Category Archives: Tax

Austrian goodwill amortization: AG Kokott issues her opinion on a landmark case for the relation between state aid and treaty freedoms

Articles, Latest News, Tax, ,

On 16 April 2015, Advocate General Kokott („AG“) advised the CJEU to rule that the exclusion of foreign EU group members of an Austrian tax group from the goodwill amortization scheme is not in line with the freedom of establishment. The AG, furthermore, argued that the scheme does not constitute illegal State aid due to the lack of selectivity.

Treaty Freedoms vs. State Aid Rules

The case Finanzamt Linz vs. Bundesfinanzgericht, Außenstelle Linz (C-66/14) is expected to result in a landmark decision of the CJEU. The importance of the case is that it deals with an Austrian tax regulation which may simultaneously infringe the freedoms of the treaty (freedom of establishment) and the state aid rules of the EU.

The mentioned combination of conflicts brings up fundamental questions, i.e. the interaction between treaty freedoms and state aid rules. The issues gives rise to a potential conundrum because in the context of alleged “aid” in relation to domestic transactions, the respective remedies for unlawful state aid and the breach of freedoms are, in effect, opposites. Unlawful state aid has to be repaid which – in the given situation – results in a non-application of the goodwill amortization scheme. However, the scope of a discriminatory rule has to be extended which would require the amortization scheme to be applied to all investments (domestic and foreign targets). The solution for this conflict cannot be derived from the already existing case law of the CJEU. Tax experts were therefore looking forward to the opinion of AG Kokott which is laid down in the following.

Facts and Circumstances

Group taxation system

The Austrian Corporate Income Tax Act (KStG) offers legally independent companies belonging to a group of companies the opportunity to form a tax group, with the result that the income of all tax group members is taxed in an added up way at the level of the group parent. This has the effect that the income of all group members is taxed in the hands of the parent company of the tax group. The main requirement for two or more companies to establish a tax group is that the group parent company holds an investment in the subsidiaries of more than 50%. Also foreign companies can take part in the tax group, if they are directly owned by a domestic group member. Therefore only first-tier foreign subsidiaries may become members of a tax group. The tax group scheme provides for the attribution of 100% of profits/losses of a domestic group member to the group parent even though the actual participation might be lower. In the case of foreign group members only losses are attributable to the parent company according to the percentage of the participation. There is a recapture of taxes when the foreign losses are set off against profits abroad in subsequent years or if the foreign group member ceases to be a group member.

Goodwill amortization

Fore share acquisitions prior to March 2014, tax groups could amortize the goodwill resulting from the purchase of Austrian group members with an active business.[1] Following this scheme the goodwill inherent in the acquisition cost was amortized on a straight-line basis over a period of 15 years. In order to avoid constitutional concerns goodwill that resulted from acquisitions prior to March 2014 and which has not fully been amortized upon March 2014, can be further amortized if the possibility of the goodwill amortization had an impact on the purchase price of the participation. As the goodwill amortization was limited to domestic participations, foreign EU group members were excluded from the scheme.

Litigation procedure

An Austrian taxpayer (a tax group which acquired a non-privileged Slovak subsidiary) concerned by the goodwill amortization started a litigation process, because under its opinion it infringed the freedom of establishment. The court of first instance (=Federal Tax Court Linz) in its decision on 16 April 2013 followed the taxpayer’s argumentation, classified the Austrian goodwill amortization as being not in line with the freedom of establishment and extended the goodwill amortization also to foreign group members.[2] After the Austrian tax office involved has appealed against this decision, the Austrian Administrative High Court (VwGH) referred two questions with regard to the goodwill amortization scheme for preliminary ruling to the CJEU.[3] The Court raised the question whether (a) the scheme constitutes illegal State aid for the beneficiaries of the scheme as defined under Article 107 TFEU and (b) the exclusion of foreign EU group members from the scheme was in line with the freedom of establishment.

Opinion of the AG

Freedom of establishment

According to AG Kokott the exclusion of foreign EU group members from the amortization scheme restricts the freedom of establishment. Since the AG found the domestic and the cross-border scenario comparable, she examined whether there was any justification for limiting the amortization scheme to just domestic targets. The representatives of the Austrian Government argued that the exclusion of foreign participations is required in order to maintain the coherence of the Austrian tax system. They based the coherence argument on the fact that under Austrian corporate income tax law capital gains from domestic participations are taxable and therefore the goodwill amortization provides a temporary liquidity advantage only, while capital gains from foreign participations are, in most cases, tax exempt with the requested goodwill amortization resulting in a permanent tax advantage which was not the intention of the Austrian lawmaker. The AG rejected this justification on the grounds of the coherence of the Austrian tax system because the goodwill amortization scheme was even not open to taxpayers who opted for tax liability of their participations in foreign EU group members according to § 10 Par 3 Nr. 1 KStG.[4] Since there were no other justification grounds the AG came to the conclusion that the goodwill amortization scheme infringes the freedom of establishment.[5]

State aid assessment

  1. The concept of selectivity

With regard to the State aid assessment the AG argued that the goodwill amortization confers a tax advantage for its recipients pursuant to Art 107 para 1 TFEU. The advantage was also granted through state resources. For the selectivity test of the measure the AG modified the traditional selectivity examination scheme, where one has to first identify the “normal” taxation approach (“derogation approach”). As the referring Court suspects that the different treatment of (a) companies and individuals, of (b) companies within a tax group and outside a tax group and of (c) companies which acquire domestic participations and companies which acquire foreign participations might be selective, one “normal” tax regime cannot be identified.[6] Therefore it is solely important whether comparable legal and factual situations are treated differently and whether this different treatment leads to a selective advantage for certain industries or undertakings (“comparability approach”). The argumentation of the AG is in line with the present case law of the CJEU, which considers the selectivity examination also as an examination of comparability. For example in the Gibraltar judgement the CJEU classified a tax-exemption to offshore companies as selective, even though less than 1% of companies were actually taxed.[7]

  1. Assessment of the goodwill amortization scheme

According to the AG the refusal to grant the goodwill amortization to individuals and to companies which are not part of a tax group cannot be considered to be state aid, since these persons are not in a comparable factual and legal situation with companies, which are members of a tax group. The AG suggests a less stringent comparability test for pure domestic situations as compared to cross-border situations. This is due to that fact that only unfavorable treatment of cross-border cases compared to domestic cases are covered by the EU Treaties.[8]

AG Kokott then states that the goodwill amortization scheme, by excluding foreign EU group members, treats taxpayers in comparable legal and factual situations differently. Consequently the goodwill amortization constitutes an advantage to companies, which acquire domestic participations, compared to companies which acquire foreign participations. This unequal treatment is not justified by the basic or guiding principles of the Austrian tax system. Therefore the goodwill amortization scheme can be regarded as a subsidy in the narrow sense (which cannot be justified by the basic or guiding principles of the Austrian tax system).[9]

However, as the scheme covers all sorts of domestic companies, it does not favor certain industries or undertakings and therefore it is not qualified as being selective. The advantage is rather that all companies within a tax group irrespective of the economic sector they perform, receive a subsidy for acquiring domestic participations.[10] With this reasoning the AG follows the view taken by the European Court of First Instance in two cases regarding the Spanish goodwill amortization (Banco Santander and Santusa/Commission, T-399/11 and Autogrill España/Commission, T-219/10).[11] There the Court concluded that the granting of a goodwill amortization only in relation with the acquisition of foreign participations was not selective since the scheme was in principle open to all companies and did not exclude a specific group of undertakings. In order to confer a selective advantage, a tax rule would have to characterize the recipient undertakings, by virtue of the properties which are specific to them, as a privileged category.[12] The mere fact that the tax rule/benefit is subject to conditions could not, alone, render it selective in favor of undertakings satisfying this conditions. Otherwise, any tax relief subject to conditions would be state aid. The AG furthermore argues that a too broad understanding of the terms ‘certain undertakings’ and ‘production of certain goods’ and ultimately ‘selectivity’ entails the risk to affect the distribution of competence between Member States and the EU as foreseen in Art 2 to 6 TFEU as well as between the European Parliament/Council of the European Union (Art 14 TEU) and the European Commission (Art 17 TEU). Consequently, the AG came to the conclusion that the goodwill amortization scheme does not constitute illegal State aid.[13]

Way Forward

The opinion of the AG provides an important indication on how the CJEU could qualify the Austrian goodwill amortization scheme. It is expected that the CJEU will render its decision still in 2015.

Until then, Austrian tax groups with foreign EU group members, which were purchased before 1 March 2014 and where the holding company exercised the option for tax liability according to § 10 Par 3 Nr. 1 KStG should, if not already done, examine their tax positions and assess whether they could benefit from the goodwill amortization scheme or not. The prerequisite that the goodwill amortization had to have an impact on the purchase price of the participation is also likely to infringe the freedom of establishment and should therefore not prevent tax groups from obtaining the goodwill amortization for their foreign EU group members.

[1] In 2014 the goodwill amortization concept was abolished for new acquisitions due to the possible infringement of EU-law.

[2] Federal Tax Court (former „UFS“, now “Bundesfinanzgericht”) Linz, 16 April 2013 (RV/0073-L/11).

[3] Austrian Administrative High Court, 30 January 2014 (Zl. 2013/15/0186).

