Tax Break

John Fisher, international tax consultant

Archive for the tag “International Tax”

GILTI pleasures

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Here they go again…

Just when you thought it was safe to put the Ibuprofen back in the medicine cabinet, the IRS has issued proposed GILTI (Global Intangible Low-Taxed Income) regulations in addition to the long anticipated final ones. (For an explanation of what was supposed to be going on, see Tax Break February 10, 2019).

Back in my day, the examinations for admission to the Institute of Chartered Accountants in England and Wales were multi-stage. The last stage was supposedly the toughest (and I do not use that word lightly). I was, therefore, very surprised (and suspicious) when I turned over the ‘Financial Accounting’ paper to discover a 25 mark question that could be answered by a page of T accounts. T accounts are the graphic form of double-entry bookkeeping, providing a framework for ‘debits by the window, credits by the door’. If that still doesn’t resonate with you, it is like being presented with a first grade Arithmetic problem in twelfth grade Maths (Google translate: Math). When the official answers were published some weeks later, there was a comment by the examiner to the effect that many students had achieved very high marks by answering the question in the wrong way. That alone made me wonder whether I really wanted to join this elite group. Monty Python may have declared that ‘It’s accountancy that makes the world go round’, but from where I was looking, it was more likely to make the world go pear-shaped.

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It was either me or the examiner

That is what I feel about the proposed US regulations – despite being neither a US taxpayer, nor US tax advisor. I shall explain.

By the time the 2018 US tax reform package in general, and Global Intangible Low-Taxed Income in particular, had been suitably chewed over, it was apparent that US corporations were unlikely to be accidentally hit with GILTI tax. (As long as their subsidiaries were paying at least 13.125% corporate tax in their country of residence, they were fairly safe, at least in the short-term). Individuals weren’t so lucky and – in order to avoid horrifically skewed tax bills – they would need to use the obscure section 962 of the tax code, electing to be treated as corporations for this income. It was a case of scratching their left ear with their right hand. And that was how it was expected to remain.

So, despite having no faith in the IRS making anything simple, I was simply gobsmacked when I saw the shock announcement last week that there are proposed regulations that will effectively exclude the reporting of GILTI income where corporate tax is paid in the foreign country at a rate of at least 90% of the US federal rate (18.9%), similar to existing – and well-oiled – passive income rules. Apart from the not-insignficant saving of paperwork for US corporate shareholders, there shouldn’t be a tax difference – GILTI tax only kicking in below 13.125% abroad. It is a sea-change, on the other hand, for individuals with companies in ‘high-tax’ countries such as Israel where they will not need to go through the fantastical rigmarole of corporate-imagined taxation. (In Israel, there will still be an issue with companies with special low tax rates).

Waidamminit! This stuff would be great for wrapping food.

What is amazing is that there is no mention in the proposed regulations of the genuine grievance of individuals that these proposed regulations will evidently redress. There were other reasons given.  In other words, it looks like something sensible and good happened (or, at least, might happen) while nobody was paying attention. Not a million miles from the examiner’s comment in that faraway accounting exam.

And, Monty Python or not, the United States economy really does make the world go round. Scary.

Votes for taxpayers!

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Some suffering is not pointless

I was sorry to hear that former US president and Nobel Peace  laureate Jimmy Carterhad  broken his hip last month.  I was not sorry to hear that the incident had ruined his planned turkey hunt in his home state of Georgia. I – like the lion’s share of the western world – have a visceral dislike of the pointless suffering of wildlife.

The Americans continue to do things their way, while the rest of us are becoming more and more constrained by multinational consensus. The latest example came last month when a Swiss referendum ensured the application of a new corporate tax regime, as well as restrictive gun laws. On the face of it, this was an example of absolutely raw democracy in action. In Switzerland, all it takes is 50,000 signatures on a petition to guarantee a national referendum on parliamentary laws. And that was the case here.

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What choice do sovereign states have anymore?

But, beneath the surface, the reality was different. Both proposals had, broadly, been up for national vote previously, and both had failed. This time, the people knew that Switzerland’s much-loved-by-foreigners tax friendly principal companies, finance branches and private tax rulings were dead in the water, thanks to BEPS and related international agreements  pushing for a level playing field for domestic and foreign businesses alike. Meanwhile, persistence with the country’s liberal gun laws would mean exclusion from the EU’s much-prized border control free Schengen Area.

Companies of all stripes will now be subject to the same rate of tax, deductions being given for EU friendly R&Dcosts, patent box and the write-off of hidden reserves. To help cover the expected shortfall in tax revenue, and  pacify the lefter leaning elements of society,  there is to be an increase in social security related taxes. At the same time, residents of Switzerland will have to get used to less freedom to bear arms.

