We are ending the year on a more positive and buoyant note than we started the year, with unemployment generally falling, inflation being controlled, interest rates still low and the prospect of an end to quantitative easing in the US heralding economic growth, not only in the US but globally. The pessimism surrounding the euro currency has abated (although without any good underlying reason), and there is a resurgence of consumer sales around the world.

And yes, the debt burden of an individual family to a bank may be too high; this may create banking vulnerability which ultimately may need to be rescued by the country where its shareholders are resident; and that country may have to issue bonds to support its burdened economy with the bonds taken up by its global counterparties. But the globe isn’t in debt to intergalactic planetary monetary providers, so perhaps we should all take a breath and thank the massive growth of global trade in the recent years. Due to this growth, country debt burdens can be managed by increased trade (perhaps following devaluation of its currency, something which Eurozone countries cannot accomplish), and in turn banks will be less volatile and consumers will be able to sleep at night more easily.

Structuring this growth of global trade is the focus of our work at IFS, and we have now created the organisation currently known as (ITSAPT). (but more about that in our next newsletter) which is the community for international business advisors and their clients. Tax is an element which will affect the returns from global trade, and there is a clear dichotomy emerging from many governments with their criticism of multinational companies mitigating their tax liabilities in a perfectly legitimate way, and their hidden acquiescence to such mitigation through legislative measures reducing the tax burden for such companies! It I time for greater honesty – if a government wishes to attract international trade with low corporate taxes and specific incentives (such as the patent box regime in several countries), then it should encourage international companies to take advantage of these incentives without vilifying them.

Before passing you over to Dmitry, may I wish all of you a very happy Christmas and a happy, healthy and successful 2014.

With my best regards

Roy Saunders

Dear Readers

You might be familiar with a certain Stephen Holmes and Maurice Brightman — the two protagonists of the case studies, first introduced in Roy’s “Red Book” and fleshed out in our newsletters and annual ITSAPT conferences. The former is a keen entrepreneur, full of energy and ideas, yet a complete tax layman eager to acquire knowledge. The latter is an experienced advisor whose passion for international tax and business planning is unrivalled.

I have worked with Roy in various capacities for over four years. Although a tax LL.M and ADIT gave me a slight advantage over Mr Holmes, when Mr Brightman decided to turn me into Mr Brightman Junior, I faced a very steep learning curve. There is still a lot of room for improvement; however, I hope that at least some of Roy’s knowledge and hands-on experience has been reflected in my work, for which I am extremely grateful. Now, having appeared before many clients, met an incredible variety of professionals, spoken at various IFS and independent events, and published numerous articles, I have the honour to talk to you through our monthly newsletter.

The end of the year is traditionally the time for recapping all the things that have happened to us in the last 12 months and the following should give you a flavour of what we did. As you know from our past newsletters, corporate redomiciliation, whereby a company changes its jurisdiction and tax residence without dissolution, is one of the hottest topics in international tax planning. We first talked about it in our October 2010 newsletter (click here). and considered in detail during our ITSAPT conference in November 2011. (click here).

This year we used our experience to successfully advise an international media group on how to migrate its business from Cyprus to a more welcoming jurisdiction on very short notice. Another client agreed to follow our recommendations to relocate a real estate business from a tax haven closer to the UK shores. Continuing with the tradition of writing about redomiciliation, I am revisiting the topic in my article below that puts some of our clients’ affairs into practical examples of various tax and business planning benefits that corporate migration can achieve.

Despite Roy’s attempt to teach me Received Pronunciation, you can still tell my origins as soon as I open my mouth. Some of Roy’s clients felt uncomfortable opening their heart and soul in presence of someone whose uncle might be a KGB henchman (he is not). However, in most cases my previous work experience and language skills gave us a clear advantage over tax and business advisors working with the clientele coming from the former USSR. We have been gaining a strong foothold amongst high-net-worth individuals coming to the UK as Tier 1 investors and also buying UK real estate. Some of the key planning points are explained in my article Tax Planning Considerations for Tier 1 (Investor) Migrants which you can read in our August 2013 newsletter (click here). Another article, which might be worth revisiting, is Holding Company Structures for Investment into Russia in the Light of Current Developments, found in the May 2013 newsletter (click here)

In November we had a great opportunity to demonstrate our experience by hosting a seminar at the Mandarin Oriental Hyde Park hotel for Russian and other Eastern European individuals who intend to live in the UK and their advisors. We invited Forsters LLP, Farrer & Co, Blokh Solicitors and Memery Crystal LLP to join us and examine the problems and opportunities of migration, immigrations issues, tax benefits for those who are UK resident non-domiciled individuals, and recent changes to the taxation of high value property. The evening seminar was attended by over 100 individuals many of whom after a long day at work continued socialising and networking over drinks and canapés until we drew carriages at 10.15 pm. You can download the seminar programme and the case study by (clicking here)

The seminar was followed by our fourth annual ITSAPT Conference whose topic was International Business Structuring in a Rapidly Changing Environment attended by well in excess of 100 delegates. You can find out more about the Conference at ITSAPT’s website by (clicking here).

I am very excited about the new year 2014. Besides client work, I am very keen to work alongside Roy and our colleagues developing ITSAPT, to which he is referring previously. Secondly, I am looking forward to helping Roy teach his annual MA course on International Tax Law at the University of London. What is even more exciting is that I might be teaching the same course in Moscow and Saint-Petersburg, but more on this in our future newsletters! I am a strong believer in fais ce que tu dois, advienne que pourra and can only do my best.

Merry Christmas everyone and a happy New Year!

With kind regards

DMITRY ZAPOL

Restructuring concept of corporate re-domiciliation

Successful international structures in most cases begins with choosing the right jurisdiction to host a company that will form part of an international business. Depending on the company’s activities, the choice will depend on the range of double taxation treaties and the availability of tax reliefs followed by a host of other tax and non-tax related factors. However, circumstances might arise that make the original hosting country no longer acceptable. This could be due to changes in tax laws, practices or rulings, or perhaps a requirement to create securities which cannot be accommodated within the original country’s legal system, or indeed a myriad of other reasons. In this situation the shareholder may of course liquidate the existing company and transfer its assets to a new entity in a different country. However, receiving liquidation proceeds may be an expensive option for such a restructuring. Alternatively, the shareholder may exchange the company’s shares for shares in a company located at a different jurisdiction, which will receive the assets of the former as dividends in specie or its liquidation proceeds.

What is not commonly understood, however, is that just like individuals are able to shift their tax residence to a different country, the relevant company might be able to migrate to another jurisdiction without the need to liquidate it. If the laws of its country of residence and the host country permit, the company can transfer its legal domicile without losing its corporate personality. As a result it will cease to exist in one State without dissolution and continue in a different country as the same entity. Although this method is not universally accepted around the world, where this is possible, significant benefits can be obtained for the shareholder without creating expensive personal or corporate tax liabilities.

