No discussion of tax havens would be complete without mention of Switzerland. Switzerland is a financial center and money haven more than it is a tax haven. The Swiss tax resident companies on three levels – federal, canton and municipal. Federal tax rates range from 3.63% to a maximum of 9.8% and that's in the ballpark with other low tax havens, but Swiss cantonal and municipal taxes can effectively raise the tax rate on a resident Swiss company to as high as 20% or 30%. That's more in-line with industrial nations' tax rates. Switzerland is very much an industrial country. Its banking system is world-renowned. It's negotiated many tax treaties with other industrial nations, including the USA.
What makes Switzerland more in-line with the low-tax and no-tax havens and boldly different from the industrial nations is the way the Swiss look upon income tax evasion and income tax avoidance. Income tax evasion is not a crime in Switzerland as it is in the industrial nations. Tax evasion is a misdemeanor. The Swiss do not consider tax evasion (or tax avoidance) a crime unless the taxpayer has falsified records. Swiss Courts will no lift the elaborate veil of secrecy that Swiss institutions offer unless a violation of Swiss criminal statutes has occurred.
Opening a secret Swiss bank account (either a numbered or ciphered bank account) is perfectly legal in Switzerland. Hiding information from outsiders has always been a tradition here. In this respect Switzerland is very much a tax haven like the Caymans, Panama, Vanuatu, the Bahamas or Hong Kong. Author Midas Malone sums up the Swiss attitude when he writes..
" In the U.S., tax evasion – failure to declare all income – is a criminal offense. In Switzerland (and several other countries) it is not. For that reason, if the U.S. Internal Revenue Service asks Switzerland for information on an American suspected of not paying all his taxes, the Swiss Government politely refuses on the grounds that no Swiss law has been broken. A Swiss citizen might be asked by his government to provide documents or other information supporting his tax claims, but Swiss law bars the government from fishing expeditions to dig up hidden information on its taxpayers. It is interesting to note that the Swiss meet all their tax needs without resorting to strong-arm methods. The Swiss attitude is that people will voluntarily support reasonable government spending and fair taxation. Obviously, their policy works, and they simply will not participate with other governments in activities they feel are unnecessary, nonproductive, and which they basically disagree. They will cooperate in prosecuting tax fraud, however, which is different from tax evasion" [Midas Malone: How to do business tax free (pg 65)]
Swiss Bank Secrecy Law is Tough
Then years ago American entrepreneur Marc Rich (now a resident in Switzerland) was indicted in New York for racketeering, fraud and tax evasion. The U.S. asked the Swiss to extradite Rich to the U.S., but the Swiss government refused. Later Rich made good the U.S. government's tax claims against his companies, paying $200,000,000 in taxes and penalties in one of the largest tax claims ever collected. But the U.S. still refused to drop charges against Rich. While Rich's companies were allowed to resume their U.S. operations, Rich remains a fugitive in the eyes of the U.S. tax authorities to this day, although he is a popular hero in his home canton of Zug.
In Switzerland, it is not a crime for you (or a Swiss citizen) to evade U.S. taxes, but it is a criminal offense if your Swiss banker or one of your Swiss corporate directors violates Switzerland's official secrecy laws. Violations of trust, as the Swiss calls them, are prosecuted ex-officio by law. A person who is subject to the Swiss banking secrecy law is bound from giving up such secrets for the rest of his life. Anyone, including yourself as a director of a Swiss company, who willfully divulges a secret entrusted to him can be punished by a prison term of up to 6 months in jail and a fine of up to $50,000 Swiss francs.
At the end of 1982 the Swiss banking system included 512 banks and investment companies subject to the Swiss "Banking Law" with total assets of Sfr.611 billion (about US$381.8 billion), fiduciary deposits of Sfr. 166 billion, and a domestic network of 5,069 banking offices, which means that on the average there is one such office for every 1,276 inhabitants – density matched by few other nations.
In addition, Swiss banks held over Sfr.218 billion in assets abroad, with the three leading big banks accounting for Sfr.142.8 billion of the total.
