As we near the end of another year, let me wish you a very happy and healthy new year when it arrives – and an enjoyable festive season over the Christmas break. I will be in Shanghai for most of the time until the new year, witnessing at first hand what it is like to be in a currency zone which isn’t about to implode, an economy which is still growing at a very respectable pace, and a business environment which is hugely in favour of the risk taking entrepreneur. Nevertheless, I will miss the many aspects of London which makes it such a wonderful place to call home – the crowds on Oxford Street shoulder to shoulder spending money on credit they can’t afford to repay, the train delays because of snow/leaves/ice on the tracks, and fake reality shows on television which pander to all of our baser instincts (other than Strictly Come Dancing which is pure gold!).
The last newsletter was sent out just before the Barclays Wealth sponsored Second Annual ITSAPT Conference at the Landmark Hotel on 3rd November. The subject was corporate and personal migration and I am glad to say that the conference was really well attended. It augurs well for next year’s conference, the subject of which will be Structuring International Real Estate Transactions. More about this in our January newsletter – but you can reserve the date now, November 8th 2012.
Many readers will know that I have been discussing the merits of corporate migration throughout this year, the possibility of moving from a disadvantageous tax regime to a more benign one, of stepping-up the basis of underlying assets to mitigate capital gains tax, and the restructuring of businesses to align the corporate structure with administrative and regulatory requirements. To date, there has been very little case law relating to jurisdictional taxing rights when a company moves to another country, but the decision in the National Grid Indus case before the Court of Justice of the European Union gives some insight in the way the Court would approach cases of corporate migration between Member States in the future. In this month’s article, Dmitry Zapol has examined the case in detail and drawn some conclusions from this, as well as commenting on some of the ‘gems’ of advice gleaned from our November conference.
With my best regards Roy Saunders
ITSAPT 2011 CONFERENCE OVERVIEW / NATIONAL GRID INDUS
The Second Annual ITSAPT Conference sponsored by Barclays Wealth was, in my view, a worthy culmination of our year-long efforts to raise the profile of corporate and personal migration as effective and novel international tax planning tools. Readers who wish to familiarise themselves with the subject can refer to IFS’ October 2010 and April 2011 newsletters that respectively provide details of each concept. Those with access to ITPA materials can also download Roy Saunders’ March 2011 presentation “Corporate migration: planning opportunities” or request us to send them the same.
The ITSAPT Conference focused on three major areas that the above materials and the new ITSAPT 2011/2012 book addressed. Firstly, speakers described methods of corporate redomiciliation and their respective advantages and disadvantages. Next, the international experts explained what methods worked in their jurisdictions and what tax benefits a company could attain by moving there. The third area concerned individual tax planning through personal migration.
A substantial part of the Conference was devoted to discussing the benefits of redomiciliation to different EU jurisdictions. To name a few; Luxembourg, which does not tax foreign capital gains under certain conditions, may attract a UK listed company that cannot otherwise avoid paying tax on sale of its foreign subsidiaries if they do not qualify for the UK’s substantial shareholding exemption. Luxembourg, however, levies 15% tax on dividends payable to non-treaty States, and therefore Malta with its complete absence of withholding taxes may be a viable alternative. So if a company has migrated to Luxembourg, a further migration to Malta may be possible.
Also, Malta allows resident but not domiciled companies (ones not incorporated in Malta but managed and controlled there) to be taxed only on profits that are remitted to its territory — an approach akin to territorial taxation practiced in Hong Kong and Singapore — and fully exempts from tax profits of qualifying aircraft companies regardless of their source. Both Luxembourg and Malta also allow a step-up in value of the immigrating company’s assets bringing their book value to the market value on the day of redomiciliation. Ireland is another popular destination with its low rate of corporation tax and less stringent anti-avoidance provisions. Finally, Cyprus may attract many by its liberal tax laws and acceptance of all of the existing methods of redomiciliation.
Speakers from the UK and the Netherlands flagged up the problem of exit taxation levied on companies changing their residence within the EU. While most jurisdictions tax emigrating companies, it seems odd that exit taxes have not been struck down for violating EU Treaty freedoms and freedom of establishment in particular. There are a string of cases that address this issue, however, and the Court of Justice of the European Union addressed Dutch exit tax in a very recent case of National Grid Indus (C-371/10). The Advocate General’s opinion provides an interesting background and serves as a perfect example of how and why a shareholder — an English parent company — may choose to redomicile its Netherlands subsidiary to the UK.
Both States follow the incorporation theory in determining residence of a company, and this allowed National Grid Indus BV to transfer its place of effective management and its entire business activity to London. It gave up its business offices in Rotterdam, three English directors replaced the Dutch directors, and the company closed its Netherlands bank accounts and opened new accounts with an English bank. As a result, the subsidiary continued to exist under both Netherlands company law and English tax law; the UK tax authorities regarded the company as resident in the UK, and under Netherlands tax law there was a permanent establishment in the UK which belonged to a Netherlands company.