A company may also move its place of effective management and become tax resident in a different country. However, this will only work between the States that follow the so-called “incorporation theory”. Broadly, the company always remains a legal entity subject to the tax jurisdiction of the country of incorporation but its “mobile” place of effective management can be situated abroad, thereby creating a tax presence there. If there is a double taxation treaty between the two States with a tie-breaker clause, the company will only be resident where it is effectively managed. In the absence of the treaty the company may be liable to tax in both jurisdictions, but if the country of incorporation is a tax haven that does not tax corporate profits, then double taxation will be avoided in any event. The incorporation theory is followed in most of the common law States and also Malta, Switzerland and the Netherlands.

The rest of the countries apply the “real seat” theory, also known as siège social or siège reel. These include mostly civil law jurisdictions, such as Belgium, Germany, Spain, Luxembourg, Russia and France. Their laws require the company’s centre of administration to remain in the country of incorporation, failing which the company will be considered dissolved with all the attendant tax costs of liquidation.

There are also alternative re-domiciliation methods envisaged under the EU legislative framework. Firstly, a company can apply the EU Merger Directive and merge into another company that already exists in the host EU Member State thus avoiding adverse tax consequences. Secondly, the company can be transformed into a Societas Europaea (European Company) that can move freely across the EU and then be converted back into a regular corporation.

There is no single best method of corporate migration and the final choice depends on a multitude of factors. These include exit taxes that might be levied when a company leaves a jurisdiction, existence of tax treaties, the time scale and financing available for re-domiciliation. The following examples illustrate the situations in which it is no longer desirable for businesses to continue operating in particular jurisdictions. The proposed solutions demonstrate how corporate re-domiciliation can be used as an alternative to more traditional methods.

Mr Yew — the property magnate


Mr Yew is a Singaporean businessman who wants to invest in UK real estate. He acquires a BVI company (BVICo) that owns rental properties situated in London. Mr Yew is not interested in running the business himself nor does he trust independent directors so he appoints his Singaporean right-hand man Mr Siong as director of BVICo. The business starts generating steady rental income and Mr Siong decides to move to the UK to promote BVICo’s business and find new customers.

Because of his dealings on behalf of BVICo Mr Siong might be considered its dependent agent therefore creating BVICo’s permanent establishment in the UK. Moreover, if Mr Siong continues effectively managing the company while in the UK, BVICo will be deemed to be resident in this country, thus losing all the benefits awarded by its purported offshore status.

Mr Siong can suggest to Mr Yew that he re-domiciles BVICo to one of the Crown Dependencies that has a double tax treaty with the UK and which is geographically close to its shores, for example, Jersey. Provided that BVICo is in good standing and its constituent documents allow for the re-domiciliation, the company will be removed from BVI’s corporate register after following few formalities, including filing a Notice of Continuation Out of the Virgin Islands (s184, The BVI Business Companies Act 2004). Equally in Jersey the company, provided it is solvent and has fulfilled certain administrative steps, can apply to the Commission for continuance as a company incorporated under domestic law (Part 18C, Companies (Jersey) Law 1991).

BVICo-turned-JerseyCo will continue with its ownership of property and rights. This obviates the need to renew any contracts besides changing the address of the company, and avoids stamp duty land tax liability on transferring the properties. Under the UK–Jersey tax treaty Mr Siong will benefit from a much more restrictive definition of the “dependent agent” compared to that provided under UK law. He will still need to curb substantially the scope of his activities; however, for as long as he does not “habitually exercise a general authority to negotiate and conclude contracts on behalf of JerseyCo” the permanent establishment problem may be avoided.

Besides changing the company’s domicile, Mr Yew needs to ensure that JerseyCo has the necessary level of corporate substance in Jersey commensurate with its business functions. At the very least, it should have an office in Jersey staffed with the employees whose skills are appropriate for the tasks they are performing. Mr Yew might decide to appoint another director who will exercise day-to-day management of JerseyCo, leaving the more strategic decisions to the former. Because of Jersey’s proximity to the UK, perhaps Mr Siong will be more inclined to fly there (as opposed to the BVI) to exercise his director’s duties to ensure JerseyCo’s tax residence.

Mr Afanasiev — the intellectual property magnate

Mr Afanasiev is a Russian businessman who has acquired a Belize company with a portfolio of various intellectual property rights (BelizeCo). The IPRs are licensed to an intermediary Cyprus company (CyprusCo) that further sublicenses them to members of Mr Afanasiev’s corporate group in Russia. The group is taking advantage of the Russia–Cyprus double taxation treaty, which allows the Cyprus company to extract the royalties tax free and accumulate them in Belize.

In light of the international anti-avoidance doctrine rapidly developing by the Russian courts the CyprusCo may not be considered to be the beneficial owner of the royalties for much longer, thus denying it the treaty benefits. Also with the pending introduction of the Russian CFC rules, Mr Afanasiev might find himself liable to include BelizeCo’s undistributed profits in his personal tax base.

Mr Afanasiev can re-domicile BelizeCo to one of the countries that has beneficial tax treaties with Russia, and which Russia should not consider to be within the jurisdictions with “preferential tax regimes” that trigger the application of the CFC rules. The three EU Member States that allow immigration of foreign companies are Cyprus, Malta and Luxembourg. Just like Mr Siong described previously, Mr Afanasiev will also need to transfer BelizeCo’s tax residence to the destination State by exercising effective management and control there, and also to create a substantial level of corporate substance to ensure that the company is indeed considered to be the beneficial owner of the Russian royalties.

Provided BelizeCo’s constituent documents permit re-domiciliation, it will be struck off the Belize Register upon submission of the affidavit to the Registrar evidencing that the company has continued its incorporation abroad (s96, Belize International Business Companies Act 2000). In Cyprus, for example, the Company can apply to the Registrar to continue as a company registered in the country and provided that the company is in good standing, it will be issued the certificate of continuation (s354ff, Cyprus Companies Law Cap 113). A similar procedure exists in Malta (Continuation Of Companies Regulations of 26th November, 2002).

Under Luxembourg law the domicile of a company is located at the seat of its central administration (head office). Any company whose head office is in Luxembourg shall be subject to Luxembourg law, even though it may have been incorporated in a foreign jurisdiction. If the company’s domicile is located in Luxembourg, it is of Luxembourg nationality and subject to its laws (arts.2, 159, Law of 10th August, 1915). Therefore, Mr Afanasiev could re-domicile BelizeCo by transferring its place of effective management to Luxembourg followed by the fulfilment of the domestic corporate registration formalities. Overall the process is more time-consuming and costly than that envisaged in Cyprus or Malta although the end result remains similar.

