I will be discussing this further in a webinar to be held on 10th December 2014 at 12.00. To dial in to this webinar, which is free, please (click here].

On a related topic, I will be moderating the next discussion group of the IBSA to be held on Wednesday 14th January. All IBSA members are invited to attend the discussion group entitled ‘Corporate Finance: Public vs Private Equity’.

I don’t know how many of you are following me on Twitter in my guise as Chairman of the IBSA – @RoySaundersIBSA – but please excuse me for not tweeting more! Or perhaps it is a mercy that my social media hasn’t become your anti-social media. But I always like to read comments from those of you who take the time to respond to these newsletters, so please don’t hesitate to send me a ‘tweet’ to roy@interfis.com.

In case December runs away with itself and I don’t get another opportunity to send you another missive, please accept this one as my best wishes to all of you for a happy Christmas and a successful year end, but above all a healthy 2015.

With kind regards

Roy

A Review of 2014 – Corporate Acquisitions and BEPS

Corporate acquisitions have returned with a vengeance in 2014 – the greatest number of deals since 2007. This is partly because the US and UK economies have recovered, partly because larger companies have amassed significant amounts of cash in the downturn and are now turning their attention to acquisitions, and although banks are still hesitant to lend again, interest rates are low and therefore money, when available, is cheap.

Perhaps the most significant phenomenon in 2014 has been the US corporate inversion, where the acquisition of a non-US company enables the US company to become a subsidiary of the non-US company where tax rates are lower, such as the UK and Ireland. But it is not only the higher tax rates in the US which are relevant, it is primarily the territorial approach of countries such as the UK and Ireland, as opposed to the worldwide approach in the US, which has triggered these inversions. The key sectors to see movement have been in pharmaceuticals and healthcare, energy and power and industrial chemicals.

Therefore, one of the driving forces in US corporate inversions is that overseas earnings, which have attracted low rates of tax, cannot be brought back to the US without significant additional US tax under their worldwide system of taxation. US tax reform is unlikely in the short term, so the US is adopting a sticky plaster policy of trying to make inversions more difficult, partly through moral persuasion and particularly where the foreign parent company has limited substance. Indeed, this may be where foreign jurisdictions themselves may help the US in demanding substantial management activities to ensure local tax residence. In the meantime, perhaps the US could adopt a semi-amnesty policy of reducing the US corporate tax rate on foreign earnings to say 10%, without a full scale tax reform programme being required.

Outside of the US, acquisitions have been prevalent within the EU countries, either through traditional take-overs or through cross border mergers. The former is fairly quick but requires minority shareholders to relinquish their shares, a protection more often afforded within Continental EU countries than in the UK. Mergers in the UK are less common and may require court approval, hence taking more time but with greater certainty as regards minority shareholders.

All corporate acquisitions, whatever their nature, have to factor in the significant costs involved, including transfer taxes and professional fees. It is clearly beneficial if the eventual holding company has a territorial approach in its tax system, whilst companies being acquired should preserve any tax losses and avoid potential tax claw-backs. The shareholders have to ensure that any paper for paper exchanges do not trigger a capital gains tax liability, but a deferral until the new shares are eventually sold. From a regulatory point of view, corporate acquisitions need to ensure that Competition and Markets Authority clearance is obtained if there is any potential that consumers will be harmed by take-overs or merger arrangements.

Private equity deals involved in corporate acquisitions are necessarily more short term in nature than longer term cross border mergers. They also feature a high degree of leverage, and may involve structures which may be perceived as embodying aggressive tax planning. Thus thin capitalisation issues may create challenges for interest deductibility, and the creation of holding companies whose substance may be questioned is more likely to come under attack by tax administrations. For example, Luxembourg holding companies have been used extensively in such deals involving hybrid instruments such as PECs (Participating Equity Certificates), treated as interest in Luxembourg but equity in, for example, the US.

The OECD in its BEPS initiative would wish to attack such structures in three ways: firstly, negating the tax benefits to be derived from hybrid instruments under Article 2 of BEPS; secondly, denying treaty access to a Luxembourg entity without the required degree of substance recognised by other countries under Article 6 of BEPS; and thirdly attacking Luxembourg itself for granting what the OECD considers State Aid to finance companies through their practice of beneficial tax rulings. Indeed, the OECD has attacked Malta and Ireland for similar State Aid practices involving financing and intellectual property licensing structures.

It appears that a whistle blower in Luxembourg has leaked that 548 tax rulings are currently being investigated by the European Commission involving Luxembourg companies created by entities in the US, Japan, China, Russia, Brazil, and many other countries, particularly in the EU. It remains to be seen whether the accusations of State Aid will be upheld by the Courts, and yet further if any claims may be made against the companies involved to repay the tax benefits obtained. And what happens in the event that a company benefiting from such tax rulings has since been acquired by another, and where tax indemnities have been entered into by the vendor shareholders?

If monies have been placed into escrow accounts to cover such tax indemnities, claims may be easy to satisfy. But the consequences of State Aid being upheld could create huge ripple effects in terms of claims, perhaps against the advisers themselves who have been instrumental in obtaining these beneficial tax rulings.