[4] Opinion of AG Kokott, 16 April 2015, C-66/14, Finanzamt Linz, para. 61.

[5] Opinion of AG Kokott, 16 April 2015, C-66/14, Finanzamt Linz, para. 69.

[6] Opinion of AG Kokott, 16 April 2015, C-66/14, Finanzamt Linz, para. 88.

[7] Commission/Government of Gibraltar and United Kingdom, C-106/09 P and C-107/09 P.

[8] Opinion of AG Kokott, 16 April 2015, C-66/14, Finanzamt Linz, para. 91.

[9] Opinion of AG Kokott, 16 April 2015, C-66/14, Finanzamt Linz, para. 104.

[10] Opinion of AG Kokott, 16 April 2015, C-66/14, Finanzamt Linz, para. 111.

[11] Banco Santander and Santusa/Commission, T-399/11 and Autogrill España/Commission, T-219/10.

[12] Commission/Government of Gibraltar and United Kingdom, C-106/09 P and C-107/09 P.

[13] Opinion of AG Kokott, 16 April 2015, C-66/14, Finanzamt Linz, para. 117.

What is Wrong with our Fiction? The Perceived Attack on Reverse Vesting

Articles, Latest News, Tax

Tax advisors in Israel are scrambling to find the best solution to the unknown risk of adverse tax treatment of reverse vesting.

Why the current increased interest in the topic? Paranoia or calculated anticipation of the Israeli tax authorities (the “ITA”) attacking a well established principle?

Reverse vesting is a commonly used technique to address the concerns that a founder of a company who is key to its success and owns shares of the company might simply walk away from the company causing damage to the enterprise’s prospects for success.

Using equity as a retention tool is nothing new. When an employee is granted stock options that are subject to a three or four year vesting period, the theory is that the employee is incentivized to stay at work for the full vesting period to receive the full benefit of the employee’s options. The shareholders are willing to share equity with the employees to align interests between the company and the employees, joining the level of the employees’ compensation with the success of the company and keeping the employee motivated during his or her period of employment.

But founders who set up a company own their shares from day one. When a few talented individuals get together to form a company, sometimes they worry about this from the beginning. They may set up a type of reverse vesting which is basically a call option. If one founder leaves the company, the others can buy his or her shares usually for par value.

The concern that this may raise tax implications is subdued. The value of the company and its shares in those early days are often low, and so the risk of a taxable transaction is by correlation also low.

The more popular use of reverse vesting addresses when our young company needs an investment of millions of dollars from a financial investor. Venture capital firms (“VC’s”) are well versed in understanding the crucial role founders may play in the chances of success for their fragile investments.

The venture capitalists could space out their investments to correspond to milestones including the continuation of the employment of the founders, but that is not popular and often not practical; they may not be putting in nearly enough funds to keep the company going for the full period they wish the founders to commit and the funds invested up to the point of departure of a founder can be tremendous.

The investors can’t force the founders to keep working. This is codified in Israel’s Basic Law: Freedom of Occupation[1]. They need another tool to safeguard their investment. A fine or penalty that the founders would have to pay if they leave the company? Not worth the wasted air expressing this out loud to a founder. It is the VC’s that are supposed to have the money, not the founders.

Reverse vesting is the obvious choice. If a founder refuses to keep working for the crucial first few years after the company has received a large investment, he or she should lose some of his or her shares and not benefit from the future success of the company. This is a penalty that sounds fair – it is in the control of the founder; it adjusts the equitable balance of ownership if the company is worth less because the founder left; and it does not impose an impossible financial burden on the founder.

So far, so good. So why are tax advisors in Israel wary of the ITA spoiling this wonderful solution that is so common in the global high tech world?

While there is no evidence that the ITA is about to challenge the arrangement, the ITA, obviously is not bound by the treatment of reverse vesting in the Silicon Valley for example[2]; some lawyers and tax advisors fear that the ITA may look at shares subject to reverse vesting as being deemed given in exchange for work and therefore could categorize the shares as work related income, taxable as ordinary income and not as capital gains. The ITA could take the position that when the founders eventually sell their shares in an exit event (a merger or acquisition), the income earned on the shares should be treated as ordinary income, even though this seems like a real stretch of the imagination. If a founder can lose shares of a company if he or she quits working for the company, the ITA could look at those shares as not really belonging to the founder until the reverse vesting lifts, as if the founders are actually receiving shares over time, in which case they should be taxed periodically at the time the shares were deemed to have been received; this translates into the dates that the shares are released from the threat of reverse vesting rather than the date of incorporation of the company when the company value was lower if not insignificant.

To protect from this troublesome threat, reverse vesting is dressed up in colorful non-ordinary income terminology.

For example, we don’t draft Reverse Vesting Agreements but rather Repurchase Agreements. We don’t state anywhere in the agreement that the rights to the founders’ shares vest over time but rather that the other shareholders will have the right to buy back some of the founders shares in decreasing amounts over time and for very little money if the founders stop working.

Not that there seems to be evidence of the topic heating up at the ITA, but nonetheless, lately there has been much discussion in Israel, or at least in the hallways of Tel Aviv tax departments and law firms, of the risk that all reverse vesting clauses in high tech companies could be in jeopardy. That adds up to a lot of clauses in a lot of companies in a country dominated by its high tech and start up culture.

Good advice is to distance the shares from employment. Make sure the founders’ shares in an exit event are not worth more than any other shareholders’ shares. Include language that the purpose of the reverse vesting is to avoid the damage and harm that would be caused to the company if the founder quit rather than any type of compensation to the founder for staying. Make sure it is shareholders who have the right to buy the shares of the founders if their employment terminates and not the company itself. Do not include death or disability as grounds to trigger repurchase so that it is punishment to the founders for quitting rather than just the founders no longer working. To the extent the founders have paid some cash for their shares and the price to be paid upon exercise of the reverse vesting returns their capital, the shares look less like ordinary income to the founders.

A more recent creative idea is to grant other shareholders anti dilution rights triggered if a founder leaves the company. To implement this concept, the other shareholders would be issued new shares or the conversion ratio of preferred shares would be adjusted to give the holders of preferred shares a larger percentage of the outstanding shares of the company; the founders’ shares of the capital of the company on a percentage basis would decrease.

It is yet to be seen if this obvious new ploy can trick the ITA into believing that the additional shares received by the investors from the company are not the same as the additional shares the investors would have gotten if they were entitled to buy shares from the founders all with the same trigger and lack of price tag.

In addition, if there is more than one founder, this smacks of collective punishment. If one leaves, all founders would be diluted including those that loyally stayed with the company. Morally it would be more appropriate to use this approach, if at all, if there is only one founder subject to reverse vesting so that other founders do not have to serve as guarantors of each other’s commitment to the company. But with only one founder, the net effect is just the same as the traditional reverse vesting. With multiple founders, there is more separation between the employment of a founder and the share ownership of the other shareholders.

Whether this fiction would be acceptable in favor of traditional reverse vesting is unclear and untested.

Until there is any clarity, some advice to investors. When you don’t need reverse vesting, don’t ask for it.   Use it when you do not have plausible alternatives to keep founders motivated. If the founders have less than 10% of the shares of a company and do not have the right to appoint a director, consider using shares or options granted under Section 102 of the Tax Ordinance[3].

General advice of course may not be applicable to your particular situation so do visit your tax advisors for the latest developments.

 

[1] The Basic Law: Freedom of Occupation (1994). The Law was passed by the Knesset on 9th March, 1994 and published in the Book of Laws No. 1454 of 10th March, 1994. It provides in part:
1. Fundamental human rights in Israel are founded upon recognition of the value of the human being, the sanctity of human life, and the principle that all persons are free; these rights shall be upheld in the spirit of the principles set forth in the Declaration of the Establishment of the State of Israel.

2. The purpose of this Basic Law if to protect freedom of occupation, in order to establish in a Basic Law the values of the State of Israel as a Jewish and democratic state.

3. Every Israel national or resident has the right to engage in any occupation, profession or trade.

[2] See for example Rev. Rul. 2007-49 from Internal Revenue Bulletin:  2007-31 dated July 30, 2007 specifying that Section 83 of the Internal Revenue Code does not apply to reverse vesting imposed by investors (changing “substantially vested stock” to “substantially nonvested stock”).

[3] Section 102 of the Israeli Income Tax Ordinance [New Version] 5721-1961, as amended, is the regime for employee stock option plans granting favorable deferred tax status; it is not available for holders of more than 10% of a company’s share capital or to those that have a right to appoint a member of the board of directors.

Cyprus IP Company: The Breathless Conundrum Solved

Articles, Intellectual Property, Latest News, Tax

The breathless conundrum for IP companies is four-fold: not only should royalties be taxed at a low rate in order to maximise profits; but also research and development (R&D) or acquisition costs should be considered as allowable expenses to the maximum possible effect, whilst also the jurisdiction where the IP holding is situated should have a considerable treaty network in order to allow for global exploitation of the IP rights, not forgetting that an exit route should always be available and beneficial. Or is it fifth-fold? Developments with regards to BEPS, transparency, tests on beneficial ownership and anti-treaty shopping provisions add another factor to the puzzle.

The recent changes effected in the IP holding taxation in Cyprus solve the problem. It is interesting to examine how.

Who qualifies under the law?

In order for an IP holder to benefit from the law all the following conditions must be met:-

The IP right should be a Qualifying IP; it must be owned by a Cyprus Company and it should be used for the production of taxable income.

