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The future of Luxembourg, Switzerland, Cyprus, Malta, the Crown dependencies of Jersey, Guernsey and the Isle of Man and similar economies relies heavily on their financial services industries, one of the major reasons why these economies have grown significantly over the past few decades. If we examine the structures that have been created and that have funded such economic growth, we can reflect on the number of holding companies established in Luxembourg since the country first introduced the concept of holding companies to avoid double taxation in their law of 31 July 1929 — almost a century ago. As the world woke up to how the new entities were being used, countries universally decided to exclude them from double tax treaties entered into with Luxembourg. Principally this was because the structures created with holding companies were not designed to avoid double taxation, but to mitigate the effects of even a single level of taxation.

The SOPARFI regime was then introduced in Luxembourg to replace the so-called “pure” Luxembourg holding companies; these being companies subject to full Luxembourg taxation but enjoying the benefits of a relaxed participation exemption regime. This regime in fact was also designed to mitigate foreign taxation without the corresponding level of Luxembourg taxation being paid. The OECD in its BEPS initiative has now decided to attack such holding companies, as well as finance and licensing companies on the basis that they should again be denied treaty access, unless their shareholders effectively would have been entitled to obtain the same treaty benefits on a direct relationship with the payer entity.

In order to provide certainty of the absence of Luxembourg taxation (or a minimum level of taxation for financing and licensing companies), the Luxembourg authorities have been requested by professional advisers to global companies to grant tax rulings confirming the level of taxable income that would be acceptable to them. In the absence of bona fide commercial justifications, many of these tax rulings, not previously made public, have now been declared by the European Commission to create State Aid for the international companies of which the Luxembourg entities are a part.

Countries such as Jersey, Guernsey and the Isle of Man have been used for decades for real estate investments into the UK, benefiting from the existing treaties these countries have with the UK, thereby avoiding the concept of creating a ”permanent establishment” (a taxable presence) in the UK. It is no exaggeration to state that nearly all of these companies were effectively managed by persons other than those directors (locally resident) who were appointed to the boards of these companies. It is quite surprising to me that over the past 20-30 years, HMRC has not attacked these companies on the basis that they are managed and controlled in the UK or, if the beneficial owner is elsewhere, that such attacks have not been made by the tax jurisdictions where these beneficial owners are resident. It is now likely that these countries will follow suit behind the UK with the creation of publicly available registers disclosing beneficial ownership of these companies, despite the claim that this infringes security and potentially endangers the relevant beneficial owners. If such publicly available registers are legally required, the scope for residence attack by tax authorities on the grounds of management and control is likely to be significantly increased.

Countries such as Cyprus and Malta have lowered their effective corporate tax rates in order to encourage trading companies to become resident in their countries. Thus until the recent post-crisis increase of the tax rate to 12.5%, Cyprus taxed corporate income at 10% for many years. Again, as with Luxembourg, Cyprus initially created so-called Cyprus incorporated offshore companies. These were not subject to Cyprus taxation at all, but again, when Cyprus’ treaty partners started denying treaty access to these companies, the Cyprus government accepted that such offshore companies would be abolished. Instead all Cyprus companies would be taxed at a corporate tax rate of 10% — an acceptable rate to the business community. As for Luxembourg and many other jurisdictions (including the UK), Cyprus has a favourable holding company regime which may still exempt such companies from Cyprus taxation on receipt of foreign income, and the Cypriot authorities have hitherto been prepared to grant tax rulings which provide certainty and beneficial profit margins in respect of finance and licensing income. With the latest OECD initiative on treaty access, these companies may not be able to obtain treaty benefits as hitherto.

In Malta, recognising that foreign jurisdictions would require a significant corporate tax rate to enable Maltese companies to benefit from double tax treaty arrangements, Malta introduced a 35% corporate tax rate, but with a catch. On distribution of profits to the shareholders of Malta companies, either 5/7ths or 6/7ths of the tax paid would be refunded, resulting in an effective corporate tax rate of either 10% or 5% in respect of distributed profits. It has surprised me that treaty partners have accepted this system without question, but again treaty access limitation rules will affect these companies as well.

So what are the treaty access limitation rules being proposed by the OECD? It is intended that countries should include anti-abuse rules in their double tax treaties, as well as implementing domestic anti-avoidance legislation to counter perceived ‘treaty shopping’. While the latter remains mostly in the domain of national legislation, albeit heavily influenced by OECD’s recommendations, the former is expected to reflect a “three-pronged” approach:

- Treaties should include in their title and preamble that broadly their purpose is to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance;

- Treaties should have a specific limitation on benefits rule, which is reminiscent of the rules existing in the US Model treaties; and

- Treaties should have an additional more general anti-abuse rule that looks at the principal purposes of transactions or arrangements.

In future, it is intended that double tax treaty benefits would only be available to defined ‘qualified residents’ of the relevant country. Such qualified residents would include inter alia individuals, quoted public companies, companies engaged in active business, and, potentially, collective investment vehicles. The proposals are very complex and I do not propose to elaborate further on these basic exclusions from the proposed limitation on benefits (LoB) article.

