THE SCHMIDT OFFSHORE REPORT - ISSUE ONE Editor’s note As usual I have more topics to cover than I have space for – in particular, a large number of queries to be answered. Therefore, this month’s ‘International Offshore Report’ consists of two main elements. First, a round-up of news stories and, second, a bumper crop of ‘Ask the Experts’ questions and replies. I would like to take this opportunity to remind readers that our ‘Ask the Experts’ service is both free and confidential. All queries are answered, and if you wish to remain anonymous simply send your question unsigned to me, care of our publisher’s office: The Editor Schmidt Tax Report Wentworth Publishing Ltd 17 Fleet Street London EC4Y 1AA wentworth@online.rednet.co.uk OFFSHORE NEWS BVI to scrap bearer shares As we go to press it appears that the days of bearer shares – in the British Virgin Islands, at least – may be numbered. Bearer shares offer total confidentiality since whoever has the share certificates controls the company. This means that the beneficial owner of a company may remain completely anonymous. The relevant legislation has not yet been approved. However, assuming that it is passed without changes, the proposed amendments will become effective later this year. The act’s key features are as follows: - Companies may maintain bearer shares or continue to issue bearer shares. However, the shares will have to be lodged with an authorised or recognised custodian. - Existing companies will have until 31 December 2004 to deposit their bearer shares with a custodian or exchange the shares for registered shares. Authorised custodians are institutions licensed under the BVI Banks and Trust Company Act. Non-BVI custodians may be permitted – probably regulated financial and professional institutions will qualify. Crucially, custodians will be required to request the provision of details on the beneficial owners of any company who have issued bearer shares. - The government registration and annual licence fee for companies with bearer shares will increase from US$300 to US$1,000. Companies with registered shares will continue to pay a registration and annual licence fee of just US$300. - At present the register of directors does not have to be maintained at the registered office of the company or with the registrar of companies. However, under the new legislation the register of directors will have to be maintained at the registered office. There will be a one-year transitional period in which existing companies can provide details. The BVI are the first offshore centre to do away with bearer shares, and it will be interesting to see whether the other jurisdictions decide to follow suit. It is likely that most will. Blair fights for EU tax veto At the EU summit in Greece two weeks ago Tony Blair remained adamant that the UK would not give up its right to veto EU tax legislation. British ministers fear any surrender of the veto could lead to rises in income taxes and indirect taxes such as VAT. “Tax is at the heart of economic policy, a key aspect of national sovereignty and a matter for national governments and parliaments,” the Treasury insisted in its recent assessment of the five tests for membership of the euro. “The Government therefore opposes unnecessary tax harmonisation which would constrain member states’ economic successes.” The British Government is in something of a difficult position with regards to tax harmonisation. On one hand, the Treasury would like to see an end to so-called tax competition from countries offering lower tax rates to British-based businesses and individuals. On the other hand, the UK is one of the world’s most successful offshore tax havens itself. Indeed, the UK is the second most favoured haven for offshore private wealth in the world accounting for some 15% of the US$5 trillion invested offshore. Money laundering It is going to become increasingly difficult to pay for expensive items using cash. New rules being brought in will apply to businesses that deal in goods and accept in cash the equivalent of €15,000 or more for any single transaction (approximately £10,000). The aim of these rules is to combat money laundering and the criminal activity which underpins it. These businesses will have to register with customs and put anti-money-laundering systems in place. Businesses can choose not to be subject to these rules by deciding not to accept large payments in cash, for example, by insisting on payment by credit card or cheque. The regulations bringing in these new rules are expected to be made in July, although there may be some delay. However, from the time they are brought in, businesses will have three months to put their systems in place and four months to register with customs. Businesses that fail to meet these requirements could face criminal sanctions or a penalty of up to £5,000. Exchange-of-information powers examined Tolley’s Taxation recently ran a fascinating article by Andrew Watters and Jonathan Levy on the Inland Revenue’s exchange-of-information powers with other countries. Increasingly, fiscal authorities are integrating their regulatory structures across borders. The driver is the need to match each nation state’s regulations with the