr Obama with Senators Levin and Coleman perhaps gives some insight into the current thinking of the President Elect.  Here, the proposed legislation introduces a rebuttable presumption that a US person who transfers property to a foreign entity incorporated or operating in one of 34 listed countries (including Switzerland, a fellow OECD member and full Treaty Partner) controls that foreign entity and would therefore be taxable on all income associated with the transfer.  It would also require that the IRS be informed of any financial account opened by a US financial institution on behalf of a US person in any one of the 34 countries.  How much of this will be given political impetus by the recent UBS undisclosed accounts case as well as the Lichtenstein LTG Bank case remains to be seen, but based on prior performance, there is every likelihood of tightening up of the reporting regulations and of enforcement activity by the IRS under the new administration.

Mr Obama will have a lot of work to do to convince both Houses of Congress, and the election has produced increased Democratic majorities in both Houses, albeit without the 60 seats required for a “filibuster proof” majority in the Senate. The new administration will inherit a budget deficit of approximately $450 billion, together with the potential exposure to additional financial liabilities under the provisions of the EESA.  This will no doubt limit his ability to borrow so heavily compared to the practices of the outgoing Administration.  

Time will tell if, in the words of Mr Obama, this is “change we need”.

Summary of the Obama major tax policy proposals:

– Increase the top two rates of income tax to 36% and 39.6%.

– New Social security payroll tax between 2 – 4% on wages over $250,000.

– Refundable $3,000 credit for firms hiring additional workers in 2009/10.

– “Making work pay” and small business health tax refundable credits.

– Increase long-term capital-gains rate to 20%.

– Qualified dividends to become taxable at marginal rates.

– Treatment of publicly-traded partnerships (PTPs) as C.corps.

– Tax “carried interest” as ordinary income rather than as capital gains.

IFS would like to thank Paul Hocking of Frank Hirth for the above article.  Should you require any further information, please go to www.frankhirth.com.

Israel: Increased Tax Benefits for new Immigrants and Returning Residents

On 9 September 2008, the Israeli Parliament (the “Knesset”) adopted an important amendment of the Income Tax Ordinance (“the Amendment”) regarding the taxation of New Residents and Returning Residents. The Amendment will be in force upon publication in the Official Gazette (“Rashumot”), and includes the following benefits:

– New Residents will enjoy tax and reporting exemptions on every type of income, both ordinary and capital gains, which is not sourced in Israel, for a period of 10 years.

– In their first year as residents, New Residents will be entitled to a tax-free “adaption year”.

– A non-resident company, which is controlled by a New Resident, will not be deemed resident even if its business is managed and controlled by the New Resident from Israel, and consequently any income derived from such company by the New Resident, during his first 10 years of residence in Israel, will be tax exempt.

– Returning Residents, who have lived out of Israel for over 10 years, will be entitled to the same benefits as New Residents above. Transitionally, Returning Residents who have returned to Israel after January 2007 or will return until 31 December 2009 will be eligible for the same benefits even if they were non-residents for only 5 years prior to their return.

– Returning Residents who returned before 1 Janaury 2007, after having been non-residents for at least 3 years, will continue to enjoy the current 5-year exemption from certain passive income and the current 10-year exemption from capital gains. Returning Residents who will return from 1 January 2010 onwards, after having been non-residents for at least 6 years, but less than 10, will be eligible for the same benefits as those who returned before 1 January 2007.

Finally, in order to avoid the inherent uncertainty in the definition of “non-resident” (foreign resident), the definition has been eased so that any Israeli resident who has resided abroad for 4 consecutive years, will be deemed non-resident from the first day that he resided abroad, even if he is able to satisfy the test of having shifted the centre of his life abroad only for the third and fourth year.

IFS would like to thank George Rosenberg and Inbal Faibish of Rosenberg, Keren-Polak & Co., Advocates for the above article. Should you require any futher information, please go to www.rosok-law.com.

The post Issue 87 – 9 December 2008 appeared first on IFS Consultants Ltd.

Having been in the US for the past couple of weeks, I witnessed at first hand Barack Obama’s impressive acceptance speech, and what a momentous occasion the November 2008 election has been right across America, and probably well beyond its shores.  I remember where I was when the news of the 6th February 1958 Munich air disaster was announced in the school playground, on Friday, 22nd November 1963 when Kennedy was assassinated, and on 21st July 1969 when I saw Neil Armstrong as the first man to ever walk on the moon saying “One giant leap for mankind”.  Last Tuesday, 4th November 2008 could be a similarly momentous occasion at a time when a giant leap for mankind is truly necessary.

Taxation was a major issue in the Presidential election, but it was not clear exactly what Joe the Plumber had to say about it!  In any event, US fiscal policy must be used wisely to re-generate the economy so that excessive tax burdens on business are unlikely in the current climate.  In fact, Obama has vowed to abolish capital gains tax for small entrepreneurial businesses, and that Joe the Plumber would be better off from an income tax viewpoint.  

Commentators have said that a recession is one way of regulating excesses in the economy, and we have certainly seen unacceptable excesses in corporate America and corporate UK, as well as many other western economies.  The aboriginals in Australia burn down large swathes of forest in order to generate new growth, and call it “creative destruction”.  Maybe the recession will provide the basis on which new economic growth can be achieved, and we all hope that Obama can lead America and the world through the current problems.

I feel slightly embarrassed to report that we at IFS are extremely busy.  Some of our work is in fact creative deconstruction and creative reconstruction for some of our entrepreneurial clients who are adapting to the current climate.  Many of our clients are still extremely active in the emerging markets of Eastern Europe, China, India and Africa, and this has been keeping IFS busy in recent months.  

Finally, I hope that by now you have received our invitation for the IFS Landmark Reception on 4th December 2008 to be held at the Landmark Hotel on Marylebone Road, London NW1.  Our Landmark Reception is going to celebrate the 25th year of the publication of “International Tax Systems and Planning Techniques” which is now on its 55th release, published by Sweet & Maxwell who are kindly part sponsoring the reception.  Having recently moved offices to Regent’s Park, and creatively reconstructed IFS to adapt to the current economic climate, I also feel that this is a landmark worth celebrating.  And after four years of developing the Opus group of companies, and since IFS is helping Opus to launch its deferred compensation message, Opus is the other sponsor for this landmark reception.  In case you have not received an invitation and would like to join me and the rest of the team on Thursday, 4th December, please click here.

Roy Saunders

Deferred Compensation

Since the directors of the Opus Group will join IFS in our Landmark celebration party and paying part of the cost!, I have agreed to write an article on deferred compensation arrangements, this being the core business model of Opus.

In very simple terms, if you are employed in the US, there is a maximum amount that you can put aside into a pension scheme which is tax deductible, and deferred compensation arrangements are being continously legislated against, even within the last month. In the UK, the maximum tax deductible amount is quite generous, although there is a lifetime cap of £1.65 mn for 2008. By contrast in Germany, the maximum annual payment which is deductible against taxable income is just €20,000!  In Italy it is even less! Thus although every country recognises the need to plan for retirement, the amounts which may be set aside annually as genuine deferred compensation out of otherwise taxable employment income are limited.

These limits of annual deferred compensation amounts may be adequate for those who are in continued employment throughout their lives. But what about those who have relatively short-term income potential where the annual amounts allowed are of limited consequence over such a short term? Individuals who come readily to mind are sports personalities who may enjoy their sporting career over, say, a 5 to 10 year period, entertainers who may earn large amounts of income but only during a relatively brief term of their popularity, and perhaps expatriate executives who are asked to work abroad for a few years only on behalf of their international employer and are offered an extremely attractive package to do so. Why cannot they be allowed to defer compensation on which they pay tax until they eventually receive this income, by utilising pension and other arrangements to receive a major part of their short-term income?