According to the tax legislation, any intangible asset that is protected by the IP laws of Cyprus will be considered as a Qualifying IP Right for the purposes of the favourable tax regime. It is noted that an IP right registered outside Cyprus, on a European or International level is still protected by the IP laws of Cyprus.

The ownership of the qualifying IP may come either through acquisition of an existing IP Right or through the actual development of the IP Right by the Cyprus Company. It must be noted that the acquisition of an already existing IP right can be done not only with cash but it can also be acquired as a contribution in the share capital of the Cyprus Company.

Further, the Cyprus IP Holding Company should use the Qualifying IP Right for the production of taxable income. This means that the IP Holding Company must be an operating company and that the IP Right should be licensed to other parties in exchange for royalty income.

Tax treatment of Royalty profits

The maximum effective tax rate for royalties received by the Cyprus IP Holding company is limited to 2.5%, as follows:- According to the law 80% of “Royalty Profit” generated from Qualifying IP Rights will be considered as a deemed expense for corporation tax purposes. The remaining 20% will be subject to the normal corporation tax rate of 12.5% rendering the maximum effective tax rate to 2.5%. For the purpose of determining the “Royalty Profit” the law allows the deduction from the resulting royalty income of all direct expenses incurred wholly and exclusively for the production of royalty income. Following the deduction of these direct expenses there is the application of 80% deemed expense on the resulting income. Additionally there are provisions in the law, for allowing capital expenditures to be deducted from the income as will be explained below.

R & D, Acquisition costs and Capital Allowances

The maximum effective rate of 2.5% can be further reduced by deducting capital allowances within the first five years of the company’s acquisition or development of each IP right. The company will be able to use capital allowances of 20% straight line, starting from the first year of usage of the asset, as well as the subsequent four years thereof.

Ability to extract royalties from multiple jurisdictions with low or no withholding tax

Another important consideration for setting up an IP holding company is whether the jurisdiction chosen is sufficiently networked in order to give such holder the ability to extract incoming royalties from various jurisdictions with as low as possible withholding tax.

Cyprus has many tools available that will enable the investor to achieve this and in particular:- a) Extensive Network of Double Tax treaties, b) Applicability of EU Royalty Directives, as well as c) Unilateral Tax Credit Relief.

  1. The Double Tax Treaties

Cyprus has over 50 Double Tax Treaties currently in effect and many more in the pipeline. This gives the ability to extract royalties from these jurisdictions at reduced or even zero withholding tax rates.

  1. Relief under the EU Interest and Royalty Directive

The EU Interest and Royalty Directive eliminates withholding taxes on Interest and Royalties paid by a licensee who is resident in one EU Member State to a licensor company being resident in another EU Member State.

With careful tax planning, a Cyprus IP Holding Company can enjoy the benefits of this EU directive, which grants the ability to receive royalties from all other EU member states with no withholding tax. It therefore opens the European Market to the investor, it reduces the tax leakage and hence, gives flexibility and significant competitive advantage in relation to pricing.

  1. Unilateral Tax Credit Relief

In cases were the Double Tax Treaty network or the Interest and Royalty Directive relief are not providing sufficient protection, it is possible for a Cyprus IP Holding Company, under the provisions of the Cyprus Tax Law, to claim a Unilateral Tax Credit Relief.

In effect, any tax paid abroad will be credited against any tax that might be payable for the particular income in Cyprus avoiding therefore the double taxation of the specific income. In order to obtain this tax credit, the company must prove the payment of such overseas taxation.

All of the above tools allow the investor to minimise its tax exposure on withholding taxes paid abroad on the incoming royalties and therefore enhance its overall tax exposure.

It is worth mentioning that any profits generated by the Cyprus IP Holding Company can be distributed to its shareholder in the form of dividends. According to the Cyprus Tax Law any dividends payable by a company resident in Cyprus to its foreign shareholders (natural or legal persons) are not subject to any withholding tax in Cyprus. This is very important as it allows for funds to be moved to the investor without any additional tax leakage in Cyprus.

Exit Route

The favourable tax treatment of a maximum effective tax rate of 2.5%, covers also potential profits from any future sale of the IP Right.

Investing through a Cyprus IP Holding Company will provide the investor with a tax efficient exit route since, 80% of the profits from the sale of the IP right will be considered as deemed expenses. The remaining 20% will be subject to corporation tax at 12.5% as in the case of Royalty profit.

BEPS/Transparency/Beneficial ownership/Anti Treaty shopping concerns addressed

In addition to the above benefits of the IP tax regime, Cyprus can further be differentiated from the traditional IP jurisdictions since it can provide an efficient and cost-effective way for companies, to create actual substance in Cyprus. This way companies can avoid concerns arising from the attacks on aggressive tax planning and most importantly the attack on the so called “conduit” or passive entities. In other words, structures that are mere vehicles for rerouting profits or are only established for the sole reason of taking into advantage a low tax jurisdiction or double tax treaty without a corresponding real physical presence in the country of its tax residence.

With its infrastructure, provision of services, supply of highly qualified personnel and low cost of living, Cyprus provides the economic ability to a wide range of companies, whether small, medium or large, to establish themselves in Cyprus and enjoy the whole spectrum of benefits to its fullest.

Conclusion

As a final note the trend of large IP companies relocating to Cyprus is becoming apparent, examples being renowned gaming and IT companies. Through careful structuring and tax planning there is light at the end of the tunnel and Cyprus demonstrates all the qualities of becoming the way forward in the IP world.

Lump-sum taxation and residence permit in Switzerland

Articles, Immigration, Latest News, Tax,

Foreigners who take up residence in Switzerland for the first time or after an absence of more than ten years may opt for a special tax regime provided that they will not carry out any gainful activity in the country. In doing so, they will benefit from the application of a special method for the assessment of their income and wealth, which is an expenditure–based taxation. This special regime is more generally known as “lump-sum taxation”. It is applied at Federal level and in some cantons, more particularly in the West part (French speaking part) of Switzerland. Opting for lump-sum taxation regime will generally be a decisive criterion for the grant of a residence permit to applicants from non EU countries who are under the age of 55 and have no specific personal relation to Switzerland.

Lump-sum taxation has raised a rather intensive controversy in Switzerland during the year 2014 and even earlier. Until very recently the system was under the attack of certain political parties and organizations that launched popular initiatives (typical democratic rights provided by Swiss constitution), in several cantons and at Federal level, calling for lump-sum taxation to be abolished. The canton of Zürich, for instance, had to abolish lump-sum taxation in 2009 as a result of a cantonal popular initiative that collected a majority of votes against this tax regime. The reasoning of the opponents to lump-sum taxation is that the system would not be consistent with the constitutional guarantee of equal treatment. In other words, tax payers benefitting from lump-sum taxation – who cannot be Swiss citizens – are considered to be taxed on a more favourable way than other tax payers – mainly Swiss citizens – who are taxed under the ordinary regime.

This is not the place to enter into the controversy even though there are many reasons to consider that foreigners taxed on a lump-sum basis in Switzerland are not actually in the same situation as Swiss nationals and other foreigners who are taxed under the ordinary regime. Therefore different situations allow different treatments, in particular when it relates to taxation. Furthermore, economic considerations surrounding lump-sum taxation show that this system brings a lot of benefits to the local economy which recovers most of the expenses, quite actual and significant, incurred by lump-sum taxpayers for their living at their place of residence. This explains why the business community strongly opposed the abolition of lump-sum taxation.

Finally, on November 30th, 2014, the initiatives to abolish lump-sum taxation at Federal level and in the canton of Geneva were strongly rejected by the population at both levels. So far there are no other cantonal initiatives against lump-sum taxation pending in other cantons.

It is now very clear that lump-sum taxation will remain in force in Switzerland, at Federal level and in some cantons, more particularly in the French speaking part of the country (for instance in the cantons of Geneva, Vaud and Valais). However, following the abolition of this special regime in some cantons of the German speaking part of Switzerland, Confederation had already taken the lead in tightening the conditions for the application of lump-sum taxation at Federal and Cantonal levels. In this respect amendments, effective as at January 1, 2016, have been made to the Federal Direct Taxation Act (DFTA) and to the Federal Act on the Harmonization of Direct Taxation at Cantonal and Communal levels (DTHA).

For the sake of clarification, it is worthwhile noting that Swiss tax system provides for tax jurisdiction at three levels, Federal, Cantonal and Communal. Taxation is however made by Cantonal authorities who act for themselves and, by delegation, for the Confederation and the home municipality of the tax payer. Confederation levies tax on income only, while cantons and municipalities levy tax on income and wealth.

