THE SCHMIDT OFFSHORE REPORT
(Vol 2, no 5)

CONTENTS

NEWS

FEATURES

NEWS

BVI launches new private trust companies

Changes to the Financial Services Commission Act in the British Virgin Islands (BVI) now allow for private trust companies to be established on a fast-track basis. Unremunerated BVI private trust companies that do not offer their services to the general public will be able to apply for these exemptions. These will allow family-controlled structures to be established and offer trustees the benefits of limited liability; they lessen the tax burden by moving the liability from the settlor to the trust company.

Take note of the new Income Tax Act 2007

Readers planning to transfer assets abroad should note that from the beginning of the current financial year (6th April 2007) the Income Tax Act 2007 came into effect. This particular legislation is part of an ongoing effort by the British Government to rewrite tax laws with a view to simplifying them and making them easier to understand. While there are no major changes in the new legislation, anyone planning to transfer assets out of the UK would be well advised to take professional advice first.

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Update: UK offshore tax amnesty

On 22nd June, the UK offshore disclosure facility closed. This so-called tax amnesty offered UK taxpayers who had previously failed to disclose offshore accounts an opportunity to declare such funds without fear of criminal prosecution. The facility came about because HM Revenue & Customs (HMRC) obtained – as a result of legal proceedings – the names of some 400,000 British taxpayers with offshore accounts. An initial analysis of this list suggested that one in four had failed to declare offshore assets on their UK tax returns. Therefore, HMRC expected tax receipts from 100,000 people. In fact, only 60,000 registered under the facility, which leaves HMRC with 340,000 ‘suspects’ to contact and investigate.

So, what will happen next?

Obviously, there are only likely to be two reasons why taxpayers who have been written to by HMRC failed to respond. The first is that they do not believe that any liability exists. The second is that they know they have a liability but are hoping to avoid detection.

HMRC is likely to pursue the following course of action:

  • Reminder letters to some or all of the 340,000 who have not yet responded offering them an extension to the original deadline.
  • A second letter pointing out that although the offshore disclosure facility has come to an end there are still ways in which they can put their tax affairs in order.
  • Smaller and simpler cases are then likely to be passed to local offices. These will be worked through as quickly as the local offices can manage but best estimates suggest that it may take them years to process so much data.
  • The new Civil Investigation of Fraud (CIF) teams and Special Civil Investigations (SCI) teams will take the larger cases. Taxpayers will be investigated on the basis of the evidence from the banks and what is already held on file. If cooperation is not forthcoming, estimated assessments of tax due are likely to be made and enforced through the courts.
  • Where suspected serious fraud exists, it is likely that investigation will take place under HMRC’s Code of Practice 9. During the registration period, HMRC was working behind the scenes to identify such cases for its specialist offices.

In other words, those who are holding serious amounts of money in an offshore account who have not made use of the disclosure facility are likely to experience a fairly fast and aggressive response from HMRC. Furthermore, Dave Hartnett, HMRC’s director general, has said that the investigations will be “intrusive and thorough”.

If you find yourself subject to an investigation – especially under Code of Practice 9 – you should, without doubt, take specialist advice. It is also important that you are seen to be cooperative. If HMRC believes you are not being cooperative, it is likely to pursue the case with even more vigour. A Code 9 investigation usually evolves in the following way:

  • You, your adviser and HMRC has a long opening meeting. At this meeting, you will be asked to give written and signed answers to certain questions on both tax and VAT. To quote one expert: “The questions can cover all sources of income and gains giving rise to tax and are without limitation as to time.”
  • Following on from this meeting, your professional advisers will agree the scope of the disclosure report with HMRC before the Revenue starts the detailed investigation. If you feel you have nothing to disclose and HMRC disagrees with you – perhaps on the basis of evidence it already holds – you can expect a criminal prosecution.
  • If you do admit that you have things to disclose, your accountants will then prepare a report covering your business and personal tax life setting out any irregularities. Appended to this must be a statement of all your assets and a certified list of bank accounts and credit cards. If HMRC has any reason to believe that you have completed this incorrectly, again you are likely to suffer prosecution.
  • At the end of the process, if you are fortunate, you will end up with a substantial tax bill covering unpaid tax, interest and penalties. If you are less fortunate, you will end up facing a criminal prosecution.

HMRC is also likely to go after non-domiciled UK residents who may have accidentally remitted funds to the UK from their offshore accounts. This happens frequently and often gives rise to a tax liability without the individual being aware of it.

