International Tax Planning and International Tax Law (Overview)
It is human nature to look for benefits. Children, for example, know what is forbidden by the mother and allowed by the father, they go to the grandmother for additional pocket money and they ask the worker on the street to buy them a beer in the shop.
Businessmen look which countries offer good business conditions, they transfer functions and use advantages from tax treaties, they check alternatives if there are too many regulations and taxes and they invest where the authorities are less strict.
If country A offers a variety of benefits but charges high taxes and country B offers less benefits for less tax, it makes sense to receive benefits in country A and to pay tax in country B. However, high taxes do not automatically mean high benefits, many countries need money to pay old debt, and other countries pay large parts of the budgets for social transfers to people who are able but not willing to work while the economy has to employ migrants to meet the demand.
As a rule, companies hire tax advisors to represent their interests vis-à-vis the authorities. The states, in turn, regulate the industry (tax consultants, accountants and auditors) in order to limit the possibilities of tax structuring.
Regarding tax laws, there is a hierarchy:
- National tax law that takes into account taxation of international activities:
- Double taxation treaties (DTT) are bilateral agreements that limit the taxing rights of the contracting states. This limitation depends, if the DTT is applicable, how this agreement defines residence and permanent establishment (tie breaker rule: stronger than the national definition) and how the countries are regulating the taxation rights for different categories of income. Almost all DTT can be found in the Internet.
- Multilateral agreements usually cover a few topics for a group of participating countries. Examples are EU directives (merger directive, parent-subsidiary directive the interest and royalty directive or ATAD- Anti Tax Avoidance Directive), BEPS or the Multilateral Instrument.
Most double tax treaties follow the pattern of the text of one version of the OECD Model, which covers specific subjects.
Examples are the definition of residence (art. 4) and permanent establishment (art. 5) as well as various income sources (e.g. art. 7 business income, art. 10 dividends, art 11 interest, art. 12 royalties) and application rules (art.23 tax credit or exemption method).
Usually, active income is taxable in the source state (employment income, business profits, etc.), while income from short time employment and passive income like dividends, interests or royalties is taxed by the residence state but there might be a withholding tax in the other state, too.
International tax planning involves steps to maximize total net income, this includes not only the tax rates, but also regulations, switching costs, structure costs and the tax basis.
It considers possibilities offered by the laws of different countries. Hence, it is possible to utilize regulations of double tax agreements but also benefit from differences in corporate laws or national tax laws.
In order to consider local laws and anti- abuse legislation, Zugimpex works together as closely as possible with tax advisors of customers, and adds to their service.
A tax planning process works like this:
- Definition of existing business processes and relevant tax subjects (who has to pay tax), tax objects (for what tax has to be paid), tax basis and tax rates.
- Possible scenarios including transfer of functions
- To benefit from liberal business regulations
- To benefit from lower salary levels
- To benefit from lowering the tax base (allowable deductions and exemptions)
- To benefit from lower tax rates
- Similar to the concept of “total costs of ownership” in IT, there should be an integrated approach when changes are planned.
- Check of alternatives and recommendation depending on objective criteria and subjective preferences:
- Non- tax topics:
- switching costs and structure costs
- audit and publication requirements
- labour law and work permits
- legal enforcement of contractual agreements
- asset protection
- marketing aspects (near to customers, language)
- costs and availability of personnel
- differences in legal structures and their cross border qualification: hybrid instruments can be used to create deductible expenses in one country that result in tax free profits in another country.
- Taxation and social charges:
- tax on business profits
- tax on dividends
- withholding tax
- social charges on employment and self-employment income
- tax on capital gains
- inheritance tax
- real estate tax
- attitude of tax authorities (degree of “form over substance” attitude)
- reliable publications by tax authorities and possibilities for a ruling
- degree of centralization and service of tax authorities
- Taxation at the private level:
- Taxation of dividends
- Wealth tax
- Capital gains tax
- Pensions and retirement schemes
- Inheritance and gift taxes
- Investment schemes
- Recommendation, taking into account objective criteria and subjective preferences
Such a process of Tax planning and structure planning is the first step, followed by the registration of a company in the proper jurisdiction.
Most important – the realization: tax planning offers opportunities, but requires actual implementation and good documentation. Not the model, but its implementation is the real success factor. Those who neglect it act like a boxer without coverage: sooner or later, a punch will knock him down!
However, professional advisory also looks how to increase sales and earnings: why only look for ways to save taxes while maintaining existing business? Suppose we find a way to combine a sales strategy of your products and services with tax benefits and thus enable your business to expand rapidly, would this be interesting for you?
In any case, everything must pay off for you – and this is only the case if your additional benefit is higher than all additional costs including those of your time and of tax consulting.
Substance and Real Implementation
12 rules to be safe in case of a tax inspection:
Tax authorities implement anti abuse rules, exchange information and data analysis to battle tax evasion and aggressive tax planning. Zugimpex shows what is important to stay safe and to benefit without struggles.