 

Principles applicable to lump-sum taxation at Federal level (art. 14 DFTA) and at Cantonal and Communal levels (art. 6 DTHA)

  • Expenditure-based taxation (lump-sum taxation) replaces ordinary taxes on income and wealth.
  • The system is available only for foreigners who set up domicile in Switzerland for the first time or after an absence of ten years. Swiss nationals cannot benefit from this tax regime.
  • Spouses living in the same household must both meet the requirement for lump-sum taxation.
  • The portion of expenditure–based taxation replacing the ordinary income tax is calculated on the basis of the annual expenditure / living costs of the tax payer, in Switzerland or abroad, for himself and for his family members or other people dependant from him and living with him. Taxes are levied on the highest of the following amounts:
  • The minimum amount set by the law, which may not be less than CHF 400’000.- for Federal direct taxation. (Cantons have to set in their legislation, at their discretion, the amount of the minimum assessment basis);
  • Seven times the annual rent or annual deemed rental value of the home of the main tax payer;
  • For other tax payers living for example in a hotel or in a pension: three times the price of the annual pension for food and housing at the place of residence of the tax payer.
  • Tax is levied at ordinary tax rate.
  • Cantons are free to determine how cantonal wealth tax is covered by lump-sum taxation.
  • The amount of taxes due on the basis of the lump-sum assessment must be at least equal to the total of income and wealth taxes that would be charged to the tax payer if he would be taxed on following items, under the ordinary regime:
  • Real estates in Switzerland and the income generated by such assets;
  • Movable assets located in Switzerland and the income generated by such assets;
  • Financial assets invested in Switzerland, including debts secured by real estate and the income generated by such assets;
  • Copyright, patents and similar rights exploited in Switzerland and the income generated by such rights;
  • Retirement pensions, annuities and other pensions from Swiss sources;
  • Foreign income for which the tax payer requires partial or full exemption of foreign taxes based on any double taxation treaty entered into by Switzerland with the country where taxes are levied.
  • If the income from a foreign state is exempted provided that Switzerland levies taxes on such income, applying the rate for global income, Swiss taxes are calculated not only on the basis of the income mentioned above but on the basis of all items of income from the state at source or attributed to Switzerland based on the relevant double taxation treaty.

 

Specific conditions at Cantonal level (limited to the Cantons of Geneva, Vaud and Valais):

Minimum annual assessment basis, i.e. lump-sum amount, set forth by law:

  • Geneva: CHF 300’000.-
  • Vaud: CHF 300’000.-
  • Valais: CHF 220’00.-

However, in practice lump-sum taxation is granted based on higher minimal amounts, as follows, by approximation:

  • Geneva: CHF 350’000.-
  • Vaud: CHF 350’000.-
  • Valais: CHF 280’00.-

So far, the above cantons have not set forth any specific condition in order to assess wealth separately, in addition to tax assessment based on expenditures.

Comments

As explained above, renouncing to any gainful activity is a key condition in order to benefit from lump-sum taxation. Therefore, foreigners who become new Swiss taxpayers under this special regime are not allowed to take up any employment in Switzerland, should it be with a third person/entity or with a legal entity under their control, for instance as shareholder or beneficial owner of such entity. The same applies to any independent gainful activity. For the time being carrying out gainful activity outside Switzerland is still allowed. The conditions in this respect might become more tightened in the future, at least at Cantonal level. According to existing practice, lump-sum tax payers are still authorised to be a member of a Board of directors of a company in which they have interests (equity and/or loan), in the capacity as “observer” for the purpose of monitoring their investment. However they may neither participate to corporate decisions nor receive any remuneration for their position within the company. In any way one must remain careful in this respect. The practice, more particularly at Cantonal level, could develop new and stricter requirements.

 

Lump-sum taxation and residence permit

Any foreigner who decides to take up domicile in Switzerland with or without any gainful activity must obtain a residence permit.

Residence permit for gainful activity must be obtained from the first day of activity. Residence permit without any gainful activity is necessary after a continuous stay of 90 days in the country.

For European citizens, obtaining a residence permit with or without gainful activity is a simple and swift process based on the agreement between Switzerland and the European community supporting the free movement of persons.

For citizens from non EU countries, the process is less straightforward. Residence permit with gainful activity requires a labour market survey to verify that there is no one available on local market and in the EU countries to take up the position. Authorizations are reserved for people at executive level for positions that will help develop the local labour market. For residence permit without gainful activity, the applicant must be over 55 and justify good ties with Switzerland. If none of these two prerequisites are met, the applicant may still show that he will be of a significant interest to his home canton in terms of taxation.

In this context, lump-sum taxation is frequently combined with the application for residence permit without gainful activity. Indeed, for non EU applicants who are not 55 of age or older and who have no ties to Switzerland, opting for lump-sum taxation is generally the only route to the grant of a residence permit without gainful activity. One must however be aware that the lump-sum amount must be of some significance in order to create a tax interest for the canton. Currently, the minimum amount of the lump-sum taxation basis is in the order of CHF 800’000.- to CHF 1’000’000.- depending on the Canton of residence. One can note therefore that the minimum assessment amounts (CHF 400’000.- at federal level) or seven times the housing expenses as lump-sum amount might not be sufficient when applying for a residence permit.

For practical reasons, it is advised therefore to obtain first a lump-sum taxation agreement with relevant Cantonal tax administration in order to be able to apply then for a residence permit in front of the population office of the Canton of residence.

Conclusion

The recent confirmation of the lump-sum taxation system in Switzerland will quite certainly result in a renewed interest for foreigners who see the country as a possible place for immigration. In addition the political and economic stability in the country combined with a high quality of life will continue to make Switzerland a first choice for immigration.

Tax planning considerations for Tier 1 (Investor) migrants

Articles, Immigration, Latest News, Tax,

The UK encourages foreign direct investments by granting high net worth individual investors and their families the right to reside temporarily in its territory, with the associated tax benefits of the resident ‘non-dom’ regime. And after a qualifying period, whose length depends on the amount invested in the British economy, the individual and their kin can obtain indefinite leave to remain (ILR) in the UK. Later, they can even apply for British citizenship.

The Immigration Rules that regulate the process are extremely complex and subject to frequent and unexpected changes. The most significant amendments became effective on 6th November 2014 following an extended period of scaremongering and rumours, which mostly turned out to be true. The new rules doubled the investment threshold and only gave panicked HNW migrants 20 days to apply under the old rules or face an expensive revision of their investment plans.

The Home Office’s explanatory notes are comprehensive; however, clients rarely submit visa applications themselves. Usually they engage a triad of advisors who are experts in the fields of UK immigration law, financial and tax planning. It is not a coincidence that the tax consultants are right at the end of the list — experience has shown that despite moving to a high-tax country, seeking comprehensive tax advice often comes as an after-thought, when the investments are made and the arrival dates are set. This article highlights the primary tax planning considerations relevant to non-domiciled investors at different stages of the UK immigration process for high-value migrants.

Immigration

There are two pathways that such high-value migrants can take — Tier 1 (Investor) and Tier 1 (Entrepreneur), although this article focuses on the planning opportunities for the former. These differ in the size of the investments and the commitments on behalf of the migrant. The Home Office’s website (http://tinyurl.com/ldtl8cw) explains the regimes in detail and contains policy guidance documents (http://bit.ly/1yIoFKt), extracts from which the author used in writing this article.

The Tier 1 (Investor) category is for high-net-worth individuals who can afford to invest at least £2 million in the UK. The investor does not need a job offer in the UK nor is he required to prove a good command of the English language although the latter will be required when applications for ILR and settlement are made. Broadly, the funds must be his own savings or belong to his spouse or a partner — the Rules no longer permit borrowing the funds. According to Home Office’s statistics (http://bit.ly/1GvfGTu) in 2013, the Chinese received the largest number of investor visas, followed by the Russians; the rest of the nationalities trailing behind. Anecdotal evidence suggests a significant number of the investors being wives of wealthy foreigners; the latter, together with the couple’s children being her dependants, who are free to visit the UK as they please without any commitments as to the duration of visits or making the investments.

For the sake of completeness, Tier 1 (Entrepreneur) is for non-European migrants who want to invest in the UK by setting up or taking over, and being actively involved in the running of, a UK business or businesses. Broadly, the applicant needs to invest £200,000 in a UK company and comply with a host of other requirements, including speaking English to a certain standard and having enough money to support himself in the UK. This route is attractive to younger entrepreneurs who might have sufficient savings and are prepared to actively manage the business and create jobs in the UK. In fact, certain graduate entrepreneurs are allowed to apply with only £50,000. With the recent tightening of the rules allowing foreign students to seek work in the UK after finishing their studies, the Entrepreneur visa has become especially popular with parents willing to help their children to stay in the UK.

Both routes allow the migrant to apply for the ILR after a continuous residence period in the UK of five years. This can be reduced to three years for the investor who invests £5 million or the entrepreneur who makes extraordinary progress with developing his business. A further reduction to two years is available to the investor who invests £10 million. Interestingly, the Rules only allow the main applicant to reduce the length of time before he applies for the ILR and exclude his dependants, who need to wait the whole five year period before submitting the application. There are also strict requirements regarding the number of days that the migrant can spend outside the UK in any 12-month period (http://bit.ly/1ndkzW5). Failing to meet them will result in the inability to apply for the ILR and settlement.

Statutory Residence Test

Taxation in the UK primarily depends on a person’s residence status. Since April 2013, residence has been determined under the statutory residence test (SRT). The SRT is explained in brochure RDR3 (http://tinyurl.com/SRTRDR3), which also contains useful practical examples, which are worth reviewing by anyone attempting to ascertain their residence situation. The SRT establishes residence status according to the number of days that an individual spends in the UK during the tax year that runs between 6 April and 5 April of the following calendar year. Residents generally pay tax on their worldwide income and gains, whilst non-residents are generally only taxed on income from sources in the UK. However, individuals resident but not domiciled in the UK can elect to be taxed on the remittance basis where non-UK income and gains are only liable to tax when directly or indirectly remitted (brought) into the UK.

