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Client Alert-WHERE HAVE ALL THE TAX HAVENS GONE?

Aug 10, 2020
  • FisherBroyles News

Many companies engaged in cross-border commerce develop structures to manage their global effective tax rates through the use of intermediary companies domiciled in low or no tax jurisdictions.  Over the past few years, more and more governments have seen revenues in their respective public fisc decline, leading these governments, either unilaterally or multilaterally, to scrutinize perceived overly aggressive structures principally designed to minimize the multinational company’s worldwide effective tax rate.  These structures include, among others, migrating/locating valuable, revenue-producing, mobile assets (e.g., intellectual property or other mobile income producing assets) to low- or no-tax domiciles, such as Bermuda, BVI, or the Cayman Islands.  This artificial “shift” of revenues combined with secrecy laws in these domiciles creates opportunities for overly aggressive structures to shield certain revenues from relevant governmental authorities.

The United States, for example, looks to the economic realities of the structure as opposed to the form (as in certain civil law jurisdictions[1]) through the common law evolution of the “economic substance” doctrine.  Recently, the economic substance doctrine was codified[2] by Congress and provides that a transaction will be respected for tax purposes only if there are meaningful changes in a taxpayer’s economic position and there are substantial non-federal income tax reasons to enter into the transaction.  In addition to the economic substance requirements, the United States adopted anti avoidance legislation and information reporting requirements under its amended controlled foreign corporation rules including the new Global Intangible Low-Taxed Income (“GILTI”) regime, to identify revenues that should have been reported and attributed to the United States.  Moreover, due to the enactment by Congress of The Tax Cuts and Jobs Act of 2017, the United States moved from a worldwide tax on profits to a territorial tax system for certain types of a U.S. company’s foreign source income to incentivize U.S. companies to repatriate offshore funds as well as operations the frictional cost including tax of maintaining the status quo of existing structures is mitigated to a degree.

OECD and EU Actions to Address Aggressive Cross Border Planning

The Organization for Cooperation and Development[3] (“OECD”) adopted the Base Erosion and Profit Shifting (“BEPS”) to identify and develop a means to address the perceived abuses through the use of migrating intangibles to low or no tax domiciles.  The EU has been adopted the BEPS initiative by introducing the Anti-Tax Avoidance Directive (“ATAD”) and the DAC6 Directive amendments on mandatory disclosures of certain tax planning arrangement.

The increased activities of these multilateral organizations led to a review of the low or no tax country’s tax policy that artificially divert profits to low or no tax jurisdictions.  This latest OECD undertaking commenced in July 2017 and incorporates actions developed under the Base Erosion and Profit Shifting (BEPS) project initiated by the G20.  The EU has followed suit through its adoption of the 2017 Code of Conduct, a country’s tax policies will be assessed for :

a.  Tax Transparency

b.  Fair taxation; and

c.  Anti-BEPS actions.

To further correct the perceived mismatch of profits to actual activities, the EU[4] and OECD have concentrated efforts on ensuring many of the low- or no-tax domiciles adopt legislation on economic substance rules, similar bit not identical to the US rules, as well as annual reporting requirements.  Failure to adopt appropriate legislation will lead to such domicile being placed on the EU blacklist.  To avoid this, countries including Cayman Islands, Bermuda and the BVI adopted legislation in late 2019 to meet the EU guidelines.  The new legislation in these domiciles will add internal resources and costs to companies for compliance in offshore jurisdictions.

Under the new economic substance rules, “relevant entities” organized in an offshore jurisdiction that carry on “relevant activities” are required to maintain an “adequate” level of “substance” in that jurisdiction (e.g., board meetings held in the offshore jurisdiction, local employees, locally-sourced income and local operating expenses). Failure to do so will potentially subject the relevant entity to large fines and penalties.

“Relevant activities” include banking, insurance, shipping, fund management, finance/leasing, holding company activities, IP holding activities, and service center or distribution center activities.  Each country’s legislation may not be identical, so it is important to have the specific domicile of the offshore entity reviewed by counsel.  Compliance will generally be assessed on a yearly basis based on reporting requirements imposed on the offshore entities subject to the rules.

