CHAPTER 1 Introduction

　　Taxes in most countries have in the last 30 years soared to quite high levels. The primary reason for this large increase has been the need to satisfy collective social consciences, which have demanded large increases in state expenditure.

　　In this respect, New Zealand’s actions have reflected a global trend towards the expansion of individual domestic tax jurisdictions for principally economic reasons. In his treatise on the Canadian international taxation regime[1] , Professor Arnold noted the potential attraction of an efficient international taxation system to a modern cash-strapped country:

　　“With the expanding role of government in society and increased government expenditures has come a seemingly relentless search for additional tax revenues. Many countries have succumbed to the temptation to extend their taxing jurisdiction. And a government’s power to tax is limited effectively only by the countervailing interests of other Governments and the practical difficulties of enforcement and collection.”[2]

　　It was perhaps inevitable then that in the late 1980’s, sustained attention would finally be given to New Zealand’s international taxation regime, and in particular, the prevalent practice of resident taxpayers deferring their domestic income tax liability by deferring foreign-sourced income until the date of their distribution and receipt in New Zealand. Such taxpayers were usually earning foreign-sourced income indirectly by virtue of an interest in a foreign corporate entity.

　　The Labour Government’s initiatives in this area resulted in the enactment of a comprehensive new international taxation regime in 1988, which combined provisions relating to Controlled Foreign Companies, Foreign Investment Funds, and Foreign Trusts, to create a sophisticated machinery capable of taxing the diverse overseas earnings of New Zealand residents.

　　Many people, being of the opinion that a burden has been imposed on them have turned to their tax advisers for advice to arrange their affairs so as either to reduce their taxable income or to ensure that they derive no income at all on which taxation is payable.

　　It is trite law that taxpayers may plan their affairs so as to ensure that income tax laws are inapplicable to their particular income.[3] So long as taxpayers declare all their taxable income, ensure that they abide strictly by the taxing statutes and do not enter into sham transactions they may use any number of legal devices in order to minimise their liabilities.

　　The use of a suitable tax haven has become a characteristic feature of modern international tax planning, and is frequently an essential element of an international group’s corporate structure.

　　When I discussed the concept of writing this paper with a few colleagues who at first were shocked and said that “You can’t write about that! And anyway, where will you get the information?”. Well, I have been quietly gathering information over the past ten years from various sources. I have worked as an external auditor for a corporate heavyweight from Hong Kong that has used places like the British Virgin Islands and the Cayman Islands to avoid taxation. Senior forensic accountants in Auckland have interviewed me, in relation to my experiences with a certain high profile Asian company and it’s relationship to organised crime and money laundering in New Zealand. In addition to these sources, I have read literally hundreds of books by other authors, business magazines from here and overseas, government reports, and Hansards. I have asked a lot of questions through my Hong Kong affiliates in overseas banks, overseas government agencies and overseas solicitors, incorporation agents and made hundreds of phone calls. It has been hard work at times, but at no stage did I become bored or disinterested. This is a fascinating subject, and as you read through the various chapters, I think you will find yourself asking, “Is there a better life for me in one of these places?”, for some of us, there certainly is! Financially anyway.

　　For those of us who plod along in our daily routines, get up, go to work, earn some tax, earn a little for ourselves, watch TV, then go to bed, the dream of white sandy beaches lined with palms in the Caribbean Islands with low or zero tax, having secret Swiss bank accounts or having a branch office of your private company on 5th Avenue in New York is about as alien as living on Mars. All these things are available to normal people and they don’t cost a king’s ransom to set up. 99% of New Zealanders know nothing of this world inhabited by International Corporations and millionaires. This paper will introduce you to their Hidden World.

　　Firstly, we have a quick look at the New Zealand Income Tax Act in regard to tax planning offshore. I think it’s necessary to start with a degree of knowledge of the tax rules before getting too excited about the following chapters.

　　We then move on to look at “What is a Tax Haven?” and the policy issues behind the enactment of those anti-tax haven legislations, “Their Uses”, and some “Likely Havens for New Zealanders”. We will also look at the relevant work in OECD on counteracting measures against the use of tax havens.

