To remind those of you who are familiar with the Polycon journey, and for those who have not yet had the pleasure of analysing the transformation of Polycon Lens Company into the Eyemax Group, the business started with my fictitious inventor–entrepreneur Stephen Holmes developing the first progressive power acrylic lenses for spectacles and manufacturing them for wholesalers prior to selling them as white label designer glasses. The business progressed into the research and subsequent manufacture and sale of high quality optical lenses for telescopes, then to lenses for digital cameras and subsequently for mobile phones. Polycon Lens Company was rebranded as the Eyemax Group. As Eyemax, it eventually harnessed Stephen’s creative brain to develop the solar lens bowl for capturing solar energy and converting it to electricity in a joint venture with a utility company.

Although the development of the business took place over a generation of 25 years, summarised below are the issues the IBSA team of experts presented during just one day!

Intellectual property
The types of intellectual property relevant to Polycon are the patents for the various lenses, the confidential information and know-how of the processes of manufacture, Polycon’s and ultimately Eyemax’s trade mark rights and the copyright in the story of Polycon’s journey used in professional journals. If its employees work on products, then protection is afforded through employment law, but this does not extend to work done by consultants and sub-contractors unless intellectual property such as copyright is specifically assigned to Polycon.

Since the acrylic lenses are innovative, Polycon should apply for patent protection but must ensure the relevant material and creation are not in the public domain. This means that Stephen Holmes should have entered into non-disclosure agreements (NDAs) when speaking to wholesalers and financiers prior to applying for patent protection.

The trade marks should be registered to provide monopoly protection, although unregistered protection through legislation of ‘passing off’ is always available. Polycon’s name as well as its logos, corporate signatures, photos of its products, as well as any associated scents and colours can be protected through trade mark legislation! Polycon can also apply for design protection.

Research and Development grants
Having spent a considerable amount of money on the development of the acrylic lenses, Stephen Holmes wonders what his options are for recovering some money against his taxable income from the tax administration. For SMEs like Polycon, the UK allows up to 26% of qualifying R & D costs as tax relief, and Polycon could even get a cash refund if it makes losses of up to 33.35% of qualifying R & D costs.

Qualifying activities require current scientific or technological uncertainty and the requirement to advance in this area, so an extension of knowledge or capability, creation of a process, material, device, product or service which improves existing material, would qualify. Moreover, Polycon can make a claim for the past two years so it is not only current year costs that can qualify. And Stephen Holmes learns that many other European countries permit similar claims.

The costs Polycon identifies relating to its acrylic lenses are the initial feasibility studies, all of its research costs, the creation of prototype lenses, their testing and independent evaluation, several pilot trials with wholesalers, as well as certain management costs, provided all of these are written off to its P & L account as opposed to being capitalised as fixed assets.

Patent box regimes
Stephen Holmes has been advised that there are certain tax jurisdictions which offer preferential rates of tax for income associated with intellectual property, but under Action 5 of BEPS it is generally required that substantial activity takes place in the particular regime for privileges to be granted.

The so-called modified nexus approach according to Action 5 is limited to patents owned by resident companies where expenditure has been incurred by these companies directly connected with the IP assets. However, although the theory of Action 5 has been agreed within OECD countries, all 16 countries currently with patent box regimes are deemed inconsistent with the nexus approach, amongst them the UK, Belgium, Luxembourg and Netherlands.

From 2021, the UK is to have a 10% tax rate on profits emanating from selling or licensing intellectual property rights related to patents (but not software copyright), and in Spain a similar rate applies for patents plus designs and know-how but again not software copyright. The Netherlands offers a 5% tax rate on relevant (patent box) income which may include software copyright, and in Ireland the rate is 6.25% for relevant income from patents and software copyright. Luxembourg has abolished its preferential regime but is considering a replacement, whilst Cyprus and Malta have specific regimes which are more widely drawn in respect of the types of income covered.

VAT
VAT issues are always being considered by the advisers to Polycon. Distant selling limits need to be observed before requiring VAT registration, and although Polycon plans to arrange consignment sales agreements with wholesalers to avoid creating taxable income where its products are subsequently returned, the absence of a VAT return is not always the case. And Polycon’s e-commerce transactions are now subject to varying rates of VAT in the countries where its customers are located, rather than where the e-commerce subsidiary is located.

Branding Polycon as Eyemax
As Polycon grows, its marketing director realises that companies cannot any longer ‘sell’ their product through advertising techniques, but instead need to create an environment where customers want to buy their products and services. This is why companies like Netflix are more successful than main-line TV channels, where consumers are not interrupted continuously by advertisements. In this case, Polycon advised to tell a story about its lenses. As a result, it decides to rebrand its spectacles, recently acquired digital cameras and mobile phone subsidiaries, and even the solar lens bowl concept, into the Eyemax Group of companies.

Corporate Finance issues
As the Group grows, Eyemax considers an IPO to access capital, raise the profile of the company, use its shares for further acquisitions and incentivise its management and employees through stock ownership schemes. Eyemax realises that it will need to enhance its Board with reputable non-executive members, and create greater corporate governance which could inhibit the creative mind of Stephen Holmes to some degree. Raising equity could be through a full listing, with its associated costs, or often through a placement of its shares with selected institutions. As to which relevant stock exchange Eyemax may consider listing, the FTSE capitalisation is twice that of Euronext and nearly four times the German bourse.

