Baker mc kenzie dec newsletter 2nd part

Private Banking Newsletter

Indonesia
Creation of HNWI Tax Office
The formation of the HNWI Tax Office in 2009 heralds an attempt to increase tax compliance of
Indonesian HNWIs and collect more personal income tax from them. Individuals with assets of at
least US$1 million are pooled in this Tax Office. Currently, there are 1,200 taxpayers registered in
this HNWI Tax Office. All of them reside in Jakarta.

This Tax Office serves as an intelligence bureau to monitor HNWI taxpayers’ transactions that have
potential to be taxed. So far, there has been no significant contribution from the HNWI Tax Office
towards tax revenue because most of the HNWI are shareholders of businesses or directors of
companies, so their income tax has been withheld from their salaries and dividends.

Although the HNWI Tax Office’s contribution towards tax revenue is small, the Indonesian Tax
Authority is considering increasing the number of individual taxpayers whose tax affairs will be
administered in this HNWI Tax Office. The Indonesian Tax Authority is also considering including
other HNWIs who reside outside Jakarta. The Indonesian Tax Authority still considers that the HNWI
Tax Office is the best tool to gather information about HNWI taxpayers and monitor their taxable
assets and transactions.

Wimbanu Widyatmoko (Jakarta)
+62 21 515 4920
wimbanu.widyatmoko@bakermckenzie.com

New rules prevent tax treaty abuse
In order to prevent tax treaty abuse, the Director General of Taxation issued two regulations that are
known as PER-61/PJ./2009 (Procedures to Implement Double Tax Avoidance Agreements) and PER-
62/PJ./2009 (The Prevention of Misuse of Double Tax Avoidance Agreements). These stipulate
procedures that must be followed before non-residents are entitled to take advantage of reduced
withholding tax rates under Indonesia’s tax treaties.

A. PER-61/PJ./2009 (Procedures to Implement Double Tax Avoidance Agreement)

Under PER-61/PJ./2009, a party may only be able to benefit from a Double Taxation Agreement
(DTA) protection if it satisfies the following requirements:

a. the recipient of the income is a non-Indonesian resident taxpayer (eg not having any
form of permanent establishment in Indonesia),

b. the recipient of the income has submitted a Certificate of Residency validated by the
competent authority of the country where the recipient is resident, and

c. the recipient of the income is not misusing the DTA Agreement as governed in the
regulations concerning prevention of misuse of DTA Agreements.

As a further qualification of the above rule, the Certificate of Residency as mentioned above must
follow a specific form set out by PER-61/PJ./2009, as follows:

Baker & McKenzie – December 2010 33

a. Form DGT-1 (attached), to be used by parties other than parties who are specifically
required to use Form DGT-2.

b. Form DGT-2 which must be used by parties receiving income through a Custodian or
Foreign Bank.

Administratively, the Certificate of Residency must be:

a. completed and signed by the recipient of the income,

b. validated by the competent authority of the country where the recipient of the income
is resident, and

c. provided to the Indonesian tax withholder before the end of the monthly reporting
period of the tax payable.

The Indonesian tax withholder will then submit a copy of the Certificate of Residency as an
attachment of its monthly tax return.

Under this regulation, if payment is made to a non-resident tax subject, the Indonesian tax withholder
must submit its monthly tax return even if due to the application of the DTA Agreement, there is no
withholding tax payable.

B. PER-62/PJ./2009 (The Prevention of Misuse of Double Tax Avoidance Agreements)

PER-62/PJ./2009 specifically deals with the substantive issue of misuse of tax treaties. It sets out the
situations in which a misuse of a tax treaty is deemed to have occurred, and the consequences of such
misuse.

PER-62/PJ./2009 provides that misuse of a tax treaty can be deemed to occur if:

a. the transaction has no economic substance and is performed by using a certain
structure/scheme with the sole purpose of benefitting from the DTA,

b. the transaction is structured in a way that means its legal form will be different from
the economic substance for the sole purpose of benefitting from the DTA, or

c. the recipient of the income is not the real owner of the economic benefit of the
income (not the beneficial owner).

If there is a difference between the legal form of a transaction and its economic substance, the tax
implication will be determined based on the economic substance rather than the legal form of the
transaction.

