Issue 75 - 5th Sept 2007
Sentiment
Welcome back folks!
What a dismal summer we have had - so much for global warming. It's been a howler here in London, and just as we get back to work the weather picks up. Despite it being quiet on the ITN front we have been busy bees' at IFS. In addition to lots of client work we have had the website re-vamped and a new-look ITN designed which is launched with this edition. Much has happened on the tax front too – news in the US of a bill which would outlaw “treaty shopping” (although this seems a bit odd to us since most of the US treaties contain anti-treaty shopping provisions). The Italian Ministry of Finance has also issued a welcome Circular on their interpretation of the taxation of trusts (see below), which clarifies a number of issues that have been vexing some of our clients and HMRC has issued a Statement of Practice on the Investment Manager Exemption.
It has also been very busy in the Dean household. Today marks a new phase with Tommy embarking on his first day at “big” school. When I left him this morning he was ironing clothes and running around the classroom with a Hoover – very domesticated, just like his father. He will be shadowed by the prodigal (Jim), who looks the part in blazer and cap and who seemed very excited to reacquaint himself with his various girlfriends (Esmé being the current squeeze).
And finally, it is with a great deal of sadness that I have to announce that my much-loved PA and good friend, Hema, will be leaving IFS in November to start her own property investment business. Hema has been the most fantastic PA and I am sure that many of you who have met, or most likely spoken to Hema, will miss her nearly as much as I will.
Happy reading!
Tax tip of the day
One aspect of international structures which is easy to overlook is currency risk. Often a structure will be comprised of any number of companies in a variety of jurisdictions, some of which may be able to prepare financial accounts in the samereporting currency, some of which won't have this flexibility. This can create an additional, and sometimes very costly, hit to the bottom line. By way of example,an offshore fund based in the Channel Islandsraises funds from investorsin, say, pounds sterling. The fundsubsequently uses the cash raised to provide a loan in sterling toitssubsidiary in Romania for the acquisition of real estate.Since the Romanian subsidiary has to report inits local currency,any currencyexchange gainwould, in principle, besubject to Romanian tax.From a group perspective, however, no gain has been realised and the local tax constitutes an additional cost to the business (even if the cost would betemporary, for example, when it isoffset in later years against correspondingcurrency losses).To avoid these unwanted tax consequences, certain jurisdictions allow local entities to report in the same functional currency as the one used by the parent company, therefore avoidingcurrency exchange differences on intra-group lending. Where this is not possible it may be worthwhile toenter into acurrency hedging arrangementwith either a bank oranother group company who will assume the currency risks. Any currency gains (and losses) will then no longer berealised by the local company but passed on to the bank or the group company. The other side of the coin isthat the group company taking over the risksmay realise currency exchange differences under the hedging arrangement which in principle would be taxable.However, if the group company is located in a (tax haven) jurisdiction that does not taxthese differences, there would be noadditional tax costs.Naturally, the hedging arrangement between the local company and the group company should be on arm's length terms, and the local company should pay a hedging fee which would be similar to the feecharged between unrelated partiesin similar situations. Usually, itshould not be too difficult to obtainsuch information from the open market.
Germany
Germany takes a firm stance on anti-avoidance
Over the past year Germany has made a number of changes tightening its anti-avoidance provisions. This includes a revision of the anti-treaty shopping rules as discussed in ITN 65 and a reform of the transfer pricing rules, as discussed in ITN 70.
The Draft Annual Tax Bill 2008 is set to amend Germany's anti-abuse rule currently found in s.42 General Tax Act. s.42 of the GTA will be applicable where a legal structure is chosen which leads to a tax advantage for which the taxpayer cannot provide significant non-tax reasons.
A legal structure is considered unusual if it does not comply with a structure that is presumed by the legislator to be in line with generally accepted standards for obtaining certain economic objectives. According to the official explanatory notes of the Draft, the competent tax authorities have to prove the existence of an unusual legal structure leading to a tax advantage. In a second step, to avoid a recharacterization of a transaction, the taxpayer would need to provide evidence of significant non-tax reasons for the chosen structure. Thus, the burden of proof is only partially shifted to the taxpayer.
In addition, and following the UK's lead, a new Draft Bill has been published on the disclosure requirements relating to international tax planning structures. Disclosure of such structures is required where one of the following is obtained:
- a reduction in German tax;
- a deferral of tax;
- ora tax credit.
The Draft Bill is aimed at closing down existing arrangements which are known to the tax authorities, such as double-dips, but will also extend to new structures. The onus of disclosure will fall on the promoter and will require details of the structure, reason for its implementation and a calculation of the tax advantage obtained.
Germany
Discriminatory treatment between domestic and foreign foundations
The European Commission has requested that Germany amend its discriminatory tax treatment of foreign foundations. Currently, the beneficiaries of a domestic foundation are subject to tax on amounts actually received; however, beneficiaries of a foreign foundation are subject to tax as the income arises, regardless of whether the beneficiary receives a distribution or not. This is a similar situation addressed by the Italian Ministry of Finance – see below.
The rules were introduced as an anti-avoidance measure. The Commission held that the rules were disproportionate to their aim and prohibited the free movement of capital under Article 56 of the EC Treaty. The Commission further argued that non-German resident individuals who had established a foreign foundation would be unlikely to take up residency in Germany because of the punitive rules. If Germany does not amend the discriminatory treatment the Commission can refer the case to the ECJ.
Italy
The taxation of trusts in Italy has been an ongoing saga for many years – are they taxed, aren't they? What is a trust? Do we recognise them? What is this Hague Convention (which we have signed)? A flurry of activity was caused earlier this year when Finance Bill 2007 was published (see ITN 69), which introduced provisions subjecting non-resident trusts to Italian corporate income tax. The reason for concern was that the rules appeared to apply to all trusts which had an Italian settlor and a named Italian beneficiary(ies), irrespective of their interest, e.g. fixed, discretionary, etc.