The Opus Group is established in both Switzerland and Cyprus to create deferred compensation arrangements which have no limit. By employing the individuals through Opus and providing their services to third parties, gross income is received by Opus and can, without limitation, be paid into deferred compensation arrangements.

The Opus Group make it very clear that these arrangements are only valid if individuals do not require the income immediately. It does not believe in ‘rinky dinky’ structures whereby the deferred compensation entities ‘lend’ money back to the relevant individuals in the hope that this is not treated as earned income. Having never promoted tax schemes, I have always advised Opus of the concept of ‘constructive receipt of income’. This is where ultimately the same employment income is received in another manner as described above, yet the pound, euro or dollar notes are just the same!

Werner Berger is Non-Executive Chairman of the Opus Group of Companies who is based in Zurich, and he will be present with his co-director Marina Pittalis at the Landmark Hotel at 6.30pm on Thursday 4th December. Werner and Marina would be more than happy to discuss Opus with any reader who would like to attend the IFS landmark celebration.

Insurance Wrappers

Single premium offshore bonds are well understood and commonly used to good effect as investment wrappers within clients’ wealth planning structures – however, the investments to which the value of the bonds are linked tends to be restricted to collective investment schemes.

Recently, there has been increasing interest in the use of insurance bonds whose value can be linked to other assets such as private company shares.  In the UK, such bonds are known as ‘Personal’ Portfolio Bonds (PPBs) or highly personalised bonds.

One reason for this is that, as a general principle, Governments encourage life insurance and therefore such arrangements are often afforded beneficial tax treatment.

Additionally insurance arrangements are accepted and understood world-wide as a truly commercial arm’s length transaction, whether the premium is paid in a single instalment or over a period of time.

Such arrangements are worth consideration when planning structures for entrepreneurial clients with private company investments.

To date, the use of highly personalized bonds in most countries has been fairly limited. This is because historically there has been difficulty in finding an insurance carrier prepared to take personalized assets onto its balance sheet at a reasonable cost. Most insurance carriers are understandably very fond of their traditional asset based fee arrangement, and unquoted assets are difficult to value.

This is now changing.  There is a growing selection of insurance carriers participating in this market place – and cost effectively. We are aware of half a dozen insurance providers who will write highly personalized bonds.

The UK is one jurisdiction where the use of highly personalized bonds is very popular. Because of their commercial nature, UK authorities have only attacked highly personalised bonds from a tax perspective with a rather ineffectual notional tax based on premiums, even through the bulk of the funds required could be contributed by way of loans.

Other than notional annual tax on the premium, the taxation of a highly personalized bond in the UK is similar to that of any other offshore bond. Which means that, all UK tax on income and gains on assets connected with the bond may be deferred indefinitely and any withdrawal or surrender is treated as income for UK tax purposes. This allows a UK resident bond holder to sell and switch any investments owned within the bond (which could consist of investment assets as diverse as land or private company shares), without triggering any immediate liability to UK tax.

Unwinding the bonds whilst UK resident will attract a potential 40% tax charge upon surrender in the hands of UK residents, however, this can be mitigated entirely if the bond is surrendered while the bond holder enjoys a full tax year sabbatical in a suitable territory.  Alternatively the bond could be owned via an offshore company, the shares of which could be disposed of for cash thus resulting in an 18% capital gains tax charge.

The benefits of highly personalized bond structures are worth investigating for clients from a number of other countries. Certainly, we have seen bonds used in structures for clients from Hong Kong, Ireland, Estonia, Italy and South Africa as well as the UK although, of course, the tax treatment of the bonds differs in each territory.

Overall, the potential applications of highly personalized bonds for both UK and overseas residents would seem to be expanding.

IFS would like to thank Martin Katz of Middleton Katz Chartered Secretaries LLC for the above artcile.  Should you require any further information, please go to www.middletonkatz.com.

The Austrian Holding Company

Austria is famous for its Austrian Holding Company Regime and the far reaching tax benefits of such a holding company.  What are the key features of this Austrian Holding Regime?

Domestic Holding

Intercompany dividends are tax exempt whereas capital gains resulting from the sale of shares in an Austrian corporation are taxable at the standard flat corporate tax of 25%. Financing costs effectively connected with the acquisition of the shares held are fully tax deductible.

Foreign Holding

Provided that the Austrian company holds at least 10% of the shares of a foreign corporate entity, comparable to an Austrian GmbH, for at least one year, any dividends received by the Austrian company and any capital gains resulting from the sale of the shares of the foreign corporation are tax exempt in Austria, regardless of whether Austria has a treaty with that foreign country or not.

Austrian law does not know any CFC-legislation or thin capitalization rules or debt equity ratios. Interest is fully tax deductible and can compensate any other income which is achieved by the Austrian corporation; moreover there is no withholding tax levied upon interest paid to foreign lenders.

Passive Interests

If the Austrian corporation holds shares in a foreign entity which receives passive income, the sale of such a participation and the dividends distributed to the Austrian company will be taxable with a foreign tax credit granted.  However, in the absence of CFC legislation, the mere holding of shares in such corporations does not trigger any taxes in Austria.

The Austrian tax authorities categorize income as passive, and therefore taxable when distributed, if the following income is achieved by the foreign subsidiary and, at the same time, the overall tax burden of this subsidiary is not more than 15%:-

 – interest income

 – royalty income

 – capital gains achieved by selling shareholdings of less than 10% in other corporations

However, foreign rental income is considered to be active income, so that the participation exemption will be available as above in such situations.

Foreign Losses

As foreseen in the New Group Taxation Regime, losses suffered by foreign subsidiaries can be set off from the domestic tax base of the Austrian company, provided that the Austrian company holds more than 50% of the shares of the foreign subsidiaries.

Although losses from the foreign subsidiary can be set off from the tax base of the Austrian parent company, dividends paid by such a foreign entity are still tax exempt. Also; indirect participations via partnerships lead to tax exempt income for the Austrian Holding Company.

Taking into consideration that Austria has a far reaching treaty network (more than 80 treaties) including countries like Barbados, Belize, Cyprus, Estonia, Liechtenstein, Luxembourg, Malta, San Marino, Switzerland, Singapore and the UAE just to name a few of those, which also have very interesting tax regimes, it is of course a fact that these very interesting tax treaties open great tax planning opportunities coupled with the Austrian holding company regime.

Together with a generally friendly tax climate and the willingness of the Austrian tax administration to give written rulings, the Austrian Holding Company serves as an  excellent tool for tax planning purposes and as a suitable platform for investments into treaty or non-treaty countries.

IFS would like to thank Erich Baier for the above article, should you require any further information on Austrian Holding Companies, please contact Erich by email on baier@austrian-taxes.com.

The post Issue 86 – 13 November 2008 appeared first on IFS Consultants Ltd.

I am bringing you this Newsletter in Roy’s absence.  He is currently away in the States for a couple of weeks and will no doubt be glued to the television watching the final stages of one of the most interesting elections of our times.  

