Tax Break

John Fisher, international tax consultant

Archive for the month “January, 2012”

Sorry, wrong number

The first to hit the catwalk at the Miss World Tax beauty contest that spanned year-end was Lady Justice New Zealand with a December 12 landmark tax avoidance decision. Following close  on her high-tax heels on December 19 was Lady Justice Canada with an insight into the application of the General Anti-Avoidance Rule and  only a day later Lady Justice Denmark strutted along with her first Beneficial Ownership Case. But the most stunning of them all exploded onto the runway on January 19 with all the self-confidence of an odds-on favorite.

Lady Justice India’s Vodafone case has eclipsed just about everything else in the international tax world over the last ten days. “Her justice system has been gloriously vindicated,” her sponsors effused, omitting to mention that the Supreme Court had just totally laid waste a number of orders of the Bombay High Court at the end of a four and a half year legal battle that had cost countless rupees and substantially any remaining goodwill towards the Indian taxation system. A closer inspection, following removal of the Lady’s blindfold, revealed two heavily bruised eyes.

I do not propose to delve deeply into the details of the case which has received wall-to-wall coverage (if you have a free evening, google: india, vodaphone, supreme court, duh-which-words-in-the-law-didn’t-you-understand-?) but , in a nutshell, for those who have been more concerned with trifling matters such as Iranian sanctions and the US election it went like this:

A Cayman Island subsidiary of  the Hong Kong based Hutchinson Group sold its shares in another Cayman Island company to a Netherlands subsidiary of the UK based Vodafone group. It just so happened that somewhere way down the chain under the purchased Cayman Island company was an Indian company with a gargantuan Indian mobile phone business. The Indian tax authorities were not terribly pleased that they had missed the chance to tax Hutchinson on the capital gain on sale of the Indian business that they claimed would have applied had the Indian company been sold directly (but that is a whole new story that we will not go into here), so decided to slap a $2.5 billion tax bill on – wait for it – Vodafone, for not having withheld the required Indian tax when paying for the Cayman company.

Now, for people like me with warped tax-drugged minds this did not, when the case originally saw the light of day, come over as quite as moronic  as it must sound to normal human beings who do not drool at the mouth. An albeit diminishing number of countries do still allow the taxation of the sale of indirect holdings in their jurisdictions and, indeed, the strict enforcement of withholding tax obligations on a payer, including criminal penalties for non-compliance, is regularly a cornerstone of, at least domestic, tax collection policy. 

The problem is that, now that the dust has settled, clearly none of this applied to India. The judgment was quite simple really – every single one of the tax authorities’ claims was rejected and the orders of the Bombay (should that, politically correctly, be Mumbai?) High Court were emphatically overturned. I am no expert in Indian tax law but, reviewing the Supreme Court decision, it did seem to be almost a case of just joining up the dots. The tax authorities  may be forgiven  (although I would not agree)  for begrudging $2.5 billion slipping between their fingers but I fail to begin to  understand what happened in the Bombay (Mumbai) High Court.

Who needs foreign investment, anyway?

There are several reasons why India is a highly favored location  for investors today. None of them relate to taxation or the legal system. The tax system is antiquated and rates are too high. The proposed new Direct Tax Code leaves much to be desired. Bureaucracy is horrendous and, as Vodafone discovered, even the Bombay/Mumbai High Court couldn’t  be relied on to get it vaguely right.

In his award-winning novel “Midnight’s Children”  set around  India’s first thirty years of independence Salman Rushdie’s  hero, Saleem Sinai, says “No people whose word for ‘yesterday’ is the same as their word for ‘tomorrow’ can be said to have a firm grip on the time”.  In case nobody noticed – “The times they are a-changin’ “. It is evident that there is still much work to be done.

L’entente cordiale?

De Gaulle once told Churchill’s wife Clementine, “France has no friends, only interests”. This could have been the motto for his great creation, the Fifth Republic or – for that matter – the Fourth, Third, Second or First. Nicolas Sarkozy is at it again.