Thankfully, Circular No. 48 has clarified various issues including the following:
- Trusts are to be treated as a “person” and subject to corporate income tax if they are deemed resident in Italy irrespective of whether or not a commercial activity is carried on.
- A trust will be deemed resident in Italy if the trust is established in a jurisdiction which does not have an adequate exchange of information system if:
at least one of the beneficiaries;
and at least one of the settlors
is tax resident in Italy. If the settlor was not resident in Italy at the time the trust was established the new rules will not apply.
- In addition, a trust whose assets comprise Italian immovable property (real estate) is considered resident in Italy.
- The key issue which has been clarified is that the above rules will only apply where the beneficiaries are "identified", in which case trust income is apportioned to the beneficiaries and taxed on an arising basis. Thankfully, common sense has prevailed and this does not apply to discretionary beneficiaries, only to those that have a fixed right to the income.
We are preparing a full analysis of the Circular which we will make available on the IFS website shortly.
United Kingdom
Draft discussion document for taxing foreign profits
In June 2007, the UK Government issued a discussion document setting out a package of proposals for simplifying and modernising the regime for taxing foreign profits. The proposed package has four main components:
- the introduction of a Dutch-style tax exemption in respect of foreign dividends on shareholdings of 10% or more, but only where the new controlled company rules apply to the dividend payer;
- the implementation of a new income-based system for controlled companies which distinguishes mobile passive income from active income and enables the UK to tax artificially located profits that are effectively within the control of the UK parent;
- a restriction on interest relief for international groups and the extension of the existing unallowable purpose rules applicable to loan relationships and derivative contracts; and
- the abolition of the Treasury consent rules.
Although the introduction of a participation exemption and repeal of the archaic Treasury consents are likely to be welcomed by businesses, it will be some time before any of these proposals take effect. At this stage, the Government is predicting Finance Bill 2009 as the most likely date for implementation, assuming that responses to the paper are in favour of legislative change. Don't hold your breath….
United Kingdom / European Union
Boake Allen & Others v HMRC 2007
This is another case where it was argued that the UK law in question (although now abolished) is discriminatory under Article 56 of the EC Treaty. The claim failed because of the restriction in Article 57(1) of the Treaty. The facts of the case are as follows:
In April 1999, Advanced Corporation Tax (ACT), payable on dividends in the UK, was abolished. The amount of ACT paid could be offset against a company's end of year corporate tax liability. Group companies were able to make an election not to pay ACT on dividends paid intra-group, under s.247 ICTA 1988. This case, before the House of Lords, addressed whether groups with non-EU parent companies could claim compensation for the ACT which would have been avoided had they been resident in the EU and were able to make such an election.
The taxpayer argued that s.247 was contrary to the standard non-discrimination article found in a relevant double tax treaty, and that particularly s.247 prohibits the free movement of capital between member states and third countries under Article 56 of the EC Treaty.
The House of Lords found in favour of the UK tax authorities suggesting that the election available under s.247 is a “group election”, and as such a non-EU resident parent company, which is not subject to ACT, is not permitted to make an election not to pay a tax that it is not subject to in the first place. Therefore the non-discrimination article was not breached.
The Court further held, regarding the free movement of capital, that Article 57(1) of the EC Treaty, which permits EU member states to restrict the free movement of capital was applicable.
United Kingdom
Revised Investment Managers Exemption
On 20 July 2007, HMRC issued a revised Statement of Practice 1/01 (SP1/01), substantially updating its guidance on the application of the Investment Managers Exemption (IME). The revised IME is intended to take account of developments in the investment management industry, providing greater flexibility and clarity as well as extending the scope of exempt activities. The revised SP1/01 applies with immediate effect.
Background
Non-UK residents are chargeable to UK tax in respect of income from a trade conducted in the UK through a permanent establishment. The IME legislation limits this charge of UK tax provided a number of tests are met. These tests are:
- the UK investment manager is in the business of providing investment management services;
- the transactions are carried out in the ordinary course of that business;
- the investment manager acts in relation to the transactions in an independent capacity;
- the requirements of the 20% test are met;
- the investment manager receives a remuneration for provision of the services at not less than the rate that is customary for such business;
- the investment manager is not the non-resident's UK representative in relation to any other income or transaction otherwise chargeable to UK tax for the same period.
The changes introduced by the new IME legislation are numerous but the most important ones are:
Investment transactions
Application of the IME legislation is restricted to investment transactions. The new legislation clarifies which transactions are considered investment transactions and which are not. For the purpose of the IME investment transactions include: shares, stock, commercial paper and warrants, future contracts, options contracts or securities, any foreign currency, carbon emission credits etc. Transactions in relation to contracts relating to land and contracts of insurance are explicitly not considered investment transactions. Furthermore, transactions in physical commodities are not investment transactions for the purpose of the exemption.
The revised guidelines also address the question of proportionality. In the past one single non-permitted trading transaction would lead to the IME failing altogether, whereas under the new SP such a breach will not lead to failure provided any profits from the offending transaction are taxed in the UK.
Customary remuneration
Based on the revised SP1/01 HMRC will be guided by the OECD transfer pricing guidelines for interpreting “customary remuneration”. All circumstances will be taken into account, including whether the remuneration for the UK investment manager has been reduced below arm's length in any way either before or after payment to the UK investment manager. HMRC has published guidance on what documentation and evidence is required to demonstrate an arm's length rate.
In our view the revised SP1/01 is a positive development which will reduce uncertainty in the fast developing UK fund industry.