What is clear is that the BEPS initiative is changing the way international business structures are being implemented. The first and foremost requirement is that any entity within a corporate structure has to have the relevant degree of substance to ensure it is tax resident in the particular country, and that it merits access to double tax treaty arrangements. Aggressive tax planning in the form of hybrid instruments, for example, are to be avoided, and inter-company arrangements have to clearly demonstrate the arm’s length principle of transfer pricing. Indeed, country by country reporting, as recommended in Article 13 of BEPS, will provide transparency to tax administrations so that they can easily identify exceptional profits in jurisdictions which may suggest tax benefits and lack of required substance.

Ultimately, companies will consider the reputational risk of transgressing the recommendations inherent in the new era of BEPS, rather than the benefits to be obtained from tax mitigation. There will therefore be a continual conflict at Board level between corporate governance involving reputational risk, and the financial requirements of maximising shareholder value. This does not mean, however, that the minimisation of tax costs isn’t a fundamental consideration when developing the growth of a company, or becoming involved in corporate acquisitions, and certainly the avoidance of double taxation is a fundamental requirement. Nowhere is this more obvious than in emerging markets, where the risks at all levels are considerably higher than in developed markets.

In countries such as China, Korea, Africa and India, tax risks are at best uncertain, as has been demonstrated in the Vodafone case in India and the Lone Star case in Korea. These countries prefer to levy taxes according to what they consider the source of income or gains, as opposed to the perceived tax residence of the recipient entity. Where other countries impose tax on the residence basis of taxation, there may be instances where tax liabilities in these emerging markets cannot be credited against tax liabilities elsewhere.

Bilateral investment treaties may be useful in protecting investors in these regions from governmental actions such as expropriation of assets, although their practical effect may be somewhat theoretical, but they do little to address the issue of potential double taxation. What is of greater effect is to maintain assets outside of the relevant country where possible. These assets may be cash assets, but are also likely to be intellectual property required for the development of any local projects. Although BEPS addresses the issue of transfer pricing of such intangible rights, their foreign ownership not only allows protection of such rights but may enable an element of double taxation to be avoided.

Thus although 2014 may have witnessed a resurgence of the mega deals and generally witnessed more corporate acquisitions than in the previous 6 years, it may be remembered more as the year in which the emphasis companies and their professional advisers place on tax mitigation has changed in the light of the BEPS initiative. Reputational risk is seen as a much higher priority than tax savings, and international business structuring consultants must reflect carefully before advising on corporate arrangements. This is true whatever their professional discipline, be they lawyers, accountants, tax practitioners, private equity managers, or corporate finance specialists. With the threat of more State Aid investigations, 2015 will be an interesting year for all of us.

The post November 2014 (145) A REVIEW OF 2014 – CORPORATE ACQUISITIONS AND BEPS appeared first on IFS Consultants Ltd.

CORPORATE INVERSIONS

I have just come back from New York where I opened the US branch of the IBSA, discussing the hottest topic in the US this year: corporate inversions. We will be covering this again in a panel discussion at our forthcoming IBSA annual conference at the Mandarin Oriental Hyde Park Hotel on 19 November. If you haven’t already reserved your place for this conference, you can do so by registering at (click here).

The mechanics of a corporate inversion is that a US corporation is acquired by a non-US corporation with a lower corporate tax rate, as well as other benefits, such as a participation exemption in respect of dividends from existing US subsidiaries. The following diagram shows the method by which such companies ‘invert’ and the subsequent restructuring of its foreign subsidiaries.

The reason for the inversion is that US corporate tax rates (35% federal plus state taxes) together exceed 40% compared to say the UK corporate tax rate of 21% reducing to 20% next year. US tax law does not allow dividend income to be exempt from US tax, so that if such income emanates from low-taxed subsidiaries abroad, the full force of US corporate tax is levied. Compare that to the UK tax system where dividends receivable from low-tax subsidiaries which have a double tax treaty with the UK with a non-discrimination clause will be exempt from UK tax. Moreover, US corporations have to withhold a 30% tax on dividend distributions to ultimate shareholders in the absence of a relevant double tax treaty, whereas the UK has no withholding tax on dividend distributions, wherever the shareholders may be resident (i.e. even for offshore recipients).

It is not difficult, therefore, to understand why US corporations wish to see if they can create a better after tax situation for their shareholders than may currently exist. The US Congress clearly does not want to permit such inversions, and US tax law currently has a limited anti-avoidance provision whereby if 80% of the inverted combined group of companies is owned by the shareholders of the previous US parent company, then the newly created inverted company will be considered a US resident company for tax purposes. This is so even if there is a relevant double tax treaty between the two countries, so that if, for example, a new UK holding company is created through the corporate inversion, the US will be able to override the UK/US double tax treaty even if the place of effective management is in the UK.

Congress wanted to reduce the relevant proportion from 80% to 50%, but this has not been agreed within Congress where Democrats and Republicans fail to decide on most legislative proposals.

Having inverted into, say, a UK company, the common practice would be for the previous US parent company to transfer its foreign subsidiaries to the newly created UK holding company under the inter-group re-organisation provisions. These prevent capital gains tax being imposed on such effective disposals of the foreign subsidiaries by the US parent company. Again, Congress disapproves of the current legislative provisions exempting the previous US parent company from tax on such inter-group re-organisations, but again the indecision in the US Congress has so far failed to reach a consensus on this.