Spurred on by the threat of his presidency being guillotined at the French elections later this year, Sarkozy has been in the driving seat, with  Angela Merkel riding shotgun , in pushing for the imposition of a Financial Transactions Tax, popularly known as the Tobin Tax, across  the European Union. So obsessed has he become with the idea that he even suggested earlier this month that France would consider going it alone to get the ball rolling which was remarkably un-French  given that it would spell untold suffering for the French financial sector. Not likely.

The realistic proposal for an FTT that would, in Sarkozy’s (and Merkel’s) view,  ideally include all 27 EU members is far more French – let the surgeon inflict a little pain on the French (and German) patient  while performing major surgery without anesthetic on the British one. Let me explain.

The Tobin Tax, a miniscule tax on the value of spot foreign exchange transactions, was first mooted in the 1970’s by Nobel Laureate James Tobin  as a means of calming the volatility of exchange rate movements arising from massive numbers of speculative transactions.  The idea did not immediately find traction but, with the global financial crisis of 2008 and the widespread demand for the public disemboweling of bankers and punitive reparations from the banking system, it received a major boost – this time with the express purpose of raising revenue.

With London at the epicenter of the financial world, the British government had to tread carefully and, along with a string of new major regulations, expressed support for the FTT if it was applied on a truly worldwide basis. Egged on by the French (and Germans) the European Commission issued a Council Directive Proposal in September 2011 for an EU-wide tax of 0.1% on stock and bond deals and 0.01% on derivative contracts between financial firms irrespective of what the rest of the world decided to do. Conspicuously absent were spot foreign exchange transactions (the original raison d’etre for the tax) as they ran foul of the EU principle of the Free Movement of Capital.

Doomsday predictions were that there would be an exodus of banks and, because of London’s dominance, upwards of 70% of the tax cost would fall on the UK.  Faced with loss of business and a  tax which would directly fund the EU – and at least partly earmarked for bailing out the Eurozone countries that do not include the UK – Mr Cameron’s government’s flat refusal last December to buy in was understandable.

But beyond the headline catching spats between the leaders reservations about the FTT run deep. A report by the Institute of Economic Affairs, a prominent free-market think tank in the UK, cites an  EU Commission survey that concluded that a 0.1% tax would lead in the long run to a 1.76% fall in GDP (subsequently revised downwards)  – at the most crude level, the additional tax will result in less tax. In considering who bears the burden of this fall the report particularly criticizes the “cascading’ nature of the tax – that because it is imposed at the corporate level, and corporations not being human beings, cannot ultimately bear the cost, the true cost is borne by workers, shareholders and customers in a combination of lower wages, lower returns and higher prices. Adding to that the mobility of the business out of London the result is a global fall in GDP accompanied by a redistribution of jobs and income to non-European centers  (sprinkling a little of the London fall-out in  Frankfurt and Paris along the way) while placing funds directly in the hands of the European Commission to be doled out to recalcitrant Eurozone countries, thus saving the French (and Germans) a lot of dosh at the expense of the British.  Not on David’s watch, mes amis.

Mr Cameron, ostracized by his EU partners, has a tough time ahead but he can take heart from his most illustrious predecessor. “We shall fight on the beaches, we shall fight on the landing grounds, we shall fight in the fields and in the streets, we shall fight in the hills” was, arguably Churchill’s greatest speech. Delivered in the darkest days of World War II it drew its strength from the exclusive use of Old English  Anglo-Saxon words.  There was, however, one exception in the last line, taken from Norman French : “We shall never SURRENDER”. There is evidently no equivalent in Old English.

For tax advisor and country

"Tax Resident Kane" doesn't have the same ring to it

There is a framed football shirt hanging on my son’s wall. It is half blue, half white – the blue half sporting the insignia of the Israel Football Association and the white half the Three Lions of England. Scrawled in indelible marker across the English half is the inscription “Good Luck, Bobby Charlton” ( for the benefit of American readers -and absolutely NOBODY else on earth – Sir Bobby Charlton is to English football what Babe Ruth was to American baseball).

