26issue twenty sixfebruary 2007

Bahamas Bahrain British Virgin Islands China Cyprus Denmark Dubai GermanyGibraltar Hong Kong Isle of Man Malta Mauritius The Netherlands Netherlands Antilles PortugalSingapore South Africa Switzerland Turks & Caicos Islands United Kingdom Uruguay

26224 european news

introduction

contents

3

5 usa + caribbean news

6 asia + pacific news

7 legal news

8 fiscal news

9

profile:

contact + info10

© The Sovereign Group 2007All rights reserved. No part of this publication may be reproduced, storedin a retrieval system, or transmitted, in any form or by means, electronic,mechanical, photocopying, recording or otherwise, without the priorwritten permission of The Sovereign Group.The information provided in this report does not constitute advice andno responsibility will be accepted for any loss occasioned directly orindirectly as a result of persons acting, or refraining from acting, whollyor partially in reliance upon it.Sovereign Trust (Gibraltar) Limited is licensed by the Financial ServicesCommission – Licence No: FSC 00143B.Sovereign Trust (Isle of Man) Ltd is licensed by the Isle of Man FinancialSupervision Commission as a Corporate Services Provider.Sovereign Trust (TCI) Limited is licensed by the Financial ServicesCommission – Licence No: 029.Sovereign Group Partners LLP is regulated by the FSA – No. 208261.

23Insurance Wrappersin Tax Planning

introduction

page 3

chairman

26There is more on this in the following pages but we would stress that we have considerableexpertise in devising strategies whereby tax on monies offshore can be legitimately avoided.Please contact us for details.

Thai foreign ownership rulesYou may have read that Thailand has amended its existing foreign ownership legislation tothe general disadvantage of non-Thai nationals.  In fact, it is simply enforcing the existinglegislation. It has been common practice to hold Thai assets, including freehold land, in acompany that is majority owned by Thai nationals (as required by the law), but whereenhanced voting rights give control to the minority shareholders. The “new” laws prohibit suchminority control. This will be of concern to anybody who owns property in Thailand throughone of these structures. We have solutions, so please contact the Hong Kong office if thismatter is of concern to you.

New head in Jo'burgChrizette Roets also joined Sovereign on 8 January to head up our Johannesburg office.She is an attorney of the High Court Of South Africa and served articles in Johannesburgat Webber Wentzel Bowens, one of South Africa's leading law firms. Chrizette holds an LLBdegree from the University of Pretoria, which she obtained cum laude in 2003.

Howard Bilton BA(Hons)Barrister-at-Law (England, Wales & Gibraltar)

Professor of Law, St. Thomas School of Law, Miami, USAChairman of The Sovereign Group

e are a little late with this issue of The Sovereign Report so, rather belatedly, I wish you alla very happy and prosperous New Year and hope you all had a good Christmas and festive

season.  It is also fast approaching Chinese New Year so Kung Hei Fat Choi to you all.

Sovereign European Art Prize DinnerIt seems to come around so quickly but this year’s European charity dinner and auction is due totake place in London on 15th March. We would love to see any clients or friends there, helpingus to support worthy charitable causes. If you are interested in attending either the exhibition ordinner, then please visit our website for details www.SovereignArtFoundation.com or e-mailtiffany@SovereignArtFoundation.com.

Sovereign InsuranceWe are delighted to announce that Sovereign is to launch an insurance business from Gibraltarto service the insurance needs of existing Sovereign clients. To this end, we appointed SteveArmstrong to head up the new operation with effect from 8 January 2007. A qualified lawyer whohas specialised in insurance for 25 years, Steve can assist Sovereign clients with setting upinsurance companies or captives, or with yacht, household or any general insurance needs.

UK residents with offshore bank accountsPerhaps the biggest news is the continuing, and increasingly successful, efforts by the Inland Revenueto force offshore branches of UK banks to reveal details about UK resident. Barclays has alreadyopened up its books, and a lot of banks will follow suit. For many years we have been advising thatrelying on offshore confidentiality is not good planning. Interest earned on offshore accounts has to bedeclared by UK residents (unless they are not domiciled) and failure to do so is tax evasion. The InlandRevenue and the general public have little sympathy with those who are caught out failing to declare. 

W

26newseuropean

page 4

europe

The European Commission has again pressed Hong Kong and Macao to comply with the EUsavings tax directive in respect of tax interest earned by Europeans in the two Chinese specialadministrative regions.

Thomas Roe, the Commission’s envoy to Hong Kong and Macao, made an appeal on 31October, only a fortnight after a Hong Kong official had stated it would be extremely reluctantto assist the EU to apply the savings directive.

The move follows the relative failure of the EU savings tax directive. In the first six monthsof the law's operation, Switzerland raised only 100m, Luxembourg collected 48 million,Jersey 13 million, Belgium 9.7 million, Guernsey 4.5 million, Liechtenstein 2.5 million,

and Ireland only 400,000.