PER-62/PJ./2009 further elaborates that the term “beneficial owner” as mentioned above means a
recipient of income who is not acting as:

a. an agent,

b. a nominee, or

c. a conduit company.

34 Baker & McKenzie – December 2010


Moreover, PER-62/PJ./2009 also states that the following individuals and entities will not be
considered to be misusing tax treaties:

a. an individual who is not acting as an agent or a nominee;

b. an institution which has been expressly mentioned in the DTA Agreement or has been
agreed by the competent authority in Indonesia and the treaty partner country;

c. a non-resident taxpayer which has received income through a custodian from transfer
of shares or bonds traded on the Indonesian stock exchange other than interest and
dividends, provided that the non-resident taxpayer is not acting as an agent or a
nominee;

d. a company whose shares are listed and constantly traded on a foreign stock exchange;

e. a pension fund that is established under the law of the Indonesian treaty partner
country and is a tax resident of that country;

f. a bank; or

g. a company which has fulfilled the following requirements:

i. the establishment of the company in the treaty partner’s jurisdiction or the
arrangement of certain transactions entered into by the company not solely to
exploit the DTA Agreement’s benefits;

ii. the business activity is managed by a management that has authority to
conduct transactions,

iii. the company has employees;

iv. the company has active business operation;

v. the income received from Indonesia is taxable in the country of residence;
and

vi. the company will not use more than 50% of its total income received to fulfil
its obligation to other parties in the form of interest, royalties, or other
compensation.

If the recipient of the income is deemed to have misused a tax treaty, the income received will be
subject to the normal withholding tax rate as stated in the Income Tax Law (i.e. 20%).

Besides setting out rules to prevent the misuse of DTA Agreements, PER-62/PJ./2009 also provides a
form of protection to non-resident taxpayers that are subject to tax thereunder, namely, the non-
resident taxpayer may apply to the competent authority where they reside to initiate a Mutual
Agreement Procedure in accordance with the rules of the applicable tax treaty.

+62 21 515 4920


Indonesia - Hong Kong Tax Treaty
On 23 March 2010, Indonesia and Hong Kong signed a comprehensive tax treaty. The treaty will
come into force after the completion of ratification procedures on both sides. The new tax treaty
provides lower withholding tax rates on, for example, dividends than those under Indonesia’s tax
treaties with other countries.

The rates under the new tax treaty for income in the form of dividends are as follows:

A. dividends are taxed at a rate of 5% of the gross amount of the dividends if the beneficial
owner is a company which holds directly a minimum of 25% of the capital of the company
paying the dividends; and

B. the maximum rate is 10% of the gross amount of the dividends in all other cases.

Withholding tax on interest under the new tax treaty may not exceed 10% and the maximum
withholding tax on royalties is 5% of the gross payment.

Further, the new tax treaty also contains an Exchange of Information clause under which the scope of
information exchange is restricted to “taxes covered” by the tax treaty, and the information exchanged
shall be disclosed only to persons or authorities (including courts and administrative bodies)
concerned with the assessment or collection of, the enforcement or prosecution in respect of, or the
determination of appeals in relation to, the relevant taxes. The information shall not be disclosed to
any third jurisdiction for any purposes.

+62 21 515 4920



India
Introduction of controlled foreign corporations regime
The Indian Income Tax Act does not contain any provision for taxation of income of offshore foreign
corporations that are controlled by Indian residents. According to the Revised Discussion Paper on
the Direct Taxes Code released by the Ministry of Finance on 15 June 2010, it is proposed to
introduce a provision in the Code that, if the passive income earned by a foreign company that is
controlled directly or indirectly by persons resident in India is not distributed to the shareholders,
resulting in a deferral of taxes, the undistributed income will be deemed to have been distributed and
taxed in India in the hands of resident shareholders as dividends received from the foreign company.

O.P. Bhardwaj
Associated Law Advisers of New Delhi
ala@ala-india.com

Regulation of unit-linked insurance products
On 9 April 2010, the Indian Securities and Exchange Board of India (SEBI) issued an order directing
14 insurance companies not to issue any offer document, advertisement or brochure or raise money
from investors as subscription for any product, including unit-linked insurance policies, having an
investment component in the nature of mutual funds, without obtaining a certificate of registration
from SEBI.