In addition, Switzerland's total assets and investments abroad, including official monetary reserves totaled Sfr. 438 billion (about US$273.7 billion). Deducting from this sum Swiss liabilities to foreigners estimated at Sfr.279 billion, and one comes to a net creditor position for Switzerland of Sfr.159 billion.
Swiss Companies Law is embodied in the Swiss Code of Obligations, which is issued in Swiss, German and Italian. An unofficial English translation of the part of the Code dealing with companies incorporated with legal liability was published by the Swiss-American Chamber of Commerce in 1980, and copies are available on request.
At least three founders (individuals, or entities) are needed to form a Swiss (AG/SA) company. To form a private company (GMbH/Sarl) two shareholders are required.
The minimum paid-up capital required to start a Swiss company is 20,000 Sfr. (about $12,400). Upon formation, a one-time Federal Stamp duty of 3% is due on the total share capital. The total expenses incurred to form a Swiss corporation starts out about Sfr. 5,000, but may be considerably higher if the authorized capital is sizable.
The Pure Holding Company, the Participating Company, and the Domicile Company
In Switzerland there are three types of companies that you can choose to use. The first is called Pure Holding Company. A pure holding company normally acquires and permanently holds "substantial participations" in the equity capital of other corporations. Its income consists of dividends, interest on bank accounts and capital gains. Pure holding companies generally pay no canton or municipal taxes. They do pay taxes on their capital gains and other ordinary incomes.
A pure holding company that holds 20% or more of the shares in another Swiss or foreign corporation is exempt from Federal tax with respect to dividends and liquidating dividends from the substantial participation. If the shares in the other company are worth at least Sfr.2 million (about US$1.3 million) the substantial participation exemption still applies.
Another category of Swiss holding company called a Participating Company is an everyday commercial or industrial company, which holds equity investments in other companies. It is a mixture of holding company and industrial company. It is permitted the same tax relief that a pure holding company can get with regards to substantial participations in other Swiss or foreign corporations.
The third type of Swiss holding company is the Domicile Company, which can engage in any type of business, but not from its registered Swiss office (which is merely an address for official communications). Its transactions must originate from places other than its registered office, and management board and directors must supervise operations essential from outside Switzerland.
Swiss resident companies are taxed on their worldwide income from all sources, and on capital and reserves at 0.825% rate pa. The tax rate on accessible income (including capital gains) for federal income tax purposes ranges from 3.63% to 9.8%. Nevertheless, certain items of income are exempt from Swiss income taxes. Aside from the substantial participation privilege described above, the following items of income are not subject to corporate tax;
- Income from a foreign branch or permanent establishment.
- Foreign source real estate income.
It is important to obtain these benefits to come to an agreement with the tax authorities beforehand, so a method of assessment can be negotiated. Once made, the agreement will remain in force until the situation of the company changes. The final decision is made by the Canton tax authority, and is valid also for federal income tax purposes.
Income Tax Treaties
What makes Switzerland a powerhouse in the financial community is her ability to negotiate important income tax treaties with the other industrial nations while persevering her own perspectives in regards to confidentiality and bank secrecy. To be sure, the Swiss tax treaty with the U.S. offers benefits to Swiss trading companies that cannot be procured anywhere else. Some of these advantages are outlined by Edwin J. Reavey, Esquire in an article beginning on page 154.
Dividend Withholding Taxes
Under the Swiss-United States tax treaty the U.S. dividend-withholding rate is reduced from 30% to 15%, with a further reduction to 5% when the Swiss company owns 95% of the voting stock of the U.S. Company paying the dividend.
Dividends paid by a Swiss company are subject to a 35% Swiss withholding tax, but resident Swiss individuals and companies get a full refund, so the 35% Swiss dividend withholding tax really doesn't apply to Swiss entities. Foreign companies and individuals are subject to the 35% Swiss withholding tax, however. Here again, some Swiss tax treaties reduce the rate and allow for a refund. Under the U.S. treaty, the Swiss will refund 30% of the tax if the U.S. Company owns 95% of the voting stock of the Swiss company paying the dividend. Under the Netherlands-Swiss treaty the entire 35% withholding is refunded if a Dutch company owns at least 25% of the Swiss company.
