I am delighted to report the success of our first ITSAPT Annual Conference held at the Landmark Hotel on 28 October 2010. At the outset, I promised everyone one “nugget” of interesting information in each of the 26 presentations, and for those of you who were unable to attend but would like to see the importance of many of these nuggets to your own professional and business activities, I thought I would select the best and incorporate them within our November newsletter.
I am proud to say that this was the first conference I have ever attended where every single assessment submitted described the conference as “excellent” and confirmed they would wish to attend next year’s conference. On the strength of that, I have already reserved rooms at the Landmark Hotel for Thursday 3 November 2011, so please make a note of this date so that you can “book early to avoid disappointment”! Of the topics discussed at this year’s conference, I enjoyed most the sessions on permanent establishment issues and how this area of corporate tax is being extended through local legislation and case law. Philip Baker was able to give some interesting insights into current OECD and HMRC thinking in this respect.
Robert Field of Farrer & Co and Karen Payne from Minter Ellison in Sydney explained corporate tax issues relating to acquisitions and mergers, and we discussed the relatively new concepts of corporate migration explained in our October newsletter.
We had a lively session on holding companies and planning for an IPO with speakers from Austria, Cyprus, Russia and Singapore, and then some issues explained in connection with the taxation of e-commerce sales including a presentation from Rafaela Brito from Brazil.
After lunch (yes that was all before lunch!) we discussed the licensing of intellectual property rights using Irish, Luxembourg, Netherlands and Maltese concessions, and looked at how Germany views conduit companies and the beneficial ownership concept. Session six was a discussion of real estate investments in UK, France, Spain and the US led by Lara Saunders with Patrice Lefevre-Pearon, Jaime Azcona and William Byrnes explaining how to structure investments in their country, and finally I discussed with Kishore Sakhrani from Hong Kong, Geraldine Schembri from Malta and Daniel Schafer from Switzerland how to maximise the benefits for both fund investors and fund managers when creating private equity funds for various forms of investment, particularly those relating to renewable energy which we have been structuring over the past two years.
The cocktail party hosted by IFS did not come a minute too soon, and this was a very enjoyable end of conference party in which delegates could meet the speakers who had entertained them. And it is the speakers whom I would like to thank for the success of the conference, and despite coming from so far away, I am hopeful that they will attend next year’s conference. I will be working on a new programme with different topics and hope that we will continue being able to supply 26 nuggets of invaluable information at each succeeding annual ITSAPT conference. Here are the 26 nuggets from this year’s conference in no particular order as they say on X Factor and Strictly Come Dancing!
1. Building site is a permanent establishment
The conference discussed claims by HMRC that a building site itself constituted a permanent establishment. Lara Saunders explained that the site was just the product or place at which the development was situated, not through which the business of the owning company was carried on. Philip Baker agreed with this view and stated that he understood that recent claims by HMRC had been settled on the basis of construction profits only being taxable as opposed to development profits in entirety. Matteo Rapinesi pointed out that even construction profits should not be assessable to local tax unless the construction exceeded a certain time, normally six months or 12 months as may be identified under local legislation or double tax treaty arrangements. He pointed out however that in Italy the time limit was only three months so that construction work that lasted for a longer period could be assessed to Italian tax.
2. Allocation of branch profits
It has always been the practice of tax administrations to disallow payments of for example interest from a branch to its parent company on the basis that the branch is the same legal entity and cannot therefore separate itself from its parent company when identifying tax deductible payments. However, the latest OECD thinking on the attribution of profits to a permanent establishment now requires a “separate entity approach” even for branches, so that indeed a branch needs to calculate an arm’s length interest payment in respect of financing from its parent company. This is also true in respect of any intellectual property that the branch uses which is the property of the parent company, so that it is now a requirement to pay notional royalties to the parent company, or at least suffer the tax consequences of doing so.
3. A permanent establishment for VAT
Patrice Lefevre-Pearon explained that the main difference between a permanent establishment for corporate tax purposes and one for VAT is the degree of permanence required for VAT purposes, which generally requires an element of human personnel in comparison with a PE for corporate tax purposes. He explained that in most cases, a VAT fixed establishment will also constitute a permanent establishment for corporate tax purposes, but that the opposite is not true.
