IFS - Information Zone

The Swiss tax system has for many years been very attractive for tax practitioners. The jurisdiction lends itself ideally to all forms of corporate tax planning (holding and trading activities, finance branches and so on) because of the availability of tax rulings. There is, however, very little tax avoidance legislation, the 1962 Federal Decree (as amended in 1999), being the main provision curtailing the use of Swiss structures as mere conduits (see the Indofoods case below). With a view to preventing tax avoidance a general doctrine based on the substance-over-form principle has developed. Thus the form of a transaction may now be recharacterised when the following conditions exist:

The move by the Swiss authorities is not surprising and a further reminder (if we needed it) that any tax planning must have substance. So often the most important aspect of a tax structure is overlooked, with more reliance placed on finding a loophole which provides the tax benefit: if a structure is not run properly or the directors do not have the requisite experience and expertise it is all too easy to assert that the real decisions are being taken elsewhere.

 

In order to help companies prepare transfer pricing reports, the Ministry of Finance has released a Transfer Pricing Reporting Model (TPRM). The TPRM suggests that the following should be included in a transfer pricing document:

The importance of transfer pricing analyses cannot be underestimated as explained in our Tax Tip.

 

 

In short it was decided unanimously by the Court of Appeal that where a husband and wife share the responsibility and hard work of running their business (tell me about it!), they are both entitled to a share in the income (tell me about it even more!). Thus the provisions of section 660A of the settlements legislation, did not apply to prevent income arising being transferred from the top rate taxpayer (the husband) to the lower/no taxpayer (the wife). Unfortunately this saga must now carry on creating further insecurity for family run businesses.

 

A civil law case in the High Court has caused a stir amongst the tax fraternity which looks like it will lead to a degree of uncertainty. The High Court ruled that the term “beneficial owner” means the actual owner of the interest income who truly has the full right to enjoy directly the benefits of that interest income. A nominee or a conduit company is not regarded as a beneficial owner of the interest, according to the High Court. The decision was not appealed and as such it is part of UK law – the extent to which it has an impact on UK tax law is debatable but it would appear HMRC have taken a keen interest in the case by mentioning at a recent conference attended by our man Binne Vries, that they will start to scrutinize special purpose finance vehicles, particularly those based in Luxembourg (more on this below).

 

The facts of the case are as follows: An Indonesian company Indofood, sought to issue loan notes in 2002 with a view to raising capital. Indonesia imposes a 20% withholding tax on interest payments, and to reduce this Indofood established a wholly owned subsidiary (“IIF”, in Mauritius to take advantage of the reduced rate of withholding tax (10%) under the Mauritius / Indonesia double tax treaty. A relatively straight-forward structure which led to IIF issuing $280mn in five-year bonds at a fixed interest rate of 10.27% which was guaranteed by Indofood. The capital raised was then lent by IIF to Indofood on substantially the same terms. Under the terms of the notes the issuer (IIF) could force early redemption if a material change of Indonesian law led to an increased rate of withholding tax than under the treaty with Mauritius. Redemption could not be enforced if "reasonable measures" could be taken to mitigate the impact of such changes.

 

Indonesia abrogated its treaty with Mauritius as of 1 January 2005 thus increasing the withholding tax to 20%. IIF claimed it had the right to redeem the notes. The note trustee JP Morgan Chase was opposed to redemption on the basis that the increased withholding tax could be avoided by inserting a Dutch SPV in place of the Mauritius company in order to take advantage of the reduced rate of withholding tax under the Indonesia / Netherlands treaty.

 

Indofood claimed that the structure would not work on the basis that the Dutch SPV was not in fact the beneficial owner of the interest. Most double tax treaties have evolved over time in such a way that the recipient of certain types of income, notably dividends, interest and royalties, must be the beneficial owner of such income if treaty benefits (that is reduced rates of withholding tax) are to be availed of. The Court found in favour of Indofood on the basis that the Dutch SPV was unlikely to be regarded under Indonesian law as the beneficial owner of the interest. The reason the court came to this decision are not simply that the Dutch company was being interposed purely to take advantage of the treaty. In addition to this the proposal would have resulted in:

 

 