However, the Insurance Regulatory and Development Authority (IRDA) took the position that the
order of the SEBI was bad in law and without jurisdiction, and would adversely affect the interests of
insurers and investors. Hence, by an order dated 10 April 2010, the IRDA directed that the 14
insurance companies that could, notwithstanding the order of the SEBI, continue to carry on insurance
business as usual, including offering, marketing and servicing unit-linked insurance products in
accordance with the guidelines issued by the IRDA.

In order to clear the uncertainty and the difference of opinion relating to the jurisdiction of SEBI and
IRDA, an Ordinance was promulgated by the President of India on 18 June 2010 to clarify that “life
insurance business” includes any unit linked insurance policy. The Ordinance also provides for the
setting up of a joint mechanism consisting of the Finance Minister, Chairpersons of SEBI and IRDA
and other officers for resolving any future differences of opinion as to whether any hybrid or
composite instrument, having a component of money market investment or securities market
instrument or a component of insurance or any other instrument, falls within the jurisdiction of IRDA
or SEBI or the Reserve Bank of India or the Pension Fund Regulatory ad Development Authority.

O.P. Bhardwaj
Associated Law Advisers of New Delhi
ala@ala-india.com


Japan
Easing of anti-tax haven rules
Japan’s anti-tax haven rules (also referred to as the controlled foreign corporation (“CFC”) rules) have
been liberalized as part of the 2010 tax reform program. While the CFC rules apply mainly to
Japanese multinational companies, they also apply to foreign owned Japanese companies that control
foreign subsidiaries. Specific amendments are outlined below.

A. Applicable foreign tax rate

Prior to April 2010, the CFC rules were triggered when a foreign related company was subject to an
effective tax rate of 25% or less. “Foreign related company” is a foreign company, more than 50% of
the shares of which are held directly or indirectly by Japanese companies, Japanese resident
individuals or Japanese non-residents who have a special relationship with a Japanese company or
resident individual.

From 1 April 2010, the Japanese CFC rules will only apply to CFCs with an effective tax rate of 20%
or less. Thus, under the previous 25% threshold, a foreign related company in China (25% tax rate),
South Korea (24.2% tax rate), Vietnam (25% tax rate), Malaysia (25% tax rate) and Taiwan (20% tax
rate), would likely trigger the anti-tax haven rule, but under the revised threshold likely would not.

B. Treatment of foreign dividend income

In calculating the effective tax rate to be used as the Anti-Tax Haven Rule “trigger”, dividend income
received by the CFC from related parties may be excluded from the CFC’s tax base. Specifically, the
tax rules in effect before the revision allowed non-taxable dividends received from a foreign-related
party of the CFC to be excluded in calculating the effective tax rate of the CFC, provided that the
country in which the CFC is located has minimum share ownership requirements with respect to its
participation exemption rules.

Under the 2010 revision, the requirements of the Japanese tax rules have been relaxed, allowing
foreign dividend income to be excluded from calculating the CFC’s tax base as long as either (i) the
foreign country has minimum shareholding requirements with respect to the local participation
exemption rules or that a company satisfies “other requirements” under that country’s laws with
respect to the participation exemption rules. Thus, where a CFC receives a dividend from a foreign
related party that it may exclude from income under the laws of the local country, such dividend
income now may arguably be excluded in calculating the CFC’s effective tax rate for purposes of the
Japanese Anti-Tax Haven Rules, regardless of whether a minimum shareholding requirement with
respect to the foreign dividend exclusion rule exists in the foreign country or not.

C. Changes to shareholding

Where a Japanese shareholder owned 5% or more of a CFC prior to 1 April 2010, income derived
from the CFC by the Japanese shareholder was deemed to be tainted and was to be included currently
in the shareholder’s income for Japanese tax purposes. (What constitutes a “shareholder” for these
purposes includes a Japanese company or a Japanese company belonging to a group which holds the
requisite proportion of shares, either directly or indirectly.) From 1 April 2010, the CFC shareholding
threshold has been increased to 10%, and a threshold test will apply at the end of each of the CFC’s
fiscal years.



