JCSM Shareware Collection 1993 November/JCSM Shareware Collection - 1993-11.iso/cl060/havensj.lzh/CHAPTER.6

Text File | 1993-01-21 | 16KB | 269 lines

                       Some Notes About Taxes


              We have already said a lot about taxes in passing.
          In doing this it was assumed that the reader has at least
          some general familiarity with most of the concepts referred
          to.  However, full utilization of the information in this
          book requires a firm grasp of the basics of taxation in
          one's home country and in the tax haven countries.  We will
          not go into arcane technicalities; that is what accountants
          and tax lawyers are for.  But informed decisions based on
          the recommendations of lawyers and accountants cannot be
          made without a solid command of the basics.  So, to work.

              The most familiar form of taxation is the income
          tax.  In view of the fact that legal entities, those kinds
          of things that can have income, spend money, sign
          contracts, etc., and hence pay taxes, are of two kinds,
          human beings and corporations (including trusts), there are
          two kinds of income taxes:  personal and corporate.

              Personal income tax is what federal, state,
          and--all too often these days--local governments take from
          each of us as a percentage of our personal incomes.  Its
          "skeleton" is a system of income brackets.  These brackets
          establish varying rates of tax, varying percentages of
          taxpayer's income to be taxed away.  The first $3,000, say,
          is not taxed at all.  The next $1,000 is taxed 5 percent.
          Thus, only $50 must be paid on a $4,000 annual income, 5
          percent of the fourth $1,000.  Observe that while the
          percentage of the tax to total income is 1.25 percent, the
          tax bracket is 5 percent.  Similarly, the fifth $1,000 may
          be taxed at a rate of 7 percent.  Thus, on $5,000 the total
          tax would be $120, or 2.4 percent--much lower than the top
          tax bracket of 7 percent.

              This concept of brackets is crucial to
          understanding what tax havens are all about because it
          makes clear what alienating income for tax bracket
          reduction means.  If one divides an annual income of $5,000
          between himself and his cat (somehow made into a
          respectable income-earning citizen by the tax computers),
          $3,000 to himself and $2,000 to Tabby, he effectively gets
          $5,000 tax-free, assuming the bracket structure in the
          above example.  This is a saving that is much more
          appreciated by someone with an annual gross income of
          $30,000 or above, which may put him in the 40 percent tax
          bracket with $6,000 in taxes.  Divided on paper between ten
          people, each getting $3,000, the bracket system implies no
          tax at all.

              Personal income tax is based on net income.  Net
          income is gross income less all expenses that can be
          claimed as necessary to produce the gross--or at least
          necessary to an attempt to create or increase it.  Thus, to
          take a less than serious example, if one earns $30,000 as
          an undertaker and spends $10,000 on futile parties intended
          to convince people to commit suicide after signing wills
          entrusting the care and burial of their bodies to him, the
          $10,000 can be claimed as business expenses and so reduce
          his taxable income to $20,000.  This means, of course, that
          the tax is also levied at a much lower rate (bracket).
          What constitutes a business expense depends, in large
          measure, on the imagination and experience of one's
          accountant and on adequate documentation--receipts,
          canceled checks, etc.  This is important to remember for
          some tax haven applications.  One may incorporate a tax
          haven company that can get funds from a high-tax country at
          a reduced tax rate, but which is locally taxable on its net
          income.

              It is important to realize that personal income tax
          is only grossly determined by the brackets applicable to
          net income.  There are further refinements, depending on
          the sources of income.  In general, personal income derives
          from some or all of the following sources:  wages, salary,
          fees for work or services; rent on property or real estate;
          dividends paid on investments; interest on bank deposits
          and corporate and government bonds; royalties on the use of
          patents or copyrights; and capital gains from the sale of
          property at a profit.