Having just returned from New York myself, I have been fascinated by the battle of personalities on the two sides of the presidential race.  The power of Brand Palin has apparently caused a buying frenzy for her Japanese-designed rimless glasses, and wig companies worldwide are marketing hair pieces which copy her various up-dos.  The face of Barack Obama, on the other hand, has become an iconic image.  Indeed, one online emporium apparently has 1.1 million Obama designs for sale, including everything from T-shirts to baby bibs.  Interestingly, on the same website, the McCain face appears on only 276,000 designs – in the image stakes, therefore, Obama has a significant lead.

In politics, clearly, image is paramount.  We need only look to the UK where Gordon Brown’s natural lack of charisma seems to constantly haunt him, and to France, where the marriage of Sarkozy to the beautiful Carla Bruni has propelled them both to celebrity status and has no doubt helped her music career.  IFS has particular expertise in advising well-known personalities (although no politicians, as yet) on the international tax aspects of the exploitation of their image rights.  In so doing, we have worked on many occasions with our close friend and colleague, Adrian Shipwright, who has penned one of the articles below on this very subject.

The first article below, however, is concerned with a related subject – the taxation of payments in respect of intellectual property.  The taxation of such payments will vary depending upon whether the initial transfer of the intellectual property rights for which the payments are made constitutes a licence or an alienation.  Also, where Adrian has written about some of the taxation aspects of an individual’s brand in his article, I have also discussed in my article the brand of a company, and where this is located for tax purposes.

Our final article has been contributed by our colleague K.C. Li at MITCO.  This features Mauritius and how this country may be used in international structuring for investing into Africa.  

I hope you enjoy reading this Newsletter.  If you would like to send us any comments you may have, please contact us at  info@interfis.com.

Lara Arnold

Taxation of Payments in Respect of Intellectual Property: When can a Foreign Country Subject the Payments to Local Withholding Tax?

As Roy mentioned in our last Newsletter, we attended the OECD 50th Anniversary Special Conference in Paris last month.  One interesting topic that was covered is the revised meaning of “royalties” under OECD Model-based tax treaties.  As intangible property plays an increasingly important role in international commerce, this is a particularly relevant area for today’s international tax planning.  In this article, I will firstly summarise one aspect of the revised meaning of “royalties” and will then discuss a connected issue – the situs of intangible property such as a company’s ‘brand’.

The Commentary to Article 12 now clarifies that payments made in consideration for the transfer of the full ownership of an element of property referred to in the definition of royalties cannot be treated as royalties under Article 12.  Royalties by definition require that payments are made in consideration “for the use of, or the right to use” that property.  If there is a transfer of ownership, the previous owner should not be charging for the continued use of the intangible property, and therefore any payment must be a capital payment taxable either under Article 7 (the business profits article) or Article 13 (the capital gains article). This charge will usually arise in the State of residence (although see Foster’s case below), as compared to when the payment is for the use of the rights, where the income may be taxed not only in the State of residence of the licensor but also in the State of source by way of a withholding tax (as may be reduced or eliminated according to the relevant treaty Article 12 if applicable).

At issue, therefore, is the actual nature of the economic entitlement. The Commentary to Article 12 states that each case will depend on its particular facts and will need to be examined in the light of the local intellectual property laws applicable to the relevant type of property and the local rules as regards what constitutes an alienation (not a particularly helpful comment). The form of documentation of the transaction is unlikely to prevent a licence being deemed an alienation, and vice versa.  Generally accepted principles of international law will also be relevant in determining the true nature of the transaction – for example, the ‘Ramsay Principle’, which states that where a transaction has pre-arranged artificial steps which serve no commercial purpose other than to save tax, the proper approach is to tax the effect of the transaction as a whole.

To provide some clarity, the Commentary introduces the concept of “distinct and specific property” and states that if the payment is in consideration for the alienation of property that meets this description (which is more likely in the case of geographically-limited than time-limited rights), such payments are likely to be business profits within Article 7 or capital gains within Article 13 rather than royalties under Article 12.  For example, the sale of software by way of CDs which give the purchaser the full rights to use the CD, being a distinct and specific property, without the requirement to pay the vendor for the regular use of the software contained in the CD, is business income to the vendor as opposed to a royalty receipt.  However, if the vendor were to sell the rights to the software contained in the CDs to an entity which then paid the vendor according to how many CDs it manufactured and sold containing such software, the payment would be considered a royalty which could be subject to local withholding tax in the State of source (where the manufacture and sale is taking place).

Where a transaction involving intangible property gives rise to a capital gains tax charge, the situs of such property will be in point to determine which country has the taxing rights – the State of residence or the State of source.  As intangible property cannot be geographically pinpointed in any one jurisdiction (being intangible), the situs is normally where the owner of the rights is resident, but this is currently a hot topic in the world of international taxation and was recently examined in the Foster’s case.

The facts of the case are, briefly, as follows.  Foster’s Australia Ltd (Foster’s Australia) granted an exclusive right to its subsidiary, Foster’s India Ltd (Foster’s India) to brew, package and sell Foster’s beer in India and also to use Foster’s trademarks and intellectual property in India.  Subsequently, Foster’s Australia and SABMiller executed a sale and purchase agreement whereby all proprietary rights and interest in Foster’s trade marks, brand and brewing intellectual property were transferred to SABMiller in India.  

Foster’s approached the Indian Authority for Advance Rulings on its tax liability.  The AAR held, in its ruling of 9 May 2008, that the income arising from the sale to SABMiller was chargeable to capital gains tax in India on the basis that Indian domestic law taxes non-residents on a transfer of a ‘capital asset’ located in India and that the relevant intangibles were located in India because this was the place of their use and development.  Foster’s Australia has appealed the decision.

Our view is that this cannot be correct on the basis of the OECD observations above.  The sale by Foster’s Australia to SABMiller was clearly a capital gain as opposed to a royalty, and the relevant treaty article is Article 13 of the 1991 treaty between Australia and India, which gives the taxing rights of such alienation of rights to the State of residence (Australia for Foster’s Australia) unless the rights form part of the business property of Foster’s Australia in India.  Foster’s India (not considered to be part of the business property of Foster’s Australia but an independent entity) had an exclusive licence to use the trade mark in India for which they would have had to pay Foster’s Australia a royalty subject to Indian withholding tax.  The recipient of that royalty would now be SABMiller, an Indian company which would indeed be taxable on such royalty income.  I think the Indian authorities are trying to reach parts of Foster’s profits which other tax authorities are unable to reach – sorry, wrong beer!

IFS has been asked to advise recently on some interesting projects involving structuring the ownership of intangible property for impending sales or acquisitions, or for long-term asset protection purposes.  If you would like further information on this, please contact us at info@interfis.com.

Tax and the Exploitation of Image and Reputation

“The purest treasure mortal times afford is spotless reputation…”  Richard II Act 1 Scene 1

A person’s reputation and image can have considerable value and are something that others want to use to promote goods and services. This can give rise to difficult tax issues especially as these rights can be exploited internationally and so, of course, for structuring. An international footballer’s reputation and image, for example, can command large payments as can a celebrity’s notoriety in endorsing a product or service. Various magazines often pay considerable sums for the right to cover a wedding or other event such as a party. Photographs taken by paparazzi also sell for large sums. This raises further issues of privacy and the economic depletion of the person’s commercial ability to exploit their notoriety and who can use it. The protection given by legal systems of these rights varies. France, for example, has stronger protection of privacy rights. There is statutory protection of these “Image Rights” to varying extents in countries such as Australia, Germany, Italy and the Netherlands. Guernsey as part of its recent Intellectual Property legislation provides for image rights to be registered in Guernsey when the provisions are brought into force.