Loan finance is an alternative proposition, and this may be from a single lender or a syndicated loan, with securities being loan stock, listed bonds or high yield retail bonds. Corporate mini-bonds are often issued to customers to raise the brand profile and engage customer loyalty, and Eyemax is considering this for its mobile phone customers.

Eyemax’s recently appointed CFO needs to consider hedging abilities where different currencies are relevant for income and expenditure, as well as considering the Group’s cash and liquidity management.

Joint venture relationships
As regards the solar lens bowl, Eyemax’s directors realise that it needs to enter into a joint venture arrangement, preferably with a substantial utility group. This would help with regard to combining the expertise of both groups, spreading the financial risk of developing the solar lens bowl and actually obtaining the relevant finance.

The JV agreement would need to cover management functions, minority share protection if relevant, deadlock and resolution, share transfers and termination, dividend and liquidation options, pre-emption rights, and drag along and tag along rights.

The relevant agreements would be the JV shareholders’ agreement, the Articles of Association of a specially created company, Service agreements of key personnel, plus related agency, licensing and intragroup agreements. The JV would usually start with Heads of Terms which would be reasonably comprehensive.

International tax issues
The international tax issues are both complex and extremely varied. Eyemax’s international tax advisers have focused on the issues which have changed in recent years as a result of the OECD’s initiatives to combat tax avoidance practices, specifically of large multi-national companies. However, these also impact on smaller companies like the Eyemax Group and have been identified specifically as follows.

The recommendations regarding the creation of specific tax provisions to the digital economy have been largely discarded, but the extension of the definition of a permanent establishment to create a fiscal presence in the relevant country has been approved. In Eyemax’s case, the warehousing operations for its lenses may simply be a storage and delivery option, which may not create a taxable presence, but if, like Amazon, the warehouse was fundamental to the business objective of Eyemax, then a fiscal presence could be established as a result.

Using beneficial tax regimes, for example for patent box benefits, requires substantive operations which actually develop the intellectual property rights concerned. Moreover, Action 6 attempts to deny treaty access for companies imposed whose principal purpose is to benefit from double tax treaty provisions.

Other provisions limit interest deductibility which previously has been dependent on the ratio of debt to equity (so called thin capitalisation provisions), but which now limit interest deductibility to between 10% and 30% of taxable profits as opposed to the company’s relevant capital. And one of the main provisions are BEPS Actions 8 to 10 relevant to transfer pricing, which primarily require a group to report its profits according to the functions and risks, and therefore relevant profits, that each operating company within a group should report.

The consequence of BEPS will undoubtedly be an increase in the number of international tax disputes between relevant countries. For example, the UK, French and Italian arbitrary assessments on Google will result in settlements being made which may have no bearing to reported profits (or the absence of them) reported in any particular country. How will the US give tax credits for such settlements, perhaps regarding them as fines or penalties rather than corporate tax credits?

The US has already stated that it will not sign up to a multi-lateral agreement, preferring to invoke its anti-avoidance provisions through bilateral and indeed unilateral provisions. To some extent, the US regards the OECD recommendations as being targeted against US companies (which is probably the case) and intends to create an environment in the US where tax avoidance is no longer relevant to US based companies.

Thus President-Elect Trump wishes to reduce personal income tax rates to bands of 12.5%, 25% and 33% for income above US$225,000, compared with current bands with a maximum of 39.6%. And he also advocates an abolition of Estate Tax, which is currently at 40% top rate over US$5.45 million. But of more relevance to Eyemax and similar companies, he wishes to create a single 15% corporate tax rate compared to the current 35% top rate, with the abolition of the complex Alternative Minimum Tax. By creating a more benign corporate tax environment, he hopes that the plethora of corporate inversions which have taken place in recent years will no longer be so attractive. And moreover, for companies like Apple who have retained profits overseas rather than repatriating them, he advocates a 10% single rate for repatriation of such foreign retained profits, which he hopes will bolster the US economy.

Summary
The metamorphosis of Polycon Lens Company into the Eyemax Group could not have been achieved without Stephen Holmes’ entrepreneurial skills and creative input. But equally, it required professional expertise in a variety of disciplines as explained above.

This then is the rationale behind my concept in creating the IBSA, the International Business Structuring Association, which is the only global multi-disciplinary association of professional advisers engaged in this type of advisory work. Reference can be made to the IBSA website for a better understanding of what the IBSA does, its branches worldwide, and the variety of discussion group meetings held across the globe on all topics connected with international business structuring.

With kind regards

Roy Saunders

The post December 2016 (162) – POLYCON CASE STUDY appeared first on IFS Consultants Ltd.

OECD’s Base Erosion and Profit Shifting (BEPS) project addresses all the cross-border planning techniques that have brought the profession of a tax advisor into disrepute. It has created a 21st century playing field and we must all know the new rules.

Over the next 6 months, Dmitry and I intend to write one article a month on the way the various Action points under the BEPS initiative of the OECD are being actioned and implemented (or disregarded) by various countries. This month’s newsletter is about interest, the tax-deductible sort (or perhaps non-deductible sort). Next month will be Treaty Access and limitations; the following month will be prospective changes to taxation in the digital economy; the following one may be International Tax Disputes and how Action 14 may be implemented.

