Few Places to Hide as Taxes Trend Higher Worldwide

http://www.nytimes.com/2012/12/03/business/global/03iht-srtaxlede03.html

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Death and taxes are the only certainties in life, if you believe Benjamin Franklin. Had he been around today, he might have observed that taxes also have become a great uncertainty in life.

Taxes on earnings, investment income, sales and a few other things have gone up already in many countries, and further increases are possible, including a huge one in the United States.

Another source of unease and doubt for taxpayers is a trend toward increases of other sorts: in scrutiny by revenue authorities, reporting requirements for individuals and businesses, and legislation to close tax code loopholes.

International taxpayers — expatriates and others whose personal or professional lives extend across borders — may find conditions particularly challenging. Dealing with a changing tax regime is tough; dealing with more than one even more so. Not only that, but some authorities are focusing more keenly on foreigners or on their own citizens living elsewhere. On the bright side, certain countries still treat foreigners better than their own citizens.

Navigating a landscape that may have been familiar but is suddenly a treacherous terra incognita is not easy, tax advisers warn, but it can be done as long as taxpayers are well prepared, take care to avoid mistakes and resign themselves not to go too far.

“There is no magic solution, no one structure that will work,” said Gavin Leckie, a wealth adviser and specialist in expatriate financial issues for J.P. Morgan Private Bank. “A lot of this is a defensive exercise. Make sure to organize yourself so that you’ve anticipated problems and taken steps to protect yourself.”

There is much, existing and potential, to protect yourself from. The biggest tax-related question mark — several hundred billion dollars big — concerns the fiscal cliff. That is the term coined by another famous Ben — Bernanke, the U.S. Federal Reserve chairman — to describe the anticipated destination of the American economy if an extensive mix of tax increases and government spending cuts goes ahead as scheduled next month.

Numerous increases are on the books or heading there in Europe, including on income and/or value-added taxes in Spain, Finland, Italy, the Netherlands and France, where a 75 percent income tax rate on income exceeding €1 million, or $1.28 million, is coming in 2013. Bucking the trend, Britain is about to lower its top income tax rate to 45 percent from 50 percent — after having raised it from 40 percent.

The European Commission has proposed, and 11 euro zone members support, a tax on financial transactions. Ireland introduced a tax on insurance premiums this year, the Dutch plan to raise their tax on premiums in 2013, and France hopes to raise taxes on rental income and capital gains from vacation homes of domestic or foreign owners.

If the expanding tax bite around the region makes you want to cry in your beer, being in France could cost you more on that score, too. The beer tax is due to rise 160 percent.

Conditions in Asia are comparatively placid, but that region has not been immune from the trend. Attempts to raise the value-added tax in Japan have failed in the past, along with governments that made them, but a doubling of the V.A.T., called the Japan Consumption Tax, was approved in August.

“Quite a few countries are trying to increase tax revenue,” said Kevin Cornelius, a partner in Geneva for the Human Capital Practice at Ernst & Young. “The question is who’s raising taxes the slowest. I can’t remember as much tax legislation going through as we’ve seen in the last 24 months.”

Americans would welcome at least one more piece of legislation. At press time, negotiations were continuing in Congress on a compromise to avoid going over the fiscal cliff. The consensus among pundits in Washington and on Wall Street is that one will be reached that preserves present rates on middle-class taxpayers and perhaps raises them on high earners.

If no deal emerges, tax rates will increase on income, capital gains and dividends. Employee payroll taxes are also scheduled to rise, and surcharges are due to be introduced on earned income and investment income of well-off individuals to defray the costs of the health care overhaul.

The increases on both sides of the Atlantic are intended to close yawning fiscal deficits after several years of heavy spending and tepid economic growth, but economists and financial advisers view them as a triple threat to taxpayers: out-of-pocket costs, of course, and the prospect of stunting future economic growth and limiting investment returns.