The UK does not recognise a generalised Image Right or Right to privacy (see e.g. Douglas v Hello!). The celebrity can sometimes have a remedy by using actions for passing off, malicious falsehood, trademark infringement and breach of confidence (see e.g. Tolly v Fry, the Princess Di photographs case, Irvine v Talksport and Douglas v Hello!) Notwithstanding this, image rights are dealt in every day in the UK and are acquired by employers (e.g. under the Premier League standard conditions).

For UK tax purposes image rights have been recognised as something different from a person’s employment (see Sports Club plc – David Platt and Dennis Bergkampf) and not giving rise to earnings but treated almost as personal goodwill. However, it is still essential to identify in any case exactly what is being exploited and paid for. This can control whether the acquirer can get a deduction (say as an intangible) or has to deduct tax on paying a royalty. A further difficulty is the identification of the location of the rights for tax purposes. Is it the forum for enforcement, the place the celebrity or rights owner is, or something else? This can be vital in the UK for non-domiciliaries and in countries with a territorial basis of taxation.

By tailoring the ownership of rights, for example, by segregating onshore and offshore rights, the return from the image rights can be maximised. The transfer into rights owning vehicles should be done as early as possible to minimise tax on transfer. Proper commercially justifiable valuation is essential. It is also possible to reduce the taxable profits of the rights owner, for example, by making appropriate payments to protect rights if there are infringements. Tax leakage can be minimised by choosing the rights that are exploited. For example, there is no UK withholding tax on the payment of royalties for the use of a trademark.

It is essential to have properly managed and run entities as well as good advice so the planning is not undone by bad documents and records and management. I have much enjoyed being involved in image rights planning with Roy and knowing that matters will be properly implemented. Notoriety as with other intangibles is a valuable new area for people to exploit in times of difficulty and uncertainty. It must be done with proper analysis, clear objectives and proper execution.

IFS would like to thank Adrian Shipwright BCL MA(Oxon) CTA(Fellow) AIIT TEP FRSA for the above article. Adrian is a Barrister (formerly a solicitor) at Pump Court Tax Chambers, Visiting Professor at King’s College, London, Member VPG, STPG, sometime Student in Law, Christ Church, Oxford and  University Lecturer in Law (CUF) Oxford University and Professor of  Business Law and Director Tax Research Unit, King’s College, London. If you have any comments on this article that you would like IFS to relate to Adrian, please contact us at info@interfis.com.

Mauritius: A Gateway to Africa

The 1970s was the decade for international development within the European Union, and the 1980s the decade when the US expanded its domestic market to encompass new markets in Europe and elsewhere.  The 1990s was the decade of the ex-Soviet Union countries opening up their borders, whilst the 2000s has seen China and lately India becoming the new powerhouses of international business. We believe that the 2010s will witness an African economic boom as the last major marketplace which has not yet seen the global development of other Continents, and in Mauritius the nearer-home base which will be used as the stepping stone of structuring acquisitions and new business opportunities in Africa.  

Why? Firstly, Mauritius is the only financial services centre which is a member of all the major African regional organizations, such as the African Union, Southern African Development Community (SADC) and Common Market for Eastern and Southern Africa (COMESA).  In fact, its neighbours consider it simply as an African country rather than a so-called tax haven, and this makes it the preferred, recognised and tax efficient route for investments into Africa.

The membership of Mauritius in the various regional African trading blocs gives access to some 400 million consumers, creating a regional market worth US$ 360 billion. The implementation of the SADC Trade Protocol started in the year 2000 with the gradual elimination of customs duties on 85% of tariff lines by 2008  and with tariffs on the remaining ‘sensitive products’ being eliminated by 2012.  Thus, Mauritius opens doors to huge opportunities for trade, services in all fields and investments and makes it a natural gateway to African countries.  

Double Taxation Agreements (DTAs)

In addition to the preferential trade arrangements and other favourable Protocols on communications, logistics and capital flows within the region, Mauritius currently has 33 DTAs, among which the following are with African states:

•  Botswana
• Senegal
• Lesotho
• Seychelles
• Madagascar
• South Africa
• Mozambique
• Swaziland
• Nambia
• Uganda
• Rwanda
• Zimbabwe

Other DTAs which await ratification include Malawi, Nigeria and Zambia.

Under these treaties, there will be no capital gains tax payable in the African states irrespective of the introduction of any eventual capital gains tax, if the recipient of the gains is a Mauritius company. On the other hand, there is no capital gains tax or exchange controls or withholding tax on outward remittances in Mauritius.

Furthermore, almost all African nations impose some withholding tax on dividend paid to non residents, the rate of such imposition ranging generally between 10% to 20%. All Mauritius tax treaties limit the withholding tax on dividend. The treaty rates are generally 0% or 5% or 10%, thereby creating a potential tax savings of 5% to 20% depending on the treaty partner country.

Investment Promotion and Protection Agreements – IPPAs

Mauritius has signed an IPPA with some 15 African member states.

The main purpose of an IPPA is to protect foreign investments from government interference with property rights in the form of expropriation, nationalization and compulsory purchase without proper compensation. In fact, it aims mainly at:

– Intensifying economic co-operation to the mutual benefit of the two contracting states.

– Creating and maintaining favourable conditions for investments by investors of one contracting state in the territory of the other.

– Promoting and protecting foreign investments of investors of one country against expropriation in the other country.

IPPAs are similar to bilateral tax treaties concluded between sovereign states and provide direct protection to both individuals and corporate entities present in one contracting state and investing in the other state.  With the volatility experienced in Africa in the past, investor protection is absolutely vital and even more important than advantageous double tax treaty arrangements.

Conclusion

Africa in general is offering attractive opportunities to investors and private equity firms looking for good value and potential growth in asset and mining acquisitions. We believe that the Mauritius double tax treaty network combined with the IPPAs and many non-fiscal benefits offer substantial and unique advantages to investors going into Africa.

IFS would like to thank Mr K.C. Li for the above article. Should you require any further information on how to structure your investments into Africa through Mauritius, please contact Mr K.C Li, Chairman, Mauritius International Trust Company Limited on  +230 210 4000 or email him on info@mitco.mu.

The post Issue 85 – 21 October 2008 appeared first on IFS Consultants Ltd.

I am delighted to announce that our move to Regent’s Park was completed with the minimum of disruption – in fact, our server was down from 5pm on the Thursday of our move from Clarges Street until just 11am on the Friday morning, so well done our IT specialists.  In case you find emails to our previous server bouncing back (despite maintaining the same domain name), please note that we are now properly ‘tutoyé’d’ as the French say, so I am now simply roy@interfis.com.  I look forward to welcoming you here in the near future.

During the past 2 weeks, I have been in Paris, Malta and Zurich, so my travelling has not abated.  Lara and I were in Paris for the 50th Anniversary of the first draft of the OECD Model Double Tax Treaty in 1958 (before even MY time as an international tax practitioner!).  Their ‘party’ to celebrate this achievement was in fact a Conference to review the latest treaty developments in the 2008 update, and in particular we discussed treaty shopping and permanent establishments in the current tax climate.  I have summarised these discussions in this Newsletter as our first article below.

Now, talking about parties, an achievement nearer to home which merits a celebration is the 25th Anniversary of the first issue of my book ‘International Tax Systems and Planning Techniques’ published in 1983.  I am proud to say that this 1000 page loose leaf work covering the tax systems of more than 30 countries, now in its 54th release, is still the leading international tax reference book on the market.  My next target is to re-vamp the work to bring its style more up to date, but in the meantime, I am planning a party sponsored by my publisher Sweet & Maxwell on Tuesday, December 2nd at the St Martins Lane Hotel (where we had a launch party 2 years ago for my more recent book ‘Principles of International Tax Planning’).  We will be sending out invitations in due course and hope to see you there.