We will be discussing the above and other BEPS Action points at the IBSA conference coming up in a couple of weeks (click here). I do hope to see many IFS Newsletter readers at this event at the Landmark hotel, London, on 18th November, so do please contact me if you would like to attend.

I always like hearing from colleagues and clients, new and old, and in the meantime, I hope you enjoy reading the current update in interest deductibility.

With kind regards

Roy Saunders

Debt v Equity and Notional Interest Deduction

In our October 2015 newsletter, we discussed the Base Erosion and Profit Shifting (BEPS) project for which the OECD had just finalised their Action Points recommendations. Unlike EU’s legislation that has immediate effect when it becomes national law (which is obligatory for all EU Member States), or some federal legislation that is immediately transposed in the Member States’ jurisprudence, recommendations given by the BEPS Action Points are … only recommendations. However, in seeking to prevent multi-national corporations (MNCs) shifting profits from high tax to low tax jurisdictions and achieving unintended tax benefits, we have seen many countries enthusiastically implementing the BEPS proposals, including some non-OECD members.

Most Action points bring a sea-change to how MNCs operate with some points being more obvious than others; however, Action 4 is amongst the easiest to comprehend. It limits the amount of interest that a company or a group can deduct in calculating its taxable profit by introducing a cap of between 10% and 30% of EBITDA on both internal and external debt. This is different from previous debt:equity ratios which looked at the capital ratios of the two methods of financing, since it now relates interest deductibility to profits of the organisation. Moreover, the limits that have been imposed on internal debt for many years as a development of thin capitalisation rules, have not included external debt in the equation. This has far reaching issues. For example, the external recipient will always be taxed on the interest receivable, but the payor may have a limited deduction, resulting in a tax mismatch. And companies within an international group may require finance in particular sectors where EBITDA profitability is limited, or even non-existent, even though the overall group finance is within the prescribed limits. This has in fact been recognised by the OECD and resulted in amended recommendations for banks and insurance groups.

For many years the UK’s legislation has provided for a host of measures in an attempt to achieve an effect similar to that of Action 4, such as thin capitalisation rules and debt cap as mentioned above. However, the Budget 2016 has introduced new restrictions on interest deductibility, including an interest deduction cap of 30% of EBITDA, with a de-minimis group amount of £2 million in interest payments per annum, below which the cap would not apply. The updated draft legislation is expected in early December 2016 and will come into effect on 1 April 2017.

Our colleagues and landlord, Simmons Gainsford, in their analysis of the original proposals of how they apply to UK property exploitation, concluded that the new rules only applied to UK corporation tax payers and not to income tax payers such as non-resident landlords. That conclusion has clearly also been noted by other respondents to the consultation document and has been picked by the UK Government. In their follow-up consultation document, the UK Government is now proposing to widen the interest cap to non-resident landlords to create a “level playing field” with UK corporate landlords!

The effect of this legislative change can be summarised as follows:

• Where a property portfolio held by an offshore investor / fund has an EBITDA of circa £10 million which would otherwise be sheltered by (say) £9 million of interest costs resulting in taxable profits of £1 million and tax of £200,000 pa.
• The interest cap would restrict interest costs to £3 million leaving £7 million of income subject to income tax at 20% = £1.4 million pa i.e. an increase in tax of £1.2 million pa which could have a very dramatic impact on cash flows and yield.

The post November 2016 (161) – DEBT V EQUITY AND NOTIONAL INTEREST DEDUCTION appeared first on IFS Consultants Ltd.

One can look at the technical aspects of the source rules, such as the ‘Nexus approach’ for the taxation of intellectual property in accordance with Action point 5 of the BEPS initiative. But in essence, governments and tax administrations are looking beneath the surface and attempting to assess substantive elements of a taxpayer’s income. Should Amazon avoid local taxation merely because it does not meet the technical definition of a permanent establishment? Should Google avoid local taxation where a fundamental part of its business emanates from local activities? Should Vodafone avoid local taxation on the sale of a local business merely because the legal ownership resides in a foreign enterprise?

Tax authorities are no longer restricting themselves to where legal ownership of assets and income actually resides, but are able to extend source rules beyond superficial appearances. Thus an offshore entity may own valuable intellectual property rights, having registered such rights in its name, yet the work in creating such rights has been undertaken by personnel based elsewhere. Transfer pricing analyses will assist tax administrations in understanding these issues, and will lead to companies reviewing historical approaches to international tax planning. Yet there remain many opportunities to mitigate tax costs which are actually encouraged by national legislation, and the function of an international tax consultant is to be aware of these incentives whilst understanding the need to substantiate activities within an appropriate structure.

IFS has held annual conferences for many years every November at the Landmark hotel, London, now under the IBSA banner (IFS created the International Business Structuring Association in 2014). We will be identifying such incentives in this year’s conference, which is based on a fascinating case study of how a small company develops its business globally, and the range of advice obtained throughout all its growth stages. From research and development planning to intellectual property identification and exploitation, to financing its expansion, dealing with VAT issues and maximising after-tax profits – and even developing a brand manifesto and digital strategy for its products, we are covering the major issues the entrepreneur experiences. We have a great programme of experts in various fields working through the case study and I know it will be an invaluable day’s experience for all delegates. For more information, please look at the IBSA website at (click here).

As a further reflection of the extension of the source rules as they apply to real estate in the UK, this month’s article has been written by Dmitry Zapol and considers some of his recent experiences with IFS clients who have acquired UK properties either for their own use or as investments.

