Ticklish issue of whether or not to migrate to another tax jurisdiction

Financial Times (www.ft.com) has just published a very interesting article entitled "Ticklish issue of whether or not to migrate to another tax jurisdiction", wrote by Vanessa Houlder:

Amid this Autumn’s financial turmoil, WPP, the world’s second largest advertising group, unveiled big tax savings from a small but significant change in its corporate structure.

It joined a handful of businesses – Shire, United Business Media, Regus, Charter and Henderson – in moving its holding company and tax base out of the UK.
More companies could follow suit. Richard Lambert, director general of the CBI, recently told a conference “any independent director worth her salt” would be asking whether the company should move headquarters for tax reasons.

Ashley Almanza, chief financial officer of BG and chairman of the Hundred Group, the influential lobbyist, says factors such as the judicial framework, the benefits of agglomeration and reputational issues ensure that any decision to move would not be taken lightly. “There are powerful reasons to stay,” he says.

But companies with large overseas operations could make big savings by moving their tax base to small, business-friendly regimes such as Ireland or Luxembourg.

The classic emigration route is via an “inversion”: setting up an overseas holding company, typically in Ireland, that acquires the old UK company on a share-for-share basis.

The company is usually incorporated in Jersey to ensure no stamp duty is payable. The UK company then sells its foreign subsidiaries to the new Irish holding company.
Provided the activities are mainly trading in nature, the gains should be exempt from capital gains tax under the “substantial shareholding exemption”.

The main reason why an inversion would save tax lies in the “controlled foreign companies” (CFC) rules, under which the UK taxes offshore passive income, such as royalties and interest. By contrast, it normally only taxes foreign profits when dividends are paid back to the UK.

These CFC rules have been tightened in successive Budgets. That has curtailed the ability of companies to do international tax planning.

For some companies intending to expand their overseas operations, the UK’s CFC regime is a powerful incentive to move to a country such as Ireland that has no CFC rules.

Another powerful force driving some multinationals to change their domicile is a fear that the CFC rules will become even tougher.

This prospect was raised by the Treasury’s consultation, launched last year, on how to reform the taxation of foreign profits.

The Treasury is sympathetic to a longstanding business request to allow the tax-free repatriation of foreign dividends. But it fears this concession will be used to find new ways to avoid tax.

As a result, it is considering adopting tougher CFC rules. After an outcry, it told businesses in July that it had dropped proposals to sweep all their overseas income relating to intellectual property into the British tax net through a new “controlled companies” regime.

The Treasury is also considering tightening up on the ability of businesses to inject debt into their UK operations, reducing their taxable profits. It has proposed a worldwide debt cap, which would stop UK entities having more debt than required to finance the worldwide group.

This proposal worries some multinationals, although the Treasury has said it would set it aside when a group was cash-rich for a temporary reason, such as completing a sale.

Henderson, the fund manager, estimated changing its domicile would cost £4.5m. Smaller or less profitable businesses or those with significant tax losses are unlikely to make big tax savings by moving.

Moreover, inversions carry risks. There is ample scope for a political backlash against businesses avoiding tax, particularly when taxpayers are having to bail out the financial sector.

There is also a risk of a change in the tax regime in the new domicile. Ireland has underlined its commitment to preserving its low corporate tax rate, even though it has announced other tax rises.

Another risk could flow from a Revenue & Customs’ investigation into whether the control of a business has genuinely left the UK.

The costs and risks mean inversions are not a sensible option for all international companies. The UK continues to attract the lion’s share of headquarters set up in Europe, according to Oxford Intelligence research for Ernst & Young. Peter Lemagnen, its managing director, suggests that smaller companies are still being drawn to Britain but the tax regime is a deterrent for some larger, more sophisticated companies.

Historically, the UK won more than 40 per cent of headquarters investment in Europe; last year it fell to 30 per cent.

Philip Cox, chief executive of International Power, which owns power stations in 20 countries, says his group’s ability to compete will be severely hampered if foreign interest income is swept in the British corporate tax net. “For us, the treatment of overseas profits is critical. It can be a deciding factor on winning or losing a bid.”

