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Primer of
International Tax Planning Strategies
by
Baltic Banking Group , as published on
http://www.lectlaw.com
We have tax codes throughout the world to thank for the development of the
offshore financial world. Without their assistance, the Cayman Islands would
probably be a set of desert islands and no one would ever have heard of
Vanuatu. One of the main purposes and motivations for offshore tax planning
is to reduce or eliminate taxes. The offshore countries are called "tax
havens".
Tax planning is the major reason for offshore financial transactions and
offshore legal entities such as trusts and international business companies.
Most of the players of the international money game are overseas because of
taxes. They share with all the peoples of the world a desire to pay less
taxes.
In principle, international tax planning is quite
simple; the details are what drive one mad. International tax
planning is based on the fact that the revenue laws of any state are largely
restricted to its domestic economy. The tax authorities have a hard time
crossing borders but people and wealth can do so easily.
A person can make three basic changes in his tax situation through offshore
tax jurisdictions. He can change his residence, the geographic source of his
income, of the form of the tax planning entities that he uses. A tax haven
is a country that imposes no taxes on the income of companies and other
entities so long as they do no local business beyond spending money. A
treaty-haven jurisdiction is a country that has a tax treaty in force with
the United States or other high-tax nations.
What one wants to do is to accumulate different forms of income through
different companies and trusts in various jurisdictions in such a way that
the total tax bill is minimised. Once the plan is in place, it might operate
something like this:
Income arises in the United States but it belongs to a corporation that is
physically located in another country which has a tax treaty with the United
Stated. The income passes to that company with little or no withholding tax
because the terms of the tax treaty between the US and the other country - a
treaty haven in this case) - require a lesser rate of withholding. If income
is paid to a person of company in a jurisdiction with to tax treaty with the
US, then the person paying the income must withhold 30 percent for United
States taxes. Now that the money is sitting in the treaty-haven company, it
is transferred to another entity - say a trust - in a tax haven
jurisdiction, where it is allowed to accumulate.
This tax plan would best be served by finding a tax-treaty jurisdiction that
does not tax US source income at all, so that the whole transaction could be
carried out free of taxation. In practice, this is not possible because the
United States tries to avoid having tax treaties in force with jurisdictions
that do not levy taxes themselves. Most tax treaties were written to reduce
the problems of the same income being taxed by two countries.
In the past, US tax treaties with Britain and The Netherlands were extended
to those countries current and former colonies in the Caribbean. Some of
those places such as the Netherlands Antilles and the British Virgin Islands
have low tax rates and do not tax various sorts of foreign activities, so it
was possible to substantially reduce the total tax bill by using those
treaty jurisdictions. In recent years, as part of the IRS crackdown on
international tax planning, several of these tax treaties have been thrown
out, including the ones with the Netherlands Antilles and the British Virgin
Islands. New treaties are being negotiated in both cases.
There are still many possibilities open, however; there are countries with
low tax rates for certain types of income. Loopholes can be found in any tax
law if one looks hard enough. Simply find a low tax rate applied to a
certain sort of income in one of the many countries with a tax treaty with
the United States and then structure the income stream to produce that sort
of income in that country. Once it is moved through the tax treaty country,
it can be transferred anywhere.
This area of the law can be as complicated as one wants to make it. In fact,
a complex series of transactions may work better than a simple one because
the simple loopholes have probably been plugged long ago. The multinational
investor and his tax expert must work this out carefully. In the course of a
single plan, one may use all of the techniques covered in this book and some
that weve
never heard of.
A Brief Lesson In Tax Law
It is important to keep in mind, as one navigates the shoals of
international tax planning, just what the hazards are. Following is a brief
lesson in tax law. Our purpose is not to torture the reader but merely to
define the terms we will be using later in this chapter in specific
examples.
In the good old days of income taxation, it was possible to transfer
income-producing assets to a foreign corporation or trust and let the income
accumulate tax free in some tax haven. When one wanted to bring the money
back to the high tax jurisdiction, one dissolved the corporation or had the
trust make a distribution to its beneficiaries and be liable only for
capital gains. While the offshore entity existed, one was free to borrow
money from it and deduct interest paid on the loans, thus expatriating more
money. These foreign corporations or trusts were considered beyond the
jurisdiction of the US tax code. Congress did not look kindly upon such
transactions however, and beginning in 1932, gradually tightened up the law.
