Issue 68 - 19 Jan 2007
Sentiment
Happy New Year to all our readers and friends from everyone at IFS. The first ITN of 2007 has come around as if 2006 never really happened; Christmas and the New Year are a mere blur (literally speaking that is) now, and our focus is on the year ahead. Quite what 2007 has to offer in terms of international tax is anyone’s guess, but one thing is for certain – we are sure to have some surprises along the way. If this year is anything like 2006 the ECJ will have a lot to say, cases will create certainty and uncertainty, close planning opportunities and at the same time create new ones. Our aim this year is to continue where we left off last year and push for more cross border corporate transaction work, together with the offshore fund and alternative asset class planning that kept us busy.
We already have various strategies underway from marketing at MIPIM and GAIM (real estate and fund expo’s respectively), to lecturing and training courses. Zoe and Sage are about to embark on their own training at the International Bureau of Fiscal Documentation in Amsterdam, which will no doubt be a stimulating week for them. Binne and Ilonka will be concentrating on continental Europe as a source of business and Roy is going to be busy Chairing several tax conferences, the first being the Effective Hedge Fund Tax Conference on 19 th and 20th April 2007. I will try and keep myself out of mischief as usual! Having said all that, it’s not all work; skiing trips beckon for several members of the team and Roy is currently on his way to Italy for a relaxing week of pampering!
Happy reading!
Tax tip of the day
Double tax treaties are designed to counter the imposition of tax by two states on the same item of income or capital. Treaties based on the OECD Model Convention will ordinarily state in the preamble that the treaty is “...FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME AND ON CAPITAL GAINS”. Whilst the treaty itself may be drafted in such a way as to achieve these ends, the domestic laws of the contracting states may in fact create significant planning opportunities as a result of the treaty. “Double dipping” is the term commonly used to describe arrangements which give rise to tax relief in more than one country, generally due to the way in which income or an entity is qualified coupled with a country which has an exemption method of taxation. In many instances standard structures can be enhanced with the inclusion of a branch or partnership arrangement - the Swiss finance branch structure is one such example of how a treaty can be used in conjunction with domestic laws to allocate income to a low tax entity. Many more types of structure can be availed of, even in trading situations, to create very tax efficient returns in otherwise high tax jurisdictions.
Australia
Cross-Border Hybrid Structures
Hybrid tax structures are frequently used in international tax planning and rely on the different qualification of an instrument (debt or equity) or entity. In the latter case it could be that in one country an entity is treated as transparent and in another non-transparent, thereby creating a tax arbitrage.
The Australian tax authorities have announced that they intend to investigate cross-border hybrid tax structures to assess whether they have been put in place with the specific intention of obtaining a tax benefit. The Australian authorities intend to attack such structures under the general anti-avoidance rule (GAAR), which allows the Commissioner to cancel the effects of any tax benefits which the tax payer would have derived from the structure in question. In determining if a tax benefit is obtained a comparison is made of the actual tax position and the position if the structure had not been designed. Furthermore, Australia will have to report such a tax benefit to its treaty partners under the Information Exchange article.
European Union/ France/ Netherlands
French withholding tax rules are contrary to EU law
We reported in ITN 50 that the French Conseil d’Etat had asked the ECJ for a preliminary ruling on whether the withholding tax that France levies on outbound dividends is in line with EC law. The relevant case was Denkavit, a much written about case in the mid-90’s. The case involved a Dutch holding company, which owned 100% of the shares in a French operating company, and a controlling interest in a second French operating company. At the time of this case the EU parent/subsidiary directive did not apply and under the France/Netherlands tax treaty 5% withholding tax was applicable on a distribution of profits to the parent holding company in the Netherlands. However, if the parent holding company was in fact a French resident company then the distribution of profits would have been fully exempt from withholding tax under the French participation exemption. The Dutch parent company was excluded from applying for this exemption as it was only available to French resident companies: it could only rely on the treaty. It was argued that this was a violation of the EC freedom of establishment. Three questions were put to the ECJ.
- Whether the application of the French participation exemption was in line with the freedom of establishment;
- Whether the Court has to consider the France/Netherlands double tax treaty which provides for the levying of withholding tax on dividends and a credit for this against the corporate income tax in the holding company jurisdiction;
- Whether the Court must consider whether the application of the French participation exemption effectively prevents the crediting in the holding companies jurisdiction.
The French participation exemption is only available to domestic companies thus preventing economic double taxation on distributed profits, and subjecting non-French resident companies to effective double taxation. The ECJ held that by treating domestic and non-French resident companies differently this was discriminatory and infringed upon the freedom of establishment.
In response to questions 2 and 3, the ECJ ruled that the France/Netherlands tax treaty did not prevent such an infringement as the treaty only provides the Dutch parent company with a credit for the dividend withholding tax against the corporate income tax owed in the Netherlands. However, in this particular case the treaty provisions cannot be applied as the Dutch participation exemption exempts the dividend distribution from tax, i.e. no Dutch tax is due, and so there is no tax to credit the French withholding tax to. Thus the ECJ concluded that as France would not extend the participation exemption to non-resident companies this contravened the principle of freedom of establishment.
Similarly the Netherlands have a participation exemption, which as in France, does not allow a non-Dutch parent company to take advantage of the exemption, only Dutch resident companies. Again, based on the ECJ’s ruling in the Denkavit case, it would appear that this too is a violation of freedom of establishment. However, from 1 January 2007, subject to a minimum shareholding of 5%, the Dutch participation exemption will now apply to dividend distributions to parent companies in other EU-member states.
