Did you know that most of the Fortune 500 Companies pay a fraction of the tax paid by smaller limited liability companies? ‘Tax treaty’ shopping, tax ‘loopholes’ and tax competition/concessions allow such companies to arrange their affairs in such a manner that they end up with a very low tax burden compared to that of totally indigenous United States and United Kingdom companies. Notwithstanding the political rhetoric sometimes expressed against multi-national companies in parts of the media, it would be a mistake to think that such activities take place without the knowledge of the US Internal Revenue Service or HMRC in the UK. In fact, quite the opposite, as there are many instances of countries where there are high corporate taxes deliberately creating, or at least turning a ‘blind eye’, to various loopholes primarily with a view to giving their multi-national companies trading advantages on the world stage. In the case of the United States, the IRS has long turned a blind eye to its larger companies using captive insurance companies as a method of mitigating tax or favourably treating investment repatriations from countries such as the favoured Republic of Ireland.
There is also a direct correlation between the sophistication of a country’s tax treaty network and its economic development witness countries such as the Netherlands, Switzerland, Luxembourg and Ireland. The objective of the SCF Group is to offer and exploit the numerous tax concessions available to those investing or trading abroad to Small to Medium sized businesses at rates a fraction of those charged by the international accountancy firms. For more information please contact us today!
Double Taxation Treaties & Why They Developed?
Many people consider that only multi-national corporations can enjoy the benefits of double taxation treaties. In reality, they are available to all investors, be they small or large. The purpose of this section is simply to provide an understanding of what they are and how they may be used.
With the rapid increase in world trade, trading blocs and multi-national corporations, it became imperative that some mechanism was interposed to prevent individuals and firms from being taxed twice, or at different levels, for the same or related activities. The result, particularly after the Second World War, was the development of an ever expanding number of Double Taxation Treaties. In addition, there developed international organisations, such as the Organisation for Economic Co-operation and Development (O.E.C.D.),the General Agreement on Tariffs and Trade (G.A.T.T) regional trading blocs, such as the European Union and more recently, the North American Free Trade Area (N.A.F.T.A). Their 'modis operandi', whether regionally or on a world- wide basis, was and still is, to set certain parameters on the potential trading conditions between countries and/or blocs. Such organisations, together with numerous conventions and agreements, lay down the 'ground rules' for the members/signatories, in respect to the exact terms and conditions that should appear in any given tax treaty. With regards to the O.E.C.D., its members have agreed to implement a standard treaty format for all major tax and intellectual property areas. Of course, the actual 'withholding tax, rates will vary depending on the relationship of the countries involved. Nevertheless, it seems certain that the demands of the modern world will, despite the many ongoing disputes, result in a more uniform trading platform for, at least, the world's developed nations. History clearly demonstrates, particularly in Europe, that nations bound together in trade, free from artificial barriers, not only prosper, but find it virtually impossible to go to war!
The Basic Objectives
Some of the most basic objectives of any treaty, based upon the O.E.C.D. Models, would include the under-mentioned:
- To define the scope and taxes covered, together with the legal entities involved and then- tax treaty definitions;
- To define the criteria necessary, either directly or by reference to national law, to establish tax residence in the contracting state. Factors such as 'domicile', 'ordinary residence' and economic interest will normally be considered. It should be noted that many treaties usurp national law and ascribe a specific meaning to 'tax residence'. Normally, this has something to do with tax compatibility, or rather lack of it, between contracting states;
- To clearly establish when a legal entity is deemed to be trading 'in' as opposed to 'with' a contracting state. The latter generally having no direct fiscal consequences save, perhaps, being subject to a withholding tax. The O.E.C.D. Model suggests that trading 'in' requires a permanent establishment where the entity's business is wholly or partly carried on. Obviously, particular attention must be paid to the time periods required to create a permanent establishment for tax purposes;
- Define what is meant by 'immovable' property. This is important since such property will normally be taxed only on the basis of local law (lex situs). However, note that shares in a foreign company owning 'real' property, e.g. a house, in the contracting state, will generally not be covered. This logic, more obviously also applies to aircraft, yachts and shipping vessels. The taxable consequences equating with effective management and control;
- Define the taxable position of dividend payments received from investments by a legal entity from the contracting state. It should be noted that the jurisdiction where the investment has been made normally has the right to enforce a withholding tax. Referring to the O.E.C.D. Model, withholding taxes are often reduced where the investing entity holds more than 25% of the equity of the 'payor' entity;
- Define interest and royalty payments. Generally payments made by third parties to the suppliers of the intellectual property rights located in the other contracting state are subject to little or no withholding taxes. However, this is not normally the case when either the recipient has a permanent establishment in the other state or when the beneficial owner of the 'foreign' recipient entity has a business interest in the contracting state. Of course, such caveats, including where there is a 'special' relationship between the payor and payee, are meant to prevent treaty 'shopping'/abuse;
- Define the position of individuals earning income from a contracting state. Generally, a clear distinction must be drawn between independent consultants and dependent employees. In respect to consultants, without a fixed base in the recipient state, they will normally be taxed in their 'home' state unless they breach residency criteria. On the other hand, dependent employees working abroad will normally be subject to local taxes for the duration of their stay if the employer has a permanent establishment. If not, then the question normally becomes dependent on the duration of the stay i.e. if over 183 days indigenous taxes will apply. In other words, an independent consultant need only be concerned with his own personal circumstances, whilst a dependent employee is often literally dependent on the structure of his employing entity.
