Issue 74 - 9th July 2007
I am writing this not from the South of France, not from Bali, Monaco or from Scarborough but from my small, humble office at home in Notting Hill. I am listening to my favourite band Talking Heads and the best album in the world: Stop Making Sense (if you haven't got a copy go out and buy one now!). We have just had a very enjoyable dinner with our Scandinavian friends who are leaving the garden square next week with their kids to return “home”. And who can blame them? The weather's rubbish, home security is shot and the tax system, in particular private equity, is under fire. My Norwegian friend is in the private equity / hedge fund industry but he doesn't have a pointed tail and horns sticking out of his head believe it or not!
I was going to write about taper relief and the furore in the press about the 10% tax rate applied to carried interests, but it all seems very futile and insignificant when car bombs are found in London and people find the need to drive burning cars into airports (at the time of writing track 6 is playing - “Burning down the house” – I kid you not). The rumours that taper relief will be raised to 20% will do more harm than good and flight of capital is very likely so please GB – now that you are at the helm – see sense and don't react too hastily.
In times like this I switch off, tune in and listen to “Heaven”, again by Talking Heads, and everything else takes a back-seat. Why don't you see for yourself?
Happy reading!
Tax tip of the day
HM Revenue & Customs have now issued the UK Tax Return for the tax year end 5th April 2007. Why is this of interest? Well, following the Gaines-Cooper case (as reported in ITN 67), whereby HMRC successfully argued that an individual was resident in the UK by including his days of arrival and departure in the calculation of days spent in the UK, HMRC issued a statement to the effect that the case would not change the calculation of the 91-day test for UK residence of individuals. Further, HMRC would not rewrite 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 generally ignored when counting the days spent in the UK.
However, the non-residence pages of the 2006/07 tax return now include a number of additional questions, including whether an individual claiming to be non-resident has had full-time employment abroad, whether the number of days an individual is claiming to have spent in the UK include trips to the UK for exceptional reasons (e.g. medical treatment), and the most poignant question: on how many separate occasions was the individual actually present in the UK. This last point allows HMRC to calculate the number of days an individual is present in the UK including his days of arrival and departure. Coupled with the other questions, HMRC are able to, perhaps more disconcertingly, determine an individual's pattern of visits to the UK.
There are also four new questions relating to an individual's domicile, including:
- Is this the first year you have claimed to have a domicile outside the UK?
- If so, and you have a UK domicile of origin, when did your domicile change?
- If you have never been domiciled in the UK, were you born here?
- If you were born outside the UK, when did you come to live here?
These questions will highlight to HMRC individuals who perhaps have lost their English domicile of origin by acquiring a foreign domicile of choice, but have returned. In such cases HMRC may well seek to argue that the individual's domicile of origin has revived or that a long-term resident but non-domiciled individual has in fact acquired a UK domicile of choice. If you are concerned by the above changes please feel free to contact us.
We have also been running training programmes on the concepts of domicile, residence, ordinary residence and the planning opportunities that exist. Please contact Zoe (zoes@interfis.com) if you would like to find out more.
Italy
Deemed residency of a non-resident holding company
A recent case before the Italian Supreme Court involved an Italian resident individual who inherited the shares of a Swiss holding company, which held shares in an Italian resident company. The Italian tax authorities claimed the Swiss shares were subject to Italian inheritance tax on the basis the Swiss company was deemed resident in Italy due to the fact that the sole activity of the Swiss company was holding Italian situs shares. A lower Italian court found in favour of the tax authorities.
We reported in ITN 64 changes to Italian anti-avoidance provisions, effective 4 July 2006, which provide that, unless evidence is given to the contrary, a non-resident company that holds a controlling participation in an Italian subsidiary is deemed to be tax resident in Italy when (i) it is directly or indirectly controlled by an Italian resident company, or (ii) the majority of its board of directors is composed of Italian residents. As such, the burden of proof that the foreign company is not resident for tax purposes in Italy is shifted to the foreign company. However, the government stressed that, the place of effective management is decisive for determining whether or not the foreign company is resident in Italy for tax purposes.
By applying the anti-avoidance provisions above, it would appear, prima facie, that the Swiss company would be resident in Italy by virtue of the fact that the only director, the individual who inherited the shares, is resident in Italy. However, it is the place of effective management and control that is the decisive factor in determining deemed residence. On the basis that the management and control of the company was carried out in Switzerland, the Swiss company could not be deemed resident in Italy under the anti-avoidance provisions.
The individual in this case appealed, argument was two-fold, that the Swiss company did not have a permanent establishment or branch in Italy and that management and control decisions were not undertaken in Italy.
The Supreme Court overturned the decision of the lower court on the basis that Article 5(6) of the Swiss / Italy DTA states, “the mere fact that a company which is resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State… shall not of itself constitute either company a permanent establishment of the other”.