In addition to my own article, we have two other articles in this Newsletter. The first is our regular country review which this month features Switzerland.  Kay Hofmann of Marcuard Heritage receives our thanks for his excellent article describing the ‘forfait’ lump sum tax system (relevant for our UK non-dom readers who may wish to leave the Brown/Darling fiasco behind them), new guidelines on trusts, and also the new Swiss measures to attract hedge fund managers (ditto re Brown/Darling!).

Our final article has been contributed by Kishore Sakhrani and Elizabeth Thompson of ICS Hong Kong.  Kishore and Elizabeth have been friends for more years than I (or they) would admit to, and they have written a fascinating article about China and its newest export: inflation!; what that means for the rest of the world – and why tax cuts may not be forthcoming.

I hope you enjoy reading this Newsletter.  If you would like to make any comments, or better still contribute an article on your country for future Newsletters, please contact us at info@interfis.com .

Roy Saunders

OECD 50th Anniversary Special Conference

The Conference commemorating the 50th year anniversary of the publication of the first draft of the OECD Model Double Tax Treaty in 1958 started with our good friend Philip Baker reviewing the 10 most significant developments over the last 50 years.  The 5 most popular topics are considered in this article:

• Beneficial Ownership Concept  
• Attribution of Profits to Permanent Establishments
• EU Arbitration Convention
• First US Limitation on Benefits Provision
• OECD Transfer Pricing Guidelines

The jocular banter generated by Philip from a ‘reality show’ voting contest as to which was deemed by the delegates as the most important one was a valiant attempt to demonstrate to everyone why tax is such an exciting topic!

Beneficial Ownership Concept

The ‘Beneficial Ownership’ concept was first introduced in 1977 in order to exclude treaty shopping through specifically nominees and agents.  The term was included under the dividend, interest and royalty articles of the Model Treaty in order to avoid such entities benefiting from reduced withholding taxes provided under these articles.  However, the panel concluded that the inclusion of this term does not prevent treaty shopping through conduit companies. The Commentary refers to economic entitlement to the relevant income as well as control over that income, so that conduit companies involved in treaty shopping would only be excluded if they are acting merely in a fiduciary capacity for third parties.

The panel considered that there needs to be more certainty as to whether treaty shopping through conduit companies may still provide withholding tax benefits, and in this respect lauded the US Limitation on Benefits provision introduced in 1980 which was a fundamental change to the approach of tax administrations to treaty shopping.

Case law in different countries does not give conclusive determination of the term beneficial owner e.g. in Aiken Industries v CIR, the case held that Aiken had no ‘dominion and control’ over interest receipts from the US but merely temporary physical possession of the interest until it was paid out to the real beneficial owner (a non-treaty entity). On the other hand, several cases have concluded that banks are entitled to treaty benefits as the proper recipient of income even though they are acting for its clients.

In summary, it was concluded that conduit companies will be entitled to treaty benefits unless they enjoy very narrow powers over the income and effectively act as a fiduciary or administrator. We at IFS have always recommended that conduit companies, such as intermediate holding companies, have a sufficient degree of substance to refute any claim that they are merely acting in a fiduciary capacity for their shareholders.

The Indofoods v JP Morgan case was discussed in our Newsletter of 10 July 2006 (you can read the full facts by referring to our website www.interfis.com).  In brief, the UK High Court ruled that the term “beneficial owner” means the actual owner of the interest income who truly has the full right to enjoy directly the benefits of that interest income. The Court held that a nominee or a conduit company is not regarded as a beneficial owner of the interest. The decision was not appealed and as such it is part of UK law – the extent to which it has an impact on UK tax law is debatable but it would appear HMRC have taken a keen interest in the case by scrutinizing special purpose finance vehicles, particularly those based in Luxembourg.

The French panellist from the tax administration said that they tend to interpret treaties in the light of the overall objective of the treaty and its purpose.  Thus the title of the Model Treaty is ‘Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion’. Since the OECD Commentary states that the term beneficial owner cannot be narrowly interpreted, he argued that it should therefore be interpreted in the light of the purposes of the treaty. If the recipient (the conduit company in treaty shopping) is included merely to avoid French withholding tax, then it may properly be disregarded as the beneficial owner since the treaty is not in place to encourage fiscal evasion. Two French court cases in 1999 and 2006 even decided to apply the beneficial ownership concept despite the absence of the term itself in the relevant double tax treaties, using the ‘abus de droits’ provision as the reason for denying treaty benefits.

The Prevost Car case in Canada reviewed whether the beneficial owner should have the meaning under domestic law or international fiscal law.  In that case, a Dutch holding company acted as an intermediary between UK and Swedish shareholders and a Canadian operating company, and was admittedly introduced in order to avoid most of the dividend withholding tax in Canada. Although there was a Shareholders’ Agreement regulating the onward dividend flow from the Dutch company, it was held that the company itself was not a party to it and therefore was not bound by an agreement of its shareholders.  Therefore, it was not considered to be acting purely in a fiduciary capacity and it was indeed the beneficial owner of the dividend income and entitled to treaty benefits.

In another Canadian case, the MIL Investmentscase, a Cayman Island company moved its residence to Luxembourg in order to be able to avoid Canadian capital gains tax on the sale of a Canadian company, which would have been levied if the owner were not resident in a tax treaty jurisdiction. There is in fact no beneficial ownership requirement for the capital gains article to apply, but nevertheless it was held that the concept is implied in treaties. In the absence of any substance in Luxembourg, the true residence of the Cayman Island company would have been questioned. In the MIL case however, the Cayman Island company rented an office and had two employees, and was therefore considered to have the degree of substance to be considered resident in Luxembourg for the purposes of the treaty.

In summary, treaty shopping through conduit companies is generally defensible unless the company is acting merely in a fiduciary capacity for the ‘true’ beneficial owner.  However, the French concept of ‘abus de droits’ as it relates to treaty shopping is clearly a warning that abusive treaty shopping is unacceptable, and the conduit company must have a proper degree of substance to benefit from double tax treaty arrangements.

Attribution of Profits to Permanent Establishments

The next topic involved a study of four different cases to examine the question as to whether a permanent establishment existed in different circumstances.  It was interesting that representatives of the tax administrations in Germany, India and Australia had a totally different view of the interpretation of relevant facts than the professional tax lawyers who made up the rest of the panel!  

Everyone agreed that the rules are quite clear. In order for a non-resident to be taxed in another country under the permanent establishment provisions of a double tax treaty, it must either (a) be conducting business within that country itself or (b) act in that country through an agent.  As regards (a), (i) there must be a place of business at the disposal of the non-resident company, (ii) it must be fixed and (iii) it must be where the business of the company is carried out. As regards (b) above, the model treaty accepts that the activities of independent agents acting in the course of their business will not create a permanent establishment for the non-resident.

A Norwegian case considered whether a non-resident principal, which sub-contracted to a Norwegian company services required under a contract it had entered into to provide catering services on an oil rig in Norway, could be taxed on its ‘delta’ profits i.e. the difference between the main contract price and the amount that it paid to its sub-contractor. The differing views centred on how intensive was the degree of control of the non-resident over the duties of the sub-contractor, and therefore whether that sub-contractor could be considered as the agent only of the non-resident company.

