Issue 71 - 10 Apr 2007
Sentiment
I am pleased to report that I am back from MIPIM in once piece, having spent a very enjoyable weekend in Eze recuperating! I am now in Scarborough for the Easter break and am officially a Southerner, see last ITN. Any claims to being a hardy northerner can no longer be substantiated – a walk along the North Bay, past the now demolished institution that was the Corner Caff, has confirmed that I belong in the South. It was barely 8 degrees yesterday but the sun was shining which meant summer has begun and short sleeves (and skirts!!!) are the order of the day. Quite an impressive display was to be had, especially the older guard, who sport all manner of wretched, faded and saggy tattoos, chubby fingers emblazoned with sovereign rings - aahh! The green, green grass of home as Elvis once put it! Major news on the family front: James can now ride a two wheel bicycle. Much to my amazement (and credit, I hasten to add) I didn’t throttle him despite the pleas for four wheels instead of two. Then, as if by magic, he was off and happy as Larry on two wheels. A tear nearly made it to the corner of my eye.
Much to report in this issue, from the UK remittance basis of taxation to offshore funds, to management and control. We also have an interesting tax tip which I am sure will kickstart the braincells after Easter.Happy reading!
Tax tip of the day
UK non-domiciled individuals believe that their foreign source consultancy income is exempt from UK tax unless it is remitted to the UK. This is true, but only to a certain extent. If some of the duties of an overseas consultancy are performed in the UK, unless they really are “incidental” to the business activities as a whole, they will have the effect of turning non-UK source income into a taxable UK source. Let’s take Heinz as an example: he is a non-domiciled resident of the UK, providing consultancy services to French and Spanish companies at a combined fee income of €500,000. He works at the offices of both companies when abroad, but when in London he works from his home in sunny South Kensington. HMRC won't believe that Heinz doesn't respond to emails from the French and Spanish companies whilst in the UK, nor undertake strategic studies for them in the UK. Therefore, although all the board meetings which he attends are carried out abroad, HMRC will consider his entire income of €500,000 as UK source subject to UK tax.
The analysis would be different were Heinz employed by our Swiss management company, Opus International Management AG. Opus would pay a salary to Heinz of, say, €50,000 for his worldwide duties, on which he pays UK tax and social security. The remaining income received by Opus from its contracts with the French and Spanish companies could be contributed to an overseas deferred compensation arrangement, such as a Trust, without UK tax consequences (or any other foreign tax liabilities). Please feel free to contact Roy if you have any queries with regard to the above example or would like to discuss a potential case.
European Union / Hungary
Investigation into taxation of intra-group interest
The European Commission has launched an investigation into the taxation of intra-group interest, which appears to give a discriminatory advantage to non-Hungarian companies, contrary to EC state aid rules. The rules apply to associated group companies and, as such, an associated group company resident in Hungary paying the interest, may only deduct 50% of the amount paid. However, the discrimination arises where an associated group company which is non-Hungarian resident is paying the interest; the non-resident company is not subject to the Hungarian rules and can deduct 100% of the interest paid.
European Union / Ireland & UK
Remittance basis of taxation
In the tax tip we mentioned the UK remittance basis of taxation. Another exception to the general rule is where the UK resident individual has income arising in Southern Ireland (and vice versa). In this case the remittance basis does not apply, that is to say if Heinz were an Irish domiciled individual living in the UK with Irish source income, that income would be taxed on an arising basis. On 30 March 2007, the European Commission announced that it had sent both the UK and Ireland formal requests to terminate this discriminatory taxation of the others foreign source income. The Commission is of the view that this treatment dissuades non-domiciled and nonordinarily residents living in the UK and Ireland from investing their money in the respective countries, and that the exclusion of this income from the remittance basis is essentially a restriction of the free movement of capital (Art. 56 of the EC Treaty). It is likely this case will be referred to the ECJ and we will keep you appraised of all new developments.
Luxembourg
A new specialised investment fund (SIF) regime, effective 13 th February 2007, replaces the Law of 1991 on undertakings for collective investments (UCIs). SIFs are subject to Luxembourg law and require a minimum share capital of €1.25m, which must be paid up within 12 months (previously 6 months under the UCI regime). Investments must be diversified to spread the risk. SIFs appear to enjoy more flexibility compared to other regulated Luxembourg funds in that they can invest in any class of asset, and as such may be used for hedge funds, private equity funds and real estate funds and the scope of eligible investors is wider.