4. Creation of a service PE
This is a relatively new development whereby employees of a company who are present in another country, but who do not create a dependant agency for that company where they are currently residing, can nevertheless create a service permanent establishment for that company if more than 50% of the company’s gross income emanates from their services. This will typically affect an employment group which seconds personnel to another country and where its gross income from that particular country exceeds 50% of its total gross income. It can also affect companies who subcontract a particular assignment to a local subcontractor, and that assignment constitutes more than 50% of the company’s gross income for the relevant year.
5. Company migration
Robert Field suggested that this is likely to be an area of international tax planning which becomes more important, particularly within the European Union. Cross border mergers, spanning the divide between civil law and common law, is now possible within the European Union, even with UK companies merging with those incorporated under civil law within continental Europe. He gave a practical example which he is currently working on with IFS and warned against using newly incorporated companies for one of the merging companies in view of a perception that this may constitute tax avoidance; clients should consider existing companies for both parts of the merger operation.
6. Step up in basis for acquisitions
Karen Payne explained that when acquiring an Australian operating company by an offshore company, a direct acquisition does not reset the tax basis of the underlying assets. However, acquiring the operating company through an Australian holding company creates a consolidated group for tax purposes, allowing the acquisition costs within the Australian holding company to be pushed down to the operating company’s assets themselves. In this way, a sale of the underlying assets would not create a capital gains tax charge except to the extent that the sale proceeds exceeded the value upon acquisition. This step-up in basis is an essential consideration when making cross-border acquisitions.
7. Acceptability of shareholder loans
Karen discussed further the financing of the Australian holding company’s acquisition which could be through shareholder loans, and of course discussed thin capitalisation rules which generally were accepted at a 3:1 safe harbour rule i.e. allowing 75% debt to 25% of equity. However, she pointed out that the loan has to be properly structured so that is not re-characterised as equity itself, and therefore needs to be for a limited period (maximum ten years) during which interest is payable. This may be tax beneficial taking into account the fact that the Australian corporate tax is 30% whilst withholding tax on interest payable is limited to 10%.
8. Austrian holding company with passive interests
Erich Baier confirmed that normally, an Austrian holding company will be subject to tax on dividends received from subsidiaries if the relevant income is considered passive income e.g. royalties which are then distributed as a dividend. However, if the subsidiary actively manages the licence arrangements, then the income may be regarded as active income, even if earned in a tax haven BVI company, and the subsequent distribution of such dividends could be received by the Austrian holding company without Austrian taxation.
9. Cyprus companies owning Russian real estate
Savvas Savvides pointed out that the current Cyprus/Russian double tax treaty allows Cyprus companies to sell the shares of Russian real estate owning companies without Russian capital gains taxation and, in the absence of capital gains tax in Cyprus generally, without Cyprus taxation. The recent protocol to the Russian/Cyprus double tax treaty has changed this and introduced an amendment to Article 13 of the Treaty permitting Russia to tax gains on the sale of Russian real estate owning companies. However, this change will not become effective until four years after the protocol enters into force, and therefore it is not until 2015 that restructuring needs to be considered. Dmitry Zapol pointed out that since 90% of Russian real estate is considered to be owned by Cyprus companies, this restructuring could be a significant activity for tax professionals!
10. Listing a Russian company for IPO
Dmitry continued discussing Russia and the traditional method of financing Russian companies through GDRs (Global Depository Receipts), issued by Russian or western banks. It is now however becoming more popular for Russian companies to seek IPO arrangements through a foreign holding company, and in this respect, the UK holding company is probably the most interesting jurisdiction for Russians (in preference to the Cyprus route). This is because even though the Cyprus/Russian double tax treaty provides for a 5% withholding tax on dividend distributions as opposed to the 10% to UK holding companies, the reputation of UK companies coupled with the substantial shareholders exemption for trading entities, and the Finance Act 2009 exemptions for foreign dividends means that the UK holding company is top of the list for Russians seeking western finance.