D. New exception to Business Purpose Test for a “Controlling Company”

An exception to the provisions of the Tax Haven rules exists for a CFC which passes four tests: the
business purpose test (jigyou kijun), the substance test (jitai kijun), the management control test (kanri
shihai kijun) and either the unrelated parties test (hikanrensha kijun) or the country of location test
(shozaichikoku kijun). Very generally, the requirements of the tests are as follows: for the business
purpose test, that the CFC engage in a business other than the passive holding of shares, licensing of
intangible rights, or leasing of tangible goods; for the substance test, that the CFC had a fixed place of
business in the local country; and for the management control test, that the CFC engages in
management in the country in which it is located. If the CFC’s main business is wholesale, banking,
trusts, dealing in securities or sea transportation or air transportation, it must pass the unrelated parties
test, whereby 50% or more of its transactions must be with unrelated parties; if its main business is
other than one of the businesses listed above, it must pass the country of location test, such that it’s
main business must be conducted in its country of location.

Under the 2010 tax revisions, where a CFC is a “controlling company” (a “toukatsu kaisha”), as
defined below, the holding of shares will be disregarded in evaluating whether that CFC satisfies the
business purpose test. In order for a CFC to be a controlling company, the requirements are that (i) all
the CFC’s issued shares are held directly or indirectly by a Japanese parent; (ii) the CFC owns two or
more “controlled companies”, as defined below, which the CFC controls and (iii) the CFC has fixed
assets and the necessary personnel in the country of its location to engage in the control of the
controlled companies. For purposes of this provision, “controlled companies” must be at least 25%
controlled, through share ownership and voting rights, by the controlling company, and must carry on
an actual business in the country in which their head office is located.

Additionally, if the other business conducted by the CFC for purposes of the “unrelated parties test” is
a wholesale business, transactions with the controlled companies will be disregarded in determining
whether the 50% threshold for non-related party transactions under the “unrelated party test” is met.

E. Inclusion of passive investment income

Currently, where a Japanese resident owns less than 10% of the CFC, none of the income of the
Japanese shareholder related to the CFC is included in the Japanese shareholder’s income for
Japanese tax purposes. The 2010 reforms have changed this situation so that passive income received
by a CFC from investments that would otherwise satisfy the active business exemption discussed
above will be included in assessable income for a Japanese shareholder. The following types of
passive income will be included:

a. Dividend income on shares, where the Japanese shareholder holds less than 10% of
the total shares, and capital gains on the sale of those shares (if sold on an exchange
or over the counter);

b. Interest income on bonds, and capital gains on the sale of bonds (if sold on an
exchange or over the counter);

c. Income arising from industrial rights and copyrights; and

d. Income derived from leases of aircraft and sea vessels.

Where, however, the total passive income received by a Japanese company from a CFC amounts to
less than 5% of its pre-tax profits or is less than JPY10 million in a fiscal year, then the new passive
income inclusion rule will not apply. Further, for income derived by the Japanese company from


items (i) and (ii) above, the relevant passive income will be excludable if it was in respect of activities
of the CFC that are essential to its business.

F. Exemption of double taxation on multi-tier companies

While dividends paid by a CFC out of previously taxed earnings directly to its Japanese parent are
generally exempt from tax, this exemption has generally been lost where the dividends were paid
indirectly; for example, by the CFC to another subsidiary of the Japanese parent and then onward to
the parent.

From 1 April 2010, dividends attributable to previously taxed retained earnings of a lower-tier CFC
are now exempt from tax in Japan if those dividends are paid through a non-CFC, but only to the
extent of the smaller of either of the following, with respect to the year in which the dividend was
received by the CFC and the two years before the first day of the fiscal year in which the dividend
was received (“the three-year period”):

a. the proportion of dividends received from the lower tier CFC within the three-year
period; or

b. the proportion of the lower tier CFC’s income taxed in the hands of the Japanese
parent within the three-year period.

Edwin T. Whatley (Tokyo)
+813 5157 2801
edwin.whatley@bakermckenzie.com

New Tax Information and Exchange Agreements
In addition to new tax treaties, Japan signed its first Tax Information Exchange Agreement (“TIEA”)
this year, and is in negotiations to ratify a second.

A. Signing of New Japan-Bermuda TIEA

Japan signed a TIEA with Bermuda on 1 February 2010 which allows for full exchange of
information regarding civil and criminal tax matters between the two countries.