Rule 1: Evidence: collect and provide evidence, because you are not dealing with sympathetic tax inspectors. Gather evidence on your own that can support your arguments:
- Documents, electronic records
- Plausibility, on-scene evidence
We recommend that you collect relevant documents from the very beginning, in order to be able to present them in the case of an audit by fiscal authorities … and that you carefully avoid such evidence that can be misinterpreted by malicious people against your interests.
Make sure you know which level of substance is required in the specific situation, calculate and arrange it properly.
Rule 2: know that tax authorities require increased cooperation from taxpayers in international business relations: outside the EU, authorities are reversing the burden of proof on the taxpayer, and this has to be taken into consideration; conversely, there should be no evidence of facts that lead to undesired tax liabilities.
A lot of money is at stake: take enough time to get familiar with the basic issues of international tax law. Expertise will not only help in dealing with tax authorities: you will recognize attractive design options which your tax consultant did not find for you; you can organize your processes so that they result in desired fiscal consequences; you can identify fiscally critical functions and implement the proper tools to monitor them precisely.
Rule 3: Pay attention to get the desired qualification of facts: collect and provide evidence in order to cope with any attempt to qualify your company as a “transparent” (not real) company based on Art. 5 of the OECD model tax convention, double tax treaties and national laws:
- assure that the company has an economic function (e.g. marketing, also online)
- substance and infrastructure (server/ web shop, staff, premises): avoid to appoint nominee directors, because they have a different set of interest, are subject to additional controls and they are not always available when needed. Part time employees, even if they work sometimes from their home office, provide substance and create real benefit for companies.
- control over available sources of income
Rule 4: Let the location of the company be the real place of management (“management & control”): make sure you collect evidence that important decisions for the company are made at its seat: strategy, signature of important contracts, attendance of management of the company (meeting minutes) and much more. Hint: if you do not have time to be there, employ a manager or let one of your employees be manager of the foreign company, but make sure in the management contract that he/she is really at the site of the company.
Rule 5: Avoid unplanned “permanent establishments”: criteria for unplanned permanent establishment can be according to Art. 5 of the OECD model tax convention: a fixed place of business through which the business of an enterprise is wholly or partly carried on; an agent with authority to conclude contracts in the name of the enterprise; permanent services that last longer than 6-12 months, depending on the double tax treaty.
If the manager of a company that is located in a country with reasonable taxation has his residence in another country, no written correspondence should be done or kept in that other country in order to avoid any assumption that the place of effective management could be in the country of residence.
Rule 6: Justify transfer prices: according to Art. 9 of the OECD model tax convention transactions between associated companies should conform to comparable transactions between independent third parties, otherwise there is threat of an classification as a hidden dividend based on tax assessment (by estimation). There are accepted ways:
- Transfer prices in the range of market prices
- Transfer prices based on sales price minus commission percentage (based on a contractual agreement that has to show adequate return-service)
- Calculation of costs and markups (pro rata allocation of overhead is accepted, but is not mandatory, often the separation of direct costs and overhead offers interesting options).
It is strongly recommended to establish from the very beginning a voluntary documentation how you calculate transactions between associated companies.
Remember: transfer pricing regulations are applied for transactions between associated enterprises, not on transactions between independent companies where a re-classification is only applied if there is clear evident of misuse.
Rule 7: Avoid qualification of payments as a hidden dividend: if there are transactions between a company and connected companies or shareholders, be sure that there is good documentation and that transfer prices can be compared with prices between independent companies. In addition, document loans carefully and do not forget to pay the defined interest.
Rule 8: Use taxed money for visible private expenses and avoid to raise suspicion of tax evasion: often it is checked whether house, car and visible lifestyle could be proven to be financed with taxed income. Keep records about such facts. Demonstrate that there is real business, by plausible transactions and by conscious involvement of witnesses who could testify their current perceptions.
Rule 9: There are increasing requirements to prove substance: (rent, personnel), think not only about taxes, but also about structure costs. If you transfer processes to a country with low wages and low taxes, you save both costs and taxes.
Rule 10: In tax audits let an expert represent you: let your tax expert deal with tax inspectors, because some tax inspectors can be dangerous: psychologically excellent educated, they establish a friendly relationship for some days and then ask some tricky questions (that procedure is permitted to them in most countries).
Rule 11: Be concealed in tax matters: tell only those who need the information and present yourself always as honest upright taxpayer, however tricky your real tax planning might be.
Rule 12: Know your personality: if you do not have strong nerves or if you are not able to work precisely in detail, do not try to engage in international activities. For intelligent business and tax planning, these personal qualities are crucial.
Make sure you implement these aspects and benefit from internationalization:
Inform yourself about the taxation in Switzerland and how to register a Swiss company, especially in the Canton of Zug.
If you want to benefit from the lowest corporate tax in Europe or the Res / Non- Dom scheme, read about taxation in Malta and how to register a company in Malta.
If you chose a jurisdiction with liberal legislation in the heart of Europe, consider the taxation in Slovakia and how to register a company in Bratislava.
(Updated July 2021)