The IRS did its part by writing pages and pages of complex, inconsistent,
and incoherent regulations dealing with foreign entities controlled by
Americans.
The United States, by the way, is unique among the major civilised nations
because it taxes the income of its citizens earned anywhere in the world.
Most countries collect taxes only on income earned within their borders.
Foreign entities that do not do business in the United States and are not
controlled by US persons are not subject to US taxes. If a US person is
found to have some controlling interest in a foreign entity, however, he may
find himself with taxable income even though the entity has no other US
contacts.
US taxpayers heading overseas for tax savings represent two different
approaches. One group of taxpayers intends to violate US tax laws (tax
evasion) by using the secrecy available in the tax havens and the logistical
difficulties of overseas tax investigations to hide parts of their tax and
income transactions. These are transactions that the IRS could set aside if
it knew all the facts but these taxpayers hope that the agency will never
discover the whole truth.
The other group of taxpayers wants to remain within the law. They don't mind
getting into an argument with the IRS but they want to remain within the
realm of arguable legality. They hope to use the varying laws of different
countries and loopholes in the complex Revenue Code to minimise their taxes
(tax avoidance).
It is often very difficult for an individual to determine whether a
particular transaction is tax avoidance or tax evasion. The terms are not at
all well defined and the law governing new transaction forms is variable and
imprecise. When the IRS encounters unfamiliar transaction, it attempts to
rule on these actions under existing laws - created with different
circumstances in mind. The result is confusion with this year's tax shelter
becoming next year's unlawful abuse. Plus there are the many grey areas.
Transactions that are not tax motivated
and may have no US income tax impact. For example, a US bank may open a tax
haven branch to avoid US reserve requirements. Another company may use a tax
haven subsidiary to avoid currency controls or other regulations imposed by
a country that it does business with. A tax haven may be used to minimise
the risks of expropriation that accompany business activities in much of the
Third World. A foreign person may use a tax haven bank or a nominee account
to shield his assets from his political enemies.
Transactions that are tax motivated
but consistent with the letter and spirit of the law. Some examples of these
transactions are flag-of-convenience shipping, (which avoids high
registration fees), banking through subsidiaries, (which postpones taxes on
the profits from loans to foreign entities), transactions between
subsidiaries of unrelated companies that are designed to avoid sales tax,
and certain transactions that take advantage of minor loopholes in the laws
aimed at tax haven use. While some of these may create anomalous situations,
they're legal.
One of the most common tax motivated uses of a tax haven subsidiary is to
change US source income into foreign source income. This increases the
amount of foreign taxes paid by a US taxpayer that can be credited against,
and thus reduce, US taxes paid by the taxpayer.
Aggressive tax planning that takes
advantage of an unintended legal or administrative loophole. Examples
include captive insurance companies, investment companies, some service and
construction businesses being conducted through tax haven entities, and
pricing of transactions. One instance of this might be the establishment of
a service business in a tax haven to provide services for another branch of
the same business located in a third country. A further example might be the
use by a multinational corporation of artificially high transfer pricing to
shift income into a tax haven. Often, the parties are aware that if the
transaction were thoroughly audited, a significant adjustment would probably
be made. They rely on the difficulties involved in overseas information
gathering and on the complexity of the transactions to avoid payment of the
taxes.
Tax evasion is an action by which the
taxpayer tries to escape legal obligations by fraudulent means. This might
involve simply failing to report income or trying to create excess
deductions. This category can also be broken down into two subcategories:
(A) Evasion of tax on income that is legally earned; and, (B) Evasion of
tax on income that arises from an illegal activity such as trafficking in
narcotics. An example of tax fraud would be the formation of sales companies
that appear to deal only with unrelated parties, but in fact deal with
related parties, hiding the fact that one owns a particular tax haven
corporation. These tax haven corporations are also used to hide corporate
receipts or slush funds.
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