With kind regards

Roy Saunders

Developments in Real Estate Taxation in Recent Years by Dmitry Zapol

For decades, the UK has welcomed overseas investors with interests in residential and commercial properties with its benign tax regime. Admittedly there had been a few mildly irritating snags: an increasingly high stamp duty land tax (SDLT), unavoidable taxation of rental income, and inheritance tax issues. These may have been mitigated with the help of foreign property owning companies and various debt instruments, whose costs were dwarfed by the ensuing benefits. However, the main advantage lay in the absence of taxation associated with ownership and disposal of UK real estate by non-residents.

Finance Act 2012 shook up the existing tax planning framework, with later legislation causing further dismay to new entrants to the property market. Readers may find useful a short rundown on how the residential taxation rules have been tightened over the last few years.

In 2012 we saw the introduction of a higher 7 percent SDLT on acquisition of residential properties with a purchase price of over £2 million (USD2.65m). The same property bought by a “non-natural” person (typically, a company) would now attract a 15 percent tax. The changes were introduced almost overnight, giving no time to prospective purchasers to restructure their transactions.

In an effort to discourage inheritance tax avoidance through personal ownership of UK situs assets, Finance Act 2013 introduced the annual tax on enveloped dwellings (ATED). Its purpose has been to discourage corporate ownership of UK residential properties by making the owner pay an annual charge, with the amount dependent on the property’s value. Also for the first time, non-UK resident owners became liable to tax on capital gains arising on disposals of UK properties in respect of which the ATED was due.

Finance Act 2014 brought in a significant limitation of the scope of liabilities that could be used to reduce a UK inheritance tax charge, while Finance Act 2015 made non-UK residents liable to UK tax on capital gains arising in connection with disposals of all UK residential properties.

In an attempt to cool down the buy-to-let market, Finance Bill 2016 has introduced an additional 3 percent SDLT rate on purchases of second residential properties in the UK. In 2017, this measure will be complemented by a restriction on the deduction of financing costs by individual landlords. Also in 2017, individuals will no longer be able to “hide” properties behind non-UK companies to avoid inheritance tax.

Alongside these major changes, the UK Parliament created a continuing narrowing of the thresholds at which the new charges would apply, causing more properties to come within the ambit of the legislation. The increasingly complex rules have been mostly aimed at shaping personal exploitation of UK residential properties — where a residential property is rented out commercially, the owner receives SDLT and ATED reliefs.

Curiously, the tax rules associated with commercial properties have not undergone such dramatic changes. This is despite the fact that much larger direct tax revenues can still escape taxation. The most significant development lies in the restriction of the use of double tax agreements with the Crown Constituencies when creating investment structures. Also, the scope of the transaction in land rules has been significantly narrowed, although these have always formed part of the legislative network.

We are now in a situation where before the legendary Englishman (or property owner of any nationality) can call his home his castle, he has to face numerous obstacles and traps set by the Exchequer for the unwary.

There is a bewildering mix of SDLT, inheritance tax, capital gains tax and occasionally income tax that is rarely imposed in a combination likely to satisfy the homeowner. Instead, as with communicating vessels, a reduction in liability in one area often leads to increased liability elsewhere. However, laws of physics do not apply to taxation, and the converse is not always true.

Let’s illustrate the above by considering the situation of a wealthy family who are looking to buy a mix of residential properties in the UK, which in the author’s view forms a fascinating tax management puzzle.

Non-Resident Property Investment in the UK: A Case Study

In the situation under examination, Michael is the father who normally lives and works outside the UK and visits his family occasionally to avoid UK tax residence. Marta is Michael’s 18-year-old daughter, who has lived and studied at Brighton College for four years and is now moving to London to attend the London School of Economics (LSE). Marina is their wife and mother, who had lived with Marta in a rented apartment while she was a schoolchild and is now looking to move closer to the capital.

The family already have a number of residential properties outside the UK, which belong to the three of them in various proportions. Now Michael and Marina are looking to buy a £7 million family home in Surrey. Also, to ease Marta’s transition into the adult life, they want to buy her a £1.2 million apartment in London.

Michael is worried that anyone can pull their names as home owners from the Land Register. He has heard that the family can remain anonymous if they buy the properties through offshore companies. Michael is concerned to hear about a flat 15 percent SDLT that the company will pay if it purchases the house in Surrey and Marta’s London apartment. Additionally, every year the company will be liable to file an ATED return and pay the ATED charge at the rate published at HMRC’s website (Note 1). Conversely, there are no such consequences where an investment property is bought by a corporate body. Thanks to the property business relief, (Note 2) the 15 percent SDLT rate and ATED are avoided, provided that the apartment is rented out on commercial terms for at least three years to persons not connected with the family.

He wonders whether a nominee holding company may provide a solution to Michael’s concerns. The corporate owner would typically be registered in a low-tax jurisdiction where it falls outside the scope of the UK’s PSC (persons with significant control) register rules (Note 3). The company acquires the legal title to the properties, which is reflected in the Land Register, whereas the beneficial title remains with the family under a bare trust agreement.

As a result, from HMRC’s point of view, the structure remains tax transparent while at the same time the anonymity requirement is achieved. Although in March 2016 it was announced that beneficial ownership information relating to UK land may become available to the public, at least for now the nominee corporate ownership achieves its purpose. In the end, the family agree to pay the annual fees to maintain the nominee company with a view to liquidating it should the proposals on the beneficial ownership disclosure become law.

