You may remember my claim to be an optimist in last month’s newsletter. Well the FTSE 100 index when I wrote that on 5 March was at its lowest at 3530 and it is now, exactly a month later at the time of writing, 500 points higher, an increase of approximately 15%.
My closing paragraph referred to the first day of spring approaching which could generate a more positive attitude to life in general, and last week’s G20 meeting in London has contributed further to this. In fact, nothing has dramatically changed in the world’s economy, but people are starting to adjust to a recessionary period with greater stability. Clearly, the recession will be snapping at our heels for the rest of this year (and we will definitely experience further dramatic swings in stock exchange indices), but the emotion which has been running at fever pitch levels over the past year may be a little less pronounced.
As a taxpayer and concerned about the world economic plight, I am pleased that the G20 summit leaders have rightly censored countries which are complicit in illegal activities. As a professional that assists with structuring the development of international business ventures, I deplore the automatic association of tax planning or structuring arrangements with illegal activities; this seems to be simply fodder to anti-capitalist emotion. Whereas redundancy programmes are accepted, and even applauded in some circles as a necessary consequence of the current recession, optimising the level of after tax income through legitimate structures is seen as anti-social behaviour. We lawyers, accountants and barristers have not yet been served with ASBO notices, yet the social unrest caused by redundancies is in a completely different league. One does sometimes wonder how genuine redundancy programmes are, or whether employers are taking advantage of the current climate to remove those whom age, sex or colour may otherwise prevent them from dismissing in a normal economic climate.
So what is this rhetoric being delivered against tax planners? In the US, the ‘Stop Tax Havens Abuse Act’ is probably the widest ranging piece of legislation against tax planning that has ever existed. My good friend Stephen Gray has written an article for this newsletter on the latest attempts by Uncle Sam to widen the reporting requirements of foreign bank accounts to non-US citizens and residents. And Gordon Brown has stated that one of his top 3 priorities is to put an end to tax havens which deprive poor countries of $86 billion a year. However, according to the US ‘Stop Tax Havens Abuse Act’, these tax havens include Switzerland, Luxembourg, Singapore, Malta and Cyprus. I wonder whether residents of those countries consider themselves to be the anti-social pariahs causing the current economic malaise?
There is no doubt in my mind of the economic benefits of minimising tax costs and encouraging the development of international investment opportunities. At this stage of the recession, the worst thing that governments can do is to discourage business by imposing prohibitive tax costs on potential but elusive profits. What I have advocated so much in recent years is that governments should generate public revenues through indirect taxes once the profits have been earned and are then spent i.e. VAT and similar taxes. People should have a choice as to whether to buy goods and services, and incur the relevant VAT costs, or to save their income for other requirements. One of the items in this newsletter is my ‘Open Letter to the Chancellor of the Exchequer’, which I wrote before the 1997 election to the then Conservative Chancellor prior to Gordon Brown taking over at the helm. It is amazing that it is just as relevant today as it was 12 years ago, indeed even more so. Although termed a regressive tax which affects rich and poor alike, I cannot see a problem with varied rates of VAT for different products, and indeed a top rate of 20% VAT would probably be accepted (and indeed in the EU this rate is quite common). Perhaps Alistair Darling will address this in his Budget to be delivered on 22 April.
In fact, VAT is an increasingly important tax to be considered by the international tax planner, and Lara has written an article on VAT with the help of colleagues from Alvarez and Marsal LLP. Lara focuses on the different source rules for VAT between different countries and how a double charge to VAT may be incurred in some instances.
The conference season is upon us again, and following the ITPA Monaco conference a couple of weeks ago, I will be in Geneva and Zurich at the end of this month, in Lisbon in mid-May, and in Zurich again in early June. Amongst the topics I will be covering at these conferences are concepts for investing into China, India and some African countries, the taxation of Private Equity funds, investment in European real estate, and recent developments in international tax law in the US, UK and EU.
