Part 6
THE SCHMIDT OFFSHORE REPORT
Vol 1, no 6 - Jan/Feb 2005
CONTENTS
EDITORIAL
- Information sharing
- A spectre haunting Europe
- Trust no one
- Offshore sector faces storm
NEWS
- Watchdogs seek better assistant
- UK Government defend tax haven
- Harrods Sur La Mer
- Brown moves against Offshore Havens
- EU Member States slow to implement new regulations
- OECD expands Fiscal Affairs Committee
- Good news on cross-border dividends
- Jersey moves ahead with New Corporate Tax System
- No more NIUE
- US move to close Barbados tax loophole
- BVI change tax rules
- Swiss–EU deal sealed
TIPS AND WARNINGS
- Think Swedish!
- Location! Location! Location!
- Keep it at arm’s length
- The Estonia advantage
Welcome to the first issue of The TSR Offshore Report for 2005. The newsletter is divided into four separate elements: my editorial, a news section, answers to readers’ questions, and tips and warnings. I would like to emphasise, as I always do, that all correspondence is treated in the strictest confidence and that if you wish to write to me anonymously I will publish a response in the next available issue of the newsletter.
As regular readers will be aware, I normally devote my editorial to a single subject. But, for this issue, I am going to make an exception and write about a number of different topics, including tax harmonisation within the EU, the jailing of a Canadian tax-planning guru, confidentiality and the state of the offshore-banking industry.
Frankly, there isn’t a single country in the world where banking confidentiality can be guaranteed. And, if there is no confidentiality in the banking system, there can be no confidentiality regarding any sort of financial transaction whatsoever. Below, I summarise the most recent attacks made by governments and revenue authorities against the concept that human beings have the right to keep their personal finances secret. It is, of course, important to understand how our rights are being eroded. What is even more important is to consider ways in which one might, legitimately, insure that one’s financial affairs remain secret.
Sadly, the world has got itself into such a state that it is now necessary to justify financial confidentiality. Those seeking to remove our rights claim that ‘if you have done nothing wrong, you have nothing to fear’. Their assumption is that a desire to keep one’s business affairs to oneself is tantamount to an admission of criminality, whether it be terrorism, money laundering or tax evasion. In fact, when we last surveyed a sample of 1,000 entrepreneurs located in over fifteen different countries with an entirely anonymous questionnaire several years ago, some of the many reasons for wanting watertight confidentiality included:
• Family reasons: a large percentage didn’t want their children, spouse, former spouse or some other family member to know their financial affairs
• Business reasons: almost as many were worried about either members of staff or their competitors learning about their financial affairs
• Political instability: in certain countries the desire for secrecy was motivated by the political environment
• Distrust of authority: a further group were worried that those in authority would misuse information; these people were not conspiracy theorists – rather they doubted the security and efficiency of government bureaucracy in general.
To my mind, if confidentiality is important, one needs to set about achieving it in an entirely new and different way. From the outset, one must assume that no one can be trusted. While bankers, nominee directors, trustees, accountants, solicitors and all sorts of other advisors may promise to keep your information secret, they cannot guarantee it. Nowadays, when I set up a trust or company in an offshore jurisdiction, I automatically assume that the day may come when everything to do with that structure will become known to any and every tax authority in the world. It isn’t that I want them to know – rather that I take a ‘worst-case scenario’ approach. I ensure that my secrecy will be observed long term by the following means:
• Being obvious: sometimes, the best way to hide something is to put it in the most obvious and public place. To give you a simplistic example of this, a company or bank account located in the Channel Islands is much more likely to attract attention than a company or bank account located in, say, a highly taxed country such as Sweden or America.
• Diversification: nowadays, I have lots of mini-structures, each dealing with something different instead of one, interconnected structure, dealing with the whole. You can ‘follow the money’ up and down any one of these structures – but never horizontally between them – because no sideways flow of money ever occurs.
• Business partners: I make great use of business partners. I have a number of ‘business partners’ in different locations around the world and, even where a written agreement exists, I have the only copy of it. This is much better than using nominees.
• Avoiding attention: I keep my nose clean. I don’t do anything that is likely to attract unwelcome attention.
Put in plain English, I maintain secrecy by thinking laterally. Much more to the point, I am extremely careful to ensure that nothing I do in any jurisdiction is against the law. It is, of course, much easier when one is resident in a country with a relatively liberal and relaxed fiscal environment. I can see that it might be harder for me if I lived in Germany or Australia. Nevertheless, the principles hold true.