In addition to having treaties that limit Russian withholding tax (although strictly speaking the treaty with Malta is not in force yet), all three jurisdictions have special royalties’ taxation regimes. Very broadly, Cyprus taxes foreign royalties and gains from disposals of the IPRs at only 20 per cent of the standard income tax rate, resulting in an effective rate of 2.5 per cent. In Malta the company can apply to be exempted from the taxation of foreign patent royalties’ income. The rest of the royalties will be taxed at an effective rate of 5 per cent. Luxembourg also has a special regime whereby royalties from the exploitation and disposal of certain IPRs are only taxed at the effective rate of 5.84 per cent.

As in the previous scenario, after the company is re-domiciled, it continues as the legal entity under the laws of the host jurisdiction with its assets and rights at their book value. Mr Afanasiev might find that between the day on which the former BelizeCo had acquired the IPRs and the day of re-domiciliation, their values have appreciated significantly. Consequently a subsequent disposal of these rights might trigger a sizeable chargeable gain. Two of the jurisdictions will allow Mr Afanasiev to step-up the base value of the IPRs. Maltese law allows a company that changes its domicile to Malta to elect that all of its assets which are situated outside Malta and which were acquired by the company prior to the change in domicile are valued at their current market value on the day of the re-domiciliation (art.4A, Maltese Income Tax Act 1949, Chapter 123). A similar rule is envisaged under Luxembourg law (art.35(4), Luxembourg Law on Profits Tax of 4th December 1967). As a result, the gain liable to tax on a future disposal will be substantially reduced.

Mr Visser — the TV magnate

Mr Visser owns an entertainment TV channel in South Africa. The rights to the films the channel shows belong to a Cyprus entity (CyprusCo). The March 2013 Cypriot crisis left Mr Visser shaken but unharmed — all of the CyprusCo’s post-tax profits were distributed as dividends to an offshore trust. However, unwilling to take further chances Mr Visser decides to leave Cyprus once and for all. Because of the broad availability of tax treaties with South Africa he chooses to relocate CyprusCo with all of its assets to another of the EU jurisdictions. The UK because of its relative economic stability and nil withholding tax on South African royalties under the tax treaty appears to be the most appropriate.

The UK does not allow foreign companies to ‘continue’ on its soil. Instead Mr Visser can merge CyprusCo into a company based in the UK (UKCo) whereby UKCo will absorb CyprusCo’s assets and the latter will be dissolved in Cyprus. It is important that the UKCo should not be a newly-founded SPV created solely for the purposes of the merger. The company should preferably have legal history to demonstrate that the merger is done for bona fide commercial reasons and it does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is the avoidance of tax liability.

The EU Directive on Cross-Border Mergers of Limited Liability Companies (2005/56/EC) governs the cross-border merger. The Directive has been transposed into UK and Cyprus laws and the description of the process can be found respectively in the Companies (Cross-Border Mergers) Regulations 2007 (SI 2007/2974) and Articles 201I–201X of Cyprus Companies Law Cap 113.

The merger broadly starts with the preparation of the detailed terms of the merger by the CyprusCo’s directors, which are filed with the Cyprus Registrar of Companies and published for public viewing. After reviewing the Directors’ and Expert Report on the merger, Mr Visser approves the terms of the merger at a general meeting. Next the terms of the merger need to be scrutinised and approved by a Cyprus District Court, which issues a certificate that evidences the approval of the same. Meanwhile a similar procedure is pursued in the UK, including the approval of the merger by a UK Court. In the end, UKCo absorbs CyprusCo and all of its assets and the latter is struck off the companies’ register in Cyprus.

Most on-shore countries impose exit taxation on companies that leave their jurisdictions. In essence, their assets are deemed to be disposed of and reacquired on the day of the departure and the resulting gains liable to tax. Council Directive 2009/133/EC of 19 October 2009 (Tax Mergers Directive) permits cross-border reorganisations, including mergers, of the EU companies in a tax-neutral manner. Luckily for Mr Visser, Cyprus does not impose exit tax in any event; however, the Directive might prove useful in the UK should he ever decide subsequently to exit the UK and merge the UKCo with a company in another EU Member State.

Overall, merger migration allows a company to achieve a clean break with an EU jurisdiction where true corporate re-domiciliation is unavailable. However, its main disadvantage lies in the length of time it takes to perform it, and also the costs arising because of the voluminous documentation and the need to hire counsels to approve the mergers in courts (or notaries who are charged with the same task in a few States). Also, the Tax Mergers Directive contains a two-tier anti-avoidance mechanism. First, the merger should not be performed for the tax avoidance purposes. Second, if say a UK company merges into an Italian company, the former should leave a permanent establishment in the UK, which remains the owner of the company’s assets. However, the question of whether a permanent establishment remains is one of act, and may not be relevant even though the merger arrangements are effected. This area of corporate tax restructuring is exceptionally complex, but nevertheless is likely to become standard procedure in years to come – the corporate equivalent of the individual brain drain of prior years.

This article will be published in December 26th, 2013 edition of Wolters Kluwer/CCH Global Tax Weekly.

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You have been spared our newsletters for a couple of months whilst I was pre-occupied with a welcome surge of Client transactional activity and also the lead up to our annual ITSAPT conference – more about this later. But our Newsletters have always carried interesting articles, and this month we will be featuring my take on the BEPS recommendations from the OECD, which are being discussed far and wide yet may have little practical application as explained in my article.

Many of you will have received information relating to the ITSAPT annual conference held at the Mandarin Oriental, Hyde Park on 7 November. What some of you may not know is that we held a seminar the previous evening at the same hotel featuring why the UK offers significant opportunities for foreign individuals migrating to the UK. Although we called it our ‘Russian’ seminar since my colleague Dmitry Zapol explained issues relating to the current practices in Russia which may encourage emigration, the seminar really applies to any foreign national who may consider emigrating to the UK, be he/she Asian, Australian, African, American or our European partners. Speaking at this seminar with me were Dmitry Zapol, Xavier Nicholas of Forsters LLP, Russell Cohen of Farrer & Co, Elena Tsirlina of Blokh Solicitors and Nicola Kravitz of Memery Crystal.

We discussed why the UK is an attractive place to live and invest, and examined the impact of current political, social and tax changes. We featured immigration issues and the recent changes in property taxation for high-end properties acquired by companies. We had just over 100 people attending and the format was that after an hour and a half of very interesting briefings, IFS hosted a cocktail party where half of the attendees were still there at 10.15 pm!

We plan to repeat the seminar in London in February, and for those who were disappointed that they could not attend, please (click here) to register your interest in attending the next seminar, details of which we will provide in our next Newsletter.