The Agreement provides a detailed mechanism for the exchange of tax information, with a view,
according to the MOF of “preventing cross-border fiscal evasion and tax avoidance”.

Although the main purpose of the agreement is to allow for sharing of fiscal-related information, the
agreement also contains tax provisions relevant to pensioners, students, and government workers, “for
the purpose of promoting personal exchange between Japan and Bermuda” and further allows for
mutual agreement procedures between the two governments.

While this was the 19th signed TIEA for Bermuda, it was Japan’s first and, according to the MOF,
“will be Japan’s practical contribution in expanding the international information exchange network
aimed at the prevention of cross-border fiscal evasion and tax avoidance”.



B. Agreement on New Japan-Cayman TIEA

On 26 May 2010 the MOF announced that Japan and the Cayman Islands had agreed in principle on a
an agreement for the exchange of information for the purpose of preventing fiscal evasion, and to set
out rights between the country with respect to certain categories of taxation.

Although the agreement is expected to include provisions to exempt tax at source for certain types of
individuals, such as pensioners (similar to the TIEA with Bermuda, discussed above), the main focus
of the agreement is expected to be exchange of information, so as to assist Japan in examining
potential fiscal evasion.

+813 5157 2801

New Social Security Agreement with Brazil
On 29 July 2010, Japan’s Ministry of Foreign Affairs announced it had signed a new Social Security
Agreement with Brazil. Under the agreement, employees from one country temporarily working in the
other country (for five years or less) will be able to join the pension system of the other country, and
count the period of employment in each country.

This agreement should promote increased economic relations between the countries, which is
particularly important to Japan in light of Japan’s aging workforce and the perceived need for
additional potential labour sources.

+813 5157 2801


Malaysia
Islamic Finance incentives
Numerous tax incentives were granted previously to promote Islamic finance in Malaysia. These
incentives were extended in the government’s last budget in terms of scope and effective period.

A. Export of financial services

(a) Banking institutions currently enjoy a tax exemption on profits of newly established
branches overseas or income remitted by new overseas subsidiaries. This will be
extended to insurance and takaful companies too.

(b) The current tax exemption is given for a period of 5 years from the commencement of
operations of the branches or subsidiaries. This effective period will be given more
flexibility to be deferred from the date of commencement of operations to begin not
later than the third year of operations.

(c) Currently, applications to establish new branches or subsidiaries overseas must be
submitted to Bank Negara Malaysia between 2 September 2006 until 31 December 3
2009. This period will be extended until 31 December 2015.

B. International Islamic Financial Centre

(a) Currently, expenses incurred in the promotion of Malaysia as an International Islamic
Financial Centre (“MIFC”) are given a double deduction incentive. This incentive
was originally effective between YA 2008 until YA 2010. This has now been
extended until YA 2015.

(b) The deductible expenses, which need to be verified by the MIFC Secretariat, are:

(i) market research and feasibility study;

(ii) preparation of technical information relating to type of services offered;

(iii) participation in an event to promote MIFC;

(iv) maintenance of sales office overseas; and

(v) publicity and advertisement in any media outside Malaysia.

C. Expenditure to establish Islamic Stock Broking Companies

(a) Currently expenditure incurred prior to the commencement of an Islamic stock
broking company is deductible. The incentive is subject to the condition that the
company must commence its business within a period of 2 years from the date of
approval by the Securities Commission.

(b) This incentive, which would originally expire on 31 December 2009 has been
extended until 31 December 2015.



D. Incentives on issuance of Islamic Securities

(a) Currently expenses incurred in the issuance of Islamic securities approved by the
Securities Commission are deductible.

(b) The incentive was originally effective from YA 2003 until YA 2010. It will now be
extended until YA 2015. This incentive will be further extended to Islamic securities
approved by the Labuan Financial Services Authority (“Labuan FSA”), effective
from YA 2010 until YA 2015.

E. Profits from non-ringgit sukuk

(a) Currently profits from non-Ringgit Sukuk approved by the Securities Commission
and issued in Malaysia are tax exempt from YA 2008. However, this tax exemption
does not cover profits from sukuk approved by the Labuan FSA. Therefore, profits
derived from the issuance of sukuk approved by the Labuan FSA will also be tax
exempt effective from YA 2010.