On its own, an individual’s immigration status or current nationality has no bearing on his UK tax liability whatsoever. The investor should be treated as a regular typically non-domiciled taxpayer who requires the usual pre- and post-arrival tax planning measures. Nevertheless, tax advice should take into account two considerations that pertain to the granting of the Tier 1 (Investor) status.

Firstly, assume that the end goal of most investors and their families is to settle in the UK. To achieve this they must spend at least 185 days in every 12-month period in the UK starting from the day of arrival in the UK under the newly issued leave to enter. This immediately denies the benefit of the UK-residence planning techniques based on the extended periods of absences from the UK. As a result, most tax planning measures should be undertaken before the investor’s arrival in the UK during Stage one as explained below.

Secondly, the Rules require the investors to physically bring the investment funds into the UK. Unless these are derived from clean capital, accumulated during the period of non-UK residence, the investor will suffer the consequences of making a remittance of foreign income or gains, which will be taxed at the appropriate rates. Further remittances might occur where the investor pays for the services rendered to him in the UK, such as immigration advisors’ and solicitors’ fees. Taxation of remittances can be avoided under the business investment relief as described below; however, the expense of planning for the minimisation of the tax burden might nullify the tax benefits it aims to achieve.

The Tier 1 (Investor) process

It is possible to split the Tier 1 (Investor) immigration process in three stages. Stage one is preparatory during which the migrant collects documents and submits the visa application. As Stage two, the investor arrives in the UK after receiving leave to enter the country. Stage three involves the migrant making the investment, which will permit him to remain in the UK and to apply for the extension of his stay until he can apply for the ILR and later for citizenship. There might be a period of several months between Stages one and two during which the investor stays in his home country waiting for the outcome of the application. The migrant typically has up to three months from the day of his arrival in the UK to fulfil the requirements of Stage three. The investor should plan to remain non-UK resident at Stage one and even partly through Stage two; and during this period of non-residence he should aim to perform the larger share of his tax planning strategy.

During Stage one the applicant prepares and submits documentary evidence of his ability to invest at least £2 million in the British economy. This amount must be in cash and kept in a regulated financial institution (typically a bank) in the UK or overseas. Sometimes instead of clear funds the future migrant has an asset portfolio that includes capital assets and undistributed income, but the Home Office will not take these into consideration. Funds held by companies or trusts are equally excluded. The investor should convert these assets into cash: any gains accumulated in securities and properties should be crystallised by selling them; where there is a right to receive income — dividends, interest, salary, royalties, business profits — this right should be exercised and the proceeds received into a bank account.

It might seem reasonable only to create sufficient cash to fund the £2 million investment. In fact, when converting assets into cash or receiving income, the investor might be subject to a double tax liability, determined by his current tax residence and the source of funds, although this might be reduced under double tax agreements or domestic tax exemptions. However, any non-UK gain that is crystallised and non-UK income that the investor receives after he becomes UK resident will be liable to UK’s fairly high taxes unless the taxpayer claims the remittance basis of taxation and does not bring the funds to the UK. As a result, the migrant might face the situation where he cannot pay for his life in the UK without incurring a significant tax cost.

‘Clean capital’

Conversely, income and gains received before becoming resident form so-called “clean capital”. If the investor loans clean capital to someone, the loan principal will always remain clean capital when repaid to the investor (but note the position with regard to loan interest below). Gifts received from related and third parties are also clean capital provided they are not considered to be a form of hidden income or gains distribution. In practice, some UK-resident investors live off the gifts made to them from their non-UK resident spouses, who earn income and gains not liable to UK tax. Clean capital will not be taxed in the UK, whether brought in its territory or not. However, in the case of an investor’s death, clean capital kept in a UK bank account will form his UK-situs asset liable to 40% inheritance tax. Therefore, it might be prudent to bring to the UK only the amounts necessary to fund current expenses.

Clean capital should be credited to a separate bank account and never mixed with non-UK income and gains that might be derived after assuming UK residence. In fact, considering that income and gains are taxed differently in the UK, they should also be kept in separate bank accounts. Moreover, if clean capital generates income — say it has been loaned and the investor receives interest — this should be paid to the income bank account and not into the clean capital account to avoid tainting it. Counterintuitively, the same cannot be done with gains generated with the use of clean capital. For example, if clean capital is used to buy shares, any gain realised on their future disposal will always form part of the proceeds and it cannot be segregated from clean capital by being paid to a separate bank account. There are methods that allow for such separation of gains involving the use of several connected trading entities or loaning clean capital to a bank to secure a bank loan, which will later be used to acquire capital assets.

If the investor runs out of clean capital he might have no choice but to bring foreign income and gains to the UK and face the prospect of the maximum 45% taxation. He can borrow from an overseas lender provided that the loan is made on commercial terms and the interest is serviced from UK-source income or gains. It had been possible to borrow under security of non-UK income and gains; however, in August 2014 this possibility was revoked.

There is no requirement or in fact possibility to declare clean capital to the UK tax authorities (HMRC) upon becoming UK resident. Equally, there is no requirement to report the use of clean capital on UK’s tax returns. However, the taxpayer should keep documents that reflect dates and methods of creation of non-UK income and gains to prove that they were received while he was non-UK resident and thus form his clean capital. Such documents include bank statements, sale and purchase agreements, loan agreements. They might be necessary in case of a future dispute with HMRC.

The Rules also allow the investor to rely on money that is owned either jointly with or solely by his close relative (spouse or partner). If the close relative is a lower rate taxpayer then, subject to the rules of their residence jurisdiction, the investor can gift the assets to the relative, which she can dispose of subject to the payment of a smaller amount of tax.

Provided the requirements of stage one are satisfied, the investor will receive the leave to enter the UK as a Tier 1 (Investor). The arrival to the UK should be timed with regards to the residence planning considerations as discussed next. At the same time the investor should not delay his arrival in order to satisfy the continuous residence requirement required to apply for the ILR at the end of his stay.

‘Connecting factors’ of tax residence

Under the SRT UK residence may be acquired automatically if the individual spends over 182 days in the UK, has a home in the UK or works in the UK on a full-time basis. If the investor is not UK-resident automatically, he might be resident under the sufficient ties test, which looks at the connection ties that the individual has with the UK. The relevant factors include having a family resident in the UK, presence of UK accommodation, working in the UK and length of visits to the UK in the preceding tax years. The more UK ties the investor has — the less number of days he can spend in the UK during the tax year without becoming a UK tax resident. It is also possible to be automatically non-UK resident under a separate set of circumstances. Residence is determined for the entire tax year starting from 6th April regardless of the taxpayer’s relocation date. However, there is a possibility to split the tax year and only begin UK tax residence from the day of arrival in the UK.

Experience shows that in the tax year of arrival in the UK, most investors have two connection ties: they acquire a home in the UK and their families become UK resident. The SRT allows them to stay in the UK for up to 120 days without becoming resident here provided they are not UK resident automatically. However, there are plenty of pitfalls and before determining his residence situation, the investor should avoid buying accommodation in the UK or entering into long-term leases, moving family and sending children to school and spending over 90 days in the UK in any tax period. Additional planning opportunities might be offered by the tie-breaker clause in the residence article of the double taxation treaty that the UK might have with investor’s residence State, although complications might arise stemming from the mismatch between the tax years’ periods. HMRC provides an interesting explanation of this rule in part INTM154040 of its International Manual (http://tinyurl.com/INTM154040).

Under Stage three the investor must invest £2 million by way of UK Government gilt-edged securities, share capital or loan capital in active and trading companies that are registered in the UK. The minimum investment threshold must be met only when the investments are made and there is no need for a top-up if their value falls during the continuous ownership period. It is also possible to rely on the existing investments, however, the Home Office will only count those that have been made in the UK in the 12 months immediately before the date of the application. Otherwise, the investor will have to make “fresh” investments, which might trigger tax consequences in the UK or in his residence State if to do so he would have to realise assets pregnant with gains.

Remittance rules and Business Investment relief

Provided that the investment comprises clean capital accumulated during Stage one, there will be no UK tax consequences on bringing the funds in the UK. In the opposite scenario, where the investments consist of foreign untaxed income and gains made after the date of first becoming UK tax resident, these will constitute remittances, on which the investor will be taxed at his applicable income tax rate. HMRC explain the meaning of remittance in part RDRM33140 of its Residence, Domicile and Remittance Basis Manual (http://tinyurl.com/RDRM33140).

Individuals who choose security over higher returns might prefer UK Government gilts, which can also be tax advantageous — there is no UK capital gains tax on their disposal and the coupon can be structured in a way that does not attract interest taxation when paid to non-UK tax residents. Also some gilts are exempt assets for UK inheritance tax purposes. Others invest through international banks that form a balanced portfolio of low risk quoted securities. UK-resident taxpayers are taxed on dividends they receive and gains derived from disposals. These methods are preferable for individuals with large amounts of clean capital that they can bring and invest in the UK without any tax consequences.

Investors with non-UK income and gains that will be taxed on remittance to the UK and who are not averse to risk might instead buy shares of UK trading unquoted companies or provide the funds to such companies as loans. The only limitation is that the companies cannot be mainly engaged in property investment, property management or property development, although it does not prevent investment in, for example, construction firms, manufacturers or retailers who own their own premises.