So, what new ways have the authorities found to damage the concept of personal confidentiality? Since the last issue of The TSR Offshore Report, here are some of the things that have occurred:
1. Recent European legislation has enabled tax authorities in EU member states to share ‘relevant information’. In addition, following the introduction last year of the new tax-avoidance disclosure regime, an international task force (The Joint International Tax Shelter Information Centre) was established to enable a more coordinated approach to abusive transactions that cross borders. Many tax-collection agencies, including the Inland Revenue, are now authorised to send information spontaneously to foreign tax authorities.
2. With regard to The Joint International Tax Shelter Information Centre their purpose is to enable the UK, the US, Canada and Australia to share expertise and experience to enable them to identify and understand better abusive tax transactions and their promoters, to exchange information about specific avoidance schemes and their promoters and to improve the efficiency and efficacy of each country’s enforcement activities.
3. Towards the end of last year, the United States’ Securities and Exchange Commission (SEC) made considerable progress in their attempt to extract financial information from so-called offshore financial centres. For instance, in the Turks and Caicos Islands the courts have now permitted banks and other institutions to disclose all sorts of information (including details of ultimate ownership/beneficiaries) to the SEC. While the SEC claimed that they were not looking for information relating to assessing, imposing or collecting tax, it seems unlikely that the data they gather in the Turks and Caicos Islands, or elsewhere, will remain confidential.
4. In a separate move, a United States District Court has granted the Internal Revenue Service (IRS) the right to seek information from certain credit-card organisations about certain-credit card transactions. The IRS have long been seeking information about holders of American Express, Visa and Mastercard credit cards that were issued by or on behalf of certain financial institutions based in more than 30 offshore jurisdictions including Aruba, The Bahamas, Bermuda, The Cayman Islands, Hong Kong, Singapore and Switzerland. Initially, the IRS are targeting people who held such accounts between 31st December 1999 and 31st December 2003. The first credit-card company to be forced to provide this information is Colorado-based First Data, an organisation that processed 12.2 billion payment transactions in 2003 alone.
5. The OECD have made a number of changes to their Model Tax Convention on income and on capital. Basically, this has resulted in banking secrecy no longer being used as the basis for refusing to exchange information. In practical terms, it means that ownership information and information held by banks, financial institutions, nominees, agents and fiduciaries could be exchanged, irrespective of banking secrecy rules.
I would say that a good 50% of the letters we receive relate to exchange of information. If there is any aspect of your personal finances that you don’t wish to be made public, now is the time to take action. This is particularly true because the sheer volume of information that is being made available to governments and tax authorities is so great that, in the short term, they are unlikely to be able to act on more than a tiny percentage of it.
I was appalled to read that at an informal meeting of EU finance ministers last September it was agreed that they would set up a working group to consider how direct-tax harmonisation might be achieved. Since this is clearly on the EU’s agenda, I thought it might be worth getting out the old crystal ball and considering what harmonisation might look like if it ever comes to pass. By direct-tax harmonisation, incidentally, I am referring to a level of standardisation of direct-tax taxes across all EU member states. This might be achieved through a commonly agreed framework for calculating the tax base and rates, or by passing identical tax laws in each of all the member states.
The history of the EU goes back to 1951 when six countries (Belgium, Germany, France, Italy, Luxembourg and the Netherlands) formed the European Coal and Steel Community, which, in 1957, turned into the European Economic Community. The whole purpose of the EEC was to build a common market in a wide range of goods and services. Over the years, however, the EU has come to stand for something much broader. I suppose this might be summarised as the closer union of its citizens. While the original EEC treaty enshrines four key freedoms (the freedom of movement of goods, of persons, of services and of capital), there is no mention of taxation. Nevertheless, as far back as 1963, there have been various initiatives aimed at improving the functioning of the single market, and it has long been felt by the proponents of the Union that different levels of taxation result in major distortions in the functioning of the single market and mean that not everyone is playing on a level field.
In fact, the key driver behind the formation of the working group agreed last September is almost certainly the fact that many of the EU member states now have relatively low headline rates, which obviously makes them attractive to entrepreneurs and allows them what the EU terms as “unfair competition”.
So what is likely to happen? Option one is the sweeping away of all the existing domestic corporate tax systems and replacing it with a single, EU-wide system. Option two is to force each member state to pass new legislation ensuring that all tax throughout the Union is, basically, levied at the same rate. In the meantime, we are likely to see more of what has already being going on. That is to say, pressure will continue to be applied to those states offering companies (and individuals) lower levels of direct tax. Thus, from Malta to Ireland and from Sweden to the UK, we are likely to see an unofficial harmonisation occurring. What should one do? In my opinion, we should be making hay while the sun shines by exploiting every possible opportunity to save tax.
If further proof of the fact that one can trust no one when it comes to offshore tax planning, consider how Jerome Schneider has dumped his clients in it. Schneider, whose book titles include Hiding Your Money and How to Own Your Own Private International Bank, made millions helping the wealthy set up offshore banks to conceal money from being taxed. Recently, however, he was sentenced to six months in prison for conspiring to defraud the Internal Revenue Service after prosecutors urged a light term in exchange for his cooperation in the case.