There were rational commercial grounds for transferring the place of effective management. The main asset of National Grid Indus was a claim on an intra-group multi-million pound sterling loan, the interest on which was deducted by group debtor companies. Considering the UK’s decreasing rate of corporation tax, the interest would no longer be taxed at a rate higher than the rate at which UK debtors could deduct it. Also, the currency risk in relation to the Dutch guilder/Euro would no longer exist after the move because in the future the profits would be calculated only in pounds sterling. Finally, there was no longer a need to profit from the Netherlands–Pakistan double tax convention — one of the reasons for establishing the company in Rotterdam in the first place.
While resident in the Netherlands, because of rises in the exchange rate of the pound sterling against the Dutch guilder, the company earned substantial unrealised currency profits in respect of the loan. Until the transfer, National Grid Indus was able to show the loan in its balance sheets at the historic rate, and until then the currency profits had not been taxed. Following the move the profits that constituted the gain would be liable to tax only in the UK under the applicable double tax treaty. Furthermore, seeing that the loan was denominated in UK currency, the gain would disappear altogether.
The Netherlands tax authorities did not object to the move. At the same time, considering that under domestic law National Grid Indus would cease to derive profits from the business taxable in the Netherlands, they sought to impose an exit tax on the company — to crystallise the currency profits into a capital gain liable to immediate Netherlands corporation tax.
The Court considered whether levying such an exit tax was compatible with the principle of freedom of establishment — the issue previously considered in, amongst others, Daily Mail and Cartesio. The Court repeated its previous findings: companies are primarily creatures of national law, and Member States are free to decide on connecting factors that determine whether a legal person is incorporated and can maintain its status in the future; whether it remains subject to national laws and is thus capable of enjoying the right of establishment. The EU law should respect the choice of a Member State to grant a company the right to retain its legal personality under the law of that State subject to restrictions on transfer abroad of the company’s place of effective management (the “real seat” theory States) or without such restrictions (the “incorporation” theory States).
In other words, a company, which loses its legal personality following the transfer of its place of effective management abroad — an approach followed in e.g. France, Germany or Luxembourg — cannot rely on the EU freedom of establishment against the Member State that imposes exit tax on its departure. Conversely, a company incorporated in a State that allows mobile place of effective management, such as the UK, Ireland and the Netherlands, continues to be regarded as a person under the laws of the State it departed from and should not be subjected to such tax.
The above, however, is not the final conclusion reached by the Court. It accepted views of some Member States that levying of exit tax can be justified by overriding reasons in the public interest. In this situation the purpose behind the exit tax is to preserve the allocation of taxation powers between the Member States. In other words, under the circumstances the Netherlands is entitled to tax the gain, which arose before National Grid Indus became resident in the UK, despite the fact that but for the company leaving the Netherlands the gain has not yet crystallised.
The Court reached two important conclusions regarding determination of the company’s tax liability. The first finding concerns the amount of the gain liable to the tax. The Netherlands is entitled to definitely ascertain the gain amount without taking account of potential subsequent decreases or increases in its value at the time when the company ceases to be resident in the Netherlands through the transfer of the company’s place of effective management to the UK. The second finding concerns the moment when the Netherlands is entitled to levy the tax. The Court found that the Member State must give the Company a choice between paying the tax immediately at the time of the transfer of residence and deferring the payment until the gain is subsequently realised.
In other words, a company that owns assets pregnant with gains may be requested by the Member State, which it departs, to ascertain the amount of gains at the moment of becoming not resident in that State. This amount will be final and not subject to further increases or decreases. It will be used as the tax base for levying exit tax. The company, however, should be given a choice of whether to pay the tax immediately and suffer adverse cash-flow consequences or to postpone the tax charge and face administrative burdens of tracing the assets together with paying interest on unpaid tax.
Failing expectations of many tax practitioners, the decision of the Court does not prohibit Member States from levying exit taxes, although admittedly it provides a useful summary of the case law to date and adds important clarifications to the existing practices.
The Conference also addressed the possibility of avoiding exit tax liability despite findings of the Court (at that time the outcome of National Grid Indus was unknown and the discussion considered the existing case law). One method, devised specifically to migrate a UK company to Italy, involved merging the existing UK corporation into an Italian SPV. The merger would not cause adverse tax consequences in the home state due to the effect of the EU Merger Directive. Benefits under the Directive, however, could be denied if the UK tax administration believed that the transaction was concluded purely for tax avoidance. To rebut such presumption it was necessary to demonstrate the genuine commercial purpose behind the merger and in particular that the Italian company was an active company with substance.
Recently, the Court expressed its views on the importance of genuine business arrangements in Foggia (C-126/10) . The case concerned a Portuguese holding company that acquired another holding company belonging to the same group in order to benefit from its losses. The Portuguese Ministry of Finance refused the transfer of tax losses on the ground that there was no commercial reason to acquire the target, which did not conduct any commercial activity, but to benefit from its liabilities. The Court found that a merger based on several objectives, which may also include tax considerations, can constitute a valid commercial transaction, provided that it is not purely tax driven. Each case, however, must be examined on its own merits taking all relevant factors into account. The Court concluded that under the particular circumstances, the fact that the target company does not carry out any activity, nor has any financial holdings and only transfers substantial losses of obscure origin, it was possible to presume that the transaction was carried out for purely tax reasons.