If they satisfy terms of the business investment relief (http://bit.ly/1wq9Wj6) the invested amounts shall not be treated as remittances and shall not be liable to UK tax. There are additional income tax and capital gains tax reliefs such as EIS, SEIS and VCT intended to encourage investment in the shares of unquoted trading companies. Finally, if the investor is appointed director or taken on as an employee of the company in which he has invested, he might be able to receive a substantial reduction on futuredisposal of its shares under the terms of the ‘Entrepreneurs’ Relief’ where the personal tax rate may be 10% on gains made.

Thus pre-arrival tax planning for a Tier 1 investor is a complex matter that should be done prior to finalising immigration plans. Future migrants should consider their medium to long-term planning strategy, which includes residence planning, creation of clean capital and acquisition of assets in the UK.

Real Estate Tax Exemption Issue Muddied Again

Articles, Food/Drugs/Healthcare/Life Sciences, Latest News, Real Estate and Construction, Tax,

On December 23, 2014, the Commonwealth Court of Pennsylvania logged another frustrating mile down the confused and confusing road of property tax exemption for purely public charities.  In Fayette Resources, Inc. v. Fayette County Board of Assessment Appeals, the Court overturned a lower court finding that an operator of group homes for intellectually disabled adults satisfied the requirements for tax exemption as a “purely public charity.”  The Commonwealth Court held that Fayette Resources failed to show that it satisfied the second requirement of the so-called HUP test (declared in Hospital Utilization Project v. Commonwealth, 487 A.2d 1306 (Pa. 1985)) — that it donate or render gratuitously a substantial portion of its services.

While this opinion may be viewed simply as Fayette Resources failing to make an adequate record below, the case also illustrates the confusion created by the Pennsylvania Supreme Court’s decision in the 2012 Mesivtah case, Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals, 44 A.3d 3 (Pa. 2012), which held that non-profit entities must satisfy both the statutory requirements of the Purely Public Charity Act (“Charity Act”), codified at 10 P.S. 371-385, and the court-established HUP test.

When the HUP test was developed by the Supreme Court in 1985, there was no statute implementing the charitable exemption for “purely public charities” under Article VIII, Section 2(a)(v) of the Pennsylvania Constitution.  When the Charity Act was passed in 1997, however, the legislature filled that void, and created what should be the standard against which such questions are evaluated, unless the statute itself is declared unconstitutional either on its face or as applied.  Instead, in Mesivtah, the Supreme Court required that entities meet both tests, which can lead to inconsistent results, as occurred here.

The Commonwealth Court recognized that Fayette Resources “satisfies all of the statutory requirements imposed by the Charity Act”; nevertheless, it overturned the exemption because it found that an element of the HUP test was not met.

Even apart from the dual standard itself, it is  troubling that Fayette Resources, which provides staffed homes for the intellectually disabled (who are legitimate subjects of charity), is exempt from federal taxation, relieves the government of the duty and burden to care for the intellectually disabled and has no private profit motive, was found not to have established its entitlement to a real estate tax exemption because it did not show that its costs exceeded its revenues.  This rationale appears to conflict with the evidence that Fayette Resources is compensated by Medicaid payments, that any surplus revenues are directed back into acquisition or fixing up of group homes and that distribution of any funds for a private purpose is prohibited by the organization’s by-laws.

Is the Court saying that an entity must lose money on a consistent basis to be entitled to a real estate tax exemption?  Must it solicit charitable contributions to establish its claim?  These are the types of questions the legislature answered in the Public Charity Act.  The Supreme Court’s, and here the Commonwealth Court’s, insistence on applying the less detailed, court-established standard of the HUP test in addition to the Public Charity Act standards only creates confusion and additional costs to charities who must repeatedly litigate the vagaries of the HUP test — the very result the legislature attempted to avoid.

Moving to the UK from France

Articles, Immigration, Latest News, Tax, , ,

Some statistics rank London as the fourth largest ‘French’ city by population, and the number of French individuals moving to the UK is growing. This is not surprising – the UK offers a highly favourable tax regime for ‘non-domiciled’ individuals moving to the UK, while entrepreneurs, professionals and high net worth individuals in France are subject to tax rises.

However, crossing the Channel is not always plain sailing. Without careful planning, individuals moving to the UK may continue to have French liabilities and may not be able to take full advantage of the UK’s favourable regime.

In this briefing note we set out ten key tips and traps which should be considered as part of any plan to move to the UK. Charles Russell Speechlys’ Private Client tax specialists in London and Paris are ideally placed to advise individuals considering such a move.

Make sure you cease to be resident in France

This requires more than boarding the Eurostar at the Gare du Nord. Breaking French residency also does not simply mean spending less than six months of the year in France. You also need to take steps to demonstrate that your home has moved from France to the UK, and that your centre of personal and economic interests has moved. Factors that will be taken into account for these tests include where you have property available for your use, where your spouse and children are living, from where you manage your assets, where is your wealth mainly located, where you hold bank accounts and where your statements are received, for example.

Make sure you become resident in the UK

Similarly, you cannot assume that stepping off the Eurostar at St Pancras will cause you to be UK tax resident. The UK has a complex residence test, which is broadly based on the interaction between the number of nights spent in the UK and other connections with the UK. The UK tax year runs from 6 April to 5 April and if you arrive towards the end of a tax year, you may find that you will not meet the conditions to be regarded as UK resident during that year. Conversely, in other circumstances you may arrive part of the way through the year and find that you are treated as having become resident from 6 April. Detailed advice is essential.

Structure your accounts to take advantage of the UK remittance basis of taxation

UK residents are generally liable to tax on their income and gains on a worldwide basis. However, non-domiciled individuals (those who come from outside the UK

and do not intend to make the UK their permanent home) can choose to pay tax on the remittance basis. This means that they are only liable to UK tax in respect of their non-UK income and gains to the extent that they “remit” (ie bring) such funds to the UK.

Complex rules determine the tax treatment of remittances to the UK from “mixed” funds, ie non-UK accounts containing a mixture of capital, income and capital gain. By setting up a series of non-UK bank accounts in the correct manner, UK resident non-domiciliaries can ensure that their foreign income and gains remain outside the UK, while “clean” capital which is not subject to tax can be used for UK expenditure. If implemented correctly, this can enable UK resident non-domiciliaries to live in the UK at a very low tax cost.

Review investments and investment wrappers

Many French residents hold investments through an assurance vie, ie life insurance “wrapper”. The UK has a special regime for the taxation of life insurance products. Unless the policy has been designed with UK tax rules in mind, it is likely to be taxed as a “personal portfolio bond” meaning that policyholder will be subject to highly punitive tax charges in respect of gains which are deemed to arise on an annual basis. Individuals holding such policies should consider encashing them on arrival in the UK, or altering the terms to make them UK compliant.

More generally, certain directly held investments may receive unfavourable UK tax treatment. For example, gains realised on the disposal of “non-reporting” funds (including hedge funds and most non-UK collective investments) are subject to income tax rather than lower capital gains tax rates. It is advisable to review investment mandates in light of UK tax considerations.

Consider the French exit tax

Individuals holding shares giving a right to 50% of a company’s net profit or with a global value exceeding € 800,000 are subject to an exit tax in respect of unrealised gains, on ceasing French residence. The tax is automatically deferred if you move to another EC country such as the UK, but will be crystallised if certain triggering events occur within 15 year such as leaving the EC or, sale of the shares.

It may be possible to restructure a shareholding in a family business through a non-French holding company in order to mitigate the consequences of the exit tax for a future sale of the business. This might involve establishing a Luxembourg holding company having sufficient substance, which we can implement through our Luxembourg office.

Check company directorships

If you are a director of a non-UK company, then there may be a risk that following your move to the UK, the company could be regarded as “managed and controlled” in the UK and thereby subject to UK corporation tax. Even if you retire as a director, you could still be treated as a “shadow director” if the board

acts in accordance with your instructions. It is essential that corporate structures are reviewed carefully to protect against this risk.

Protect UK real estate from inheritance tax

London property is expensive, and the purchase of a property is often easily the single largest item of expenditure by individuals moving to the UK. UK property is subject to 40% inheritance tax on death and so the tax bill can prove costly. There are, however, opportunities to structure the purchase of a property in such a way that its value is protected from inheritance tax. It is essential to take advice before the purchase because the opportunities for tax mitigation are severely limited once a property has been bought.

Review marriage contracts

A French marriage contract will not generally be respected in English divorce proceedings. In certain circumstances, the starting point for the division of assets between a couple in the English divorce courts will be a 50/50 split. Our Family team can advise on putting in place a “mid-nuptial” agreement to protect your assets.

Put in place a Will

If you acquire property in the UK, you should put in place a suitable Will to ensure that it will pass to your chosen heirs smoothly and in a tax efficient manner.

Your move to the UK may also have implications for your estate outside the UK. From August 2015, an EU regulation will alter succession laws in France. The operation of this regulation is not straightforward but, broadly, it could result in English law governing the disposition of your French assets, if you are resident in the UK at the time of your death. It is therefore important to review your estate planning, following moving to the UK.

Don’t forget France when estate planning

Much tax and estate planning in the UK involves trusts. However, trusts can have very disadvantageous consequences where assets or beneficiaries in France are involved. A typical UK estate plan might result in punitive tax charges for French heirs or in relation to French assets. Estate planning needs to have regard to both the French and UK systems.