Eligible investors under the new regime include:
- Professional investors, i.e. banks, investment companies, management companies of UCITs; and
- Any other investor who invests at least €125,000 or invests less than €125,000 but a credit institution or a professional of the financial sector certifies that the investor is aware of the risks involved.
Netherlands / Hong Kong
The Lower Court of Arnhem in Case AWB06/290 had to determine whether a company incorporated in Hong Kong was actually resident in the Netherlands for tax purposes. The facts are as follows: two individuals resident in the Netherlands owned equally shares of a company (X Ltd) incorporated in Hong Kong. X Ltd also owned an office in Hong Kong with 5 employees, two of whom expanded X Ltd into China, with a representative office. One of the Dutch resident shareholders (E) was also a director of X Ltd.
The issue before the Court was whether, due to functions undertaken by E in respect of the management of X Ltd, it was in fact resident in the Netherlands. Based on Article 4 of the General Tax Act, the place of establishment of a company is determined on the facts and circumstances of the case. The Lower Court referred to a Supreme Court decision which held that this is determined with reference to the place of effective management. According to the Supreme Court the place of effective management is generally where the board exercises its management tasks; however, if a person other than a member of the board exercises effective management the place of management could be where this other person is located.
The Lower Court considered that in this case the place of management was where the core activities of X Ltd were carried out, i.e. in China by X Ltd’s employees. The Court held that E had limited involvement with the activities in China, and although he addressed the activities of the China office from the Netherlands and that he visited China only twice a year, this was not sufficient to make the place of establishment the Netherlands. The case seems to suggest that where the management board does not have a material role in business decisions, the place of effective management is where the core or main activities of the company are carried on.
An analogy can be made with other countries. Under UK law the place of effective management is regarded to be where the management board (i.e. board of directors) carries on its activities, as was the case in Wood v Holden (See ITN 63 for the case details). It is arguable that, based on the UK interpretation of effective management and control, anyone other than the management board, (such as an employee) can not, by definition, exercise the requisite control, unless such powers have been delegated to that employee by the board of directors.
In such circumstances, a relevant double tax treaty would be helpful in clarifying which country has the applicable taxing rights. Article 4 of the OECD Model convention provides that where a person (other than an individual) is a resident of both contracting States, then it shall be deemed to be resident only of the State in which its effective management is situated, and considers this to ordinarily be the place in which the most senior person or group of persons (e.g. board of directors) makes it decisions; the place where the actions of the entity as a whole are determined. Italy on the other hand does not consider that the most senior person or group of persons is the decisive factor in identifying the place of effective management of an entity. Italy regards the place where the main and substantial activity of the entity is carried on as also to be taken into account when determining the place of effective management.
In certain situations the Dutch lower court appears to take a similar approach to the Italians. In the Dutch case it was decided that the place of effective management was where the core activities were carried out, rather than where the members of the board resided or conducted there formal duties. In the Dutch case, it seems that where the board is only sideways or merely in a formal capacity involved in business activities and decisions, the place of residence of the company may be determined by where the day-to-day management is carried out.
This highlights that what constitutes ‘effective management’ varies from jurisdiction to jurisdiction. Within international structures it is important to ensure that the boards of the various companies are actively involved in the business decisions and therefore actually carry out effective management and control.
Turkey
New anti-avoidance provisions for individuals introduced
New anti-avoidance provisions have been introduced with effect from 1 January 2007, regarding transfer pricing, controlled foreign companies (CFCs) and payments made to low-tax jurisdictions, on which a withholding tax of 30% will be levied.
The new transfer pricing rules provide that transactions between individuals and related persons must be made on arms length terms, i.e. the price at which a transaction would be made by unrelated persons. Where a transaction is conducted with a resident of a low-tax jurisdiction, it will always be deemed to be treated as if it was conducted with a related party. Advance pricing agreements may be made with the Ministry of Finance providing clarity.