11. Asian holding companies: Hong Kong and Singapore
Hong Kong is now extending its double tax treaty network so that it now has treaties with Luxembourg and Belgium and is negotiating treaties with many other countries. Singapore already has an extensive network of double tax treaty arrangements, and in view of the territorial approach adopted by both jurisdictions, foreign dividends may be exempt from local tax, and can be distributed to investors without further withholding taxes. Thus Singapore and Hong Kong could be interesting vehicles for IPO listings on Asian stock exchanges particularly. Moreover, Shanker Iyer explained the Singaporean incentives for financial services and shipping in generally, whilst Kishore Sakhrani demonstrated why Hong Kong companies are the most practical entities for investment into China. The Chinese withholding tax on distributions to Hong Kong companies is restricted to 5%, and with no Hong Kong tax on inbound dividends nor on capital gains, no VAT or estate duty, an investor would improve after tax returns by investing into China through Hong Kong than any other country.
12. Requirement for substance in holding companies
Roy Saunders wrapped up the session on holding companies by explaining the views of tax administrations generally to the interposition of holding companies without the relevant degree of substance. Thus the Swiss tax administration are very reluctant to commit the avoidance of their 35% withholding tax on dividend distributions to a holding company without the relevant degree of substance, namely an office and at least one personnel fully employed by it. However, in a June circular by the Swiss tax administration, they accepted that this condition did not apply to EU holding companies, and generally this is the view of other EU tax administrations. Nevertheless, if it may be considered that a company has no substance in one country but is effectively managed in another, then double tax treaty relief may be denied. It was recommended therefore that any holding company in any corporate structure must have a certain degree of substance, certainly as regards effective management even if no office or personnel is employed.
13. General reliance on double tax treaties
Roy continued his talk to explain that the title of a double tax treaty is “for the avoidance of double taxation and the prevention of fiscal evasion”. There have already been cases where tax administrations attempted to deny the benefits of a treaty to residents of a treaty jurisdiction who are exempt from tax (even if liable to tax as a resident) on the basis that the treaty does not exist to deny a single level of taxation but merely to avoid double taxation. Taking advantage of a treaty to avoid single taxation is tantamount to fiscal evasion which the treaty is designed to prevent, and therefore the treaty should not be applied in certain situations. Although this is a far reaching development, and generally frowned upon on the basis that double tax treaties should be interpreted literally according to their terms, and therefore specific provisions should be incorporated within treaties to prevent erosion of a single level of taxation, this is nevertheless a cause for concern. Thus now that Jersey, Guernsey and the Isle of Man have eliminated the 20% corporate tax rate for most entities, one has to wonder whether HMRC will respect the current double tax treaty arrangements with these countries since there is a possibility of no single level of taxation arising.
14. Avoiding VAT through e-commerce sales conducted offshore
Robert Field explained that certain items of minimal value may be imported into EU countries without the imposition of VAT e.g. in the UK items of less than £18 for VAT and £9 for customs duties can be imported without tax. Thus Jersey or Guernsey based servers can be employed to design and print greetings cards, for example, and have them sent into the UK without any VAT, and this of course is similar for all low priced products. Daniel Schafer suggested that Switzerland could be an alternative since the Swiss VAT system is not applied to goods flowing outside of Switzerland, yet companies may register for VAT to reclaim any input VAT which may be relevant e.g. on professional services. In addition, depending on the value of the goods sold, input EU VAT may not be due in the EU jurisdictions where those goods are imported due to de minimis rules. Moreover, a beneficial tax rate can be achieved with total federal and cantonal taxes of approximately 10 to 11.5% (or even lower if the company qualifies as a principal company and/or if a federal and/or cantonal tax holiday is made available following the creation of a substantial number of new jobs).
15. Intellectual property rights within an Irish company
Mark Barrett presented Ireland as an excellent jurisdiction to own intellectual property rights, citing the 12.5% standard tax rate for trading companies which could also be applied to passive income if the company is actively managing its licence negotiations and participating in the R & D process. Research and development work itself can qualify for a 25% tax credit and this may be offset against a corporate tax liability with excess even being refunded to the tax payer for example against PAYE liabilities. Moreover, income from qualifying patents is entirely exempt up to a limit of €5mn per annum, and there is no need to register the patent in Ireland for this exemption to be available. And finally, income earned by writers, composers etc will be exempt from Irish income tax under certain circumstances.
