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The Importance of Substance in International Tax Planning

21 Mar 2011

The current environment
Multinational companies try to generate an optimal return for their shareholders, partly by reducing their tax charge. They operate in a global environment where tax systems differ widely from country to country. Frequently the tax authorities intentionally create differences between tax systems in order to attract (foreign) investors. Multinationals use these differences to their advantage in an effort to achieve a low effective tax rate and increase shareholder value.

Much tax planning is however done as legal or financial (re)structuring without changing the operational structure of the company. These structures therefore often lack economic substance. Taxand discusses the importance of substance in ineternational tax planning and why structures which are considered to be artificial are under ever increasing scrutiny by tax authorities and now also the press.

Companies such as Google, Dolce and Gabbana and Exxon Mobil have been described in the press as using tax loopholes to avoid paying tax. A recent article published in the media for example accused Exxon Mobil of using a Spanish holding company with one employee as a tax shelter to avoid paying tax on billions of euro's. The content of these press articles frequently does not describe the actual facts and are lacking in technical analysis. Still these articles can result in reputational damage to the companies involved and increased scrutiny on these companies by the relevant tax authorities.

Furthermore a lot of companies are facing questions from tax authorities on their tax structures and especially the "substance" of their structures. Due to the economic downturn governments are facing budget pressures and any tax income is welcome. Tax structures reducing this income are therefore targeted by tax authorities. They increasingly demand economic rationale behind international tax planning structures. Recent high profile court cases in a number of countries are a result of this increased scrutiny. We refer for example to the recent court cases in Denmark on beneficial ownership and the Vodafone court case in India.


Taxand's Take


Our view is that setting up or maintaining holding, finance or IP companies in any jurisdiction without proper allocation of substance (functions, risks, employees, decision making powers and assets) should be avoided. We do however feel strongly that this should not prevent companies from engaging into tax planning strategies. The tax planning strategy should however be aligned as much as possible with the business strategy and sufficient substance should be present at the level of the holding, finance or IP companies.

Companies frequently ask us to provide a standard list of the necessary substance requirements for a certain jurisdiction. Although guidelines are in general available, we feel that a cookie cutter approach should not be taken. We advise to tailor the necessary substance to the business strategy and the tax requirements in the source jurisdiction and holding, finance or IP jurisdiction. We also feel that the company should perform a cost/benefit analysis on investing into establishing the necessary substance. An empty letter box company in a tax haven may be a short term cost efficient solution but may prove costly in the long term.

Substance is relevant in different types of tax planning structures. In holding, finance or IP structures which are based on the legal structure of the company tax residence and beneficial ownership are the relevant criteria while in a sales structure transfer pricing is more important. Taxand can provide substance reviews please contact Marc to discuss.

Your Taxand contact for further queries is:
Marc Sanders
T. + 31 207 570 905
E. marc.sanders@vmwtaxand.nl

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Taxand's Take Author