So the jury is still out on whether US corporate inversions will continue to be an effective way of minimising tax incurred by the ultimate shareholders of the US parent companies. But there is another question that should be asked: why are US corporate tax rates so high that corporate inversions have become so popular? According to my US colleagues, it seems as though the US public believe that US corporations are the ‘fat cats’ in their society who pay far too little tax, and any attempt by Congressmen to promote lower corporate tax rates would be extremely unpopular with their electorate. Since Congressmen are elected every two years, and tax reform is not a short term possibility, there is little incentive for Congressmen to rock the boat and risk losing votes when they come up again for re-election in two years’ time.

And just a final thought of mine. The short-term nature of politics is illustrated in the specific issue discussed in this newsletter, but the system may also prevent politicians taking unpopular decisions in other areas. Whether it be the US presidential elections every four years, or parliament dissolving every five years in the UK, politicians need to have tremendous courage to engage in unpopular decisions which they believe are required for their particular country. This could be in respect of an austerity programme to cut budget deficits, or waging war at an early stage of the development of a terrorist force.

But back to the subject with which I am most familiar – governments need to take a long term approach to create a tax system that motivates taxpayers to work and encourages multi-national companies to stimulate economic growth. The IBSA will be holding discussion groups and workshops over the next year, in various regions around the world, to which tax administrations and regulatory authorities are invited to share their ideas with multi-disciplinary professional advisors and their Clients, so that the pathway to reform, where relevant, can be explored to mutual benefit.

I look forward to seeing many of you at our conference next month, and would like to wish my Jewish readers a very happy new year.

With my best regards

ROY SAUNDERS

Roy Saunders, Chairman, IFS and IBSA. IBSA is the network for international business advisors and their clients, bringing together specialist advisors to enable businesses to optimise the structure of their international operation by enhancing resilience in tax planning, mitigating regulatory and market risk and enabling sustainable multi-jurisdiction growth.

Roy Saunders created International Fiscal Services in 1971 which is a niche international tax boutique at 44 Southampton Buildings, London, WC2A 1AP. Website: (click here) Email: (click here)

The post October 2014 (144) CORPORATE INVERSIONS appeared first on IFS Consultants Ltd.

AN IMPOSSIBLE DREAM?

As an additional newsletter this month, but without an appending article, I would like to share with you a vision of the future, where Tax Administrations have trust in tax computations submitted by Taxpayers; and where Taxpayers no longer have the administrative burden of a myriad of reporting and regulatory requirements, sometimes amidst the unwanted apprehension of unnecessary investigations into their affairs. Even perhaps where tax legislation becomes less complex, so that the need to employ advisors simply to decipher compliance with relevant legislation can be avoided. Living in today’s environment, we may all be forgiven for thinking that this is an impossible dream, but fast forward 25 years and we may think differently.

The OECD BEPS initiative is not the herald of a new era, but more the pronouncement of the end of a previous era. The much awaited OECD Deliverables announced last week amidst a fanfare of self-congratulatory speeches from officials, advances the progress of this new era in a typically slow fashion. Treaty shopping has been denounced as the modern day scourge of international business structuring if the entities involved have little or no substance, but this has been realised by professional advisors for the past twenty years. The OECD have reiterated, unnecessarily, that we are now in a digital age which cannot be reversed, and that tax legislation must recognise this; but then in the same sentence they state that Tax Administrations must follow traditional concepts of taxation, and that the way of dealing with the digital economy is through existing legislation together with the introduction of other measures promoted under the BEPS initiative.

The OECD has also stated that hybrid mismatches must be neutralised, as they represent harmful tax practices. But for those of us who have always denounced tax schemes in general, this idea of treating income in different ways in two jurisdictions has always seemed like ‘now you see it, now you don’t!’. And the need to develop transfer pricing scrutiny by Tax Administrations has been part of the anti-avoidance legislation of most developed countries for the past thirty years. Unfortunately it is the Tax Administrations themselves that may not have implemented the legislation that exists in a practical and effective way. Hence, the furore over Starbucks and other companies who may have taken advantage of a lax approach to transfer pricing. We have been constantly advising clients for many years to develop comprehensive transfer pricing manuals to demonstrate the functional analysis of each company within a group, the intercompany relationships that exist and the methodology behind intercompany payments that could be affected by transfer pricing adjustments.

The OECD has formalised the need for transfer pricing manuals to be available with a master file describing the activities of the business as a whole, and local files analysing the way in which companies relate with each other. The country by country reporting which is the logical extension of the preparation of transfer pricing manuals will help Tax Administrations to identify where profits are being allocated and enable them to confirm that the transfer pricing manuals correctly reflect the business operations of the taxpayer’s group.

So, yes, the OECD BEPS initiative should be welcomed, but one has to be concerned about the bureaucracy underlying the initiative. Creating greater complexity in tax legislation is the antithesis of what the business world requires. The OECD must explain to the world at large a fundamental objective, and that is to create the element of trust between Taxpayer and Tax Administration alluded to at the beginning of this review. Taxpayers, from individuals to entrepreneurs and multi-national corporations, will always attempt to minimise the tax that they pay to Tax Administrations. Sometimes they attempt to justify this on the basis that they can deploy tax savings in a more productive way than governments can, and they do not like to see their hard-earned income frittered away through bureaucratic waste. Many of us have sympathy with these views. Unfortunately, there does not seem to be a political will at present to overhaul the complexity and indeed unfairness of tax laws, merely the denouncement of those offending the laws.