- To specify the exact method by which double taxation is avoided in each member state. In the O.E.C.D. Model Article 23 (A & B), reference is made to tax 'exemptions1 and 'credits'. Both terms follow their normal meaning. The first exempts a party from a given tax liability in his home country, whilst the latter simply affords a future tax credit. However, the most important factor is that a tax credit or exemption can never be larger than the tax rate which would have been payable in the 'home1 country. Thus, if tax was payable at 50% in country 'A' but only 40% in country 'Bf, the 10% surplus could not be used for local tax credit or exemption purposes. If, however, these figures were juxtaposed, then either a 10% credit or exemption could be enjoyed;
- Elucidate 'Exchange of Information* details between the contracting states. By definition, it is in the interests of both parties to ensure that the information supplied by their respective taxpaying entities is correct and truthful. To ensure this, virtually all treaties allow for a considerable flow of information between then* revenue collecting bodies. The normal constraints require that such information is only used for 'tax collection' purposes. Of course, any such gathered information can be adduced in an applicable court of law.
How Tax Treaties can be used in Tax Planning
It is obvious that no contracting parties would have the intention of creating potential tax 'loopholes'.
It is also true that most modern tax treaties have anti-evasion/avoidance provisions, with the objective of preventing third party residents from utilising such instruments merely as a tax mitigation 'tool'. Nevertheless, the effective employment of such provisions is almost impossible, since it is universally accepted that companies are separate legal entities fully subject to the benefits and detriments of their jurisdiction of registration. To try and impose ownership criteria or general rules on their use would entrap far too many 'innocent' traders and re-create constraints on international commerce - The diametric objective behind the establishment of organisations such as G.A.T.T. and the O.E.C.D. In synopsis, the benefits derived from treaty 'shopping' emanate from the diversity of national requirements and differing tax regimes. Until such divergences are significantly narrowed, an almost impossible event, even within trading blocs such as the European Union, treaty 'shopping' will remain a viable and legal 'weapon' in the tax consultants arsenal. Specific examples of how treaties are used would include the following:
(i) Taking advantage of what is deemed 'movable' and 'immovable' property, with the objective of taking advantage of different countries tax systems. A prime example of this would be using a company in the United Kingdom to purchase a property in Spain. This procedure, under the applicable tax treaty, preventing the payment of an annual property tax of 5% (on its rateable value), whilst also circumventing capital gains tax on a future sale for non-domiciled residents or non-residents of the U.K. The reason for this, as indicated earlier, is that the shares in the U.K. Company are considered 'movable' property and hence, under basic O.E.C.D. rules, will be taxed under the 'home' country's rules and regulations. In this particular case, taxes are only payable for those British domiciled and resident. Note, if there is a conflict between a treaty and indigenous law a treaty should take precedence.
Example: Using Tax Treaty provisions to reduce Tax Obligations
BASED UPON STANDARD O.E.C.D. RULES RELATING TO 'MOVABLE1 AND 'IMMOVABLE' PROPERTY
Standard situation: 'A' directly buys property in Spain = 'Immovable' property subject to indigenous taxes. Resolved by using U.K. company and Spanish/British Double Taxation Treaty.
The shares in the UK Company are considered "moveable" property and will be subject to the UK tax system. This system, however, does not impose capital taxes on those not domiciled and/ or resident in the UK. This distinction does not exist in Spanish law and, therefore, circumvents Spanish capital and potentially property acquisition taxes. Note, Spain positively discriminates against traditional "Tax Havens" with a 5% Annual Property Tax. This discrimination will not apply if there is, as is the case here, tax treaty protection.
