Some fundamentals of the international tax system

Traditionally, the right to tax (or not tax) subjects has been the sole preserve of the sovereign and its parliament. This worked while most capital and citizens were static although freeports have existed since ancient times.

As an example, Jebel Ali was a free port long before Dubai became a modern tourism and finance centre. It was possible to form a Jebel Ali Freezone company (FZE) subject to a minimum capital requirement. A trader of commodities between Europe and Asia, for example, could buy widgets for $10.00 in Asia, sell them to their Jebel Ali FZE for $20, then deliver them to an agent in Rotterdam for $30. Only half of the sale price was exposed to tax for the contract performed at the port of delivery.

These days, the freedom of states to set their own tax rates has been restricted by pressure from international organizations. The Financial Action Task Force (FATF) was set up in 1989 to counter money laundering. Low or nil tax rates and inadequate supervision were seen as harmful practices akin to attracting the proceeds of crime. The FATF became politicized with perceived rates of wealth inequality increasing.

The rise of international dotcom business, able to trade from anywhere, gave rise to multilateral Base Erosion and Profit Shifting (BEPS) agreements permitting states to tax some transactions that would otherwise escape their domestic tax net. BEPS was known as the Amazon tax because many domestic taxes and double tax agreement rules only applied international transactions when the agreement was made in the state, there was a “dependent” agent in the state or the taxpayer had a physical presence in the state. Amazon and other dot com vendors were often outside the scope of such tax rules. The rule for the place and time of formation of a contract, was where the acceptance of an offer was posted.

The BEPS rules were in the process of being implemented when further multi-lateral agreements entered into by 130 states were entered into in 2021 known as Pillars 1 and 2. Pillar 1 allocates some taxing rights over very large and profitable multinations’, to states where they do business without a physical presence having to be established. Pillar 2 sets a minimum 15% rate of corporation tax.

In the case of individuals, capital became more mobile when exchange controls were lifted in the late 1970s. Individuals found ways to use the special attributes of individual states and territories. Some British Crown dependencies legislated for international business companies (required to trade outside their place of incorporation), with zero corporation tax rates.

Until around the 1990s, the UK had a policy of wishing to attract foreign banking and finance experts to the City and exempted them from UK tax on the income and gains of their assets retained outside the UK. This was the non-Dom rule. In general, before 2017, a individual born outside the UK would not be deemed to be UK domiciled until they had been resident for 17 of the last 20 UK tax years. Residence was assessed according to the number of days spent in the UK in a tax year. In one year, if more than half (183 days) or over 90 days on average over four years, then the UK would claim residence. Also, until 2019, a non-resident was able to buy and sell some UK assets without the gains being subject to UK Capital Gains Tax.

Employment and other active income from the UK and income from a fixed base was taxable in the UK even if it belonged to non-UK resident so, for most people, whether they are resident or not wasn’t, from a tax point of view, very important but; for wealthy mobile people, with passive income such as interest, royalties and dividends, it matters.

Generally, once a person or company is resident in a state, they may be taxable on their worldwide income. The UK exempts foreign passive income of non-doms subject to the ‘remittance basis’ rules. New Zealand and Aus don’t generally offer this exemption but they have a temporary transitional residence status, during which, passive from income is exempt.

Some international business centres such as Singapore and Hong Kong exempt the foreign income of their residents.

The UK updated its residence test in 2013. Tax rules are complex. This newsletter is not intended to be legal or tax advice. Please consult a tax adviser before selling an asset.

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