Confidentiality, tax avoidance and evasion

Dennis Healy, when he was the UK Chancellor of the Exchequer, once said that “the difference between tax avoidance and tax evasion is the thickness of a prison wall.” What he meant was that there is a fine line between tax evasion, which is illegal, and tax avoidance which might be frowned upon but is legal. Put another way, if someone gets married and the unplanned consequence is that tax is saved that is lucky. If that person gets married and the main reason is to save tax, it is tax avoidance. If that person tells the tax authorities that they are married when they are not in order to save tax it is tax evasion.

Governments all around the world, including China, need to find more money and are under great pressure to collect more tax. Tax departments are becoming more sophisticated and better at catching tax cheats. Many are mounting concerted campaigns to convince the public that tax avoidance is illegal and immoral. It is not the former but is arguably the latter. The public relations war is being lost by wealthy tax payers. The vast majority of the population is paid a straight-forward wage and has little or no opportunity to reduce their taxes.. Even if there were tax saving possibilities it is likely that the fees they would pay to properly implement any kind of tax planning would be more than the tax saving. It is hardly surprising, then, that the majority do not like the idea that the wealthy minority employ professional advisors to reduce their taxes or simply hide their money, fail to declare taxable income and illegally evade tax.

As professional advisors, we clearly see nothing wrong in engaging in legitimate tax mitigation. That is not necessarily a view which the majority will agree with. Frequently we find it necessary to point out to those who judge tax saving to be immoral that it is also possible for us to advise them how to pay more tax if they feel that any sort of tax saving is wrong. Rarely is that offer taken up.

There is a worldwide effort being made to prevent tax evasion. Swiss banks are now being forced to offer up details of clients so that their home tax authorities can check that the capital in their accounts has had tax paid upon it and that the revenue generated on the capital sum is also being taxed correctly. In many cases it appears that this is not the case and that some naughty people have been using Swiss bank secrecy to assist their efforts to evade tax by failing to declare correctly on their tax forms. Who would have thought it!

Another question we frequently hear asked is how the home tax authority will find out if an individual fails to declare their income correctly. It is a strange question from otherwise law abiding persons but the answer is that normally they find out because the tax payer tells them. The process of being caught out generally starts with a tax investigation. This could be triggered by an obvious disparity between lifestyle and declared income. Last Christmas the Italian authorities visited the ski resort of Cortina and started investigation procedures against the large number of Italian citizens who were arriving in Lamborghini’s and Ferrari’s but had been declaring either no income or only minimal income. They promised to conduct the same exercise on the Amalfi Coast this summer against those parking up in large boats. Investigations can start because another person is investigated and a connection is noted between them and the tax payer. Or it can start due to a random audit. Frequently the information which leads to an audit is supplied by an aggrieved ex-employee or spouse. Normally if a tax authority suspects that income is not being properly declared it will give the tax payer the chance to come clean and make a full disclosure of undeclared income. At this point the tax payer will have no idea what the tax authority knows – or if indeed they know anything. If the tax man does know about some undeclared income then he will not indicate what so the tax payer will have no information about what they are looking for. The burden of proof is always on the tax payer. They are guilty until proven innocent on tax matters even if their criminal code provides for innocence until guilt is proven beyond reasonable doubt on all other matters.

If the tax payer satisfies the authority that he has fully and properly declared everything previously undeclared the normal result is a tax bill, a hefty fine and interest. If he fails to come clean the normal result is criminal prosecution and frequently a prison sentence. Legend has it that a world famous jockey used to ride races all over the world and opened bank accounts wherever he raced. Most of what went into the foreign bank accounts was not declared as required back in his home country. On enquiry by his tax authority he reluctantly provided what he said was a list of all foreign bank accounts and undeclared income. He confirmed that this was indeed everything he had not previously declared. The tax authority then issued him with a substantial bill which he promptly offered to pay using a cheque drawn on an account he had failed to reveal. He went to jail for a number of years. Hence the joke that the only 18 stone man to ride a Derby winner was this jockey’s cell mate.
Most countries, now including Hong Kong, Singapore, China have signed tax treaties which contain exchange of information clauses. All offshore financial centres such as BVI, Cayman etc, under pressure from the OECD, have been forced to sign Tax Information Exchange Agreements (TIEAs) which can be used by onshore countries to obtain information about the ownership of offshore companies, trust and bank accounts. Banking secrecy laws are being rolled back or removed altogether as evidenced by the details supplied recently by Lichtenstein and Switzerland to various tax authorities around the world. And finally if a tax authority cannot obtain the information legally then they are paying thieves who stole it to give it to them. My law studies suggested to me that it was illegal to pay for stolen information or property but apparently this law does not apply to governments. Recently a Swiss banker who was actually jailed for assisting US citizens to evade tax was awarded US$120 million for handing over details of the US tax evaders he assisted.

