This month’s newsletter reflects the tax advisor’s role in the current environment of penalising what has hitherto been considered acceptable tax planning. It also highlights the demise of bank secrecy and the new role of banks as unpaid detectives for tax administrations. The article is not intended to support nefarious tax advice of yesteryear, but to explain the consequences of maintaining a non-transparent policy towards tax administrations as to where an individual is resident.
As I have explained in previous newsletters, I established the International Business Structuring Association (IBSA) to promote such transparency and demonstrate the integrity of the professional advisory community who become members of the IBSA. In our second year of the Association, we have been commended by our members for the discussion groups we have held around the world on various topics including intellectual property protection, private equity financing techniques, developing strategies for international businesses and other pressing issues with the current OECD BEPS initiative. It is through the dissemination of knowledge amongst our members that our common entrepreneurial clients can benefit, and I am proud to report that we now have principal branches in the US, Asia, UK and Continental Europe, with potentially smaller chapters in countries such as Luxembourg, Switzerland and Malta.
For those IFS readers of our newsletters who would like to become members of IBSA, I would be happy to invite them as my guests to the next discussion group to be held on 29 September at the offices of Ince & Co opposite the Tower of London, on the subject of growth funding, M&A and structuring the growth of entrepreneurial businesses, details of which can be found on the IBSA website. For those readers who are based in Continental Europe and who cannot make the London meeting, you are welcome to attend the Paris meeting the next day on 30th September at the offices of Jeantet et Associés on the hot topic of Supply Chain Methodology and the continued use of countries such as Luxembourg, Switzerland and Malta in international business structuring.
Our annual conference is to be held at The Landmark Hotel in London on 19 November, and we are now taking bookings for this conference entitled ‘Issues Affecting the International Development of SME’s’. This one-day conference delivered by IBSA members will discuss financing, tax and relevant economic issues, the protection and development of intellectual property and business strategies for the development of SMEs. Again, information on this conference can be found on the IBSA website.
And finally, welcome back after the long summer break. I hope that you enjoyed your summer and look forward to seeing you again in the near future.
With kind regards
Roy SaundersTHE TAX ADVISOR’S ROLE TO TAX PLANNING
Tax mitigation and tax avoidance
Tax avoidance is to be distinguished from tax mitigation.
In the words of Lord Nolan:
The hallmark of tax avoidance is that the taxpayer reduces his liability to tax without incurring the economic consequences that Parliament intended to be suffered by any taxpayer qualifying for such reduction in his tax liability. The hallmark of tax mitigation, on the other hand, is that the taxpayer takes advantage of a fiscally attractive option afforded to him by the tax legislation, and genuinely suffers the economic consequences that Parliament intended to be suffered by those taking advantage of the option.
Furthermore, it is widely accepted that taxpayers who mitigate their tax liability are not likely to be subject to anti-avoidance legislation. Even a US Court of Appeals judge has proclaimed:
Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.
Tax mitigation is often the result of forward tax planning. It amounts to a reduction of a taxpayer’s tax liability, not by entering into an ‘arrangement’, but by a reduction of taxable income or by an increase in deductible expenses, or perhaps the availability of tax credits.
Tax avoidance generally includes situations where a person’s liability to pay tax is avoided, reduced or deferred. However, unlike mitigation, tax savings results are achieved in a way that government did not intend.
Acceptable tax mitigation
In some cases, the government promulgates laws that are aimed at a reduction, often permanent, of tax liability for taxpayers. Where taxpayers avail themselves of such opportunities by directing their affairs in such a way as to reduce taxes, the tax mitigation is acceptable. Tax incentives and tax holidays are examples of such measures introduced by government. Another example is that a married couple can reduce their exposure to inheritance tax by ensuring their wills are drafted in such a way that on the death of the first spouse all assets vest in the surviving spouse, on whose death inheritance tax will be due. Alternatively, it may be possible for a married couple resident in a civil law jurisdiction to separate their assets.
Unacceptable tax avoidance
Some tax avoidance is within the confines of the law, but was not intended by government. Such tax avoidance often results from loopholes or defects in the law, and is contrary to what government intended. A common example is treaty shopping, of which we have written in previous newsletters and which is the target of Action Point 6 of the OECD BEPS initiative.
Tax mitigation and avoidance relate to the question of whether a tax liability has arisen, but with tax evasion a tax liability has always arisen, albeit hidden from the tax authorities – with or without intent. Innocent tax evasion exists where the intent to defraud the tax authorities does not exist (e.g., where reportable income remains forgotten in a bona fide manner), and may lead to a reassessment. Fraudulent evasion exists where the taxpayer intended to defraud the tax authorities, and may lead to a criminal prosecution together with a reassessment.
Constituent elements of avoidance
In determining whether a tax avoidance scheme exists, tax authorities look for certain elements when analysing the facts. Some of these elements are discussed below:
Tax minimisation or elimination: the onus is on the tax authorities to prove that the tax paid was less than would otherwise have been the case.
Lawfulness or legality of the transaction: tax planning, tax mitigation and tax avoidance are carried on within the confines of the law; tax evasion (for example, the non-declaration of profits), on the other hand, is illegal. In the current era of media attack against tax planning, the difference between tax avoidance and tax evasion is often a very thin line.
Relevance of the purpose or motive of the taxpayer: generally, tax arrangements of which the primary motive and/or purpose is tax minimisation can be rebutted by the tax authorities.
