Corporate Residence in Modern World - Essay Example

Corporate residence in the modern world 0 Introduction 1 Background information The concept of residence is essential in deciding the tax foundation that falls under the federal Income Tax Act.1 A purpose of residence will influence the scale of income taxable,2 the tax rate, 3special taxes imposition,4 the requirement to hold back tax 5 and the accessibility of tax discharge and incentives. The Income Tax Act does not present a common meaning of residence for corporate taxpayers, but does have a considerate stipulation which imposes resident status. 2.0 Literature review This article will examine how the UK law determines the tax residence of a company. It will emphasize the statutory regulations applying to company residence and set out the case law of central management. It will also reflect on the residence requirements which a company must adhere so as to be valued as resident for treaty functions and thus be eligible for treaty benefits. The article will portray the task played by the treaty residence tiebreaker requirements, in conflict resolution of dual residence that occur in case a company is a resident under the home laws of both countries. 2.1 The case law rule In 1988, a company’s tax residence was defined only by the case law. 6This case law had developed over a period of more than a century. The origin of the case law test can be determined in the judgments of the Calcutta Jute7 and Cesena cases8 both heard in 1876. The case law test was articulated by Lord Loreburn in 1906 in the famous De Beers9 case. This test mainly concentrates in determining the position of high level strategic choices affecting the company. It is often known as the rule that a company is resident where its directors adhere to as long as they carry on the valid business of the company at those meetings. The case law rule which decides Company residence is firmly displayed in Lord Loreburns speech in De Beers Consolidated Mines Ltd v Howe: ‘A company exists where its actual business is conducted and t where the central management and control truly abides.’ The De Beers Company was integrated in South Africa and its major trading activities were there.10 The active board of directors implemented its powers in the UK.11 The company was was resident in the UK.12 The rule was sanctioned in the much later case of Bullock v Unit Construction Co Ltd, 1959. 13The African auxiliary companies which were incorporated and trading in Africa were seized to be resident in the UK by basis of the level of control and organization over their activities implemented in the UK by the parent company.14 The bill of each subsidiary company vested management and control in its board of directors which was required to conduct its meetings outside the UK.15 The Special Commissioners noted that, in fact, the directors were stepping aside in all issues of great significance affecting the central management and control was executed, albeit unconstitutionally, by the parent companys board of directors in the UK. 16 The judgment in both the De Beers and Unit Construction cases makes it obvious that the place of central management and control is principally a matter of fact. Both cases also display that it is the maximum level of control of the business which reckons. 17That control may be exercised by the board of directors in harmony with the provision Articles of the company, as in De Beers.18 From 1988, the UK has taken a divided approach to company residence. On the one hand, the approach applies a simple incorporation statute which treats all companies incorporated in the UK as UK resident.19 On the other hand, the case law test has been preserves as a completely separate test, which is functional in foreign integrated companies and UK incorporated companies exempted from the incorporation rule.20 An extra constitutional provision overrules the case law test and the incorporation rule and is applicable in situations where, under the tiebreaker stipulation of a tax contract, the residence of a company is awarded to the other state. This stipulation was introduced in the Finance Act in 1994 to deal with an apparent weakness intrinsic in basing a test of residence exclusively on an incorporation rule.21 The rule formed opportunities for tax evasion, since a UK based company that is resident and falls under this rule can be the resident and alleged assistance under a relevant tax treaty. From 1993, Finance Act, 1994, s 249, now endorsed as the Corporation Tax Act 2009 (CTA 2009), s 18 removed this opportunity for evasion by providing in a case where the tax treaty applies, residence was given to the “other state” the company stopped to be UK resident for all reasons.22 Modern UK tax treaties narrowly follow the Organization for Economic Co-operation and Development (OECD) treaty.23 The fourth Article of that Model treaty contains the treaty residence tiebreaker provisions. This article exercises the principle of ‘place of effective management’ as its favored determinant. The test is described upon in the Commentary on the OECD Model treaty. Conversely, the courts have had difficulties in differentiating its features from those of central management and control. Therefore, from a UK viewpoint, this test may, for most occasions, be taken to link with the case law test. This is in question to the provision that, where central management and control is divided among states,24 the place of effective management is usually established in the country in which the features of central management and control are most prevailing. In 2006, Wood v Holden case decided Chadwick LJ at the Court of Appeal stated: ‘It is not apparent whether the place of effective management test varies from the De Beers test, i find it hard to see how in the conditions which the Special Commissioners had to judge they could direct to different answers.’25 2.2 A substance over form approach The UK tax system is founded upon on the principle of residence taxation. The