global nature of many of the entities being regulated. Where, for instance, a United Kingdom company is part of a global group, it is not possible to understand fully what is happening in that company, for example with its debt structure or its pricing policy, without an understanding of its place in the worldwide group. Similarly, individuals often have financial arrangements which reflect the fact that their activities and interests are not restricted to any one country. Again, fiscal authorities are moving to exchange more information in order to minimise loss of tax revenue. People have referred to the ‘global village’ for about 40 years. The term reflected the mass media’s ability to ensure that people in any one country knew all about what was happening to people in lots of other countries. Previously, it was the village inhabitants who gossiped and who knew all about each other. Now, fiscal authorities are exchanging information to ensure that taxpayers are good citizens in the global village. The finance bill 2003 includes legislation that will not only enable the Revenue to collect information automatically about the payment of savings income to overseas residents (by imposing reporting requirements on businesses and public bodies dealing with such payments) but also allow it to exchange the information with other European Union countries. The favour will be reciprocated. Put in plain English: if you have a one which bears interest anywhere within the EU, you have to assume that information about your bank account will reach the Inland Revenue’s ears. Exchange-of-information agreements are being reached with a growing number of other, non-EU countries. For instance, in April of 2003 a new double-taxation convention was agreed with the United States. Now, if the United Kingdom suspects a company of avoiding tax and that company is associated with a United States company, the Inland Revenue can ask the Internal Revenue Service to provide information on the United States company which may help the Inland Revenue enforce United Kingdom tax law. There are two meagre concessions to libertarians to be found in the new legislation. First, where such information powers are being used, at least you will be aware of it. This contrasts with the previous position where the exchange of more limited information could take place between the fiscal authorities without the group’s or individual’s knowledge. Second, because the information powers are now so wide, restrictions have been placed on how they may be used. For example, the Inland Revenue must persuade a General or Special Commissioner that in his reasonable opinion documents requested by an overseas tax office contain relevant information. The Proceeds of Crime Act and the Money Laundering Act Leading tax expert Michael Sherry recently commented further on the Proceeds of Crime Act and Money Laundering Act. As reported in last month’s TSR accountants and tax advisers face new obligations under this legislation. There is a general duty under the Proceeds of Crime Act and a specific duty under the Money Laundering Act to report any client who has evaded tax. The effect of this is that: Accountants, banks and other professionals (with the exception of solicitors and barristers) must report anyone they even suspect of evading tax to the relevant tax authorities – whether or not they are certain. Furthermore, they must not tip off their client or prospective client that they are making a report. Some taxpayers should exercise caution before going to an accountant or other professional adviser to ask for their help in – say – sorting out previous misdemeanours since they risk immediate exposure. However, it now appears that if you are an accountant and your client, old or new, has submitted false tax returns and spent the money he saved, there is no obligation to report. It is only if the money is in the bank or elsewhere, the adviser has a duty to go to the National Criminal Intelligence Service. This is definitely good news since it means that if you have committed some sort of tax felony and spent the money you can, at least, now talk to an accountant about the problem. Nevertheless, you must be careful as some accountants and other advisers may err on the side of caution or may not fully understand the law as it stands. Do remember that there is no legal professional privilege with regard to accountants or banks. There is, however, with solicitors. Therefore, if you have (or think you have) committed some sort of tax fraud and you wish to receive advice, please write to us or approach a solicitor first and foremost. ASK THE OFFSHORE EXPERTS Q. In 1989 I opened a bank account with the Jersey branch of a UK-based financial institution. I opened the account using a cheque drawn from my UK bank. During the 1990s I topped the account up using non-UK income and made a number of payments – all to non-UK-based third parties. I am now concerned that details of this account will be passed to the Inland Revenue. What should I do? Please note the total amount involved is in the region of £100,000. A. In your letter you don’t state whether you are UK resident and/or UK domiciled. Nor do you explain whether or not UK