Increasing corporate capital gains tax fails – offshoring

CAPITAL GAINS TAXES (CGT) AND OFFSHORE INDIRECT TRANSFERS (OIT) Capital Gains and Capital Gains Taxation A capital gain is the rise in value of an asset – for example shares of companies, real estate property or valuable art items. When there is a change in ownership of an asset (normally through a sale), the capital gain is realized. Some of the most valuable transactions often involve licenses for extractive industries or telecommunications. Domestic legislation varies on the fine print and specific details, but it is widely accepted that capital gains occur when an asset changes hands. For example, at the moment shares in a company are sold. The amount considered to be a capital gain will be the value received by the final transfer of the asset minus the value initially paid. A simple example can illustrate this: As countries need revenue for financing public services, governments are normally interested in levying taxes over meaningful economic activities. This includes capital gains. In most domestic tax regimes, the right of a jurisdiction to tax capital gains is either included in the main tax legislation (such as an Income Tax Act) or established in a specific legislation (a Capital Gains Act). While some countries design a specific rate for the taxation of capital gains, other countries will simply use the rate already in place for Corporate Income Taxation. Following on the previous example: The structure of multinational corporations also affects the ability of countries to tax its operations. Most people think of a multinational corporation as one entity that has direct control over its assets spread around the globe. However, it is not that simple. The ownership structure of multinational corporations is often complex – motivated by management structures, international operations, corporate legislations and of course, tax minimization. For instance, multinational corporations often establish a complex network of holding companies and subsidiaries to control assets that generate revenue (like oil extraction licenses). This can be illustrated by examining two opposing scenarios: Simple scenario of direct control: · OilCorp is a multinational corporation with its headquarters in the United States; · OilCorp has direct ownership of OilCorp Resourceland, a subsidiary registered in the oil-rich country of Resourceland; · OilCorp Resourceland has direct ownership of extraction licenses of oil fields located in Resourceland. Complex scenario of indirect control: · OilCorp is a multinational corporation with its headquarters in the United States; · For tax purposes, OilCorp has created a holding company in the Netherlands. The corporate structure of OilCorp involves subsidiaries located in many jurisdictions, including locations that have no oil reserves or relevant staff and that are described by some as competitive and business friendly, or as tax havens by others. These jurisdictions tend to have a broad network of Double Tax Agreements, generous corporate tax incentives, secrecy around transactions and ownership structure, reduced tax rates and non-intrusive tax administrations; · OilCorp’s Resourceland subsidiary is not directly owned by the main entity of OilCorp but is routed through a number of related entities located in various jurisdictions. As a result of these relatively complex structures and networks of entities spread across many countries, multinational corporations have at their disposal a number of techniques and strategies they can use to reduce their tax payments. Among these is the shifting of profits out of resource-rich countries to low tax jurisdictions. This often results in the avoidance of taxes in developing countries. This paper looks into a specific technique for the avoidance of Capital Gains Tax, which is the focus of the following pages. Abuse of CGT through Offshore Indirect Transfer (OIT) Due to the wide variety of laws and regulations across different jurisdictions, corporations are able to structure their organization and cross-border transactions for their own benefit. This will be again examined through our previous example: As observed in the example above, the objective of OITs is the transfer of the effective control and ownership of an asset without actually changing its legal direct owner. While there is an actual transfer in the control of legal entities, the relevant asset (which holds value) is only being indirectly transferred. OilCorp Resourceland continues to control the oil license, but now EnergyCorp controls OilCorp Resourceland. As the license remains directly controlled by OilCorp Resourceland, no CGT is levied in the jurisdiction where the asset is located. OIT is a clear example of a technique used to avoid taxes which would normally have been charged after the direct transfer of an asset. As direct and indirect transfers both result in the actual control of the asset changing hands, tax systems should guarantee that both forms of transfers are treated identically for tax purposes. With the system as it is, there is a clear incentive for multinational companies to distort transactions and deny developing countries of much needed public revenue8 .