The message to the Swiss from the international community was loud and clear – you can vote any way you like, as long as it’s ‘yes’. Two thirds of voters duly obliged in both referenda; the rest are helping police with their enquiries (that bit isn’t true).

Careful thought about the Swiss situation  raises the long-standing question of the importance of nations and, with it, the importance of citizenship. Before the ascendancy of the nation state, the 17th century poet John Donne meditated that, ‘No man is an island, entire of itself; every man is a piece of the Continent, a part of the Main’. Napoleon, Bolshevism, two World Wars, Apple and Amazon later, and nations have limited control of their own destinies, while hundreds of millions of their citizens live beyond their borders. Despite the passing centuries, we are evidently not done with Donne. And, despite a declaration of the League of Nations scarcely 90 years ago that: ‘Every person should have a nationality and should have one nationality only’, growing numbers of people collect citizenships like their grandparents once collected cigarette cards. 

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This bloke was a US citizen until recently. What was that quote of Baldwin?

The time has surely come to reassess the State/Individual connection. In  a world where -with a few prominent exceptions – compulsory conscription to defend the nation is no longer necessary, too many people fit Stanley Baldwin’s assessment of: ‘Power without responsibility – the prerogative of the harlot throughout the ages’.  An excellent candidate for consideration to, at least partly, replace citizenship in assessing an individual’s rights and responsibilities vis a vis the State, would be long-term tax residency.

Who knows? Monaco might one day be a permanent member of the United Nations Security Council.

Hand it over and nobody will get hurt

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Automatic exchange of information between governments has been suspected for years

The ink on the page of my last post about the new softer, gentler approach to tax collection was not yet dry when Israel’s main financial daily ran a banner headline concerning the upcoming automatic exchange of information between tax authorities. The wording was a rather unimaginative: ‘ A flood of requests from foreign banks on the way: Demand  reporting of Israeli residency.’ Personally, I would have gone for the more catchy: ‘We will find you, and we will kill you.’ Game on.

The Common Reporting Standard, that – based on domestic legislation –  will require most  of the world’s tax authorities to collect data on foreign resident accounts from financial institutions in their jurisdictions and ship it out to the salivating jaws of the tax authorities of the account holders’ countries of residence, is at the door (see Tax Break January 7, 2019).

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Not a word about tax evasion

What bothered me about the headline, and the accompanying two page article, was not the accuracy – in my younger days, I would periodically pull my hair out at the distorted product of an interview I had given to that particular journal on a hot topic. This piece, however, appeared researched and reasoned. My problem was that any reader of the newspaper, other than someone with a financial death wish, has already done what they had to do (compliance, voluntary disclosure, or expensive – and possibly regrettable – planning). Meanwhile, a colossal number of people who do not read the financial press, and may not be financially savvy, remain – incredibly – blissfully ignorant as their canoe careers inexorably towards the falls.

As the death knell for international tax evasion has grown louder in recent years, the Israeli tax authorities (in line with many of their international counterparts) have shown remarkable restraint in enabling errant residents with unreported income from abroad to come clean with minimum fuss (paying some tax and remaining friends). Voluntary disclosure programs have been renewed, extended (there is currently a program in force until the end of this year – albeit without the previous advantage of anonymity),  and-where relatively small amounts are involved – even made simple.

The trouble is that, in a country like Israel that does not require a tax return from most salaried employees, many people  don’t ‘think’ tax of their own volition. So, when Belgian Aunt Sophie left Yossi  the contents of a bank account in Switzerland which sensible Yossi didn’t touch – treating it as rainy day money – he also didn’t think to report the interest to the Israeli tax authorities. And, unprompted, he still doesn’t. He will presumably start thinking about it when he gets a summons to appear in court in his mail box. The tax authorities will have achieved exactly what they actively set out not to do – waste valuable resources crucifying people they are not interested in. As Jesus  is reputed to have said a mile and a half  from where I am now sitting: ‘Forgive them, for they know not what they do.’

The solution is so simple, it hurts.

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I don’t care WHAT you were doing in the bank…

In the absence of a universal tax return, every resident over the age of 18 should be required to complete and submit a simple annual questionnaire (either online or offline) including such questions as: ‘Do you, or any of your children under the age of 18, have any access to the contents of a  foreign bank account?’ The answer ‘Yes’ to such questions should result in a compulsory tax return coming through the door. Failure to complete the form should result in a compulsory tax return coming through the door together with an appropriate fine designed to concentrate the  mind of even the most financially illiterate.

And, if that doesn’t work – the tax authorities need feel no guilt in unleashing the Spanish Inquisition.