Combining the Swiss substantial participation privilege, the dividend refund provisions (above), and the tax treaty benefits can lead to a very low effect tax rate, even though the Swiss federal and canton taxes can approach 30% on other types of incomes.
Exporting U.S. Products Tax Free
A U.S. manufacturer that exports or ships his products overseas would be liable to U.S. federal income tax on his profits, the same as on sales of product sold within the U.S. However, if a Swiss trading company coordinates the sales through its U.S. branch office, thereafter exporting the goods overseas, its profits would go entirely untaxed.
This often-used tactic was highlighted in the December '86 issue of an international tax journal by Boston attorney Dale Johnson. According to Attorney Dale Johnson.
"The U.S. exempts a Swiss enterprise operating through a U.S. office from U.S. tax on its foreign source income even though such income might be taxable in the U.S. absent the treaty. This means a Swiss enterprise may export U.S. goods from the U.S. through a U.S. office (permanent establishment) without incurring any U.S. tax on its income."
Where you place your Swiss trading company branch office within the United States may one day save you a bundle of state taxes too. Although each U.S. state taxes differently, some states conceivable can apply their state. States like Minnesota and New York have income tax rates that approach 18%. Others, like Texas, do not tax corporations or individuals. A Swiss branch could operate in Texas free from federal and state income taxes.
Texas' sales tax (about 6% for sales within Texas) does not apply to cattle and farm products. Those products are exempted. In addition, companies that export Texas products within 30 days get a tax refund. The Texas office of a Swiss Trading Company could export products from other states (using telephone, fax machines and independent agents) tax free, so long as it doesn't open a branch office within the other state.
The Tax Reform Act of 1986 and the Technical & Miscellaneous and Revenue Act of 1988 added some minor restrictions to the Swiss-U.S. treaty loophole for exporters and importers.
The following article by Edwin J. Reavey, Esquire analyzes this U.S. tax loophole. It is reprinted for you here with written permission from Tax Management International Journal (1987) – the publisher.
TRA 86 Changes to the Source of Income Rules can result in taxation of a Swiss or Netherlands Antilles Trading Company Operating in the U.S. [by Edwin J. Reavey, Esq.]
Prior to the Tax Reform Act of 1986 (P.L. 99-514), it was possible for a foreign corporation to purchase U.S. goods for resale abroad through its foreign office without incurring U.S. tax, if the title to the property passed outside the U.S. If the foreign corporation was incorporated in certain treaty countries, it could conduct these same operations entirely within the U.S. and still avoid U.S. tax. A change to the source of income rules in the 1986 Tax Reform Act has the effect of overriding this favorable result for foreign corporations incorporated in those treaty jurisdictions.
Under §882, a foreign corporation is taxed at regular U.S. corporate rates on its net income, which is "effectively connected" with its U.S. trade or business. For a foreign corporation purchasing U.S. inventory for resale, its "effectively connected" income upon which U.S. tax is imposed includes its U.S. source trading income and, under certain circumstances, also its foreign source trading income.
To determine the geographical source of income, §§861(a)(6), and 862(a)(6) provide that the income from the sale of purchased inventory property is generally sourced at the location where the sale occurs. Under Regs. §1.81-7(c), a sale is considered as occurring at the place where title to the property passes to the purchaser ("title-passage" test). Thus, a foreign corporation that purchases U.S. equipment for resale to foreign purchasers, with title passing outside the U.S., would generate foreign source income on the transaction. Where the title-passage test was used, the foreign source income generated by selling U.S. equipment for consumption abroad would only be "effectively connected" and taxed by the U.S. if the foreign corporation (i) had a U.S. office or other "fixed place of business" within the U.S., (ii) the income from the equipment sale was attributable to that office, and (iii) a foreign office did not participate materially in the sale. See §864(c)(4)(B) prior to the TRA 86 amendment.
