The Most Common International Tax Trap
Someone came to me a while ago saying: “I’ve got a friend who is living in XYZ country but doesn’t pay taxes there because…”
This is probably one of the most common things I hear and it can get you into massive amounts of trouble.
I used to have a client who would call up every a couple months with a story like this, about someone they knew who had some setup and apparently, this was a solution for the client… except it wasn’t.
Don’t fall into this trap!
Just Because It Works For Them Doesn’t Mean It Works For You
International structuring is very facts specific.
Each person has different circumstances.
If you’re from Germany and someone else is from France what works for them won’t necessarily work for you.
The dumbest thing you can do is simply copy someone else’s set up.
Let’s consider some variations:
- Different residency rules
- Different tax treaties
- Different lifestyles
- Different family ties or centre of vital interests
- Different businesses
- Different customers
- Different goals
- Different ownership structures
- Different CFC rules
- Different transfer pricing rules
- Different long term investment plans
- Different liabilities
The point is thousands of things can change and just one of those things could change what will work best for you, compared with someone else.
With this client, I’d have to point out to them: “They are resident in New Zealand and you’re resident in Belgium… different rules. What works for them isn’t what works for you.” (jurisdictions changed to protect client privacy).
It goes deeper though…
Just Because They Haven’t Gotten Caught Doesn’t Make it Legal
I can’t count the number of times I’ve seen someone come to me or ask about someone else’s structure that isn’t legal.
Sometimes the refrain is: “They’ve been doing this for years and it’s all good”.
No, it’s not!
For decades wealthy people hid money illegally in Swiss bank accounts. In 2009 the US government broke UBS and over the next few years broke virtually all the remaining Swiss banks getting them to turn over key account holder info and penalized account holders 20% to 50% of the account balance on the assumption of tax evasion.
Just because nothing has happened yet, doesn’t mean it’s all good.
In the Swiss banks incident, the thing I found so sad was most of these people could have done legitimate legal tax planning that would have resulted in little to no taxation. Moreover, they wouldn’t have needed to look over their shoulder for a surprise.
In theory, if you’ve gone through a tax department examination this should mean you’re good to go… but even then not always.
The Truth About Audits
To anyone who hasn’t been through an audit — the process seems really scary.
I’ve gotten the call from clients who received a letter from the IRS or some other tax department and we get to help them through it.
For the most part it’s actually not a very big deal. You act polite, you provide the information requested, and if you’ve been doing everything well — all is good at the end.
But even being cleared from an audit doesn’t mean you’re in the clear in terms of the compliance of your structure.
What many people don’t realize is most tax department audits aren’t full audits, where they are going through every detail.
Tax departments have a limited targeted scope.
Maybe the tax department is auditing your payroll records, maybe they are auditing your transfer pricing documentation, or maybe some particular set of expenses.
It’s possible during the process of the audit they’ll discover something to give them cause for concern and they’ll widen the scope of the audit.
Naturally, this is inconvenient.
Nothing about audits is ever convenient except getting cleared at the end.
I’ve very rarely seen audits where the focus is on the types of issues relevant to international tax.
For example, although there are definitely audits and court cases related to the residency of companies, it’s fairly rare to see this show up as a major point of examination even though it probably should be a big focus for tax departments as it’s a major gap in many structures.
Source income and intangible permanent establishments are another example of something rarely audited, but frequently a huge gap in structures.
The bottom line is you need to understand how international tax works and what vulnerabilities might exist in a structure, so you can address them so even if you do get reviewed you’re fully above board.
A structure isn’t sound because you know someone who has done it and hasn’t gotten in trouble.
It’s not even sound because they went through an audit and didn’t get in trouble.
It’s sound because the facts and the laws align in order for it to be valid.
A great advisor on the subject should be able to provide you with citations of the laws and case law backing the validity of a particular structure.
For the most part, the beautiful thing about the law is you shouldn’t have to rely on someone’s opinion. You should be able to go to the source to see the language and see how the cases were ruled.
Yes, there are always cases with ambiguity and this is the reason we have case law in the first place. There are certainly cases where the law is unclear but by and large, you have the ability to go to the source and know with a fair degree of confidence your structure is sound.
Perhaps more importantly, you’ll be able to defend it in the event of challenge and stand a very good chance of winning.
If you’d like assistance reviewing your own circumstances, designing a structure, or verifying the integrity of a structure or just have some questions about international structuring, banking, etc. please reach out and we’d be happy to schedule a consultation.