 

 

 

Bog standard (almost)

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These days a bloke would do anything for a free ticket to Australia

Charles Dickens’s fecund imagination allowed Pip’s benefactor Magwitch to return to England  from transportation to an Australian penal colony, albeit at risk of judicial execution. By all accounts, thanks to the triple-knot of location, location, location, escape for  real-life transportees wasn’t all that simple. What the desperate convicts of the nineteenth century needed was the solution of the  twentieth – air travel. And, in a twist of fate, the first person to pilot a controlled flight in Australia (back in 1910) was none other than history’s greatest master of escape, Harry Houdini.

Well, by now, the world’s tax advisors are becoming used to the locks, double locks and padlocks being used to prevent international tax planners from thinking out of the box. But, the tax treaty signed (though not yet ratified) last month between Israel and Australia plonked a kangaroo, with a 10 ton weight in its pouch, on the box’s lid.

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Truth be told, the Wright Flyer never did move very much.

The treaty itself is not very exciting. It contains much of the usual – just about comprehensible – gobbledygook, together with a fair share of the totally ludicrous. An  example of the latter: SHIPS AND AIRCRAFT SHALL NOT BE REGARDED AS IMMOVEABLE PROPERTY. Thanks for that.

There is also an unhealthy obsession with the amount of time that needs to elapse before work on a  construction site or installation project by a resident of one country  becomes taxable in the other – too many numbers and too many conditions (and given the nature of trade between the two countries – not too many instances).

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Spreading the love (and hate)

At the end of the day – as with all treaties – it is withholding taxes that are the real bread, butter and Vegemite of the agreement. These fit within the ‘new normal’ of international double taxation treaties: 5% – 15% for dividends, 5% – 10% for interest, and 5% for royalties. It is the Australians who benefit from this much more than the Israelis. While, in the absence of a treaty, dividends from Israel can rack up upwards of 30% tax, as long as Australian corporate income is franked (ie the company paid tax in Australia), there is no Australian withholding tax. Similarly, Australia’s withholding tax on interest is 10% as opposed to Israel’s mainly 25%. Only when it comes to royalties are the tables  turned.

Among the sparse points of genuine interest is the question of whether the exemption on pensions from Australia to Israel applies to immigrants to Israel in their first 10 years of residence.That one will have the experts opining vigorously.

What makes this treaty ‘different’ is the (what I believe to be unique) ‘Article 28, Protocol’. Now, many treaties have protocols which are agreed explanations and adjustments to those carefully negotiated agreements.  The recent protocol (not yet in force) to Israel’s treaty with the UK (Tax Break  27/1/19) is effectively a new treaty. But, to have a section in the treaty that simply refers to an attached protocol as part of the treaty is – at first sight – circular and balmy.

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No!! Not Hybrid Instruments!

However, closer inspection reveals all. Article 28 is to tax advisors what Room 101 was to Winston Smith in Orwell’s 1984 – the fulfillment of their greatest fear. Among all the normal explanations and clarifications, just in case anyone had any ideas about favourable interpretation of the treaty,  is a section that lists most of the goodies of the BEPS project, stating that nothing in the treaty can stop a country clobbering anybody who tries it on, whatever the wording. Game, set and match.

The Great Houdini’s most famous escape was from a water-filled tank in which he was inserted upside down, heavily manacled. Antipodean tax planners will  soon be standing upside down working out what to do next, together with their right-way-up Israeli counterparts.

Tell it like it is

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Not a robot? Spot the quotes

A rose by any other name would smell as sweet’. That quote from Romeo and Juliet has occupied my thoughts this last week. As an Israeli judge found recently, the concept is only a ‘truth universally acknowledged’ to the extent the rose is inarguably a rose. And, in the process, the learned gentleman took pains and, dare I say liberties with the law, to rub compost in the face of the Knesset (Israel’s parliament).

Israel has had a Law for the Encouragement of Capital Investment for the last 60 years. Primarily a treasure chest of tax and monetary incentives to further the needs of the economy, it has been touched up and renovated periodically as the needs of the State changed and matured. In 2005, in an attempt to simplify a cumbersome process befitting a formerly socialist country,  a boost was given to those industrial enterprises that exported a pre-ordained percentage of their production.

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Not a robot? You don’t need the word ‘export’ to understand ‘export’.

However, the word ‘export’ had to be expunged from the Law’s lexicon. Offering export incentives threatened a shower of fire and brimstone from the World Trade Organization and, specifically, those with whom Israel had free trade agreements (including the US and EU). So, the sophists engaged to draft the law came up with a need to meet one of the following requirements:

  • Income from a specific market must not be more than 75% of total income;
  • 25% or more of total income must be  from a specific market numbering at least 12 million residents.

