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Financial expert Binne Vries from International Fiscal Services Ltd gives his personal opinion on the latest tax schemes:
Tax Tip
United Kingdom - real estate developments
The Chancellor of the Exchequer Alistair Darling recently announced a u-turn on the 10p tax rate, and since then we’ve been following with interest what other rabbits may appear from his hat. Meanwhile, the so-called “IOM partnership scheme” has been closed down by the Budget 2008 (see BN66 “Double Taxation Treaty Abuse” for specific details) with retroactive effect to 1987. UK tax is avoided by the establishment of two interest in possession trusts which together form an Isle of Man partnership. The scheme is designed so as to ensure that the income realised by the partnership continues to belong to the UK resident, as beneficiary of the foreign trust.
This structure was commonly used for undertaking UK real estate development projects. We have always been quite blunt when clients have asked us about this structure; it doesn’t work! A scheme devised so that a UK resident individual who has UK property development activities is able to make a profit subject to no tax and bring it all back into the UK for his enjoyment will never find favour with HMRC – unsurprisingly. If you have been affected by these anti-avoidance measures and would like a reality check of what can still be done to minimise tax on property developments please contact us.
United Kingdom
Multinationals flee the UK
Last year the Government issued a discussion document on the taxation of companies’ foreign profits with the stated aim of modernizing and creating a more straightforward regime for taxing foreign profits. The main components of the proposals include:
- The introduction of a Dutch-style tax exemption method for 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.
- The abolition of the Treasury consent rules.
Although the proposals were initially applauded by multinationals, particularly as a means to repatriate their foreign profits tax free, companies have become increasingly concerned about the ‘small-print’ in the form of anti-avoidance measures. It now seems that the UK’s competitiveness compared with other European countries has been severely damaged. Furthermore, the new Controlled Companies Rules seem to narrow significantly the scope of the ECJ decision in the Cadbury Schweppes case which limited the UK CFC legislation to ‘wholly artificial arrangements’.
A few weeks ago, Shire, the pharmaceutical group, relocated from the UK to Ireland, the aim being to “help protect the group’s taxation position” and it is believed that the main reason behind this decision is uncertainty over the proposed changes to the UK corporate tax system. Not only will Shire be able to benefit from Ireland’s 12.5% tax rate (compared with the UK’s 28% rate), but Ireland does not have the extensive anti-avoidance legislation that the UK has, for instance no thin cap or transfer pricing rules.
It has also recently been announced that the UK publishing and events firm, United Business Media, also aims to relocate to Ireland by the end of the summer. The reason given by them is: to “manage the interaction between the UK tax system and the tax systems of the multiple countries (in which it operates)”. These cases follow other relocations out of the UK in recent years by companies including Ebay, Kraft, Omega and Google. The Treasury is due to produce another consultation document on the issue soon – whether it will be soon enough is another matter.
EU / Netherlands
ECJ Opinion on real estate IHT transfer tax
The Dutch Supreme Court asked for a preliminary ruling from the ECJ in respect of case Arens-Sikken v. Staatssecretaris van Financien (C-43/07). AG Mazak gave his opinion regarding the rules on Dutch inheritance tax, affecting residents and non-residents.
In the Netherlands residents and non-residents are taxed differently on inheritances received. A resident testator’s assets are subject to inheritance tax. For non-residents, inheritance tax is levied only on certain Dutch source assets such as immovable property. For residents, when calculating the Dutch IHT due on immovable property, any debts relating to the property are subtracted from the value of the property, before levying IHT. In addition if the inheritor has other debts to settle out of the funds of the property (over-endowment debts) as instructed by the testator, these will also be subtracted from the value of the property.
However, non-residents are not entitled to subtract over-endowment debts from the value of the property when calculating the amount chargeable to IHT. The facts of the case before the AG involved an Italian resident testator who owned a Dutch property. In his testament the property was left to his wife on the condition that she later paid each of the children the cash equivalent of their share of the estate, i.e. her over-endowment debts. The Dutch authorities would not allow the wife to deduct these debts from the value of the property when calculating the Dutch IHT liability. The AG made the following comments:
- Cross border inheritance is a ‘movement of capital’ within the meaning of Art 56 of the EC Treaty.
- The case was not purely domestic as the immovable property situated in the Netherlands was inherited from a person who was a resident on another Member State.
- Immovable property situated in the Netherlands and inherited from a non-resident person is treated less favourably than a resident person.
- The AG opined that the Dutch legislation constitutes a restriction on the free movement of capital.
