Welcome to all our readers from the Winter Wonderland that is London! Rarely do we enjoy the scenes of children tobogganing down Hampstead Heath, building snowmen, or throwing snowballs at adults, nor endure the cars abandoned by the sides of roads, tube trains cancelled, the occasional bus overflowing with people reminiscent of Mumbai or Cairo, and of course the perennial closure of airports, even Heathrow and Gatwick. It all adds up to a warning that this year is not going to be an easy one!
My son-in-law bought me a book this Christmas depicting 800 years of economic cyclical history, the message being “Why did they think it would be different this time?” And, indeed, it is unlikely to be so different from previous recessions, so it should not be too much of a problem to foresee what is likely to happen in the coming year(s). No one has any doubt that interest rates will rise soon, probably not until 2011, and that taxes will increase. Everyone has a watchful eye over (admittedly currently unlikely) inflationary tendencies, hence the current level of stock market activity as an anti-inflationary measure which tends to give a false impression of economic stability and indeed growth. However, these newsletters are primarily concerned with international tax issues, and I thought it may be useful in this first issue of 2010 to present some challenging ideas to readers of what one may expect on the tax scene. To the phrase “Why did they think it would be different this time?”, we do not want to add the phrase “Why could they not see this coming?”.
The interesting aspect of my work as an international tax consultant is comparing tax systems of one jurisdiction with another, how they differ and why, and what is likely to be legislated to achieve the same objectives. To this end, my book ‘International Tax Systems & Planning Techniques’ covers the tax systems of approximately 30 major countries. In 1983 when it was first published, I took on the task of writing about the tax systems of all of these countries, but pressure of work has meant that I have had to ask my colleagues around the world to help me with their respective jurisdictions. However, now in its 57th release, the book still enables me to make the relevant comparisons.
Tax Planning Crystal Ball
In our December newsletter, I wrote an article about permanent establishments, and how tax authorities attempt to assess foreign companies on domestic profits by virtue of the concept of a permanent establishment. I also mentioned that the UK HMRC is treating development properties in themselves as permanent establishments so that the profits arising therefrom can be taxed. So, I wondered why the UK simply doesn’t introduce legislation to treat any gains arising from the ownership of real estate in the UK, whether capital gains or trading profits, as arising from a trade or business activity effectively connected to a UK source. After all, this is what the US did in 1981 with the ‘Foreign Investments in Real Property Taxes Act’ known by the acronym ‘FIRPTA’ and since then virtually every other high tax jurisdiction imposes domestic tax on gains realised on the disposal of real estate by foreign persons. This would solve the problem about whether properties themselves constitute permanent establishments, and could raise enormous revenue for the UK government. This is particularly true taking into account the inflationary decade that we have had, particularly if base cost is not uplifted to market value if such legislation is introduced.
Readers with foreign companies owning UK real estate may like to consider creating a disposal of any UK property held for many years which may be pregnant with potential capital gains, perhaps by selling the property to another foreign company with a group structure so that SDLT (stamp duty land tax) is not an issue.
If additional tax revenue is part of the economic equation to reduce the debt burden that most major jurisdictions are suffering from, then it makes sense that governments will look at every avenue for opportunities that may not be immediately apparent. However, since all economists agree that economic growth is the only acceptable way to reduce the debt burden (as opposed for example to currency devaluation or hyper-inflation), governments have to be careful not to stifle that potential growth through higher taxation. Thus, the conundrum.
Bashing the bankers in the US and UK with punitive tax burdens, or Alastair Darling’s plans to impose the new 50% higher rate tax for those earning more than £150,000 per annum in the UK, may be seen to be counter-productive. Increasing the VAT rate throughout the European Union will affect consumer demand and may be similarly counter-productive. Therefore, governments are likely to be sly, if this word can apply to governments, either by introducing so called stealth taxes, which do not have the appearance of inhibiting growth; or perhaps by ‘tweaking’ certain rules so that the cost to the Exchequer is reduced.
I discussed with one of my clients recently whether he should crystallise some capital gains in this current tax year to absorb very considerable losses brought forward, on the basis that there could be a restriction of loss carry forward possibilities in the future. Such a restriction would mean that any future gains would be fully taxed, without being absorbed by prior losses, with the resultant positive tax revenue being received by the relevant government.
And this tinkering with the tax loss rules again has historical precedents in the United States, Germany, France and many other high tax jurisdictions. Indeed, many countries (such as the US, India, Austria to name but a few) already effectively restrict the utilisation of tax loss carry forwards by the imposition of an alternative minimum tax based on current profitability ignoring prior year losses. Clearly, many companies have lost considerable amounts over the last few years; a restriction of loss carry forward would not be politically unpopular, nor would it necessarily inhibit potential growth since it would merely be a fait accompli in respect of past activities.
So creating capital gains this current tax year which can absorb prior year losses may be a good idea. Even for those without capital losses brought forward, it still may be worthwhile to crystallise capital gains if the tax rate on capital gains is likely to increase. Certainly, this is a likelihood in the UK, where the current capital gains tax rate of 18% is now very considerably lower than the maximum income tax rate of 50%. Again, looking back at recent history, it is not so long ago since the rate of tax on capital gains was identical to that for income. Indeed, in most countries, there is no distinction between the tax rate on capital gains and income, so that a move to align the tax rates closer together would not be a surprise.
Although much of this has been written because the current UK tax year ends on 5 April 2010, and there is time to plan for such eventualities prior to that date, the ideas explored above may be relevant for readers resident in many other high tax jurisdictions. Indeed, Governments did indeed think that the economic story would be different this time, but of course it wasn’t; the entrepreneurial community must also realise that it will not be different this time, that taxes will rise by whatever method is considered not to restrict economic growth, and therefore they must plan accordingly.