He originally faced the maximum five-year term, but the Government urged the judge to imprison him for no more than six months because of his cooperation. He has been assisting authorities to catch his former clients and others, and has made himself widely available to the media to tell viewers and readers that offshore tax havens are illegal.
Inside the court room, Schneider, 53, of Vancouver, British Colombia, begged the judge for no prison time. “I have lost everything,” he said, noting that his February guilty plea to one count of conspiracy had cost him his marriage and he was now broke. He added that he is helping the Government to plug the loopholes and get tax cheats.
For years, Schneider persuaded wealthy investors to pay him tens of thousands of dollars each to create banks in venues such as Nauru, the Cayman Islands, Granada, the Cook Islands and Vanuatu. He told his clients that they could lawfully hide money in those banks, a practice the IRS say is illegal.
It is not know how much money was transferred offshore through Schneider’s investment schemes. When agents raided his Vancouver offices in 2001, they took hundreds of files from his clients, who are named in court documents. They include physicians, dentists, entrepreneurs, computer technicians and retirees.
Not surprisingly, many of his clients are now under IRS investigation.
The Boston Consulting Group recently issued a report on the state of the offshore-banking sector. In it, they suggest that a global crackdown on money laundering, combined with regulatory pressure for companies that become more transparent, have eroded the tax and disclosure benefits of offshore financial centres over onshore centres. The report estimates that US$580,000 billion is held offshore with more than half coming from European countries. Wealthy Europeans, apparently, hold US$130,000 billion in Switzerland, US$726 billion in Luxembourg, $554 billion in the Tamar Islands and $72 billion in the Caribbean. Boston Consulting Group say their wealth managers’ profits declined last year as costs rose faster than revenues. They predict onshore investing is likely to grow faster than offshore investing, especially in Europe and North America, where increased supervision and regulation is dampening enthusiasm for tax havens.
Of course, some governments, such as Italy’s, have provided strong incentives to repatriate money. Tax amnesties are having a significant and growing effect on the amount of wealth held in offshore markets. Interestingly, when, in 2002, Italy reduced the tax on repatriated funds to 5%, some US$50 billion – or 12% of the country’s offshore money – floated back from Swiss accounts. This compares with more-punitive rates by countries such as Germany, which taxes repatriated assets at 25%.
Not everyone shares the Boston Consulting Group’s negative views. Paul Pattison, head of RBC Global Private Banking (British Isles), recently told the Financial Times that their offshore business was proving resilient. “The opportunities in the domestic UK market have become smaller, but the world is becoming more international,” explained Pattison. “For international clients that live in multiple jurisdictions there is still a definite need for offshore wealth centres.”
There is no doubt that the harsher environment for offshore private banking – in particular the global clamp down on tax evasion, EU tax harmonisation efforts and a tax on banking secrecy – will result in the sector shrinking. On the other hand, the needs of the market it serves – privacy, security and tax mitigation – remain as great as ever and so there will always be a demand for the services that the sector offers.
WATCHDOGS SEEK BETTER ASSISTANT
Security regulators are to press offshore tax havens to provide them with better assistance during investigations into wrongdoing by individuals and companies. The International Organisation of Securities Commissions (IOSCO) started a dialogue with tax havens in January after expressing concern that offshore financial centres could be thwarting the effective supervision of capital markets. Roel Campos, joint chairman of a special task force set up by IOSCO, warned that some havens could be ostracised if they maintained an uncooperative stance. IOSCO are the main caucus body for securities regulators and are reviewing which financial centres should be regarded as uncooperative in cross-border cases involving violations of securities laws. Tax havens have traditionally protected individuals and companies from outside scrutiny through stringent confidentiality laws, and IOSCO want reforms to enable assistance in cases involving breaches of security laws. IOSCO say that sanctions will only be considered as a last resort.
Parmalat, the Italian dairy company, made widespread use of tax havens such as the Cayman Island to raise funds. The IOSCO task force will publish a report next year that seeks to draw lessons from Parmalat and other financial frauds, and is expected to include a section on how offshore centres can provide better assistance to securities regulators. Although IOSCO have 105 members, only 26 are signatories to the memorandum that allows regulators to exchange information, such as bank and brokerage records, during enforcement investigations. Jersey is the only offshore centre among the signatories. Many offshore centres are not members of IOSCO, but they will be urged to join in the coming months and sign the memorandum. Another difficulty faced by regulators is the struggle to return assets to countries where violations of securities laws occurred.