Laszlo Kovacs, the EU tax commissioner,wants to bring both Hong Kong and Singaporeinto Europe’s tax net by persuading them toapply the July 2005 Savings Directive, whichaims to tax the interest on European citizens’offshore savings.

The Commission estimates that, as of August,there were more than 37,000 EU citizensresident in Hong Kong – a figure that doesnot include Hong Kong citizens who also holdEU passports.

In July a Commission memo, citing 2005 datafrom the Bank of International Settlements,noted that there were “external” – or non-bankingsector – deposits of $158.1bn ( 124bn, £83bn)in Singapore and $82bn in Hong Kong.

But Martin Glass, Hong Kong’s deputy sec-retary for financial services and the treasury,argued that the territory was legally andconstitutionally constrained in its ability toshare information with other tax authorities,including China.

Singapore has refused to discuss the issue.EU commissioner for external relations BenitaFerrero-Waldner said the EU had wanted toinclude the savings directive as part of nego-tiations over a potential economic partnershipand co-operation pact. But Singapore hadrefused to include the issue on the agenda.

Sovereign CommentIf an EU resident earns interest on moniesbanked then that interest is both reportable andtaxable. Failure to report is tax evasion and inmost countries this constitutes a criminaloffence. Many EU residents who previouslybanked in places like the Channel Islands,Gibraltar, Cayman or BVI have switched theiraccounts to a country not covered by the EUDirective, such as Hong Kong or Singapore.This does not mean that the interest no longerhas to be reported. It does and it is still taxable.It is however possible to set up a compliantand legal structure to hold offshore funds thatwill also relieve the owner of the burden toeither report or pay tax on the income generated.

Agreements over Gibraltar signedThe UK, Spain and Gibraltar signed, on 18 September2006, a range of ‘historic’ agreements in Cordoba. Areascovered by the agreements include the expanded use ofGibraltar Airport, the full inclusion of Gibraltar in EU airliberalisation measures, recognition by Spain of Gibraltar'sinternational dialing code and unblocking by Spain ofGibraltar mobile telephone roaming in Spain. The signingcompleted 20 months of talks under the terms of the JointCommuniqué of 16 December 2004.

A joint statement said: “These agreements show ourcommitment to the solution of specific problems buthave no implications whatsoever regarding sovereigntyand jurisdiction, or regarding any issues thereby affected,and any activity or measure undertaken in applyingthem, or as a consequence of them, is understood tobe adopted without prejudice to the respective positionson sovereignty and jurisdiction.”Sovereign CommentThis agreement does not mean that the issue of Sovereigntyover Gibraltar has gone away, but it signals a lessantagonistic approach by Spain. Gibraltar has had greatsuccess in attracting high net worth individuals who canreside in Gibraltar and pay only a fixed rate of tax, up toa £20,000 pa maximum, irrespective of their worldwideincome. But the inability to fly anywhere out of Gibraltar,except London, has been a drawback. The new agreementshould remedy this and make Gibraltar an even moreattractive place of residence for wealthy individuals. Pleasecontact our Gibraltar office for more details.

The New Manx Vehicle (NMV) is basedloosely on the international business company(IBC) model and is introduced alongsideprevious Isle of Man Company Legislation(the Companies Acts 1931-2004). Companiesformed under the 1931 Act are permitted toconvert to the 2006 version in the future.

Sovereign CommentWe have followed the progress of this newlegislation with interest and, of course, ourIsle of Man office is able to advise on allaspects of the NMV and how it may beused in the structuring of even the morecomplex situations.

Our opinion is that this new legislationcombined with the new zero corporationtax policy creates an excellent model forboth the practitioner and client going for-ward. For further information please e-mail:iom@SovereignGroup.com.

Isle of Man introduces New Manx Vehicle

The Isle of Man Companies Act 2006, which introduces a new simplified corporate vehicleinto Manx Law, was brought into force on 1 November 2006. Royal Assent was receivedon 14 October 2006.

The Act provides a streamlined process forsetting up and running a company in the Isleof Man and complements the zero ratecompany tax strategy introduced in April 2006.It has been designed for a range of corporatetransactions and is likely to be particularlyuseful for public offerings, securitisations,asset and project finance.

Key elements of the new Act include: greaterflexibility of use; simplified reporting; use ofregulated corporate directors; one director,individual or corporate; use of registeredagents, in place of company secretary; un-limited corporate capacity, but restrictedobjects permissible; no preclusion of financialassistance; pre-incorporation contracts canbe adopted; simple merger and consolidationprocedures; introduction of protected cellcompanies for general business use; andsimplified corporate redomiciliation fromother jurisdictions.

EU pursues Asian compliance with savings tax directive

usa + caribbean news

26usa+caribbean

page 5

The supervisory powers of CIMA have beenextended to include the ability to cancel acompliance certificate or the registration ofa fund in certain instances, such as wherethe fund is carrying on business in a mannerthat is prejudicial to investors.

The Mutual Funds (Annual Returns) Regu-lations have also been passed to bring intoeffect CIMA's electronic reporting initiativefrom early 2007. This will enable regulatedfunds to submit annual returns using a secureand paperless system and provide CIMA withaccurate, electronic data for use in reportingaggregate information on the funds industry.