A November report by the Congressional Budget Office predicted a recession in 2013 if the fiscal cliff tax increases and spending cuts go through. Bill Gross, a portfolio manager and widely followed authority on the influence of economic and government policy on financial markets, predicted in a recent Bloomberg News interview that whichever way the dilemma was resolved would take about one percentage point off the U.S. economy and send growth “closer to the zero line.”

The relationship is not perfect, but lower tax rates have tended to coincide with stronger economic growth in America and Europe, said Roger Ibbotson, a professor in the Yale School of Management. He noted, for example, that a multidecade trend of reducing rates and closing loopholes in Europe “has been a very positive thing for the economy.”

Positive enough that the tax rate increases of the past few years have raised doubts among economists about Europe’s growth prospects. The package of increases introduced in France by President François Hollande, especially the 75 percent income tax rate, has attracted outright scorn.

“It’s perhaps the most foolish set of tax policies under discussion in all of Europe,” said J.D. Foster, a senior fellow at the Heritage Foundation. “You just have to laugh and ask whether he was elected for the sole purpose of destroying the French Republic. Everyone says they want a growth agenda, then everything they do harms growth.”

Because the stock market is seen as a barometer of economic progress, share prices also move inversely to tax rates, Mr. Ibbotson said, though the relationship is fuzzier because investors tend to take tax changes into account well before they are enacted.

“There’s usually quite a bit of discussion beforehand, and the market can react before the event itself,” he said.

The Standard & Poor’s 500-stock index of large American companies fell as much as 6 percent in the eight trading days after the Nov. 6 presidential elections as investors began to focus on the small but growing possibility that continued gridlock in Washington would produce no deal to prevent the fiscal cliff measures. Stocks that have had strong rallies suffered steeper declines, most notably Apple, whose shares fell from about $583 to $506.

Concern about the fiscal cliff might even have reached a galaxy far, far away. Media reports of Disney’s acquisition of George Lucas’s Lucasfilm production company noted that the tax liability on Mr. Lucas’s estimated $2 billion capital gain would drop substantially if the deal closed in 2012.

The decline in U.S. stocks has been particularly noticeable in companies that pay big dividends. Barclays Capital pointed out in a research note that two of the three sectors hit hardest in the first half of November, utilities and telecommunications, had the highest dividend yields. Tax rates are scheduled to go up far more on dividends in January than on other income.

Not only that, but history suggests that if dividend taxes are raised, fewer American companies will pay dividends and instead will use their earnings in other ways. Data from S.&P. Dow Jones Indices show that the number of companies paying dividends held fairly stable during periods when the highest tax rate was the same on dividend income as on long-term capital gains, as in the past decade or in the mid-1980s through late 1990s. In between those periods, when dividends were taxed at higher rates than capital gains, the number of dividend-paying companies fell sharply.

That might not happen this time around, a study by WisdomTree Investments, a provider of exchange-traded funds, suggests. The study notes that dividend payments as a proportion of corporate earnings have been declining for decades, so the effect of higher tax rates could be muted.

American investors worried about rising tax rates might consider selling stocks in which they have large unrealized gains, investment advisers say. After the selling wave in early November, however, and with the outcome of fiscal cliff talks in Congress still unknown, it is hard to gauge whether that would be better than hanging on until 2013 or not acting at all.

“Things could be radically different a week or two from now,” said Adam von Poblitz, head of estate planning for Citi Private Bank. The uncertainty “has put a lot of clients in a state of paralysis,” he observed. “If people knew that XYZ were going to happen, they might not like it, but they would know how to proceed.”

One tactic for well-off individuals that Mr. von Poblitz considers a surer thing involves giving money away rather than making it. While attention has been focused on income and investment taxes, he notes that the tax rate on gifts is also due to rise in 2013, to 55 percent from 35 percent, payable by the giver. Perhaps more important, the lifetime amount that can be given tax-free is due to fall to $1 million from $5.12 million.