The annual ITSAPT conference was more of a ‘corporate’ conference aimed at entrepreneurs developing their businesses worldwide. Joining me as speakers at the November conference were Kishore Sakhrani of Orangefield Hong Kong; Kevin Gardiner, Chief Investment Officer of Barclays; Philip Baker, QC OBE, Gray’s Inn Tax Chambers; John Whiting, OBE, Director of the Office for Tax Simplification in the UK: Nigel Eastaway, OBE, Tax Partner at MHA MacIntyre Hudson; Anne Fairpo, CTA (Fellow) and Barrister; Peter Kingsley, Chairman of PJR Limited; Jonathan Lawrence and Katie Hillier, Finance Partner and Senior Associate at K&L Gates; Heather Self, Partner at Pinsent Masons; Jackie Maguire, founder and Chief Executive of Coller IP; and Adrian Walton, Tax and Business Services Partner at Smith & Williamson. You can visit the conference page (click here) to see the broad range of topics that have been discussed. Again, we had approximately 100 attendees and the feedback from them was tremendous. ITSAPT will be sending information out relating to this and future conferences, and if you would like to have the course documentation sent to you, please (click here)

I am delighted to announce that my colleague, Dmitry Zapol, is now a director of IFS and I am looking forward to helping Dmitry build a 40 year old practice into an 80 year old one – yes by then I may be a centenarian, but we have no word for ‘retirement’ in the Saunders’ household. For those of you who have not yet had the pleasure of meeting Dmitry, he is a Russian lawyer who practised in Moscow with Russia’s leading law firm, Barshchevsky & Partners after completing his studies in Switzerland, France and the UK. Dmitry speaks fluent Russian and English of course, but also French and a smattering of other tongues. Having acquired his tax LL.M. and passed the ADIT exam, he has been working with me since September 2010 and has now been offered a post at a prestigious university in Moscow teaching an international tax course similar to the one that I teach at the University of London in an MA course developed by my good friend Philip Baker. I am delighted at Dmitry’s achievements over the past three years and my colleague, Giselle Peters, and I wish him every success for the future.

Politics and BEPS

The buzz word around the international tax community is ‘BEPS’, the acronym for the ‘Base Erosion and Profit Shifting’ project. BEPS is an initiative of the OECD launched at the request of G20 Finance Ministers, which I first talked about in our April newsletter (click here). At first glance it appears to be a new initiative to create a level playing field and prevent taxpayers benefiting from aggressive tax planning structures. So confident does the OECD consider the acceptability of its proposed ideas on BEPS that it has given the participating States only two years to agree on all of the issues. To put this into perspective, the European Union issued its Proposed Directive on the Harmonisation of Taxes within the European Union in 1975 with very detailed Articles, and we are still waiting for harmonisation!

Before looking at the detailed provisions recommended by the OECD, it is interesting to understand the politics behind this initiative. Could it be that countries are concerned that the US is turning a blind eye to the tax planning adopted by US multinationals such as Apple? Its effective tax rate on non-US sales is 1.8%, enabling huge amounts of cash to be available in its offshore subsidiaries for acquisition of assets such as the rights to Nokia’s patents recently acquired for $600mn? Clearly the use of virtually pre-tax profits for asset acquisitions is a major advantage over competitors outside the US who have to use post-tax profits for such acquisitions. The benefits to companies such as Apple, Starbucks, Google and Amazon appear to have the tacit approval of the US government which allows its ‘check the box rules’ to be applied at the taxpayers’ discretion to blunt the US’ Sub-Part F rules on accumulation of untaxed profits outside of the US — an equivalent of UK’s CFC rules. Is this why the US have not been so keen on implementing the Action Plan envisaged by the BEPS project, whilst Germany and the UK are gold sponsors of the initiative? Yes, the OECD has had to obtain sponsorship to cover the costs of its initiative! And through that sponsorship, the UK is able to address the issues raised by Margaret Hodge and the Daily Mail and gives the UK a much larger role in shaping international tax policy.

There are certainly some valid issues within the BEPS initiative, probably the principal one being the impact that the digital economy has had on established concepts such as the permanent establishment concept and its constituent parts: the need for a fixed place of business and what constitutes auxiliary activities in today’s world. However, if the OECD really wants to address inequalities in the way multi-nationals are taxed, why are they limiting their initiative to corporate tax which forms only a small part of the total tax revenue of any developed State? In the UK, corporate tax has never exceeded 10% of total tax revenue and is currently approximately 6%, whilst by far the greater revenue raiser is VAT, a tax which must very clearly be relevant in today’s digital age. Ideally, VAT should be levied at the point of delivery, basically where the customer is based. Although this may be possible when delivering products to customers who have acquired them over the Internet, the downloading of items and the acquisition of digital services has proved to be a much more ‘knotty’ problem. Indeed, would the UK’s City of London benefit from making its digitally received financial services more expensive to the consumer?

So in my view, the BEPS initiative, whilst of interest, does not address the inequality of revenue raising amongst the OECD’s Member States and other participating countries, and of course the provisions are not intended to apply to less developed nations, who may be seriously disadvantaged by some of the provisions. It appears that political issues may be driving the BEPS initiative, which of course is not overly surprising.

The digital economy has indeed raised issues relating to many forms of taxation, and in respect of corporate tax the concept of the permanent establishment is perhaps the most pressing issue. For example, keeping a warehouse in order to store goods in a country without conducting actual trade has traditionally been outside the scope of the permanent establishment. Yet if a warehouse is highly integrated within a business such as Amazon in order to process and deliver products within a certain time frame, this is no longer simply a storage facility but a functioning part of the enterprise. Amazon’s business is indeed to deliver parcels yet it is contended that most of the global profits of Amazon in relation to its UK business are outside of the UK tax net. But the UK does have legislation to counter such practices – it is called transfer pricing and the question is whether Amazon UK is paid commensurably for the function it undertakes, which is not merely to store goods but is a complex goods sorting and delivery activity. The transfer pricing adjustments should be able to establish an arm’s length price for the costs charged by Amazon UK to its related companies outside of the UK. This concept applies to Starbucks and other companies where products are delivered to the end user.

Certainly, the warehouse exemption under Article 5(4)(a) of the Model Tax Convention needs to be revisited. The exemption may have been applicable when it related to the simple storage of goods, but this may not be the case nowadays. However, it should be recognised that opening up the definition of what constitutes a permanent establishment in different countries could result in significant additional reporting requirements and resultant tax liabilities which may discourage global trade. Indeed, it may even create tax assessments covering prior years where companies did not believe they had such liability. The effect on global economic recovery by requiring the BEPS initiative to be implemented within two years could be very serious indeed. In any event, it will be legally necessary to amend the provisions of the relevant double tax treaties between two countries, and this is clearly a procedure that will take much longer than two years.

