Issue 70 - 13 Mar 2007
Sentiment
I am barely back from some winter sun chez family Dean in Sharm el Sheikh and it’s off to Cannes for MIPIM – God help us all! I have been shocked into fitness action having made the schoolboy error of watching the holiday video of T’gypt with my in-laws. It was quite evident that I have been eating lots of pies recently (this is an English expression describing someone who is of the Teletubby persuasion), and the time has come for change. I thought I was having trouble sinking on the diving trip, it taking almost my entire body weight in lead to submerge me. I have now commandeered the services of a crazy South African to kick me into shape at the gym, which he seems to enjoy despite the volley of verbal abuse thrown at him on a regular basis. I think it might be some time before the washboard appears, but we live in eternal hope. As part of the regime I have had the push-bike serviced and will now be cycling into the office (weather permitting of course – too many years living down South has taken the edge off my granite-like Northern toughness), which will be a sight to behold as I have bought a matching set of acid yellow gloves and jacket – I look like a huge lemon on two wheels!
This month’s ITN is a real mixed bag. Our tax tip looks at an often-overlooked provision of Dutch tax law which might be solved by using the Malta holding company regime. Roy has contributed two excellent articles on the recent changes to the US tax code which we have been busy grappling with, whilst Sage has provided a useful update on the Marks & Sparks case. Zoe has also been flexing her academic muscle writing an article on the Construction PE which will be published in Tax Planning International Review – copies will be made available to our ITN subscribers in due course.
We are also pleased to announce that despite my assertions to the contrary the IFS team are busy developing a new on-line publication, the “IFS International Tax Knowledge Base”, which will be available by subscription only within the next 12 months. We believe the service will be unique, combining factual country-by-country surveys with commentary and planning tips and techniques. We will of course keep you posted! Oh, and by the way – you can download a copy of our new brochure here!
Happy Reading!
Tax tip of the day
Malta
Malta’s original holding company regime provided for a full refund of tax on distribution of dividends to a foreign shareholder. On 6th March 2007 a participation exemption was introduced which exempts from Maltese tax dividends and capital gains derived from participating holdings. The advantages of the participation exemption over the existing imputation system are of course, cash flow and no risk of tax leakage which could arise due to undistributable profits. Furthermore, there being no dividend withholding tax on dividend distributions and Malta being a member of the European Union make it altogether a very interesting holding jurisdiction.
For example, using a Maltese company as the shareholder of a Dutch company might be advantageous. Under Dutch national law there is an often over-looked provision relating to substantial shareholdings which can catch non-treaty foreign shareholders of Dutch companies. If all the conditions of this provision are satisfied, dividend income and capital gains realised on the transfer of the substantial interest are taxable at the rate of 25.5%. In addition, so is interest income from loans provided to the Dutch company.
In the past we have discussed the possibility of using a Singapore holding company. Dividends received by a Singapore company are in principle exempt from Singapore tax to the extent that the dividends are paid out of taxed earnings. In their Circular of 12 December 2006 the Singapore tax authorities specified that foreign income may be exempt if the taxpayer receiving the specified foreign income is not a ‘shell company’. The requirements under Singapore law are relatively restrictive and a Maltese company is a very attractive alternative providing a tax efficient route out of Europe.
Canada
Publicly listed trusts and partnerships subject to tax equivalent to corporation tax
Canadian trusts and partnerships became transparent for tax purposes in 2006. As a consequence many Canadian public corporations converted into trusts, namely ‘public income trusts’, in order to avoid paying corporation tax and the effects of economic double taxation. However, the government has announced proposals whereby publicly listed companies and partnerships will be subject to tax at a rate equivalent to the Canadian corporation tax rate. To prevent tax loss further distributions made by the trust will be subject to withholding tax in line with the withholding tax applicable to corporations.
Germany
Transfer pricing amendments
In 2005 and 2006 we saw the reform of the transfer pricing rules and advance pricing agreement arrangements. Now the corporate tax reform for 2008 will address the transfer pricing regulations. In determining the arms length basis the comparable uncontrolled price (CUP) method should be applied where available. This is unfortunate since the CUP method is the most difficult of the various methods to apply because it is often very difficult to obtain the required comparable information - businesses quite understandably do not want to give away or make public such information! Where the CUP method is not available, indirect comparisons may be made.