Artificiality: where steps that have no other purpose than the avoidance of tax are inserted into a transaction, artificiality exists, but on its own, artificiality is not usually enough to justify sanction by the tax authorities. In this respect, common law developed the ‘business purpose’ and ‘substance over form’ rules. Under the former, a transaction must have a main purpose other than tax avoidance to be acceptable to the tax authorities; under the latter, the facts must be assessed according to bona fide economic and commercial substance, and not the formal content. Comparable concepts under civil law are the abus de droit and fraus legis concepts.
Economic reality of transactions: generally, taxpayers are not entitled to tax advantages resulting from legal means that are different from the economic reality. This includes the exploitation of defects/loopholes in the law.
Legislative intent or purpose: it is generally held that a tax avoidance scheme is an attempt to reduce the tax liability to a level below that which the legislature intended, and legislative intent is generally decisive of the question of legitimacy of the result.
The tax adviser’s role
In order to assess whether tax advice is lawful, the tax adviser must have a client who is willing to divulge all the relevant facts. It is an impossible task to give meaningful tax advice if what is being disclosed is only half the story. This, however, creates difficulties in itself, because if the tax adviser is aware of circumstances that constitute, for example, ‘money laundering’, he is duty bound to make an official report to the relevant authorities. Not only that, but ‘tipping off’ the client that a report is being made is also an offence. The tax adviser’s role and responsibilities have come a long way since September 2001, when the tax adviser’s profession, along with many others, changed overnight. Money laundering legislation introduced subsequent to that date has imposed upon each tax adviser an overriding obligation to ensure that all aspects of the advice given are legal. The consequences are very penal and, as such, ‘know your client’ policies and internal take-on and review procedures are vitally important to ensure and maintain the integrity of the office.
Anti-money laundering legislation
The regulations relating to money laundering differ from country to country, and the continuing evolution of the problem means that the rules are constantly being rewritten and updated. Through its Financial Action Task Force (FATF), the OECD has forced compliance on many of the world’s tax havens using a blacklist and the threat of sanctions for those who fail to comply with money laundering regulations, information exchange, and the like.
Transparency and the OECD BEPS initiative
The OECD has become the think-tank for developed countries and has repositioned itself as the brain of tax in terms of international fiscal policies. It is acknowledged that a global tax system is a fiction: ultimately, there will always be disparity between tax systems, and competitive tax rates and incentives are inevitable and desirable in a market economy. BEPS is trying to provide a holistic viewpoint so that tax authorities know the relevant questions to ask. The key words of transparency, openness, communication and accountability, is the underlying premise of the BEPS project, requiring businesses to engage with tax authorities and vice versa. Volunteering to share information means that the tax authorities have accessibility to the affairs of their corporate taxpayers, so that they may decide whether they wish to review in more detail tax computations submitted. However, to share such information, big businesses will require confidentiality, particularly where what may be regarded as trade secrets could be shared with competitive companies.
The OECD Common Reporting Standard (CRS)
The CRS is due to be implemented by all banks with effect from next year, with tax authorities requiring banks to collect and report certain information about the individual beneficial owner and their financial accounts held with the bank. Where corporate or other non-personal entities have accounts with banks, it is a requirement that the beneficial owner (and if there is more than one, all beneficial owners) are identified on separate forms held by the bank which may become available to tax authorities. The term ‘beneficial owner’ is an individual who can exercise control over the relevant entity either from his/her shareholding, or control over voting rights, or even potentially control through debenture and other loan documents. The complexity of ascertaining the correct beneficial owner for certain entities is readily apparent.
The CRS form requires the beneficial owner to state their current residence address, mailing address if different, their date and place of birth, and then specifically the country where he/she is resident for tax purposes. This again can lead to considerable confusion where the individual may be considered to be tax resident in more than one country, or indeed not tax resident in any country. The form to be submitted requires disclosure of tax residence on a certain date during the relevant fiscal year, when perhaps it is difficult to know whether the individual has ‘lost’ their tax residence in one country or ‘acquired’ a tax residence in another country. There is also the concept of extended residence where for example an Italian or Spanish resident moves to a country with a privileged tax regime, in which case the individual may be unaware that they remain a tax resident of those countries – a fact which is not reflected on the CRS form. Although a US individual may have discontinued their tax residence in a particular year, if they return to the US within a three year period, they will be considered tax resident in the intervening three years as well.
In this age of multi-national entrepreneurial activity, many individuals will have homes in various countries and spend differing periods of time in these countries in the relevant fiscal years, and may find it impossible to determine which country will decide on their tax residency. There is indeed scope for identifying other countries in the form where the individual may be considered to be tax resident, but the individual’s assessment of their tax residence status may not coincide with the views of relevant tax administrations. The CRS form does require confirmation that the individual has a tax or legal advisor to assist them in the completion of tax filing obligations, but again this is subjective determination, and the form is not required to be signed by the tax advisor.
The tax advisor’s role in assisting clients with their tax obligations is clearly much more complex than hitherto. Clients may be blissfully unaware of the changes that have taken place over the past decade in determining acceptable versus unacceptable tax planning, but they need to be aware that the proceeds of their profits and gains may be reported to one or more interested tax jurisdictions. Bank secrecy is therefore a thing of the past, and what is most concerning is that information may be given to an interested tax administration that has no legal right to claim taxes based on an individual’s non-residence of that country. However, proving non-residence, and especially defending spurious claims made by tax administrations can be an extremely costly and stressful exercise. The tax advisor’s role is to ensure that their clients meet the demands of transparency towards relevant tax administrations, whilst at the same time, legally minimising the tax burden according to the concept of acceptable tax mitigation.