Sovereign CommentSovereign has considerable expertise insetting up, managing and administeringoffshore funds. We can set funds up in manyjurisdictions but hedge funds have tended tofavour Cayman, one of the world's mostexpensive places in which to do business.Sovereign has formed an alliance with a locallaw firm in Cayman to offer much lower feesfor the formation of funds, fund managementcompanies and preparation of full funddocumentation. In short we offer a turn-keysolution. Anybody interested in this serviceshould contact funds@SovereignGroup.com.

Cayman "tweaks" its mutual funds legislationThe Cayman Islands has brought in several amendments to the Mutual Funds Law (2003Revision), the most significant being a doubling of the prescribed minimum initial subscriptionfor registered funds from US$50,000 to US$100,000.

The latter figure therefore becomes the new benchmark for what constitutes a non-retailinvestment, but the new law contains "grandfathering" provisions so that existing registeredfunds with a minimum initial subscription belowUS$100,000 will be permitted to continue tooperate on that basis.

The Mutual Funds (Amendment) Law 2006 alsoprovides that foreign funds may carry onbusiness in or from the Cayman Islands, with-out having to be licensed by the Cayman IslandsMonetary Authority (CIMA), provided that theyare: subject to equivalent regulation; marketedthrough a regulated Cayman service provider;and where the securities offered are listed ona stock exchange approved by the CIMA andoffered to the public in the Cayman Islands.

Certain obligations on administrators licensedin the Cayman Islands, which previously onlyapplied in cases where they provided aprincipal office, have now been extended toall mutual funds. These include ensuring thata promoter is of sound reputation and thatadministration is undertaken by persons withsufficient expertise.

BVI legislates forprivate trust co’sThe British Virgin Islands brought in new laws, as of 1January 2007, designed to make it easier for privatetrust companies to set up in the BVI. Under the proposalstrust companies that do not offer their services to thegeneral public will be able to apply for the new exemptionfrom the licensing requirements and other provisionsof the BVI Banks & Trust Companies Act.

Unremunerated BVI companies that merely holdassets as nominees or “bare trustees” and which donot offer, or purport to offer, their services to the generalpublic are expected to be automatically exempted. It isalso anticipated that those exemptions will, once granted,take retroactive effect.

Lisa Penn-Lettsome, President of the BVI BarAssociation, said that the ability of BVI-domiciledcompanies to act as trustees of trusts was integral tothe provision by an offshore financial centre of a com-prehensive range of financial services.Sovereign CommentDespite being a world leader for Incorporations, BVIhas rather belatedly legislated for private trust companies.Sovereign has been setting up these structures in otherjurisdictions for many years. For clients who dislike theloss of control entailed by putting their assets into trust,a trust company ensures that the trustee remains underthe control of the settlor and his family. This can removemuch of the anxiety. Sovereign has particular expertisein this area and can advise upon request.

Canada targets offshore tax havensCanadian Finance Minister Jim Flaherty set into legislative motion a process to restrict theuse of offshore "tax havens" by introducing, on 10 November 2006, an amendment to theIncome Tax Act to prevent "non-resident trusts and foreign investment entities" from usingthem to avoid paying tax.

Flaherty said the use of offshore tax havenswas costing the government considerableamounts of revenue. Last year, StatisticsCanada reported that Canadian direct invest-ment in such shelters has risen eightfold since1990 to C$88 billion in 2003, with much of themoney being invested in the Caribbean. Thelargest increases went to Barbados, Bermuda,the Cayman Islands, the Bahamas and Ireland,the five countries being among the 11 nationswith the most Canadian assets.

Federal Auditor General Sheila Fraser reportedthat multinational firms operating in Canadahave avoided "hundreds of millions" of dollarsin taxes over the past decade through the useof tax havens.

Flaherty said: ''The motion will amend existingincome tax rules to help ensure that incomeearned by Canadians through foreign juris-dictions, including tax havens, is subject to taxas if it had been earned in Canada.''

The proposed amendments, which carry throughon long-standing proposals that were firstannounced in the 1999 Budget, deal primarilywith the taxation of income earned through theuse of non-resident trusts and foreign investmententities, the department said.

The proposed amendments are separatefrom the overall review of income trust funds,which is still underway. Flaherty defendedhis decision to break an election promise notto tax income trusts, saying that the loss inrevenues resulting from the escalating numberand size of corporations that were convertinginto trusts would have eventually pushed thefederal government back into a deficit.

There had been some C$70 billion (US$61.83billion) worth of income trust announcementsso far this year, which was "not right and notfair," said Flaherty. "It is the responsibility ofthe Government of Canada to set our nation’stax policy, not corporate tax planners."

26asia+ pacific

page 6

newsasia + pacific

India draws up tax haven black list for foreign funds

A negative list of tax havens, countries that levy very low or no tax, is being prepared in Indiato reduce the vulnerability of equity markets in the country to foreign funds, according to theFinance Ministry on 7 November 2006.