16. Conduit licensing companies
Heinz Zimmermann asked the question whether an intermediary licensing company is a conduit company or a valid entity, and cited the German rules concerning conduit structures. Basically, interposed entities are to be disregarded if the ultimate beneficiary would not benefit from income received direct from Germany e.g. a BVI company that has no treaty with Germany. Moreover, there is a general anti avoidance law which treats the interposition of conduit companies as an abuse of law. However, he accepted that companies may be incorporated within the European Union without being qualified as conduit companies, and therefore the use of Dutch and Luxembourg licensing companies may still be available.
17. The Luxembourg securitisation entity
Although primarily discussing the beneficial Luxembourg tax regime whereby 80% of gross income is considered a deemed income deduction for self developed patents exploited by the taxpayer itself (leading to a 5.72% effective Luxembourg tax rate), Herman Troskie discussed an entity which could be very useful for international tax planning, the Societe de Titrisation. This entity is a securitisation company which is a normal Luxembourg company and which can benefit from double tax treaty exemptions in respect of royalty income. Its shareholders may even be Luxembourg individuals, but investors can invest in the securities company either through special shares issued or through participating bonds, each of which can be “stapled” to specific underlying assets of the Luxembourg company. Thus real estate may be owned by a securitisation company in order to avoid net wealth tax or inheritance tax in the country where the real estate is located, or the special taxes such as the 3% tax in France, Spain and Portugal designed to attack corporate structures beneficially owned by relevant individuals.
18. The Dutch regime for intellectual property rights
Christian Strik explained that Dutch licensing companies were always hitherto conduit companies where royalties were received from licensees and paid out to a head licensor subject to a 7% maximum spread of royalty income permitted by the Dutch tax administration, on which Dutch tax would be payable. Although conduit companies may still be relevant, Dutch legislation has introduced the box system of taxation whereby the patent box may be ticked in respect of income received from licensees without the need to pay a head licensor, but still with a beneficial tax consequence. Thus in total the Dutch tax rate will be 5% in respect of royalty income with the ability to benefit from lower rates of withholding taxes according to Netherlands treaties, subject to limitation of benefits clauses. Moreover, Christian introduced the concept of being able to split economic ownership from legal ownership, so that the patents could perhaps be owned by an offshore company that permits royalty income to be earned by a Dutch subsidiary subject to tax within the patents box.
19. Re-domiciliation of R & D companies with valuable rights
The Conference discussed generally the situation where research and development had taken place within a high tax jurisdiction, with relevant grants and credits attached thereto, but suddenly the entity found itself with valuable IP rights, the income from which would be taxed at high corporate tax rates. A disposal of these rights to a related group company in a more favourable jurisdiction would create a capital gains tax issue, whilst an export of the company could trigger an exit tax as if the assets had been sold on the date of migration. Rachel Saliba discussed the Maltese laws relating to re-domiciling foreign entities in Malta, and although the standard Maltese tax rate is 35%, refunds are allowed in respect of dividend distributions to shareholders depending upon the source of income so that the effective tax rate can be reduced to 5%. Roy Saunders suggested that corporate mergers may be the way to transfer assets across borders without exporting a company, as may be permitted under the EU merger directive. When re-domiciling a company it is also possible to uplift the tax base.
20. Hidden tax charge for owner occupiers of UK residential homes
The typical way of avoiding inheritance tax on assets situated in the UK is to buy those assets through an offshore company, often itself owned by a trust. In this way, when an individual dies, it is the shares in the offshore company (its non UK situs asset) that passes to the heirs rather than UK situs asset, the real estate direct. Lara Saunders pointed out however that in respect of private homes, an individual could be considered a shadow director of the offshore company and as such an employee to which the benefits in kind legislation in the UK applies. Thus a home of £10mn could create a taxable benefit giving rise to an annual tax charge of almost £250,000. However, this is only relevant if the individual can be considered a shadow director, not if the individual does not have any control whatsoever over the owning company or the way that it enters into agreements in connection with the property and pays relevant expenses.