As many of you are aware, I have created the International Business Structuring Association (IBSA) to demonstrate the integrity and professionalism of those advisors to international businesses who understand the need for trust to be nurtured between Taxpayers and Tax Administrations. I have been gratified that Tax Administrations themselves, whether HMRC or their international counterparts, have been willing to attend IBSA conferences and discussion groups to understand better the ideas promoted by IBSA members. And it is healthy for these members to understand the difficulties faced by Tax Administrations in implementing their governments’ legislation. This is a start, and I am hopeful that multi-jurisdictional firms of lawyers, accountants, corporate financiers, bankers, IP specialists and corporate service providers will embrace this vision. Governments themselves should cease the ‘carrot and stick’ approach they have adopted for decades, and indeed still seem to be under their new initiative, and instead start a generational change in tax policy and legislation with the ultimate aim of representing fairness and simplicity, which equals trust. An impossible dream?

On this topic, the IBSA held a discussion group last week on fiduciary relationships in international business structures, which explained the extent of exchange of information available under FATCA and other legislation. Such information is relevant to determine whether entities, such as trusts and companies, should be considered separately from their beneficial owners, and the discussion group centred on reviewing this complex principle underlying international business structures.

I will be in Malta next week opening the Maltese branch of the IBSA, and in Washington and New York the following week opening the US branch of the IBSA. For further information relating to these events and indeed the IBSA annual conference on 19 November 2014 at the Mandarin Oriental Hyde Park Hotel, London, entitled ‘Trends in Cross Border Corporate Acquisitions’, please (click here).

With my best regards

ROY SAUNDERS

Roy Saunders, Chairman, IFS and IBSA. IBSA is the network for international business advisors and their clients, bringing together specialist advisors to enable businesses to optimise the structure of their international operation by enhancing resilience in tax planning, mitigating regulatory and market risk and enabling sustainable multi-jurisdiction growth.

Roy Saunders created International Fiscal Services in 1971 which is a niche international tax boutique at 44 Southampton Buildings, London, WC2A 1AP. Website: (click here) Email: (click here)

The post September 2014 (143) AN IMPOSSIBLE DREAM? appeared first on IFS Consultants Ltd.

There was one small omission from the August newsletter that I recently sent to you, being the fact that IFS has moved from 44 Southampton Buildings near Chancery Lane to new offices at 83 Baker Street, London, W1U 6AG. After a hectic few days of servers being re-located and internet access denied, we are now up and running in our first week and we are all delighted to be located in such a gastronomically delightful environment. Our telephone number and all other details remain unchanged.

As many readers are aware, IFS has been involved in many corporate re-domiciliations over the past few years, our practical experience supplementing the books and articles we have written about this topic. However, we are often asked what happens if the CEO of a company moves his personal residence, but continues to run his company from his new location. Would this create adverse tax consequences under the management and control concept, or indeed represent a transfer of corporate residence which could have tax consequences in respect of deemed capital gains arising on exiting a country? Or perhaps even create a constructive liquidation of the company in certain jurisdictions? Our article this month examines these issues, with particular practical recommendations to ensure that a company ensures it is tax resident in its preferred jurisdiction.

In fact, most of the article is lifted from the new book we have written entitled ‘Principles of International Tax Planning’, which will be published and available before the end of September. £95 a copy but free for IBSA members!

As usual, I am very involved with the development of the IBSA and have a particularly hectic three months’ schedule to look forward to! If you would like to attend any of the following events please visit our branch events or conference pages on the IBSA website at (click here).

3 September – Asian branch discussion group in Hong Kong – “Relevance of Hong Kong double tax treaties in international planning’ (too late I’m afraid! – but the slides and audio will be available to IBSA members on the website shortly).

16 September – UK branch discussion group in London on ‘Fiduciary relationships in international business structuring to include examination of FATCA, beneficial ownership concept and conduit companies – with HMRC representative on the panel.

18 September – Webinar with John Timpany of KPMG Hong Kong and me examining International Double Tax Treaties and their use in the light of new OECD recommendations. Visit our Bright Talk Channel for more information and to register.

1 October – European branch seminar in Maltareviewing international business structuring and the Malta connection.

7 October – US branch meeting in Washingtonto discuss corporate inversions and the use of UK holding companies, comments in the light of the latest OECD BEPS project developments and IP patent box models.

8 October – US branch meeting in New York to discuss corporate inversions, UK holding companies and CFC legislation in the light of OECD BEPS project development.

19 November – IBSA annual conference in London highlighting trends in corporate acquisitions. There is an excellent early bird discount offer available: 50% discount for IBSA members and 20% discount for non-members when booking by 19th September.