A panel chaired by Ashok Lahiri, chief economic advisor in the Finance Ministry, with membersdrawn from the Reserve Bank of India (RBI) and the Securities & Exchange Board of India(SEBI), recently suggested that such a list be drawn up.

The National Security Council (NSC) under the Prime Minister's Office had also warned thatwithout proper checks, Pakistani or Chinese investors could route their investments into Indiathrough tax havens like Mauritius, Cayman Islands or Cyprus.

The move could also be a negotiating stanceto increase pressure on Mauritius, the largestsource of foreign direct investment (FDI) toIndia, to amend the current tax treaty. ReserveBank of India figures for FDI in 2004-2005 showMauritius as the lead external investor into Indiawith US$820m out of a total US$2,320.

The Indian government has been unsuc-cessful in convincing Mauritius to amendthe treaty. But the Mauritius governmentannounced in October that it is to tighten uprules on the issuance of Tax Residence Cer-tificates, and in future will issue them foronly one year at a time.

Pressure on India to re-negotiate the Mauri-tian tax treaty has increased; particularlyafter stronger residence qualifications wereincluded in a similar treaty signed recentlywith Singapore.

Sovereign CommentIndian GDP continues to grow at around 9%p.a. Both our Mauritius and Dubai offices areactive in this increasingly important market.The proposed changes serve to illustrate theimportance of using carefully plannedstructures when investing into India. Contactdetails for both offices are given on the innerback page of this issue.

Fear were raised when the Council was toldthat more than 85% of foreign fund inflowsinto India in 2005-06 were through participatorynotes (PNs) – an anonymous instrument. In2003-04, PNs accounted for a little over 20%of foreign fund investments in India, but theproportion rose to 42% the next year.

The NSC said: “Billions of rupees come intoIndia as foreign investment but hardly any moneyleaves our shores as open taxable returns oninvestment or the repatriation of principalamounts. This raises suspicion that some otherclandestine method is used for this purpose.”

The Council suggested that existing legislationbe not only strengthened but also extendedto cover flow of funds into India from taxhavens in order to check money laundering.

Australia to expand TIEA networkThe Australian Taxation Office (ATO) plans to expand

the number of tax information exchange agreements

(TIEAs) with offshore financial centres in a bid to

restrict corporate tax avoidance.

A TIEA with Bermuda was finalised last November

and similar agreements with nine other countries are

well advanced, said ATO Commissioner Michael

D'Ascenzo. Preliminary discussions are also being

held with several countries in the Pacific Region.

"We also want to extend our comprehensive treaties

so that they will cover information exchange not just

on direct taxes but also GST (goods and services tax),

and other indirect taxes," D'Ascenzo said.

The Commissioner said the majority of tax avoidance

by Australian companies occurred through transfer

pricing by companies selling their own goods and

services to overseas divisions of their company, so

that most of a company's profit could be booked in a

country with low taxes. Since 1998, the ATO had

garnered more than A$1.7 billion in tax and penalty

adjustments from audits of transfer pricing, together

with disallowed losses of around A$1.9 billion.

He also said the ATO was seeing evidence of

"aggressive" moves to avoid royalty and interest

withholding, and currently had a number of cases

under audit.

The Trust Law, to govern trustees and trust administration in Bahrain, was enacted on 16August 2006. Bahrain is one of the first countries in the Middle East to put in place such alegal framework. The Dubai International Financial Centre enacted a trust law last year.

"The establishment of a trust, in a well-regulatedenvironment, will broaden the available optionsfor the transfer of business, property or otherassets from one generation to another. It willalso enable the Bahrain-based wealth manage-ment industry to develop and extend more inno-vative products and solutions," said AbdulRahman Al Baker, executive director of FinancialInstitutions Supervision at the Bahrain MonetaryAuthority (BMA).

The new trust law provides that trusts must beregistered with the BMA. Trusts may be esta-blished for a maximum of 100 years and trustproperty may comprise any form of property,moveable or immoveable, tangible or intangible.

A trust may have one or more trustees and thetrust law sets out the obligations on a trustee toprovide adequate protection to the beneficiariesand ensure that the trust is managed in accor-dance with the terms and conditions of the settlor.

The law provides for high levels of confiden-tiality for the execution and administration ofthe trust fund. It also provides for the esta-blishment of a register of financial trusts bythe BMA and obliges the BMA to maintaincomplete confidentiality of all informationrecorded in the Register.

Trusts are a relatively recent structure in theMiddle East but the potential for growth is great.The region boasts the world's highest concen-tration of high net worth individuals, whosecollective wealth is estimated at over $1.3 trillion.

Sovereign CommentThis is an exciting new development andshould be of interest to anyone looking toestablish trust structures in the region.Sovereign is represented in Bahrain and ourlocal manager, Hadi Daou, will be able toassist with any trust or related enquirieshdaou@SovereignGroup.com.

