3.2.2.2 Australia

　　In Australia, Cohen was somewhat more circumspect about the value of neutrality in comparison to other policy objectives :

　　“In respect of neutrality, the Government should be cognisant of its taxes that are non-neutral and the effects of such non-neutrality. While it may be a desirable objective to make the Australian tax system more neutral one should not do so at the expense of equity and simplicity. Being an insignificant exporter of capital, the Government ought to be aware that its aim to introduce capital export neutrality will not have great significance in terms of world-wide allocative efficiency.”[51]

　　3.2.3 Efficiency (or Simplicity)

　　The concept of efficiency or simplicity requires that the tax system “be readily understood by taxpayers and therefore as far as practicable be inexpensive to administer”[52] . Thus, the clearer and simpler the tax system, the more easily it will be able to be understood by individuals and organizations from whom the tax is to be collected.

　　Both New Zealand and Australia embraced the notion of efficiency wholeheartedly. The New Zealand 1987 Consultative Document even went so far as to say that :

　　“The two major objectives guiding the Government’s reform of the tax system are efficiency and equity.”[53]

　　Waugh also noted the importance of efficiency and simplicity in this context :

　　 “With manpower and technical resources of the Inland Revenue Department sorely stretched, ease of compliance with the requirements of the proposed legislation will be crucial. Not only must the scope and application of the legislation be clearly spelt out, but ease of taxpayer compliance must be a cornerstone of the proposals. They must not place too great a cost or work burden upon the taxpayer. This is especially so since the ministerial guidelines make it clear that the legislation will be based on the principles of self-assessment.”[54]

　　Whether the resulting regime in this country could be termed “efficient” is a difficult question. Given the size and complexity of the legislation in both New Zealand and Australia, however, one would perhaps be forgiven the somewhat cynical thought that neither country has attained either efficiency or simplicity. Both structures are exceptionally difficult to use, and, as one Australian academic put it, “are no doubt going to provide tax professionals with significant levels of income in the years to come”[55] .

　　Other commentators, such as Davidson & Simcock, seem to agree :

　　“The underlying aims and objectives of the international tax legislation are by themselves not objectionable. However the legislation increases the complexity of the Income Tax Act 1976 to almost unmanageable proportions and many of its concepts remain to be tested for logic and more importantly, workability.”[56]

　　3.2.4 Summary & Discussion

　　From this discussion it is not hard to appreciate that the primary motivating force behind the enactment of the CFC regime was the desire to effectively end the ability of New Zealand residents to defer their domestic tax liability through the utilisation of foreign entities – especially those resident in recognised tax havens.

　　Such a concept of deferral is, however, central to any potential scheme to minimise a taxpayer’s domestic tax liability under the CFC regime. As a result, any arrangements entered into as part of such a scheme are likely to be subjected to reasonably close scrutiny by revenue authorities, who will be anxious to nip such practices in the bud.

　　In terms of tax planning in this area, then, it would appear that any potentially successful scheme must not be seen to blatantly flaunt the legislation in any way, but must instead be justifiable on the grounds of prudent business activity beyond the purview of mere tax minimisation.

　　Moreover, such a scheme must also attempt to be as true as possible to the policy objectives discussed earlier.

　　CHAPTER 4

　　The Use of Tax Havens

　　The principal function of tax havens is undoubtedly the avoidance of current and future taxes. However, they may also serve the purpose of postponing the imposition of tax (tax deferral).

　　4.1 Advantages of a Tax Haven

　　A tax haven may offer one or more of the following advantages:

　　• Low or No Tax.

　　• No restrictions on the nationality of shareholders, directors and other officers, and the ease with which any such restrictions may be overcome by the use of nominees.

　　• The allowance of bearer shares and of shares without a par value.

　　• Guarantees against future taxes (the Cayman Islands’ government offers attractive guarantees to both exempted trusts and exempted companies).