In respect of the provision of services over the Internet, there are many different opinions as to what may create a permanent establishment in a particular country. For example, in India the provision of services for more than six months may create an Indian tax liability even if the services are delivered virtually; there is no personnel in India, no fixed place of business and therefore seemingly no permanent establishment. Knowing how aggressive India is on raising corporate tax assessments (possibly because of its inability to impose effective VAT) it may well be that services supplied electronically to Indian customers will create a services PE and be subject to Indian taxation.

And it is not only the provision of a particular service that adds to the value of a global service provider such as Google. Its advertising revenue, for example, is derived from analysing its customers’ browsing patterns – they are feeding important information such as their purchase habits, and this becomes very valuable to advertising companies and therefore the value of Google. The French tax authorities have recognised this and are now intending to impose tax on Google on the basis of having a services permanent establishment in France.

There are also some bizarre findings coming from the OECD in the shape of its Intangibles Report which primarily focuses on patents. It basically disregards the ownership condition stating that income derived from licensing intellectual property rights should be attributed to those entities who developed the rights rather than who currently has the legal ownership to such rights. For example, if rights are created and subsequently transferred within a group to say a Liechtenstein entity, it is not the Liechtenstein entity that should receive the relevant income and pay tax on it, but the group entities that have contributed to the development process. Whilst this is clearly understandable, one cannot dispute that income derived from licensing must legally be taxable on the entity which owns the intellectual property rights, be it patents, copyrights or any other intellectual property rights. What tax authorities need to investigate is whether other group entities who have contributed to the development process have been adequately remunerated for their services, or if a transfer of rights has been made within a group, whether that transfer has been made at the appropriate price and tax paid accordingly. Indeed, US tax policy has the ability to look back at who has created the intangibles and assess such entities on what they refer to as a ‘super royalties’ basis if the rights have been transferred to an entity outside of the US.

In other words, in connection with this aspect of taxation of intellectual property rights, or indeed the provision of services and the idea that one could create a services permanent establishment, countries do not need to follow the BEPS recommendations but can rely on their own existing transfer pricing legislation. All of these issues could be dealt with by requiring companies within a multi-national group to submit a transfer pricing memorandum signed off by its auditors demonstrating the activities conducted by each group company, explaining the functional analysis of these activities, why profits have been allocated to each country in the way that they have been, and thereby justify the taxable profits that are being reported to the relevant local tax administration.

In the US, the unitary tax system is a system which attempts to create a level playing field within the States of the US whereby US profits are allocated to the relevant Member States through a weighted method according to assets in that particular State, personnel in that State (payroll) and sales in that State. The weighted average of these three elements is then calculated against the global US profits, and a comparison made with the profit reported by the US company in a particular State under normal accounting principles. A transfer pricing adjustment is then made by each State according to the unitary system. At one stage, the US adopted this approach globally, but had to restrict it to a ‘water’s edge’ approach in the light of the inability to have other countries outside of the US adopt a similar approach.

The transfer pricing approach that I am suggesting would address in part some of the issues raised by BEPS, but again it is only in the corporate tax area. The VAT approach is a much more complex one and in my opinion should be considered at the same time as considering the corporate tax inequalities derived from aggressive tax planning.

With my best regards

Roy Saunders, Chairman, IFS and ITSAPT

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International Business Structuring in a Rapidly Changing Environment

This is the title for the fourth annual ITSAPT conference to be held this year at the Mandarin Oriental Hyde Park Hotel in Knightsbridge, London, on 7 November 2013 (click here for the programme) We all may accept that the environment is rapidly changing, but we don’t necessarily understand the alternatives to traditional business activities that exist nowadays and more important, how these alternatives will rapidly become the standard for their particular sector of the business environment.

Kevin Gardiner, Head of EMEA Investment Strategy at Barclays will open the conference to reveal thought provoking ideas of the strategic intelligence required to navigate this rapidly changing business landscape. This theme will be developed by Peter Kingsley of PJR Ltd who will examine some of the intellectual property ideas of how entrepreneurs will create wealth for the next decade.

Taxation

My personal field is international taxation, and my July newsletter fully explains my thoughts on tax compliance for international groups (click here) Perhaps the most important strategy highlighted in that newsletter is the need to provide auditors with a detailed transfer pricing memorandum in respect of all inter-company relationships, and the probability that tax administrations will request auditors to submit such transfer pricing memoranda with tax computations. These memoranda do not need to be the daunting documents prepared by so called transfer pricing experts, daunting in terms of both volume and cost.

In truth, the real transfer pricing expert is the Client, for only he/she understands the entirety of his/her business, the functional analysis of each entity within the business and the risks and therefore the rewards in terms of profitability that should be divided between the relevant entities. Certainly, OECD guidelines are a help in understanding the different methods of computing profits where companies deal with one another, but in my experience, few companies can show comparable profit margins or royalty rates which apply both to them and their competitors. Each company has distinct business models, products and services, and only the Clients themselves can truly prepare the functional analysis required for a transfer pricing memorandum.

We have helped many Clients produce a simple 10 page document which is appropriate for submission to any tax administration reflecting the functional analysis prepared by the Client and justifying the tax computations of the various companies involved.

Regulation

In the field of regulation, many of us have despaired at the extent of the due diligence information required by banks, professional advisors and corporate service providers. We all understand the need to protect the public against terrorism, and the prevention of money laundering which fuels such activities, but there needs to be more pragmatism in the approach of compliance officers at these organisations.

The law itself, in many of its guises, has become complex, convoluted and sometimes contradictory, and it is noteworthy that one of our speakers at the conference is John Whiting, the Head of the Office of Tax Simplification in the UK. He will be explaining to delegates his ideas to enable governments and taxpayers to achieve their mutual objective of simplicity and fairness in the tax system. The rapidly changing environment may well see more of a partnership between governments and taxpayers to achieve the right balance of tax revenue payable and receivable, in contrast to the aggressive and confrontational stance adopted by both sides in recent years.

Finance

The very term ‘banking’ has had perhaps the worst press of any sector of the business environment, perhaps even more than the taxation exploits of multi-national corporations! Following the banking collapse of 2008 and fuelled by excessive staff bonuses and manipulation of financial markets, banks have had to re-define their modus operandi in all areas of their activities. Although there have been several collapses of banks in recent years, all over the world, governments have generally intervened to ensure depositors are protected as much as possible.

Not so of course in Cyprus where the so-called ‘Troika’ have created a unique collapse of its two principal banks. This has produced enormous losses not only for investors with deposit accounts but also for many of the hard working Cypriot businessmen whose current accounts have also been decimated, leading to many bankruptcies. The illegality of these actions, un-paralleled previously and certainly no precedent for future crises, has led to mass unemployment and a total collapse of confidence in the Cypriot business community.