Thus, where there is a relevant double tax treaty in place, the anti-avoidance provisions are overridden, as such, the mere control of a non-Italian resident company by an Italian resident individual would not be sufficient to prove the existence of a PE in Italy. Further, where the place of effective management and control is outside Italy the anti-avoidance provisions will not deem such a company to be resident in Italy.
Luxembourg
Abolition of the 1929 Holding Company
Luxembourg has repealed its 1929 holding legislation following a decision of the European Commission that the regime violated EC treaty state aid rules. During a transitional period that started on 1 January 2007 and that will end on 31 December 2010, grandfathering rules apply to companies that benefited from the regime as of 20 July 2006, so that benefits of the regime will only be granted to holdings existing at that date. Benefits of the regime will definitely cease by the end of 2010.
By strange coincidence a new vehicle for private wealth investment, the "Société de Gestion de Patrimoine Familial" (SPF), was introduced by the Law of 11 May 2007. SPFs may be used for private wealth management activities only, and any commercial activity is therefore prohibited. Funnily enough the SPF is exempt from corporate income tax, municipal business tax and net worth tax and is also exempt from Luxembourg withholding tax on distributions! Like the 1929 company the SPF will not be able to benefit from the double tax treaties agreed by Luxembourg.
As one door closes, so another one opens.
Switzerland
EU-Swiss cantonal tax regime dispute
On 14 May 2007 the European Commission received authorisation to begin negotiations with Switzerland on the application of State Aid rules under the 1972 Free Trade Agreement between the EU and Switzerland. This is in response to a decision of the EC Commission which ruled that the Swiss cantonal tax regimes, which grant more favourable tax treatment to entities whose income is generated from outside Switzerland, are incompatible with the intended application of the EC-Swiss Free Trade Agreement.
The European Commission consider that such differentiation in the tax treatment of domestic and foreign source income constitutes state aid and consequently will affect trade between the EU and Switzerland. The Swiss Minister of Finance strongly rejects any accusation of violating the EC-Swiss Free Trade Agreement and has refused any negotiations with the EU in the field of taxation. The Swiss Federal Council is, however, more open to discussion based on the importance of keeping good economic and political relations with EU.
Individual income tax rates to be amended in the canton of Obwalden
In 2005 the canton of Obwalden, in order to compete with the other more economically sophisticated cantons, introduced a tax system for individuals whereby “the more you earn the less tax you pay”. As a result of this ingenious tax break Obwalden, not surprisingly, attracted many wealthy individuals increasing its competitiveness. However, following criticism of Obwalden's new tax system, the Swiss Federal Court held that the digressive tax rates for individuals violated article 127 of the Swiss Federal Constitution that an individual must pay tax based on his ability to pay. The Obwalden government has agreed to amend these provisions but will aim to keep tax rates for individuals attractive and competitive.
Many readers will be familiar with the lump-sum taxation rulings which are available in many cantons in Switzerland. Known as “forfait” or “pauschal” agreements they are designed to tax an individual by reference to a pre-agreed lump-sum of income rather than the actual income earned. The difference between the Obwalden ruling and the forfait ruling being that the forfeit ruling allows the agreed lump sum to be taxed on a progressive basis, and that any income not taxable in Switzerland is allocated to another jurisdiction and taxed there. The forfait ruling is constitutional as it effectively subjects all income arising to the individual to progressive tax rates, albeit perhaps in another jurisdiction.
For more information on the benefits of becoming resident in Switzerland or structuring commercial activities there please contact Ilonka (ilonkav@interfis.com) who is our in-house Swiss specialist.
United Kingdom
Private Equity industry under fire
The UK Treasury is examining the amount of tax paid by private equity firms and key individuals within those firms after widespread criticism of the industry.
Bosses of several major private equity firms have defended the industry's right to these tax breaks to a Treasury Select Committee. It is expected that the findings of the select committee will be disclosed in the Pre-Budget Report in November.
In 2003 a Memorandum of Understanding between the British Venture Capital Association and HM Revenue and Customs was reached allowing “carried interest” returns to be treated as capital gains rather than income. In many cases the carried interest element can be very significant and it is argued by opponents of the private equity industry that providing a tax rate of just 10% is unjust and disproportionate. MPs have said the influential Treasury Select Committee could recommend that buy-out chiefs be forced to justify favourable tax treatment on a case-by-case basis.
Our view is that any revision of the tax code will be marginal, and indeed would affect only a very small minority of individuals. Needless to say this one is set to rumble and we have already advised a number of hedge and private equity funds on how they could restructure into jurisdictions outside the UK to pre-empt any future changes. Don't hesitate to contact any of the IFS team if this is of relevance to you.