Bahrain enacts new trust law

page 7

26legal

legal news

guidance, but agreed with Revenue &Customs that ignoring both the dates ofarrival and departure would create a distor-ted picture. It therefore adjusted the timespent in the UK to include nights spent inthe UK.

The tribunal rejected Gaines-Cooper's claimthat he had moved his domicile on thegrounds that he retained connections withthe UK. As well as educating his son in theUK and visiting his wife who was mainlybased in the UK, he visited regularly forpheasant shooting, Royal Ascot and theRolls-Royce Enthusiasts Club rally. It heldthat Gaines-Cooper was resident andordinarily resident in the UK.

Sovereign CommentIt is understood that Gaines-Cooper, whosebusinesses ranged from a jukebox companyin Henley-on-Thames to a medical equip-ment supplier incorporated in the Nethe-rlands Antilles, intends to appeal the deci-

The Special Commissioners ruled, on 31 October 2006, against British-born businessmanRobert Gaines-Cooper, who sought to establish he was resident and domiciled in theSeychelles for the tax years 1992/93 to 2003/2004. If upheld on appeal, the ruling meansthat many wealthy business people may be stripped of their non-resident status.

In Robert Gaines-Cooper v. Revenue &Customs, the appellant, who had businessinterests across the world, purchased a housein the Seychelles in 1975 and obtained aresidency permit in 1976. He indirectly retaineda house and assets in England and latterlyhis wife and son resided in England. He oftenvisited his family in the UK at weekends, buthe judged he was not liable to tax becausehe had moved his domicile to the Seychellesand spent fewer than 90 days a year onaverage in the UK.

Since 1993, days of entry and departure havebeen disregarded when calculating whetheran individual has spent an average of morethan 90 days in the UK during four consecutivetax years - or more than 183 days during anysingle year. Anyone who exceeds either limitis liable to income tax.

The Special Commissioners acknowledgedthat Gaines-Cooper had based his assess-ment of the days spent in the UK on Revenue

Ruling in DeutscheMorgan GrenfellIn a landmark decision of 25 October 2006, the Houseof Lords reversed the Court of Appeal’s decision andfound in favour of the taxpayer in the Deutsche MorganGrenfell (DMG) case.

The ruling considered whether a claim to recover taxpaid more than six years ago could be based on a mistakeof law – in this case, when UK rules are in breach ofEuropean law. The decision enables DMG to recover taxpaid more than six years ago – the six-year time limit forclaiming running not from the date on which the tax waswrongly paid but when the mistake was, or couldreasonably have been, discovered.

This decision has wide implications. It will not onlyimpact upon claims under European legislation, such astaxpayers currently challenging the UK’s group reliefrules, CFC rules or taxation of overseas dividends rulesas being contrary to the provisions of the EC Treaty, italso applies generally to claims for repayment of taxbrought against HM Revenue & Customs (HMRC).

The level of concern shown by the UK government asto the implications of this case is clear from the fact thatit introduced blocking legislation in the Finance Act 2004to remove a taxpayers’ right to reclaim from HMRC taxpaid under a mistake of law.

The effect of the law change is to restrict claim timelimits for claims brought after the introduction of theblocking legislation, which took effect retrospectively fromSeptember 2003, to six years. The legality of the blockinglegislation is itself currently being challenged in the courts.

sion. The ruling may affect a lot of peoplewho avoid tax by carefully limiting their timespent in the UK. It also raises wider concernsabout the reliability of the Revenue guidance.But the change in how residence and domicilestatus are determined for tax purposes means,conversely, that many wealthy foreigners wholive and work in the UK are now less likely tobe forced to pay UK tax.

New ruling hits “tax exiles” over days spent in the UK

ECJ rules against Azores’ tax breaks

Dismissing the action, the ECJ said: "The courtfinds that the Portuguese government has notproved that the adoption of the measures atissue was necessary for the functioning andeffectiveness of the general tax system.”

Portugal had permitted the regional assemblyof the remote, mid-Atlantic islands to set theirown income and corporate tax rates well belowthose of the mainland, with cuts of as muchas 30% in corporate income tax. It argued thatthe tax cuts were a matter of sovereignty andmotivated by the geographical isolation, difficultclimate and economic dependence.

The Commission ruled in December 2002 thatthe tax cut was prohibited state aid becauseit gave the Azores an economic advantage atthe expense of other EU areas. It ordered theregion to raise its rates. Portugal appealed.

The ruling was being closely watched for impli-cations by the UK and Spain, which both inter-vened on the side of Portugal. The UK said a

decision against the tax cuts would raise"regional autonomy issues of considerableconstitutional importance”.

Spain also said the decision could affect thespecial tax powers granted to its northernBasque Country and Navarre regions.

In October 2005, the ECJ Advocate GeneralLeendert Geelhoed of the Netherlands saidthe purpose of the tax reductions was tocompensate for disadvantages of doing busi-ness in the Azores, but that did "not constitutea valid justification based on the nature andeconomy of the Portuguese tax system".