As of the date of this article the countries that are on the EU’s blacklist include the Cayman Islands[5], Fiji, Oman, Samoa, Trinidad and Tobago, Vanuatu, the three US territories of American Samoa, Guam and the US Virgin Islands, Palau, Panama and Seychelles. To avoid being black-listed by US and EU member countries, many of these offshore jurisdictions adopted legislation in the fourth quarter of 2019 to meet the requirements of economic substance rules. Accordingly, an offshore entity must now maintain adequate premises, employees, local activities, locally-generated income, and locally-generated expenses to satisfy the economic substance test.  The days of a mailbox in a lawyer’s office will no longer suffice.

In the case of the Cayman Islands (related to non-CIV investments), Bermuda, and BVI, this will take the form of a special informational return which must be filed beginning in 2020.  As a result of the COVID-19 pandemic, the EU allows provides member states, at their option, to extend the due date for information reports to January 1, 2021 (as opposed to July 1, 2020).

As the deferred reporting dates approach, a review of an entity’s global structure, especially where third-party countries are used as headquarters companies and/or IP holding companies should be commenced to ensure the structure meets the EU economic substance requirements as well as other anti-tax avoidance schemes.  The global structure review can also consider other jurisdictions for the location of a holding company’s headquarters, such as Singapore.

As a result of the new DAC 6 requirements as well as growing concerns over Hong Kong, domiciles such as Singapore seek to fill the voids that may arise.  In January 2020, Singapore adopted a new entity structure – the Variable Capital Company (“VCC”), focused on attracting the assets of fund managers domiciled in Cayman Islands or other blacklisted country.  Singapore will also offer other incentives under its VCC regime including offsets to start-up costs up to $108,000 per year (up to January 2023).

 

FisherBroyles International Group Takeaways

Any company with cross border investments and/or operations should review their overall structure in light of the recent changes resulting from multilateral organizations and individual countries to gauge the impact of the new reporting and compliance regimes enacted in the EU, US and by the OECD.

About FisherBroyles

FisherBroyles’ International Group is well-suited to undertake such a review and develop alternative options to comply or restructure the company’s global footprint to best meet the company’s objectives and comply with the recently enacted reporting regimes.  This is especially true for EU investment funds that may have operations in the Cayman Islands or other low tax jurisdiction.

In addition to advising on international taxation issues, FisherBroyles provides a full-service offering in London with practice areas covering corporate, litigation, capital markets and M&A, securities, employment, international arbitration, intellectual property, data privacy, media, sports, energy, technology, and outsourcing.

 

For additional information, please contact: Stuart Anolik at [email protected] with any questions or more specific situations.

 

[1] In civil law jurisdictions, courts apply the law strictly as written, and will not look behind the words of a statute or regulation to apply it according to the supposed intention of the drafters.

[2] See §7701(o) of the Internal Revenue Code of 1986, as amended (the “IRC”).

[3] The Organization of Economic Cooperation and Development (“OECD”) is made up of 37 countries to stimulate global trade and provide a platform for identifying key economic and finance concerns, including taxation (direct and indirect).  The OECD publishes and routinely updates model tax conventions and commentaries that countries may use as templates.

[4] As a result of Brexit, the UK is viewed as a member of the EU, and following the Brexit transition period, many practitioners expect the UK to amend legislation an continue application of DAC 6.

[5] The Cayman Islands was added to the list, notwithstanding the OECD’s determination that its economic substance regime was not “harmful”.  The EU’s reason for blacklisting the Cayman Islands is that “Cayman Islands does not have appropriate measures in place relating to economic substance in the area of collective investment vehicles (“CIV”).”  In February 2020, the Cayman Islands adopted legislation for investment funds to satisfy the EU’s concern regarding economic substance for collective investment vehicles, however, the deadline for legislation to be in effect was February 4, 2020.

 

About FisherBroyles, LLP

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