That would avoid detection in a word search by nosy foreign governments,  while anyone with a brain that worked in accordance with evolutionary theory could interpret the law as demanding  at least 25% export, with no restrictions on the level of exports to any major foreign country. Why 12 million? Probably because it was a lot more than the population of Israel in 2005 (the number was updated a few years back to 14 million with an annual automatic increase).

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How can we be sure anymore that the number of residents of New Zealand doesn’t include the sheep?

Well, populations have a habit of growing, and by sometime in 2012  Israel’s market, which included the residents of  Judea and Samaria aka the West Bank had grown to more than 12 million, and companies that sold exclusively to Israel decided to claim the benefits of the Law. The tax authorities told them, in no uncertain terms, to go fly a kite.

The courts got involved and agreed with the tax authorities (the tax authorities’ argument had layers not elucidated here). The appeal was heard this month.

Although, at bottom line, the appeal was thrown out, the judge disagreed with the tax authorities that Israel could not, in principle, be included in the second condition, offering a long and reasoned argument. The upshot would be that no exports were required at all – a surprising conclusion. Interestingly, in addition to arguing that exporting was not the clear intention of the law, he completely ignored the first (alternative) condition which, although not negating entirely the Israel-only possibility, made the whole thing Monty Pythonesque.

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They are going to take the judge’s comments very seriously.

Faith in the judge was restored, however, towards the end of the 39 page judgement. Quoting from some of the committee discussions surrounding the 2005 amendment, he lambasted the parliamentarians for the underhand way in which they had sought to hide the export incentive from Israel’s trading partners, making clear that white man mustn’t speak with forked tongue. If, as a result, they got their wording in a twist, they deserved to be punished. He forcefully suggested that the legislature should update the wording of the law.

There is nothing new, or unique to Israel, about actively confusing laws. Back in the 1850s, the author of Little Dorrit invented a whole government department to promote the idea – the Office of Circumlocution. But, perhaps, times they are a changin.

Dead Wrong

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April fool!

It’s bad enough that, thanks to the controversy surrounding Brexit, the average Briton no longer lives with peace of mind. From April 1 they will no longer die with peace of mind.

A headline-grabbing exaggeration perhaps, but probate fees for opening a file to deal with a deceased person’s estate are due to jump from £155 to, in some cases, £6000 from next week. While the government insists it is a fee – in order to avoid a legal requirement to include it in the annual Finance Act – the Office for Budget Responsibility announced on March 15 that it would be included, alongside Inheritance Tax, as a tax for statistical purposes.

Her Majesty’s Revenue and Customs  has been administering the controversial – and widely hated – Inheritance Tax since its inception in 1986.

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The Twilight Zone?

As in other countries imposing an Estate Tax or Inheritance Tax (there are many that have either cancelled or never adopted either) UK Inheritance Tax is  controversial for the wrong reasons. It is argued that it represents a double tax on already-taxed income, while at the same time not bringing in much revenue (other than from the good dead people of Guildford, the recently crowned inheritance tax capital of Britain). The first argument cries out for a different spin, and the second (it represents around 1% of tax-take) may anyway cease to be valid in the years ahead.

As taxes go, an Inheritance Tax makes a lot more sense than an Estate Tax.

An Estate Tax imposes tax on the estate of a dead person – beneficiaries receive what is due to them out of the post-tax value of the estate. There is, unquestionably, an element of double tax (although the likes of Thomas Jefferson and liberal philosopher John Stuart Mill gave the finger to that), and the fact that estate tax planning is entirely within the bailiwick of the donor (subsequently the ‘dead person’) such tax can often be minimized.

An Inheritance Tax imposes tax on the beneficiaries. In that case, the double tax argument is weakened – the dead person passes on their estate free of tax (but without a tax deduction for the transfer as they, rather than society, decide who is to receive it) and the beneficiaries – similar to the winner of a lottery – pay taxes on their windfall. As regards the level of collections, imposing tax on the beneficiaries also puts something of a spanner in the works of aggressive tax planning during the donor’s lifetime.

There are two types of inheritance tax  – accessions and inclusion. An accessions tax system provides the beneficiary with their lifetime tax-free inheritance threshold, and hits them with the prescribed rate of inheritance tax on  the balance of what they receive from any number of donors, while an inclusion tax  charges beneficiaries according to their marginal income tax rates  (plus an inheritance surcharge). While inheritance tax is always fairer than estate tax, the inclusion tax system is the fairest of them all – as it clearly works in favour of beneficiaries of smaller amounts and/or lower income.