My son is part of an ever growing phenomenon in the modern global village- the dual citizen. The Economist ran an article last week questioning the continued relevance of citizenship as a basis for a person’s rights and responsibilities vis a vis a particular country given the almost ad hoc way in which citizenship can be acquired. The recommendation, in a world where the military draft is becoming increasingly rare, was for tax residence to supersede citizenship.

Hallelujah!  If you have been wondering what we international tax advisors  are going to do for a living when the European Union institutes the Common Consolidated Corporate Tax Base (CCCTB) and the US Congress adopts a Territorial Tax Basis – we are saved!  As soon as The Economist’s proposals are accepted by the world’s legislatures anybody wanting to do whatever citizens do in a country will need to prove  tax residence, and that means fees.

At a cursory glance the concept of residence looks fairly consistent internationally – many countries insisting that, if an individual spends over 183 days (six months in plain speech) within their borders, they are resident. But, as the Eagles said:  “You can check out any time you like, but you can never leave” – in addition to differing  applications of the 183 day rule between a single tax year and straddling two tax years, nation after nation traps individuals with further multi-year calculations  as well as a host of additional tests that point in only one direction – the national piggy-bank. Warring tax authorities are forced into the tie-breaker clause in the double tax treaty they hopefully concluded earlier and, given the subjective nature of some of the tests, they often end up fighting it out around a negotiating table.

What does all this mean for this brilliant alternative to citizenship? Fast forward to 2015. Giovanni, the Italian plumber we met a few posts back  who is now working under Single Market rules in the UK,  turns up at his local Town (City) Hall on March 15,  to register to vote in the upcoming  General Election. The clerk asks for proof of his days present in the UK since last April 5 (the potty fiscal year end there). Giovanni proves 200 days but the clerk, after calling the tax residence hot line,  points out that in calendar year 2014 he was probably still resident in Italy under Italian law since he was present there for 239 days in the calendar (fiscal) year, and, it was as yet unclear, whether he would be similarly classified in 2015 depending on future circumstances. He tells him to go and get a tax opinion. Giovanni, who despite being a plumber is not flush with cash, tells the clerk that he cannot afford an opinion. “In that case”, the clerk informs him, “We can approach the Italian authorities and institute Mutual Agreement Procedures under the tax treaty”. Being Italian, Giovanni has an inbred aversion to tax authorities, especially those he has not been reporting to for the last thirty years, so he scrams fast –  internationally disenfranchised.

Then there is  the situation of tax exiles. On the assumption that, as long as there is tax there will be tax exiles, in a world of economic growth their numbers are likely to increase. So it would seem quite possible that, in the foreseeable future, Monaco and Andorra could become so popular that one or both of them could claim a permanent seat at the United Nations Security Council.

World War III

Personally, if there is a need to change the current system, I would go for pledge of support to a national football team. When push comes to shove everybody only really supports one team and, although I have never asked my son whether he is for England or Israel, I do recall taking his older brother to an Israel v Argentina game in the early nineties with Diego Maradona playing (Americans -ask your friends). There was almost a riot between Argentine fans and Israeli fans – ironically the Argentinian contingent being made up almost exclusively of people who had fled the Junta in the early eighties and sought and found refuge in Israel.

And if you think there is anything trivial about the football idea, Bill Shankly,the legendary manager of Liverpool famously said: “Some people think football is a matter of life and death. I assure you, it’s much more serious than that.”

Lies, damned lies and tax rates

Romney 25%! Gingrich 12.5%! Santorum 17.5%! Perry 20%!

Remember the old Fair Ground game where you had to guess the number of candies in a jar? If you got the nearest number you won a massive, totally inflammable, furry toy that Mum and Dad refused to take home in the car but relented when they couldn’t find a big enough garbage can in the car park for the toy, and  – “If you will not stop crying” – you.

Well, the attitude to the corporate tax rate of the plethora of today’s New Hampshire Republican Nomination hopefuls  is looking remarkably similar. Pick a number, any number, that you think might be accepted as optimally serious by the  voting members of the GOP and your prize could be four years, rent free, in a massive house in Washington DC , lots of big cars and your own Boeing 747.