Copyright The Financial Times Limited 2008

Regulating Tax Competition in Offshore Financial Centers

Regulating Tax Competition in Offshore Financial Centers

Craig M. Boise (Case Western Reserve University - School of Law) published this paper at Case Legal Studies Research Paper No. 08-26

Here is the Abstract:

One of the more entrenched issues in international taxation over the last thirty years has been how to define and respond appropriately to harmful tax competition among nations, especially competition from offshore financial centers (OFCs). The Organization for Economic Co-operation and Development (OECD) and the European Union (EU) have both mounted initiatives seeking to regulate such competition, and OFCs have strongly objected to these initiatives as an abrogation of their sovereignty in tax matters. This paper provides an introduction to the debate over the regulation of international tax competition, beginning with an overview of the essential architecture of international taxation and the way that its structure creates problems for developed countries and opportunities for OFCs, and continuing with an assessment of the arguments asserted in favor of, and against, regulating tax competition.

The paper then examines how developed countries, through the OECD and EU, have defined international tax competition, and the efforts made by both organizations to regulate such competition. Finally, the paper draws on the way the OECD and EU dealt specifically with the twin touchstones of virtually all definitions of tax havens-low or no income taxation and bank secrecy-to suggest the direction that regulation of tax competition is likely to take in the future.

Available at SSRN: http://ssrn.com/abstract=1266329

Schwidetzky: Musings on a German Tax Conference

Walter D. Schwidetzky shares his interesting "Musings on a German Tax Conference" on http://taxprof.typepad.com/:

"I have recently returned from a German tax conference on the value added tax (19% in Germany). Some musings:

A big issue for the value added tax in Europe is people gaming the system. As there is not a uniform value added tax in Europe, people will often buy a product in a country with a lower value added tax and then bring it into the country where they live. With higher end items like cars, this has mostly been stopped, but for other items it is a common problem, especially for people living near borders.
German maximum income tax rates are high by US standards, in the low 40%’s for income above around 60,000 Euros (around $81,000 depending on exchange rates). Germans may, however, effectively deduct payments for medical insurance and mandatory pension contributions. As a consequence, the net effective rate of income tax in the US and Germany, especially for middle class families, may not be that different once medical insurance and pension contributions are taken into account. Most Germans do not think their tax rates are too high, at least judging by the comments of people at the conference (who are mostly high earners). However, Germany significantly lowered its income tax rates in 2000, and its economy has done significantly better since then, providing some possible evidence of a move from the right side of the Laffer curve to more in the middle. While Germany’s unemployment rate has come down as a result of the recent boom in exports, it remains stubbornly high, around 8%, 15% in the former East Germany. At the same time, Germany has a shortage of skilled workers. I have been told that most of Germany’s unemployed have few skills and often a limited capacity to develop them. I should add that many Germans feel that the reunification has created many of Germany’s economic problems, which have been tough to solve. The unemployment rate in the former West Germany is comparable to that of the U.S.

Most Americans have a somewhat romanticized view of universal health care. While few Germans would support moving away from universal health care, most would agree that their system is badly in need of repair. There is a bewildering array of some 300 health insurance companies, mostly private, though some at least have a state association. A minimum amount of health insurance is required. Most who can afford it buy upgraded private insurance to get better care and better service. If you have the standard insurance, and you want to see a doctor, you don’t make an appointment; you just show up and wait until the doctor sees you. Might be an hour, might be half of a day. An American friend of mine gave birth to her third child in Germany. Initially she was put in a room with 7 other women, which freaked her out as she was used to US standards. She and her husband paid extra for a semi-private room. (A digression: When she and her husband asked for a circumcision, the doctor responded: ”Half or whole?” Not a question they wanted to answer incorrectly…). Many young German hospital doctors by the hour make the same as the janitorial staff. As a consequence, large numbers of young doctors are leaving Germany for better paying jobs in the US, Switzerland, and England. I would rather be sick with good insurance in the US than in Germany, but if I was poor, I would rather be sick in Germany where at least I would get treatment.