Furthermore, in all cases (Estate Tax and both types of Inheritance Tax), the increased exchange of information between tax authorities mean it is increasingly difficult to hide assets ‘abroad’ – which should also substantially serve to increase the revenue collection.

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‘More tea, guv?’

Britain claims to have an Inheritance Tax. The problem is that – to all intents and purposes – no, it doesn’t. It has an Estate Tax. The government website (Gov.UK sounds like an initiative of the Kray Twins) talks to the donor. Other than in specific circumstances the tax is claimed from the estate. The tax-free threshold is given to the estate – and even in the case where specific gifts are given outside the will in the 7 years prior to death, they get first benefit of the tax-free amount. And the tax rate is fixed.

So, why is it called an Inheritance Tax?  We shouldn’t complain. At least it is called a ‘tax’ as opposed to the Probate Fee, which is a tax but the government can’t afford to call it that. And what about Her Majesty’s Revenue and Customs?  Isn’t it a tax authority?

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At least they still call it a ‘tax’ return

Perhaps we shouldn’t ask too many difficult questions of a country with a tax year-end of April 5th.

Ain’t no Bonanza

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Let’s face it. The bar was pretty low

Jay Leno once went walkabout in New York asking innocent passers-by if they could name a country beginning with the letter ‘U’. Apart from the usual camera induced deer-in-the-headlights non-responses, a few bright sparks came up with Uganda and Uruguay. At the close of the piece, as the camera faded out, Leno was heard asking: ‘Have you ever heard of the United States of America?’

Judging by the above experience, it can safely be assumed that, had Leno carried on to ask  the name of the alphabetically last of the 50 States, at least one person – having realized there was no State starting with Z – would have thought long and hard about Y and come up with Utah. Alternatively, still on Y, they might have gone for Wyoming. And Wyoming, dear readers,  is actually the correct answer.

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Named ‘The Virginian’, filmed in California, and set in Wyoming. Only in America

Although there is a tendency to think of Wyoming as still set in the 19th century, with characters like Buffalo Bill, Wild Bill Hickock, Doc Holliday and Calamity Jane ambling around the state capital, Cheyenne, it was the birthplace – in 1977 – of one of the most important tax sanitizers in US history.

The Limited Liability Company (LLC) – a mongrel of the corporation and partnership with descriptive terminology all of its own – crawled along at cowboy pace until 1988 when the Internal Revenue Service issued a ruling that LLCs were transparent for tax purposes. At the speed of a Colt 45, American taxpayers could suddenly combine the limited liability of a corporation with the personal taxation of a partnership or sole trader. This was particularly important in America where, despite Reagan’s major tax reform two years earlier, there was no correlation between the tax paid by an individual (up to 28%), and that paid by a corporation (up to 34%) followed by 28% individual tax on a subsequent dividend (over 52% in total). Congress failed to recognize that inanimate companies – while being vehicles of tax liability – cannot pay tax. Unlike Shylock, if you prick them, they do not bleed. Human beings pay the tax – either through the higher prices suffered by the consumers, or the lower profits earned by the shareholders. There is little justification economically for wide differences in total rates.

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Companies don’t have anything to cuff, either

As it turned out, it took until 2018 for the tax rates to be aligned. In the meantime, the vast majority of American private businesses organized themselves as either sole-proprietorships (and partnerships) or – thanks to Wyoming’s pioneering spirit – the new fangled LLCs.

And, thereby, hangs a tale. It was all well and good that America – with the biggest economy in the world – knew how to treat her LLCs, but other countries struggled with defining their treatment under their own laws. They ended up one of the major ‘culprits’ in hybrid mismatch tax planning that was so fiercely attacked in the OECD’s BEPS initiative.

 

Put simply, tax transparent companies in Israel are a rare and specific phenomenon. On the principle that, if it walks like a duck and talks like a duck, it’s a duck, LLCs fit the bill as companies. Therefore, according to statute law, they are not transparent.  However, given the large exposure of Israelis to the American economy, ever since its big 2003 tax reform the Israeli Tax Authority has been finding accommodation for these hybrid beasts. As long ago as 2004 it produced a circular that reiterated the corporate nature of the LLC, but offered solutions to the availability of a foreign tax credit for US individual tax being paid (since the LLC is tax transparent in the US). If the LLC is deemed controlled and managed from Israel, despite being liable to Israeli corporate tax, a credit is given for the US individual tax on profits attributed to the US (up to the level of the corporate tax). Alternatively, the taxpayer can elect at first filing to be taxed on the profits in Israel at the member (Google translate: shareholder) level, with credit for the US taxes. Some have incorrectly interpreted that as complete transparency for the LLC. In fact the circular stresses that the LLC is a body of persons and, in practical terms, that means that losses of  one LLC cannot be offset against those of another. As LLCs are set up at the drop of a cowboy hat in the US, this represents a real problem for many Israeli investors. There are certain planning devices, but advisors have always been aware that the problem exists.