All the hype about the need to lower the tax rate to encourage entrepreneurship, competition etc. may have much to recommend it but, in an economy with colossal debt, a choice of plans that –  according to the Tax Policy Center of the Urban Institute and Brookings Institution – will result in a cut in annual federal tax revenue of between 16% and 35%,  demonstrates clearly that all the candidates have “slipped the surly bonds of earth… to touch the face of God”.

Although Mitt Romney has played it safest – which is comforting really, since he might one day actually have to translate some of this into policy AND walk around with the nuclear launch code in his head – there does not appear to be any clear reason why he chose 25% , while Rick Santorum just seems to have halved the current 35% rate to 17.5% and, the increasingly comical, Mr Gingrich chose 12.5% to pull in line with Ireland, presumably because that is where Ronald Reagan’s ancestors were born. At least Ron Paul, who took a stab at 15%, had the decency to also call for the demolition of the Fed (and, I believe at one point, the IRS) so that his voters are fully informed that their candidate is on another planet.

Ironically, not everybody on the right seems to think that corporate taxes are necessarily far too high. While headline rates are undoubtedly in the stratosphere (taking corporate tax and the tax on dividends when distributing profits to shareholders together, the US ranked 4th among the 34 members of the OECD), Bruce Bartlett, a policy advisor to various Republican presidents, pointed out in the New York Times last month that 90% of US businesses are run through S Corps and other tax transparent entities meaning that no corporate tax is paid, the income being taxed to individuals at a far more charitable overall rate. Furthermore, regarding the remaining  10%, he cites a report on “Corporate Tax Payers and Corporate Tax Dodgers 2008-2010” of Citizens for Tax Justice and The Institute of Taxation and Policy which claimed that ,while 25% of US companies paid close to the statutory rate of 35% , 25% paid less than 10% (with, even, negative tax in some circumstances) and the rest flopped about in between.

According to the report,  negative tax arose where companies had carried back losses to years when they had profits and received a refund of the tax paid. Effective tax rates had been depressed through : accelerated depreciation on assets ; certain deductions taken for the exercise of stock options for tax purposes but not required to be reflected in the financial statements; industry specific tax breaks ; and tax deferral of offshore operations. Much of this list is a matter of timing differences, although, in fairness,  handled intelligently they can become very very long timing differences.

Give me your tired, your poor, your huddled masses, yearning to be free, but not your investors

There does not seem to be much concern among the candidates over the long suffering foreign investor which is not surprising since:  a) he does not get to vote in November; and b) he is foreign. Meanwhile, foreign investors do not benefit from S Corporations and, if they invest through a tax transparent LLC – a foreign corporation will still face branch tax (equivalent to dividend withholding tax) while an individual has estate tax exposure. Faced with tax rates genuinely among the highest in the world, foreign investors will more than welcome a healthy drop in the headline rate. Otherwise, they might just start looking for other countries in which to invest with rates like 25%, 12.5%, 17.5% and 20%.

To tax or not to tax…..

It all makes sense to him

Forced to summarize Israel’s international tax legislation in half a sentence, I could not better Shakespeare’s all time bogeyman – Richard III:  

“Deformed, unfinished, sent before my time/ Into this breathing world, scarce half made up”.

Tax legislation in the first half-century following Israel’s independence adopted, what might now be termed, the “Mitt Romney Approach” –  inconsistent but pragmatic. At a time when citizens were largely barred from investing abroad, work income and capital gains were charged to tax on a worldwide basis while income such as dividends, interest and royalties from abroad were, in practice, exempt.

Then, following liberalization of exchange controls and serious personal and corporate investment abroad in the late 1990s, legislation passed the Knesset in mid-2002  moving Israel to a pure worldwide basis of taxation with effect from January 2003.  This almost pedestrian approach to enforcing the new law – allowing around six months to get organized –  was, and is, in contrast to the normally frenetic approach  adopted by the Knesset, Israel’s parliament, which regularly enforces  legislation almost overnight (and, sometimes, the previous night or earlier).

This may explain the remarkably naive stance adopted by certain respected tax advisors at the time, who insisted, to the horror of the more worldly among us, to advertise their prowess at every opportunity in the national  press, explaining the broad (but, rarely, precise) methods to legally circumvent the new regime.

