During my 35 years in practice as an international tax consultant, I have seen major changes in both the types of taxation levied and their rates, as well as the methods adopted to mitigate or avoid such taxes. Starting from a UK tax base of 98% tax on investment income in the ‘60s we experienced a decade of wholly artificial structures using offshore companies; this, coupled with the development of an industry devising tax schemes which had no real substance but were the figment of the clever brains of tax barristers, discredited our professional integrity for serving our respectable clients.
The entire industry was hauled up by its bootstraps in the early ‘80s following the Ramsay decision which created the requirement of commerciality for transactional activities that were designed to mitigate the tax burden. There then followed a decade of wholesale treaty shopping until the US imposed its first limitation of benefits article in the 1992 Dutch treaty effective from 1994, preventing conduit companies used for treaty shopping purposes to minimise the impact of US withholding taxes. Tax authorities then became more aware of the conduit company rules and started to challenge whether an entity was really the beneficial owner of relevant income, and imposed anti-abuse provisions under unilateral legislation, within double tax treaty arrangements and also under multi-lateral Directives.
I suppose the Noughties could be seen as the decade when tax technicians from both the profession and the tax administrations locked horns through a plethora of court cases as to the merits of assessments based on source of income as well as personal residence e.g. Vodafone case and the Gaines-Cooper case. Certainly the money laundering push of the Noughties seems to have drastically reduced the use of offshore entities in international tax structures. So what does this leave us for the ‘10s.
My prediction is that the international tax technicians will examine ever more closely the hugely complex web of domestic and international tax legislation in order to utilise wholly legitimate paths for securing tax advantages wherever possible. One of these areas is company migration, using the tax laws of another more favourable jurisdiction to reap advantages for an entity which can no longer benefit from tax advantages in its state of residence. Indeed, this type of entity was envisaged when creating the Societe Europeene which is described in the article below. But even if an SE has not been created at the outset, the EU Merger Directive explained below provides the opportunity to change residence of an entity from one EU state to another without crystallising adverse tax charges.
Or it may be that offshore entities, finding themselves incurring additional tax burdens as a result of changes in legislation in a particular country, decide to re-domicile from their jurisdiction into another. Or finally, without any re-domiciliation or merger, a company may simply move its tax residence by virtue of the resignation of its directors and the appointment of others in another country, thereby moving management and control to another state.
Examples of benefits derived from such cross-border migration of one type or another are explained in this month’s special article, and I would be delighted to receive the views of our readers with any comments they may have on what I believe will be one of the new concepts of international tax planning which categorises this coming decade. Click here for your comments.
This is the last newsletter before our Conference on 28 October 2010 at The Landmark Hotel, London, hosted by IFS. Cross-border migration will be amongst the topics discussed at the Conference and should any reader wish to attend the Conference who has not already booked their place, please do not hesitate to click here click here for the Conference programme and booking form. This will be an invaluable opportunity to listen to international tax experts from over 20 different jurisdictions discuss the commercial and tax issues relevant to the development of a company as it becomes an internationally renowned brand name and successfully quoted multinational group.
I look forward to seeing you soon.
Company Migration: A Tax Planning Concept
“One step forward, two steps back” was how Vladimir Lenin described the state of Russian political affairs in 1904. Had the famous revolutionary met Stephen Holmes, he would have invariably described him as “full speed ahead.” Mr Holmes scared his competitors and awed his allies with the swiftness of his decisions and velocity of Polycon’s expansion beyond its home state. The flipside of Mr Holmes’s business acumen was the excessive self-confidence and gusto with which he attempted to plan his tax affairs, and which created a bottomless source of income for the advisors hastily summoned to remedy the situation. We are reminding you that Mr Holmes and his Polycon group are the subjects of the International Tax Systems and Planning Techniques (ITSAPT) case study that lies at the heart of IFS’ Conference which will be held at The Landmark Hotel, 222 Marylebone Road, London, NW1 6JQ on Thursday, 28 October 2010.
Many years ago Mr Holmes left his Northern European Republic (NER) homeland in search of a better life in the UK. There he created Polycon Group Holdings Ltd, which held together the pieces of the Polycon lens-manufacturing empire. As a UK tax resident Stephen was taxed heavily on the generous income and dividends that he received from the holding company and envied his more fortunate Monegasque friends who paid no taxes at all. When the top income tax rate hit 50%, Stephen decided that something had to be done.