Remarkably, 15 years after the issuing of that circular, essentially an extra-statutory concession, some  jester with nothing  better to do recently inexplicably allowed – not for the first time – a no-hope case to be brought before the courts. The claimant had set off losses between LLCs – in defiance of the circular – basing his claim on (1) Israeli law determining that when a word is stated in the singular, it also means the plural, unless – inter alia – the context does not support that interpretation, and (2) an informal conversation with a senior tax officer who allegedly told him that the problem could have been solved if all the LLCs had been held under a single holding LLC.

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Why have they stopped us handing out the death penalty?

The judge swatted away the first argument – the context clearly didn’t support the multiple LLC claim. But, the second argument was even more off the wall. Whether or not the senior tax officer had been quoted correctly about forming a group of LLCs, THE CLAIMANT HAD NOT DONE SO. Robert Frost wrote a famous poem on the subject, ‘The Road Not Taken’

‘I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.’
His Honour politely demolished this argument, too. Had I been the judge, I would have been tempted to return to the cowboy country roots of the LLC and quote from Clint Eastwood’s 1976 Western, ‘The Outlaw Josey Wales’:
‘Don’t p**s down my back and tell me it’s raining.’

Prospecting for tax

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True heroes…

If you hear the term: ‘sans frontieres’, it is odds on that – after ‘French’ – the first thing that will come into your mind is ‘Medicins Sans Frontieres’, that truly remarkable international humanitarian medical NGO founded in 1971 and based in Switzerland. Add to that ‘Avocats Sans Frontieres’, the human rights lawyers, and a plethora other ‘Without Borders’ organizations, and your forehead will probably furrow as your thoughts turn to the altruism of Churchill’s ‘Never in the history of human conflict was so much owed by so many to so few’, and Kennedy’s ‘Ask not what your country can do for you’.

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… and true fools

As proof of my innate cynicism, when for the first time last week I came across  ‘Inspecteurs des Impots Sans Frontieres’ (Google translate: Tax Inspectors Without Borders), my agile memory leapfrogged all those worthy international bodies dating back to the early seventies. ‘Jeux Sans Frontieres’ – known on my TV set as ‘It’s a Knockout’ – was a banal  pan-European TV competition tracing its history to 1965. Similar to a well-funded kids’ birthday party, participants were required to engage in physical contests of the utmost idiocy. Europe had been laid waste twice in the preceding half century by the two most utterly mind-boggling catastrophes in the annals of mankind, and this was the reward.

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Tax inspector in the mind’s eye

Thinking my memory was treating the world’s tax inspectors to the respect only they deserved, I plunged first into an Economist article – the headline of which had introduced me to TIWB – and then the  OECD literature on the topic.

I was wrong.

TIWB was founded by the OECD and UN in 2015 around the time the world’s governments started to take international taxation cooperation seriously. Tax administrations with well-developed international tax audit capabilities, as well as retired tax inspectors, are now targeted to assist less fortunate administrations with developing their own tax audit capabilities.

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It just got harder

It turns out there are dozens of these projects going on around the world (there is even a bi-annual newsletter), and it is estimated that, for every dollar spent, a hundred dollars of tax avoiding revenue is collected.

Along with complex changes in rules, much of the stress over the last half-decade has been on transparency and the exchange of information. But, if a cash-strapped tax administration does not know what to do with all the data it receives on international groups  who exploit the system to the full – albeit within legal limits – little will happen. Projects based in the Caribbean, Africa, Asia, Latin America and Eastern Europe are closing the gap. According to the IMF, over 20% of tax revenues were still being lost to the legal playing of the system as recently as 2016.

It looks like it is time to take tax inspectors seriously. When American humorist Dave Barry was chosen for audit in an  IRS sample, he wrote a syndicated article of comical unctuousity to the Service: ‘The truth is that I have the deepest respect for the IRS, and for the thousands of fine men and women and Doberman pinschers who work there….IRS are regular people just like you, except that they can destroy your life.’

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I do, honestly

I have decided to  turn over a new leaf and show respect to tax inspectors whether with or without borders. They are good people. Really good people. Really.

Nexus, shmexus

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What tax advisers think they look like

In my halcyon days as a tax adviser, a client conference meant lots of numbers thrown at a stark white screen via an overhead projector, the small audience looking pale and bored under the harsh fluorescent lighting. We, the professionals, were geeks that nobody wanted to talk to unless we were saving their cash, or saving their hides.