Profits derived from CFCs established in low-tax jurisdictions by Turkey resident shareholders will be subject to Turkish income tax. Even where the profits are not distributed they may be treated as dividends, and taxed as such, where the following conditions are satisfied:
- At least 25% of the CFC’s income is passive; and
- If the taxes levied on CFC profits are similar to corporation or individual income tax; and
- The tax burden on CFC balance sheet profits is less than 10%; and
- The CFC’s total turnover in the relevant taxable period is more than YTL 100,000 (or foreign exchange equivalent).
United Kingdom
Budget 2007
Employee benefit trusts
The existing rules prevent a UK company from obtaining a corporation tax deduction for contributions to an EBT until the Trustees of the EBT provide “qualifying benefits” to the beneficiaries, or incur “qualifying expenses”. Employee benefit contributions include a payment of money, or the transfer of an asset, by the employer to the trustees of an EBT. For a benefit to be a “qualifying benefit”, a payment of money, or transfer of assets (other than by way of loan), must take place, and that transfer must give rise to both a charge to tax on employment income and a charge to National Insurance Contributions (NICs).
Schemes have been developed which attempt to by-pass these rules. Finance Bill 2007 puts ‘beyond doubt’ that such schemes, whereby, for example, rather than making a payment to an intermediary such as an EBT, employers declare trusts over assets they already control, and subsequently make a tax deduction to the value of that declaration, is within the scope of existing rules. Cunning, but no longer a runner.
Film tax
The Finance Act 2006 provides for how companies making films for cinema and other (e.g. television) should be taxed. Currently, each film is treated as a separate trade with its own income and expenditure, with film tax relief available (as reported in ITN 70) only to qualifying British films. Once the Finance Bill 2007 receives Royal Assent, film production companies will be able to irreversibly elect to be taxed under general tax rules.
Overseas properties
One very welcome announcement was that individuals who purchase properties overseas through a company will now not be subject to UK benefit in kind rules provided the property is owned by a company owned by individuals, and the company’s only activities are ones necessary to owning the property. The property must be the company’s only or main asset, and the property must not be funded directly or indirectly by a connected company. The new rules will apply regardless of how long the property has been owned. This is good news for directors (and in many cases, “shadow directors”) of foreign real estate holding companies, since they were regarded as having received a benefit in kind for the free use of holiday homes and were taxed on this benefit accordingly – this treatment came about as a result of the cases R v Dimsey and R v Allen [2002] AC 509.
Changes to offshore funds
The UK's offshore fund regime is quite complex and, as I have previously explained in lectures on this topic, an offshore fund is not always an offshore fund for UK tax purposes. If an offshore fund qualifies for treatment under the regime, UK investors are subject to income tax on gains realised from a disposal of their investment unless the offshore fund distributes a certain minimum per annum, inter alia. If the fund qualifies as a so-called "distributor fund", UK investors will be subject to capital gains tax on any disposal rather than the income treatment explained above. The aim of the legislation is to prevent UK investors from rolling up income offshore and converting it into a capital gain on disposal, and it achieves this by either taxing the gain as income or forcing the fund to distribute the bulk (85%) of its income in order to qualify as a distributor fund.
A fund seeking “distributor status” is subject to various other conditions, one of which being that it may only invest in another offshore fund where that other fund is also a distributor fund. However, that second tier fund may not invest in another offshore fund even if that third fund is also a distributor fund. This two tier limit is essentially a restriction for fund of funds seeking to attract UK investors. The Budget has changed this, such that there is effectively no limit to the number of tiers provided that each tier is or could be a distributing fund.
One final noteworthy change relates to the definition of an “offshore fund”. The regime, as you may have gathered by now, applies where a UK investor disposes of an interest which is “material” in an offshore fund which does not have distributor status. By material it is meant that the investor can reasonably expect to realise the investment within a reasonable period, defined as being within 7 years. However, an offshore fund will only fall within the offshore fund regime if it is an open-ended investment company (OEIC) as defined by the FSA. This definition also includes a condition that an investor is able to realise the investment within a reasonable time, but this is generally taken by the FSA to mean within 6 months. The change introduced by the Budget appears to be an attempt to streamline the definitions such that the period is 7 years for both purposes.
Rates
From 2008/9 the basic rate of income tax will be reduced from 22% to 20%. However, the 10% starting band will not be available for non-savings income.
The main rate of corporation tax is to reduce to 28% from April 2008 and the small companies’ rate will be increased to 21% from April 2008 and will increase further to 22% from April 2009.