Tax Information Exchange Agreements (“TIEAs”

Articles, Latest News, Tax

Introduction

Tax Information Exchange Agreements (“TIEAs”) provide for the exchange of information, on request, in respect of specific criminal or civil tax investigations.1

Since 2001 the Cayman Islands has signed over 30 bilateral agreements and arrangements of this kind which serve to promote the jurisdiction as an internationally co-operative jurisdiction on tax related matters and have earned the Cayman Islands a well-deserved place on the OECD “White list”.

The Tax Information Authority Law2

The Tax Information Authority Law (2013 Revision) (“The Law” or “TIAL”) is the principal legislation which enables the provision of tax information to other countries.3 The Law was first introduced in 2005. It has undergone several revisions and the current version is dated 2013.

The TIEAs entered into between the Cayman Islands and foreign states are scheduled in the latest revision of the Law. These agreements are modelled on the format created in conjunction with the OECD Global Forum on Taxation.

Prior to the Law, the Cayman Islands had already entered into a TIEA with the United States (in 2001). This provided for information exchange relating to criminal tax matters from 2004 onwards and civil matters from 2006. It did not require a dual criminality test. The Cayman/US TIEA was updated in 2013 further to the Cayman US Intergovernmental agreement in relation to the US Foreign Account Tax Compliance Act (“FATCA”) which is beyond the scope of this paper and for which further guidance can be found in a separate Samson & McGrath client advisory. The Cayman Islands also maintains a Double Taxation Agreement with the United Kingdom.

Tax Information Authority

The Cayman Islands Tax Information Authority (“the Authority”) is part of the Ministry of Financial Services, Commerce and Environment. It is designated by the Law as the competent authority for international co-operation on matters involving the provision of tax related information.

“The overriding objective of the Tax Information Authority is to carry out the lawful and effective implementation of Cayman’s international cooperation arrangements in tax matters.”4

The Authority has responsibility in the areas of:

  1. Tax information assistance under the Law; and
  2. Reporting of savings income information under the reporting of Savings Income Information (European Union) Law.

These responsibilities are governed by separate statutory schemes and this paper in concerned with the former activities only.

Functions

The Authorities statutory functions include5:

  1. Executing requests for tax information;
  2. Ensuring compliance with the Law and international agreements for the provision of tax information;
  3. Making costs determinations in relation to requests; and
  4. Entering into operating arrangements with, or issuing operating procedures to, counterpart competent authorities.6

Scope of assistance7

The Law provides for assistance generally in relation to criminal and non-criminal tax investigations but specifically provides for:

  1. The taking of testimony;
  2. The obtaining of information;
  3. Service of documents;
  4. Executing searches and seizures; and
  5. Interview and examination, by consent, of taxpayers of the requesting country who are in the Cayman Islands

The bilateral agreements and the schedule in relation to each country specify taxes covered and operative dates.8

Definitions

“Information” means any fact, statement, document or record in whatever form;

and includes –

  1. any fact, statement, document or record held by banks, other financial institutions, or any persons, including nominees and trustees, acting in an agency or fiduciary capacity; and
  2. any fact, statement, document or record regarding the beneficial ownership of companies, partnerships and other persons, including –
    1. in the case of collective investment funds, information on shares, units and other interests; and
    2. in the case of trusts, information on settlors, trustees and beneficiaries

“Taxation matters” includes matters relating to the collection, calculation or assessment of a tax referred to in a scheduled Agreement or specified in a Schedule to the Law under section 3(6)(a)(iii) or matters incidental thereto.

“Proceedings” means civil or criminal proceedings;

Procedure for making a request: Standard format9

All requests must be made in English and in the following standard format:

  1. The nature of the request
    • New or supplementary request;
    • Criminal or non-criminal tax matter; and
    • Whether seeking information for proceedings or related investigations
  2. The purpose of the request
    • Whether it is for testimony, information, permission to interview and examine in the Cayman Islands or whether for ancillary purposes
  3. The identity of the person who is the subject of the request, the taxable periods to which the request relates and the tax purpose for which any information is sought
  4. Detailed statement of basis of request
  5. Full specification of the information being sought by the request
  6. Statement of reasonable grounds for believing the information requested is present in the Cayman Islands or is in the possession or control of a person subject to the jurisdiction of the Cayman Islands.
  7. The name and address of the person believed to be in possession of control of the information
  8. An undertaking that all information provided in relation to the request will be kept confidential
  9. A declaration that the request conforms to the law and administrative practice of the requesting jurisdiction and that the information would be obtainable by that jurisdiction under its laws in similar circumstances for its own tax purposes.
  10. Confirmation that all available legal channels have been pursued in its own territory
  11. An undertaking not to disclose the requested information to any third party without consent of the competent authority.

Declining a request

The Authority has the power to decline a request for information if the criteria above is not adhered to, for example, where the requesting party would not be able to obtain such information in its own country.

Furthermore, if the requested information may divulge a trade or business secret, the Authority may refuse to supply the information. In addition, the Authority can decline information where such information is in the form of communications between client and attorney and is therefore subject to legal professional privilege.

Confidentiality10

All information provided and received by the competent authority, including requests and other formal notices and documents, or any other communications relating to request, are confidential to the respective competent authorities.

The competent authority may impose conditions of confidentiality on any person who is notified of the request or involved in its execution, and, in requests involving criminal proceedings, disclosure is prohibited by law. Breach of such confidentiality attracts criminal penalties.

The competent authority can approve the onward transmission or further use of information or evidence provided in response to a request by the competent authority of the requesting country.

Confidentiality may not be claimed against the production of information to the competent authority and no civil or criminal liability attaches to the person providing the information in respect of the production of information to the competent authority.

Execution of request

Once a request is determined by the Authority to be in compliance with the Law and relevant TIA, the Authority is obliged to execute the request in accordance with the Law and any such Agreement.

The Authority has the power to seek additional information to assist in executing the request, to certify requests as compliant and has general power to deal with all information brought to it in accordance with the Law.

Depending on the nature of the request, the Authority may issue a formal notice to produce information or make an application to a Judge for an order to produce information. In cases requesting the taking of testimony, the Law requests the Authority to apply to a Judge and for the Judge to receive the testimony of the witness.

Obligation of confidentiality or other restrictions on disclosure do not prevail against a request for information. Legal privilege does apply.

There exists a tipping off offence in the case of requests in criminal tax matters.

Where a Judge has made an order to produce information, the Authority has power to seek further orders to allow a constable access to premises where the information may be held.

MH Investments v the Cayman Islands Tax Information Authority11

This case concerned a legal challenge to a decision of the Authority to provide documents in response to requests from the Australian Tax Office. The decision provides guidance on how the Authority should treat requests for information, the application of the Law (including its interaction with the Confidential Relationships (Preservation) Law (“CRPL”)) and serves as a reminder that the decisions of the Authority may be judicially reviewed by the Cayman Islands Grand Court.

The litigation concerned a TIEA which the Cayman Islands and Australia entered into and which came into force on 14 February 2011. The TIEA allowed for the sharing of information in respect of taxable periods commencing 1 July 2010.

Whilst a detailed examination of the decision is beyond the scope of this paper, it should be noted that the applicants applied to the Grand Court seeking judicial review of the actions of the Authority and seeking declarations that the Authority had failed to observe the requirements of the Law and had acted unlawfully. In short, the Court granted the plaintiff’s application, quashed the decision of the Authority and ordered it to revoke its consent to the Australian Authority and ordered the return of the unlawfully provided information.

Striking the right balance

Notwithstanding the internationally recognized measures which have been put in place since 2001, the Cayman Islands recognizes that investors and financial institutions are entitled to privacy in the conduct of their private affairs. With this in mind, the Islands continue to strike a careful balance between legitimate client confidentiality and reasonable international transparency.

Fishing expeditions are not permitted and information is only exchanged in response to specific requests which are in compliance with the strict statutory criteria. Various protections and safeguards are built into the Law and these standards will be enforced by the Cayman Islands Grand Court.

The Law will also be interpreted and applied in accordance with the Cayman Islands Bill of Rights which came into force on 6 November 2012. Such rights include respect for private and family life in similar terms to the equivalent articles of the ECHR and UK Human Rights Act thereby placing necessary and proportionate limits upon disclosure.12

List of bilateral agreements

A full list of agreements can be accessed on the TIA website: www.tia.gov.ky

Footnotes

1. www.oecd.org

2. TIAL (2013 Revision) Section 4

3. Guide to the Tax Information Authority Law (as revised)

4. Tax Information Authority, Publication Scheme, 2009.

5. TIAL (2013 Revision) Section 5

6. www.tia.gov.ky

7. TIAL (2013 Revision) Section 9

8. Guide to TIAL March 2009

9. TIAL (2013 Revision) Section 11

10. TIAL (2013 Revision) Section 13

11. Cause No G391/2012, Quin J, 13.9.2013

12. See MH Investments (ibid)

Blurred Lines: The Shifting Position Between Lawful Tax Avoidance & Unlawful Tax Evasion

Articles, Fraud & White Collar Crime, Latest News, Tax

1. The traditional attitude to tax avoidance is encapsulated in the judgment of Lord Tomlin in the English case of IRC v Duke of Westminster (1936):

“Every man is entitled if he can to arrange his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure that result, then, however unappreciative, the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax”

2. Whether this principle has survived in practice into the present era is a matter of speculation. In the last five years, there has been a growing tendency to conflate the two hitherto distinct concepts of avoidance and evasion together.