　　• Secrecy of Information (the Cayman Islands, Luxembourg and Liechtenstein make it a criminal offence for tax officials and bank employees to reveal any information at their disposal).

　　• Flexibility (certain tax havens provide that domicile of a company may be moved out of the jurisdiction in the event of a change of circumstances).

　　• The existence of a tax treaty network or double tax agreements (certain tax havens owe their existence to these networks such as the Netherlands Antilles whilst the lack of agreements is beneficial in precluding the furnishing of information to other governments).

　　• The conduct of active business in the tax haven country itself.

　　• Zero tax treatment of non-resident and foreign income.

　　• The adequacy of banking, professional, commercial, transportation and communication facilities.

　　• No exchange controls and restrictions (while there are significant advantages in operating in a tax haven that does not have exchange controls, a foreign company can avoid most of the restrictions of exchange controls by maintaining a non-resident status).

　　• The existence of anti-tax avoidance legislation or government attitude to tax haven operations.

　　• Free trade zones with no imposition of import or customs duties (such as Panama, Puerto Rico, Ireland, Switzerland and Vanuatu that depend upon trading as one of their principal incentives to lure overseas companies cannot afford to inhibit imports of required materials or equipment).

　　4.2 The Choice of The Tax Haven

　　There is no single answer to the question of which is the best tax haven. The type of transaction planned is the most important factor in determining the choice. As every tax avoider has his/her own unique problem each needs a particular kind of tax haven. The only way that his/her question may be resolved is for the tax avoider to set his/her problem out in detail and then, with the assistance of accounting and legal advisers skilled in international taxation problems; work out the best tax haven solution. On some occasions such a solution will be entirely inappropriate and could even increase the taxpayer’s aggregate tax burden and a better answer would be provided by domestic tax planning procedures being undertaken. Thus an analysis of the problem must precede the search for the tax haven and only when it is finally decided that a tax haven plan is viable will the actual choice of the tax haven be made.

　　The choice of the tax haven depends on numerous factors: if an international finance company is to be established it would be necessary to choose a country with a sophisticated network of financial and legal facilities (such as Hong Kong or the Bahamas); if an importing or exporting company is planned a country mutually convenient to both importing and exporting countries would perhaps be the best choice; and if both parties to the transaction were from New Zealand or its close neighbours it would probably be better to consider some local tax haven (such as Vanuatu).

　　There are numerous other factors that determine a tax avoider’s choice, several of which are essential to the formation and continued existence of a successful tax haven. The first and most important element is that it must have low, or no taxes on at least one major category of income. Secondly, it must have political stability. There should be little possibility of a new administration gaining power and abandoning the country’s tax haven status.

　　A third requirement is that the haven must be accessible. Physical accessibility is very important although legal accessibility is also a material consideration as some European havens, notably Liechtenstein; make it practically impossible for individuals to become residents. Vanuatu, a popular local choice, also has stringent restrictions on residency[57] . The attitude of the Bermuda Government is perhaps quite typical of governments of third world tax haven countries. There, there are very stringent restrictions on aliens becoming residents and thus gaining tax-free status[58] - only after five years can a British subject become a resident and for other nationals, notably citizens of the United States, a ten year wait is necessary. Because of the government policy of ensuring that Bermudans have the first choice of all jobs on the island non-Bermudans are discouraged from working. Moreover, it is the government’s policy to ensure that Bermudans also have the first choice in all property sales so land and housing are at a premium.

　　A further key consideration to be taken into account is the availability of competent legal and financial assistance within the tax haven. Without expert advice not even the most basic tax plan can be put into effect.

　　Other important elements, depending on the needs of the particular tax fugitive, include the absence of currency controls, the availability of labour (crucial to companies wanting to set up industrial operations), the climate and cost of living (often decisive for individuals), a strongly based monetary unit and the protection and certainty of a good legal system.

