IFS - Information Zone

 

Crikey what a couple of weeks! First up was a cultural visit to Tallinn with a select group of friends from Yorkshire to sample the delights of Estonia in honour of one of ours who is tying the knot later this summer. I was looking forward to understanding the tax system of this new EU Member State (see below) as well as sampling the delights of this historic medieval city. I am pleased to report that I arrived back safe and sound much to everyone’s amazement. I was invited to the 20/20 final in Nottingham, home of the greatest football team in the world, and had a day at the cricket last week, trying to promote our services to sports agents and the like. Finally to Wembley for the Thomas the Tank Engine extravaganza on Saturday with Jim and Tom – all too much really but hugely enjoyable! Our annual holiday to Scarborough is underway (I am writing this as the Scarborough sky darkens and yet more rain threatens) I am out of the office until Thursday but with technology and the dreaded “Crackberry” in hand I will no doubt be contactable. The rest of the team will, of course, be on hand to assist.

 

Happy reading!

 

 

Due to Estonia’s entry into the EU on 1st May 2004, its expanding network of double tax treaties and excellent infrastructure, it has some very interesting planning opportunities. The Estonian corporate income tax regime is quite unique in that corporate income tax is not charged at the moment the profit is generated; instead, the moment of taxation is postponed until the profits are distributed. Thus, a company not distributing any profits is not obliged to pay corporate income tax. A proposal to reform this system has been put forward which would tax corporate profits at 10% annually beginning in 2009 regardless of whether any distributions have been made. No further tax would be imposed upon distribution of profits. The Estonian Government has recently announced that the next government will decide this issue effectively putting it on the “back-burner”. The next government is likely to convene in 2007 and thus this beneficial tax system will be around for a bit longer.

 

No dividend withholding tax is levied on dividends to non-resident shareholders provided that the non-resident shareholder is a company owning at least 20% of the shares in the Estonian company. Due to the favourable tax treaties, interest and royalties can flow from these companies with low or no withholding tax. Due to the absence of thin capitalization rules or debt-equity ratio rules (subject to the arms length principle) Estonian companies can be used as group financing vehicles to include group leasing facilities and credit control and factoring services intra-group. The lack of corporate income tax until distribution also makes the Estonian company an ideal company for trading or service provision purposes. With effect from 1st January 2009, Estonia will be able to benefit from the EU parent/subsidiary directive and thus Estonia as a holding company location could be a useful exit route for EU dividends without withholding tax.

 

The tax tip of the day is to review your existing structures and consider using an Estonian holding company, which has excellent planning opportunities until 2009 and likely favourable dividend tax treatment thereafter.

 

The European Commission have found that the tax levied by Belgium, Italy, Luxembourg, Netherlands, Portugal and Spain on outbound dividends is far higher than that levied on domestic dividends. Domestic dividends, being those paid to shareholders in the same jurisdiction are either not taxed or subject to lower rates than the equivalent withholding tax. The Commission established that the rules on taxing dividends in these above named member states infringes upon the principles of the free movement of capital and the freedom of establishment. This matter may have to be referred to the ECJ.

 

The case of Vodafone 2 v Revenue and Customs [2005] UKSPC 00479 was referred to the ECJ.This is another case where the UK CFC’s regime is tested on its compatibility with EU law. In the Cadbury Schweppes case the principal question was whether the low (10%) Irish corporate income tax rate in itself was sufficient to apply the UK CFC rules. In the Vodafone 2 case the UK shareholder refused to answer formal enquires on its entitlement to the so-called motive exemption of the UK CFC rules. In this case new issues are raised with regards to the compatibility of UK CFC rules with EU law. The principal questions are whether the breach with EU law is justified if i) the CFC only carries out minimal activities in its jurisdiction of location (i.e. Luxembourg), ii) only a minimal part of the profits of the CFC in Luxembourg is subject to tax in Luxembourg and iii) the CFC is established as part of an artificial scheme to avoid tax. Clearly, the answers to those questions are important, for example the use by UK shareholders of Luxembourg finance structures, where the finance activities are allocated to a foreign branch.