As John Cassidy, a partner specialising in tax investigations for PKF, recently remarked: “Now that the offshore disclosure facility registration period has closed, investigations will start in earnest. HMRC has a huge amount of data to work with and there will most likely be a large number of serious cases opened very quickly, with more to follow. Much of this will be done under Code of Practice 9 creating risks for advisers tempted to operate outside their area of expertise. In some cases, HMRC may use their self-assessment powers, for example, to inquire into the 2005/6 tax return as a way of unearthing irregularities that may have arisen in earlier years. They can then use their discovery powers to re-open those years. The volumes involved also suggest we may see a form of intervention on offshore bank accounts or non-domiciliaries for those who have not made use of the amnesty. HMRC may be looking for informal, voluntary answers to questions.”

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Russian tax amnesty fails to attract

President Putin’s tax amnesty – which runs until the end of December – has not been a success. The offer is generous – just 13% tax, no fines, no interest and no need to actually speak with anyone in the tax office (you just deposit your tax straight into a special account) – but Russian taxpayers, who are used to extremely rough treatment at the hands of tax collectors (not to mention having to pay out substantial bribes) remain sceptical. Response is said to be disappointingly low.

Chinese tax rates rise

Earlier this year, the Chinese Government moved to unify corporate-tax rates. The new regime starts on the 1st January 2008. Until then, domestic firms continue to pay between 15% and 33%. From the start of next year, there will be a unified rate of 25%, with some preferential rates of 20% and 15% for certain enterprises. To reduce the effect of what will be higher taxation for many companies, those currently enjoying lower rates will have a five-year transition period during which their existing benefits will continue.

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NMV gets off to a flying start

On 1st November 2006, the Isle of Man introduced a new form of company known as the New Manx Vehicle, or NMV. It is, in essence, an amalgamation of the best features of the International Business Companies (IBCs) found in the British Virgin Islands (BVI). The NMV has been described as “a vehicle which is legally robust, yet flexible, cost effective and easy to administer”.

One of the areas where the NMV is likely to come into its own is that of aircraft ownership structures. On 1st May 2007, the Air Navigation (Isle of Man) Order 2007 legislation came into force allowing private and corporate aircraft to be registered in the jurisdiction. The Isle of Man’s intention is to seek business not from commercial airliners but from professionally flown privately and corporately owned business jets as well as helicopters and the new lighter jet aircraft being produced by companies such as Cessna. As the Isle of Man is already a leading centre for aviation finance and leasing, it is likely to win a reasonable percentage of this market. It is worth remembering that since 6th April 2006 the standard rate of income tax for companies in the Isle of Man has been 0%. There are really only two exceptions. Banks are taxed at a rate of 10% on income from their banking business, and for companies with non-resident owners there is a withholding tax on rental income. As a result, the Isle of Man is an ideal location to register an aircraft since the net effect is tax-neutral. It is also to be noted that the Isle of Man is also an ideal location to register ships.

Incidentally, the Isle of Man may still be an ideal location to register an aircraft even if you are a UK resident. The key issues to consider are:

  • management of the NMV: this should, obviously, be in the Isle of Man to avoid UK-residency issues
  • anti-avoidance provisions: UK anti-avoidance measures will need to be reviewed for UK residents
  • personal benefit: to quote leading expert, Richard Curtis: “Even though the company is Isle of Man resident and probably outside the scope of UK corporation tax, there is the potential for a UK resident to benefit from an asset, such as a private aeroplane or boat, owned by the company; generally speaking, it is thus best to ensure that a UK resident benefits to no greater extent than other employees or pays the market rate for the use of the asset.”
  • VAT: the Isle of Man is part of the UK for VAT purposes. If VAT is paid on the importation of, say, a boat to the island, and thus has ‘VAT paid’ status, it can move freely around the EU; to recover VAT, it will be important to show that the asset is used for bona fide business purposes.

With regard to the latter point, it is worth remembering that if you purchase assets such as planes and boats through a specially set up company the business should be able to recover all VAT.

EU anti-crime measures hit new trusts

Under a new EU directive, solicitors have to make sure that trusts are not being used to launder money and so in the future, for the first time ever, they will have to perform due diligence not just on a trust’s settlor but on the beneficiaries as well. This will not affect trusts being set up outside the EU. However, within the EU it will mean a substantial extra cost as solicitors perform background checks. The EU adopted its Third Money Laundering Directive in September 2005, and this requires all members to put this requirement into their national laws before the end of this year. It might be an argument for setting up any trusts now, rather than later. Note: the primary use of a UK-based trust is to shield assets from IHT.

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FEATURES

Are you tempted to become a PT?

In the high-tax regime of the 1980s, a number of tax experts came up with the concept of ‘perpetual travel’. The basic idea was that an individual could avoid income and capital gains tax (CGT) – plus many other taxes – by ceasing to become resident in their home country and not taking up residence in any other location. By perpetually travelling in this way, they would, in theory, escape all tax nets. It is not a concept that works for most people, since it requires:

  • no static employment
  • no pressing family ties
  • a willingness to live in a minimum of two or three different places simultaneously.

