Worldwide: So what exactly is international tax planning? Is this practice illegal?
Author: George Schizas (Genshape Management Limited)
Well, as most matters on human universe have two sides ‘the good and the bad’, tax planning has its own good ‘the tax avoidance scheme’ which is perfectly legal, and the bad ‘tax evasion scheme’ which is illegal in terms of law.
From the beginning of 20th century many court cases took place in many industrial countries (USA, Germany, UK) and as summary the main outcome was that ‘every person or a legal entity in this planet has the right and duty to take reasonable steps to protect their assets using legitimate ways’.
That said, for an investor, the key to exploit this right and avoid unnecessary cost (taxes), is to pro-actively plan and assess exposure to tax authorities.This is a recurrent process performed every time when conditions change.
The rise of internet and electronic communication push tax authorities to their limits, since more people are taking advantage of this right. Anyone may established a company in every jurisdiction around the world and exploit the tax systems in place.
There are two possible ways to own or control an assets. This can be done either directly or indirectly. For a small amount value of assets such as car is more beneficial to own the asset directly but for larger value items such as the shares in a company it would be better off if the control is exercised indirectly. The reason for this is simple, why paying 30% on capital gains on the disposal of those shares when you have the option to invest or spend that 30% somewhere else.
For example, considered that you own a house of US$1.000.000 and you want to sell it. You have to go to the land registry taxes and in addiction declare those gain to your annual tax return. On the other hand you can established a company as an intermediate and let that company being taxed on those gains or the best way is to establish two or even three entities in suitable jurisdiction and sell the shares of those companies to prospective buyers. The most important part is that you will not go again to the land registry and you have transfer the house to the new owner.
Tax regimes around the world
Every jurisdiction must made a choice on how the tax system will be function. As always a system may function either on one way or another. The one way would be a person or a legal entity would be taxed at the jurisdiction which is a tax resident on its worldwide income. Worldwide income means the net profit for example of a shop based in Netherlands of a UK company. The profits earned in Netherlands will also be taxed in UK.
The other way around is that a company would be taxed on its income if that income derived from economic activities at the place which is a tax resident. For example if a Luxembourg based company has a factory in France it will not be taxed in Luxembourg if no sales are made there.
Now, having established the first layer of tax system, the following step is to assess on what income each jurisdiction is effectively levy with tax.
There are numerous ways on how tax authorities can set-up their system to work.
As with previous example the one way is to effectively tax a specific source of income at a rate above 0%.
Double tax treaties are used to minimise taxes around the world and restrict the twice taxation of profits in one country and to another. The most common elements included in tax treaties are the dividends, royalties and interest income. In some cases it will beneficial to use finance a subsidiary or a group of assets using a loan agreement whereas in other cases it would be better to subscribe for share capital.
In regards to royalties, special consideration needs to be given since the importance of them are now realised even more. Most obvious example was the consideration given by the USA and an innovate policy applied to include intangible assets as part of GDP from the end of 2013.
The 21st century will position intangibles assets as a must priority for corporation. In a world where everything are going to be green, most of the information will be held in electronic form. This especially important for big corporation and that is the principle on why big companies step up the competition to acquire and protect these assets.
Bill Gates the founder of Microsoft once said that the biggest asset of a corporation are not shown in the Statement of Financial Position. This is especially true for intangibles mainly because of the complex legal framework and the difficulty to for the innovator to show back to the remaining public that he/she actually has create something.
Google is a notable example as its business model is mainly in electronic forms.
Another issue on royalties is the fair value of these patents. When a valuation is performed for intangible, the person takes into account the net amount future cash flows. This calculation also includes tax expense. Imaging trying to sell a patent and a considerable percentage of its value to be wasted due to tax, which can be minimise by an effective tax structure.
This article first appeared on mondaq.com.