　　A conclusion will then be drawn on whether they are havens or hells for the taxpayers?

　　Enough of introductions, enjoy the paper and I hope you get something useful out of it and if not, I hope it is satisfied your curiosity as to what other people get up to in the Hidden World when it comes to their finances.

　　CHAPTER 2

　　New Zealand Tax Considerations

　　These are a few of the issues that must be considered before applying any information in later chapters in this paper. There is one rule above all others that must be adhered to in respect to offshore business dealings, all transactions must not be an arrangement which has tax avoidance as either its sole purpose, or, if it has two or more purposes, one purpose of tax avoidance which is more than incidental. Tax avoidance measures under Section BG 1 of the Income Tax Act 2004 give the Commissioner power to reconstruct the tax accounts of taxpayer in order to counteract any tax advantage obtained by virtue of such an arrangement.

　　2.1 Tax Havens – Can they still be useful?

　　In 1988, an Accrual Taxation System was introduced in relation to Controlled Foreign Companies (“CFC”) and Foreign Investment Funds (“FIF”). The introduction of this system reduced the benefits and therefore the use of tax havens. The past use of tax havens by huge companies has seen some of these companies avoid many millions of dollars in tax. These days due to changes in the law it has made the use of tax havens difficult, but not impossible.

　　2.1.1 The Controlled Foreign Companies (“CFC”) Regime

　　The problem of New Zealand resident taxpayers either deferring or avoiding their domestic income tax liability by directing their foreign-sourced income through tax havens overseas, was thought to be rampant in the late 1980’s. Such practices were often carried out through the medium of a foreign company or trust controlled from New Zealand and interposed between the resident taxpayer and an income-producing asset located offshore. The 1984 and 1987 Labour Governments thought that prolonged activity of this nature was a threat to the New Zealand tax base.[4]

　　The existing anti-avoidance provisions of s 99 were generally viewed as inadequate to counter the problem, largely because tax liability only arose when an avoidance scheme was uncovered. On 22 December 1986 the then Minister of Finance, the Hon R.O. Douglas, indicated that increased penalties would be introduced where a transaction had been found to breach s 99[5] . Nevertheless, the same inherent problem remained, and an alternative solution was sought.

　　The Budget statement of 18 June 1987 contained more detailed international tax measures, based in the main part on anti-tax haven legislation already in force in other countries. Overseas controlled companies and trusts which were used to manipulate transactions for tax avoidance purposes were to be subject to the new laws with effect from income years commencing after 18 June 1987.

　　From the beginning, the method of taxation proposed by the Government was to tax a resident’s share in a controlled foreign company as of it was derived from a foreign branch of a resident company. This was known as the “branch equivalent” method. Further, a controlled foreign company was to be defined as an overseas company which was at least 50% owned by five or fewer New Zealand residents. Finally, where a resident could not provide the Commissioner with sufficient information about the company and its income, domestic taxation liability would be based on the annual change in the value of the taxpayer’s interest in the company. This alternative process was to be known as the “comparative value” method.

　　In New Zealand, the identification of various jurisdictions as tax havens has in the past been facilitated by the CFC legislation itself. The so-called “black list” countries listed in the Seventeenth Schedule[6] to the Income Tax Act 1976, including for example the Cayman Islands and the Cook Islands, were determined to be potential tax havens for the purposes of the CFC legislation at the time of its enactment in 1988, based upon the fact that these jurisdictions had lower effective tax rates than New Zealand.

　　As such, the initial application of the CFC regime (from 1 April 1988), was restricted to interests held solely in the specified black list countries, and not elsewhere. For interests in CFC in other countries, the universal application of the regime was first postponed to 1 April 1992, and then deferred further until 1 April 1993[7] .

　　As a result, the transitional black list has subsequently become of less importance in terms of defining which countries are “tax havens”. To elaborate, the present CFC regime is premised on an exclusionary approach, and now applies instead to all foreign companies resident in another jurisdiction, whether on the black list or not, but with the exception of certain countries with similar tax rates to those of New Zealand.

　　These seven designated countries, being Australia (excluding the Territory of Norfolk Island), Canada, Germany, Japan, the United Kingdom, the United States (excluding its possessions and territories) and Norway, are collectively known as the “grey list” countries, and are contained in the Third Schedule to the Income Tax Act 2004.