As always, I will be delighted to hear from you with your views on the above comments, and generally hear your views on the current economic, political and business climates.
The Long Arm of the (US) Law
The expression ‘the long arm of the law’ has taken on a whole new meaning. You may have thought that if you were not a United States citizen or resident, or responsible for a United States corporation, trust, estate, partnership, or other business entity, your financial affairs would be of no interest to the IRS. Wrong!
True, it is only “persons” as defined (but see below) who are required each year to disclose to the United States Department of the Treasury detailed information about each non-United States financial account (including bank, securities, or other types of financial account) in which such a person has a financial interest in or signature authority over. The term account also “includes any bank, securities, securities derivatives or other financial instruments accounts … and any accounts in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund (including mutual funds).” Since partnerships and trusts are pass-through entities, their non-United States accounts are reportable by the U.S. persons partners and trust beneficiaries, unless these entities file the forms themselves.
The relevant form, officially designated as TDF 90-22.1 and more informally called the FBAR (foreign bank account report), is not an income tax return and is not presently filed with any income tax return; indeed, it has its genesis not in the tax law but in the Bank Secrecy Act of 1970. Reportable accounts are those which individually or in the aggregate have more than US$10,000 in them on any day in the calendar year. If an account is reportable, the form filer must list the account number, the name and address of the place where the account is held, and (historically) only indicate, in general categories, the highest account balance or value during the calendar year. This form is due on 30 June to report accounts with regard to the preceding year, and the form is filed at a special office in Detroit, Michigan. The filer must also indicate whether he/she/it has a financial interest in the account or is merely a signatory. Historically, if one was only a signatory and the real owner was a non-United States person, a simple statement to that effect, without identifying the real owner, was sufficient.
And now let’s look at the definition of a “person” for these purposes. Iin October 2008, the Treasury published a revised form which has gone largely unnoticed. The new form, which is already required for calendar year 2008 reporting and thus is retroactive in its effect to 1 January 2008, is revolutionary in its scope. It now states that it must be filed by any “United States person”, a term now defined to include a “citizen or resident of the United States or a person in and doing business in the United States.” Plainly, this expanded definition intentionally imposes a filing obligation on many non-residents and may encompass anyone who earns any United States-source business income and who has been “in the United States” (see below).
The IRS has issued some helpful guidelines to the effect that a person who is not a United States citizen or resident and who visits the United States to manage his personal investments, such as rental property, and conducts no other business, is not considered to be in or doing business in the United States for these purposes. The IRS guidelines also state that whether a person is considered to be in and doing business in the United States is determined according to the facts of each specific case, but generally, a person is not considered to be in, and doing business in the United States unless that person is conducting business within the United States on a regular and continuous basis. For example, a person who is not a citizen or resident of the United States, is engaged in a business, and only occasionally visits the United States to meet clients, would not be in, and doing business in the United States for reporting purposes. Also, artists, athletes, and entertainers who are not citizens or residents of the United States and who only occasionally come to the United States to participate in exhibits, sporting events, or performances, do not have to file the FBARs.”
But what is clear is that if I, as a UK professional, open an office in the US, I have to disclose details of all my bank accounts, wherever located, and the balances thereon – unless of course the accounts are in the US! I have said publicly on many occasions that the US, when attacking foreign tax havens, fails to acknowledge that it may be the world’s largest and most uncontrolled tax haven, and this seems to be a further example of one law for the world, and another for the US.
The form also now demands that the name and address of the non-United States owner of any account over which a United States person has signature authority must be specifically identified and that person’s social security number or, if there be none, that person’s passport number and passport details must be disclosed. Thus, no United States person in the future should ever have any reportable interest in any non-resident alien’s financial accounts, if at all possible. It is already too late to do anything about 2008 and 2009, but one should change any affected accounts as soon as possible.
Additionally, the new form does away with the old, general boxes to be ticked of the highest account balance, the highest previously being over US$ 1 million, and requires an exact figure of the year’s highest balance. This is an audit invitation.