While the income tax authorities could (and can)  be accused of many things, illiteracy is not one of them and, lo and behold, they managed to fit the art of newspaper reading  into their busy schedules. It was therefore little surprise to the mature and experienced when, prior to enforcement of the new law, an amendment to the amendment was passed in the Knesset to close the loopholes that had been so altruistically revealed by our fellow professionals.

But, as Hamlet (topically since Israel has just ratified a new double taxation treaty with Denmark) said – “Aye, there’s the rub”. 

The authorities were in such a rush to get the legislation passed ahead of the January 1 deadline that the adjustment left much to be desired ( for them, if not for the rest of us). To add to the misery that awaited them, they had insisted in going it alone with the legislation. They had neither canvassed extensive public comment nor, apparently, recognized that, not being the first, second or fiftieth nation on earth to adopt a worldwide basis of taxation, it might be wise to benefit from the learning curves of others rather than starting from scratch.

The result was : a flawed system of credit for foreign taxes paid; ambiguous controlled foreign corporation rules, the latest explanatory notes in respect of which came out only a month ago – nine years after the legislation came into effect; a participation exemption regime that  literally exempted almost everyone from participation and, from day one, was treated as if it had leprosy; and a tax-transparent company system that has transparently gone nowhere. We were subsequently introduced to Trust-Nobody Trust rules in 2006 and, two years later, the Worldwide Untax Regime for new immigrants and returning residents.

While this blog will endeavor to maintain a truly international flavor, I make no apology for including from time-to-time in the weeks and months ahead, reflections on the system with which I have an “up close and personal” relationship. At the end of the day there is much more that unites countries in their international taxation rules than divides them and I hope those reflections are of interest to everyone.

Dead loss

Angry Talk (Comic Style)

Image via Wikipedia

Liu Zhuiheng was executed last Thursday.  Xinhua, the Chinese State News Agency,  reported that the 52 year old from Hunan Province had been convicted of the July 2010 bombing of his local tax office resulting in 4 dead and 17 wounded. The motive for the crime was  frustration over his business losses.

Now, if we are honest with ourselves, most of us – at one time or another – have dreamed about taking a match to the local tax office. But,  in my case, at least, there was always a good reason: because they insisted on reading a treaty upside down; because they were basing their decision on a non-existent law; or simply because they were getting up my nose.

What did not make sense was that Mr Zhuiheng was punishing the tax authorities  for something for which they were not to blame- his business losses. If he felt some need, as he clearly did, to let off steam it would  have been more appropriate to trot off to the local Party Headquarters  and harangue the Party over the absence of any mention of  business losses in  Das Kapital or the Little Red Book.

Then I got to thinking that, while Mr Zhuiheng got it tragically wrong, maybe tax authorities are not as innocent as they look. The basic principle of the carry forward of losses is a tried and tested one. Countries have differing approaches, some allowing carry back, some restricting the period of carry forward. A phenomenon that has been gaining momentum in recent years and, particularly, in 2011 has been the restriction on use of loss carry forwards in a particular year. Following Germany’s earlier lead, in 2011 countries including France, Japan, Spain, Portugal, Austria, Denmark and Hungary either enacted measures, or moved towards,ensuring  that companies that are profitable in a particular year pay a certain amount of tax despite sufficient brought forward losses – by only permitting a certain percentage of taxable income to be relieved.

Although this may appear unfair and will doubtless upset (although I hope without the same consequences as in China) the businessmen of the western world, it must be clearly viewed against the backdrop of the world financial situation, with governments desperately trying to balance their books and facing a multiyear delay in tax revenues as companies pull out of recession and utilize their losses. The OECD estimated in 2011 that in some countries loss carry forwards represent as much as 25% of GDP.

When added to the tightening of change of ownership rules as well as the expected effect of the OECD’s  2011 report “Corporate Loss Utilization through Aggressive Tax Planning”,  which identified key risk areas where governments should  clamp down as; corporate reorganizations; financial instruments; and non-arm’s length transfer pricing – it does not look like companies have a lot to smile about when it comes to their, already  painful, losses.

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