The next step is to decide on the financing. Michael has enough capital to pay for the properties outright, although he has access to finance, and Marina together with Marta can take out low-interest UK mortgages guaranteed by the father. With everything else being equal, the mortgage option is recommended – if the mortgage is on market terms, it constitutes a liability that reduces the value of the family’s estate for the family’s inheritance tax liability. If the mortgage is interest only, the liability remains for its entire term. Alternatively, as repayments are made, Michael and Marina may think about taking inheritance tax insurance to cover the shortfall.

The three family members are happy to own the Surrey home as joint tenants where each person has equal rights to the whole property. If one of the parents dies, their share of the property automatically passes to the other parent and to Marta. In the former case, the spousal exemption applies, (Note 4) resulting in no inheritance tax liability. In the latter case, the liability can be managed by insurance, as discussed above. Later, the surviving parent can gift his or her share of the home to Marta, although this could be considered a gift with reservation of benefit (Note 5). Unless the parent moves out of the home, starts paying Marta market rent, or occupies the property under Section 102B of the 1984 Inheritance Tax Act, paying their proportion of the running expenses, the property will remain in the parent’s estate on death.

It is decided that Marta will be the sole owner of her London apartment.

Before the family exchange the contracts with the sellers, the question of SDLT comes up again. Marina and Michael already own homes in their country and as a result they are liable to pay the extra 3 percent tax on the purchase of the UK property (Note 6). Because they are married, even if Marina sells her share, the charge will not be avoided.

Michael cheekily suggests a divorce, but faces the wrath of Marina and an explanation that the separation must be absolute and not just on paper! Still looking for ways around paying the tax, Michael wants to know how the tax is administered. The conveyancing solicitor tells Michael that he is under an obligation to disclose ownership of his homes worldwide and that Michael faces substantial interest on unpaid tax and penalties for non-disclosure, with HMRC being able to contact foreign tax authorities using the tax information exchange agreements.

Grudgingly, Michael comes to terms with the inevitable tax liability. However, it occurs to them that Marta will also face the 3 percent charge when she purchases her London apartment due to her share in the family’s property outside the UK. There is still time for Marta to gift that share to her parents without adverse foreign tax consequences. But a gift of the foreign property constitutes a chargeable disposal from the point of view of UK capital gains tax, leading to a 28 percent liability. Luckily, Marta has been in the UK for less than seven years. As a non-domiciled person, she can claim the remittance basis of taxation without paying the £30,000 remittance basis charge and avoid the tax completely.

Even if Marta parts with her offshore property, the fact that she co-owns the Surrey home keeps her within the ambit of the 3 percent charge. In the end, the family have to decide whether avoiding the extended SDLT expense is more beneficial than the hassle of getting rid of the foreign real estate and facing a potential future inheritance tax liability when passing the family home to Marta. HMRC have a useful SDLT calculator that helps them with making the choice (Note 7).

In the end, it is agreed that Marta will be one of the joint tenants of the family home and will own the flat on her own. It is decided that Michael will pay for the property outright. To avoid a potentially exempt transfer that could lead to his inheritance tax liability, Michael transfers the required funds to Marta’s non-UK bank account from which she pays the solicitors in the UK.

In the future, when the parents or Marta decide to sell the properties, they can claim the principal private residence relief and avoid capital gains tax on disposal, although Marta may have to choose which property constitutes her home and make an election within two years of the acquisition.

Soon the parents decide to acquire a £3 million apartment, also in London, that they plan to keep as an investment property and rent out through a letting agency for at least five years. Considering that neither the 15 percent SDLT nor ATED will be an issue, they can acquire the property both directly or through a company. Unfortunately, since they already own homes, the extra 3 percent SDLT will apply if they own the property personally, whereas the company will be charged at the regular progressive rate.

In reaching his final decision, Michael should consider taxation of the rental income. Whether it is Michael or the company letting the apartment, they have to register as a non-resident landlord (Note 8). Although rental profits can be received net of income tax from the tenants or from the managing company, it is normally more efficient to receive them gross and pay tax directly to HMRC by filing an annual tax return.

As an individual, Michael is liable to UK income tax on the net rental income at his marginal rate; however, only his UK source income affects the effective rate. Additionally, as a resident of a country with which the UK has concluded a double tax agreement (DTA) with a non-discrimination article, he can benefit from the annual income tax allowance, which is currently £11,000.

Notably, not all DTAs provide for the exemption, and HMRC have published useful notes explaining this (Note 9). In most cases, UK income tax can be credited against Michael’s tax liability in the country of his residence. Conversely, the company pays a flat 20 percent income tax on UK rental profits. Absent further corporate taxation in the offshore jurisdiction, it can distribute taxed income as dividends elsewhere. Unless Michael meets the terms of the controlled foreign company rules in the country of his residence, such income will not be taxed further.

In both situations, the rental income can be reduced by the amount of financing expense, such as loan interest. However, as an individual, Michael is limited in his ability to reduce the rental income by the finance cost up to his basic rate of tax (Note 10). There are no such strict restrictions imposed on corporate landlords at the moment, although legislation is expected to this effect in the near future (Note 11).