At one point, it would also have necessitated a substantial income. However, thanks to budget airlines springing up all over the world, becoming a perpetual traveller is no longer prohibitively expensive.

Perpetual travellers do not, of course, have to perpetually travel. Many locate themselves in just two places. The first and main residence is likely to be located in a very low- or zero-rated jurisdiction. For instance, it might be Egypt or Belize. The second might be their former place of residence such as the UK or Germany. The benefit of such an arrangement is that you are not forever moving about. The disadvantage is that zero- and low-tax jurisdictions tend not to be as pleasant to live in. Many perpetual travellers, therefore, have a third or even a fourth residence to spend time in. For instance, you might be legally resident in Egypt and have a modest home there but actually spend most of your time in France, Ireland and the UK. Under these circumstances, you could spend three months in the UK, four months in Ireland and so forth without becoming resident in those countries. The thing about Egypt is that there is no minimum residence requirement in order to be taxable. All you have to do is declare that you want to pay tax there. Furthermore, they are not particularly interested in your worldwide income. You can arrange to be taxed on a remittance basis, which, as income tax is 10%, need not be onerous.

Is there any actual benefit to having a definite tax residence? Yes and no. One of the major risks when you become a perpetual traveller is that one of the countries you are visiting will claim you as a tax resident. If you can point to paying tax somewhere else – even if it is clearly a very low amount – this may be of substantial use to you. On the other hand, many tax authorities will examine closely the amount of time you spend in your so-called tax residence. If you are UK-domiciled and are challenged by HMRC to prove that you are not resident in the UK, simply stating that you are resident in Egypt may not be enough. HMRC may decide to look at the amount of time you spend in Egypt versus the UK. If you are spending three days a year in Cairo and 91 days in London, HMRC is unlikely to give much credence to the concept that Cairo is your main home. Therefore, having a tax residence for the sake of it may serve no purpose.

Another thing to consider is death duties or inheritance tax (IHT). In the UK, for example, if you do not lose your UK domicile, you will remain liable to IHT. There are a number of ways around this. You could, for instance, transfer all your UK assets to trusts and/or offshore companies and secretly have these passed on to your beneficiaries after your death. Nevertheless, such a move is likely to be challenged by HMRC if your beneficiaries are UK-resident. The same would be true if your assets were UK-located.

It is hard to know how many perpetual travellers there are in the world. Anecdotal evidence would suggest that among the professional classes, self-employed and entrepreneurs there are more than one might expect. The well-known Irish entrepreneur Tony O’Reilly, for instance, is understood to move constantly between Ireland, the UK, Australia and the US – thus avoiding residence in any of those places.

Finally, if you do decide to become a perpetual traveller, you need to think carefully about what you put down on any official form. When entering any country, if you put down that you do not have a place of residence, you are likely to be denied entry. Therefore, it is important to put down somewhere! And to be able to back up your ‘somewhere’ with hard evidence.

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Beware the new ‘permanent establishment’ rules

As part of the British Government’s ongoing attack on the use of trusts, the definition of trustee residence for both income-tax and CGT purposes has been changed. The new rules took effect from 6th April 2007. Basically, what HMRC wishes to do is bring as many offshore trusts into the British tax net as possible. Accordingly, the new trustee residence test is as follows:

Trustees are treated as resident and ordinarily resident in the UK at any time if one of the following conditions is satisfied. First, that all the trustees are resident in the UK. Secondly, that at least one trustee is resident in the UK and at least one trustee is not resident in the UK and the settlor was resident, ordinarily resident or domiciled in the UK when he made the settlement or added assets to the settlement.

Furthermore: “a trustee who is not resident in the United Kingdom shall be treated for the purposes of sub sections (2a) and (2b) as if he were resident in the United Kingdom at any time when he acts as trustee in the course of a business which he carries on in the United Kingdom through a branch, agency or permanent establishment there.”

HMRC has stated that the branch or agency tests will not be relevant to corporate trustees but only to trustees who are individuals. There is a similar provision for income-tax purposes.

Why is this important? The location of a trust is determined by the location of the trustees. Furthermore, it is almost always beneficial to a trust to pay CGT than it is income tax. If you are involved with the use of a trust and are UK-resident and/or –domiciled, it is well worth checking that the trust is still offshore.

Finally, the new definition and rules have some bearing on the purchase of own shares by a company. Historically, a purchase of own shares from trustees would always get income-tax treatment. Since 5th April 2006, however, it may have changed to capital-gains treatment if there is an s219 clearance.

