09/28/2009 02:08:00 PM EST
Practical Strategies for Investment in the U.S., Europe and Asia Building Blocks Four Key Strategies in International Tax Structuring
Summary: Though practical limitations wiill prevent most practitioners from dispensing advice regarding foreign tax laws, a U.S. tax practitioner may, nevertheless, effectively structure investments in a tax efficient manner without completely deferring to foreign counsel. Although numerous factors impact any investment, there are four key building blocks that most often influence transactions.
The Authors write: When considering an investment abroad, several factors are relevant...
Building Block #1 - The Effects of Tax Treaties: ...[E]ven an investment in a jurisdiction possessed of a tax treaty may still require the need for some alternative tax structuring.
For this reason, many tax structures utilize intermediate holding companies in jurisdictions other than the one in which the ultimate investment lies... Practitioners repeatedly place such holding companies in the same jurisdictions. That is no accident. These jurisdictions tend to have favorable tax rates, low administrative tax burdens, and a wide range of treaties available.
Building Block #2 - Permanent Establishment: ...Most tax treaties define a "Permanent Establishment" (PE) as a "fixed place of business through which the business of an enterprise is wholly or partly carried on." The OECD Commentary imbues further meaning into the term "fixed place of business, stating that a place of business must be "fixed" to constitute a Permanent Establishment, as determined both by "location" and by "time." Most treaties, including the U.S. Model Treaty and most older versions of the OECD Model Treaty, then include a specific (but not exclusive) list of types of business locations that qualify as a Permanent Establishment. 8 Most tax treaties provide a list relatively similar to that provided in the U.S. Model Treaty and older versions of the OECD Model Treaty..
Building Block #3 - Withholding Taxes (Interest, Dividends and Royalties): Even if PE status is avoided, a foreign investor is not necessarily free from foreign income tax liability on its investments. Withholding taxes are typically imposed on certain types of passive investment income streams earned in a foreign jurisdiction...
Building Block #4 - Taxation of Capital Gains:The U.S. Model Treaty, as well as many of our bilateral tax treaties, contain Capital Gains provisions that source gains from the sale of personal property to the residence of the seller. Thus, the sale of shares of stock by a non-resident, which does not have a PE, is not subject to taxation...
Most U.S. bilateral tax treaties with European nations contain a capital gains provision that follows the Model treaty to the letter. Contrast that, however, with the capital gains articles contained in the bilateral tax treaties conducted between the United States and Asian jurisdictions, particularly China and India. These articles generally impose capital gains taxes on foreigners who sell shares of a domestic corporation. This state of affairs, of course, seriously affects the method by which U.S. investors would seek to structure investments when they venture into China or India.
To minimize, or eliminate, the impact of capital gains taxes, and other tax issues, practitioners should consider using one of several tax strategies.
- The Holding Company Structure to Eliminate Capital Gains Tax (but Beware of Limitation of Benefit Clauses)... The practitioner should treaty shop to locate a bilateral tax treaty between the country of investment and a third Country possessed of a more favorable capital gains provision than the United States' treaty... Treaty shopping, however, is not without its limitations... Beneficial treaty arrangements involving other Asian countries exist, 18 as well, and it is advisable to ascertain where the most benefit lies. Caution should be exercised, however, since treaties are subject to renegotiation more freely in Asia than in the United States or Europe. Caution should also be exercised to ensure that the Treaty does not contain an "Anti-Treaty Shopping" provision, or a "Limitation of Benefits" provision that would prevent the Holding Company from claiming the treaty benefits of the bilateral tax treaty with the source country.
- Use of a Holding Company in a Tax Haven (But Beware of Vodafone)... The second method typically utilized by tax practitioners for avoiding capital gains taxes is the insertion (or "stacking") of an extra holding company in a tax haven jurisdiction. At the time of disposition, the investor will avoid the direct sale of the shares of the target corporation by instead selling the shares of the holding company.
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