Holding Structure for Cross Border Deals

Firstly, I wanted to thank everyone who has written in wishing me well after my altercation with the Lionfish. My foot is still attached, and has failed to morph into some ungodly attachment that I fail to recognize upon waking each morning.  I am up on two functioning feet again and ready to kick the snot out of any fish with spikes coming my way!

Today, as promised in my last post, I have asked my friend Sam to chime in on something that most of us would much rather never have to deal with. Sam is a specialist tax accountant, with a Master of Laws from the University of Sydney. He’s one of those truly unique people who loves working on tax related matters, while the rest of us would more often than not prefer to put an appendage through a meat grinder than deal with taxation issues.

Over to Sam…

“As I sit here in an Irish pub in downtown Ulaanbataar pondering a Mongolian economy about to take off, I observe suits talking business in their Aussie-accented English and Korean traders negotiating their latest deals. It occurs to me that this scene could be playing out almost anywhere in the world. In fact, I’m sure I overheard a similar conversation over a month ago whilst sipping coffee at Starbucks in central Kuala Lumpur.

The ubiquitous Irish pub, and the even more ubiquitous Starbucks, are classic signs that national borders are melting away and cross border deals are now very common. Being the tax geek that I am, I started thinking what this means for the international investors.

Structuring cross border deals can be a tricky exercise and getting the tax side wrong has the potential to really mess up carefully calculated returns on investment. Being financially involved in two or more countries means potentially paying tax in multiple jurisdictions (in tax talk, this is called “double taxation”)

Double taxation occurs when two countries seek to tax the same income leaving the investor with two tax bills (classic examples include capital gains and dividends). An investor does not always have to suffer double taxation. As with most things in life, with proper planning, the tax bill can be managed or at least the surprises kept to a minimum.

So, what are the tax issues and pitfalls to look out for when putting together a holding structure for a cross border deal?

Below are some useful tips and guidelines to consider as a starting point. Of course, if you are looking at a live deal, nothing beats getting well thought out advice from a qualified tax advisor (how’s that for a cheap plug for my profession!)

1. Plan as early as possible

Planning is most effective when undertaken at the start of the deal. This allows time for the structure to be set up and substance to be built to justify the structure. Trying to do this later may involve costly restructuring or end up looking too contrived so as to raise alarm bells with the tax authorities.

2. Keep it simple if you can

We tax advisor types love coming up with elaborate structures but sometimes it pays to keep things simple. If it is possible to structure a deal from the home country directly into the country of investment, then do so.

Using multiple jurisdictional holding structures can be costly and involve too many moving parts that need monitoring. This really comes down to a simple cost-benefit analysis to determine whether the tax savings justify the cost of setting up and maintaining the structure.

3. Know what you are planning for

The bread and butter tax issues for international investors are dividend withholding tax and capital gains tax (CGT). It is also possible to plan for tax effective leverage but I’ll save that topic for another day.

Depending on the nature of the investment, one aspect may assume greater importance over another. If I am, for example, investing in a growth story, I would focus on reducing my CGT exposure rather that on withholding tax as the company is less likely to pay dividends.

The trick to effective planning is to reduce the tax rates. This can be achieved if there is a tax treaty between the country of investment and the investor’s home country. If there is no treaty, an investor may try using a third country as an entry point and use the tax treaty between the third country and the country of investment instead to reduce the tax rates.

Using a third country holding company structure also has the added benefit of allowing an offshore sale, thereby totally bypassing the tax jurisdiction of the country of investment.

Of course, some of the more sophisticated tax authorities are onto this trick and have implemented various anti-avoidance measures to prevent such planning. They usually require some proof of economic substance in the third country before allowing their tax treaty with a third country to be used.

4. Build economic substance

Often a holding structure looks really good on paper but when the deal is done, nobody pays attention to maintaining the structure. Worse case scenario is if the tax authority in the country of investment challenges the structure because it looks too much like a tax play.

Whilst tax can be a reason for setting up a structure, tax authorities don’t like it if it is the only reason for doing so. Sometime there is a level of “dressing up” a structure so that it looks commercial and the requirements for substance are fulfilled.

The substance requirements vary from country to country. Sometimes all that is required is a tax residence certificate from the tax authority in the third country to confirm that the holding company is indeed a resident in that jurisdiction. As tax authorities become more sophisticated, so do the requirements, which may range from maintaining books and bank accounts in the third country to having an office and employees there.

The key to getting the structure right is to know what the substance requirements are and to fulfill them not only at the time of set up but throughout the life of the investment.

Remember you may only need to use the tax treaty at the end when the investment is sold and it would be tragic if the structure becomes invalid because no-one maintained it.

Sam Lim”

Thanks Sam, and thank you readers for reading. The feedback from fellow investors has been very inspiring and its gratifying to have so many intelligent folks along for the ride.

Until Monday, have a great weekend

Chris

Be wary of strong drink.  It can make you shoot at tax collectors… and miss. -Robert Heinlein

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Simon
11 years ago

Thanks Sam and Chris, that was awesome.
I’d love to hear more from Sam. Perhaps high level comments on some structuring strategies. Like which tax havens are least out-of-flavor these days, or at least, where’s best to incorporate for maximum tax benefit. I know there millions of variables but it would be good to set out a framework so we at least know what factors to look for.

I agree with Chris’s comment about how unpopular tax is, but tax structuring is a different matter altogether. I have unlimited energy for outsmarting the tax man… (legally). 🙂

cheers
Simon

Naresh
10 years ago

Cross border taxation has become a vexed issue. India has a treaty with Mauritius which was originally for local Mauritians to invest in India. There are no withholding taxes, no capital gains taxes when a GBC-II company invests in India. That sounds like a leaf right out of a fairy tale where you can indeed pay zero tax in a high tax country like India. Recently there have been changes. The Tax Residency Certificate (TRC) requirements have been more strict, investors have to maintain books of accounts, offices and employees in Mauritius (Real Estate in Mauritius is going to go up in value since more and more investment is going to come to India eventually). Also there is the concept of ‘deal testing’. Deals through Mauritius have been ‘tested’ a.k.a. the precedence of zero taxation has been established though a series of judgements in court of law. However the TRC requirements are becoming more and more stringent, and investors of late are now rerouting funds through Singapore. I also need to add that ’roundtripping’ of funds is also illegal where Indian funds reroute their India originated funds through layers of structuring to show Indian tax authorities that the funds originate from Mauritius.