Although living in the UK for many years, Mr Holmes never abandoned the hope of returning to the NER one day (at least that is what he maintained), and thus he was not considered domiciled in the UK. A search on the HMRC website showed that while he paid taxes on income arising in the UK, he had the option to have his foreign source income taxed only upon remitting it to the UK. Although the bulk of his income was generated in the CER (Central European Republic), that company was owned by the UK-based Polycon holding company, and by receiving dividends from that company, he was effectively converting foreign source income into UK source income taxed on an arising basis. He wondered whether he could move the UK company abroad, and Maurice Brightman was the first point of call.
Maurice explained that Stephen was about to engage in cross-border tax arbitrage through either migration, re-domiciliation or perhaps a more convoluted merger arrangement of his holding company. This had to be approached from two different angles. First, the corporate law and tax regimes of both the destination and emigrating jurisdictions had to enable the strategy to be pursued. Second, the method of effective re-domiciliation had to be time and cost-effective, especially taking into account charges that the host jurisdiction could impose on the departing enterprise.
Addressing the first issue, the ideal tax regime would have a low rate of corporate income tax, it would not tax dividends or capital gains received from the subsidiaries and would not withhold tax on profits distributed as dividends. There also would be a wide network of double tax agreements. These considerations are well-known, and Maurice suggested migrating the holding company to say Cyprus, Malta or Luxembourg.
Regarding the second issue, often jurisdictions discourage companies from abandoning their residence through introducing the “exit charge.” The charge operates on an assumption that the company has realised and immediately reacquired its assets at their current market value on the day of becoming non-resident and it taxes the resulting gain. Maurice therefore said that the method of re-domiciliation depends on legislation of the states to and from which the company was migrating, as well as on any applicable supra-national agreements that could offer tax benefits. As Mr Holmes contemplated moving the Polycon holding company within the EU, its laws should be considered first.
Until relatively recently in the EU, it was considered unacceptable for companies to profit from ‘legal tax arbitrage’. The “real seat” approach in states such as France, Germany or Luxembourg prohibits companies from having their head office (the real seat) and registered office in different countries. The transfer of the head office abroad either results in the winding up of the original company or is subject to conditions and penalties (such as an “exit charge.”) There is currently a shift towards the “incorporation” approach, practiced in the UK and Ireland. The enterprise retains its status of a national company in the state where it was incorporated and under whose corporate laws it operates and it can establish its head office in another state.
A company’s residence is also determined by the tie-breaker residence clause in any applicable double tax treaty (DTT), which also stipulates the taxing rights of each jurisdiction. Maurice stressed however that although DTTs make tax arbitrage more accessible, they do not provide for every eventuality, and an enterprise may be subject to some obscure charges and levies in both states.
This move towards the “incorporation” method is the result of the developing ECJ jurisprudence, which found the “real seat” approach to be in violation of the freedom of establishment principle. Although, most EU “incorporation” states still impose exit charges on companies whose head office moves to another Member State (MS), these are contrary to the EU law and should be non-enforceable. As a result, enterprises are not prohibited from having their registered office and the head office in separate MSs, making the best use of corporate and tax laws in different jurisdictions. Where a company, which is lawfully incorporated in one state, moves its office to a “real seat” jurisdiction, the latter may not discriminate against the immigrating enterprise but must regard it as a national company.
Such right to the non-discrimination abroad still does not fully equate to the ability to re-domicile a company while keeping its legal personality. In fact, a company that wishes to migrate must often first be liquidated under the laws of the home jurisdiction, incurring financial penalties, such as exit charges, discussed earlier. In the absence of the specific legislation such as 14th Company Law Directive on cross-border transfer of the registered office, the only effective alternative lies in the cross-border merger method, derived from the EU Merger Directive.
Were Mr Holmes to migrate the existing holding company from the UK to, say, Luxembourg, the first step would involve establishing the company’s presence there by incorporating a Luxembourg company. In fact, this should be an existing company which has a record of activity to be acceptable to the UK court. The two would then perform a down stream merger, whereby the UK company would cease to exist and the Luxembourg company would take on all of its assets. This legal procedure requires the pre-consent of the UK court, followed by a notarial deed in Luxembourg which eventually gets registered in the UK court again, after which the company is dissolved.