In short, banking secrecy and confidentiality has either completely disappeared or will completely disappear in the near future. Any tax plan which relies on the detail not being revealed is probably tax evasion and is probably going to be revealed and get the perpetrators, including their advisors, into a great deal of expense and trouble. So get it right and seek professional advice. Getting it right will almost certainly involve a degree of inconvenience and expense but should keep the tax payer out of trouble and out of jail. I suppose the other way of looking at it is that not seeking advice and just trying to hide taxable money involves two levels of saving: There is no need to pay professional fees and the end result is likely to be free board and lodge provided by your home penal authorities.

The Chinese tax authorities have quickly become much more knowledgeable and efficient at collecting tax. The tax code in China is quite basic but it is interpreted by different tax inspectors in different ways. Normally those tax inspectors consider offshore companies and trusts to be ineffective for saving tax. The tax system relies upon the tax payer properly declaring his taxable income and if there is doubt about whether income is taxable then it should be declared and the tax man can decide whether that income taxable or not. He rarely decides it is not. Chinese nationals appear to becoming increasingly sophisticated as well. They do have large amounts of money in Swiss banks and this has as much to do with security as with tax saving. They want to know that they have money outside the country in case something goes wrong inside the country. Spending some money and seeking professional advice as to how to give the best possible protection to that money and making legitimate tax savings is of increasing importance. Do not take short cuts and just try and hide money. It will not work. There are legitimate structures available which will protect assets held abroad and ensure that the money within them is not subject to tax. So why risk being a tax evader if you can achieve the same savings and protection with a legitimate, legal and compliant structure?

Howard Bilton is an UK and Gibraltar barrister, professor at Thomas Jefferson School of Law, San Diego and Chairman of The Sovereign Group.

Expats and tax: the lowdown on living the high life in Cyprus

CASE STUDY:

Retired
Personal status:
Couple in their early sixties.
Expat status:
Retired to Cyprus five years ago.
Financial status:
UK pensions income about £35,000 per annum. UK investment income £20,000 per annum. Flat in Cyprus now worth £350,000. UK family house worth £500,000. UK investment property worth £500,000 with mortgage of £300,000 and rented out.

This couple will be tax resident in Cyprus and subject to Cyprus tax on their worldwide income. The maximum tax rate in Cyprus is 35pc but there is also a "tax" of up to 20pc as a "Defence Contribution".

The UK pension income would generally be subject to withholding tax in the UK, but the UK and Cyprus have ratified a tax treaty that normally gives the taxing right only to Cyprus. Pension income accumulated from services rendered abroad is taxed at a rate of only 5pc for amounts exceeding €3,420.

Moving the pension to a qualified recognised offshore pension scheme (QROPS) would be advantageous as the special member payment charges that apply to UK-registered schemes would be avoided.

The most punitive charge is the special 55pc death charge imposed on the remaining fund after the member's death. It should also mean that the couple could drawdown a greater level of income from their pensions as the UK's drawdown limits also cease to apply.

Depending on the type, income from investments in the UK might be subject to withholding tax in the UK, but this would generally be credited against tax due on the same income in Cyprus under the tax treaty. Moving the investments offshore should avoid any UK tax. Dividend income is exempt from tax in Cyprus but is still subject to the Defence Contribution at 20pc. Capital gains on qualified securities and funds are also tax-exempt in Cyprus.

The rental income on the investment property would be liable to UK tax but all expenses of maintenance and interest on the loan could be deducted. The couple could elect to be taxed according to the non-resident landlord scheme so the rental income can be received gross. The income after expenses would be subject to UK tax at the individual rates, but the couple would still enjoy their tax-free personal allowance, so the maximum rate would probably be only 20pc. Tax paid in the UK on rental income is allowed as a credit against tax due in Cyprus.