Luxembourg
Tax efficient investment vehicle: improvement to the SICAR
The Luxembourg SICAR is a regulated investment vehicle used for investments in risk capital. It is a private equity and venture capital vehicle that can take a number of different forms. Most notable is the corporate form which, as a general rule, is subject to Luxembourg corporate and municipal tax and (in the view of the Luxembourg authorities) in principle can rely on EU Directives and benefit from Luxembourg’s tax treaty network. Some EU member states (France, The Netherlands) have disputed that the SICAR can benefit from double tax treaties.
Luxembourg, in a bid to improve the legislative framework of its financial sector, has proposed new measures regarding the SICAR. The proposals may be summarised as follows:
- Creating sub-funds or multiple compartments within a SICAR, i.e. an umbrella fund.
- Ability to segregate assets and liabilities.
- Securities may have different par value within each sub-fund.
- Investor liabilities will be limited to each sub-fund.
- Each sub-fund can be liquidated separately.
These changes coupled with other administrative modifications make the SICAR regime more flexible and make Luxembourg an even more favourable jurisdiction for establishing such funds. As a re-cap, the tax advantages of the SICAR are as follows.
- Normal Luxembourg 1% capital duty is capped at €1,250.
- Income resulting from the sale of securities and from the sale, contribution or liquidation of these
assets does not constitute taxable income.
- There is no withholding tax on dividends or liquidation proceeds distributed by a SICAR to its shareholders.
- The return on short-term cash deposits held pending their investment into qualifying targets does not constitute taxable income within a maximum period of 12 months preceding their investment in risk capital.
Australia
Dividend income and capital gains from Dutch Co-operatives
The ATO recently issued a private binding ruling on the treatment of Dutch co-ops for Australian corporate tax purposes. It decided that dividends paid by a Dutch co-op and any capital gains arising on a disposal of a co-op, can be exempted under Australia’s participation exemption provided the usual conditions are satisfied. This ruling is not binding on other taxpayers, but provides a good indication of Australia’s views on this issue. Since there is no Dutch withholding tax on dividends paid by the Dutch co-op and the co-op itself is entitled to the Dutch participation exemption and the EC Parent-Subsidiary Directive on profits distributed to it (provided the conditions of each are satisfied), the use of a Dutch co-op as a top intermediate holding company between an Australian parent and its European subsidiaries can allow for a tax-efficient repatriation of EU group earnings to Australia.
Dutch co-ops are being widely used to extract dividends from the Netherlands, and by extension from the EU, without withholding tax. The big question is whether the Dutch authorities will limit such use of the co-op in the future. Co-ops were hardly introduced to facilitate tax efficient repatriation of profits within a multinational context - they were, as the name would suggest, intended for use by farming collectives, but what the heck! We would usually advise that a Dutch tax ruling is obtained, confirming the benefits from an international tax structuring point of view, when using a co-op. However, it is our understanding that the Dutch authorities are no longer issuing such rulings pending an internal review of the situation.
OECD
Distributions by Real Estate Investment Trusts: Draft 2008 Update to the Model Tax Convention
Many countries provide beneficial tax regimes for Real Estate Investment Trusts ("REIT's") to increase liquidity and access for small investors to the property market. The tax benefits vary per country but in general they include reduced rates compared to the normal corporate income tax burden, or even provide for an overall exemption of income generated by the REIT. Thus, the basic concept of a REIT is to exempt income at the entity level but for investors to be taxed on distributions, either via the domestic withholding tax on dividends or through (income) tax at the level of the shareholder. Since the main purpose of REIT regimes is to enable local small investors to participate in the property market, the conditions to be satisfied under the REIT regimes usually make it unattractive for foreign investors. However, the elements that make it unattractive for foreign corporate investors under domestic law could, in principle, be blunted by EU Directives and double tax treaties.
Naturally, some countries hold the view that the relevant EU Directives and tax treaties do not apply and as a result subject distributions to foreign (corporate) investors to full domestic withholding tax. Where tax treaties do apply, a REIT may benefit from reduced withholding tax rates (sometimes 0%) on dividend distributions to shareholders.
Since the tax treatment of REITs differs from one country to another the OECD has proposed new provisions in the Model Tax Convention to allow countries to levy higher withholding tax rates on distributions made by REITs. This is an important first step in the harmonisation of the tax treatment of REITs, since if the proposals are accepted by the members of the OECD, then over time these changes may filter through in the bi-lateral tax treaties concluded between individual states.
The good news is that the taxation of REITs and distributions thereof would be clarified, thus avoiding confusion and uncertainty. However, the downside is that it is very likely that distributions by REITs under the proposed changes would result in higher rates of withholding tax. No doubt it will take a long time before such changes will be implemented, and in the meantime there may still be some advantages to be obtained under existing tax treaties for cross border REIT structures.
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