purpose of residence status is important in determining a company’s disclosure to UK tax. In this view, the case law test which applies to foreign integrated companies and also the constitutional residence tiebreaker laws which relate despite of where the company is integrated, both reveal a residence determination approach. In fact, the central management and control test functions mainly as an anti-avoidance stipulation to avoid companies from controlling their residence status. The CTA, 2009 may be held to stop a company from manipulating its residence status in favor of the UK. For instance, a foreign group resident in a country which is in a tax treaty with the UK having a suitable treaty tiebreaker provision based on ‘place of effective management’. If the group wants to shift its company to the UK, it can make arrangements for a UK company to be included for this reason. However, it would be very risky for that group to solely rely on the incorporation rule to argue that its recently incorporated UK holding company is UK resident. 26Why? Since under the residence tiebreaker stipulation of the relevant tax treaty, efficient organization will offer residence to the other state and CTA 2009, s 18 will function in order to take that company as non-UK resident. For more than a century ago, Lord Loreburn made clear when first disseminating the case law test of central management and control in the De Beers, that the major substitute test of company residence, that is, incorporation, was simply too open to abuse. 27The judge emphasized the main limitation of the incorporation test, that is, it would leave the UK’s tax base highly susceptible.28The case law test by contrast, did not display this weakness. Instead in most cases, this test focused at where the company directors make the key decisions affecting the running of the company. 2.3 Double taxation The main element of the case law test is that it creates a liability to UK corporation tax in which the company directors are UK resident and carry board meetings in the UK even where the fiscal body of the company is located offshore. For instance, in the De Beers case, the company dealt trade in diamonds. The mines were being controlled by local board of directors which had the responsibility for the daily activities of the business. Though, the London board made the key choices affecting the company’s business, that is, finance, the purchase and clearance of subsidiaries and the payment of profits. Since the company was proved to be UK resident, since the key choices affecting the company’s activities were carried by the directors sitting in London. Evidently, the function of this rule creates the likelihood of double taxation. It is doubtful that a treaty residence tiebreaker provision would aid in these situations since under the ‘place of effective management’ model often used as the tiebreaker principle. The ease for double taxation at the corporate stage provides credit against UK corporation tax for foreign tax awarded on the company’s dividends. The levy of foreign profits by reference to the residence of a corporation may possibly be reasonable if the shareholders of the company also live in the residence state.29 The dispute being that the application of major decision making in the residence state creates the economic benefits that arise in the source state, all of which may be sent back to the residence state, by way of profits. This argument simply reflects colonial approaches to the associations which flow among the residents of the mother country. Even as the taxation of foreign profits occurring to a company whose shares were detained by UK shareholders was challenging, even more fragile matter was mitigating the taxation of such dividends where foreign investors held a greater part of the company’s shares. Kelly CB acknowledged this complexity and its insinuation for global law in the Calcutta Jute and Cesena cases. ‘’both cases are of vast value, because they raise a very significant question important in the degree of its function and nature and entails most essential principles of great credence as involving the law of England as well as the global international law because it is rather futile to refuse that what may be straight the terms our verdict, the result in both cases is that the legislature of this country tax foreigners, not citizens of this nation, not residents of this country.’30 The judge went ahead to conclude the facts of the Calcutta case: ‘I conclude it with regret, that there can be no hesitation that, what is called the earnings of this Company, and as two-thirds of those earnings, belong to people not inside this country, and not question to the taxation and the rules of this country, it surely is a breach upon one of the taxation principles is taxed by the laws of any country, that those two thirds should be thus taxed.’31 Possibly this confusion reveals the fact that, at the time this case was resolved, the features of a limited liability company had not yet been entirely elaborated. For instance, the landmark case of Salomon v Salomon32 being decided more than twenty years later. If it is established that the article itself is completely separate from the people who, most of the time happen to be its shareholders, the subject becomes less contentious.33 2.4 Shareholders The case law test stresses UK taxing rights based on the implementation management. In case the investors are based in UK, it will be obvious to hire UK directors to supervise the running of the company; this is in spite of of the fact that local directors may also be selected to run the foreign activities. As a result, in many cases, the central management and control test duplicates the results of a shareholder test. In spite of this, the central management and control test is theoretically separate.34This is predominantly real where subsidiaries will be tax resident under the case law test in the country where the board meets and decides. Thus, “foreign” subsidiaries are not unavoidably resident where their UK parent, that is, the main shareholder is resident. 