It transpires that  a quarter of a century is a long time in tax, and in recent years we have found ourselves in  conference centers bathed in blue light, no numbers in sight, talking (and talking) about ‘paradoxes’ and ‘paradigm shifts’, and other intelligent concepts that have as much to do with tax as that other famous three-letter word ending in ‘x’. It isn’t that much has really changed. It is just that we have learned to talk-the-talk and walk-the-walk in our designer suits. The meaning of the words – or their dubious relevance – doesn’t really matter. Conferences are all about the sound bytes and the press coverage. The public face of tax has had a makeover.  Meanwhile, real tax consulting – exactly as in the good old days – continues to be undertaken by consenting adults behind closed doors.

It is, therefore, with some trepidation and a shaking pen, that I find myself writing about – what might actually be – both a ‘paradox’ and ‘paradigm shift’  in international taxation.

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When physical nexus made sense

I refer, of course, to the OECD’s invitation for public input on the possible solutions to the tax challenges of digitization. The topic is not new (see Tax Break October 5th 2018), and is, indeed, Action 1 (of 15)  of the Base Earnings and Profit Shifting (BEPS) initiative that has been monopolizing the attention of tax practitioners for the last five years. However, it has for some time been looking like it would be sacrificed on the altar of disagreement and procrastination, as it requires a complete rethink of two of the pillars of the existing century-old system – nexus (connection to a country) and profit allocation (between countries).

On February 13th, the Inclusive Framework on BEPS (comprised of just about every self-respecting nation in the world – not to mention a few others) came up with a Public Consultation Document, the member countries having previously been divided on any way of moving forward. To be clear, it is stressed that the comments are ‘without prejudice’ (which I think means countries are not committed). Different countries have different interests – in the rawest of terms developing countries that are not hi-tech originators have a major interest in attracting tax from digital companies interacting with their populations, while the United States would ideally like to keep as much of Google and friends’ taxable income as possible for itself. The indisputable paradox here is that – in a world veering more and more towards trade wars and protectionism –  they  were able to come up with a series of alternative proposals, any one of which  – if adopted – will represent a paradigm shift in international taxation affecting everybody.

There are three proposals for tampering with profit allocation and nexus, with the aim of ensuring that taxable profit is allocated according to where value is created.

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No comment

The first proposal focuses on ‘user participation’. This is fairly specific to the ‘highly’ digitalized economy –  social networks, search engines and on-line marketplaces, where the activities and participation of these users contribute to the creation of the brand, the generation of valuable data, and the development of a critical mass of users, which helps to establish market power. For this purpose, nexus would no longer be only to where the company physically undertakes its business. but also to  where the users build part of its profits, with suitable allocation of those profits.

The second proposal is based on ‘marketing intangibles’ such as brand and trade name which are reflected in  favourable attitudes in the minds of customers and so can be seen to have been created in the market jurisdiction. There are also other marketing intangibles, such as customer data, customer relationships and customer lists  derived from activities targeted at customers and users in the market jurisdiction, supporting the treatment of such intangibles as being created in the market jurisdiction. Once again the definition of nexus would need to be expanded beyond the physical and profit allocated accordingly.

The third proposal relates to ‘substantial economic presence’ via digital technology and other automated means. Such presence could be evidenced by:  the existence of a user base and the associated data input;  the volume of digital content derived from the jurisdiction;  billing and collection in local currency or with a local form of payment;  the maintenance of a website in a local language;  responsibility for the final delivery of goods to customers or the provision by the enterprise of other support services such as after-sales service or repairs and maintenance; or  sustained marketing and sales
promotion activities, either online or otherwise, to attract customers. Same again, in terms of revolutionary forces in international tax.

As already mentioned, each of the proposed methods requires an overhauling of ‘nexus’, until now based on a level of  physical presence in a jurisdiction, and ‘profit allocation’ which – even in the BEPS world – suffers from the vagaries of the Old World Order.

Pending public comment – the deadline for which has been extended to March 6 – the bets are on  ‘Marketing Intangibles’ over ‘User Participation’, the former catching a wider cross-section of the digital industry in its net. ‘Substantial Economic Presence’ was a late arrival at the ball, and  – if the digital tax revolution is consummated – will likely be confined to the role of chaperone.

Will anything happen? There is no question that the BEPS project has achieved a momentum that could not have been predicted five years ago. The Americans are said to favour ‘marketing intangibles’ – although when they calm down from the sound bytes, soft blue light and dark suits, they might start to run the boring numbers and discover it (and any other change) is not in their best interests.

