Cross-border tax planning is of course a creation of national governments, which jealously guard their power to decide what, who and how to tax. If all governments taxed the same assets in exactly the same manner or if they delegated tax raising powers to one supra national authority, the issues would not arise. The cession of Value Added Tax (VAT) issues to the EU has removed most VAT conflicts between member states. However, generally, states not only guard their tax deciding powers but also use them as instruments of policy, deciding whether to give particular assets, such as business assets belonging to taxpayers sited in that state, particularly generous tax treatment for specific and sometimes temporary policy or political reasons.
Thus the battle lines are set. Tax authorities accuse individuals of the sin of tax avoidance. Innocent tax payers are subject to double taxation due to the avarice of states.
The pendulum swings between:
Individual jurisdictions tax wealth, transactions or transfers of income or wealth in many different ways. A taxing state may be unitary or federal, a kingdom or a republic. Federal jurisdictions may have sole or joint taxing rights with their subsidiary states.
Assets sited in the taxing jurisdiction are often, but not always, taxed, irrespective of any other connecting factor. In the case of tangible assets there are rarely any difficulties, but intangible assets produce a myriad of issues. (The conversion of the US tangible immovable property into bundled intangible insurance policies is perhaps a case in point). Since intangibles are artificial animals they must by nature be defined by artificial and differing rules. Some states will define an interest in a corporation as being in the place of incorporation and others at its seat; the situs of a right to an asset may be the place of the underlying asset or the place where the right can be enforced.
Assets, though, must be taxed through their owners, and then the fun begins. No man is an island, but which man owns the island? Many states have an extremely artificial rule that whoever is registered as the owner, will be treated for all purposes as the owner, whether he/she is or not. Such jurisdictions are puzzled by arguments that someone other than the registered proprietor may be the owner and that this other person should be taxed as such. There are always exceptions to every rule and such states may be perfectly happy to accept that; notwithstanding that a property is registered in the name of Mrs Donne, her spouse or registered partner may have rights under a matrimonial property regime, which means that it is not actually all taxable on Mrs Donne: Mr Donne must take his share too.
Corporations are usually thought by states to be a good thing if trading and paying corporation tax often attract tax concessions, so that, for example, profits can be accumulated at low tax rates and reinvested. Foreign trading corporations often receive financial encouragement to come into the state to invest. Non-trading investment companies, however, are often thought to be a bad thing, especially if they are considered to be foreign corporations. Foreign investment companies may therefore be subject to penal rates unless underlying owners of the company are disclosed and the underlying owners themselves become taxable. Trusts which may or may not separate interests in capital and income are penalised, while usufructs which do the same job may be treated more or less favourably.
The use of taxation as an instrument of policy and politics means that in some states transfers between spouses or registered partners may be exempt while not in other jurisdictions. Transfers between parents and children or grandchildren may be encouraged in some, while in others generation skipping is penalised. Exemption may be given to transfers to worldwide charities or limited to local ones. Insurance and pension policies, business assets and agricultural property may each be subject to particular and peculiarly defined advantages often in breach of constitutional or international treaties or obligations.
Then one considers who is to be the taxpayer. It may be the underlying owner, however that may be defined, or it may be the registered owner or trustee. Gift and estate taxes are particularly difficult since the taxpayer may in one jurisdiction be the donee or heir or beneficiary while in another state may be the donor, settlor or representative of the deceased. Some states will tax any one of them if that one happens to have the misfortune to be a taxpayer of that state.
But who is to be a taxpayer? In addition to the connection by ownership and situs of assets, taxpayers can be connected by the usual factors of nationality, residence or domicile. Within those factors lies a multiplicity of definitions. US non-aliens may remain subject to US tax and penalised by a heroic tax if they attempt to give up their nationality. German nationals may remain subject to German tax for five years after they have ceased to be resident, extended to 10 years if they choose to go to the US. Dutch nationals similarly remain subject to tax in the Netherlands for 10 years if they are foolish enough to move to a state without a relevant double tax treaty. Non- residence may need to be proved by becoming a taxpayer in another jurisdiction.
Most states tax in one way or another on the basis of some form of residence. Residence, however, comes in many shapes and sizes and can be habitual, usual, normal or ordinary. Will the existence of a room in a parents’ house suffice? Must there be physical presence in the state for a period? How is the period defined? Is it to be 90 or 183 days or some other period? Do days of arrival and/or departure count, and in what circumstances? Is there a look-back provision? The artificiality of the rules does mean that taxpayers who do not keep very precise records and factual evidence may be penalised.
Some states still tax in one way or another on the basis of domicile, each with its own individual rules and meanings.
Treaty or unilateral relief can mitigate the impact of double taxation, but many treaties still give jurisdictions the right to tax on a universal basis and the applicability of treaties can be completely artificial. Is it logical that a person domiciled in the UK can have the benefit of the UK/US estate duty treaty and that a person with a French domicile/residence can have the benefit of the France/US estate duty treaty, but that a person with French domicile resident in the UK can have the protection of neither?
In the field of gifts and inheritance there are only a very limited number of double tax treaties and many of them do not apply to lifetime gifts.
Ireland only has treaties with the UK and the US.
The UK has four pre-1974 treaties with India, Pakistan, France and Italy and six post- 1973 treaties with Ireland, the Netherlands, South Africa, Sweden, Switzerland and the US. The treaties with India, Pakistan, France, Italy and Switzerland only deal with tax on death.
The US has nine pre-1970 treaties with Australia, Finland, Greece, Ireland, Japan, Norway, South Africa and Switzerland. None of these apply to gift skipping tax (GST) and only the Japan treaty applies to gift tax. The remainder only deal with estate tax. There are seven post-1979 treaties with Austria, Denmark, France, Germany, the Netherlands, Sweden and the UK. The Dutch treaty only applies to estate tax, while the remainder covers estate, gift and GST.
Material law cannot be ignored. Whether or not a donor or testator can take advantage of particular tax exemptions will depend upon whether the relevant applicable law permits such a gift or inheritance. A full spouse exemption is of limited use, if only one quarter or one third of assets can pass to a spouse and the remainder must pass to children or parents. The connecting factors for the material law are often not the same as for taxation. Whether or not a particular matrimonial property regime is recognised may have a significant tax effect. If a usufruct is characterised as a discretionary trust this may produce unforeseen and unpleasant tax demands.
Helping clients avoid double taxation therefore requires discovering exactly
Keeping track of the nationality, domicile, deemed domicile, residence, ordinary residence and habitual residence for each individual client and their families under the laws of all possible relevant states is extremely demanding both on the advisor and the family. Mr and Mrs Donne may not remember to tell their advisor that young John has moved to a different state before he became entitled to money or an inheritance, or that they have forgotten to change the locks so that he no longer has accommodation available to him.
One or more of them may find the tax effects a nasty surprise.
Richard Frimston, Russell-Cooke LLP, London, UK