35 The daily impact of the residence status of the shareholders noted above may be differentiated from the control they exercise at meetings in other places rather than in their state. The location of shareholder meetings has long been recognized as an issue applicable in determining the residence status of a company.36 In John Hood & Company, Madden J considered that on the scrupulous facts which involved a supreme director. “The central management and control of this company obeys with the shareholder meeting, where the registered office of the company is located and where the meetings of the company are held.’37 HMRC have dealt with the possible events concerning subsidiary companies by endorsing controlled foreign company legislation.38 This legislation makes sure that, where subsidiaries are resident in low tax jurisdictions, their dividends may be taxed on their UK resident parent company. 2.5 An international comparison The UK’s residence rules, though complex, provide a structure to guard the UK’s tax base from abuse. Certainly, many other rules take a generally analogous approach to that approved by the UK and apply, at least as one part of their individual residence rules, a test based on control. Each country may understand these concepts in a different way, even where they are given the same classification. Nevertheless, they all share the main characteristic of defining a company’s residence by identifying control. For instance in Canada: 2.6 Central management and control While the Canada Business Corporations Act tries to convey a Canadian identity to the corporate vehicle, it is just to say that the legislation does not seek out to point to the corporation a distinct residence for the purpose of income taxation. The statutory corporate residence in section 250(4) of the Income Tax Act does not, for example rule out the likelihood of a diversity of residences for tax purposes, nor does it reject the traditional common law criterion for residency developed in De Beers Consolidated Mines, Ltd v. Howe.39 This ruling set forth the following principles: 1. A company resides for the reason of income tax where its real business is located, that is, where the central management and control abide. 2. The corporate residency test is a clean question of fact, to be determined, not based on corporate rules but by an evaluation business and trade. 3. The issues to be measured in when establishing residence include: the location of the office, meetings, residence of the directors and the place of office incorporation.40 To that effect, official features of the company are often used as a simple tool in determining the true tax residence of the corporate responsibility.41 2.7 International tax policy reform In this period of enhanced worldwide economic interdependency, global governments are reverting to their international tax policies with an aim to remain competitive with other countries.42 At the same time, policies must also promote foreign investment, shun double taxation, and prevent financial evasion.43 Encouraging foreign investment in a cutthroat market is a hard task, and is a valid worry for most countries. Australia, Canada, Germany, Italy, Sweden, and New Zealand have all addressed reforming their tax systems to promote international investments.44 The implication of attracting investment may, for better or worse, offer taxpayers a more bargaining control than the government. 45 Meanwhile, avoiding double taxation and preventing fiscal evasion are highlighted by difficulties in recognizing which country has authority to tax income that has a link to many countries.46 Countries have long ago established a multifaceted network of tax treaties to stop double taxation and support positive trade relations across nations.47 Although tax treaties have now turned out to be more significant means to achieve those ends, they are not essentially sufficient.48 Congress is obviously sentient of these goals and has presented the proposal under the premises of both “international tax competitiveness” and “stopping tax haven abuse.”49 3.0 Outcome and Conclusion Foreign direct investment can act as a possible train of growth for economies around the globe. It allows technology to cross jurisdictional boundaries and decreases production costs. It distributes knowledge and acquaintance and motivates creativity, pushing our world a little bit further every day. It has the prospect to improve the standard of livings in near and distant regions of the globe. The UK should therefore not inflict constraints by placing an undue tax burden on investments in overseas jurisdictions. Also, it cannot permit UK residents to evade tax through non-resident subsidiaries. The theory of corporate residence, based on the tests of place of incorporation and central management and control, is not capable to make certain the feasibility of the system without opting to anti-avoidance measures. Given that the De Beers test was first enunciated over a century ago, the question arises as to whether the rule remains practical and functional Bibliography Books and articles Arthur, J. Cockfield. International Tax Competition (1990). 63:867 Larza, Sarna. (1979). McGill Law Journal vol 25 Pyrec, C. The basis of Canadian corporate taxation: Residence. (1973) Reuven, S. Global perspectives on income taxation law. 2001. Oxford University Press Victor, V. Double taxation conventions. 2012 Table of cases Calcutta Jute Mills Co Ltd v Nicholson (Surveyor of Taxes) 1 TC 83. Cesena Sulphur Co Ltd v Nicholson (Surveyor of Taxes) 1 TC 88. De Beers Consolidated Mines Ltd v Howe John Hood & Co Ltd v W E Magee Aron Salomon (Pauper) v A Salomon and Company Laerstate BV v. Commissioners Para Rubber Estates Ltd. v. Fed. Comm’r of Taxation Unit Construction Co. Ltd. v. Bullock Wood v Holden case Statutes Canada Business Corporations Act Corporation Tax Act (CTA) 2009 Finance Act (1994), 249 The Case Law Rule Read More