Their main concern should be UK inheritance tax (UK IHT). If they intend to remain in Cyprus for the rest of their lives, they could be domiciled in Cyprus. If so they would not be subject to UK IHT on their worldwide estate. Contrary to popular belief, the fact that they still own UK property would not be a barrier to claiming a non-UK domicile.

Irrespective of domicile, they would still be liable to UK IHT on any UK-situated assets. They each get an allowance in the UK of approximately £325,000, so a total allowance of £650,000. The total equity (value less loans) in their UK properties is £800,000. This would still leave them with a UK IHT liability of 40pc of the balance, being about £70,000. If they were still UK domiciled, IHT would bite on the whole of their estate. This would give them a substantial IHT bill in the UK. The couple should get certainty on their domicile.

There are steps they could take to mitigate IHT. If they are not domiciled in the UK, they could turn their UK investments into non-UK investments by transferring them to offshore companies so their asset was the shares in the non-UK company rather than the UK property itself. The shares would not be subject to UK IHT. The new penal taxes on residential property held by offshore companies apply to properties worth more than £2 million, so won't affect them.

Howard Bilton is chairman of The Sovereign Group and a barrister at law.

Gibraltar

Ian Le Breton is Managing Director at Sovereign Trust (Gibraltar) Limited. He explains why Gibraltar can no longer be characterised as an “offshore tax haven”.

When Gibraltar’s new income tax regime came into force on 1 January 2011, it signalled the end of a long journey to reposition its financial services centre from an offshore tax haven to an onshore European Union (EU) finance centre.

The new regime brought Gibraltar into compliance with the rest of the EU by doing away with the previous exempt status tax regime. The new Act ended any discriminatory distinctions between onshore and offshore business by introducing a single 10% corporation tax across the board.

As an onshore EU country with competitive rates of corporate and personal taxation – as well as the absence of capital gains, value added, inheritance, wealth or gift taxes – Gibraltar now offers opportunities that few other international finance centres, or specialised finance centres as Gibraltar prefers to be known, can match.

Gibraltar firms engaged in financial services are regulated by the Financial Services Commission. Implementation is critically important and by all measures, Gibraltar benefits from excellent regulation. The Gibraltar government is highly responsive; recent changes to legislation have allowed the industry to develop in such vital areas as insurance, funds and investment management. 

When considering financial services, professional advice should be sought at the earliest opportunity.  Options can be explored but it is critically important that corporate or trust structures comply with reporting requirements and that any tax implications are carefully considered. 

One way to demonstrate international credibility is to appear on the OECD Global Forum’s “white list”. The main criterion for achieving such a cherished position was for a jurisdiction to have entered into a series of bilateral Tax Information Exchange Agreements (TIEAs). Demonstrating the willingness of the two signatory countries to exchange information relating to a taxpayer, Gibraltar has engaged fully with the process and entered into such accords with 20 separate countries. 

Gibraltar competes effectively with its peers within the diverse sectors that make up the finance centre. Several global banks are represented providing a full range of banking services and investment management is another important cog in the wheel. In particular, Gibraltar benefits from Experienced Investor Fund (EIF) legislation and its funds regime has a well-deserved excellent reputation globally. Insurance is another vitally important component of the finance industry. 

Under EU “passporting” rules, regulated Gibraltar firms are permitted to expand across Europe in respect of insurance, reinsurance, banking and investment services.

The establishment of companies, trusts and other structures remains core to firms such as Sovereign. The larger firms have diversified into other areas including investment management, accounting and insurance services. A few also able provide marine and aviation services including registration of yachts and aircraft. In our own case, established a quarter of a century ago, we boast 25 offices around the world. With over 70 staff, Gibraltar remains our largest office hence we are well placed to provide the services and advice international clients will need.

Overall then, Gibraltar has a good story to tell. The next time you come across lurid reports about international tax havens, rest assured that Gibraltar is now recognised as a preeminent onshore EU finance centre and all of us in the finance industry are striving to ensure that this story can only get better in the future.