　　Pursuant to s EZ 29, income need not be attributed to a New Zealand resident where the CFC is itself resident in a grey list country, unless the CFC applies any feature of that country’s taxation law, which has been expressly specified in the Third Schedule to the Income Tax Act 2004 as being concessionary in nature[8] . There are currently six such concessionary features specified in the Third Schedule.

　　The idea behind the Grey List is to promote investment in countries with tax systems similar to ours and to discourage investment in tax havens.

　　Basically attributable means, regardless of whether you received the cash, the income will attract tax in New Zealand. If it is not attributable, this means it will only attract tax when the income physically enters New Zealand.

　　As you can see the Tax Department doesn’t make it easy.

　　2.1.2 The Foreign Investment Funds (“FIF”) Regime

　　This is another long-winded piece of legislation gone mad.

　　Introduced on 1 April 1993 to close up some fairly major loopholes that the CFC legislation didn’t cover. The FIF measures apply where a foreign entity, although not controlled by New Zealand residents, is an attractive investment vehicle because it allows for the accumulation of income offshore in low tax or tax-free countries, thereby allowing the investor to minimise or defer his or her liability to New Zealand Tax. The main difference between a CFC and a FIF is that the CFC is controlled by New Zealand residents and the FIF is controlled by foreign residents. The loophole allowed you to have a CFC like company being looked after and controlled by someone on your behalf and the Tax Department wouldn’t know.

　　The purpose of the FIF regime, enacted in what are now ss CQ 4 to CQ 6 of the Income Tax Act 2004, is to tax New Zealand residents on a current income basis where they have investments in, but do not control, foreign entities. It also extends New Zealand’s taxation jurisdiction by eliminating the deferral obtained by investing funds in many overseas resident entities.

　　The regime is complementary to the Branch Equivalent regime, which takes precedence where both apply to an interest, so that a person holding a 10 % or greater interest in a CFC will be covered by the CFC regime. But a person holding a less than 10% income interest in a CFC will usually be covered by the FIF regime, as will a person holding any interest in a foreign company that is not a CFC.

　　A New Zealand resident taxpayer who has the misfortune to hold an interest in a FIF is taxed upon any increase in the value of his or her interest in the FIF taking into account both revenue and capital gains both realised and unrealised.

　　Both regimes share a common grey list of seven countries and both regimes are supported by the trust rules.

　　A similar regime was also proposed for foreign trusts, which were deriving income in low-tax jurisdictions. This area will be discussed in the following section.

　　2.1.3 The Foreign Trusts Regime

　　In New Zealand, Subpart HH of the Income Tax Act 2004 dictates the taxation of both domestic and foreign trusts.

　　When considering the deferral of New Zealand tax through offshore entities resident in known tax havens, the Labour Government was unable to ignore the role of trusts in implementing such arrangements. In the Ministerial Guidelines to Anti-Tax Haven Measures[9] it was stated that :

　　“The anti-tax haven measures will also apply to trusts used by New Zealand residents, as trusts connected with tax havens can be used to avoid New Zealand tax. The accumulated income of such trusts may often not be assessed in New Zealand, and may itself be diverted New Zealand source income. The rules will closely parallel those for CFC’s. There may be differences, however, as unlike a company a foreign trust may have contingent beneficiaries or the distribution of its assets may be discretionary. Another obvious difference concerns the concept of control.”[10]

　　As a result of this statement, some commentators, such as Waugh[11] , initially called for the implementation of a regime able to deal with so-called Controlled Foreign Entities (“CFE”) – particularly in the context of the prevalent use of trusts for income tax deferral through tax havens. In line with the Ministerial Guidelines, it was proposed that this regime should be founded on the same tests as those, which characterised the CFC regime, namely the concept of control.