F. Standardizing tax assessment system for special purpose vehicles

(a) Currently a special purpose vehicle (“SPV”) established under the Companies Act
1965 solely to channel funds for the purpose of issuing Islamic securities approved by
the Securities Commission will not be subject to income tax and is not required to
comply with administrative procedures under the Income Tax Act 1967.

(b) Income received and the costs incurred in the issuance of Islamic securities by the
SPV are deemed income and the cost of the company establishing the SPV.
Therefore, the company establishing the SPV is subject to tax on that income and
given a deduction on such cost incurred.

(c) The above will now apply to SPV’s established under the Labuan Companies Act
1990 who elect to be taxed under the Income Tax Act 1967. This will be effective
from YA 2010.

G. Stamp duty exemption on Sharia Financing Instruments

(a) Presently, stamp duty exemption is available on instruments executed pursuant to a
scheme of financing which is in accordance with the principles of Sharia approved by
the Bank Negara Malaysia and the Securities Commission. The same incentive is now
extended to schemes of financing which are in accordance with the principles of
Sharia approved by the Labuan FSA.

H. Extension on stamp duty exemption on instruments of Islamic Financing

(a) Presently, the instruments of Islamic financing approved by the Sharia Advisory
Council of Bank Negara Malaysia or the Sharia Advisory Council of the Securities
Commission are given additional stamp duty exemption of 20%. The additional
exemption is given after ensuring tax neutrality between conventional and Islamic
financing. The exemption period is now extended until 31 December 2015.

Adeline Wong (Kuala Lumpur) Gladys Chun (Kuala Lumpur)
+603 2298 7880 +603 2298 7935
adeline.wong@bakermckenzie.com gladys.chun@bakermckenzie.com


Reforms affecting Labuan
On 2 April 2009, the OECD issued a report on the progress made by offshore jurisdictions in the
implementation of the international tax standard for the exchange of information, which categorized
Labuan IBFC as a jurisdiction on the OECD’s blacklist.

Labuan FSA (then known as LOFSA) had issued a statement to the OECD to clarify Labuan’s
position. Labuan stated that it is committed to the international standard for the exchange of
information and has cooperated with competent tax authorities from other countries on tax evasion
matters and financial crime, particularly money laundering. As a result, in April 2009, the OECD
recharacterized Labuan as a jurisdiction committed to fighting tax abuse and to implementing
internationally agreed tax standards (that is, it was moved to the OECD’s gray list).

In February 2010, the OECD listed Malaysia on the “White List” (that is, a jurisdiction that has
substantially implemented the internationally agreed tax standards for transparency and exchange of
information between countries).

Malaysia is committed to these international standards and has been engaging in discussions with
Malaysia’s tax treaty partners to remove elements of its treaties that do not conform to the OECD
standards. Malaysia has signed an Exchange of Information (EOI) protocol with several countries as
part of a commitment to implementing the internationally agreed tax standard on transparency and
exchange of information. The countries are Belgium, Brunei, France, Ireland, Japan, Netherlands,
San Marino, Senegal, Seychelles, Turkey, United Kingdom and Kuwait. The protocols are in line
with the exchange of information provision of Article 26 of the OECD Model Tax Convention. Over
the next few months, Malaysia will be signing a number of other EOI protocols to continue to
enhance its Double Taxation Agreements with other countries.

This creates a higher platform for Labuan to position itself as a major regional and global offshore
financial centre.

Labuan’s commitment to the international tax standard on EOI is also reflected in the recent revisions
to the Labuan legislative framework on 11 February 2010.

Changes to the EOI standards are embodied in amendments to existing legislation as well as in four
new acts. The new laws and amendments to existing legislations governing Labuan offshore entities
came into effect on 11 February 2010. The four new acts enacted are Labuan Limited Partnerships
and Limited Liability Partnerships Act 2010, Labuan Foundations Act 2010, Labuan Islamic Financial
Services and Securities Act 2010 and Labuan Financial Services and Securities Act 2010.
Amendments were made to the Labuan Business Activity Tax Act 1990, the Labuan Companies Act
1990, the Labuan Trusts Act 1990 and the Labuan Financial Services Authority Act 1990.