Poland
Participation Exemption
A participation exemption has been introduced effective from 1 st January 2007. It is applicable only to income in the form of dividends received by a Polish company from a Polish or EU, EEA and Swiss resident company, but not to gains realized on a disposal of such shares. To qualify for the exemption the receiving company must have a minimum shareholding requirement of 15% (Switzerland 25%) (reducing to 10% in 2009) for an uninterrupted period of two years.
United Kingdom
Restriction on loss relief for individuals in partnerships
On 2 nd March 2007, HMRC published a Brief affecting individuals in partnerships which has had a far reaching effect on certain sectors in the financial services market. Currently individuals in partnerships can set off their losses against their other income under ss. 380 & 381 ICTA 1988 or against their chargeable gains under s.72 Finance Act 1991. Partners of an LLP can only claim loss relief to the amount of capital that the partner contributes to the partnership.
As from 2 nd March the government propose to restrict this relief further to exclude certain capital contributions where the main purpose of the contribution is to generate losses – hardly surprising! Further, in respect of nonactive partners, i.e. a limited partner of a trading partnership who does not give a significant amount of time to the trade in the relevant period for the tax year, an annual limit of £25,000 is available for loss relief.
This restriction is directly aimed at tax schemes involving, for instance, film partnerships which have been widely used (and dare we say it, abused) over the last decade in the UK. In addition to the HMRC Brief the draft Corporation Tax (Taxation of Films) (Transitional Provisions) Regulations 2007 was published containing the provisions of the new film tax relief which came into effect on 1 st January 2007, details of which are available in ITN 68. Together the new film tax relief and the Brief go a long way to closing down various tax shelter schemes. No doubt there is much activity amongst UK tax bods devising new methods of creating losses!
Marks and Spencer Case
The ITN has followed this case for some time now and full details of the case can be found in ITN 58. To summarise, Marks and Spencer (M&S) a UK public company with subsidiaries in Belgium, France and Germany claimed that the UK rules for offsetting losses of foreign subsidiaries against the taxable profits of the UK parent company is contrary to EC law in that loss relief is only available to UK trading subsidiaries. The UK tax authorities rejected Marks and Spencer’s claim that this infringed the EC principle freedom of establishment.
There were a succession of appeals and the UK High Court referred the case to the ECJ. The ECJ, in December 2005, held that UK group relief did in fact infringe on the freedom of establishment principle enshrined in EC law as UK domestic subsidiaries have a tax advantage over non-domestic subsidiaries. However, the ECJ said that UK group relief rules could be justified where firstly, the foreign subsidiary has exhausted all possibilities of relieving the losses in the accounting period in which the loss arose and any preceding periods. Secondly there must be no possibility of claiming loss relief in future years; this second proviso is strict in the sense that it is not enough that it is ‘unlikely’ that the foreign subsidiary will not have any future profits. The ECJ handed the case back to the UK High Court to determine what group relief the company should be entitled to following the ECJ’s judgement.
The UK High Court held that in respect of the French subsidiary group relief was not available as the loss had been relieved. However the Court passed the decision of the availability of group relief to the Belgian and German subsidiaries to the Special Commissioners, whilst providing directions. Both HMRC and M&S appealed against the directions as given by the High Court. The Court of Appeal, largely agreeing with the High Court, held that the ECJ’s judgement (that all possibilities to relieve the loss in current, previous and future years in the foreign subsidiaries state of residence must be exhausted), should be determined at the date the claim for group relief is made, normally being two years after the accounting period end. HMRC, however, claimed that it should have been at the end of the accounting period in which the loss arises. This point is the most noteworthy as it opposes the provision in the UK Finance Act 2006 which effectively states that the “no possibility” proviso must be satisfied “immediately after the end of the accounting period” in which the loss arises. M&S, looking for a wider application of the ECJ judgement, claimed that the UK group relief rules requiring the loss making company to be UK resident and carrying on a taxable trade in the UK should be dis-applied. However the Court of Appeal rejected this line of argument and rejected M&S’s request to refer this question back to the ECJ. This case will be heard by the Special Commissioners.