tax has been paid on the money involved. For the purposes of my response I will assume that you are UK resident, UK domiciled and that you did not pay tax on the original money. As I am sure you must be aware, the situation I think you are describing is, essentially, tax evasion and, as such, a criminal offence. If you wish to stop breaking the law the first thing you should do is take legal advice (which will be privileged) arranging via a solicitor to make a declaration of your wrongdoing to the Inland Revenue. The result will be that you will have to pay the original tax plus a fine and interest. Harsh as this may seem, you should, by coming forward voluntarily, at least avoid criminal prosecution and thus the increasing risk of a prison sentence. What other alternatives are open to you? Well, you could consider becoming a non-resident. While this wouldn’t remove your liability, once you were abroad it is unlikely that the Inland Revenue would be very interested in you. However, it is a drastic measure for £100,000 – especially as you will always have it hanging over you. Of course, you may be tempted to transfer the money elsewhere and hope for the best. While this will, clearly, slightly reduce your chances of detection, you will still be leaving a paper trail from your existing account to your new account – wherever it is located. Someone who had no scruples about playing cat and mouse with the Inland Revenue might go to their financial institution in person over a period of several months and make small, regular cash withdrawals so that there was no record of where the money was going. They could then close the account. I am almost 100% certain that sooner or later details of bank accounts held by UK residents in the Channel Islands will be handed over to the Inland Revenue. My guess is that they will look at active accounts first and that it may be many, many years (if ever) that they look at dormant accounts. Ultimately, anyone who has avoided UK tax by using an offshore bank account located anywhere within the EU must accept the fact that, despite any promises made by the financial institution concerned, banking confidentiality is no longer worth a fig. Incidentally, you are also at risk another way. If you come under direct attack from the Inland Revenue in the UK, they may ask to look at your bank records. You could resist them going back 14 years – but you may not be able to stop them. If they did so, evidence of your actions would immediately come to light. I am sorry not to offer you more comfort, but it is best to be realistic in these situations. It is possible that there may be extenuating circumstances which will count in your favour – happily Ken Dodd got off, after all – so I don’t want to paint too black a picture. Q. A business contact has asked me to recommend an import/export agency to handle the UK sales of a range of organic food products sourced from overseas. I can suggest whoever I wish. What is to stop me recommending an offshore company? Would there be anything wrong in me owning shares in this company? I have no short-term need for either extra income or capital (eventually, I think the agency would have a value and could, therefore, be sold – at a minimum it would make a substantial profit), but I wouldn’t mind building up a long-term nest egg. I am UK resident and domiciled – though I wouldn’t mind becoming non-resident for a period if it was worth my while. What do you recommend? A. Let me start by saying that the position you have adopted is an excellent one. If you, personally, start a business anywhere in the world and legally own some or all of it you must – sooner or later – declare your interests to the UK taxman. On the other hand, if you have no legal interest in a business – and derive no benefit from it while resident in the UK – there is no need to make such a declaration. This is a very crucial point. Many extremely wealthy people take advantage of the benefits of offshore financial structures but can say – hand on heart – that they have absolutely zero involvement. Let me give you two examples. In example one Mr A – a man in your position – goes to a company formation agent and asks them to set up an offshore company on his behalf. He pays for their services in cash. Perhaps he uses bearer shares or else the shares are held by a discretionary trust. Either way, in principle, his involvement is not obvious. This company, which is run by directors on his behalf, acts as the import/export agency. Because it is located in a tax haven, it doesn’t pay any tax. Mr A isn’t running the company – but he does help it out on a friendly basis by introducing clients and so forth. No paperwork exists with his name on it. He doesn’t derive any short-term benefit from his ownership, but he is, effectively, entitled to the profit. In example two, Mr B has absolutely no connection with the offshore structure. He has gone to an overseas contact – ideally an old friend or relative living outside the EU – and has suggested to them that they may like to set up a discretionary trust naming himself, Mrs B and the B children as beneficiaries. In passing he may offer his friend a few suggestions on how the trust could set up an