So what, then, is the future for these jurisdictions? Under the treaty access limitation rules, one of the exemptions is for active trading companies. Such companies need to have the relevant level of substance required to demonstrate that the companies are effectively managed in the location they claim to be resident in. Thus although there may be no requirement for local directors, it would help not only to have local directors but also a local manager and relevant key personnel with appropriate skills sets for the operations being carried out by the trading company. All of the countries mentioned in this article have the appropriate infrastructure to attract international operations and can create incentives to local companies offering services to global corporations for such trading activities.

Another exception to the treaty access prohibition may be companies which are registered to carry out investment activities. Collective Investment Vehicles such as private equity funds may fall within this exception, and may be attracted to those jurisdictions who have developed an awareness to offer incentives both to the funds themselves (such as the SIF legislation in Luxembourg) and equally as important, to their fund managers. This is particularly relevant in the current era of limitation of bank lending, where private equity funds may be the only alternative to raising finance from conventional banks. As mentioned in the introduction, the discussion groups that IBSA is holding in Luxembourg, Malta and the UK will examine the type of incentives that may be offered to investors wishing to pool their investments through a tax neutral entity.

I have shown in previous newsletters how the international business structuring world has changed so dramatically even in the past twelve months. I am proud that the association I have created, the International Business Structuring Association or the IBSA, is growing rapidly and is featuring these changes in its discussion groups being held around the world. For IFS Newsletter readers who have the acceptable qualifications but who haven’t yet joined the IBSA, we need to further develop the multi-disciplinary and multi-jurisdictional approach which makes the discussion groups such a vital part of our knowledge bank. The IBSA website at (click here) has a tremendous amount of information within the Knowledge Bank and also explains the benefits of membership.

Roy Saunders

Roy Saunders qualified as a chartered accountant in 1967 and created his own niche international tax practice in 1971. He wrote his first book “Tax Planning for Businesses in Europe” in 1976 which was published by Butterworths and his second book “Principles of Tax Planning” which was published by Bureau of National Affairs in Washington in 1978. His best known work has been “International Tax Systems and Planning Techniques” which was published by what is now Thomson Group/Sweet and Maxwell in 1983 as a loose-leaf work, and is still the only major international tax reference work which was written by one person covering the tax legislation of more than 20 countries at that time. Since then, it has been updated in 60 releases as a loose-leaf edition until its first bound work was published in 2010 and is now published on an annual basis. The number of countries now covered within the book is more than 30 and includes chapters on personal and corporate tax legislation of the United States, the United Kingdom, Spain, Italy and Russia as may affect the potential client (there may also of course be other jurisdictions in which the client has an interest which are covered by the book). Other books written by Roy Saunders include “Cyprus in International Planning” for Longman Group, “Structuring International Real Estate Transactions” for Sweet and Maxwell and “Principles of International Tax Planning” published by his own company IFS in 2005 as an update to the 1978 version.

Roy has lectured around the world on international tax issues for many organisations including his own institute, the Institute of Chartered Accountants in England and Wales, the International Tax Planning Association of which he is on the Executive Committee, the Economist Intelligence Unit, many commercial conference organisations such as IBC, and for his own company IFS. He runs an annual conference in London as an IFS sponsored conference at which the contributors to “International Tax Systems and Planning Techniques” are invited as speakers on specific topics, this year’s topic being personal and corporate migration. Roy is currently teaching an MA Course on International Taxation at the Institute of Advanced Legal Studies at the University of London.

Roy practices as an international tax consultant with his own company International Fiscal Services (IFS). He specialises in personal and corporate international tax issues for entrepreneurial clients and covers inter alia income tax, capital gains tax and inheritance tax issues. As his boutique practice grew, he established offices in London, Amsterdam, New York, Madrid, Jersey, Cyprus and Curacao which provided international tax advice in the relevant jurisdictions through a team of specialist tax accountants and lawyers. Now in his mid sixties, Roy has divested himself of these offices and operates his consultancy practice from a small base in St John’s Wood, London.

The client base of IFS has been very diverse over the years. In the past ten years say, the following clients have been advised by IFS:

  • A leading Russian gas and other energy conglomerate as regards their international structure from the ownership point of view as well as subsidiary enterprises, acquisitions and sales, IPO arrangements etc.
  • Switzerland’s largest bank in establishing an $8 billion Global Real Estate Fund with investments in the US, Japan, Western Europe and specifically the UK.
  • A leading UK law firm in a negligence claim against an international tax advisory firm where Roy acted as expert witness on a failed IPO in which the tax legislation of several countries were relevant factors.
  • A significantly wealthy family whose interests range from Spain, UK, US and central Europe to review problematic tax issues relating to succession planning and personal residence of relevant family members in respect of assets in various jurisdictions.
  • Advising a wealthy Italian family with a manufacturing business on their trust arrangements for succession planning.

On a personal note, Roy has been married to his wife Sonia for 44 years, has four children and (currently) four grand-children. He is a keen golfer and his hobbies include music, painting, writing and the theatre.

Website: www.interfis.com

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