Many modern double tax treaties, such as the Netherlands/UK treaty contain limitation of benefit clauses which seek to do exactly what it says on the tin: limit the benefits of the treaty in specific circumstances, for example if the only reason for inserting a Dutch company in a particular structure is to take advantage of the treaty itself. Some treaties on the other hand, such as the Luxembourg/UK treaty, do not contain a specific limitation on benefits provision and it would appear that Indofoods is being hailed by HMRC as being a very fundamentally important case, especially in structured finance deals. According to HMRC on the basis of the Indofood decision it is no longer necessary to amend the existing double tax treaty with Luxembourg to include an anti-treaty shopping clause. Time will tell how aggressive HMRC will be in tackling structures where a Luxermboug conduit company is being used but uncertainty is never a good thing and our suggestion is for all structured finance or royalty arrangements to be reviewed as soon as possible. Needless to say we have had our thinking caps on and we have various solutions to this potential issue. If you would like to discuss a particular structure with us do contact either Roy, Binne or at a push me!

 

We have reported this case on an ongoing basis because of its importance to all offshore structures. Together with Indofoods (the two cases in many respects complement each other) this is a significant case and a reminder of the importance placed on effective management and control. The facts of the case are set out in Issue 61 of the ITN. The Court of Appeal held that on the primary facts the Dutch SPV’s affairs were managed by its sole managing director in the Netherlands, within the limits of its constitution, consequently the company was not UK resident.

 

A company will become UK tax resident if it is “managed and controlled” in the UK. Central management and control is determined by where the company’s affairs are conducted. Where a company’s board of directors delegate the powers granted to them in the constitution of the company to another person, and that other person is exercising those powers in the UK, then the company will be regarded as UK resident. This case distinguished between “constitutional and unconstitutional” management. It was argued that the company’s UK tax adviser in fact dictated to the managing director as to what decisions to make with regard the purchase and sale of a particular shareholding. However it was held that it would be common for the director to allow his decision be dictated by his professional advisors because that is the capacity they are acting in.

 

Two important points emerged when assessing the place of management and control; firstly that because the director merely made two major decisions does not mean they are irrelevant with regards the exercise of management and control and secondly a management decision will not cease to be a management decision just because it may have been made on fuller information, “ill informed or ill advised decisions taken in the management of a company remain management decisions”. HM Revenue and Customs have now been refused leave to appeal by the House of Lords.

 

HMRC brought a claim against Richard Madeley and Judy Finnigian in an attempt to subject them to severe back taxes for claiming their agent’s fees as properly tax deductible expenses, the Revenues’ basis for this claim being that Richard and Judy are not entertainers! Richard and Judy’s grounds for appeal were two-fold.

 

Firstly that the fees were allowable in accordance with s201A ICTA 1988 (now s352 ITEPA 2003). This section provides that agency fees are tax deductible where they are incurred by an ‘entertainer’. An entertainer is defined as ‘an actor, dancer, musician, singer or theatrical artist’. The Revenue claimed that Richard and Judy did not fall within the definition of entertainer as they are in fact TV presenters. However Special Commissioner Howard Nowlan ruled that “I accept without hesitation that Richard and Judy are entertainers and they are performers. If an artist is performing on TV, in a club or even in the street, and the performance can be described as theatrical the fact the performer may never have set foot in a theatre is irrelevant”. However Nawlan made it clear that only TV presenters that can demonstrate that they put on some form of act will qualify as a theatrical artist, mere news or weather readers do not.

 

Secondly, that the fees were allowable in accordance s198 ICTA 1998 (now s336 ITEPA 2003). This section considers the nature of the agency fees and whether these were incurred ‘wholly, exclusively and necessarily in the performance of the duties’. This case only concerned employment income taxed under Schedule E, however Richard and Judy also had, at the same time, self-employment income under Schedule D. Richard and Judy also claimed their agent’s fees against their Schedule D income, however HMRC did not bring a claim against this. The Special Commissioner found that the expenses such as negotiating and monitoring Richard and Judy’s contracts, dealing with practical matters and the press by the agency were not sustained in the performance of the duties of the employment and would thus not qualify. However it is a point to note the agents fees claimed against Richards and Judy’s Schedule D work were for similar services and an allowable tax deduction.

 

The revised rules, that are effective from 1 August 2006, replace any current guidance. Under the current rules disclosure with respect to income tax, corporation tax and capital gains tax was limited to employment income and financial products. Under the revised rules they include any tax arrangement relating to any aspect of those taxes. Furthermore, under the revised rules a tax arrangement with respect to those taxes becomes disclosable if any of a series of ‘hallmarks’ applies. The hallmarks do not apply to stamp duty and land tax, which are subject to different disclosure rules. The disclosure rules do not apply to national insurance contributions but proposals to this extent are expected in due course.