UK GOVERNMENT DEFEND TAX HAVEN
Somewhat ironically, the UK Government have been fighting to maintain a tax break for thousands of international companies registered in Gibraltar after the European Commission found the scheme violated state-aid rules. The tax break, known as the Exempt Company Scheme, will have to be phased out by 2010 and the British Government will have to curb the use of the scheme in the years leading up to that date. Officials and diplomats in Brussels said the UK stood ready to accept the Commission’s order in an attempt to close a dispute that has been raging for more than five years. Such a deal would make it hard for newcomers to win favourable tax treatment in Gibraltar, since the number of beneficiaries would be capped at the 2003 level. Businesses registered there are likely to retain their special status until the end of the decade, and they will not be forced to reimburse past savings. Under the scheme, companies can be exempted from corporate taxation in return for a payment of £225 to £300. It was first identified as a potentially harmful and distorting measure by a group of European tax experts in 1999. Since then, the Commission and the British Government have debated how to phase out the scheme, but the UK Government offered to replace the regime with a less-advantageous system was rebuffed. In fact, the British Government have launched a legal challenge against the Commission’s refusal to accept the replacement scheme, but a court ruling is only expected in 2007. A victory in court would allow Gibraltar to retain a favourable tax regime, independent of the phase-out demanded by Brussels today.
The Egyptian tycoon, Mohammed Al-Fayed, has finally decided to set up residence in Monaco – joining the likes of Formula One racing driver David Coulthard and actor Roger Moore. After 35 years in the UK, the owner of Harrods and The Ritz Hotel in Paris left Britain eighteen months ago for the shores of Lake Geneva, angry over the “grossly unfair treatment” dealt to him by the British establishment and tax authorities. But Switzerland has not proved so benign, and a recent change in the local law excluding foreigners from a loophole to avoid inheritance taxes has prompted his move to Monaco. Apart from American and French residents who have to pay their county’s income taxes, the tiny principality’s other foreign residents still enjoy no income or inheritance taxes. However, French residents will also soon have to pay France’s controversial special levy on large fortunes, as well as their normal income taxes. Furthermore, Monaco, along with Lichtenstein and Andorra, is considering signing up to the OECD’s transparency and exchange-of-information standards already adopted by 33 other offshore tax havens. This would then leave only two offshore centres on the OECD’s blacklist: Liberia and the Marshall Islands.
BROWN MOVES AGAINST OFFSHORE HAVENS
Tougher action against tax havens and strong rules to tackle bribery and corruption should be implemented by the world’s richest nations, Gordon Brown, the Chancellor of the Exchequer, said in a speech delivered during January. He urged developed and developing nations alike to “open their books” to external scrutiny and to adopt a “full framework of transparency… that makes the reality of our mutual responsibilities and the need for accountability”. The Chancellor’s comments follow UK moves to tackle bribery by multinational companies operating overseas and reflects his impatience for reform of the European Union’s common agricultural policy, which has been criticised as protectionist.
EU MEMBER STATES SLOW TO IMPLEMENT NEW REGULATIONS
Since October last year, it has been possible to set up a special European Company – or Societas Europaea – if one wishes to avoid the red tape of having to set up a network of subsidiaries. Such companies can be set up through the creation of a holding company or a joint subsidiary by the merger of companies located in at least two member states or by the conversion of an existing company set up under national law. However, of the 28 EU and EEA (European Environment Agency) member states, only Austria, Belgium, Denmark, Finland, Iceland and Sweden have so far implemented the regulations necessary to allow European companies to be set up within their own territories. Ultimately, the Internal Market Commissioner, Fritz Bolkestein, believes that European companies will replace companies located in individual countries.
OECD EXPANDS FISCAL AFFAIRS COMMITTEE
At the end of last year, China and South Africa joined Argentina and the Russian Federation as permanent observers on the OECD’s Committee on Fiscal Affairs (CFA). The CFA bring together senior tax officials, allowing them to exchange views on taxation policy, including treaties, the taxation of multinationals, combating tax avoidance and evasion, and consumption taxes. Meanwhile, China has expressed concern that so much of the foreign investment into China is coming through offshore financial centres. For instance, by actual investment amount, the British Virgin Islands ranked the second-largest source of foreign investment for mainland China in both 2002 and 2003. A report by the Chinese Academy of International Trade and Economic Cooperation, a part of China’s Ministry of Commerce, has suggested various measures to reduce the country’s dependency on this type of foreign investment.