              This breakdown of income sources is important for
          tax purposes.  To begin with, capital gains are almost
          universally taxed separately on the basis of much more
          lenient scales and rates than those applying to ordinary
          income.  Some countries do not tax capital gains at all.
          It is possible to channel investments in such a manner as
          to place all returns on the books as capital gains.
          Further, governments are not only interested in taking away
          part of our incomes as taxes.  They are also interested in
          encouraging us to use what is left in "socially
          responsible" ways.  Thus, they can reduce tax rates on
          income derived from interest paid on certain types of bonds
          or on certain dividends.  Similarly, royalties may be taxed
          differently, depending on their source.  In other words,
          the constitution of a taxpayer's income can make a big
          difference in his tax bill.

              This means that, when making investment decisions,
          a businessman or investor should take into account tax
          rulings on the various tax rates applicable to income from
          different sources.  For instance, if he gets dividends from
          stock he holds in a company, he is taxed twice, indirectly
          when the company is taxed on its net profit, and directly
          when he is taxed on his dividend income.  The tax on
          dividends is inevitable, if the investor personally holds
          the stock.  The tax on corporate profits may be eliminated
          if the stock is in a tax haven corporation or offshore
          fund, because a company operating outside the source
          country cannot be reached by the source country's tax
          authorities (with certain limited exceptions).

              It is also important to realize that Americans are
          citizens of the only major country in the world that taxes
          total worldwide income, regardless of where in the world a
          taxpayer may live.  And it does so on top of whatever taxes
          he may pay to the government of the country in which he
          resides, unless that country has a double-taxation
          agreement with the U.S.  In some cases, the United States
          is "generous" enough to allow the taxpayer to deduct the
          foreign taxes from his income for U.S. tax purposes.

              But, the American reader may wonder, if I am living
          abroad, what can the IRS do to me if I simply choose to
          ignore it and not pay U.S. taxes?  For one thing, the U.S.
          government can ask the country in which you live to deport
          you on the criminal charge of tax evasion.  For another,
          your American passport can be revoked.  Neither seems a
          happy prospect, though some Americans have become "tax
          refugees."

              There is much less to say about corporate income
          tax.  It is a flat-rate tax, usually levied on the net
          income of a corporation, irrespective of its amount.
          Capital gains taxes may be different in come countries and
          states from taxes on income from other sources, and
          interest, dividends, rent, and royalties may all be taxed
          differently from straight business profit.

              Other kinds of taxes to be concerned about, whether
          on the federal or state level, are estate, death, and
          probate.  To protect loved ones after death, trusts as well
          as certain Liechtensteinian entities can serve very well.
          To avoid death taxes the simple way, by giving loved ones
          part of an estate while one is still living, is to reckon
          with gift taxes.  Even so, the relative rates of gift taxes
          and estate taxes, especially when gifts are so divided as
          to be outside certain critical brackets, may make this
          approach worthwhile exploring.  A trust, though, is
          generally the best solution.

              Another sort of tax to be especially concerned
          about if one wishes to save money through tax havens is
          withholding tax.  We have already referred to it, but it is
          important to clarify it in detail.  Withholding tax is a
          tax deducted at the source from incomes generated in
          Country A by a legal entity residing in Country B and
          transferred from A to B.  For example, if a businessman has
          a tax haven corporation, X, which owns stock in American
          Company Y, and American Company Y pays X $1,000 in
          dividends, Y must pay $300 of that (30 percent, the U.S.
          withholding rate) to the U.S. at the same time it makes
          remittance to X.  X may be a genuine non-American residing
          in India or Belgium, but he is nonetheless subject to the
          withholding tax.  Interest paid to non-Americans residing
          outside the U.S. ("nonresident aliens") on bank deposits in
          the United States is exempted from the U.S. withholding
          tax.

              Withholding taxes are of importance whenever one
          has to consider the interaction between tax systems of
          different countries because he lives in Country A and
          derives income, directly or indirectly, from Country B.
          Thus, if one intends to receive dividends from his foreign
          corporation, or from any foreign corporation in which he
          has stock, the dividends may be reduced by the local
          withholding tax imposed by the country from which the funds
          are being sent.