Transfer pricing

However, in some of the case studies reviewed, representatives of the tax administrations said that they would rather rely on transfer pricing provisions rather than trying to deem a permanent establishment of the resident company in situations where their success would be in doubt. Thus in the above case, the profits that would be retained by the non-resident could be deemed to be excessive, and even if the non-resident principal and the sub-contractor are independent entities, tax administrations may seek to make a transfer pricing adjustment. Such an adjustment would be on the grounds that the payment to the sub-contractor does not adequately reflect the risk and reward profile that it undertakes for performing the entire services required of the non-resident principal (within Norway). The general consensus was that transfer pricing adjustments may be a more successful tool in attempting to impose local taxation on a non-resident company that earns income from a local source. This is particularly so if the profits under question may not be attributed to a local permanent establishment.

Mutual Agreement Procedure and Dispute Resolution

It is well known that where disputes arise as to the tax treatment of particular items of income, taxpayers are reluctant to involve the Mutual Agreement Procedure (MAP) of double tax treaties by applying to the Competent Authorities to determine the position.  The time and expense of doing so, and the uncertainty of the outcome, discourages all but the desperate. However, dispute resolution under the MAP provisions has now been strengthened by a new paragraph 5 of article 25 which includes an arbitration clause if MAP is not agreed within two years. However this arbitration clause is not binding on the tax administrations if they cannot agree and therefore there is still the same potential impasse.

So, the first day of the Conference ended and I have to confess that I skipped the second day and returned to London on the morning flight.  I guess I simply couldn’t take any more excitement in one week!  However, Lara stayed for the second day as well and you may be hearing from her direct in next month’s newsletter as to what was covered during the remaining part of the Conference.

Switzerland’s Role in International Tax Planning

Switzerland is a highly attractive jurisdiction for international tax planning, for some too attractive! The European Commission regarded the cantonal taxation of holding and administrative companies as a form of state aid not to be compatible with the 1972 Free Trade Agreement between the EU and Switzerland. The Swiss Federal Council considers this interpretation of the FTA by the EU to be unsubstantiated and rejects any negotiations. However, the Swiss government is nonetheless prepared to hold a dialogue in this matter in order to clarify the mutual positions and to improve the understanding of the Swiss tax system.

Having a small and open national economy, it is essential to constantly improve Switzerland’s legal and fiscal framework for corporate and individual taxpayers. Recently, there have been some major developments and IFS’ readers should become aware of at least the following two:

Firstly, on July 1st, 2007 the Hague Trust Convention came into effect in Switzerland after its ratification by the government. Based on this, the tax authorities issued a circular letter in order to harmonize the taxation of trusts for federal and cantonal tax purposes. And there is some good news; neither a trust nor a Swiss based trustee is taxed on the trust assets and the income thereof. A Swiss trustee is only liable for income taxes on his fees earned (the same is true for Protectors). Taxation of settlors and beneficiaries who are tax resident in Switzerland is more complex. These legal and fiscal clarifications have made Switzerland even more attractive for professional trustees. A good number of trust companies have newly been established and in addition, the Swiss Association of Trust Companies has been founded for the furtherance and development of trustee activities in Switzerland.

Secondly, ever since last year’s introduction of the Swiss limited partnership as a new vehicle for Private Equity funds, the income tax treatment of distributed carried interest (performance fee) in the hands of the fund manager has been a hot issue for the following reasons: A capital gain realized following the sale of shares by an individual investor is tax free in Switzerland, but only if the shares have been held as private assets (note that the Swiss limited partnership itself is treated tax transparent). Good arguments have been put forward to qualify the carried interest received by the fund manager as a tax-free private capital gain. However, the tax authorities had taken the view that the whole carried interest should be subject to income tax at ordinary rate because the carried interest is effectively connected with the manager’s activity for the fund.

However, with the new act on collective investment schemes, Switzerland wanted to boost its attractiveness for fund managers, but the uncertain tax treatment of the carried interest has prevented fund managers from moving to Switzerland in large numbers. Cooperation efforts between the finance sector and the authorities have eventually resulted in a draft of new guidelines on the taxation of performance fees and carried interest. The final version of these guidelines is expected to be published in November of this year but it is believed they will be beneficial for the fund managers so that carried interests will be treated as a (non-taxable) capital gain as opposed to a (taxable) trading receipt.

And finally, not a new measure but nevertheless attractive is the special tax arrangement available for foreign citizens fulfilling certain requirements. Moving to Switzerland and being subject to the so-called lump-sum taxation has particularly been considered by some UK resident non-domiciled individuals after the recent changes in UK tax law.  In a nutshell, taxes are levied on the basis of living expenses in Switzerland rather than on worldwide assets and income. The lump-sum taxation does not allow carrying out gainful activities in Switzerland; indeed it is aimed at financially independent individuals who are not seeking employment here.

IFS would like to thank Kay Hofmann for the above article. Kay is a Certified Tax Expert, LL.M. (Tax), TEP and Head of Legal and Tax at Marcuard Heritage AG and Managing Partner at Marcuard Trust AG. Their website is www.marcuardheritage.com.

China’s Newest Export: Inflation

In understanding China’s impact on the West, a useful rule of thumb went as follows:  “If China uses it, the price will go up.  If China makes it, the price will go down”.  That relationship has held true for well over the last decade but recently, the second part of that adage has broken down quite dramatically.

Over the last decade, Chinese ex-factory prices only declined, what with cheap labour, access to cheap capital, a devalued currency and, in some instances, subsidized commodity prices.  However, in the last year or two, prices of Chinese made goods have been rising materially, with price increases of 10% to 20% a year not uncommon.

We believe that the age of deflationary exports is over and that an extended period of inflation in Chinese made goods is just beginning.  This has serious ramifications for inflation in the Western economies, as China has essentially become the factory to the world, particularly in many consumer items.

Why are prices in China going up?    There are a number of short term factors, such as the recent currency revaluation.  However, we believe that there are a number of longer term causes to this inflationary pressure, most of which are not easily reversible.

Shortage of labour:

Surprising as it may seem, China is starting to experience a shortage of cheap, young labour, the source of much of China’s competitive advantage for the last two decades.   Chinese official statistics indicate that the number of people between the ages of 15 to 34 have declined from 443 million in 2000 to 380 million in 2005, a decline of 14%. Allied to this has been a general decline in population growth in the last several years.  

This shortage of labour has been exacerbated by the growing unwillingness of young Chinese to move from the country’s interior to the sweat/workshops on the coast.   What with China’s one-child policy and an underdeveloped social welfare system, many young Chinese are unwilling to leave their ageing families.  Economic reforms and revitalizations in the Chinese interior mean that they don’t have to leave to find work.  

Changes in China’s employment legislation:

At the start of 2008, sweeping changes to China’s employment legislation came into effect.  These changes seek to improve the working conditions and tenure of China’s workforce, thereby reducing the impact of many of the exploitative labour practices so prevalent in the manufacturing sectors.  A major investment bank estimates that the upshot of these changes is a permanent increase in labour costs of between 10% to 20%.  

These changes in the labour situation mean that the current wage inflation now prevalent in many sectors of the economy is not merely cyclical but likely marks the beginning of a structural realignment of China’s labour costs.