The new laws allow for the creation of Labuan Foundations, limited liability partnerships, protected
cell companies (insurance and mutual funds), shipping operations, Labuan Special Trust and financial
planning activities.

A. Labuan Financial Services and Securities Act 2010

The new Labuan Financial Services and Securities Act 2010 provides for the registration of
Labuan private trust companies to act as trustees for specific trusts where the settlors are
family members or connected persons.



B. Labuan Foundations Act 2010

The new Labuan Foundations Act 2010 provides for the establishment of foundations based
on the concept of contractual duties recognized in civil law countries. The main purpose of a
Labuan foundation will be to manage its property and the founder and beneficiaries of a
Labuan foundation may be residents or non-residents.

C. Labuan Islamic Financial Services and Securities Act 2010

The new Labuan Islamic Financial Services and Securities Act 2010 sets the licensing and
regulatory framework for Islamic financial services and securities in Labuan and provides for
the establishment of Islamic banking and Takaful businesses including captive Takaful
businesses plus Labuan Islamic trusts, foundations, limited partnerships and limited liability
partnership.

The Labuan Islamic Financial Services and Securities Act 2010 represent a prominent
highlight in providing a platform for the establishment of Sharia-compliant entities to
promote the continuing growth of the Islamic financial market. The roles and functions of the
Sharia Supervisory Council (“SCC”), formerly known as the Sharia Advisory Committee,
have been boosted with the enactment of this Act. Moreover, any rulings made by the SSC
can now service as the reference point for the court in dispute resolution on Sharia issues
related to Islamic banking and finance.

D. Labuan Limited Partnerships and Limited Liability Partnerships Act 2010

The new Labuan Limited Partnerships and Limited Liability Partnerships Act 2010 renamed
offshore limited partnership as Labuan limited partnership and provide for the establishment
and conversion of Labuan companies into Labuan limited liability partnerships.

E. Amended Labuan Companies Act 1990

The amended Labuan Companies Act 1990 allows for the incorporation and conversion of an
existing Labuan company into a protected cell company (“PCC”) for the conduct of insurance
and mutual fund businesses. The PCC remains a single legal entity but may segregate its
asset into separate legally independent cells, each of which is ring fenced from the other cells.

F. Amended Labuan Trusts Act 1996

The amended Labuan Trusts Act 1996 now allows a Malaysian resident to set up and be the
beneficiary of a Labuan trust.

The legislative overhaul is aimed at enabling Labuan to offer a wider range of financial products and
services and to become the first common law country to have specific legislation for Islamic financial
services. These complement the existing range of products and services readily available and provide
investors with a wider choice of financial products to maximise investment opportunities whilst
ensuring that the business transactions and practices in Labuan IBFC continue to be conducted in
accordance with the internationally accepted standards and best practices.

There have been other developments in Labuan that provide flexibility for Labuan banks and to locate
its operations outside of Labuan.


A. On 19 January 2010, Labuan FSA announced that Labuan banks and Labuan investment
banks have been accorded the added flexibility of being able to establish their offices in other
parts of Malaysia other than Labuan with immediate effect.

B. The recently introduced policy is an extension of the initiative that was introduced in May
2009 that allowed Labuan Holding Companies to establish their operational and management
offices in Kuala Lumpur.

C. This policy is aimed at attracting more international banks to choose Labuan IBFC as a base
for their regional operations and leverage on the offerings of first class infrastructure,
facilities, human capital and professional services that are available in Malaysia.

D. The general criteria for establishing offices outside Labuan include the following:

a. An application for approval to set up the co-located office submitted to LOFSA prior
to its establishment;

b. The applicant must continue to have applications continued holding of an office in
Labuan with suitable number of staff to perform the functions assigned to the Labuan
office; and

c. The applicant is conducting the following business activities at the co-located office:

i. banking business as permitted under the Offshore Banking Act 1990 or any
other relevant legislation; and

ii. any other banking businesses as may be permitted from time to time.