(ii) Taking advantage of Time Discrepancies1. When tax treaties are negotiated, they are based on the existing tax systems applicable in both countries. If new tax systems and/or incentives are introduced after the contracting parties have signed they will both remain, under international law, liable to honour their commitments until a new agreement is negotiated. It should be noted that treaties are normally negotiated every 5 to 7 years and therefore cannot take into account all contingencies. Nevertheless, there have been instances when tax treaties have been unilaterally abrogated, but such actions are very rare and frowned upon by the international community. A recent example being the unilateral cancellation by Denmark of its treaty with Malta.
Example: Tax Treaty 'Discrepancies'
Country 'A' and 'Bf sign a tax treaty. After the signing, Country tBt introduces special regional incentives reducing the normal tax rate to half. The provisions of the tax treaty will still be honoured.
A year later, Country "B" introduces a special regional tax rebate which reduces the real tax rate down to 25%. Because the normal tax rate has remained at 50% and ostensibly all companies, even in the special regions (before rebates are given), are subject to this rate, a company located in such an area will still benefit from the full tax credit of 50% in Country "A" - Probably eliminating any further tax liability.
(iii) 'Developing' country concessions: There are many examples of contracting parties deliberately allowing the lesser developed jurisdiction to offer tax benefits. In many instances, such concessions are necessary to allow the less developed jurisdictions business community to compete on an equal footing with its competitors. In other instances, the reason could emanate from a particular trading blocs desire to assist under-developed members. An example of the latter would be the European Union turning a 'blind eye1 to the significant tax concessions available on the Portuguese island of Madeira. Many entities located here are being treated as if they are fully taxed Portuguese undertakings, enjoying full tax treaty benefits. Either way, the benefits are still available for the tax planner.
(iv)Taking advantage of 'cognisance deficits' - By definition, even the most erudite tax treaty negotiators could not be fully aware of all the potential variations, concessions etc. available in the other contracting state - Such variations potentially affording significant benefits.
(v) Maximising tax exemptions and credits. In many instances, the insertion of a holding company for foreign investments can allow the 'mother' company to ensure that all available tax concessions are used. This principle is based on the fact that virtually all tax treaties will only give tax exemptions/credits up the applicable tax rate in the country where the exemption/credit is sought.
If a holding investment company is injected into the formula then surplus exemptions/credits can still be utilised. It should be noted that such holding vehicles can simultaneously be used for investments in many different jurisdictions.
Example: Tax Exemption/Credit Maximization
Existing situation is that company 'A' located in country 'X' has investments in countries 'Y' and 'Z', 'Y' and 'Z' both having standard O.E.C.D. type treaties with country 'X'. In country 'Y' the tax rate is 60%, in 'Z' it is 20%, whilst in 'X' the rate is 40%. Without the holding company's insertion, the following would happen:
- There would be no tax exemption/credit available, as is standard practice, in respect to the 20% surplus tax paid by 'A' in country 'Y'. In other words, if the total tax paid in 'Y' was £30,000.00, then the £10,000.00 surplus over and above what would have been paid in 'X' could not be recovered.
- In respect to the £10,000.00 tax paid in 'Z', 'A' will be subject to pay the balance, a further £10,000.00, in its home country 'X'. Full credit/exemption being given for the sum paid in 'Z'.
RESULT: £10,000.00 of potential tax credit/exemption lost.
(vi) Treaty 'Sandwiching': The concept of treaty 'sandwiching' is, without doubt, the most beneficial and most popular method of utilising tax treaties. The concept is based on the fact that virtually all developed, and most developing countries, have negotiated tax treaties amongst virtually all of their respective major trading partners. Even small countries regularly have more than 20 separate treaties. If one then accepts, which is quite a conservative estimate, that each of the other contracting states has 20 independent treaties with other jurisdictions then, by 'sandwiching' or inserting a third party treaty related to at least one of the original contracting parties, there would be 400 possible treaty permutations - This simple geometric progression making it almost impossible for treaty partners to avoid 'tax loopholes'. In particular, significant benefits can derive from those instances where political expediency demands a tax treaty with a territory which would not normally be considered a suitable treaty partner. Prime examples of the aforementioned would include Britain's treaties with the Isle of Man, Jersey and the Netherlands treaty with the Dutch Antilles. The result of such politically expedient treaties is that any country negotiating a treaty with Britain or the Netherlands will often find that it has, involuntarily, created an access route to these treaties for its own citizens and companies.