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‘I am just the greatest ever paradox and paradigm shift!’

So, it looks like ultimate success in achieving the paradigm shift rests on the continued goodwill of the United States, which in the current political climate would be a paradox par excellence. But, we are living in interesting times.

Keep Calm and Carry On

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About as intellectual as it got

The British have always been a supremely pragmatic people. It was thanks to a fickle king that they knocked religious hegemony on the head early on, and thanks to another misguided monarch that they got their revolution out of the way before the Rousseaus, Marxes and Engels of the world could fill the vacuum with an ideology. Indeed, it was the utterly pragmatic empiricist John Locke who tidied up the mess in the latter half of the seventeenth century.

It is, therefore, no surprise that – despite the cataclysmic events in Parliament surrounding Brexit – the British Government has been beavering away, preparing for the morning after (which, because Brexit is planned for the night of Friday March 29th, will be effectively Monday April Fools Day).

The big news from Davos last week was that Britain and Israel have confirmed ‘in principle’ a Free Trade Agreement similar to that enjoyed between the EU and Israel. With £10 billion of trade, that is eminently sensible for both parties. What received less coverage was the signing  a few days earlier of a protocol to the double taxation agreement between the two countries that dates back to 1962.

Protocols amend treaties. Hearing the words ‘protocol’, ‘tax’, ‘treaty’, ‘Israel’, ‘UK ” (not strictly a word) in the same sentence came as no surprise to my tax-attuned ear. What with all the OECD changes in respect of Base Earnings and Profit Shifting (BEPS) and the automatic exchange of information, protocols are the name of the day. The media reports (that all appeared to stem from the same press release) gave a few details of new provisions and mentioned the obvious. It was only when I downloaded and read the document (who, for heaven’s sake, ruins the party by reading primary sources these days?), that I realized the enormity of what had happened. Perfidious Albion, God bless her!

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What an interesting job

Israel and the UK initialed a new treaty to replace the 1962 one way back in 2009. I remember it well, because I was informally consulted just before initialling, and found a couple of boo-boos. In order for a treaty to take effect, each country needs to take it through whatever processes its domestic law requires – but the stages are identical: initialling, signing, ratifying. In the UK, following the signing,  an Order in Council is issued. That is a process where a Government representative rattles off the wording of a load of boring regulations while the Queen listens (yeh, sure!) and, in the case of a tax treaty or protocol, it goes to a delegated  legislation committee, where it is considered and then brought before Parliament. It can then be ratified.

The 2009 treaty hit a total snafu after initialling. The original 1962 treaty bore the wording: ‘the term “Israel” means the territory in which the Government of Israel
levy (sic) taxation’, and  ‘the terms “resident of the United Kingdom” and “resident of Israel” mean respectively any person who is resident in the United Kingdom for the
purposes of United Kingdom tax and any person who is resident in Israel for
the purposes of Israel tax’. It was widely understood that somebody in London (I hazard a guess, from the Foreign Office) decided that Israeli residents of Judea and Samaria aka the West Bank aka the Occupied Territories should not be included. That was never going to pass muster with  the Israeli Government, and both sides got back in their trenches for the next decade.

But, times change, and these days it might be cheekily argued that go-it-alone Britain needs Israel more than Israel needs Britain (although Britain is still a very-nice-to-have). And that treaty is seriously prehistoric. Meanwhile, as Professor Emeritus of Empire Building, Britain had to watch its step.

Then came the Eureka! moment. It was time to sign protocols with treaty partners. A month after  the UK’s High Commissioner in Cyprus signed with the Cypriots, a British government representative signed with the Israelis. But, there was a subtle difference. The Cypriot protocol ran to a familiar 3 pages; the Israeli protocol ran to an eye-boggling 19. The British and Israelis had effectively shoehorned the long-dormant new treaty into the Protocol, simply passing over the naughty bits.

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I wonder if Mel is one of George’s

The signatory for the British Government was one Mel Stride, Paymaster-General – a name and title which, together with the plot, could have come straight out of a John Le Carre novel.

All that now remains is for the Queen to cock a deaf’un, and for Parliament to be pre-occupied with Brexit. (Israel also needs to ratify).

As regards the new provisions, they can be easily found popping up all over the internet in the same form as they were initially announced.  What seems to have escaped the journalists’ attention is the long-awaited exemption on UK pensions received by Israeli residents (as opposed to the highly-specific exemption from withholding tax on interest and dividends to Israeli pension funds, which was included). New and potential expats, benefiting from a ten year tax exemption on foreign sourced income in Israel,  should be talking to their advisors.

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