One challenge for tax authorities is to ensure that wealth held through foreign structures remains within reach of domestic tax rules, even when the underlying assets, owners and beneficiaries span multiple jurisdictions. This has led to the development of increasingly sophisticated anti-avoidance frameworks, which other countries are now adopting at a much faster pace.
The Development of International Anti-Avoidance Rules
The legislative response has run in two broad strands:
- Controlled foreign company (CFC) and attribution rules: Tax residents are taxed on the income of foreign entities they own or control, whether or not it is distributed.
- Transfer-of-assets, settlor and foreign trust rules: Look-through trusts and similar vehicles to the person who funded them or benefits from them.
Around these sit transparency measures like reporting regimes, information exchange and trust registers, as well as general anti-avoidance rules.
The pioneers of these measures were the USA and the UK. The USA first introduced legislation to address foreign personal holding companies in 1937, followed by CFC legislation in 1962. The UK introduced the “Transfer of Assets Abroad” rules in 1936 and CFC legislation in 1984. Other nations have followed a largely similar path in the subsequent decades.
Today, most developed tax regimes follow a common structure that is largely built on the following elements:
- Deemed income attribution: Income of the foreign entity is treated as income of the resident owners, as it arises.
- Settlor and transferor charges: A person who transfers assets abroad remains taxable on the income or on benefits later received.
- Anti-deferral interest charges: Delayed distributions bear an interest or rate penalty that removes the benefit of waiting.
- Information and penalty regimes: Disclosure obligations backed by heavy penalties.
- General anti-avoidance rules (GAARs): A backstop for arrangements that the specific rules miss.
Rapid Global Advancements
With global exchange of information and increasing use of technology and AI, tax enforcement is moving quickly. Now, once-developing nations are building similar regimes at an increasingly rapid pace.
China provides a recent example of how quickly the regulatory environment can evolve, as Peter Tung explores in this quarter’s Country Focus.
Although China has had CFC and GAAR legislation in force for over 10 years, its application and enforcement by regional tax authorities have been inconsistent.
However, while it took developed nations decades to build robust anti-avoidance frameworks, China has done this in a matter of several years. It has used technology to cross-check CRS reports with declared wealth and developed electronic “nudge” systems to encourage individuals to correct tax returns. It has also enhanced the use of integrated tax administration systems like Golden Tax Phase IV, together with data analytics capabilities, to identify discrepancies across multiple data sources and support tax compliance activities.
In addition, this year has seen the introduction of a unified and consolidated approach to the taxation of offshore trusts and similar structures with Chinese connections.
This trend is likely to continue. Taiwan, for example, only implemented CFC provisions for individuals in 2023 and already has a framework in place that mirrors those in the pioneer countries.
The Problem for Wealthy Families
The main issue for families is to ensure that wealth structuring can withstand changes in legislation, technology and global mobility.
It is often in the context of global mobility that families in low tax jurisdictions first encounter the layered anti-avoidance frameworks of high tax jurisdictions. Often, this happens when it is too late.
Take an individual living in Hong Kong who establishes a family discretionary trust for the benefit of their children and future generations. The structure works well while the family remains in Hong Kong. Years later, one of the settlor’s children moves permanently to Australia and wants to receive money from the trust. The problem is that a payment to the child can potentially be linked back to income accumulated in the trust over many years, creating a significant Australian tax and interest charge.
At that point, it may already be too late to simply restructure the trust and remove the problem. The historic income has already accumulated. The better time to review the structure is before the child becomes Australian resident, when there is still an opportunity to consider how the family’s arrangements should adapt to the change in circumstances.
The Role of Insurance in Planning for Uncertainty
Insurance-based wealth solutions are built on a different legal and regulatory framework from fiduciary structures. They occupy a space that has largely remained stable and are universally recognised across low tax, high tax, common law and civil law jurisdictions. Insurance therefore acts as a long-term structure for family wealth by providing a simple, tax-compliant solution that can adapt to changing legislation and circumstances.
Let’s go back to our family in Hong Kong. This time, part of the family wealth is held within an insurance-based solution, as provided by Utmost. When the child decides to move permanently to Australia, the family can review the implications before they relocate and determine how the policy should be managed in light of a new tax residence.
The important difference is that the family is not waiting until money needs to be transferred to discover the tax consequences. The insurance structure can remain in place while the planning evolves around the family’s changing circumstances.
Being universally recognised, insurance has portable features that act as a bridge between jurisdictions. This is particularly suited to increasing family mobility.
In Part 2 of this Technical Spotlight, A 10-Year Stress Test, we put these principles to the test, following two familiar client scenarios through more than a decade of legislative change, migration and changing family circumstances.