I am thrilled with the quality of speakers that we have been able to attract to the various seminars, discussion groups and conferences, and this has been the hallmark of IBSA’s development since March this year. I really hope that readers of our IFS newsletters will join the IBSA as members in order to help in the development of the organisation. As a not for profit organisation, my motivation in creating the IBSA is to demonstrate the professional integrity and competence of its multi-disciplinary members throughout the world, and to encourage transparency and communication with Tax Administrations through exchange of ideas at discussion groups in particular. The combination of intellectual stimulation with the ability to establish personal relationships with professional colleagues throughout the world, whether they be lawyers, accountants, tax advisors, bankers, corporate finance advisors, IP specialists, corporate service providers, etc., makes the IBSA a unique global organisation for the professional advisory community engaged in international business structuring.

If you have any comments regarding the article below, please do not hesitate to let me know.

With my best regards

ROY SAUNDERS

CORPORATE RESIDENCE

The importance of determining corporate residence is that the taxing rights of any particular country are usually defined by reference to whether an entity is resident or non-resident. Depending upon the taxation policy of the country in question, residents will typically be subject to tax on their worldwide income, while non-residents may find that the taxation rights of the jurisdiction concerned are restricted to income, gains or profits derived within the relevant jurisdiction.

Management and control concept

Most readers will be aware that a company is not simply resident only where it has been incorporated, but may also be resident in another jurisdiction as a result of the management and control concept. While the basic concept has been developed over the years, the principle remains the same. The classic UK case of De Beers Consolidated Gold Mines v. Howe [1906] AC 455 considers ‘where the real business of the company is carried on, where the central management and control actually abides’. In this case, a South African company, operating in South Africa but whose affairs were controlled from the UK, was held to be resident in the UK, because that was where it ‘keeps house and does business’ (even though the ‘nuts and bolts’ of the business were, in fact, in South Africa). It was held that since the principal office was in the UK, and the majority of directors met in the UK, the profits were therefore realised in the UK.

In Australia, substantial case law has also established that the real test of central management and control is found in the determination of where the actual business of the company is carried on; not in the sense of where it trades, but in the sense of from where its operations are controlled and directed. This determination can only be made after an examination of the course of the company’s business and trading operations.

Thus, in the case of Koitaki Para Rubber Estates v. FCT [1941] 64 CIR 15 criteria considered as secondary tests included: the place where dividends are declared; the place where general meetings are held; the fact that the company operates a bank account in the country; and the place where the company’s books and corporate seal are kept.

Canadian courts have followed the rulings of UK courts that a corporation is resident according to the country where its real business is carried on, and that its real business is carried on where its ‘central management and control’ is actually located. In most cases, the central management and control will be located where the board of directors of the company meets and carries out its responsibilities. It is important to note, however, that de facto control is the determining factor (in this respect, legal control, based on the percentage of voting shares, is not important). In order to establish where central management and control is exercised, factors such as where the effective decision-making relating to the activities of the corporation takes place are considered. The courts have also considered factors such as the place of incorporation, the country of operation, the residence of shareholders, the place where books are kept and bank accounts opened, and the place where shareholders meet.

Some questions that may therefore be relevant are as follows:

• Does the board of directors have a majority of residents in a particular country?
• Are all the strategic decisions affecting the company made, and can they be shown to have been made and implemented, by the board of directors and in that country?
• Does the company maintain its headquarters in the country in question?
• Does the company operate a local bank account?

An interesting document was issued by the Israeli Tax Office in connection with this topic. The Israeli Circular 4/2002, Guidelines for Determining Control and Management, makes clear that the substantive issues of who is really responsible for the conduct of the entity are key. The most significant issues are where the most important decisions are made, business strategies are set and the decisions that allow the company to function are taken. Important aspects of the decision-making process that should be examined include:

• the whereabouts of the source prompting the need for a decision,
• the place where the alternatives were prepared and discussed,
• and where the final decision was agreed.

The location of certain decisions is particularly important, including entering into certain dealings which impact heavily on a company’s future, certain financing decisions, and those concerning large investments. It is clear that the Israeli position bears a close resemblance to the concept of management and control in the UK.

Case law in the Netherlands highlights that the most important factor is the place of effective management. This is considered to be the place where the managing directors pass management resolutions, which is usually where they meet and carry out their management duties. It has, however, been recognised that there are instances where management cannot be considered to be in the hands of the managing directors, such as where their functions are restricted to management of day-to-day matters, with more important aspects lying within the domain of the shareholders’ meeting which must then be approved by the board of directors. In particular, management is deemed not to be carried out by the managing directors in the following scenarios:

• where the type of business in which a company is engaged requires specialist knowledge (which they do not have); or
• where one individual acts as managing director of numerous companies and cannot therefore be considered to have the specialist knowledge required for all of them.

The latter case must clearly sound a warning note to trust companies which generally will not have the specific skills or knowledge required to manage each Dutch company under their ‘management’.

In contrast to the management and control principle, the US has the concept of taxable income ‘effectively connected’ with a US source, and if a foreign corporation has effectively connected income, then the foreign corporation will be subject to US tax on such income.

Ensuring non-residence in a particular country

Taking all of the above into account, it is clear that if an overseas incorporated company is to remain non-tax resident in a particular country (country A), but resident in its country of incorporation (country B), it is necessary to ensure that:

• no country A resident director takes decisions or gives instructions affecting the business of the company in country A, nor even really considers the business of the company while in country A;
• there is a majority of non-country A resident directors, some of whom have expertise in the commercial business of the company;
• regular board meetings take place outside country A and preferably in the same location where the company is incorporated (country B);
• agendas and minutes of board meetings are accurately recorded and clearly reflect the decisions effected at the meetings;
• the statutes of the company reflect, wherever possible, that the company operates in the desired manner;
• the administration of the company, separate from policy decisions affecting the company, is conducted as far as possible in country B, being the country of desired residence, including inter alia the maintenance of an office, employment of local individuals, operation of a local bank account, keeping statutory books and conducting accounting operations there.