However, along with these collapses have come greenshoots in terms of new methods of financing businesses. We are all aware that traditional banks have curtailed their lending activities, leading to a much slower global growth pattern than would otherwise have been the case, and therefore new means of financing have emerged. These include ‘peer-to-peer’ banking, borrowing funds direct from the public and lending to businesses in need of such funds through a risk spreading strategy. The public receives a return higher than standard deposit rates, but of course with additional risk. Corporate retail bonds are another means of raising capital which have become a feature of modern financing techniques, and even the Islamic financing model has been introduced to businesses which have no Islamic connection whatsoever. Jonathan Lawrence, partner at K & L Gates, will be revealing some financing ideas at our conference.

BRICS and Emerging Markets

One cannot speak about a rapidly changing environment in the global sense without reviewing the various emerging economies over the past ten years which are taking over the growth pattern from Western countries. The BRICS countries of Brazil, Russian, India, China and South Africa now make up 20.5% of the global economy in terms of gross domestic product, but their average growth rate of 5.35% makes the growth of Western countries laughable in comparison. Certainly, international business is extending to all of these regions and many others where the potential for growth is unlimited. We believe Africa generally is one of the main areas for unlimited growth potential, and structuring business to penetrate this market is on top of the agendas of many professional advisors.

Intellectual Property

I referred in our July newsletter to the under-utilisation of techniques developing intellectual property. Just to repeat one section of the newsletter ‘What companies may be less aware of is the degree of know-how that exists in running their particular business, and if this know-how could be written into appropriate modus operandi, it may be capable of being licensed at the appropriate level of royalty income.‘ This is clearly an area of tremendous growth potential requiring a realisation of the inherent value of a company’s IP rights. Various speakers will address this issue in a separate Intellectual Property Stream at the November 7th conference including Nigel Eastaway OBE, Barrister Anne Fairpo, Dr Jackie Maquire and Adrian Walton in an informal workshop style format.

I hope you will be pleased to note that Philip Baker QC and I will be presenting topics of interest, Philip on how to protect the corporate taxpayer by reviewing the Vodafone case in which he was involved, and my review of the global tax and investment incentives that may still be available options to mitigate the overall corporate tax costs for international businesses.

This year’s ITSAPT conference, the fourth annual one we have held in London, is geared to cover so many interesting topics The detailed programme and speakers are on the ITSAPT website (click here) and I do hope that you will be able to join me at the Mandarin Oriental Hyde Park hotel on November 7th.

With my best regards

Roy Saunders, Chairman, IFS and ITSAPT

The post September 2013 (133) International Business Structuring in a Rapidly Changing Environment appeared first on IFS Consultants Ltd.

The Immigration Rules that regulate the process are extremely complex and subject to frequent and unexpected changes. The Home Office’s explanatory notes are comprehensive; however, it is uncommon to submit a visa application without the help of immigration and financial advisers. What is most surprising is that despite moving to a high-tax country, seeking comprehensive tax advice often comes as an after-thought, when the investments are made and the arrival dates are set. This article highlights the primary tax planning opportunities available to non-domiciled investors at different stages of the UK immigration process for high-value migrants.

There are two pathways that the prospective investor can take — Tier 1 (Investor) and Tier 1 (Entrepreneur) although this article focuses on the planning opportunities for the former. These differ in the size of the investments and the commitments on behalf of the migrant. The Home Office’s website (click here) explains the regimes in detail. In writing the article the author used extracts from the policy guidance available at the website.

The Tier 1 (Investor) category is for high-net-worth individuals who can afford to invest at least £1 million in the UK. The investor does not need a job offer in the UK nor is he or she required to prove a good command of the English language. Broadly, the funds can be own savings or a loan from a UK bank if there is at least £2 million or more in net personal assets. Many investors come from developing economies such as BRICS where British citizenship is a prized possession. Anecdotal evidence suggests a growing number of the Investors being wives of wealthy foreigners; the latter together with the couple’s children being her dependants who are free to visit the UK as they please without any commitments as to the duration of visits or making the investments.

For the sake of completeness, Tier 1 (Entrepreneur) is for non-European migrants who want to invest in the UK by setting up or taking over, and being actively involved in the running of, a UK business or businesses. Broadly, the applicant needs to invest £200,000 in a UK company and comply with a host of other requirements, including speaking English to a certain standard and having enough money to support themselves in the UK. This route is attractive to younger entrepreneurs who might have sufficient savings and are prepared to actively manage the business and create jobs in the UK. With the recent tightening of the rules allowing foreign students to seek work in the UK after finishing their studies, this route has become especially popular with parents willing to help their children to stay in the UK. Both routes allow the migrant to apply for the ILR after the continuous residence period in the UK of five years. This can be reduced to three years for the investor who invests £5 million or the entrepreneur who makes extraordinary progress with developing their business. This can be further reduced to two years for the investor who invests £10 million in the UK. During the continuous residence period, the migrant cannot be outside the UK for more than 180 days in any 12 consecutive months.

Taxation in the UK primarily depends on a person’s residence status. Since April 2013 residence has been determined under the statutory residence test (SRT) explained in brochure RDR3. (click here) The SRT establishes residence status according to the number of days that an individual spends in the UK during the tax year that runs between 6 April and 5 April of the following calendar year. Residents generally pay tax on their worldwide income and gains whilst non-residents are generally only taxed on income from sources in the UK. However, individuals resident but not domiciled in the UK can elect to be taxed on the remittance basis where non-UK income and gains are only liable to tax when brought into the UK.

On its own, an individual’s immigration status has no bearing on tax liability. The investor should be treated as a regular non-domiciled taxpayer who requires the usual pre- and post-arrival tax planning measures. These are well publicised and may involve avoiding individual UK tax residence. Otherwise, prior to becoming UK tax resident, the investor should maximise the amount of clean capital and separate this account from foreign income and chargeable gains by creating separate bank accounts and thereby avoid remittances of anything other than clean capital once becoming UK tax resident. There are also more complicated arrangements that involve trusts and foreign banks. However, these measures should be taken with consideration of certain obligations that pertain to the granting of the Tier 1 (Investor) status.

Firstly, most investors seek to satisfy the requirements for the issuance of the ILR. In doing so they must spend at least 185 days in every 12-month period in the UK starting from the day of arrival in the UK under the newly issued leave to enter. This immediately denies the benefit of most UK-residence planning techniques based on the extended periods of UK non-residence. As a result, most tax planning measures should be undertaken before the investor’s arrival in the UK during stage one as explained below.

