Economic Rationale of Tax Planning Strategies
Tax authorities around the globe (OECD member states as well as the so-called BRICS countries) are increasingly looking further than at the place where central management and control are exercised. They search thoroughly for the economic rationale (often also referred to as economic or commercial substance) behind the use of a company, particularly if the company is incorporated in a low-tax jurisdiction. For example, in order to benefit from tax treaties, the recipient of dividends, interest and royalties also has to be the eneficial owner of such income. An empty letterbox company may be a short term and cost efficient solution but may prove very costly in the long term, not only from a financial, but also reputational perspective.
It is becoming increasingly necessary to counter the charge that an entity or structure was set up solely for tax purposes, that it is wholly artificial, or is not set up for so-called bona fide reasons, otherwise domestic anti-avoidance legislation in the country that seeks to tax may be triggered.
How are Chinese outbound investments (out of China into a third country) and inbound investments (into China) affected?
Chinese tax laws have vast majority of anti-avoidance provisions, which Chinese investors must consider when investing out of China. Due to the unfavorable tax treatment in China of foreign source dividend income or capital gains, Chinese outbound investment into third countries have usually been routed through offshore jurisdictions. While tax-efficient investments via low-tax jurisdictions into third countries remain possible, it will be important to equip such investment vehicles with sufficient substance (s. discussion further below).
More importantly, when investing into China, Chinese revenue authorities will closely look at the investment vehicles and their functions. Chinese tax treaties typically require that the non-resident recipient of Chinese income such as dividends, royalties or interest, must be the beneficial owner in order to enjoy the treaty benefits. A good example is the SAT Bulletin (2012) No 30 (issued in June 2012), which authorizes Chinese revenue authorities to review documents such as articles of association, financial statements, board resolutions, expense information, functions and risks assumed by each entity, loan agreements, license agreements, patent/copyright registration certificates, and agency/proxy agreements in order to determine the commercial purpose of a particular transaction. As a result, if a company is a mere conduit (flow-through) entity, ie if the entity does not have the full discretion as to what it does with the monies, then revenue authorities might argue that the entity is not the beneficial owner but merely an artificially interposed entity set up for the sole purpose of avoiding the payment of taxes.
How do I achieve enough Substance?
First of all, there is no standard approach as to when sufficient substance is actually achieved. Each company and its corporate structure have to be reviewed on a case-by-case basis. As a rule of thumb, the entity owning the most valuable intangibles and performing the most important functions within a corporate structure will typically be entitled to the largest share of the profits or losses. In order to achieve this, key personnel must be allocated to that entity where these functions are performed and where the assets are located.
There appears to be a general agreement that an entity cannot have ubstance in a given jurisdiction unless (1) It conducts genuine business activities in that jurisdiction and (2) The recipient of any income (dividends, royalties and interest) must be the direct beneficiary. Naturally, agents, nominees and their ilk do not qualify as beneficial owners.
The Treaty Network and Substance in the GCC
In the past few years many countries of the Gulf Cooperation Council (the GCC includes the UAE, Bahrain, Qatar, Saudi Arabia, Kuwait and Oman) have concluded a vast majority of double tax treaties. Some of the countries (particularly Bahrain, Dubai and now also Qatar) are often looked at when establishing regional and international hubs partly also due to their favorable tax regimes. If companies want to access the benefits of the broad treaty network, substance as mentioned above can and should be established in all GCC countries. It must be emphasized that there are plenty of non-tax reasons for a company to establish a presence in the GCC. The business hubs of Bahrain, Qatar and the UAE are strategically located at the crossroads between Europe, Asia, and let not forget Africa. They offer outstanding and fast-growing infrastructure, access to a huge regional market, a great pool of talent, just to mention a few points of attraction.
How can we help?
Following a cost/benefit analysis, we help in aligning the tax strategy with the business strategy and assist in restructuring existing company groups by establishing sufficient substance through holding, finance, IP or other companies in any jurisdiction with proper local representation in terms of functions, risks and assets.
We do not only solve problems and develop solutions but we also help with implementing them. BBD does not operate with agents, nominee directors, nominee shareholders and we do not promote a particular jurisdiction. We are prepared to establish and manage companies in any given jurisdiction, depending on the client´s needs.
Who are our clients?
Our clients are typically firms that are large enough to establish a significant presence in global markets, but not large enough to develop an in-house fully staffed international division necessary to stay on top of the multitude of dynamic changes that influence business opportunities in foreign markets.