　　4.3 Techniques for Using Tax Havens

　　Although there might appear to be a great number of techniques in using tax havens, some of the fundamental techniques become apparent. Whilst it might not be possible to look at every possible structure used to benefit from tax havens, I have tried to illustrate, where possible, the most important techniques appropriate, and those currently in use.

　　It should be pointed out that any company wishing to commence overseas operations is fully entitled to expect to obtain tax savings by careful planning. However, to ensure that the overseas structure is not subject to attack by tax authorities throughout the world, it is essential that the plan have substance. In order to achieve substance, the plan may, for example require the establishment of a holding company with permanent office accommodation and employees overseas. Thus before any international tax plan is implemented a thorough cost-benefit analysis must be made.

　　4.3.1 Distribution of Post-Tax Profits

　　The most relevant and permanent savings can usually be achieved by minimizing withholding taxes deducted from dividend distributions paid to foreign shareholders. The technique generally involves the use of holding companies located in countries with numerous favourable Double Tax Agreements or unilateral tax relief relating to dividend income. The Netherlands, which has no less than 47 tax treaties, offers dramatic withholding tax savings. By employing an intermediary holding company in the Netherlands to absorb all the profits of the underlying subsidiaries, the parent company located in a tax haven such as the Netherlands Antilles is able to benefit from an incredibly low tax toll on dividend payments passed through the corporate structure. This technique can often usefully be employed in an international group structure, which provides for the movement of products from one country to another.

　　4.3.2 Source Allocation of Pre-Tax Profits

　　The utilization of price differentials is a very useful tax saving technique, but is not a device for the greedy. An example of this is where an exporter located in a high tax country, sells his/her products at a relatively low profit margin to a subsidiary operating in a tax haven. This subsidiary then resells the product at a higher price and this traps profits, which incur low or no tax.

　　The Japanese when selling goods in the US has utilized this technique. In order not to incur substantial US taxes the Japanese route their goods through Singapore and resell them at a substantial profit margin on to their US operations. Tax authorities around the world are acutely aware of this technique and have strengthened the anti-avoidance provisions in their tax legislation to counter this potential loss of tax revenue. However, the tax benefit arising from the source allocation of profits to a tax haven can still be obtained provided the following four factors are taken into account:

　　(i) Substance – it is important to ensure that the operation has commercial substance.

　　(ii) Permanent establishment – this concept is found in most DTAs and its existence in a country will subject the profits attributable to that establishment to tax in the country in which it is located.

　　(iii) Transfer pricing – it is essential to be able to justify on a commercial basis the various selling prices charged which result in the source allocation of profits.

　　(iv) Management control – where it is situated.

　　4.3.3 Profit Extraction

　　Profits earned in a high tax country can sometimes be extracted to tax havens as interest, royalties or management fees. In all these cases the country of source is likely to have rules limiting the effectiveness of the technique. The object here is to arrange for payments to be made which are allowable deductions against taxable profits in the country of origin thus reducing the taxable profits there. There may be withholding taxes in the country of origin, and taxes in the country of receipt. Provided that these total less than the tax that would have been levied on the profits against which the payments are charged, there is a net advantage.

　　4.3.4 Treaty Shopping

　　There are two main ways in which treaty shopping occurs:

　　• Direct-conduit method; and

　　• Stepping-stone method.

　　Direct-Conduit Method

　　• Treaty Shopping: Direct-Conduit Method

　　 Treaty

　　In this example, the tax treaty between Country A and Country B provides for an exemption from Country A’s tax on dividends paid by companies in Country A to shareholders in Country B. Country C has no tax treaty with either Country A or B. In order to benefit from the dividend exemption in the A-B tax treaty, a company resident in Country C establishes a wholly owned subsidiary in Country A. The Company C parent then transfers all its shares in the Country A company to another wholly owned subsidiary in Country B. This intermediary company is exempt under Country B’s domestic law on dividends received from a wholly owned subsidiary. The income from the parent company’s investment in Country A can thus be accumulated tax-free in Country B. The same sort of result might be achieved if Country B was a tax haven. Thus, the success of the conduit method depends on the intermediary company being located in a low tax jurisdiction.