It is therefore rather short-sighted to give advice which involves the incorporation of a foreign company in order to save tax where that foreign company is obviously only incorporated for tax avoidance reasons and has no substance in actual effective management.

Place of effective management under the OECD Model Treaty

It may be that two countries consider a particular company to be tax resident, perhaps one on the grounds of its place of incorporation and the other on the grounds of where its management and control are located. In such circumstances, a relevant double tax treaty would be helpful in clarifying which country has the applicable taxing rights. The Commentary to Article 4 of the OECD Model Treaty considers the overriding intention to be the ‘place of effective management’, which is considered to be the place where:

… key management and commercial decisions that are necessary for the conduct of the entity’s business are in substance made. The place of effective management will ordinarily be the place in which the most senior person or group of persons (for example, a board of directors) makes its decisions, the place where the actions to be taken by the entity as a whole are determined; however, no definitive rule can be given and all relevant factors and circumstances must be examined to determine the place of effective management. An entity may have more than one place of management, but it can only have one place of effective management.

The OECD has further refined the ‘place of effective management’ concept by expanding the Commentary explanations as to how the concept should be interpreted and by introducing the ‘hierarchy of tests’, which provides for different tests applying in succession. In addition, much of the above Commentary has been replaced with wording indicating that the place of effective management will usually be the place where the most senior person or group of persons makes its decisions. Where key decisions are made in one place but formally finalised in another, the place of effective management of a company would be where the key decisions are made. Also, the place where a person or entity with a controlling interest makes key decisions in respect of the company may be deemed to be the place of effective management. Where a board of directors routinely approves the strategic decisions made by the executive officers, the place where the latter make their decisions is important in determining the place of effective management of the entity.

Summary

Ascertaining information relevant to determining where a company is effectively managed and controlled is much easier nowadays as a result of the exchange of information between tax authorities. Having nominee directors acting under the instructions of the UBOs is likely to lead to unwanted investigations and adverse tax consequences. Having said this, it must be stated that there is a considerable difference between the degree of effective management required for say a holding company or an IP owning company as opposed to a trading entity. The concept of effective management is applicable to all companies, but the requirements of personnel, office accommodation and other functions will be different.

Roy Saunders, Chairman, IFS and IBSA. IBSA is the network for international business advisors and their clients, bringing together specialist advisors to enable businesses to optimise the structure of their international operation by enhancing resilience in tax planning, mitigating regulatory and market risk and enabling sustainable multi-jurisdiction growth.

Roy Saunders created International Fiscal Services in 1971 which is a niche international tax boutique at 44 Southampton Buildings, London, WC2A 1AP. Website: (click here) Email: (click here)

The post September 2014 (142) CORPORATE RESIDENCE appeared first on IFS Consultants Ltd.

I hope you have had a great summer wherever you are. We have had one of the best summers I can recall (and I have many to choose from!). And now it is time to turn my attention to a very busy autumn that is looming for IFS and the IBSA.

I have not actually been idle this August as Nick and I have been putting the finishing touches to the new edition of ‘The Principles of International Tax Planning’ which hopefully will be in print by the end of September. The book chronicles the international tax exploits of a very inventive family, the loveable rogue grandfather Papa Filipe, his entrepreneurial son Giuliano, and his grandchildren, the now infamous footballer Paolo and the beautiful model Renata.

The eight chapters explain the principles of international tax planning and then reveal how these have or have not been adopted by the Filipe family. As an incentive to existing and future IBSA members, IFS will proudly send them a signed complimentary copy of the book.

One of the major issues discussed in the book is the question of residence, both corporate and personal. The current topic of US corporate inversions has attracted vociferous altercations in the US Congress, but elsewhere corporate re-domiciliation is accepted as the consequences of a level playing field where tax rates are nevertheless the prerogative of particular jurisdictions.

As for individuals, the European Court of Justice has upheld the right of individuals to move from one European country to another without having to pay exit taxes when they leave a particular country until the relevant assets are eventually sold. Quite how this will be policed is a different issue, but the principle of being able to move from one European country to another without tax impediments has been upheld. This month’s article reviews some planning opportunities which may be adopted by individuals migrating to and from the EU and focuses on those coming to live in the UK via an intermediate country of residence. Indeed, in the past year IFS has helped many Eastern Europeans and Asians who have decided on a life changing transfer of personal and family residence.

I will be discussing fiduciary relationships in international business structures with some professional colleagues and also with a representative from HMRC on 16 September at an evening discussion group of the IBSA to be held in Mayfair, London. We will be reviewing the role of conduit companies, the concept of beneficial ownership, exchange of information and FATCA rules, and it promises to be a very stimulating discussion of these topics. The meeting is open to all IBSA members and to guests invited by me, so please let me know if you would like to attend (click here).