GOOD NEWS ON CROSS-BORDER DIVIDENDS
If you are resident in the EU and receive dividends from a company in a different EU country, you may be eligible for a tax rebate. Recently, Peter Manninen, a Finnish taxpayer, went to the European Court of Justice because the Finnish Government taxed the dividend he received from a company quoted on the Stockholm Stock Exchange at the rate of 29%. He argued, successfully, that his dividend income would have been virtually free of tax if the company had been Finnish. Interestingly, the French and British Governments backed the Finns, but Manninen still won his case. The court ruled that to “deny tax credits on non-domestic dividends did amount to double taxation because corporation tax had already been paid in another member state”. The discriminatory tax-credit systems is already being challenged in the British High Court in a number of class actions brought by corporate shareholders in companies based in other member states. The European Court of Justice’s ruling suggests that the litigants will ultimately be successful.
JERSEY MOVES AHEAD WITH NEW CORPORATE TAX SYSTEM
As reported in recent copies of Schmidt Tax Report, the Jersey Government have confirmed that they will be introducing a new tax regime in order to cut headline corporate tax from 20% to 0%, and to 10% for finance institutions. The loss of revenue arising from these cuts will be made up for by a new sales tax, public expenditure cuts and plans to grow the economy. The reason for these new tax rates is that Jersey wishes to end discrimination between the taxation of offshore and domestic companies so that it can meet OECD and EU concerns over “harmful tax competition”. The new system will be phased in over a five-year period.
The Niue Government have decided to give up their ongoing battle with the Financial Action Task Force (FATF) and OECD, who have been putting pressure on the country to combat money laundering and end so-called harmful tax practices. The Niue offshore financial centre was only launched in 1996 and has been plagued with problems ever since. However, what is interesting about this move is that since the Government made a commitment to exchange information with overseas tax investigators and also altered their financial sector legislation Niue has no longer been on the OECD/FATF blacklist. Commentators assume that the new transparency has made the country less attractive to its investors. Niue’s international business register will close down at the end of 2006. After that, any international business companies (IBC) registered in Niue will cease to exist. Niue IBCs have a choice to relocate themselves to other jurisdictions or to become domestic Niue companies. Anyone with a Niue international business company would probably be well advised to contact the registry: Panama-based Mossack Fonseca & Company.
US MOVE TO CLOSE BARBADOS TAX LOOPHOLE
For many years, US corporations have been carrying out ‘corporate inversion transactions’ in Barbados in order to reduce their liability to US taxation. Now, however, a new protocol to amend the 1984 Barbados/US tax treaty has been brought into force, and it is expected that this will close the loophole.
The British Virgin Islands are going to stop offering non-resident companies preferential tax rates where compared to resident companies. This is in order to comply with the European Union Savings Tax Directive and the EU Code of Conduct on Business Taxation, as required by the UK of all its overseas territories. Under the proposal, a new payroll tax will be introduced at a rate of between 2% and 8%; in future, BVI companies – regardless of whether they are resident or non-resident – will pay a zero corporate tax rate.
After several years of disagreement, the Swiss parliament has finally approved legislation to enact the Swiss–EU savings tax agreement. Under the new accord, Switzerland will introduce a withholding tax of 35% on the savings income of EU residents. Broadly speaking, the agreement with Switzerland and with the other non-EU countries forced to enter into an EU savings tax arrangement, contain the following commitments:
• There will be a withholding tax of 15% on interest income paid to individual residents of EU member states between 2005 and 2008 rising to 35% in 2011.
• EU residents will now have the option to avoid the withholding tax by voluntarily disclosing to their home state tax authorities the interest income paid to them.
• There will be regular consultation between the non-EU countries and the EU on the operation of the agreement.
• There will be exchange of information on request in cases of tax fraud.
Q – Several years ago, I used a BVI company with bearer shares to purchase a property. As it currently stands, the bearer shares are held in an envelope by my bank. They have instructions to return the envelope to me when requested or, on shown evidence of my death, they are authorised to pass the envelope to my eldest daughter. Am I correct in understanding that I will shortly be required to register my beneficial interest in this company with the BVI Government?
A – If your BVI international business company was incorporated before the 31st December 2004 (and I assume it was), you will have until 31st December 2005 to comply with the new registration requirements. However, it looks as if there will be a short-term loophole. By increasing the annual fee you pay from US$300 a year to US$1,000 a year, you may be able to postpone registration. Generally, it is believed that anonymous bearer shares can remain in circulation and fully confidential until 31st December 2010. At that point, it is understood that these bearer shares will have to be lodged with a licensed custodian.
Q – What is a single premium insurance policy and are there any tax advantages?