              Some people try to get around withholding taxes in
          a number of ways.  One of these is to keep the dividends in
          a checking account in the country where the money
          originates and exchange a check on it with someone going
          there against a check on his deposit in the United States.
          This is usually illegal, and it may sometimes be illegal to
          have a foreign bank account.  But, still, it is a gimmick
          that is hard to detect or prove without special and
          expensive detective work.

              Suppose one doesn't want to take such risks.  He
          may repatriate his dividends reduced by the local
          withholding tax.  In this case, the following possibilities
          exist in principle:  (1) The home country considers the
          dividends to be part of the gross income, regardless of
          what the gross sum of the dividend was.  It therefore taxes
          the dividend again, by applying the relevant tax bracket
          after deduction of the foreign withholding tax.  (2) The
          home country considers the gross dividend paid to be part
          of the gross income and deducts the tax withheld at the
          source from the total tax liability.  (3) Some compromise
          between (1) and (2) occurs, in which the home country
          construes some part of the foreign withholding tax payment
          as a credit against the home country tax bill.  (4) There
          is a double-taxation agreement between the foreign country
          and the home country consequent to which the foreign
          withholding tax deducted at the source is reduced and also
          credited against the total home country tax liability.

              Double-taxation agreements are what to look for if
          one intends to invest in foreign stock from one's own
          country.  They serve to reduce the foreign withholding tax
          and, at the same time, to cancel the double penalty of
          being taxed by both the home country and a foreign tax
          department.  As such, these agreements have been introduced
          for "business" rather than tax reasons.  They exist in
          order to encourage, or at least not discourage, investment
          in foreign companies.  However, double-taxation agreements
          become of much greater tax-minimizing importance when
          considered from the point of view of a foreign corporation
          created for the purpose of investing in a high-tax country.
          Remittances to foreign corporations with such investments
          are normally subject to the full withholding tax on the
          gross.  If a corporation is located in a completely no-tax
          haven, an investor manages to reduce his tax liability.
          This may be quite a saving, but he may wish to pay even
          less.

              It is here that double-taxation agreements come
          into play.  Of course, there are no double-taxation
          agreements with no-tax countries.  But there are such
          agreements with a number of low-tax countries.

              Suppose, for purposes of illustration, that a
          company's net income is what remains after a 15 percent
          treaty rate withholding tax has been deducted (85 percent
          of gross).  The total tax on the gross would then be 27.75
          percent, which is less than a typical 30 percent
          withholding.  Clearly, the net income of a company can be
          reduced to much less than 85 percent of gross.  And by
          using more than one company, the local tax can be virtually
          eliminated by eliminating the net profit of the local
          company.  Moreover, certain approaches may allow reduction
          of the withholding tax to as low as 5 percent.

              Thus, withholding tax is a curse that can be
          virtually neutralized by the careful exploitation of
          double-taxation agreements.  But there is one fly in the
          ointment:  more or less active cooperation between the tax
          departments of the governments involved.  This is not as
          bad as it sounds, however, for there are plans that require
          nothing illegal, using only highly sophisticated, legal
          tax-avoidance techniques.

              Let us wrap up this discussion of taxes with brief
          mention of a few less important, but still existent, taxes.
          Some countries levy annual land-value taxes.  Others charge
          stamp duties, now almost universal taxes imposed on the
          value of certain officially registered documents
          (incorporation papers, bonds, bills of sale, IOUs, and even
          checks) and required for making these documents legally
          valid.  Stamp duties must always be taken into account when
          dealing with a tax haven.  Thus, even when we discuss
          no-tax havens, we do not mean places where nobody pays the
          government anything--more's the pity.

              Now that we have the theory and practice of tax
          havens in hand, let us tour the best of these wonderful
          lands.