For those ‘US persons’ who now may be covered by the reporting obligations, guessing wrong about whether filing is required is highly dangerous. The penalties for non-filing are draconian – a fine up to US$500,000 per year, and up to 5 years in prison per account per yearfor each “wilful” failure to file, and a fine of US$100,000 per account per year for non-wilful failures. A few years of delinquency with respect to just a few accounts would lead one to a financial wipe-out and a life possibly spent in jail – all without the United States government having to prove the more difficult case of tax evasion, and with a much larger financial upside!
IFS would like to thank Stephen Gray, BA, JD, LLM (Tax) for the above article. Stephen is an Attorney and Counsellor at Law. If you would like to comment on Stephen’s article please click here.
Interpreting VAT Laws is Rarely a Piece of Cake!
Although the basis of IFS’ advice to clients usually concerns the mitigation of direct taxation by businesses operating in an international context, we have been prompted to write an article on VAT by the recent victory on behalf of the taxpayer in what is regularly referred to as the “M&S teacakes” case. At the crux of this case was a difference in interpretation with regard to a provision of UK VAT law. Differences in interpretation occur both domestically, between taxpayer and tax authority, and between countries, where the taxpayer faces a tax exposure in more than one country in relation to the same item of income. Where the latter is the case, a business operating internationally faces potential double (indirect) taxation with no obvious method for elimination of such double taxation (as is usually the case in respect of direct taxation), and it is this issue which is of concern to our international clients and of which the international tax practitioner must be aware.
John Ruskin, the 19th century social thinker, is quoted as saying “the first duty of government is to see that people have food, fuel, and clothes”. To some degree, VAT legislation reflects the need for these basic necessities, as there are indeed VAT reliefs on food, fuel and some items of clothing. However, as with most taxes, things aren’t quite as simple as one would imagine. There are more than 20 different VAT rates applied to various items of food across the 27 EU Member States – the lowest being 0% and the highest 25%.
In the UK, interpretation issues arise from the way UK legislation was originally drafted. For example, “food of a kind used for human consumption” is zero rated, but then there is a list of exceptions which includes confectionery and certain products for the preparation of beverages. Then there are “exceptions to the exceptions” so that coffee, tea, cocoa etc. are zero rated unless already prepared as hot drinks (as in Starbucks for example).
And now for a bit of fun with the law! Confectionary (VATable at standard rates) includes biscuits (including chocolate biscuits e.g. bourbons and chocolate chip cookies) but not chocolate covered biscuits such as chocolate digestives. Cakes, on the other hand are zero rated whether they are chocolate covered or not.
Marks & Spencer took HMRC to the UK House of Lords on 4 February 2009 after a dispute with HMRC lasting 13 years – and won back £ 3.5 million in excess VAT paid over a 20-year period. Apparently, teacakes that had been charged to tax at the standard rate (applicable to biscuits) rather than the zero rate (applicable to cakes). Although it was accepted that VAT was indeed unlawfully levied, HMRC refused to refund more than 10% of the claim by invoking the unjust enrichment defence. Their argument was that as M&S had “passed on” 90% of the VAT to the consumer, it would receive an unfair advantage if it received the full amount of the VAT paid, even though it was accepted that HMRC had no right to the VAT in the first place.
The House of Lords referred a number of questions of EC law to the ECJ in the context of the unjust enrichment defence. The ECJ ruled that HMRC had to make a full refund of the VAT to M&S on the basis of EU principles – in essence, that taxpayers in the same line of business should be treated equally with respect to tax refunds unless any discrimination could be justified. The UK tax authorities had argued that as the zero-rating of teacakes applied pursuant to an exemption (and a specific derogation) in domestic law, then the general principles of Community law would not apply. However, this was refuted by the ECJ and the decision was endorsed by the House of Lords on 4 February 2009.