A – Such policies are very straightforward. In order to effect one, you would pay a premium to the insurance company. They would then issue an insurance policy that would mature in, say, 20 years or upon your death. You may also maintain the right to surrender it before the 20-year term is up. The premium is used partly to cover the life-insurance risk and partly for investment. When the policy matures (or when you cash it in), you will receive the profits made on these investments. Should you die before the policy matures, your estate will receive a pre-agreed lump sum. Such policies are often referred to as ‘wrappers’ for investments. In tax terms, there are, broadly speaking, two benefits. First of all, most countries give policy holders tax relief. Secondly, it is unusual for any policy holder – regardless of where he is resident – to suffer any tax in a year when he does nothing except hold the policy, even though income may be rolling up in the insurance company. In other words, it is an ideal way to defer taxation. This is particularly useful if one plans to move from a high-tax country to a low-tax country or, alternatively, if one is planning to move from a high-tax bracket to a low-tax bracket. It must also be mentioned that with careful planning (for instance a period of time over seas) it may be possible to receive the entire proceeds of the insurance policy tax-free.
There is another benefit to this type of investment. Many of the insurance companies offering these types of bonds are located in low-tax or no-tax jurisdictions, such as the Bahamas or the Cayman Islands. This means that the gains from the investments will also remain tax-free because they are rolled up inside the policy.
Finally, there is one other tax benefit to using these financial products. It is this: many insurance companies will allow the purchasers of their policies to dictate how some or all of the investments are made. Furthermore, by choosing an insurance company located in an onshore jurisdiction, it is often possible to gain a further tax benefit. For instance, the tax treaty arrangement between the UK and USA means that withholding tax on dividends (normally 30%) can be entirely avoided, and not only withholding tax, incidentally. In some countries, other taxation such as death duties and capital gains tax can also be avoided. By the way, in Ireland and Luxembourg there are insurance companies that are willing to make investments in unquoted companies… another key benefit.
Incidentally, I suppose there is another reason to use single premium insurance policies as a way of investing. They don’t attract the attention of the revenue authorities. For instance, invest your money in a BVI international business company and, if the UK revenue authorities find out, you are likely to receive a great deal of unwanted attention. On the other hand, the taxman is unlikely to be terribly interested, even if he notices it, if you invest in an insurance policy.
Q – Are there any advantages, for a UK resident, to using a non-resident trust and company?
A – First of all, we presume that you are not only resident in the UK but also domiciled in the UK. As Lee Hadnum points out in his excellent book (Non-resident and Offshore Tax Planning) on offshore tax planning “directly owned offshore companies are not actually that common in practice. Instead offshore companies owned by offshore trusts are used more frequently. Such arrangements are often popular from a non-tax angle due to the practical advantage of owning the trust investments through one or more wholly owned offshore companies.”
The reason why people set up offshore companies owned by offshore trusts is that it is an ideal way to avoid any tax on the income, profit or capital gains made in the underlying investment or trade. Provided the beneficiaries of the trust were not resident, they would not have to pay any UK tax on distributions from the trust, and the company/trust would also suffer no UK tax charge if the assets held were overseas assets. If, on the other hand, the beneficiary of the trust was a UK resident, the main problem would be the UK anti-avoidance legislation. However, it might be possible to apply the motive test. This states that the anti-avoidance provisions do not apply if:
• the avoidance of tax was not the purpose for which the transfer of assets was made or
• the transfer of assets overseas was a bona fide commercial transaction and was not designed for the purpose of avoiding tax.
“Therefore,” as Hadnum points out, “for an individual to take advantage of this rule and claim that income from an offshore company or trust should not be attributed to them, they would need to show that there was no tax avoidance motive in the transfer of any asset overseas and essentially the companies were located overseas for sound commercial reasons.”
In order to be non-resident for income-tax and capital-gains-tax purposes, the trustees would all need to be non-resident and the general administration of the trust would need to be carried on abroad.
Hadnum gives an excellent example in his book and I hope he will forgive me for quoting it here verbatim:
“Peter, a UK resident and domiciled individual, wishes to purchase a business and property in Ibiza. One option would be to establish a trust, and transfer funds to the trustees. They would then either purchase the property directly, or via a wholly owned company.
“The transfer of funds from Peter would, however, be a problem from an inheritance tax perspective. As Peter is UK domiciled, the settlement is an immediately chargeable transfer, taxable at 20% for amounts above £263,000 (this assumes that he has made no previous gifts).
“However, the advantage of using a discretionary trust route is that the property would then be excluded from his estate for inheritance tax purposes. The drawback is that the trust would be subject to a separate regime of UK taxation. For inheritance tax purposes, the trust is subject to UK inheritance tax if Peter was domiciled in the UK when the transfer was made. This would undoubtedly be the case.
“In these circumstances one option to exempt the trust from UK inheritance tax would be for the transfer to the trust to be of ‘relevant business property’. The transfer to the trust would then be exempt from UK inheritance tax, and the trust itself would not suffer an ongoing inheritance tax charge, as business property relief (‘BPR’) would exclude the property from the inheritance tax charge.