Most Germans probably also have a greater sense of social obligation to those less fortunate than most Americans. Most Germans trust their government more than most Americans trust theirs. Governmental paternalism is much more accepted in Germany than the US. The reach of this would surprise many Americans, however. For example, free speech is not allowed nearly to the same extent in Germany as it is in the US. Also, Moslem women who want to teach school are not allowed to wear head scarves (which has the effect of preventing many from entering the teaching profession). Germans commonly feel that the scarf subjugates women and also feel that teachers’ religious views should not be obvious to students. These considerations trump religious freedom issues. The Church of Scientology is at risk of being outlawed in Germany, something that could not happen in the US. (I might add that there is some hypocrisy here. In Bavaria it is common to see crosses on the walls in courts and schools.) Last I checked, if you change abodes in Germany, you are required to register with the police. Name changes are generally not allowed.

Many of my liberal colleagues probably would prefer the German system to the US system. Having lived in Germany and experienced German paternalism first hand, I am more hesitant, but I don’t doubt the US and Germany could learn from each other. As Prof. Ted Seto pointed out in a recent posting on TaxProf, the US needs to pay more attention to how other countries do things. There is plenty we could learn."

Constitutional Restraints on Corporate Tax Integration

Walter Hellerstein (University of Georgia School of Law), Georg Kofler (NYU School of Law) and Ruth Mason (University of Connecticut School of Law) published the report Tax Law Review, Forthcoming. Available at SSRN:http://ssrn.com/abstract=1101560

Here is the Abstract:

States that conclude that double taxation of corporate profits unacceptably distorts the choice of business form, the debt and equity capitalization of companies, and the character and timing of profits distributions may adopt integrated corporate tax regimes, but states almost always limit such re gimes to domestic dividends¿those paid by a corporation taxable in the state to a shareholder also taxable in the state. In contrast, states generally deny double tax relief to cross-border dividends. Failure to extend relief to cross-border dividends distorts locational investment decisions.

Although restricting double tax relief to domestic dividends does not violate international tax nondiscrimination rules, more stringent nondiscrimination rules govern state taxation in the European Union and the United States. Member states of those common markets may not constitutionally prefer domestic commerce over cross-border commerce, and that constitutional constraint limits EU and U.S. states' ability to confine double tax relief to domestic dividends. This symposium paper establishes the basic framework for taxation of cross-border dividends, closely analyzes and compares constitutional challenges to states' failure to extend double tax relief to cross-border dividends in Europe and the United States, and identifies the principal policy considerations emerging from the nascent cross-border dividend jurisprudence in the European Court of Justice.

What Problems and Opportunities are Created by Tax Havens?

Dhammika Dharmapala (University of Connecticut) published this paper.

Here is the Abstract:

Tax havens have attracted increasing attention from policymakers in recent years. This paper provides an overview of a growing body of research that analyzes the consequences and determinants of the existence of tax haven countries. For instance, recent evidence suggests that tax havens tend to have stronger governance institutions than comparable non haven countries.

Most importantly, tax havens provide opportunities for tax planning by multinational corporations. It is often argued that tax havens erode the tax base of high-tax countries by attracting such corporate activity. However, while tax havens host a disproportionate fraction of the world's foreign direct investment (FDI), their existence need not make high-tax countries worse off. It is possible that, under certain conditions, the existence of tax havens can enhance efficiency and even mitigate tax competition. Indeed, corporate tax revenues in major capital-exporting countries have exhibited robust growth, despite substantial FDI flows to tax havens.

Available at SSRN: http://ssrn.com/abstract=1279146

The Impact of Taxes on Internet Purchase Behavior

No Longer a Tax Haven? The Impact of Taxes on Internet Purchase Behavior

Peng Huang (Georgia Institute of Technology) and Nicholas H. Lurie (Georgia Institute of Technology) published this study on September 2008.

Here is the Abstract:

Using the online transaction data of 88,814 U.S. households in 2006, we analyze how local tax rates affect online purchasing behavior. Although earlier survey-based research has found that consumers who live in high-tax localities are more likely to shop online, our transaction-based data show the opposite. We find that higher local tax rates are associated with lower online expenditures, reduced transaction frequency, and a lower probability of making an online purchase. A disaggregate analysis shows that increased sales tax does not significantly boost demand from tax avoiding retailers but significantly lowers demand for online retailers that collect tax. In addition online shoppers are more than twice as sensitive to tax as traditional store shoppers. Finally, we document that tax losses from Internet sales are more moderate than previously estimated.

Available at SSRN: http://ssrn.com/abstract=1266432