　　Waugh was not unaware of the difficulties, which this might pose, however :

　　“Establishing a test to determine who controls a foreign trust is not as straightforward as in the case of a CFC. The reason for this is the very nature of the trust itself. Prima facie, the trustees of the trust control that trust. However, the plain truth of the matter is that de facto control of a trust frequently rests with persons other than the trustees – perhaps with the settlor, the appointer, or indeed with one or more of its beneficiaries. The issue of de facto control is far more relevant to a trust than it is to corporations. It is going to be very difficult for New Zealand’s legislators to walk the line between a broad de facto test that will inevitably cause uncertainty and hardship, and an objective test that will allow too many loopholes through which the aggressive tax planner can slip.”[12]

　　Whether or not New Zealand’s legislators actually took heed of this or not is unclear, but nevertheless the Consultative Document on International Tax Reform published in December 1987 stated quite clearly that it would be impracticable to try and tax beneficiaries under a trust on the basis of any interest they might have in the earnings of the trust :

　　“In many cases it will not be possible to ascertain, at the end of a trust’s accounting year, whether there are any resident beneficiaries, or, if there are, their respective shares of the trust income. Consequently, it is often not feasible to tax resident beneficiaries on their share of the trust income of non-resident trusts.”[13]

　　Instead, the Consultative Document proposed a different basis for calculating an “interest” in the trust :

　　“In order to achieve the objectives of these reform measures with regard to non-resident trusts, any person resident in New Zealand (referred to as a “resident settlor”) who has contributed property by way of gift, including a transfer of property for inadequate consideration, to a non-resident trust will be considered to have an interest in the non-resident trust.”[14]

　　This sudden reliance on the concept of the “settlor” having an interest in a trust reflected a change in perspective and perception for the revenue authorities dealing in this area, namely that :

　　“… the economic substance of a trust often differs from its legal appearance and form. A settlor may have substantial influence over a trustee, usually on an informal basis, though there may be specific provision in the deed or in the manner of funding the trust so that in practice, if not in law, a settlor is able to wind up a trust or influence or control the disposition of capital or income.”[15]

　　 Moreover, the concept was also potentially very flexible :

　　“The definition of a “resident settlor” will include residents who make indirect contributions to non-resident trusts through resident or non-resident interposed entities such as trusts, companies or financial institutions, or through non-resident individuals. A resident will also have to be considered to have an interest in any non-resident trust to which a non-resident trust or a non-resident company in which the taxpayer has an interest contributes property. … A resident settlor with an interest in a non-resident trust will also be deemed to have an interest in any non- resident company in which that trust has an interest.”[16]

　　This so-called “settlor regime” found its way into a Bill[17] before the Finance and Expenditure Select Committee of Parliament where it was further explained as on the basis that in economic terms non-resident trustees could often be seen to be acting in an agency capacity with respect to a resident settlor, on the grounds that such trustees deal with trust property and income in a manner which is consistent with the economic interests of the settlor.

　　Although that rationale was hardly indisputable, the settlor regime survived various changes made by the Select Committee chiefly to prevent unacceptable retrospective effects, and finally became law on 16 December 1988 when the Income Tax Amendment Act (No 5) 1988 received Royal Assent on 16 December 1988.

　　So why is the residence of the settlor so important? The answer to this question relies on two main points :

　　(1) Pursuant to s HH 4(1) of the Income Tax Act 2004, a trustee is liable to income tax on all trustee income, which the trust derives from New Zealand. However, the taxation of trustee income derived from outside New Zealand is determined on the basis of the residence of the settlor.

　　Thus, subject to certain exceptions, trustee income derived from outside New Zealand in an income year is liable to tax only if at any time during that income year :

　　- the settlor of the trust is resident in New Zealand[18] ; or

　　- the trustee is resident in New Zealand and the settlor died resident in New Zealand.[19]

　　(2) If a settlement has been made on the trust after 17 December 1987, any settlor who is resident in New Zealand at any time during an income year is liable to tax on the trustee income, derived in that income year, as agent of the trustee.[20] The settlor is not liable, however, where :

　　- if at all times during that income year, a trustee is resident in New Zealand[21] ; or

　　- the settlor, being a natural person, was not resident in New Zealand at the time of any settlement by that settlor and who has not at the time of any settlement since 17 December 1987 previously been resident in New Zealand[22] ; or

　　- the settlor can establish to the satisfaction of the Commissioner that the liability of the settlor to income tax on trustee income exceeds the liability which that settlor should bear by comparison to other persons who have made a settlement on the trust, having regard to the respective settlements made by the settlor and those other persons.[23]

　　2.1.4 Residence

　　Why do I pay tax on income I earn overseas?