　　Stepping-Stone Method

　　• Treaty Shopping: Stepping-Stone Method

　　 Treaty

　　In this example, the tax treaty between Country A and Country B provides for an exemption from Country A’s tax for interest going from Country A to residents of Country B. Country C has no tax treaty with either Country A or B. In order to benefit from this provision in the A-B treaty, a company in Country C assigns to a subsidiary in Country B the loans it has made to persons resident in Country A. The subsidiary in Country B, in order to provide the consideration for this assignment, borrows an equivalent amount at an equivalent rate of interest from the parent company. The subsidiary is liable in principle to Country B’s tax on the interest it receives, but the liability is effectively eliminated because the subsidiary’s taxable income is reduced to nil by a deduction for the interest that it has to pay. Country B does not impose a withholding tax on interest, and the parent company is exempt from domestic tax on the income in its own country of residence. Thus, the parent company uses the A-B treaty as a stepping-stone to enable it to receive its interest from Country B without suffering Country B’s tax.

　　4.3.5 Trusts

　　Trusts are separate entities governed by two varieties of laws; common law and civil law trusts. The former are prevalent in those tax havens, which are or were British territories (e.g. the Cayman Islands, the Bahamas, Bermuda, Hong Kong or the Isle of Man), the latter in havens such as Liechtenstein, Switzerland and Panama.

　　The essence of a trust is that it breaks the chain of legal ownership between the creator of the settlement and his/her wealth. US tax rules are particularly tough in this regard, however even the IRS can be avoided through the concept of a grantor trust, where the deemed owner of a trust’s assets in terms of US law is a person who is neither a US citizen nor a resident of that country. In this case the distributions to a beneficiary who is an American citizen or resident are considered as gifts and therefore not taxable in the beneficiary’s hands.

　　In order to hide the ownership of an underlying company, an effective method is to interpose a discretionary type trust between the beneficial owners and the underlying companies.

　　A discretionary type trust is one created under Anglo-Saxon law whereby the class of beneficiaries are named in the trust documents but their entitlement to any benefit of capital or income from the trusts is wholly dependent on the trustees exercising their sole discretionary powers. The reason these types of trusts are more commonly used in international tax planning is that the individual beneficiaries do not have vested interests and are dependent on the trustees to make all decisions. As such a beneficiary will not be considered to have a taxable interest until such time he/she receives a distribution.

　　In the case of business trusts, a trust that owns a business or company, by having the overall ownership of the trading companies vested in the trustees of a trust, the directors of those underlying companies may be able to truthfully disclose the ownership of the companies without there being any apparent involvement by the beneficial owners. The trustees in a particular tax haven jurisdiction would only know the actual beneficiary of the trust. Under general trust law, beneficiaries of discretionary trusts are not the owners of the trust or its assets or income.

　　Trusts are extremely flexible and are used by both individuals and companies. Often by setting up a trust the beneficiary is able to transfer his/her wealth, in secret and facilitate global expansion with limited tax consequences. Tax havens often play a crucial role with their permitted use of secretive bearer shares, zero tax with guarantees in certain cases (the Cayman Islands) for zero tax for the next 50 years.

　　4.3.6 Offshore Holding Companies

　　One can incorporate an offshore holding company to own the foreign subsidiary. It might be located in one of a number of jurisdictions such as the Netherlands, Switzerland and Luxembourg, which grant special tax privileges to holding companies. The Netherlands Antilles with its low tax has been actively used as a springboard for parent companies by employing an intermediary holding company in the Netherlands, which then in turn takes advantages of the Netherlands extensive tax treaty network. The offshore holding company may provide some or all of the following benefits:

　　Reduced Withholding Taxes

　　Withholding taxes on the foreign subsidiary’s dividend, royalty or interest payments can be reduced by having the foreign subsidiary owned by a holding company entitled to the benefit of a tax treaty.