European Union / United Kingdom
Film tax relief
As of 1 January 2007 a new tax relief for British films came into force. This tax relief has been given State Aid approval by the European Commission. Much attention has been given in the UK press to the former rules, which were packaged and widely sold as investment products with significant tax benefits. Like many tax products devised and sold in the UK, film partnership schemes have been mass marketed and many would say missold by financial services professionals, resulting in widespread changes to the legislation and a possible knock on effect to the film-industry itself.
The new tax relief means that:
- For films that cost up to £20 million, the Film Production Company (FPC) will be able to claim an enhanced deduction of 100% with a payable cash element of 25% of UK qualifying film production expenditure;
- For films that cost over £20 million, the FPC will be able to claim an enhanced deduction of 80% with a payable cash element of 20% of UK qualifying film production expenditure.
Tax relief is only available for British qualifying films. Films must either pass the Cultural Test or qualify as an official co-production to be considered a British qualifying film. The UK Government has been working with the European Commission to ensure that the Cultural Test does meet the State Aid requirements of European law.
The Cultural Test now has four parts, which together measure the extent of a film’s British cultural character. Film makers will be awarded points in each of the categories and must score a minimum of 16 points out of a possible 31 to pass the test.
Other requirements for accessing film tax relief are:
- the minimum UK spend threshold for qualifying films will be set at 25%;
- the FPC responsible for the film needs to be within the UK corporation tax net;
- tax relief is available on qualifying UK production expenditure up to a maximum of 80% of the total qualifying costs.
European Union / United Kingdom
The ECJ Judgement in the Franked Investment Income (FII) Group Litigation Order
On 12 December 2006, the ECJ issued its decision in the Franked Investment Income (FII) Group Litigation Order. The case concerned the differential treatment of dividends received from UK resident companies and dividends received from non-UK resident companies. Essentially, a UK company, which receives a dividend from another UK company is normally exempt from corporation tax on that dividend (similar to the above Denkavit case), whilst dividends from non-UK resident companies are generally taxable but with a credit for foreign taxes paid. Advocate General Geelhoed opined on 6 April 2006 that the differential treatment of such dividends is contrary to the freedom of establishment and the freedom of movement of capital in the EC treaty.
However, on 12 December 2006, the ECJ went against the Advocate General’s opinion and held that provided that the UK tax burden imposed on foreign dividends is not higher than that applied to UK dividends (i.e. 10%), the UK rules are not contrary to EU law. In effect the ruling means that the UK could run separate systems for domestic and foreign taxpayers so long as the tax levied was the same. The ECJ nevertheless has left the national courts to review particular situations to see if such a system is unfair in practice in and our view this will only complicate matters further.
United Kingdom
HMRC confirms that the Robert Gaines-Cooper v The Special Commissioners of HM Revenue & Customs SPC00568 decision has no impact on 91 day average residence test
A welcome statement from HMRC in respect of the Special Commissioners’ case in Gaines-Cooper has been issued to the effect the case does not change the calculation of the 91-day test for UK residence of individuals. HMRC will not be rewriting its own guidance as detailed in “IR20 - Liability to tax in the United Kingdom” where it states that the normal rule is that days of arrival and departure from the UK are ignored in counting the days spent in the UK. (See ITN 67 for full details of the case).
Despite the above statement, our advice is for all non-residents to include their days of departure and arrival in their calculation of days spent. HMRC’s position has been made clear: in cases where significant sums are at stake the normal rules can and will be ignored.
United Kingdom
Deutsche Morgan Grenfell Group plc v Inland Revenue Commissioners: Companies to recoup millions in tax after ruling by Lords.
The House of Lords ruled that the Investment Bank, Deutsche Morgan Grenfell (now owned by Deutsche Bank), was entitled to recover taxes that it was unlawfully charged in the 1993, 1995 and 1996, before advance corporation tax (ACT) was ruled illegal by the European Court of Justice (ECJ). The ruling upheld the decision of the High Court at [2003] STC 1017, reversing the Court of Appeal decision at [2005] STC 329 and as a result Deutsche and its fellow claimants were in line for compensation worth hundreds of millions of pounds. However the Pre Budget Report has limited the effects of this decision.
Facts
Between 1973 and 1999, UK legislation required a UK company to pay ACT on dividends paid to another company. However, where two companies were in the same UK group, they could make a "group income election" such that it was not necessary to account for ACT on dividend payments. Following the decision in 2001 in the Metallgesellschaft / Hoechst case which ruled that the imposition of an ACT charge on dividends paid by a UK subsidiary to its overseas parent was contrary to the freedom of establishment principle of the EC Treaty, it was held that the group income exemption could be claimed by payees resident anywhere in the EU.
In 2001, the European Court of Justice ruled that aspects of Deutsche Morgan Grenfell’s advance corporation tax payments had been unlawful and that the bank should never have had to pay them. The issue in Deutsche Morgan Grenfell was whether sums paid as ACT could be recovered, once it became clear that they should never have been paid. HMRC accepted that Deutsche Morgan Grenfell were entitled to compensation for ACT payments but successfully argued in the Court of Appeal that the limitation period expired six years after the ACT was paid, this being 1993. However, the House of Lords ruled that the claims could only have begun when the ECJ ruled that the UK’s ACT regime was unlawful in 2001 and thus claims to recover ACT wrongly deducted are not limited to six years from the date of the mistaken payment, but from the date when the mistake was discovered in 2001. However, the Pre-Budget Report controversially announced that claims would only be credited if the claim was made no later than six years from the date the tax was paid, rather than the date it was discovered. It is expected that this measure will be disputed.
The IFS Team:
Roy Saunders
Miles Dean
Binne Vries
Ilonka van der Hoeven
Sage Lakhani
Zoe Shorten
Stuart Stobie