 

In this case the Indian Authority for Advance Ruling (AAR) were required to determine whether a US company had created a permanent establishment in India by outsourcing services and sending staff to its Indian subsidiary. The personnel sent to India were to be engaged either for providing stewardship services to the Indian company or were to be seconded to work under the control of the Indian company. Under the India/USA double tax agreement a US parent company could have a PE in various situations. For example, when its Indian subsidiary can be regarded as a fixed place of business through which the business is carried on. The AAR held that the Indian subsidiary was a fixed place for the US company but did not constitute a PE since the business of the US company was not carried on through that fixed place. However, the AAR went on to look at whether a PE could be formed under the agency provisions of the treaty. The AAR held that the Indian subsidiary was not an agent for the US company regardless of the fact that it was dependant on its US affiliate. The AAR further examined whether the deputation arrangement would result in a PE under the service PE rule. Under the provisions of the treaty, for an entity to have a service PE, an enterprise should furnish services through India through employees or personnel and such activities should continue within India for more than a specified number of days. The AAR found that conditions laid down in the treaty were satisfied and that the deputation arrangement led to a PE under the service PE rule.

 

Italy has enacted new rules for determining corporate residency. The new rules, which are effective from 4 July 2006, will treat a company as tax resident in Italy for all Italian purposes unless it can be proved that the entity is not resident in Italy under the ordinary corporate tax residency tests. These are that a company is regarded as resident in Italy if, for the greater part of the tax year, it maintains in Italy either a) the legal seat or b) the place of management or c) the main business. This presumption of residency applies to foreign entities that control a resident company and are directly or indirectly controlled by Italian residents.

 

Reforms of the participation exemption have been announced which will be implemented in 2007. Currently, Dutch participation exemption provides for a full exemption against income from a qualifying subsidiary of a Dutch company. The new proposals are to abolish the existing portfolio test and the subject to tax test, which were additional requirements for the non-Dutch subsidiaries. The Dutch participation exemption would then generally apply to Dutch domestic as well as non-Dutch subsidiaries if the Dutch parent company holds at least 5% of the shares in the subsidiary, provided that the shares are not held as stock-in-trade (inventory). However, only a foreign tax credit instead of an exemption would be available for participators in passive subsidiary companies in low taxed countries. ‘Low taxed’ means an effective rate of less than 10% calculated under Dutch principles. In addition, on disposal of a participation the cost can no longer be deducted.

 

The corporate income tax rate has been reduced from 24% to 20% in respect of income received by legal entities registered within the special innovative economic zone whose activities are innovative. This is effective for five years from 1 January 2006 until 2011.

 

The Finance Act 2006 was enacted on 19 July 2006 and implements the proposals laid out in the Budget on 22 March 2006. Following the Budget there was much controversy at the change in the taxation of trusts in that all future trusts, with few exceptions, will be subject to 20% inheritance tax (IHT) on lifetime transfers that exceed the IHT threshold (currently £285,000). In addition to the proposed changes trusts will be subject to a ten yearly charge of 6% on the value of the trust assets over the IHT threshold, and an exit charge. Transitional rules apply to existing trusts. However following intense criticism and petitioning, the government amended its proposals in respect of taxpayers wanting to leave money to their spouses without a charge to tax. In addition the tax burden is reduced on trusts set up to pay out after a child reaches 18, but only on trusts paying out at 25 and this is reduced to 4.2%. This is poor legislation, even with the slight back-tracking, the changes to the trust laws will only encourage tax avoidance, which is ironic considering the Revenue’s aim is to stamp out tax avoidance by 2008!

 

As from 1st August 2006 the proposed amendments to the disclosure regime for UK anti-avoidance schemes took effect. A tax arrangement must be disclosed when:

Where a disclosure is required it must be made by the scheme “promoter” within 5 days of it being made available. Although the scheme user may need to make the disclosure when the promoter is based outside the uk, when the promoter is a lawyer and legal privilege applies if there is no promoter.

 

The Federal courts decision in 2004 in the case involving Coltec Industries Inc, the former subsidiary of Goodrich, manufacturer of aircraft landing systems has been overturned by a US appeals court. The issue in this case involved a tax shelter known as a ‘contingent liability deal’, which allowed artificial capital losses to be generated, Coltec then offset these losses against a capital gain realised on the sale of a business unit. The appeal court held that the transaction involving the contingent liability lacked economic substance and accordingly this was sufficient to prohibit the transaction despite the fact that there was no evidence that the taxpayer’s singular motive was tax avoidance.