Growing middle class:

The emergence of a Chinese middle class has caused an explosion of demand for consumer goods.  As a result, many firms have moved production away from the export sector to the burgeoning domestic market.  As Chinese consumers increase their standard of living, demand for all kinds of commodities will continue to increase.  We believe that we are in the relatively early stages of a secular uptick in commodity demand, with higher commodity prices the end result.

What does this mean for the West?

Higher prices, for all kinds of hard and soft commodities are here to stay.  There will be short term corrections, but the long term trend line is clearly up. Western consumers will find their cost of living increasing as much of what they buy has a Chinese component.  In the face of an increasing cost of living, will consumers in the West continue to be satisfied with relatively low wage increases or will wage pressures start to intensify?

As China moves from being a source of deflation to one of inflation, the flexibility of Central Bankers everywhere will decrease and, as a result, interest rates in the West are likely to be higher than they otherwise might have been.  Traditionally, economic growth is stimulated by low interest rates or tax cuts.  With higher than desirable interest rates, tax cuts are unlikely to achieve anything other than a neutralizing effect.  Global economic growth will therefore be affected unless Governments join forces to address the impact of China’s newest export.

IFS would like to thank Kishore Sakhrani for the above article. Kishore is a director of ICS Trust (Asia) Ltd, a Hong Kong based trust company that provides a range of services to North American and European companies looking to do business in Asia. Their website is www.icstrust.com.

The post Issue 84 – 19 September 2008 appeared first on IFS Consultants Ltd.

I am delighted to announce that with effect from 26 August 2008 IFS will be moving from 45 Clarges Street to a property that I purchased a few years ago on the edge of Regent’s Park in London (view map).  For the present, we all feel that this house is an ideal base for the development of IFS Consultants, IFS Corporate Services and our new team, and we look forward to welcoming our clients and colleagues to meetings there in an atmosphere of exceptional charm.

Our address will be 40 Townshend Road, London, NW8 6LE and our telephone number will be 020 7449 6970 with direct lines which will be advised to you on request.  Our email addresses of course remain the same, except that we have dropped the first letter of our surname to be more user-friendly, so my address is simply roy@interfis.com.  Our website remains as www.interfis.com.

A busy time for IFS

In addition to our move to new premises announced, IFS has been exceptionally busy, with new clients ranging from a €300 million private equity fund specialising in renewable energy, to the acquisition of a large shopping centre in an Eastern European capital city, and advising on various licensing structures for brands where there are cross-border arrangements envisaged. The major introducers of such business are lawyers, accountants, private bankers and other professionals all over the world.  They view IFS as a niche international tax boutique with a reputation for optimising business structures from a commercial and legally acceptable point of view. They know that IFS neither creates nor markets ‘tax schemes’ as such, and IFS’ clients are comfortable with their status vis à vis all tax administrations all round the world. We welcome our close relationships with our professional colleagues as the way in which IFS will continue to grow in the years to come.

Each monthly newsletter will include an interesting article written by one of our professional colleagues. Dr Philip Baker QC has penned the first article on Taxation and Human Rights, very apposite coming at the same time as the Olympics in Beijing.

We will also feature a particular country in each newsletter which is known for its favourable tax laws relevant for international transactions and we are pleased to include Raymond Busuttil’s article on Malta below in this issue.

We hope that you will enjoy reading about our area of expertise and which topics are interesting to us, and we hope that this method of communication maintains the close relationships that we have enjoyed with our clients and professional colleagues over the past 35 years. We welcome any suggestions or other comments that you may have (click here) and please do not hesitate to contact us at any time.

With kind personal regards

Roy Saunders

Current Developments in International Taxation

Changes to the OECD Model Tax Convention re Permanent Establishments

On 17 July 2008, the OECD Council approved the contents of the 2008 Update to the OECD Model Tax Convention. We will comment on particular aspects of the changes in instalments over the course of the next few newsletters, the first of which is below.

Of particular interest is the introduction of an alternative service permanent establishment (PE) paragraph in the PE article of the Model Convention (Article 5).  Under the Model Convention, services performed in the territory of a State by an enterprise of the other State are generally only taxable in the resident State, unless they are attributable to a PE situated in the source State.  Although no change to the PE definition in the Model Tax Convention has been proposed, the Commentary is now to address the tax treaty treatment of services.  Briefly, a deemed service PE would be present if either:

a)    An individual engaged in a project is present in the project State for 183 days or more and more than 50% of the gross revenue of the enterprise is derived from the services performed in that other State through the individual; or

b)    Services are performed for 183 days or more for the same project or for connected projects by one or more individuals who are present and performing such services in that other State.

The alternative provision would have the effect of creating a deemed PE in circumstances where, under the main provisions of Art. 5, a PE would not exist.

This alternative provision raises a number of interesting technical issues.  Firstly, subparagraph (b) seems to be in conflict with paragraph 3 of Article 5 if the services are relevant to a construction site for less than the period of time referred to in that paragraph.  The Commentary deals with this point and states that if a shorter period is used in the alternative provision, this will significantly reduce the practical effect of paragraph 3 in the case of activities performed exclusively at a single site.  The Commentary therefore suggests that States that wish to use the alternative provision consider referring to the same periods of time in that provision and in paragraph 3 of Article 5.

It has also been queried whether subparagraph b) of the alternative provision would apply where work is performed through subcontractors.  The OECD have stated that subparagraph b) would exclude most situations where an enterprise does work through a subcontractor since it only applies if an enterprise supervises, directs or controls the manner in which the relevant services are performed by an individual, which will typically not be the case where the individual is employed by a subcontractor.  However, in the absence of a clear rule that the activity of employees of a separate enterprise cannot be treated as the performance of services by a non-resident enterprise and, therefore, cannot create a PE for that enterprise, this provision is likely to lead to some uncertainty.  Another area of potential uncertainty is the concept of “connected projects” in subparagraph b) as there is no set rule for determining whether a commercial coherence exists in any particular case, although the Commentary points to various indicative factors.

Subparagraph (a) appears to sound the death-knell for personal service companies whose income derives entirely from the services of one individual (who generally also is the owner of the SPV).

Attempts to widen tax base in the UK frustrated

The UK tax authorities received a blow on 4 July 2008 with the decision of the UK High Court in the case of Vodafone 2 v. The Commissioners of Her Majesty’s Revenue & Customs.  This case was concerned with the compatibility of the UK Controlled Foreign Company (CFC) rules with EU law, and in particular the principle of freedom of establishment enshrined in the EC Treaty.  Since 2002, HM Revenue and Customs have been attempting to claim tax on the activities of a Luxembourg financing company within the Vodafone group. HMRC claimed that the UK’s CFC legislation meant that the interest on money that the Luxembourg company lent to German subsidiaries was taxable in the UK. The judge concluded that the UK rules are not compatible with EU law and are therefore ineffective in respect of CFCs established in EU Member States.  According to the case therefore, the UK can no longer tax the profits of low-taxed EU-based subsidiaries.

These findings are in line with the 2006 European Court of Justice decision in the Cadbury Schweppes case, which established that the UK CFC rules restrict the freedom of establishment principle unless they are limited to wholly artificial companies with no real economic activity.  These cases are interesting not only for UK practitioners but also those overseas in EU countries.  And even transferring the residence of companies between EU Member States (as envisaged by the Société Européene but without the difficulties attached to such an entity) may become acceptable planning without incurring relevant ‘exit’ charges that may otherwise be involved.