Secondly, the Immigration Rules require the investors to physically bring the investment funds in the UK. Unless these are derived from clean capital, accumulated during the period of non-residence, the investor will suffer the consequences of making a remittance of foreign income or gains, which will be taxed at the appropriate rate. Further remittances might occur where the investor pays for the services rendered by him or her in the UK, such as immigration advisors’ and solicitors’ fees. In the first case the recently introduced business investment relief might offer a solution as described below; however, the expense of planning for the minimisation of tax burden might nullify the tax benefits it aims to achieve.

It is possible to split the Tier 1 (Investor) immigration process in three stages. Stage one is preparatory during which the migrant collects the documents and submits the visa application. As stage two the investor arrives in the UK after receiving leave to enter the country. Stage three involves the migrant making the investment, which will permit the migrant to remain in the UK and to apply for the extension of stay until the he or she can apply for the ILR. There is usually a period of several months between stages one and two during which the investor stays in the home country waiting for the outcome of the application. The migrant has up to 90 days from arrival to fulfil the requirements of stage three. The investor should plan to remain non-UK resident during stage one and even partly through stage two; and during this period of non-residence should aim to perform the larger share of his or her tax planning strategy.

During stage one the applicant prepares and submits documentary evidence of the ability to invest at least £1 million in the British economy. This amount can be in cash or in readily convertible assets, such as bonds, shares, investments in companies or trusts. While the Home Office only requires proof of funds, it might be better to convert the assets to cash immediately without waiting for stage three. The rules prohibit the use of assets such as property as evidence of funds. The investor with funds locked up in capital assets will have no choice but to realise the assets in order to amass the necessary amount.

By disposing of the assets the investor will create clean capital that will not be liable to UK tax on future remittance. However, the investor might be liable to pay income tax in the country where the assets are situated or where he or she is resident. The rules allow the investor to rely on money that is owned either jointly with or solely by a close relative (spouse or partner). If the close relative is a lower rate taxpayer then, subject to the rules of their residence jurisdiction, the investor can gift the assets to the relative, which she or he can dispose of subject to the payment of a smaller amount of tax.

The money may be held overseas at the time of application or it may already be in the UK. However, the Home Office will only count investments that have been made in the UK in the 12 months immediately before the date of the application. The investor will have to make “fresh” investments, which might trigger tax consequences in the UK or in the residence state if to do so he or she must realise locked in capital.

As an alternative to realising the assets to make the investments, the investor can borrow £1 million from a UK bank provided that he or she can demonstrate the availability of net personal assets whose value exceeds £2 million. Provided that the loan is secured on clean capital assets, such as cash, real estate or shares, there should be no UK tax consequences on its receipt. However, there can be an issue if the investor uses their foreign income or gains to pay the loan interest. Because the loan is connected with the UK, any such payment will constitute a remittance liable to UK tax. If possible, the loan agreement should stipulate that interest is chargeable at the end of the loan period when the investor might become non-UK resident. Alternatively, the investor should use UK-source income, which has already been taxed to pay the interest.

Provided the requirements of stage one are satisfied, the investor will receive leave to enter the UK as a Tier 1 (Investor). The arrival in the UK should be timed with regard to the residence planning considerations as discussed next. At the same time the investor should not delay arrival in order to satisfy the continuous residence requirement required to apply for the ILR at the end of his or her stay.

The 12-month continuous residence period does not have to coincide with the UK tax year and can fall across two consecutive tax years. Under the SRT’s automatic UK test, the individual will become UK tax resident if he or she spends 183 days or more in its territory in a tax year. Therefore, if the investor arrives in the UK say on 1 February 2013 he or she will not be automatically UK resident during the tax year 2013/2014. Instead, the investor will use the sufficient ties test. The test envisages a number of the so-called “UK ties” that determine the proximity of a person’s connections with the UK. The more UK ties he or she has — the less number of days that can be spent in the UK during the tax year without becoming a UK tax resident. According to RDR3 (see the reference above) the investor will probably have only two UK ties in the first year in the UK: family and accommodation, which allows him or her to stay in the UK during the tax year 2013/2014 for up to 90 days without assuming residence here. If, however, the investor becomes resident under either of these tests, they might be able to apply split-year treatment and begin the UK residence period only from the date of arrival.

Additional planning opportunities might be offered by the tie-breaker clause in the residence article of the double taxation treaty that the UK might have with investor’s residence State, although complications might arise stemming from the mismatch between the tax years’ periods. HMRC provides an interesting explanation of this rule in part INTM154040 of its International Manual. (click here)

Under stage three the investor must invest £1 million in the UK. At least £750,000 of this amount should be invested by way of UK Government bonds, share capital or loan capital in active and trading companies that are registered in the UK. This amount should be maintained and replenished if market fluctuations cause the value of the investments to decrease. The rest of the sum can be invested in the UK, held on deposit or used to fund the purchase of a property in the UK.

Provided that the investment comprises clean capital accumulated during stage one, there will be no UK tax consequences on bringing the funds in the UK. In the opposite scenario, where the investments consist of foreign untaxed income and gains made after the date of first becoming UK tax resident, these will constitute remittances, on which the investor will be taxed at the applicable income tax rate. HMRC explain the meaning of remittance in part RDRM33140 of its Residence, Domicile and Remittance Basis Manual. (click here)

Most investors with clean capital choose investments in UK Government bonds preferring security to higher returns. However, at the 45 per cent maximum rate on the remitted untaxed income and gains the tax liability might be significant and there are ways of making the investments in UK companies without suffering tax consequences. More particularly, there is the business investment relief that was introduced in 2012. The relief allows the non-domiciled investor to invest foreign income and gains in UK companies through loan or share capital. The invested amounts are not treated as remittances and not liable to UK tax. However, there is a host of exemptions and limitations, which might deter some investors. Alternatively, the investor might receive income from his or her spouse who is resident outside the UK and earns income not liable to UK tax. The funds received from the spouse will constitute a gift, which is not liable to tax in the hands of either person.

There are high net worth individuals who choose the Tier 1 (Investor) route and find themselves in a situation where in the absence of UK credit history, banks refuse to lend despite the availability of significant assets worldwide. The investors might have cash and freely convertible assets but only just enough to make the qualifying investment in the UK; the rest being locked in various capital assets. To fund their living expenses in the UK such individuals might have no choice but to realise these assets and pay UK tax on the remitted income and gains. It is always preferable, however, for investors to take a medium to long-term planning strategy in respect of their immigration status, creating clean capital at the earliest opportunity before becoming UK tax resident and thereby minimising their future UK tax liabilities.

The post August 2013 (132) Tax Planning Considerations for Tier 1 (Investor) Migrants appeared first on IFS Consultants Ltd.