Sovereign CommentThis ruling is of importance not only to theAzores but also for the implications this mayhold for another similar case presently beforethe ECJ involving Gibraltar. The decision inthis latter case is expected shortly; the out-come and implications for Gibraltar will bereported in a future edition.

The European Court of Justice (ECJ) dismissed, on 6 September 2006, the Portuguesegovernment’s challenge to a 2002 European Commission decision which found that thereduced income tax rates applied in the Azores Islands were contrary to EC rules.

26fiscal

page 8

newsfiscal

Hong Kong signs new tax treaty with ChinaThe People's Republic of China (PRC) and the Hong Kong Special Administrative Regionsigned their first comprehensive income tax treaty on 21 August 2006. The new treaty extendsthe scope of the existing 1998 agreement, which was limited to business profits and incomefrom personal services, and will strengthen Hong Kong's competitiveness as the investmentgateway to the Chinese mainland.

Based on the OECD model, the new treaty covers direct income earned by businesses andindividuals, such as operating profits and employment income, as well as indirect income,such as dividends, interest and royalties. It also contains new administrative provisions,including an exchange of information article.

Under the new treaty, China-sourced passiveincome – including dividends, interest, royaltiesand capital gains – received by Hong Konginvestors will derive preferential treatment byway of reduced withholding tax rates or, if speci-fic conditions are satisfied, a tax exemption.

This compares favourably with China'sdomestic tax law and many of China's bilateralincome tax treaties, including those withMacao and Singapore, and is particularlyattractive because the items of income coveredare not subject to Hong Kong tax, resultingin a net benefit to the Hong Kong investor.

A CGT exemption will facilitate cross-borderrestructuring, and merger and acquisition activi-ties, because capital gains derived from thedisposition of shares in a Chinese company byHong Kong investors would otherwise be sub-ject to a 10% withholding tax. This exemptionwill not apply if the Chinese company is mainlya property holding company or the ownershipinterest disposed of represents an interest of atleast 25% in the Chinese company.

China does not currently tax dividends paidby foreign investment enterprises in Chinato foreign investors, but that exemption maybe curtailed. If this is the case, the new treaty's5% withholding tax rate on dividends will bepreferential to a possible 10% or higher rate.

The new treaty's 7% withholding tax rates oninterest and royalties received by Hong Konginvestors from Chinese sources comparefavourably with the standard 10% rate underChina's domestic law and the PRC-Macaoincome tax treaty. These rates should furtherencourage “capital exports” by Hong Konginvestors to the mainland.

If ratified before 31 December 2006, the newarrangement will take effect with respect toHong Kong taxes from the year of assessmentbeginning on or after 1 April 2007, and withrespect to PRC taxes from the taxable yearbeginning on or after 1 January 2007.

Sovereign CommentWith an exchange of information provision inthe new treaty, taxpayers should seek tomanage their cross-border business trans-actions and tax affairs in a consistent mannerand maintain proper records to support thecommercial objectives that underlie the busi-ness transactions. Readers are reminded thatSovereign specialises in China Entry Servicesfrom our Hong Kong office. Such support isvital when considering doing business in China;advice should be obtained sooner rather thanlater – email hk@SovereignGroup.com.

Chinese Protocolwith MauritiusThe People's Republic of China and Mauritius signed,on 5 September 2006, a protocol amending the existing1994 treaty to provide for an expanded exchange ofinformation article.

Mauritius has become a popular jurisdiction formultinational companies seeking to establish holdingcompanies for their Chinese operations because aMauritian company will only be subject to Mauritiusincome tax on gains arising from the transfer of itsinterest or shares in a PRC company, provided that theassets do not consist primarily of immovable property.But the Chinese revenue believed the inability of thesource country to tax capital gains on the transfer of asignificant shareholding in a Chinese company allowedscope for tax avoidance. Under the new protocol, Chinahas followed the UN model and added a clause thatpermits the source country to tax capital gains on thetransfer of a 25% or more shareholding of a companyresident in the source country.

The protocol with Mauritius also incorporates thechanges in the 2005 OECD model to expand the scopeof the treaty's exchange of information article. Theinformation exchanged can include particulars aboutnon-residents and can be applied to the administrationor enforcement of taxes other than income taxes. Chinawill probably seek to include broader exchange ofinformation articles, based on the 2005 OECD model,in future bilateral tax treaties and protocols.

The Malta-Spain tax treaty, signed on 8 November 2005, was brought into force on 12 Septemberand came into force on 1 January 2007. The treaty, which follows the OECD model, applies toresidents of one or both contracting states, except for tax-exempt entities formed under theMaltese Merchant Navy Act of 1973.

Malta-Spain tax treaty comes into force

In Spain, the treaty applies to the individual andcorporate income tax, non-resident income taxand local income taxes. In Malta, the treatyapplies only to the income tax.

Dividends paid by a company that is a residentof Spain to a resident of Malta, will be subjectto Spanish withholding tax at a maximumrate of 5% of the gross amount of the divi-dends. Spain will further exempt from with-holding tax dividends that are paid to acompany that is a resident of Malta, providedthat the company holds at least 25% of thecapital of the company paying the dividends.Interest and royalties are taxable only in thepayee's state of residence.