　　Deferral of Tax on Dividends

　　Depending on the tax laws of the home country, dividends received from the foreign subsidiary will be fully taxed at home. By interposing an offshore holding company, tax on such dividends can be deferred since the offshore holding company rather than the home company will receive them. Due to tax privileges for holding companies the offshore company will not be liable for taxes on capital gains or dividends it receives. Thus it will accumulate profits offshore and be able to re-invest pre-tax.

　　Mix of Foreign Taxes

　　If the home country taxes dividends received from foreign subsidiaries, it will normally derive foreign tax credits for the taxes paid by the foreign subsidiaries. By placing all foreign subsidiaries under one offshore holding company, these foreign tax credits can be mixed, so that high and low tax rates are brought together to enable the foreign tax credits to be fully utilized.

　　• Sample group of companies funded from a tax haven

　　 Loan

　　4.3.7 Offshore Licensing and Patent Holding Companies

　　The taxpayer can utilize a licensing company suitably located offshore to license patent rights to his/her foreign subsidiary. In paying patent royalties to the offshore patent owning company, profits are effectively shifted from the foreign subsidiary to the offshore patent owning company, which pays little or no tax on the royalties received. Other intangible rights such as trademarks, copyrights, know-how and franchising rights can be received in the form of royalties with tax advantages if a tax haven company is established to sub-license other companies in various countries.

　　To illustrate, a tax savings can be effected on patent royalties by combining offshore companies. The US does not deduct withholding tax on royalties paid to a Dutch company. Thus, if an offshore company sets up a Dutch subsidiary, licensing its patents to the Dutch company, the Dutch company can in turn license these patents onto the US manufacturer. Now the American company can pay the Dutch subsidiary the patent royalties tax-free. The Dutch company can pay the offshore company (the patent owner) the royalty, thereby avoiding Dutch withholding taxes on dividends. The net result is that the Dutch company is not taxed in the Netherlands, and the offshore company avoids the US 30% withholding tax. As a further advantage, since the offshore company owns the American manufacturer, it can get the royalty rate in such a manner as to absorb much of the US profit, thereby minimizing US taxes.

　　It is possible to use a network of tax treaties and tax havens to obtain the best features of each as a means of avoiding onshore withholding taxes. The new US-Netherlands tax treaty has limited the above option. For example, a German patentee seeks to license a US company without paying US or German tax by the following steps:

　　1. The German company assigns the patent to a Liechtenstein holding company.

　　2. The German company grants a license to a Swiss letterbox company, which in turn licenses a US company.

　　3. The US company pays royalties to the Swiss company, which is free of US withholding tax by virtue of the US-Switzerland tax treaty.

　　4. The Swiss company pays royalties equivalent to the Liechtenstein company and suffers no withholding tax or profits tax.

　　5. The Liechtenstein company pays no profits tax and no tax distribution of profits. Royalties are accumulated until the German company requires them.

　　• Patent licensing to shelter royalties

　　Flow of royalty payments

　　4.3.8 Offshore Finance Companies

　　The taxpayer can utilize a finance company suitably located offshore to channel loans to his/her foreign subsidiary. In paying interest to the offshore finance company, profits are effectively shifted from the foreign subsidiary to the offshore finance company, which pays little or no tax on the interest received. It may be necessary for the loans to be channelled through several companies in order to avoid actions since it will invariably be located in a territory that imposes no withholding taxes on source. That is why international companies often organize their borrowings through finance subsidiaries in, for example, Bermuda and the Netherlands Antilles.

　　In capitalizing the foreign subsidiary with these loans the taxpayer should bear in mind that a number of foreign countries impose restrictions on thinly capitalized companies with a large ratio of debt to equity. The benefit of an offshore finance company will normally be curtailed when the home country operates controlled foreign company-type anti-avoidance legislation (i.e. pierce the corporate veil). In that case the interest received by the offshore finance company will normally be automatically taxed at home. But there may be methods of avoiding this, such as getting the offshore finance company to undertake other activities, ensuring it pays tax at a specified minimum rate or repatriating a specified proportion of its income.