“Relevant business property includes a sole trader, business, assets used in a partnership and shares in unquoted trading companies. Therefore in this case it would be far better for Peter to purchase the business and property directly and subsequently transfer this to the trust/company.
“Provided any transfer was made shortly after transfer, there would be unlikely to be a capital gains tax charge as any increase in value would be minimal. The trust would then be exempt from UK inheritance tax as the assets transferred would qualify for Business Property Relief.”
Q – In recent issues of The TSR Offshore Report, you have mentioned the concept of using offshore partners. Could you explain, briefly, what you mean by this?
A – The concept first came to our attention as a result of listening to a well- known international tax planner, Milton Grundy. He believes that “the service provider who acts as a kind of offshore butler to carry into effect the client’s wishes has pretty well come to the end of the road… for the UK resident, the future lies with the offshore company he can do business with – an offshore business partner. An offshore business partner can do things for the UK taxpayer that he cannot do himself. There are examples in the field of capital gains tax, income tax and inheritance tax.”
There are really two sides to international tax planning. To begin with, there is the problem of transferring an onshore asset from a high-tax jurisdiction into a low-tax jurisdiction. This asset may take the form of physical property, stocks or shares, cash, business, a stream of income or something else, such as intellectual property. The second part of the problem is, of course, being able to spend any gains one has made as a result of saving tax in this manner. We will put the repatriation of profits to one side for the purposes of this answer. We will also assume that the taxpayer has no desire to evade taxation but wishes to use legal methods in order to reduce their tax bill.
There was a time when the residents of high-tax jurisdictions, such as the UK, could set up discretionary trusts overseas safe in the knowledge that the Inland Revenue would never learn anything about them. If anyone (including the taxman) asked them if they were the beneficiary of an offshore trust they could answer, hand on heart, that they weren’t. This is because the trusts were discretionary and could award money to anyone. This meant that the onshore taxpayer had no legal right to money held in the trust even though he jolly well knew he would be receiving it. Anyway, that’s all history now since (a) most high tax jurisdictions have enacted complex anti-avoidance legislation to stop offshore structures being used in precisely this way and (b) there is no longer any such thing as confidentiality even in what was once considered to be the most secure jurisdictions in the world.
However, where there is a will, there is a way.
The problem with the traditional offshore structure is that, ultimately, it is owned by an onshore individual who can expect to be discovered and punished for evading tax. Supposing, though, the onshore individual has nothing whatsoever to do with the offshore structure? Supposing, in fact, that the offshore structure is not an offshore structure at all but an offshore business partner. Suddenly, the situation changes.
An offshore partner can trade, hold assets and carry on all sorts of activities in a wholly tax-free manner and without putting the onshore half of the partnership at risk of prosecution. There are many ways in which such partnerships can be set up. If you look at previous issues of The TSR Offshore Report, we do discuss one or two of them, and we will be looking at further structures in future issues.
Readers may be interested to hear that Sweden has become an extremely attractive country in which to set up a holding company. This is because, as long as profits stay in the company, all the dividends are distributed to individuals or companies resident outside of Sweden; therefore, the tax impact will often be extremely low. Borrowing from a fascinating article on the subject by Clas Ramert, let’s look at some of the characteristics of a Swedish holding company:
• dividends from unquoted companies are tax-free
• no capital gains on sales of shares in unquoted companies
• no withholding tax on interest
• no thin capitalisation rules
• interest expenses are always deductible
• there is seldom withholding tax on dividends
• no capital tax on the creation of a company or increases of share capital
• credit for double-taxation rules are very favourable, even without applying treaties
• Swedish corporate income tax is 28%; taking the favourable possibilities of postponing tax payments into consideration, the effective tax rate is often around 25% or lower
• Sweden is a member of the EU
• accounting in euros is possible
• Sweden has double-tax treaties with around 80 countries and territories and the number is increasing
• advisors’ fees are relatively low in Sweden.
As Clas Ramert says at the end of his article, the unique characteristic of Swedish holding companies is that Sweden has them without being regarded as a tax haven or even a low-tax country. For this reason, it can be expected that a Swedish holding company will have fewer problems in relation to tax authorities outside of Sweden than a holding company located in a real low-tax country.
One of the key issues attached to locating any business in a low-tax jurisdiction is the question of acceptance by other, higher-tax, jurisdictions. Put another way, corporate residence is a major tax risk-management issue.
The penalties for making a mistake about corporate residence can be severe. There have been a number of recent criminal cases involving corporate-tax residence where taxpayers and their professional advisors resident both in the UK and abroad have been successfully prosecuted by the Inland Revenue under the common-law offence of cheating the public revenue. In more than one case, prison sentences have been imposed. Basically, these cases have revolved around the fact that, although a company may be located overseas, if it is, effectively, managed and/or controlled from the UK, it should be liable to British corporation tax.