Malta is currently included on Spain’s ‘black-list’of tax havens but, under Spanish law, a countryis automatically scratched when it signs a taxtreaty or exchange of information agreement.Thus, the new tax treaty should exclude Malta.

Sovereign CommentWith the accession of 10 new states to the EUin 2004, and two more (Bulgaria and Romania)joining in 2007, the tax treaty network is sureto be extended over the next few years. Eachtreaty must be studied to consider the impli-cations for existing structures as well as forproposed new arrangements. Corporate taxrates differ across the extended EU andSovereign is well placed to advise.

page 9

profile

26profilethan income. The underlying capital gainsand income will not be taxed unless anduntil withdrawn at a later date.

The disadvantage of using the services ofthese insurance companies is that they placerestrictions on what investments the wrappercan hold. They will rarely allow private assetsto be held within the structure and normallyinsist upon the whole of the capital beinginvested into a limited range of mutual fundsthat often carry quite high entry and annualcharges. They are also expensive to set up– insurance brokers who sell these products

will normally earn up to 8% of the capitalvalue in commissions. This is not alwaysimmediately apparent at point of sale.

But smaller insurance companies are moreflexible and much cheaper. Bespoke in-surance contracts can be written for eachclient and used, for example, solely to ownthe shares of an offshore company whichcan then undertake a whole range oftrading or investment activities free fromthe high charges and restrictions imposedby larger competitors. The insurance com-panies normally allow the assets of eachinsured to be held within a segregated‘protected cell’. The return on the insurancecontract is thus directly related to the valueof the underlying assets of each insuredand assets of one contract are not mingledwith assets of another.

This system has the added advantage thatif the insurance company itself has financialproblems, the assets within the individualcells would be protected.

The actual level of insurance within thecontract can be quite small and generallythe insurance will promise to return onlywhatever that particular cell of assets isworth upon the death of the life insured. In

Life insurance provides tax planning coverIt is a truth universally acknowledged, that due to ever increasing amounts of anti-avoidancelegislation, most straightforward offshore company or trust arrangements are no longer effectivein reducing tax for residents of high tax countries.

Onshore countries attack these offshore struc-tures in slightly different ways but by the samebasic principles. Attribution rules apportion theincome of an offshore structure to the bene-ficial owners of that structure in proportion totheir interests. For example, a UK resident anddomiciled individual who owns, directly orindirectly, 50% of an offshore structure will berequired to report that interest and will be taxedon 50% of the income within that structurewhether he receives it or not. Additionally, if thesame UK client exercises control over the man-agement of that company – either as a directoror by issuing instructions to the directors – thenthat will make the structure itself tax resident inthe UK and liable to UK tax as a result.

Fortunately all developed countries recognisethe importance of encouraging people to takeout life insurance and pensions so that they canlook after themselves and their family withoutbecoming a burden on the state. For this reasonconsiderable tax breaks are still available forthose who wish to save for their retirement orthose who wish to insure their lives to the benefitof their dependents. And these offer great po-tential for creating tax efficient structures.

Having an offshore structure owned by an off-shore life insurance contract will generally meanthat the attribution rules referred to above nolonger apply. Income and capital gains can begenerated offshore, and remain outside thescope of onshore taxation, until withdrawn fromthe structure. In short, indefinite tax deferral –and sometimes complete tax avoidance – canbe achieved. This occurs because the assetowned by the client is transformed from sharesin a corporation to a life insurance contract thatjust happens to invest in the shares of an off-shore company. As a result a very different taxregime applies.

The large insurance companies recognisedthese possibilities long ago and created whatthey call “offshore bonds”. In this scenarioinvestments can be held by an offshore lifeinsurance “wrapper”. Cash injected into theoffshore bond is invested into a range of mutualfunds offered by the insurance company andselected by the owner of the contract. Undercurrent rules, 5% of the premium paid into thelife insurance contract can be withdrawn taxfree every year for 20 years. This is not par-ticularly generous as it represents a return ofthe invested capital, but at least it clarifies thatthe withdrawal will be treated as capital rather

other words, these contracts work rather likean offshore piggy bank. They can be used asprivate investment vehicles that have thenecessary characteristics to be classified asinsurance and give the same tax advantagesas pure insurance contracts. They are highlyeffective tax deferral vehicles.

While we have used the example of a UKresident and domiciled client we know thatsimilar principles would apply to clients residentin most countries of the world, including theUS, Australia, Spain, Portugal, France, Swe-den and many others.

In the UK the Revenue has tried to removesome of these advantages by creating rulesthat attribute 15% of the initial life insurance pre-mium as an annual capital gain taxable uponthe owner of the insurance policy. The 15%deemed gain is then taxable in the hands of thepolicyholder. But if the policy itself is owned byan offshore company and that company is ownedby an offshore trust, the 15% charge would notapply and a tax free structure is created. Thiscan be used to defer tax indefinitely, even whenthe beneficial owner of the structure is a UKresident and domiciled individual.