In another recent UK case involving issues of interpretation, the British actress Saffron Burrows won a case concerning the correct place of supply in respect of an actor taking part in the making of a film. In this case, Miss Burrows acted in the film Perfect Creature (a sci-fi vampire action movie – not one of her best achievements) where the filming took place in New Zealand. HMRC claimed that she owed more than £18,000 in unpaid tax on the basis that the place of supply of acting services that were supplied in New Zealand by a UK based actress was at the address of the actress in the UK, according to Article 9(1) of the Sixth VAT Directive. HMRC had argued that the exception to Article 9(1) found in Article 9(2) did not apply on the basis that a) acting on film was not a cultural, artistic or entertainment activity (although perhaps they had a point in relation to this particular film!) and b) this was not a live performance. HMRC’s arguments were rejected and it was found that the place of supply of the acting services was New Zealand – a fact that caused all British actors plying their wares in Hollywood to breathe a sigh of relief.
As interesting as the above cases are to illustrate some examples of difficulties in interpretation of VAT laws, of greater relevance to our clients is where a double VAT charge could be imposed on the same turnover.
We are currently advising a UK-based Group which runs conferences around the world, sponsored by international businesses. The UK company receives the sponsorship income, as well as income from the delegates to the conference, also based internationally. From a UK perspective, and according to the particular facts of the case, the sponsorship sales would be treated as advertising services with their place of supply where the customer is located, and the delegate sales would be treated as services relating to exhibitions and conferences whose place of supply would be where the event takes place. Within the EU, this interpretation should be uniform with no possibility of double taxation. However, because of a lack of clarity in the VAT Directive, there is certainly scope for differences in interpretation.
For example, the Directive only provides the term “advertising”, but leaves it up to the Member States to determine what this means. Italy for example may consider the sponsorship services to have a place of supply where the conference is located (in this case Milan). And so the company may need to charge UK VAT to UK sponsors for what is considered advertising, and Italian VAT to the same UK sponsors for what is considered to relate to ‘land’ i.e. where the Milan conference takes place. New place of supply rules are to be introduced with effect from 1 January 2010 with the aim to provide greater clarity, but it is more than likely that some differences of interpretation will still exist.
The issue is, of course, no less complex where non-EU countries are involved as the possibilities for a double VAT charge are even greater (where a VAT system is used in both countries). Additionally, where there is a potential nexus to one or more US states, it may be necessary to consider whether another form of indirect tax such as sales tax or usage tax may apply, and if so, there may well be different rates and rules of application from state to state that need to be considered.
Establishing the indirect tax exposure of an international business can often prove a complex process because of a lack of harmonisation of the rules both within the EU and outside it. However, this is a process which should not be overlooked as part of the initial planning stages in light of the potential liabilities that could arise as a result of a non-payment of VAT in a particular country where it is considered due.
IFS would like to thank Andrea Clarkson, Richard Baxter and David Pert at Alvarez & Marsal Taxand UK LLP for the above article.Further information can be found on their website www.alvarezandmarsal.com or www.taxand.com.
Open Letter to the Chancellor: The Case Against Direct Taxation in Today’s Society
Dear Kenneth (or Gordon),
All political parties agree that quality of life is inevitably affected by equality of taxation. Students of economics are always told that indirect taxation is a regressive form of taxation unfairly hitting poor and rich alike. Such is the unimaginativeness of (previous) Chancellors that this statement is basically true; but it doesn’t need to be. And, moreover, it is recognised in the European Union that the present tax system based primarily on direct taxation has resulted in the United Kingdom in particular having the greatest differential between rich and poor within the Union. I am sure this is a state of affairs you would not wish to continue.
