IFS - Information Zone

First off, some house-keeping. As you will no doubt already know we are holding an Offshore Funds conference on the 4th of October at the Pennyhill Park Hotel, just outside London. There are still a handful of places left and if you haven’t signed up yet, now’s the time. Please email us at Conferences@interfis.com and we will send you an application form.

 

Now to business! It has been something of a tumultuous couple of weeks in the world of tax following the decision of the ECJ in Cadbury Schweppes which is discussed in some detail below. The case, as many of our readers will know, revolves around the establishment by Cadbury Schweppes, a UK company, of two companies in the Irish Republic which were, at the time, subject to a tax rate of 10%. The question posed was whether the UK controlled foreign company legislation (CFC) was in breach of the fundamental freedoms contained in the EC Treaty. The Advocate General’s opinion was issued several weeks ago and this gave an indication of a favourable outcome for the taxpayer, although the Marks and Spencer case was of some concern on the basis that seemed to shift the trend of decisions towards the authorities. The decision in Cadbury Schweppes is such that it appears that UK CFC legislation is contrary to the fundamental freedoms prescribed by the EC. Provided that the arrangements entered into are not “wholly artificial” it would appear businesses in the EU can now look at establishing elements of their operations in low tax Member States (Gibraltar springs to mind), without breaching domestic anti-avoidance rules.

 

The case is fascinating for a number of reasons but I am really interested in the effect of the case on other anti-avoidance measures similar to the CFC rules, for example Article 209b in France or section 739 TA 1988 in the UK. Are these anti-avoidance rules now defunct as regards transfers of assets to EU based companies? Can a UK resident and domiciled individual establish an investment company in the European Union and shelter income and gains arising to that company with impunity? I understand that this is the view of several members of the UK Tax Bar and would be interested to understand the views of practitioners in other EU Member States – if you would like to share these views we would be delighted to hear from you.

 

On a lighter note the wedding I went to a couple of weeks ago (the Tallinn trip refers) was excellent, made all the more enjoyable by the appearance of childhood heroes The Wurzels. Much singing to old favourites such as “I’ve Got a Brand New Combine Harvester” and “I Am A Cider Drinker” was accompanied, funnily enough, by quite a lot of scrumpy!

 

Happy reading!

 

 

The changes made by the Finance Act 2006 to UK inheritance tax (IHT), in relation to trusts, will affect capital gains tax (CGT) planning for UK resident but foreign domiciled individuals who have become UK deemed domiciled for IHT purposes only. Previously such clients could form an offshore life interest trust including themselves as the life tenant and transfer assets to the trust without a charge to IHT (CGT would of course have needed to be considered on such a transfer). Once the assets were contained in the offshore trust the client could benefit from the beneficial CGT provisions of s86 and s87 TCGA 1992 i.e. tax free gains (even on UK situs assets) and tax free remittances to the UK.

 

However, following the FA 2006 changes, a 20% IHT charge will now apply on the initial transfer of assets to the trust if the client is UK deemed domicile. Where the client is not yet deemed UK domiciled, but will become so in the not too distant future, consideration should be given to creating an offshore trust now, at a time when a transfer on non-UK assets will not trigger the life time charges.

 

ECJ rules UK controlled foreign companies legislation does no comply with EU law The European Court of Justice (ECJ) in the case of Cadbury Schweppes ruled that the UK's controlled foreign companies (CFC) legislation is incompatible with EU law, and in particular with the freedom of establishment principle enshrined in the EU treaty. The court said in its ruling that the legislation can only apply automatically in the case of arrangements which are “wholly artificial” and have been established abroad purely to benefit from a lower tax rate. Furthermore, 'objective criteria' must be applied in order to decide whether a company is carrying on genuine economic activities in addition to subjective considerations.

 

Under the UK's current CFC rules, a UK parent company can be taxed on the profits of subsidiary companies located in jurisdictions which are classified as low tax. Ireland, Cyprus and Gibraltar currently fall into this category. Whilst there are exceptions from this tax charge, these are very limited. Following the opinion of Advocate-General Léger, the ECJ said that that establishment of a company to take advantage of a favourable tax regime was not an abuse of UK tax laws, as long as the CFC operated from genuine offices and employed genuine staff.

 

The ECJ has referred this case back to the UK Special Commissioners who must apply 'objective criteria' to decide whether Cadbury established these companies in Ireland purely for tax benefits. If the test is objective, the current CFC tax legislation should be regarded as being compatible with EC law. However, if the criteria applied mean that companies are liable to pay the CFC tax rate when there is insufficient evidence to prove the foreign company is a 'wholly artificial arrangement,' the UK legislation in question is 'contrary to community law'

 

Following this judgment it is likely that the UK Government will have to revise its legislation to ensure that the UK rules can only be applied to wholly artificial tax arrangements. If the arrangements are only partially artificial, for example a lack of substance in the overseas company, can it be assumed they are not caught by the ruling if the activities that are carried on are bone fide? This one looks to rumble on but the writing is seemingly on the wall.