The tax advantages provided by life insuranceproducts were tested by the House of Lords.In the case of Willoughby, the Law Lords ruledthat Parliament had created a specific taxregime for life insurance contracts and theirtax treatment should therefore remainunchanged until Parliament legislates other-wise. This would seem to mark the end of theattempts by the UK Revenue to tax life in-surance contracts at a point before the distri-bution of funds.

Sovereign has taken opinion from leadingexperts on the tax efficacy of these arrange-ments and can arrange for such opinions tobe written to clients upon request. Contact yournearest Sovereign office for further details.

“In other words,these contractswork rather like anoffshore piggy bank.”

contacts + info

page 10

The ultimate offshore credit card.Instant access to your

offshore funds

any place, anywhere.

Contact your most

convenient Sovereign

office for further details.

contactcontact

informationFor more information on the services provided byThe Sovereign Group, please visit our website:www.SovereignGroup.com or contact your mostconvenient Sovereign office listed below.

change ofaddress?Have your subscription details changed recently?

Do you wish to redirect your quarterly issue of

The Sovereign Report to a different address?

Or do you wish to unsubscribe?

If so, please contact Michelle Gallardo by email:

mgallardo@SovereignGroup.com or by fax on:

+852 2545 0550. Please note that The Sovereign

Group is committed to ensuring that your privacy is

protected. All details submitted will be held in the

strictest confidence.

thesovereignmastercard

BAHAMAS Alan ColeTel: +1 242 322 5444bh@SovereignGroup.com

BAHRAIN Hadi DaouTel: +973 1721 3199bahrain@SovereignGroup.com

BRITISH VIRGIN ISLANDSSusannah MusgroveTel: +1 284 495 3232bvi@SovereignGroup.com

THE PEOPLE’S REPUBLICOF CHINA, ShanghaiSunny LiewTel: +8621 6103 7089china@SovereignGroup.com

CYPRUS Vassos HadjivassiliouTel: +357 2267 6519cy@SovereignGroup.com

DENMARK Jan EriksenTel: +45 4492 0127dk@SovereignGroup.com

DUBAIJohn HanafinTel: +971 4 397 6552dubai@SovereignGroup.com

GERMANYDr Norbert BuchbinderTel: +49 (0)911 92668 30de@SovereignGroup.com

GIBRALTARIan Le BretonTel: +350 76173gib@SovereignGroup.com

RegisterAYacht.comGabriel GonzálezTel: +350 51870ray@SovereignGroup.com

Sovereign Asset ManagementChris LabrowTel: +350 41054sam@SovereignGroup.com

HONG KONGJacques SchermanTel: +852 2542 1177hk@SovereignGroup.com

Sovereign Accounting ServicesTel: +852 2868 1326sashk@SovereignGroup.com

ISLE OF MANPaul BrennockTel: +44 (0)1624 699 800iom@SovereignGroup.com

MALTA Mark MiggianiTel: +356 21 228 411ml@SovereignGroup.com

MAURITIUS Ben LimTel: +230 403 0813mu@SovereignGroup.com

THE NETHERLANDSSusan RedelaarTel: +31 (0)20 428 1630nl@SovereignGroup.com

NETHERLANDS ANTILLESRudsel LucasTel: +599 9 463 6138na@SovereignGroup.com

PORTUGALNigel Anteney-HoareTel: +351 282 340 480port@SovereignGroup.com

SINGAPORE Ahmad IsmailTel: +65 6222 3209sg@SovereignGroup.com

SOUTH AFRICA – CAPE TOWNTimothy MertensTel: +27 21 418 4237sact@SovereignGroup.com

SOUTH AFRICA – JO'BURGChrizette RoetsTel: +27 11 881 5974sajb@SovereignGroup.com

SWITZERLANDDr Norbert BuchbinderTel: +41 (0)43 488 36 29ch@SovereignGroup.com

TURKS & CAICOS ISLANDSRuth BenebyTel: +1 649 946 2050tci@SovereignGroup.com

UNITED KINGDOMSimon DentonTel: +44 (0)20 7389 0555uk@SovereignGroup.com

Sovereign Accounting ServicesStephen BarberTel: +44 (0)20 7389 0644sas@SovereignGroup.com

Sovereign Group Partners LLPHugh de LusignanTel: +44 (0)20 7389 0655capital@SovereignGroup.com

URUGUAY Noel OteroTel: +598 2 900 3081uy@SovereignGroup.com

SovereignGroup.com

SovereignGroup.com

Editor Christopher OwenDesign Alan PitchforthPublisher Kamilian Limited enquiries@kamilian.com www.kamilian.comPrinter Pioneer Printers Limited www.pionprint.com.hk

SovereignGroup.com

© The Sovereign Group 2007

The material set out herein is for information purposesonly and does not constitute legal or professionaladvice. No responsibility will be accepted for lossoccasioned directly or indirectly as a result of acting,or refraining from acting, wholly or partially in relianceupon information contained herein.

Photocopying this publication is illegal.26www.