import/export agency – but his involvement is minimal. There is nothing linking him to either the trust or the import/export agency. In the first example, because Mr A is the owner of the offshore company – even though he may have attempted to hide it from the Inland Revenue and everybody else – his gain (or any income he derives from the business) will be liable to UK taxation (and not to pay it would be fraud). In the second example, however, the situation is rather different. Crucially, Mr B is not the person who set up (the settlor of) the discretionary trust. Because the trust is discretionary (in other words, the trustees can give any money held by the trust to whoever they want, whenever they want), Mr B has no legal interest in it. There is, therefore, no need for him to make any declaration to the Inland Revenue unless or until he receives money from the trust. If this happens when he is non-resident, any such money would be tax-free in the UK. It might be worth mentioning a couple of key points in relation to trusts. The settlor (person setting up the trust) should give the trustees something called a ‘letter of wish’. This letter of wish is not a legal document, but the trustees will be strongly inclined to follow whatever it sets down. So if the settlor says “should my pal, Mr B, ask you to pay him any money in the trust, please listen to what he says”, the trustees will be more than likely to do so. If you were Mr B., how might you – mistakenly – break the law? Here are some things you would want to be wary of: - Even if, on paper, you aren’t breaking the UK’s tax laws, if it is your intention to evade UK tax, you will be considered just as culpable. In other words, it is the end result which counts not the different steps in the process. - If you pay for the offshore trust and the offshore company to be established, this is likely to severely damage any claim you may subsequently make of not being behind the entire structure. I am afraid to say that less scrupulous people pay the relatively modest amounts required to set up such offshore structures using cash – cash which is, of course, untraceable – but that doesn’t make them any less culpable. - It is perfectly legal for anyone to help anyone else out in business. What you can’t do is be seen to be acting as a shadow director of the offshore company. If you are running the show, it will, so far as the UK tax authorities are concerned, appear to be yours. - Beware of transfer-pricing rules. Any transactions between the agency and the UK suppliers must be on an arm’s-length basis. In this day and age, even though an offshore structure may remain 100% confidential, it is important to consider what would happen if everything about it were known by the Inland Revenue. If you actually ask someone offshore to set up a trust of which you are the beneficiary and the trust then sets up the import/export agency, the Inland Revenue may consider that, even though you have no legal interest in either the trust or the company, you are liable to UK tax. Moreover, they may consider the whole thing was an attempt to defraud them. On the other hand, if you know absolutely nothing about the trust or the import/export agency and it all comes as a wonderful surprise at a later date, no one can really say you have done anything wrong. You may remember the case of a well-known British political personality who was the beneficiary of a series of trusts set up by a non-UK resident (I seem to think she was based in Belgium) who seems to have enjoyed all sorts of tax-free benefits as a result. He was able to say that he had nothing to do with her setting up the trusts and no control over them, and, legally, it was true. This is a complicated area and I would strongly recommend taking professional advice from an expert in a non-EU offshore location – perhaps Switzerland. Q. Please update me with regard to discretionary trusts set up overseas. How exactly do they work? What impact has recent legislation had on their effectiveness as a tax-planning vehicle? A. Discretionary trusts work like this. They are established by someone called the settlor. This is the person who decides that the trust will be set up and who dictates how it will be run and for whose benefit. For instance, Joe Smith might come along and establish a trust for himself, Mrs Smith, the Smith children and the Smith grandchildren. He might give (or settle) a sum of £5,000 to the trust or he might give them £500,000 – it makes no difference. The trust deeds will set out how the trust is to be run. Because Mr Smith has decided to set up a discretionary trust, it is completely at the discretion of the trustees as to who receives money from the trust fund. In most discretionary trusts in addition to specific individuals there may also be named a charity – traditionally the Red Cross. In other words, legally, the assets held by the trust do not belong to any of the potential beneficiaries. Mr Smith, Mrs Smith, the Smith children and the Smith grandchildren are not, legally, guaranteed any benefit whatsoever. If they so desire, the trustees could give all the money to he Red Cross or, as it happens, someone else. As you may imagine this is a situation which