When the time comes to sell the apartment, Michael will be liable to UK 28 percent capital gains tax on the disposal gains, despite being non-UK resident. Conversely, the company will pay 20 percent tax on capital gains. In principle, Michael may be able to sell the company’s shares and pay no tax whatsoever; however, under the new anti-avoidance rules, HMRC may see this as a disguised trading transaction and impose tax.

In conclusion, it is worth noting that the government has also announced that in 2017 it will legislate so that inheritance tax is charged on all UK residential property, including property held indirectly by non-domiciled individuals through a structure such as an offshore company (Note 12). It is probable that the rules will include residential property that has been rented out.

Despite the mammoth efforts of the Office for Tax Simplification, legislation keeps growing in size and complexity. Readers must appreciate that a concise case-study cannot avoid the oversimplification of certain matters and the author has left outside the picture many permutations that the real-life clients throw at him. In the end, however, the UK still remains an attractive destination for property investments provided of course that competent tax advice is sought!

Endnotes:

Note 1 (click here)
Note 2 (click here)
Note 3 (click here)
Note 4 (click here)
Note 5 (click here)
Note 6 (click here)
Note 7 (click here)
Note 8 (click here)
Note 9(a) (click here)
Note 9(b) (click here)
Note 10 (click here)
Note 11 (click here)
Note 12 (click here)

The post September 2016 (160) – DEVELOPMENTS IN REAL ESTATE TAXATION IN RECENT YEARS appeared first on IFS Consultants Ltd.

And then the doubts crept in. I have always thought the initial idea of a free trade association had been hijacked by bureaucrats intent on their political ambitions of a United States of Europe, a project which I think is doomed to monumental failure. Indeed, I am sceptical about the longevity of the Euro and delighted we will share no part in its eventual downfall. But do I really want the UK to share in the collapse of the European Union if the politicians refuse to curb the dictatorial directives coming out of Brussels.

Boris Johnson’s support for the Leave campaign has not helped me decide one way or another. If Cameron’s gamble on remaining in the EU fails, he could well be our next Prime Minister, and without even venturing to compare such an outcome with what I perceive as a disaster for the US if Donald Trump is elected President, Boris as our PM is not someone I would want to preside over a post Brexit period of instability. His gung-ho approach to an independent UK doesn’t really address the true consequences of a potential exit of the UK from the European Union.

Perhaps the most emotive reason for the general population to want to leave the EU is the perception that immigration levels will fall and that we will not have to accept Eastern European migrants nor Turks, should they be accepted into the EU in the near future as envisaged. The risk of increased terrorism has been raised by Leave campaigners, although Remain campaigners say that continued co-operation with anti-terrorism squads in our neighbouring EU countries will be jeopardised if we leave the EU. Who to believe? Do we really think that our ex-EU partners will withhold information on terrorists and allow attacks to be made within the UK?

That’s one of the problems, scaremongering from each side confuses everyone. But let’s continue to look at the immigration issue. Countries such as Norway and Switzerland have negotiated separate trade agreements with the EU and one of the conditions of such agreements is that the freedom of movement of labour is upheld. This means that all EU citizens may live in Norway and Switzerland if they choose to, and the sovereignty of these countries to close their borders to such migrants is therefore compromised. It is very unlikely that the UK would be able to reach a different trade agreement to the ones that exist with Norway and Switzerland, and indeed the Leave group have pointed to these agreements as evidence that we will indeed be able to negotiate an agreement with the EU to demonstrate that trade barriers will not exist if we leave the EU. So it is more than likely that we will have to accept the same level of migration from EU citizens as currently.

As for non-EU citizens, maintaining our non-Schengen status means we do indeed have control over our borders, even if internally we are sometimes lax in their execution. So leaving the EU to reduce the level of migration seems to me something of a myth.

One of the events in the last few years which upset me the most was the way Cyprus was treated by the EU during its banking crisis of 2012. Heavy handed and patently unfair, many Cypriot bank accounts were frozen with a maximum permitted withdrawal of €100,000 in total. Those with more than €100,000 in bank accounts with Laiki Bank and Bank of Cyprus had to forfeit the excess in what most citizens would have identified as daylight robbery. By remaining outside of the Euro, we do not risk the same level of control by the EU, but nevertheless their actions must serve as a warning to all countries that the dictatorship of bureaucrats working within the EU must be addressed. This is something that the UK needs to consider should we remain in the UK, where our influence should be a material factor in persuading all politicians that similar actions should be made illegal in the future. This may also help to ensure that member countries remain as sovereign states able to take their own decisions, even if they fall short of Euro requirements of fiscal management. This seemingly incompatible conflict is the reason why ultimately I believe the Euro is a failed concept in the absence of a political Super State, and why there will need to be at least two levels of currency with the Eurozone to cope with conflicting economic realities. But as for Brexit, the UK is not within the Eurozone and maintaining the Great British Pound was probably the best political decision ever made!

Then we come to the economic benefits or otherwise of staying within the EU. The downside is very real, the budgetary payments we make are very costly to our economy, and there are certain subsidies within the EU from which our businesses are unable to benefit, which may seem patently unfair. So there is no doubt there is a cost of being a member of ‘the club’ of the EU; but that is the same with any club and one has to weigh the economic benefits against such costs. From what I have read, most economists are squarely divided down the middle as to whether the costs outweigh the benefits or otherwise. That, of course, is normal for economists, but politicians for Leave or Remain have been unable to convince me that there is a clear economic benefit, one way or another. I am sure that the majority of the country is unable to make a clear considered conclusion as to the economic benefits or otherwise, and therefore it seems to me that emotional arguments will prevail.

