Onshore tax

PRESSURE from the Organisation for Economic Cooperation and Development (OECD) regarding the application of the EU Savings Directive, and the allied negotiations between the EU and Switzerland, have created a situation where, in the OECD’s attempt to level the EU tax recovery playing field and to reduce tax leakage by the use of structures taking advantage of some member states’ tax benefits, tax advantages have been highlighted in states such as Luxembourg, Ireland, the Netherlands and Denmark.

The regimes have differed. For example, Luxembourg provided a good general tax-friendly regime, whereby full use could be made of its extensive double tax treaty network to minimise withholding taxes on payments made from other member states to Luxembourg, and utilising tax rulings to permit onward distribution of such receipts at a minimal tax cost. A similar type of regime applied in the Netherlands, where the use of Dutch companies and Dutch Antilles holding companies permitted a convenient route for the transfer of profits out of EU countries at a 4.2 per cent maximum tax rate.

Many of these structures were used for corporate tax planning, but such structures were also used in significant numbers by private client investors to mitigate their European tax liabilities, particularly in relation to royalties and real estate investment. For example, taxation arising from real estate investment in France and Germany could be reduced significantly by using the `double Dutch’ route.

The tax authorities in those countries became increasingly concerned at the loss of tax caused by such arrangements, and the introduction of legislation and alterations to the double tax treaties reduced the effectiveness of such structuring – although ever inventive tax practitioners would usually discover some new method of mitigation as soon as a particular route was closed down.

Except for some very specific double tax treaty use, the offshore centres such as the Isle of Man and the Channel Islands were not particularly involved in these arrangements other than being, perhaps, the ultimate recipients of the funds realised. From a UK perspective, because of its capital gains tax regime, which does not tax non-residents, the use of onshore European structures was usually not necessary, except where royalties or similar income arose in the UK.

As a result of the pressure brought by the EU’s Code of Conduct Committee to reduce `harmful tax practices’, the EU Savings Directive countries within Europe are being forced into reorganising tax regimes that discriminate between taxpayers. For example, exemptions or reliefs which have a specific geographical limit, such as the Dublin scheme, are no longer regarded as appropriate, with the result that Ireland has abolished such special treatment and in 2002 introduced a general low rate of corporation tax of 12.5 per cent, applicable to all Irish companies. Similarly, Cyprus, which had an attractive 4.5 per cent tax regime for its offshore companies, has introduced a general 10 per cent tax rate for companies; but in the case of Cyprus, it has introduced a number of reliefs and exemptions which reduce significantly the impact of what might otherwise have been a substantive increase in the tax liabilities of such companies.

This has been mirrored in the offshore jurisdictions by, for example, Jersey, Guernsey and the Isle of Man deciding that they will move to a zero per cent corporate tax regime for all companies so that there is no differential between tax paid by local companies and tax payable under their offshore regimes. However, many of the Caribbean jurisdictions remain undecided as to how to proceed.

Generally, EU countries have been moving towards lower corporate tax, and the introduction of holding company legislation in a number of jurisdictions, the UK being a prime example, has increased the attractiveness of those jurisdictions.

Allied to the above has been the finalisation of the terms on which the EU Savings Directive will be applied, which has enabled Luxembourg in particular to retain its bank secrecy rules by imposing a withholding tax of 15 per cent where disclosure of beneficial ownership is not a route that the customer wishes to take. This provides EU countries with the same possibility as that which applies to Switzerland, which now governs the retention or otherwise of the internal EU tax-friendly states.

This has enabled Luxembourg to retain its full complement of tax-efficient corporate entities, although it has altered some of the exemptions applicable to 1929 holding companies (Luxembourg companies exempt from all tax – including withholding taxes – other than capital duty and the annual `taxe d’abannement’) to make them less aggressive. The use of those companies within the EU can still provide a very attractive route for minimising tax, and Luxembourg (despite its high costs) has once again become the principal player in the onshore taxation game.

An example of the increasing low tax competition is the attempt by Denmark (never a big player in this field) to become more heavily involved as a tax-efficient jurisdiction. Some years ago, Denmark abolished withholding tax on distributions from Danish companies. By making use of Denmark’s extensive double tax treaty network, it is possible to transmit funds from other European jurisdictions through Denmark without suffering any further tax charge. Very recently, Denmark has legislated to provide that Danish companies no longer pay capital gains tax on foreign real estate, and in conjunction with its other benefits (including income tax exemption in such circumstances) it is moving up the scale of jurisdictions which should be included in any consideration of tax-efficient structures.

No doubt there will be much debate in the future as to the political correctness of EU member states seeking to override the spirit of the principle of an all-equal and transparent EU taxation regime, but it is clear that there are significant tax advantages still to be obtained from taking steps to structure trades and investments by the use of entities set up in carefully chosen EU jurisdictions. Indeed, there is a continuing thrust by a number of countries to maintain and expand their shares of the market for such tax-efficient structures, and there will be continuing opportunities for practitioners and their clients to be creative in their pursuit of reduced taxation.

Wynne Thomas heads the private client department at Dawsons