The Generation Gap
If I may focus on the generation roughly in the age gap from 25 to 50; during this time the costs of rental or home ownership, bringing up a family including clothing and education, and generally struggling to make ends meet creates huge pressures on today’s couples. The divorce rate bears witness to the growing dissatisfaction between partners as their justifiable aspirations for themselves and their families are unrealised, often because of financial hardship, and this is the case for people who have been brought up in more well-to-do families as much as for those in the poorer end of society. Perhaps even more so, as they strive for things their parents had. Nowhere is this more evidenced than in the home ownership market where young people have risked everything in order to own their own homes, saddling themselves with enormous loans which have often ended up creating a negative equity in their properties and a crippling financial burden on them.
And what has happened to their parents’ generation in the meantime, say the 50 to 75 year olds, having struggled through the same problems in their youth, but luckily having emerged as one of the happier statistics that have kept together. If still in employment, their income is generally at its highest, forced endowment insurances taken out on their homes mature, their own annual expenditure has been cut as their children have left the home, and for some of the more fortunate, they sell their marital home to move into smaller accommodation and realise a capital sum in the process.
And yet for both of these groups, the burden of direct taxation is exactly the same. Limited family allowances create little differential in the tax cost on earned income, and without a surcharge on investment income, the younger generation are not provided with any real benefit which could ease the huge financial burdens of raising a family in today’s age.
How would indirect taxation be a better alternative? Quite simply without forced direct taxation on earnings, individuals or couples would have the choice on how they spend, or save, their earnings; if they choose to spend their money on the essential elements of bringing up a family, zero or low rates of indirect taxation on such items would ease their financial burden enormously. For the older group who no longer need to spend their money on the essential ingredients of raising a family in today’s age, they may enjoy the well-earned luxuries of life on which standard or higher rates of indirect taxation would create much of the revenue required for society’s needs as a whole. The pleas of archbishops, chief rabbis and others in an influential position in society cannot be heard by the younger generation without a fundamental re-evaluation of the pressures today’s society brings on them.
Special Privileges to Foreigners
With greater mobility of labour, the more privileged sections of society may decide to move from one country to another where, although the tax regime may be equally as severe, concessions in the form of reductions in direct taxation are given to such individuals in an effort to boost the local economy. This is of course perfectly understandable, but do not the local workforce boost the local economy by their efforts? To change tax laws offering such incentives (as for example the non-domicile benefits which caused such an uproar) may rightly be politically disastrous, yet if the entire system were changed, this could be a more acceptable proposition. After all. why should people pay less taxation yet enjoy the same services in their country of residence.
Graduated Rates of Indirect Taxation
Obviously, wealthier people spend more money than poorer people; a tax on expenditure should not therefore necessarily be regressive in nature if there is a differentiation in the tax rates on essential and luxury items. Few people would object to a low rate of standard direct taxation on earnings and investment income, say between 10% and 20%, which would hit all sections of society equally. There is also likely to be less furore from wealthy members of society for whom a 40% higher rate of direct taxation is replaced, say, with a 33_% luxury rate of VAT. National insurance or social security should not be a covert way of increasing tax rates, but should fund the social security system that their name suggests.
The hugely complex web of legislation designed to enforce compliance with the laws of direct taxation could also be significantly simplified. Controlled foreign company legislation and similar anti avoidance regulations would be far less cumbersome if there were a simplified standard rate of taxation universally. There will always be people who wish to avoid even a 10% rate of tax on income, but the costs of entering into complex tax structures would be unlikely to justify tax avoidance on such a limited scale.
Choice in Today’s World
The Conservative Party has made a terrific play on the word “choice” in today’s society; it now requires the courage to speed up the process of the changes you have commendably introduced during the period of your government. Who would have thought the maximum income tax rate of 98p in the pound in the sixties would be reduced to 40%, or that VAT when introduced at 8% would have jumped to 17.5% in the United Kingdom, and above 20% in several European countries. It is not impossible for the tax system to change, it merely requires the will and a speedier process.
In the meantime, we at International Fiscal Services remain committed to providing structures for the minimisation of direct tax burdens, whether relating to income, capital gains or capital taxation, retaining the required level of choice for our clients that is not available currently to them.
I look forward to your reply.