And this is where we are with scaremongering. The Remain group say that we risk years of uncertainty, that the stock market will plummet affecting people’s pensions, that the pound will fall fuelling inflation and making our European holidays more expensive (if we are allowed in without visas!). The Leave group say that the UK is one of the strongest economies in the world and will easily withstand maybe a couple of years of uncertainly (which the Remain group considers could last for a decade). I don’t believe in either camp’s views; the UK will certainly survive an EU exit without a dramatic effect on our economy, yet there will be certain elements of the economy that will suffer.

One of these could be the role of the City of London as the world’s financial centre. Another could be the ability of our service professionals to ‘passport’ their business into the EU. At best, there will be an inconvenience, at worst, a financial loss of revenue. But economic issues should not lie at the heart of our decision making, certainly not when they are uncertain and neither camp can demonstrate responsibly that they have a clear understanding of the consequences of a Brexit. Nor should emotion govern the voting decision on June 23rd, especially when the understanding of what a sovereign state can control in terms of immigration is unclear.

What may eventually sway the vote should be the moral question of the role of the UK within the EU and the wider world. One fact that is indisputable is that the EU has experienced decades of peace which have never before been experienced. Should the UK leave the EU, it is my belief that this will be followed by other countries leaving the EU and the eventual disintegration of what was originally conceived as a free trade area with co-operation between countries in many areas of public life; police, travel, welfare, and the free movement of capital and labour throughout the EU. By leaving the EU, maybe we are throwing away the baby with the bathwater!

Instead, we need to take a lead within the EU, perhaps along with Germany in particular, to ensure bureaucracy is curbed and perhaps to limit the accession of new countries by imposing new conditions of migration and welfare benefits. If we cannot do this through co-operation, we should show our bulldog spirit by doggedly using our veto to create changes in the way the EU works.

So maybe I have made up my own mind as to how I am going to vote on June 23rd. But I would love to hear from you with your views, and your comments on what I have written above. In the end, will it be our heart or head that votes?

Join the debate via our LinkedIn discussion group.

With kind regards

Roy Saunders

The post April 2016 (159) – SEEKING VIEWS OF IFS NEWSLETTER READERS ON BREXIT appeared first on IFS Consultants Ltd.

Although the article interestingly describes mainly non-tax issues relating to IP, the international tax ramifications of profit allocation across borders is likely to give rise to lengthy and costly tax disputes. The ‘modified nexus approach’ referred to at the end of the article is just one example of how tax administrations are going to make assessments based not on legal ownership nor established understanding, but on arbitrary profit allocation. The Google example in last month’s IFS newsletter is a good example of how the concept of permanent establishment is being extended beyond existing law, undoubtedly leading to more disputes in the future.

I have arranged a workshop for the IBSA on 12th April [click here] to study the ramifications of such arbitrary assessments in the absence of definitive and conclusive mutual agreement procedures between multinational tax administrations. We are fortunate to have HMRC’s head of transfer pricing participating in the workshop who is responsible for the mutual agreement procedures in the UK. Also participating will be Philip Baker QC, a leading and influential international tax barrister, Keith Brockman, tax director at Mars Ltd, and Philippe de Saint-Bauzel, French lawyer with Squire Patton Boggs who are the hosts for the workshop.

There is no doubt that we are tumbling into unchartered waters if the Action points of the BEPS initiative are adopted in part or in entirety. But regardless of tax implications, understanding that 80% of global corporate wealth is in their intellectual property demands a thorough awareness of the need to fully understand such a valuable asset.

Identification

Using the two case studies to illustrate the range of intellectual property identified, we started with the school entering into a licence or joint venture agreement with the Chinese group, giving it an exclusive right to use the name and brand in China. The school would also provide its know-how, curricula, course materials and consultancy services in consideration of an up-front payment and an annual royalty based on fee income. The school is aware that although it has registered its trade name, the unregistered rights relating to the longevity of its brand and the goodwill attached to it, and the copyright in its course materials and know-how, are unprotected.

The gin distillery business has registered its name as a trade mark, and has also attempted to register the particular taste of the gin it distils. It has a website which provides online distillery tutorials which is growing internationally, as well as a social media following of over 500,000 individuals. It wants to broaden its merchandising and brand possibilities to other products such as clothing and sports equipment. As with the school, its intellectual property is partly protected through local trade mark registration of its name, but the copyright in its logo and packaging, and the very significant database of its followers are incapable of protection.

In both cases, the companies need to consider what they can protect, where they should seek protection and critically how much they need to spend on such protection.

Protection

The discussion group recommended that the school should search the trade mark register in China to see if there are competitors with earlier rights in identical or similar names. It may be that individuals have registered speculative trade marks in the hope of ransoming legitimate owners who want to create such licence agreements, and although there is a code of conduct for lawyers in most countries preventing spurious applications, this code may not be universally applicable.

When registering a trade mark, the school may simply require registration under the category of education services. But the gin distillery may wish for a much broader range of protection with a view to licensing and merchandising, although the broader the range of services/products, the more likelihood there is that other registrations may already exist under conflicting trade marks.