 

The French tax system is based on the principle of territoriality: the tax law is not applicable beyond French territorial limits. There are, however, exceptions one of these being the French CFC rules. The French CFC rules are codified under Art.209B of the French Tax Code and state that a French shareholder holding a qualifying interest (in an entity established outside France and benefiting from a low tax system) is assessed on a pro rata share of that income derived by the foreign entity whether or not the income is distributed to the shareholder.

 

Article 209B should not be applicable where there is a double tax treaty between France and the country in which the foreign company is located, and the provisions of that treaty exempt the foreign company from French taxation in the absence of a permanent establishment in France. However, the French tax authorities have sought to attack foreign subsidiaries of French companies and tax the profits of a foreign entity with no permanent establishment in France as, in their view, Art 209B does not lead France to tax the foreign controlled entity in itself, which would violate the aforementioned tax treaties, but rather the French shareholder with respect to their shareholding in the foreign entity, which as such does not breach the tax treaties.

 

The French Supreme Court ruled in the Schneider case (28 June 2002) that Article 209B was contrary to the French/Swiss double tax treaty. This case concerned the taxation of the Article 7 (business profits) under which the right to tax profits is reserved to the country in which the permanent establishment is located. The Supreme Court’s decision affects most of the tax treaties concluded by France which are based on the OECD Model Convention and do not contain a provision allowing France to apply Article 209B notwithstanding other treaty provisions. In light of this case and EC law, the French have released draft guidelines on the application of the French CFC legislation in a treaty context, which are due to apply from 1 January 2006. Essentially, for taxation at the French Company level, the new draft of Article 209B distinguishes between (i) income derived from permanent establishments, which is taxed as business profits, and (ii) income derived from legal entities, which is taxed as passive income for the French company

 

(i) Business income derived from permanent establishment of French companies

 

Income derived from permanent establishments of French companies and assessed under Article 209B falls under the business profit article (Article 7 of the OECD Model). France may apply its CFC legislation if the applicable tax treaty contains an express clause allowing France to apply its CFC legislation. In other cases, two situations must be distinguished:

 

Income derived by legal entities and assessed under Article 209B falls under the "other income" article (i.e. Art. 21 of the OECD Model). It does not fall under Art. 10 (dividends) of the OECD Model because there is no effective profit distribution. The draft Guideline expressly mentions that the French participation exemption does not apply to such income.

 

The German finance ministry has tabled a considerably tighter version of the anti-treaty shopping rules.

 

This draft imposes extensive substance requirements on a foreign company claiming relief from withholding taxes for its shareholders (unless such shareholders would be entitled to the same relief on direct receipt of income, or the shares of such company are regularly traded on a recognised stock exchange).

 

According to these requirements, not only must the company maintain its own premises and participate demonstrably in the business community; it must also derive more than 10% of its gross income from its own commercial activities and have valid non-tax (business or otherwise) reasons for its interposition. In this description, management fees can probably be defined as income, but neither dividend nor most forms of interest or recharges of outsourcing costs are likely to qualify.

 

New regulations have been implemented that determine the withholding tax due on payments from residents and permanent establishments to non-residents. The new regulations impose the following tax rates:

 

The Mauritius / India double tax agreement, concluded in 1983, has regularly received criticism for the apparent loophole that allows Indian companies to avoid paying capital gains tax in India. The loophole allows Indian companies to ‘round-trip’ through Mauritius in order to escape capital gains tax on stock market investments. Round-tripping is achieved where a foreign institutional investor registers themselves in Mauritius in order to take advantage of the treaty which exempts companies there from Indian taxes. Some companies had used the treaty to set up subsidiaries in Mauritius and invest in India through that route to avoid paying taxes. Mauritius has agreed to work with India to review the current treaty. The two most significant new proposals include:

 

The Dutch ministry of finance has announced additional reductions of the dividend withholding tax to avoid conflicts with European law. At this moment dividend payments to foreign companies are sometimes taxed more heavily than dividend payments to domestic companies. These inequalities are now removed and the modifications introduced have responded to requests from the European Commission.

 

It will be also stipulated that a Dutch company does not have to withhold dividend withholding tax if the dividend is paid to a company established in another EU member state, if that company holds at least 5% of the shares in the Dutch company. Currently, this exemption applies only to foreign companies holding a participation of at least 20%.