United States
US tightens the screw on its citizens
Rabbi Trusts
There have been two major new provisions in US tax law over the past couple of years, which are designed to restrict the ability of US citizens to be in control of their own tax destiny. The first was introduced more than two years ago, with the attack on foreign Rabbi Trusts, under section 409A IRC. These Rabbi Trusts are deferred compensation schemes, where the ‘’constructive receipt’’ rules are not fulfilled, because there is a risk that the individual may not receive his deferred compensation. Typically, the assets of the Rabbi Trust are still available for the creditors of the employer company should that go into liquidation. There is therefore a “substantial risk of forfeiture”, meaning that constructive receipt, and a tax liability, does not happen until the funds are actually vested in the individual. US tax law enacted provisions, following the Enron scandal, designed to avoid US companies transferring cash earmarked for deferred compensation to its employees into foreign trusts, effectively outside of the reach of creditors (although nominally still available for creditors to fall within the beneficial rabbi trust provisions). This seemed wholly unacceptable to Congress and the Senate.
Thus unless one of the remedies mentioned below is adopted, the full amount of the deferred compensation is now taxable with effect from 1 January 2005, not only at the federal income tax rate of 35% but also accompanied by a penalty tax of 20% and further penalties in the form of interest: in other words, almost the entire amount of the deferred compensation fund could be virtually expropriated by the IRS. US citizens have until the end of this year, 31 st December 2007, either to bring the foreign trust onshore, so that it becomes subject to US taxation and reporting requirements (and this theoretically means bringing all the assets into the US so that there is US source in the future for all income), or distributing the entire fund to the relevant individuals, so that they pay income tax at regular rates on the full amount of deferred compensation.
By bringing the trust onshore (into the US) the government seems to be satisfied that the individual would not be in constructive receipt of the deferred compensation, because the fund would really be available to creditors of the employer company, not only in theory (as in the Enron case), but actually, because the assets would be in the same place as the creditors.
What seems to have been overlooked by Uncle Sam is that foreign employers’ deferred compensation schemes are also affected by the new rules if US citizens are beneficiaries of the trust arrangements. In such situations the same requirement to bring the offshore trust into the US applies. But this means that the creditors of the foreign employer (typically in the same country as that of the employer) are indeed separated from the funds’ assets, which now have to be re-located in the US! The logic seems to have gone awry somewhere, and although it is possible to seek dispensation from these provisions from the IRS, we doubt whether many applications would be successful. We are examining ways with our US tax colleagues, to help those US citizens employed by foreign corporations to meet the new provisions without incurring penal US tax consequences.
Exit tax
The second turn of the screw has occurred within the last few weeks, with the submission of the Minimum Wage Bill to the Senate for approval. This included a provision introducing the (long-awaited) exit tax for US citizens who renounce their US citizenship. As we write, this has now been dropped from the Bill for further discussion, but its introduction is imminent understandably triggering mass renunciations of US citizenships all over the world. The ‘exit’ tax, which is a feature of tax laws in many countries (such as Canada, Australia, Denmark) permits the IRS to tax expatriating citizens as if they had realised all of their assets on the day of renouncing their citizenship, creating a potential capital gains tax liability on the excess of the value of those assets over their cost.
The ‘ten year rule’ is still applicable, i.e. those citizens who renounce their citizenship are still taxed on US source income for the following ten years (although not on worldwide income as is commonly thought). There is, however, another sting in the tail of the new provisions: since US expatriates are no longer subject to estate and gift tax, transfers of assets to their children will be outside of the scope of US taxation under current law; therefore the new law creates a new ‘donee’ based system for those specific gifts and inheritance, and imposes an income tax charge on those US citizens who inherit or receive such gifts from expatriates.
So it seems that one is screwed by remaining a US citizen, and similarly screwed in renouncing one’s US citizenship if it is for tax reasons. Interestingly, renunciation of US citizenship could solve the Rabbi Trust problem above, since deferred compensation, if paid out to an expatriate for non-US services (e.g. for the foreign employer companies mentioned above) will not create a US tax charge even though the compensation arose while the individual was a US citizen.
And that, as they say, is quite enough for this edition!