There is no global trade mark registration, so the next issue is in which countries registration should be made. Local registration in one EU country may be made, but this can be extended to all 28 EU countries through a Community Trademark costing just €900 for 10 years! Then the Madrid Protocol is a bundle of national trade mark rights which may protect companies when licencing their names in countries such as the US, China and Japan, which is also cost effective.

Whether registration is worthwhile depends on whether a company can use such registration for protection within a particular country. However, there may be a need for registration to satisfy the due diligence requirements of investors and bankers who may be more impressed with documents of registration than the relevant company merely having traded profitably for many years.

Valuation

We then addressed the issue of valuation and royalty rates. Maybe the school has no intention of selling its IPRs and merely wishes to licence the rights, but perhaps it wishes to open its own schools in other Asian countries once it has experienced the problems and opportunities in China, for which it needs to raise finance. The banks or investors will require a valuation which will take into account not only the registered trade mark but the other identified IPRs. The valuation will also depend on the licensing agreement entered into, with issues such as exclusivity, term and jurisdiction dictating whether a premium or otherwise on valuation is required.

The gin distillery company may wish to expand its horizons and may contemplate developing a group structure where a foreign entity is to own and exploit the brand. In this case, the valuation will take into account the desire of the local tax administration to ensure a fair market value is attributed to the IPRs as a package. Or perhaps the IPRs are to be charged to pension fund trustees to secure an advance from an existing pension trust for business development.

For the gin distillery, creating a strong brand in a very competitive field may dictate a lower valuation. Moreover, value can be enhanced through licensees, and it must be established who has the rights to the enhanced value of the IPRs going forward.

Unfortunately, where bank finance is concerned, valuation of IPRs in a going concern may not be acceptable to the banks, whose Domesday approach to business also may require a valuation based on a forced sale basis pursuant to a liquidation of the going concern.

It is unfortunate that accounting standards do not enable companies to reflect the value of their IPRs on their balance sheet, other than merely the cost of their development. Otherwise, a company could revalue its IPRs to current valuation with a corresponding Reserve account in Shareholders’ funds. This would clearly demonstrate to banks, investors and customers that the company has a valuation in excess of merely share capital and retained earnings. This is especially relevant since 80% of global corporate wealth is in undervalued intellectual property. However, it was explained that only in circumstances of a merger or acquisition do current Accounting Standards, lamentable as they are, allow for the recognition of intangibles in Accounts; in-house developed IP cannot be shown at fair value.

The meeting then considered whether an inter-group sale could achieve this objective whilst allowing for tax efficient exploitation of the IPRs. This has tax implications which I explain below. Another technique may be to illustrate the value of in-house IP, its management and exploitation by say licensing, in an accompanying Operational Review document, a technique used by some of the major IP rich companies. There is no reason why SMEs cannot adopt the same strategy.

Exploitation

As regards the tax implications of an inter-group transfer of IPRs to a more favourable tax jurisdiction, this will result in a taxable disposal which will be calculated by the excess of valuation over acquisition and development costs. However, this would enable the acquiring group entity to reflect the full value on its balance sheet. The tax cost may be worthwhile if the IPRs are likely to increase substantially in value, and if royalty income from the exploitation of the IPRs is to be receivable in a low tax jurisdiction.

In the case of the school, being a registered charity, such a transfer of rights is unlikely and would be carefully monitored by the Commissioners. The gin distillery may however think this is a suitable strategy, subject to reputational issues should these affect the brand’s value. The valuer of the IPRs may also be requested to determine the royalty rate applicable to licensing arrangements so that transfer pricing adjustments can be countered with such independent documentation.

Many countries such as Malta, Cyprus, Luxembourg and Ireland have had advantageous tax regimes applicable to certain types of intellectual property, although the European Commission have determined that some of these regimes provide unacceptable State Aid. These jurisdictions have therefore adapted or even repealed their regimes to fall within accepted EC wisdom.

But another problem has raised its head, being the OECD BEPS initiative where countries are required to adopt the ‘modified nexus approach’ in relation to intangible assets, meaning that income from intellectual property rights should be where the initial risks and development work have been undertaken. Thus legal ownership (through acquisition) may not be sufficient to allow profits to be allocated for tax purposes to the relevant legal entity, and not to those entities where the risks and development work occurred.

With just one minute to go before the discussion group dispersed to a cocktail party of wine and nibbles courtesy of Farrer & Co, we fielded the question of the consequences of ‘Brexit’ on the Community Trademark and other aspects of European co-operation in the field of intellectual property (for example the Trade Secrets Directive or the protection of consumers from database infringements). Unsurprisingly, we agreed to leave this question for another occasion as this Molotov cocktail should not spoil our enjoyment of a more welcome cocktail.

For those readers who have not been to IBSA discussion groups which are held for IBSA members four or five times a year in London and in various other venues globally (Hong Kong, New York and many European capitals), the IBSA stands for the International Business Structuring Association (click here for the website). It is the only global association which is both multi-disciplinary as well as multi-jurisdictional, operating through four regional branches (Dubai to be added in October this year), and providing both knowledge in areas of expertise outside of members’ own area of knowledge, as well as informing members who to ask for advice in such areas should that be necessary. Having been established for just 2 years now, we are now pursuing a membership drive; if you would like further information, please email me or Joanna Bott.

With kind regards

Roy Saunders

The post March 2016 (158) – INTELLECTUAL PROPERTY IS MORE THAN JUST A NAME appeared first on IFS Consultants Ltd.