settlors can find a little worrying. Our Mr Smith may be concerned that the trustees will ignore the Smith dynasty and hang onto the cash for themselves. What’s to stop them doing so? Well, it is possible to put in place all sorts of legal obstacles to prevent this, but the more effective the obstacle the less effective the trust will be. Because if a distribution of trust assets isn’t really at the trustees’ discretion, the tax authorities are likely to see any assets of the trust as belonging to the settlor and/or the beneficiaries… and to tax them accordingly. What most settlors do (as explained above) is give the trustees what’s called a letter of wish. This explains what the settlor hopes will happen to the money in the trust. Providing the advisers being used to handle the trust are well established and professional, there is very little chance that they won’t follow the instructions set out in the letter of wish. In all my years of dealing with offshore matters I have never once heard of a trustee deciding to go against the wishes of the settlor and, of course, they can’t simply pocket the money for themselves since this would be theft. So what are the advantages of this structure? Well, discretionary trusts are fully recognised by UK law. They are deemed to be a completely separate entity, like a person or a limited company. Assets in a trust, providing they were placed there legally and with no tax evasion being involved, belong to the trust. No one can remove them. In the case of the Smith family, already mentioned, there is no need for them to make any mention of the trust in any of their tax returns, providing they have received no benefit from it. By establishing a discretionary trust in an offshore jurisdiction where little or no tax is levied, it is possible to preserve its assets effectively tax-free. Furthermore, most trusts are established in such a way as to allow them to own offshore companies, which means that they need not be dependent on the initial settlement. They can, of course, also hold shares in onshore companies, though for various technical reasons this often isn’t ideal. To summarise: a discretionary trust is the ideal way to remove an asset (or potential asset) from the clutches of a high-tax jurisdiction. Once an asset is in the discretionary trust, providing no law has been broken, it doesn’t belong to any of the potential beneficiaries until they actually receive some sort of benefit. Now to the second part of your question. Until relatively recently it was possible for UK taxpayers to establish their own trusts offshore and to use them to postpone UK tax. This is no longer permissible, and, if you establish a trust of which you or an immediate member of your family is a beneficiary, there will be no tax advantage. Has this stops trusts being used? No! To start with, many UK entrepreneurs still establish trusts but count on secrecy laws to protect their identity. It is certainly true that, if you go to Lichtenstein and set up a trust there, the trustees will assure you that no one – apart from themselves – will ever know that you are involved. However, given the general climate regarding offshore tax havens, I don’t think any prudent person would rely on any jurisdiction’s secrecy legislation. Furthermore, any UK person going overseas who set up a trust with a view to avoiding UK tax would be breaking the law should it ever be found out. This is why discretionary trusts nowadays often appear to be being set up by people not named as beneficiaries. Q. What is the point of an offshore structure? If it is against the law to receive any benefit from an offshore company or an offshore trust in the UK without paying tax on it, why go to the bother? A. There are various ways in which a UK citizen might, perfectly legitimately, benefit from an offshore structure. It all depends, of course, on the individual’s personal circumstances. For instance, the offshore structure might be used simply to delay UK taxation or during a period of working overseas. By the same token they can be used in all sorts of complicated employee share schemes and to preserve wealth for future generations. It must also be said, regrettably, that many UK residents receive benefits from offshore trusts and never declare the fact. This is, of course, against the law. The benefits could come in many forms, such as cash given while abroad, credit cards from offshore bank accounts, bills paid on their behalf and so forth. Q. Can you explain the current EU relations with its tax haven enclaves? A. The first thing to point out is that not all tax havens are considered such. The UK, for instance, is probably the second-largest tax haven in the world but the British Government certainly doesn’t see it like that. So I will confine my answer to the more obvious havens. Some EU member states have special links with offshore financial centres and the nature of these links can take any of four different forms: - The first is full membership. Luxemburg is a full member, but its holding companies do not benefit from the tax treaty network. Madeira and the Azores are autonomous provinces of Portugal and, as such, an integral part of the EU. The treaty of Rome provides they