The UK has also been forced to abandon its attempts to strengthen its CFC rules as part of its overhaul of the taxation of foreign profits.  In summary, it was proposed to introduce a Dutch-style exemption method for foreign dividends on shareholdings of 10% or more, allowing UK-based companies to repatriate their foreign profits tax free.  However, the proposal was to limit the dividend exemption to situations where enhanced CFC rules apply, and it was this that has caused a furore in the business community with the actual and threatened exodus of multinationals from the UK.

The new CFC rules were to be income-based (as opposed to the current equity-based rules), with the aim to distinguish mobile passive income from active income, thereby enabling the UK to tax artificially located profits that were effectively within the control of the UK parent.  These proposals were not acceptable to multinationals, particularly those with high levels of global intangible assets, the income from which would fall within these rules. The Treasury has now announced that these anti-avoidance proposals have been axed and that it indeed aims to strengthen the competitiveness of the UK’s intellectual property tax structure.

As regards the proposed dividend exemption, the Treasury has stated that this will not be introduced in next year’s Finance Bill, and is no doubt working on alternative ways to protect tax revenues before re-starting discussions on this.  Although HMRC will no doubt appeal the decision of the Vodafone 2 case, it will clearly have to work hard now to find ways in which protect the UK tax base whilst ensuring that it adheres to EU law and does not alienate UK-based multinationals.

Taxation and Human Rights

There can be no better time than now, with China hosting the Olympics, to explain in an international tax newsletter that human rights are not just concerned with torture, extra-judicial executions and forced labour, but also with taxation (which usually – but not always – involves none of these).  Increasingly, however, human rights law is not simply concerned with the egregious breaches of individual rights: more broadly, it is concerned with limits on what a government can do to its nationals, its residents and others affected by its decisions. And since the department of government with which most people have most contact on a regular basis is the revenue department, taxation and human rights must be inter-linked.  That being said, the protection of human rights in the field of taxation has not exactly advanced by leaps and bounds.  In some countries a constitutional bill of rights has been applied to protect taxpayers, and in a few instances – Germany is perhaps the most notable – constitutional courts have struck down tax rules or actions of the revenue authority.  In recent years there has also been a trend to enact codes of taxpayers’ rights (and sometimes obligations) in the tax legislation itself or in a taxpayers’ charter or taxpayers’ bill of rights.  This process is certainly gaining momentum, with countries such as Italy and Spain enacting such legislation in recent years.

At the international level, most human rights conventions were adopted without much thought being given to fiscal issues.  The European Convention on Human Rights, dating from the 1950s, was adopted without any particular consideration of tax matters (as an examination of the travaux préparatories to the Convention show).  However, the European Convention has been applied in an increasing number of tax cases both before the European Convention’s own Court in Strasbourg, and before national courts which have been called upon to apply the Convention.  The Strasbourg Court has not shown itself to be particularly assiduous in its concern for taxpayers, but there have been some positive developments.

On the one hand, the European Court of Human Rights has held that ordinary tax disputes do not benefit from the guarantee of a right to a fair trial under Article 6 of the Convention, and the Court has frequently recognised the “wide margin of appreciation” enjoyed by States in enacting tax legislation.  Thus, for example, there is no right under the Convention to the determination of a tax case within a reasonable time; and, recently, the Court held that it was not discriminatory to deny an exemption from inheritance tax to two siblings living together as a family unit, while such exemption would have applied if they had been a married couple (or a homosexual couple in a registered civil partnership).

On the other hand, the Court has now decided that virtually all tax-geared penalties should be regarded as “criminal charges” for the purposes of the Convention, so that the penalty hearing must be concluded within a reasonable time, there is a right to full information about the charges which may lead to the penalty, and there is an (albeit limited) right to legal aid.  Equally, discriminatory tax legislation has been struck down on several occasions, and the right to privacy in tax matters has been upheld.

As revenue authorities seek and acquire more extensive powers (see, for example, the results of the Powers Review in the United Kingdom), these safeguards become more and more important.  It also becomes more important that tax advisers are aware of the rights of their clients when seeking to advise them.  An example is the right to silence in the context of a criminal investigation (which, as explained, will include an investigation which may lead to a tax-geared penalty).  It may not always be advisable for a client to exercise the right to silence and refuse to supply information to the revenue authority: nevertheless, it is important to be aware that such a right exists.

The starting perception is that human rights are concerned with disappearances, executions and torture.  However, as these extreme breaches of rights become (thankfully) rarer in most countries, acts of government which may make the life of the ordinary citizen unbearable or even just unacceptable, are being recognised as worthy of intervention by courts applying human rights norms.  We are likely to see this trend continuing in future years.

We are grateful to Dr Philip Baker QC for the above contribution and would invite readers who have any comments that you would like IFS to relate to him to click here.

The Maltese Fiscal Regime

The City of London publication “Global Financial Centres Index”, has recently recognized that in terms of competitiveness and growth, Malta ranks fourth out of sixty-six worldwide jurisdictions as a centre ‘that is most likely to increase in importance over the next few years’ and fifth in ranking of ‘Top Financial Centres where organizations may open new operations in the next two to three years’.

Undoubtedly one of the key drivers of this success is entrenched in Malta’s attractive fiscal regime which has received endorsement by the European Commission through an agreement signed with the EU early in 2007, preserving the competitive full-imputation taxation system.

Major changes in the Maltese Income Tax Law came into effect on the 1st January 2007 when significant amendments were made to remove the distinction between resident and non-resident shareholders, thus becoming compliant with EU non-discrimination principles. Companies incorporated in Malta are now considered to be ordinarily resident and domiciled in Malta and are therefore subject to tax on their world-wide income at the standard 35% tax rate. Companies incorporated outside Malta are considered resident, if their management and control is exercised in Malta.

However, Malta operates a full imputation system that applies on the taxation of dividends. A shareholder, irrespective of nationality, residence or domicile, becomes entitled to a credit for the company tax paid upon distribution of profits. A refund is paid in part or in full in a pay, claim and rebate, 14 day process. The tax refund is set at 6/7ths of the 35% advance corporate tax paid (5/7ths in the case of passive interest or royalties), bringing the effective tax rate down to 5% (or 10% for passive income as above) final tax in Malta. A Malta resident shareholder will remain neutral and derive no benefit since personal income tax will in most cases eliminate any advantages on rebate.  Moreover, the timing can be arranged so as to limit cash flow to the effective tax rate.

Malta also gives special tax treatment in the Maritime sector. The Malta flag is the 6th largest fleet worldwide, and 2nd in Europe. Vessels owned through a resident Malta Company pay an annual tonnage fee and are otherwise tax exempt. Maltese law also provides for bareboat charter registration of foreign ships under the Malta flag, and the bareboat charter of Maltese ships under a foreign flag, both acquiring the same fiscal incentives.

Redomiciliation to Malta of corporate entities from other jurisdictions that make such relocation possible, has become a significant planning opportunity.  Thus it is possible to bring black-listed offshore companies within an acceptable jurisdiction in order to avoid anti-avoidance laws of high-tax countries. Similarly Malta allows its corporate entities to relocate elsewhere, without any interruption of business. Malta also has a very advantageous double taxation treaty networks spanning 48 countries. These treaties, combined with zero tax on gains of listed securities makes Malta a very attractive destination for investment funds, boosting its aspirations as an international centre for business and finance.

IFS would like to thank Raymond Busuttil for the above article.  Ray is a Maltese ex-banker whose commercial expertise on the boards of the Maltese companies for several of IFS’ clients is greatly valued.  If you would like to comment on Ray’s article, please click here.

The post Issue 83 – 22 August 2008 appeared first on IFS Consultants Ltd.