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A VERY FAVOURABLE OFFSHORE BUSINESS STRUCTURE
by Nathaniel Litmann

Most people when setting up offshore structures think in terms of companies and trusts. The normal route is to start a trust that, in turn, owns one or more companies. By carefully locating the companies and trust in zero- or low-tax rate jurisdictions it is, therefore, possible to keep any profits virtually tax-free. But is this structure always the most sensible one to establish? Probably not.

Let me explain what I mean with an example. Charles is a UK resident with two boys – Harry and William. Harry has immigrated to New Zealand and Willy has immigrated to the United States of America. During their Christmas holidays, one year the three men decide that they will start an investment company that will buy and sell shares in different markets around the world. None of them is in any hurry to collect such profits as there may be. Indeed, Charles is desirous that all the profits should flow to his two boys since he has more than enough money and is thinking about his IHT situation. Harry and William are not in any need of the money and worry that their father, in his old age, will be hard up for cash and should hang onto his cash just in case he needs nursing care.

One of the key problems facing these budding entrepreneurs is that if they locate the company in an offshore jurisdiction there is a great likelihood that the British tax authorities will claim that it is “managed and controlled” onshore in the United Kingdom. Indeed, the New Zealand and American tax authorities may make similar claims. Nowadays, it is much harder to prove that a company is managed and controlled offshore – it is no longer sufficient to simply hold the board meetings in the offshore jurisdiction. Since Charles, Harry and William do not want this international venture to be taxed in their home countries, they are all quite worried about the offshore-company route. What they decide to do is form a simple partnership. This solves the residence problem so far as the United Kingdom is concerned. The British system no longer regards a partnership as having a residence; so Charles’ share of the partnership profits is regarded as his income, and, provided the partnership does not carry on business in the United Kingdom, HMRC is not interested in either Harry’s or William’s share. Since the three of them did not require the profits in the immediate future, it was agreed – and drawn up in the partnership agreement – that the profits would be divided in such proportions as the partners may unanimously decide at some point in the future with the proviso that if they have not made a decision at the end of ten years a person will be appointed to make a decision for them.

Consider the beauty of this situation. As far as the British taxman is concerned, because this is a partnership he doesn’t care where it is located. Furthermore, because there is to be no distribution of the profits in the immediate future, there is no question of any income accruing to Charles. How so? Because the partner is in the same sort of position as the beneficiary of a discretionary trust: he might get something from the partnership in the future or on the other hand he might not. To quote Lord MacNaughton when he was deciding a leading tax case over 100 years ago: “Income tax, if I may be pardoned for saying so, is a tax on income. It is not a tax on anything else.”

Clearly, the arrangement made between Charles, Harry and William does not involve avoiding income tax, merely postponing it. If you are a higher-rate taxpayer (in fact, if you are a taxpayer at all), postponement offers an amazing benefit. It means that you can compound your profits.

Incidentally, a side issue with regard to this partnership, arrangement is whether or not the UK resident – Charles – has what is called the ‘power to enjoy’ the income from the partnership. Clearly, until such time as they divide the partnership profits up, he doesn’t. How different this position might be if he had shares in – and control of – an offshore company.

So far, so good. By establishing a partnership, it has been possible to postpone tax on any profits being made for up to ten years. Might it be possible to avoid tax at any point? If Charles is willing to have a run-in with HMRC, then the answer is that he may be able to avoid all income tax. How? When Charles receives income from the partnership, is it income of the year in which it was earned by the partnership or income in the year in which he receives it? As a partnership is fiscally transparent, the answer ought to be it is the income from the year in which it was earned whether or not it was distributed. On this basis if the partners refrain for a certain period from deciding how the profits of the partnership are to be divided, a distribution after the end of that period may not give rise to a tax liability. In the United Kingdom, the period of limitation is in principle six years, and if six tax years have gone by since the income arose, the income cannot be taxed. This is not the case, of course, if the taxpayer has been guilty of fraud or wilful default in relation to the income in question. But a taxpayer cannot commit fraudulent or negligent conduct by missing from his tax return income that has not yet been ascertained. In theory, it follows that six-year-old income can be distributed to Charles without triggering an income-tax liability.

What about the situation regarding IHT? Supposing Charles dies at a time when there are undistributed profits in the partnership? Even though there may be substantial profits within the partnership, the nature of the partnership agreement means that the share in the partnership is probably not actually worth that much. After all, the partners have to unanimously agree before any distribution takes place. Therefore, it is probable that the share in the partnership can pass to Harry and William without bearing any IHT liability.

Let me just say that this concept – which was explained to me at a conference I recently attended – is, as yet, untested. The legal side of it certainly appears to stack up but – as we all know – HMRC is quick to plug any perceived loophole when it spots them. This said, one of the beauties of a discretionary partnership of the sort I have just described is that it cannot be considered a tax-avoidance scheme. It is a business partnership first and foremost.

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 2007. 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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