are entitled to state aids, including tax incentives, to promote the economic development of areas where the standard of living is abnormally low. Such incentives are deemed to be compatible with treaty provisions, at least until the end of 2011. A special Programme of Options Specific to the Remote and Insular Nature of Madeira and the Azores has covered the relationships between the EU, the Portuguese Government and regional authorities since 1993. Individuals and companies resident in these territories are entitled to any benefits to be derived from Portugal’s tax treaty network. Similarly, the Canary Islands are an integral part of Spain, and therefore part of the EU. European Commission approval had to be obtained for the island’s special tax regime. Although Gibraltar is a full member of the EU, under article 28 of the Treaty of Accession it is not subject to the common customs tariff, the common agricultural policy or the harmonisation of turnover taxes (Gibraltar has no VAT). A similar regime applies to Åland, a semi-autonomous island province of Finland. - The second concerns territories covered by special provisions in Article 299 (formerly 227) of the Treaty of Rome: “European territories for whose external relations a member state is responsible.” They apply to the Channel Islands and the Isle of Man, which are subject only to the Common External Tariff and certain agricultural levies as part of the customs union. They have no access to the UK tax treaty network. - The third consists of ‘associate’ members of the EU and bilateral treaties. Cyprus has an association agreement signed in 1973 and updated in 1981 to remove EU trade barriers on exports from the island. Malta has a similar commercial arrangement dating back to 1971. As you will be aware, both (all things being equal) will shortly become full members. - Lastly, there is a grey area, or more accurately a collection of grey specks. Andorra is not part of the EU, but it has a customs union agreement. Monaco and San Marino are technically responsible for their own external affairs, and therefore not covered by the Treaty of Rome. Nevertheless, Monaco is considered part of EU customs territory; it also levies VAT. Monaco has a tax treaty with France, but Monégasque residents would not benefit from the French treaty network except through a French intermediate entity. San Marino has a customs agreement with the EU. San Marino residents cannot benefit from Italy’s tax treaties. Campione is part of Swiss customs territory and also part of Italy and therefore of the EU. Swiss tax treaties do not apply to Campione; Italian treaties do, but Campione does not allow holding companies so, in practice, there is no demand for treaty protection. Owing to the enormous pressure being put on them, no EU-related offshore centres can be considered to offer confidentiality on a long-term basis. Q. Offshore tax havens appear to be under attack from every quarter. How on earth can one plan long term? And, more particularly, how can one ensure one’s long-term confidentiality? A. First of all, it is important to consider the bigger picture. Although there are several international initiatives to stamp out international money laundering and to identify ‘harmful competitive tax havens’, offshore financial centres are not without their friends and supporters. For instance Paul O’Neill, the US Treasury Secretary, recently said “the US does not support efforts to dictate to any country what its own tax rates or tax system should be and will not participate in any initiative to harmonise world tax systems”. The fact is, while tax-haven governments have little international power, the owners of the capital held in offshore structures do. Furthermore, there is so much money held offshore by such a diverse range of businesses and individuals that in the short to medium term it is hard to imagine more than a modest portion of it being tempted (or forced) back onshore. What is much more likely is that the least-well-regulated tax havens plus those tax havens that cooperate too much with anti-tax-haven initiatives will lose out on business. What I foresee is that lesser-known, undeveloped tax havens are likely to become more popular in the coming years. Of course, what has really thrown a spanner into the works is the hunt for terrorist money. Nevertheless, I don’t think this will have any effect on the legitimate use of offshore havens by either corporations or individuals. Because professional advisers, banks and so forth have to ‘know their customer’, I can’t see that legitimate customers have anything to be concerned about. The biggest fear – so far as UK residents are concerned – is the increasing exchange of information between British and overseas tax authorities. How do you counter this? To begin with, I think one always needs to think short term with regard to any offshore tax structure. In the old days one would hope to get a lifetime’s use out of an offshore structure; nowadays, I think one has to think in terms of about five to ten years. Also, I for one would have nothing to do with any offshore structure that is strongly influenced by either the EU or the USA. Nowadays, one needs to be looking further afield.