The basic 'Sandwich'
The first point to note, is that a sandwich will often have more than one filling, although there many instances where the simple insertion of one extra jurisdiction can achieve the objectives sought.
For example, 'X' in country 'A' could find that a direct investment made into country 'B' could result in high withholding taxes or some other unfavourable fiscal consequences. To avoid such problems 'X1 may find it more beneficial to employ a catalyst company in country 'C', where 'C' has a tax treaty with 'B' which avoids withholding taxes on dividend payments back to 'C'. In turn, 'C' could also have a favourable treaty with 'A', eliminating or considerably reducing tax consequences.
The 'Filled' Sandwich
Most tax mitigation plans require the use of more than one Catalyst Company. The reason for this is simply that the geometric progression becomes more complicated and hence, opens up more possibilities. A typical example would again be where 'X' Ltd, located in country 'A', wants to invest in country 'B'. However, in this example there is no direct tax treaty available. The solution would be to use a country, 'C', with an extensive treaty network, probably with high taxes, but which has a close connection with an offshore jurisdiction, 'D'.
Using Tax Treaties International Property Investments
How Massive Tax Savings can be made in respect to Stamp Duty, Capital Gains and Inheritance Taxes
Investing in property, be it private or commercial, can often be made a significantly more lucrative endeavour if executed with the benefit of tax planning principles: Principles which are often not made readily available, or perhaps even known, by the vast majority of non-specialist lawyers and accountants.
Using the Separate Legal Identity of Limited Liability Companies
The most fundamental ‘tool’ of the tax planner is the use of limited liability companies since they are almost universally accepted as being totally separate legal persons/entities to their directors and beneficial owners. In fact, provided there is proper and suitable local management and control, it is often possible to extrapolate tax responsibilities from high to low (or even tax free) jurisdictions*
*SEE DOUBLE TAXATION TREATY INFORMATION BELOW
‘Passive’ or ‘Trading’ Investments
The obvious desire of any investor is to legally reduce taxes to as great an extent as possible.
How far this can be achieved is controlled by a number of factors including whether the investment is ‘passive’ or ‘trading’ in nature. An example of a ‘passive’ investment would be when one wishes to acquire a property with the specific objective of avoiding capital gains tax on a future disposition – In many cases, particularly where one is non-domiciled in a country such as the UK, the use of a simple tax exempt International Business Corporation (IBC) based in countries such as the Bahamas or British Virgin Islands (BVI) can be used to realise virtually total tax savings provided any profits are kept outside of the United Kingdom. For those who are UK domiciled and who wish to invest in UK properties it may be necessary to employ a private interest foundation and/or use a domestic UK limited company to afford similar benefits. Where however the investment is not simply about a simple purchase and future resale but involves financing and/or the renting of a property it may be necessary to use domestic ‘loop-holes’ and/or certain tax treaty provisions – For example, it is possible to create ‘back-to-back’ loans on an investment property and locate the ‘lending’ company in a jurisdiction which has a treaty with the UK which results in no withholding taxes on interest re-payments
Commercial Property Investments
In many ways, these can be the most dynamic and interesting of tax planning structures since they can often allow even significant building construction to take place in one country, perhaps a high tax zone, but pay tax in another low tax jurisdiction. Obviously, the correct expertise must be in situe but literally hundreds of millions of Euro have been saved by using such structures with the greatest prerequisite being genuine external management and control - An area, which licensed trust and management firms such as Hibernian Trust e Management Company Lda are in a unique position to offer
Why it is Prudent to use a Company to Purchase Private Property Abroad
As can be seen in the other links within this Section, it is often possible to use selected offshore or tax planning companies to avoid future capital gains (CGT), inheritance (IT) or even re-sale stamp duties on property dispositions. However, it is also clear that certain jurisdictions are making the use, if one is only to consider the avoidance of CGT and IT, less financially prudent due to more and more sophisticated anti-avoidance provisions. Nevertheless, it is certain that wealthier clients can still benefit and indeed are inevitably advised to use either offshore and/or local companies to make their investments – Why? The reason is simple, in that apart from the UK and Republic of Ireland; most European countries tax all residents on their worldwide income and in many cases wealth!! For this reason, even if there are no CGT savings available by using a company, the use of such an entity can separate and reduce ones personal wealth both in the investment country and indeed worldwide. Certainly, anyone with significant assets in the UK or Ireland and who wishes to invest in countries such as Spain, France or Portugal should seek professional advice from a qualified tax planner who considers not only the myopic property investment but the overall tax situation of a client … Something SCF specialises in!