Alternatively, Mr Holmes could simply replace the company’s CEO – an Englishman Mr Smith with his Luxembourg based director Monsieur Lefevre, and ensure that the company is effectively managed in Luxembourg, thus changing its residence under the UK-Luxembourg double tax treaty residence article. However, this would create a change of residence of Polycon Holdings from the UK to Luxembourg, as opposed to a dissolution of the company, and this may have other UK tax consequences which could be argued by HMRC. In both cases, Mr Holmes would of course become the shareholder of a Luxembourg holding company and therefore enable him to receive foreign source income taxed only on a remittance basis, permitting him to remain in his favourite location overlooking the Thames not far from central London, without the adverse tax costs he currently faces.
The principal benefit of the merger method lies in the absence of any sanctions that the home state (the UK) can impose on the migrating company or on its shareholders under the protection of the EU framework. Its main disadvantage stems from the relative rarity of cross-border mergers and lack of regulatory experience on the part of the national tax authorities, which still could attempt to impose financial penalties. Also, until passing of the legislation permitting the direct company re-domiciliation, the shareholders must contend with the cost and the need to establish a prior presence in the target MS through incorporating a company there.
As an additional option, Mr Holmes could convert the Polycon holding company into a Societas Europaea (SE) – a relatively new European corporate structure, and then transfer its registered office to Luxembourg. Although corporate migration within the EU is expressly pertinent to the SEs, this method is only likely to be acceptable in very particular circumstances. First, only a public limited company with a subscribed share capital of at least €120,000 can become an SE. This may attract corporate giants, such as Basf SE, Porsche Automibil Holding SE and BP Europa SE, but excludes smaller privately-owned enterprises. Also, a company can only be converted into an SE provided that for at least two years previously it has had a subsidiary company governed by the law of another MS.
Concluding on his discussion of company migration within the EU, Maurice Brightman pointed out that thanks to the EU Merger Directive and the principle of the freedom of establishment, the Polycon holding company could effectively be moved across the EU without incurring any tax losses and charges normally associated with winding up a company, and in most cases subject only to direct legal and registration expenses.
Mr Brightman warned that the same cannot not be said in case Mr Holmes wanted to move the enterprise beyond the EU. In most states the only way to strike a resident company off the register is through winding up, while only a few permit corporations to re-domicile abroad without incurring financial penalties. A Cypriot company for example can continue its existence abroad, provided the laws of the host country allow it and subject to receiving the consent of the Registrar of Cyprus Companies. A Maltese company can also emigrate to an approved jurisdiction which includes the MSs of the EU, EEA and of the OECD, together with the Bahamas, Bermuda, British Virgin Islands, Cayman Islands, Gibraltar, Guernsey, Isle of Man, Jersey and Mauritius. Redomiciliation is conditional to the laws of the host country envisaging such move and subject to the company retaining or succeeding to all assets and liabilities of the Maltese company. Similar requirements apply in Switzerland. Less stringent conditions apply in low tax jurisdictions, such as Bahamas, Barbados, Cayman Islands, Cook Islands, Guernsey, Isle of Man, Jersey and Mauritius.
Shareholders thinking of migrating their holding company from a State whose laws do not envisage re-domiciliation and which are not limited by the EU legislation should be wary of the exit charges that may apply. For example, if a UK-incorporated and resident company or a non-UK company, which has been previously fiscally resident in the United Kingdom ceases to be UK resident, it will be treated as if it has disposed of its assets at the date of changing its residence, and to have reacquired them at their market value, crystallising any unrealised gains for corporation tax purposes (TCGA s185). Such a charge may be postponed where the exiting company is itself a 75 per cent subsidiary of a UK parent, and will only crystallise if either the assets are actually disposed of within the following six years or if the exiting company ceases to be a 75 per cent subsidiary.
Similarly, if an Italian-resident company transfers its tax residence abroad, it is similar to the transformation of its legal status and change of its nationality. For income tax purposes this entails a realisation of the company’s assets or of its business at a fair market value, unless these are conveyed to a permanent establishment located in Italy.
Just as explained earlier, a company’s residence is determined by the residence clause in any applicable DTT. Sometimes failure to observe these rules can lead to unexpected results, particularly for companies registered in “incorporation” states. If, for example, Mr Holmes as the sole director of the UK-incorporated Polycon moves to the NER, he will be deemed to have acquired residence there. As a result, the company itself would be treated as having changed its residence and subject to the “exit” corporation tax charge on deemed disposal of its assets.
Having virtually held his breath during Maurice Brightman’s discourse, Stephen Holmes breathed a sigh of relief that at last he had learned the value of asking questions first and acting later.