So what are the key issues? And, more to the point, how can you avoid a corporate-tax residence problem?
It is worth remembering that the key issue has to do with ‘central management and control’; so a foreign incorporated company may be UK tax resident where its ‘central management and control’ resides in the UK. What is meant by ‘central management and control’? It first came up in a 1906 court case in which the judge said:
“A company resides, for the purposes of income tax, where its real business is carried on… I regard that as the true rule; and the real business is carried on where the central management and control actually abides.”
The Inland Revenue resolve doubts about a particular company’s residence status by:
• first trying to ascertain whether the directors of the company in fact exercise central management and control
• if so, they will seek to determine where the directors exercise this central management and control (which is not necessarily where they meet)
• where the directors apparently do not exercise central management and control of the company, the Revenue then looks to establish where and by whom it is exercised.
In the case of parent/subsidiary relationships, it is obviously sometimes difficult to establish. One way to ensure that subsidiaries incorporated outside the UK are deemed to be resident outside the UK is to establish a properly functioning board of directors. Effective management can be another problem. If the head office of a group is in the UK even if the company itself is incorporated in Belgium, and the directors meet in Belgium the UK is likely to be deemed the place where the company should be taxed.
Not enough attention is paid to the question of corporate residence, and readers using offshore structures or with offshore subsidiaries would be well advised to pay close attention to the topic.
A reminder to UK-based entrepreneurs that the transfer pricing rules will be changing this year. The UK transfer pricing provisions, like most others, cover transactions on tangibles, intangibles, funding and services. What this means is that any transactions between group entities need to be priced on an arm’s-length basis. If they are not, the Inland Revenue can tax the profit that would have been earned if arm’s-length pricing had been used. Prior to 2005, transfer pricing provisions in the UK have only covered transactions between UK and non-UK resident entities. However, the scope of the rules has now been extended to include transactions between UK entities. This said, transfer pricing rules do not apply to small businesses unless that business has transactions with a non-exempt country. Non-exempt countries are those with which the UK does not have a double-taxation treaty containing a non-discrimination clause. If you would like to know more about this, we would suggest reading an excellent article on the subject by Colin Clavey and Nipun Abhat which appeared in Taxation on 2nd December 2004.
If you are looking for a country in which to establish a corporate entity, you could do worse than consider Estonia. Since the year 2000, Estonian companies are no longer taxed on their profits, provided no distribution takes place. The idea of these regulations is to stimulate investment within the economy. Furthermore, although dividends are taxed at an effective rate of 26%, loans to corporate parents are permitted. Furthermore, there is no capital gains tax for an Estonia-based company, provided, again, the gain is not distributed to shareholders. Other key tax benefits include:
• interest received by resident companies is exempt from withholding tax
• royalty payments do not suffer withholding tax either
• if an Estonian company pays a management charge or for some other services, VAT will normally apply.
To quote a leading expert, “due to the fact that Estonia only levies a corporate tax on distributed profits, that it does not levy withholding tax on dividends paid abroad if the non-resident shareholder is a company that holds at least 20% of the shares and it is expanding its tax treaty network, Estonia has become an interesting holding and trading company jurisdiction, especially given that Estonia has recently joined the EU and entered into many favourable tax treaties with other jurisdictions.”
Other things to bear in mind about Estonian companies include:
• the minimum share capital for a private limited company is about €2,500, and authorised share capital must always be fully paid up
• bearer shares are not permitted
• at least half the directors of an Estonian company must be either Estonian or EU resident
• although details of the directors, annual returns and shareholder information are all public, beneficial ownership can be kept confidential
• Estonia has excellent communications with the rest of Europe, there are no exchange controls, the banking system is fully modernised and offers online banking, costs of company administration are very low
• although the official language is Estonian, English is widely spoken
• Estonia is an independent country and has been so since 1918
• it is run by a stable, democratic, parliamentary Government
• with modern anti-money-laundering legislation in place, Estonia has never been blacklisted by any international supervising bodies
• finally, it is possible to operate your bank account in a ‘soft’ currency.
It is our intention to be as accurate in fact, detail, analysis and comment as possible. However, publishers and their representatives cannot be held responsible for any error in detail, accuracy or judgement whatsoever. The Schmidt Offshore Report is sold on this understanding. The Schmidt Offshore Report is commissioned and published by Wentworth Publishing Ltd, 17 Fleet Street, London EC4Y 1AA. Email: wentworth@online.rednet.co.uk Tel: 020 7353 6606. © Wentworth Publishing Ltd 2005. All rights strictly reserved. This publication may not be lent, hired, reproduced (in any way whatsoever) or re-sold. This information is authorised for personal consumption only.
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