Two days later, on 18 September, I will be hosting a webinar with John Timpany of KPMG Hong Kong to discuss double tax treaties in general but specifically how Hong Kong’s network of double tax treaties has proliferated, and how they may be used in international business structures. We will specifically discuss the role of Hong Kong for Chinese inward and outward investment, and compare Hong Kong’s treaty arrangements with those of Singapore, the UK and elsewhere. Again, if you would like more information on this please let me know (click here).

What I would really like to draw to your attention to is the annual conference of the IBSA (previously known as the ITSAPT annual conference) which we are holding on 19 November 2014 at the Mandarin Oriental Hyde Park Hotel, London. The conference details are on the IBSA website (click here) and for those booking by 16 September 2014, there is a reduction from the standard £875 + VAT to £438 + VAT for IBSA members and £700 + VAT for non-members. We have had some amazing feedback from prior conferences such as “Thank you for a remarkable conference – possibly the best one I’ve attended in the last 20 years”, so I do hope that you will register and take advantage of the reduced price for what promises to be a fascinating day.

I always think that September heralds a new year (perhaps from my school days or those of my children), so I wish you all a happy new business and professional year.

With my best regards

Roy Saunders

PERSONAL MIGRATION 2

Readers of our newsletters may recall our fascination with tax planning achieved through corporate and personal re-domiciliation. We wrote articles in October 2010 (click here) and April 2011 (click here) covering these issues in detail and addressed tax driven migration at numerous conferences. Over the years we have helped many clients overcome the complex issues inherent in a change of personal residence and we are happy to share a few interesting observations with our readers.

Exit taxes and residual tax liability

In the April 2011 article we talked about exit taxes that some countries, including Canada, Israel and the US, impose on the departing individuals. On becoming non-resident in a particular country the person will be deemed to have sold and reacquired their assets at the current market value therefore potentially creating a deemed capital gain liable to tax. For those considering migrating to the UK and enjoying the benefits of the non-domiciled but resident regime, a problem could arise. What if they sell the relevant assets when resident in the UK and remit the proceeds to the UK? Can they credit the foreign tax on a deemed liability against UK tax on an actual one? The answer is no, and what they should consider is selling the relevant assets prior to migration so they have what is known as ‘clean’ capital to bring into the UK tax free, but more on this below.

Other countries, including Germany and Italy, retain the so-called residual taxation rights towards their departing citizens or former long-term residents. As a result, income or gains realised after the departure might still be subject to tax in the original State.

Pursuant to the EU Treaty protection of the fundamental freedoms, tax assessments on deemed gains have to be deferred when the person moves to a different member state, until the relevant assets are eventually sold. Quite how this will be policed is uncertain, especially for those assets held for many years after migration. Also, the terms of a double tax treaty may state that the taxing rights are solely with the country where the individual is now resident: do treaties have to be renegotiated to comply with the ECJ rulings?

For those who migrate outside of the EU, the exit tax often hits like a tonne of bricks. And the exit tax materialises on the day of departure, whilst the individual is resident in the relevant country.

What about those countries which do not have an exit tax for individuals, such as Ireland? It is well known that the Emerald Isle attracts many entrepreneurs with its broad double tax treaties network and benign tax regime. Although the country has a swingeing 33 percent capital gains tax rate, which makes the disposals of businesses problematic, in its recent eBrief No. 01/14 (click here) the Irish Revenue have informed taxpayers about entrepreneur’s relief from capital gains tax, introduced to encourage entrepreneurs to reinvest proceeds from the sale of certain assets in assets used in a new business. However, unlike the UK’s entrepreneurs’ relief, which allows for up to £10 million of chargeable gains to be taxed at 10 per cent instead of the normal 28 per cent, the Irish relief does not allow the taxpayer to simply dispose of business and keep the proceeds after paying a beneficial rate of tax: the proceeds need to be reinvested.

Such entrepreneurs may therefore consider leaving Ireland for another country. What they may not realise is the consequences of the lasting effect of Irish ordinary residence. A person is ordinarily resident in Ireland if he has been resident in the country during the three tax years preceding the year of assessment. If the person is leaving Ireland, he will not cease to be ordinarily resident until he has been Irish non-resident for three continuous tax years.

Now a person who is ordinarily resident in Ireland is liable to tax on his worldwide gains. Therefore, for three years following his move to a different country the same individual will be liable to Irish tax on capital gains realised during this period. While double tax treaties often prove useful in planning residence through the tie-breaker clauses that can override domestic residence determination, they often contain carve-outs that allow the participating States to keep the residual taxing rights in respect of the non-resident individual.

Many of Irish double tax treaties contain such a carve-out clause. For example, Article 13 of the Ireland–Canada double taxation treaty says:

5. Gains from the alienation of any property, other than that referred to in the preceding paragraphs of this Article, shall be taxable only in the Contracting State of which the alienator is a resident.

6. The provisions of paragraph 5 shall not affect the right of a Contracting State to levy, according to its law, a tax on gains from the alienation of any property derived by an individual who is a resident of the other Contracting State and has been a resident of the first-mentioned State at any time during the five years immediately preceding the alienation of the property if the property was owned by the individual before becoming a resident of that other State.

Essentially, the treaty allows Ireland to keep its residual taxation rights until the person becomes not ordinarily resident there after the three year period of regular tax non-residence.