THE BOUNDARY WITH UNLAWFUL EVASION

3. Lawful tax avoidance becomes unlawful tax evasion where there is deliberate and dishonest making of false statements to the Revenue (whether written or not and whether by omission or positive act). Tax evasion is often prosecuted under the English common law offence of cheating the public revenue. Cheating the revenue can include any form of fraudulent conduct which results in depriving the Revenue of the money to which it is entitled. To be fraudulent conduct, the Defendant’s conduct must deliberately prejudice, or risk prejudicing, the Revenue’s right to the tax in question, while the Defendant knows that he has no right to do so.

FRAUDULENT CONDUCT

4. Typically, fraudulent intent on the part of a taxpayer or professional adviser is demonstrated where there is evidence of collusion between the taxpayer and others, or there is evidence that documents have been forged, with the intent of deceiving HMRC.

5. Many tax avoidance arrangements fail on technical grounds because they are artificial, lack a sufficient degree of commerciality and/or have been poorly implemented. Where an avoidance strategy fails in these circumstances, taxpayers and their professional advisers will not necessarily have acted fraudulently. More often than not, the conduct is characterised by a failure to implement the terms of the arrangement as advised rather than deliberate fraud.

6. Cases where there has been fraudulent conduct are distinguishable from cases where a tax avoidance arrangement has failed on technical grounds. Failed tax avoidance will only amount to criminal tax evasion where the taxpayer or professional adviser acted dishonestly, or fraudulently, in their dealings with the Revenue.

DISHONESTY

7. Dishonesty, as a touchstone for criminal tax evasion, has two elements:

Objective dishonesty: Firstly a jury must first of all decide whether according to the ordinary standards of reasonable and honest people what was done was dishonest.

Subjective dishonesty: The jury must consider whether the defendant himself must have realised that what he was doing was, by those standards, dishonest.

8. If the jury finds what was done was not objectively dishonest, that is the end of the matter but if the jury finds it was objectively dishonest it is then necessary to consider whether it was also subjectively dishonest.

9. In other words, it is dishonest for a defendant to act in a way which he knows ordinary people consider to be dishonest, even if he claims he genuinely believes that he is morally justified in acting as he did.

10. A jury’s perception of what is honest or dishonest conduct has shifted dramatically in the last five years. That poses a considerable risk to a taxpayer who may have entered into a tax avoidance arrangement some years ago and there is a determination that the avoidance has failed due to artificiality or shoddy implementation such as not signing documents, back-dating documents, not making interest or capital repayments on loans or not devoting time to the loss-making activity in respect of which a tax deduction is claimed.

11. Will a jury give the taxpayer the benefit of the doubt that he did not appreciate what he was doing was dishonest by the standards of ordinary people?

PUBLIC PERCEPTIONS OF AVOIDANCE AS EVASION

12. Juries live in an atmosphere which is increasingly hostile even to the idea of tax avoidance. Erstwhile law-abiding individual and corporate tax avoiders are frequently publicly vilified in the media and by the authorities as morally repugnant and enemies of the public good. Senior government ministers include ‘evasion and avoidance’ in the same breath and the practice of tax avoidance/evasion at the top of the income scale with benefit fraud at the bottom. Further, while the UK’s new GAAR is said to be directed at tackling ‘abuse’ rather than ‘avoidance’ the threshold of what is considered to be an abusive tax arrangement appears from the official guidance to be astonishingly low.

NO SAFE HARBOURS

13. Jersey professionals and taxpayers should also note that section 13 Indictable Offences Act 1848 provides that an English arrest warrant may be executed against a taxpayer or professional advisor in Jersey who may be arrested and conveyed back to England to face trial or prison.

JERSEY

14. While the Jersey courts have stated that they have no sympathy for unlawful tax evasion, Commissioner Bailhache, when Bailiff, stressed that in cases of tax avoidance “Leviathan [a reference to the tax authorities] can look after itself”, a position much closer to that espoused in Duke of Westminster.

15. However, Jersey has been keen to signal its cooperation with the UK government in tackling what it perceives to be a problem with offshore evasion and aggressive avoidance. Jersey clearly has an interest in being perceived as a reputable jurisdiction in which to conduct legitimate business. With that in mind, the Jersey government is currently consulting with the Island’s finance industry on the viability of a so called ‘Sniff test’ to identify “aggressive tax avoidance schemes”, association with which would be “detrimental to the good reputation of the Island”. What the authorities propose to do when the ‘Sniff test’ is failed and how that action would stand up to scrutiny remains to be seen.

DIRECTION OF TRAVEL

16. The attitude of the UK authorities and public perception has hardened against tax avoidance in the last five years. That has implications both for the authorities’ willingness to bring charges and the benefit of the doubt juries are prepared to give to taxpayers and professionals. There is a heightened risk that tax avoidance schemes that fail for artificiality, poor implementation or lack of commerciality will be perceived as tax abuse or worse, evasion.

17. The attitude in Jersey to tax avoidance has been more generous than is currently the case in the UK. However if the reputation of the island as a financial centre is threatened by the perception that it is a safe harbour for unacceptable tax avoidance schemes we can expect measures to counter that perception. The message is watch this space.

Tips For Midyear Tax Planning

Articles, Latest News, Tax

Tax-saving strategies take time to implement, so it is important to not wait until the end of the year. This blog offers several midyear strategies for individuals to consider,  including reducing taxable income, modified adjusted gross income (MAGI), and/or net investment income; contributing to retirement plans; and planning for medical expenses.

In the quest to reduce your tax bill, year-end planning can only go so far. Tax-saving strategies take time to implement, so review your options now. Here are several midyear strategies to consider.

Consider Your Bracket

The top income tax rate is 39.6% for individuals with taxable income over $400,000 ($450,000 for joint filers). If you expect this year’s income to be near the threshold, consider strategies for reducing your taxable income and staying out of the top bracket. For example, you could take steps to defer income and accelerate deductible expenses.

You could also shift income to family members in lower tax brackets by giving them income-producing assets. This strategy will not work, however, if the ” kiddie tax” applies. That tax applies the parents’ marginal rate to unearned income (including investment income) received by a dependent child under the age of 19 (or age 24 for full-time students) in excess of a specified threshold ($2,000 in 2014).

Look at Investment Income

This year, the capital gains rate for taxpayers in the top bracket is 20%. If you have realized, or expect to realize, significant capital gains, consider selling some depreciated investments to generate losses you can use to offset those gains. It may be possible to repurchase those investments, so long as you wait at least 31 days to avoid the ” wash sale” rule.

Another tax that higher-income investors need to be concerned about is the 3.8% net investment income tax (NIIT). It applies to taxpayers with modified adjusted gross income (MAGI) over $200,000 ($250,000 for joint filers). The NIIT applies to your net investment income for the year or the excess of your MAGI over the threshold, whichever is less. So, you can lower your tax liability by reducing your MAGI, reducing net investment income or both.

Contribute to Retirement Plans

Deductible contributions to traditional IRAs and pretax deferrals to employer-sponsored retirement plans like a 401(k) plan save taxes in a variety of ways. First, they reduce your taxable income, and thus your income taxes, for the current tax year.

Second, they reduce your adjusted gross income (AGI) and MAGI, which not only can reduce or eliminate your exposure to the NIIT, but also can help you reap maximum benefit from various tax breaks. The benefit of many deductions and credits is reduced if your AGI or MAGI falls within certain ranges or exceeds certain levels. For example, in 2014, if your AGI exceeds $254,200 (singles), $279,650 (heads of households) or $305,050 (married filing jointly), many of your itemized deductions will be reduced and your personal exemption reduced or even eliminated.

Third, traditional IRAs and employer-sponsored retirement plans grow tax-deferred. So you pay no tax as long as the funds are in the account, which reduces your taxes for years to come. Plus, tax-deferred compounding can help your investments grow more quickly. When you start taking distributions in retirement they will be taxable, but if you are not working, you may be in a lower tax bracket.

Plan for Medical Expenses

Beginning last year, the threshold for deducting medical expenses went up from 7.5% of AGI to 10% of AGI (unless you are age 65 or older). You can deduct only expenses that exceed that amount.

One way to save taxes, even if your expenses do not exceed that amount, is to contribute to a tax-advantaged health care account, such as a Health Savings Account (HSA) or a Flexible Spending Account (FSA). Contributions are pretax or tax-deductible, and withdrawals used to pay qualified medical expenses are tax-free. Many rules and limits apply, however.

If an HSA or FSA is not an option or will not cover all of your medical expenses, take a closer look at the medical expense deduction. Deductible expenses may include health insurance premiums (if not deducted from your wages pretax); long-term care insurance premiums (age-based limits apply); medical and dental services and prescription drugs (if not reimbursable by insurance or paid through a tax-advantaged account); and mileage driven for health care purposes (23.5 cents per mile driven). You may be able to control the timing of some of these expenses so you can bunch them into every other year and exceed the applicable floor.

Get a Head Start

These are just a few ideas for slashing your 2014 tax bill. To benefit from midyear tax planning, consult your tax advisors now. If you wait until the end of the year, it may be too late.