Thus, a foreign corporation conducing a trading operation that could generate foreign source income by passing title abroad could avoid having the income "effectively connected" with a U.S trade or business, and, thus, avoid U.S. taxation if:
- the corporation did not have a U.S. office, or
- the corporation had a U.S. office, but its foreign office participated materially in the sale of the U.S. equipment. Avoiding the existence of a U.S. office. Ordinarily, it is a question of fact whether a foreign corporation has a U.S. office or "other fixed place of business in the U.S." Under certain circumstances, the U.S. office of another person (e.g., a shareholder or an agent) could be viewed as the foreign corporation's office. Because of the concerns in determining whether a U.S. office existed, as well as the difficulty from an operational viewpoint in not having some presence in the U.S., the first threshold mentioned above avoiding the U.S. office was often not relied upon to escape U.S. taxation. Having the foreign office participate materially in the sale. Where a U.S. office existed or was needed by the foreign corporation, it was still possible under (he Code to avoid "effectively connected" income status on its foreign source income U.S. inventory that was sold for consumption outside the U.S. if a foreign office or other fixed place of business of the taxpayer participated materially in the sale. Thus, if a foreign office existed and was significantly involved in the transaction, it was possible for the foreign corporation to conduct its operations without incurring U.S. tax, and still maintain a U.S. presence.
The Treaty Exception, notwithstanding the above Internal Revenue Code rules, it was also possible for a foreign corporation operating as a trading company and generating foreign source income from the sale of U.S. equipment abroad, to have a U.S. office, and have that office perform all of the activities with respect to the sale, without such income being taxed by the U.S. as effectively connected income. This possibility arose under certain tax treaties which provided that only the U.S. source income of the foreign corporation could be taxed by the U.S., even where the foreign corporation had a U.S. as effectively connected income. This possibility arose under certain tax treaties which provided that only the U.S. source income of the foreign corporation could be taxed by the U.S. even where the foreign corporation had a U.S. "permanent establishment" (e.g., an office). Thus, a foreign trading company, incorporated in a country, which had a tax treaty with the U.S. containing such a provision, could have a U.S. office, which participated materially in the foreign sales of the U.S. property, and still avoid U.S. taxation on its foreign source trading income. In general, it was only the older U.S. treaties that prohibited U.S. taxation of this foreign source income.
The 1986 ACT Changes
Although the 1986 Tax Reform Act retained the title passage test for inventory sales, it did make certain changes that will have an impact on a foreign trading company, incorporated in a tax treaty jurisdiction, that relied on the treaty rule discussed above. Specifically, the Act made the following changes:
- It deleted §864©(4)(iii). This, by itself, has the effect of treating only U.S. source trading income as effectively connected income.
- It added new §865(e)(2)(A) which, for foreign persons, overrides the title-passage rule with respect to inventory sales and treats the income from such sales as U.S. source, if a U.S. office exists and the income is attributable to the U.S. office.
- It added new §865(e)(2)(B) which creates an exception to the U.S source rule mentioned immediately above, if a foreign office of the foreign person participates materially in the sale. If this exception applies, the title passage rule continues to determine the source of the income. Thus, as a result of the Act, a foreign corporation purchasing U.S. goods for resale and use abroad can only avoid U.S. taxation if it generates foreign source income with respect to the sales, and
- It does not have a U.S. office, or
- If it does, a foreign office participates materially in the sale. If, one the other hand, a U.S. office participates materially in the sale on a regular basis, §865(e) will treat this income as U.S. source so that the treaty rule does not apply.
Netherlands Antilles or Swiss corporations that were conducting U.S. trading activities through their U.S. office and relying on a combination of the title passage rule and Article lll of their respective treaties to escape U.S. activities to a foreign office in order to continue to avoid U.S. taxation under the remaining Code exception. Failure to take such steps may subject these entities to both U.S. income taxation as well as the new §884 branch profits tax. Note also that, although a Netherlands Antilles or Swiss corporation that had been relying on Article III of their respective treaties would no longer be able to rely on such treaty to escape U.S. tax as a result of the 1986 TRA change, it is questionable whether such change would be considered a "treaty override". In this area, the 1986 Reform Act only changes the internal U.S. rules for determining the geographical source of income, and neither treaty contained specific source of income rules.
(Courtesy of New Providence Press: Tax Havens of the World).
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