If during the period of Irish ordinary residence the individual realises the gains while being resident in a different country, he might incur double taxation, arising in Ireland and in the State of immigration, although this is normally relieved under domestic unilateral provisions or under the applicable double taxation treaty.

Unfortunately, there is no satisfactory solution to the issue we raised above. Unless the individual holds off selling the property for three years following his departure from Ireland, he will be liable to the Irish capital gains tax regime. Even if this is avoided, the gain might be liable to tax in the country of the new residence, unless a domestic relief such as entrepreneurs’ relief or the remittance basis of taxation applies. Some countries, such as Canada or Malta, allow a step up in the base value of the person’s assets upon the move in their territory. This might prove useful to minimise the amount of the chargeable gain in the absence of other reliefs if the individual delays selling particular assets until after the three year period.

Migration to the UK via Spain

The UK attracts a large number of foreigners thanks to its migration scheme aimed at high net worth individuals and to the remittance basis of taxation that allows non-domiciled individuals to avoid taxation on their non-UK income and gains. Our August 2013 newsletter (click here) looks into tax planning considerations for the HNW migrants in detail.

Before becoming UK resident, the expecting migrants should create a sufficient amount of clean capital, which will not be subject to UK tax upon its remittance to the country. This is the principal planning technique, which might be costly and time-consuming. Sometimes the circumstances are such that the individual is forced to leave his country of origin but not ready to become resident in the UK due to the insufficient amount of such clean capital. In such circumstances, the individual might consider making a temporary stop-over in another country prior to committing himself to his new life in the UK.

For several of our clients, we have considered recommending a temporary sojourn of say a couple of years in sunny Spain, and not just for tanning purposes. Spain has a special tax regime aimed at attracting foreign executives to work on the Spanish soil (known to many as the ‘Beckham rule’), otherwise the ‘impatriate regime’ provided in article 93 of the Impuesto sobre la Renta de las Personas Físicas (click here). Our colleague Florentino Carreño, of the Spanish law firm Cuatrecasas, has provided us with a useful summary of the regime.

Spanish non-residents who, due to the signing of a labour contract or being instructed to do so by their employer, transfer their residence to Spain and become Spanish tax residents, may apply the regime, provided certain requirements are met. These might be substantially revised in the light of the amending legislation which will become law in 2015. The “impatriate” individual will only be taxed on Spanish source income and at the rates applicable to non-residents without any remittance rule being applicable.

This means that the migrating individual can sell his assets after emigration (subject to the relevance of the exit tax described above), yet not be subject to Spanish tax which is normally taxed on a worldwide basis — assuming the assets are not Spanish source, no capital gains tax will be payable in Spain. The individual may then migrate to the UK, his final port of destination, with an abundance of clean capital with which to start his new life.

The basic requirements to apply the impatriate tax regime are as follows:

• The individual must not have been tax resident in Spain in the ten years prior to his entering into Spain.
• The move to Spain must be a consequence of an employment contract (or as a consequence of a letter instructing to do so by the employer).
• The work must be effectively performed in Spain; however, up to 15 percent of the employment income may derive from work carried out outside Spain (30 percent in the case of group-related activities). In the proposed amendments this requirement is removed.
• The work must be performed for a company resident in Spain or for a Spanish permanent establishment of a non-resident entity. This is no longer an express requisite according to the proposed amendments.
• The employment income must be subject to and not exempt from Spanish non-resident income tax.
• The expected employment income in every given year cannot exceed €600,000. If it exceeds this threshold, the regime does not apply to any amount. Under the proposed wording if the impatriate earns more that €600,000, he will not lose the entitlement to the impatriates regime. Up to €600,000 will be taxed at 24 percent and the excess will be taxed at 45 percent.
• To benefit from the impatriate tax regime, the taxpayers must file their application within six months of commencing their activities in Spain.
• In addition, the proposed amendments introduce the restriction whereby the impatriate aiming to benefit from the regime cannot own over 25 percent of the company that employs him.

The regime operates for up to five years. Considering the amount of Spanish tax revenue potentially lost, it is common to discuss the individual application of the regime with the Hacienda. Also, as explained above under the proposed amendments the regime will not apply where the individual has a controlling stake in his employer directly or, we presume, through his connected persons. This means that the employment must be on truly commercial terms with the justification for the relocation.

This is of course only one country which encourages foreign individuals to take up residence within their shores. Our advice to clients centres not only on where they have chosen to live, perhaps with a tax motivation, but more importantly where their spouse or partner wishes to live. Many a divorce trail begins with disaffected partners incarcerated, so they think, in an offshore island where travel opportunities are restricted, and where sometimes their foreign language skills are severely tested. Not that Spain qualifies as an offshore island, but other tax beneficial jurisdictions I can think of certainly do.

Article written by Dmitry Zapol

21 August 2014

Roy Saunders, Chairman, IFS and IBSA. IBSA is the network for international business advisors and their clients, bringing together specialist advisors to enable businesses to optimise the structure of their international operation by enhancing resilience in tax planning, mitigating regulatory and market risk and enabling sustainable multi-jurisdiction growth.

Roy Saunders created International Fiscal Services in 1971 which is a niche international tax boutique at 44 Southampton Buildings, London, WC2A 1AP. Website: (click here) Email: (click here)

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