　　All income of a person is taxable if it is their income under a provision of Part C of the Income Tax Act 2004. Part C contains no general territorial exclusion to the source of income or the residence of the recipient. However, s BD 1(4) preserves the source and residence principals by excluding income that is a foreign-source amount and is derived by a person who is not resident in New Zealand when derived. Thus, it makes the point that a taxpayer, whether an individual or a company, who is a resident of New Zealand is taxable on all income from all sources whether made inside or outside New Zealand.

　　At the heart of all problems a tax haven user faces is that of complying with the provisions of the Income Tax Act 2004 that relate to residency and the derivation of income. These provisions are of fundamental importance and if not complied with serve to avoid all would-be gains to a tax avoider.

　　This comprehensive provision, s BD 1(4), implies that the only available way for individual New Zealand taxpayers to avoid New Zealand tax is for them to lose their New Zealand residency and to assume that of another country.

　　As discussed earlier, certain income derived by foreign companies or trusts is attributed to New Zealand taxpayers on the Accrual Taxation System despite whether they actually receive the money or not. Secrecy laws in certain tax havens are quite often used in this situation, much to the frustration of the Tax Department.

　　Is it possible to be a perpetual traveller to escape paying tax in New Zealand and what is the definition of a resident of New Zealand?

　　Firstly, let’s define resident, this area tends to be a little grey. Obviously, a resident pays tax in the country in which he or she resides. A resident is defined as someone who dwells permanently[24] or present for a considerable time (the 183-day rule)[25] . Citizenship and nationality do not constitute liability to taxation. Also keep in mind that a person can be a resident of more than one place.

　　Now to the question of being a perpetual traveller. A perpetual traveller is someone who travels the world never staying in one place long enough to pay tax. For instance, if someone stays in most places for more than six months, tax traps will start closing just about everywhere.

　　I have read that perpetual travellers (“PT”) organise their lives in at least 5 countries, and this is really looking like a nomadic existence, here is how they would organise it.

　　Country No. 1 – Business Base

　　These are the countries in which the PT earns their money and nothing else. They need to look for administrations which will look after the entrepreneur with things like free commercial real estate, investment subsidies, interest free loans as well as tax exemptions and which limit bureaucratic regulations to a minimum for this purpose. Some of the Caribbean states are excellent in this regard, or the more orthodox addresses such as London, Tokyo and New York. Other possibilities are Zurich, Hong Kong, Singapore, Frankfurt and Milan.

　　Country No. 2 – Passport and Citizenship Issuer

　　Passport havens whose travel documents can be used in many countries without the need for visas and which require very little of its expatriates when it comes to things like tax and military service. New Zealand is perfect.

　　Country No. 3 – Domicile

　　This is where the PT will be spending a lot of their time, perhaps even living in their own home, during their unavoidable breaks in travel. Channel Islands, Andorra and Bermuda would all be fairly good.

　　Country No. 4 – Asset Management

　　Preferably, this asset management base should allow the PT to have trustees or solicitors manage their assets, insurance and business affairs in their absence. Requirements are qualified asset managers, bank secrecy assured by the law, and tax exemption for non-residents. The best place is Liechtenstein, followed by Austria, Luxembourg, Switzerland, Channel Islands and the Isle of Man.

　　Country No. 5 - Playground

　　These are countries with a high standard of living, easily accessible without too many bureaucratic regulations (visas), as well as no restrictions or limits on the duration of stay. Australia, Caribbean, and EC are possible.

　　American tax consultants advise “long term vacationers” in the US to take the following precautions to avoid being declared as residents liable to pay tax: always have your return ticket with confirmed booking ready, don’t register your flat in your own name, don’t be available at your US office all the time, don’t maintain any US bank accounts (at least, don’t have the bank statements sent to your US address) and don’t operate with US letterheads. In short, clearly show that your ties with your old residence outside of America outweigh everything else.