 

In what would appear to be a ground-breaking change of law the Dutch Minister of Finance has decided to bring an end to the source taxation of non-resident artistes and sportsmen in the Netherlands from 1 January 2007 and allow the residence country to levy tax from their international performing artistes and sportsmen. This is a major departure from the OEDC recommendation in Article 17, which has been incorporated into the majority of the Netherlands double tax treaties. Article 17 grants primary taxing rights over non-residents artist and athletes to the state in which the performance is undertaken. The provisions of Article 17 are unique, and some would say extremely unfair, in that an individual who may spend, say, only two weeks in a particular country in a given tax year, is fully exposed to that country’s tax laws on the earnings he generates whilst there performing. The Netherlands plans to ask other OECD and EU countries to follow this proposal, which could see a major shift in the taxation of sportsmen and entertainers. See the England v. Pakistan case below for an example of the law in practice.

 

The Dutch lower court decided that the restriction of the Dutch group taxation regime is compatible with the freedom of establishment and the freedom of movement of capital of the EC Treaty. Under the Dutch consolidated tax regime the losses of a Dutch subsidiary can be set off against the profits of the Dutch parent company but the losses of a foreign subsidiary that does not have a permanent establishment in the Netherlands cannot be offset. A fiscal unity between a Dutch parent company and non resident subsidiary is not possible and therefore can be argued to be a restriction on the freedom of establishment since it is less attractive for a Dutch parent company to form a subsidiary in a member state.

 

The Court referred to the decision of the ECJ in Marks & Spencer plc v. Halsey in which the ECJ held that the UK group relief rules, which do not allow a deduction of losses incurred by foreign subsidiaries, in principle, is compatible with EU law. The ECJ decided that the restriction could be justified with the requirement to preserve a balanced allocation of taxing powers between the Member States, the need to prevent a double use of losses, and the right to counter tax avoidance.

 

The Lower Court stated that those justification grounds do not apply to the Dutch group taxation regime, as special provisions concerning double loss compensation and tax avoidance do already exist. The Lower Court has refused to refer preliminary questions to the ECJ and as such an appeal has been lodged before the Supreme Court who will be under obligation to refer the matter to the ECJ. Such a referral will enable the ECJ to demonstrate how the reasoning behind the Marks & Spencer case can be applied to other member states, which have a group system of taxation.

 

HMRC are claiming that Pakistani cricketers should pay UK tax on their earnings during the time spent playing in the UK, during the last victorious cricket series. The CBR of Pakistan point out that when England toured Pakistan last winter they were not subject to Pakistani taxation.

 

Article 18 of the Pakistan / UK double tax treaty (which is based upon Article 17 of the OECD Model) provides that an athlete of Pakistan may be taxed in the UK where he exercises his activities. This prima facie implies that the UK has taxing rights which would be the correct interpretation of the treaty not only in the UK but in any country which has concluded OECD style treaties. However, the CBR claim that cricketers are in fact not ‘athletes’, which in the case of certain heavily-set cricketers may be an argument that could be advanced, but does not really hold water. The interesting aspect of this case is that the treaty in question is 20 years old, and whilst it followed the OECD Model (1977) at that time, it has not been updated to coincide with the current OECD model treaty which uses the term ‘sportsmen’ rather than ‘athlete’. This would seem, however, irrelevant. Reference is made to the OECD Report dated March 27, 1987 entitled “As far as athletes are concerned, it was agreed that the intention was to cover sportsmen in the broad sense of the word. The term is not restricted to what are traditionally thought of as athletic events (e.g. running, jumping, javelin throwing). It also covers, for example, footballers, golfers, jockeys, cricketers and tennis players, as well as racing drivers.”

 

If the Pakistani interpretation of the treaty is to be followed then HMRC would not have taxing rights over the cricketers’ sponsorship payments under this article. It is submitted that this is not the correct interpretation and that unless there is a change in tax policy along the lines proposed in the Netherlands, the Pakistani cricketers will lose this contest as well.

Glaxo Holdings will pay IRS $3.4 billion

The IRS has settled a dispute with GlaxoSmithKline Holdings under which Glaxo will pay $3.4 billion (including interest) in the largest tax dispute in IRS history. The agreement covers a transfer pricing dispute for the tax years 1989 to 2005, which involved intercompany transactions between Glaxo and certain of its foreign affiliates relating to various pharmaceutical products. In addition, Glaxo will also abandon its claim seeking a refund of $1.8 billion in overpaid income taxes.

 

On 3 October 2002 the US and the IOM signed an exchange of information treaty which entered into force on 26 June 2006. Covering all taxes on income or profits imposed by the IOM and all US federal taxes, the agreement provides that the parties will exchange information that is regarded as relevant for the collection of taxes covered by the agreement, the recovery and enforcement of tax claims and the investigation or prosecution of tax matters.

 

The agreement is effective from:

 

Criminal tax matters: 1 January 2004

Other tax matters: 1 January 2006