As readers of my ITSAPT launch letter released last week will have read, it is no longer APT to plan aggressively with the aim of avoiding paying tax where income is sourced, particularly if this means that profits are transferred to low or no tax countries. In fact, item 2 of the Lough Erne Declaration from the G8 Summit 2013 says:

“Countries should change rules that let companies shift their profits across borders to avoid taxes, and multinationals should report to tax authorities what tax they pay where.” (click here)

This statement is buttressed by extensive disclosure and tax information exchange obligations envisaged under the Declaration. At G8’s request the OECD has also issued a new report “A Step Change in Tax Transparency” (click here). The report suggests four concrete steps needed to put in place a global, secure and cost effective model of automatic exchange of information, which will put an end to many aggressive tax planning techniques.

Regular readers of our IFS newsletters will recall our April newsletter entitled “Aggressive tax planning: the view from Brussels” which discusses the EU and OECD recommendations on profit shifting where in one country, payments are tax deductible whilst they may be effectively exempt from tax in the other country through legislation or structural design (click here).

Part of the programme for this year’s ITSAPT conference at the Mandarin Oriental hotel in London on 7 November (click here) is to expose ideas and recommend how businesses can adapt to new concepts in taxation, finance, law and regulation, showing them how they can navigate through a very uncertain future world. Economists, financiers and entrepreneurs as well as officials from the OECD and HMRC will consider how the next decade is going to significantly change the ways in which international businesses will both operate and report their taxable profits.

This newsletter focuses on my individual field, international taxation, and what governments will do to use their existing legislation in order to ensure that tax is paid where profits are earned. There is no need to re-invent the wheel of already complex and voluminous legislation; tax administrations merely need to use the considerable fire power of the arsenal of tax law that exists. Some countries, such as the US, have created additional laws to ensure a certain level of taxation is paid, such as the ‘alternative minimum tax’. This is aimed at preventing individual and corporate tax payers from avoiding income tax through tax shelters, adding back most of the tax preferences otherwise provided under the standard method of computing taxable income. The unitary system of taxation in the United States is a further alternative basis of assessment whereby the taxable income of a corporation within one State is arrived at by aggregating the national (previously worldwide) profits of the group of companies of which the US corporation is a part and, under this combined reporting method, allocating the profit of the corporation on the basis of, for example, the turnover, payroll and property within the State compared to a total combined turnover, payroll and property. This could potentially answer the debate on tax morality if adopted worldwide, but this is as unlikely to happen as permanent stability within the Eurozone area. And these additional methods of creating a fair spread of tax revenue throughout all territories in which a multinational corporation operates creates further problems, not only administratively through the burden of submitting hugely complex returns but may create tax liabilities for companies which clearly are not profitable for one reason or another.

What is certainly appropriate is to focus more on inter-group relationships and what is understood by the term ‘transfer pricing’. In my opinion, the balloon of the media fury and governmental censure of certain companies could be pierced by tax administrations insisting on reviewing the relevant group’s ‘transfer pricing memorandum’. In future, governments may insist on being informed of global profits of a group of companies in which one of the companies is located in its jurisdiction, and then reviewing the transfer pricing memorandum to see what level of profits should be reported locally.

Basically, a transfer pricing memorandum illustrates the functionality of every entity within a group and the risks undertaken by such entities for which relevant profits should be acceptable. Thus, if a company in say the UK has a significant payroll cost, a substantial asset base and is able to achieve a considerable level of turnover, then in a similar way to the unitary approach to taxation, the tax administration would rightly consider that there are significant trading risks for such a company. If the group as a whole earns profits, it is unlikely that the local company would also not create a similar level of profits.

Auditors should be obliged to review the company’s transfer pricing memorandum when reporting on the accounts of a company and should provide the tax administration with a detailed statement (with appropriate schedules) showing how the local company is reporting profits in line with the relevant transfer pricing memorandum. So concluding this part of the newsletter and what is likely to be a feature of the next decade, all clients with international activities should ensure they have prepared a transfer pricing memorandum which meets their objectives and is unlikely to be challenged by tax administrations.

This does not mean, however, that tax planning cannot be legitimately arranged for international businesses, and there is probably no single asset capable of appropriate arrangements for such purpose than intellectual property. My March 2012 newsletter (click here) details very fully all of the types of intellectual property and how their valuation and licensing can achieve significant tax benefits whilst at the same time providing control of IP within one entity, and allowing such IP to be used as collateral to finance the development of the business.

There is so much intellectual property that is spread throughout a group and may even be totally unrecognised by the management team. The intellectual property may be marketing related, such as trademarks, brands, trade names, internet domain names, etc.; customer related such as customer lists, contracts with restrictive covenants, etc., artistic related such as copyrights; as well as the more commonly understood technology based IP, often protected through patents which may also include computer software, databases, etc. What companies may be less aware of is the degree of know-how that exists in running their particular business, and if this know-how could be written into appropriate modus operandi, it may be capable of being licensed at the appropriate level of royalty income.

What is APT for today’s world is to capitalise on the value of IP within a separate entity located in an appropriate jurisdiction which provides incentives to such companies, either in the form of low taxes, tax holidays, grants or other tax credits. Personnel employed by such companies can manage the IP rights, perhaps transferring such rights from disparate entities within the group at relatively low market valuations. Collectively, however, the value of such combined IP is considerable and its value to the group in potential royalty income enormous. The personnel will ensure that all rights are protected internationally on an annual basis, as well as in jurisdictions in which the business wishes to expand. They can create all of the contractual arrangements to license the full package of rights including know-how rights with the minimum of tax consequences, collecting the royalty income and fulfilling the substance requirements which are of paramount importance to ensure that management and control is within that particular entity. If these licensing agreements can minimise the value of the IP remaining within high tax jurisdictions, on exit via a trade sale or IPO, the maximum value can be achieved for the group as a whole. This control of value can be achieved through limiting exclusivity, length of agreements, territorial rights, etc., and require specialist skills who understand valuation concepts in intellectual property.

And so we come back to the transfer pricing memorandum discussed above. Where it is clear that significant costs have been incurred in developing IP within the relevant entity, it is justifiable to expect a reasonable return to that entity via licensing agreements in the form of royalty income. Double tax treaties may ensure that the licensing entity, if located in the appropriate jurisdiction, is able to receive such royalty income without foreign taxation at source. However, if the royalty rate is too high, profits remaining in local companies will be artificially lowered, resulting in the debate over certain multinational corporations which has so enraged the public at large. An appropriate transfer pricing memorandum would have revealed that it is not only the IP company that has taken risks and should be rewarded through profits, but also the trading entities, and the allocation of group profits on a global basis should be split between those companies who are assuming risks for their role in the global business. As I have said, transfer pricing memoranda are essential, but transfer pricing legislation is not new, it exists within the anti-avoidance armoury of all developed countries. It is through transfer pricing memoranda, however, that tax administrations can be provided with all relevant information to enable a fair split of profits to be declared for tax purposes, and the provision of such information by auditors and management is likely to be the most important development in the next decade.

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