　　The offshore finance company may also be utilized to raise outside borrowings for the group as a whole. Its attraction to lenders will be the fact that it can pay them interest free of withholding tax deductions since it will invariably be located in a territory that imposes no withholding taxes on source.

　　Furthermore where a Payor Company is paying interest to its Finance Company it is possible to reduce the tax charge of the Finance Company to an immaterial amount. By interposing a Netherlands finance company between the Payor Company and a separate offshore company the group/individual will effectively not have to pay any withholding tax to either the US (normally 30%), UK (normally 25%), Germany (25%) and France (33 1/3%) due to the Netherlands tax treaty with these countries. Generous benefits (tax spread) within the Netherlands itself will allow Dutch tax to be equal to only 0.125% after management fees due to the offshore company’s services are paid. The interest payment thus originating from the US can pass on to the Netherlands company with no withholding tax and therefore pass to the offshore company after a minimal Dutch tax deduction.

　　• Structure using offshore finance company

　　Loans Loans

　　4.3.9 Conduit Finance Companies

　　A conduit finance company is used to receive interest subject to the minimum possible rates of withholding tax under applicable double taxation treaties. Typically it then pays most of this interest onto another territory, the interest payment representing a tax-deductible expense, but leaving a small margin, which will be subject to corporate tax in the territory where the conduit is established. A suitable location for such a company would meet the following requirements:

　　• an extensive network of favourable double taxation agreements;

　　• little or no withholding tax on interest payments;

　　• corporate tax rules allowing the full deduction of interest expense paid to non-residents, subject only to leaving a small financing margin in the company.

　　Thus the conduit may lend funds at say 10.25%, receiving the interest subject to nil or low withholding taxes through the benefit of tax treaties between the country (e.g. Netherlands Antilles) it is established in and the country of residence to its borrowers. The conduit would then pay interest at the rate of 10% on an equivalent loan from a company in another tax haven (e.g. Cayman Islands). The conduit company thus earns a 0.25% margin on its borrowing and lending.

　　• Dual finance company structure

　　 Loan to borrower

　　 10.25%

　　 Inter-company loan 10%

　　4.3.10 Offshore Banking Secrecy

　　The simplest and fastest way for ordinary people to place their private money and investments that no one else knows about is to set up a structure of offshore bank accounts.

　　The allure of using offshore bank accounts has much to do with the confidentiality and secrecy factors as the reputation of the countries or jurisdictions to have strict bank secrecy laws.

　　For example, in the Cayman Islands, a law passed in 1976 threatens anyone who divulges Cayman Islands bank information gained in the course of work with a penalty of US$5,000 or 2 years imprisonment. According to the government’s interpretation, it is also illegal to help foreign tax investigators to obtain information.

　　4.3.11 Real Estate

　　Private investors in real estate would do well to consider the use of an offshore company to hold their real estate investment. This is possible in most tax havens and has the advantages of preserving a degree of anonymity and offering the possibility of avoiding eventual capital gains tax liability by the expedient of selling shares in the company owning the real estate.

　　4.3.12 Tourism Companies

　　The travel business is well suited to utilize tax haven benefits. As an example, a retailer or group of retailers, could make a viable operation out of establishing their own travel wholesale operation in a tax haven such as Bermuda, and channelling their business through it. It is important to understand that the tax-free profits of such a Bermuda based operation should not be repatriated to the home country, but rather invested in other foreign operations where capital growth can continue unhampered.

　　4.4 Summary

　　Tax havens have acted as a catalyst for world trade and at present at least 50% of all the world’s money is to be found either in tax havens or transferred through them. As such, the remainder of this paper is dedicated to some likely havens for New Zealanders and the interaction between tax havens and the international community such as the OECD.