“There is a huge incentive to get gifting in by December 31,” he said. “Use it or lose it. That’s really the hot topic in trusts and estates.”

For Americans who are unlikely to give or receive millions, some simple maneuvers can limit tax liability if rate increases go through as planned and cause little harm if they do not. While the typical year-end strategy is to push back income and bring expenses forward, Joyce Franklin, a financial planner in Larkspur, California, points out that this is not a typical year end.

“Many of the traditional planning ideas are reversed for 2012” for people with high incomes, she advises clients on her Web site. “In 2012, you’ll want to accelerate income and defer deductions,” such as for business income, charitable contributions, and state income tax and property tax payments.

A rise in rates is not the only unpleasant matter that taxpayers must contend with. Tax lawyers, accountants and bankers highlight a global game of gotcha being played by revenue authorities.

Taxpayers are being asked to provide more detailed information about financial accounts. Americans living or doing business abroad are conspicuous targets in this effort, and on the off chance that they will be less than forthcoming, the Internal Revenue Service is asking foreign financial institutions and tax agencies to join the cause.

Elsewhere, vehicles that individuals and families use to shelter income and assets from tax, like trusts, corporations and foundations, are being examined more closely and critically. In certain cases, laws are amended to neutralize the effectiveness of tax-avoidance methods soon after they are devised. Also, foreign visitors’ claims of nonresidence for tax purposes are being treated more skeptically.

“We’ve seen a huge amount of tax scrutiny,” said Mr. Cornelius at Ernst & Young. “Authorities are more aggressive in pursuing individuals. There’s more sharing of information across borders. That’s going to continue.”

Gregory Jones, head of tax for KPMG on the Isle of Man, warns that such a climate demands that taxpayers treat any strategy they might contemplate with great circumspection, because that is how the authorities will treat it.

“People have to be conscious of whether whatever they do will hold up to scrutiny,” Mr. Jones said. “Eventually, anything you do will have to be put on the table and explained.”

One way to get around elevated tax rates and scrutiny is to get around. While international cooperation and efforts to collect more tax are intensifying, many jurisdictions maintain a tradition of hospitality and generosity toward foreigners and their money. These days, Mr. Cornelius said, governments “are showing an intent to differentiate themselves from the French” by cutting special deals to limit taxation of wealthy foreigners who move there.

Those who earn very good money, but nothing spectacular, will not be able to rewrite tax rules, but the ones already on the books in some countries make them attractive places to relocate.

“In Europe you tend to find people exploiting better regimes, moving to countries to get better rates,” Mr. Jones said. “Some countries give incentives to get senior workers to come.”

Examples include the Netherlands, Ireland and Britain, and the inducements typically include an ability to use legal structures like offshore trusts or companies to shelter capital and investment income.

But because such vehicles are frowned upon elsewhere, Mr. Jones urges great caution — and perhaps some reference books and a map — before packing your bags.

“If I’m advising a client to go abroad for tax reasons, there are a number of countries I wouldn’t send them to, like Germany and France,” he said. “You’re better off in the U.K. or Monaco.”

In other parts of the world, Canada allows new residents to shelter foreign assets for five years, he added, and Hong Kong and Singapore are excellent locations in Asia, though more for corporations than individuals.

As helpful as these tax regimes are, some foreign residents may be tempted to get creative and bend a country’s legal system to their own advantage. Mr. Jones would urge them to reconsider.

Mr. Leckie, at J.P. Morgan, cautions present and future expatriates to be clear on the rules that can work against them, too. Certain retirement and savings plans that confer tax advantages back home may not qualify elsewhere, generating an unexpected tax burden, he points out.

“You need to anticipate what the issues might be,” Mr. Leckie said. “People are busy, they move to a new job or see a new business opportunity in a new country without being aware of these issues. People used to take a more laissez-faire attitude. They really need to watch it and make sure they’re not caught by these increasingly complicated tax rules.”