21. UK income tax on speculative property transactions
Lara then went on to explain that an individual entity buying a property for the purposes of making a capital gain will be treated differently from someone who clearly buys a property for investment purposes. An anti avoidance section will treat the gain as being in the nature of a trade and will subject that gain to income tax. This may even apply to the sale of shares in an offshore company owning such real estate. This section however would not apply to trading entities which, if non-UK based, would only be subject to UK tax in the event of a permanent establishment existing if such entity were able to benefit from a double tax treaty with the UK.
22. Sale of shares in French real estate owning companies
Oliver Couraud suggested that the 3% special tax applicable to French real estate held by non resident entities may be avoided if more than 50% of the company’s assets are not French real estate but for example portfolio assets. Since the 50% is based on gross assets, one could consider borrowing funds for the purposes of purchasing a portfolio of non French real estate interests in order to avoid the 3% tax. Moreover, this could be an idea for other jurisdictions where sale of shares in real estate owning companies are subject to capital gains tax, but not where the company’s assets comprise more than 50% in non real estate assets.
23. Use of participating loans
Jamie Azcona described the benefits that can be derived by non residents investing in Spanish real estate through the use of participating loans, i.e. loans carrying a relatively low level of interest but with a participation in relevant profits. These participating loans are permitted under Spanish law, with the participation in profits treated as tax deductible interest rather than as dividends, and indeed may be used for other assets and businesses generally. Participating loans are also allowed in other jurisdiction such as France and Italy, and indeed may be considered generally in international tax structures e.g. participating equity certificates (PECs) in Luxembourg structures. Notably, the US re-characterised equity kicker loans so as to avoid interest deductions being permitted on such loans.
24. Private equity funds in Malta
Geraldine Schembri explained the private equity fund rules in Malta and particularly the professional investor fund with investments in excess of €750,000. She described the funds as having access to Malta’s double tax treaties, and the absence of Maltese taxation if more than 50% of the assets are non prescribed (assets based outside of Malta). Fund management companies would then be taxed at an effective 5% tax rate with the tax refund due on distributions to shareholders.
25. Carried interests for fund managers treated as capital gains
Switzerland is trying to attract fund managers to base themselves in Switzerland, and Geneva particularly has benefited from the UK attack on relevant non-domiciled individuals. Daniel Schafer described the way of avoiding carried interests being treated as income (management fees) on the proviso that any investments in equity share capital in the relevant funds made by the fund managers have the same rights as other investors. Thus the other investors would subscribe for preference loans or preference shares at the same time as subscribing for ordinary equity, as long as all ordinary equity shares have the same rights as those shares issued to the fund managers. In this way, any capital gains derived from those shares in the form of the carried interest would be tax free (Switzerland does not impose capital gains taxation on individuals) as opposed to being subject to income taxation at federal and cantonal level.
26. Splitting fund management fees between related entities
Roy Saunders explained that where there is one entity which performs all fund management activities, it is difficult to assert that the carried interest should be earned by a related entity in another jurisdiction. However, such is the variety of functions undertaken by a fund manager that in reality, one can set up related entities in different jurisdictions with the relevant level of substance in each jurisdiction. As for any other split of activity, transfer pricing considerations will be relevant, but Roy listed the type of services that may be reviewed as to their place of supply as follows:
* promotion and marketing development
* brand management
* fundraising from investors
* subsequent liaison with investors
* investment preparatory work and research
* investment recommendations
* investment decision making
* cash management
* regulatory and compliance work
* fund accounting and documentation
* administration services
Such is the variety of these services that if conducted in different jurisdictions, it would be difficult to ascribe entire carried interest to any one jurisdiction, particularly if a significant investment is made by the fund managers into the fund at the outset as initial risk capital.
The above are my 26 nuggets of information although I have to say that there were many other issues discussed at the conference – this comment is to encourage readers to express their interest in coming to next year’s conference by clicking here. No need for any commitment or payment as yet!
With my best regards to all readers.