+603 2298 7880 +603 2298 7935



Reintroduction of Real Property Gains Tax
Although Malaysia has a real property gains tax (RPGT) regime on gains from disposal of real
property as well as shares in real property companies, real property gains were exempted from
Malaysian tax during the period 1 April 2007 to 1 January 2010. The Government has now reinstated
the real property gains tax beginning 1 January 2010 where the disposal is made within 5 years from
the date of the acquisition of such chargeable asset. Gains made from the disposal of chargeable
assets which are held for more than 5 years will be exempted from the real property gains tax pursuant
to the Real Property Gains Tax (Exemption)(No.2) Order 2009.

Transfers of property between spouses, parent and child or grandchild as well as the once in a lifetime
disposal of residential property for a Malaysian citizen or a permanent resident of Malaysia will
continue to be tax exempt.

In many respects the RPGT, in its new incarnation, is fairly similar to the old regime but some of the
most notable changes include:

A. Both the disposer and the acquirer must submit a return on the disposal of real property via
the requisite forms (regardless of whether the exemption applies) and the time allowed for
doing so is extended to 60 days instead of one month under the old regime;

B. An acquirer will be required to withhold 2% of the total consideration for the disposal or the
whole amount of the cash consideration if that is less and, whether withheld or not, to pay that
amount directly to the Inland Revenue within 60 days of the date of the disposal. Failure to
do so causes a 10% increase in the amount payable. This is significantly different from the
previous system under which the acquirer was required to retain a part of the disposal
proceeds pending tax clearance but with no requirement to make any payment unless required
by the Inland Revenue Board; and

C. A certificate of non-chargeability will be issued to the disposer where there is no tax liability.

A taxpayer who is an individual will normally be entitled in respect of each chargeable gain to an
exemption of RM10,000 or 10% of that chargeable gain, whichever is greater.

Where the disposal price of an asset is less than the acquisition price, there is an allowable loss.
Relief is to be given for such loss by deducting it from the total chargeable gains for the year of the
loss (after excluding, in the case of an individual the exemption of RM10,000 or 10% referred to
above). Any amount that cannot be relieved due to an insufficiency of chargeable gains can be carried
forward and offset in future years.

This differs from the previous loss relief which required the allowable loss to be multiplied by the rate
of tax that would have applied for that year if it had been a chargeable gain. Relief was then given
against tax on chargeable gains in the same or a future year. Old losses calculated in this way
sustained up 31 March 2007, which have not been relieved, may be carried forward for relief in the
period commencing 1 January 2010.

+603 2298 7880 +603 2298 7935


Liberalization of foreign investment restrictions on real estate acquisitions
Following the announcement made by the Government on 30 June 2009 to liberalise property
acquisition by foreigners, the Economic Planning Unit of one Prime Minister’s Department (“EPU”)
has revised the Guidelines on Acquisition of Properties (“Guidelines”) accordingly. The new
Guidelines came into effect on 1 January 2010.

Those with foreign interests will no longer be required to obtain the approval of the Economic
Planning Unit for acquisition of commercial, industrial, agricultural land above the value of
RM500,000. The relevant State Government will, however, continue to have authority in respect of
real property transactions involving foreign interests.

Acquisition of residential units by foreign interests will not require the EPU’s approval if the value of
the residential unit is more than RM500,000. This measure will take effect from 1 January 2010 and
will increase from the previous threshold of RM250,000.

Kindly note that those with foreign interests are not allowed to acquire the following:

A. properties valued at less than RM500,000 per unit;

B. residential units under the category of low and low-medium cost as determined by the State
Authority;

C. properties built on Malay reserved land; and

D. properties allocated to Bumiputra interest in any property development project as determined
by the State Authority.

EPU approval is required for real property transactions resulting in the dilution of Bumiputras or
Government interests in real property, as follows:

A. Direct acquisitions of real property where (a) there is a dilution of Bumiputra or Government
interests in real property; and (b) the real property is valued above RM20 million.

B. Indirect acquisitions of real property by those with a foreign interest through acquisition of
shares if:

a. the transaction results in a change in control of the company owned by Bumiputra
interests and/or a Government agency;

b. real property makes up more than 50% of the said company’s assets; and

c. the real property is valued at more than RM20 million.

Where EPU approval is required, the following conditions will be imposed:

a. the acquiring company is to have at least 30% Bumiputra shareholding; and

b. a Malaysian-incorporated company owned by those with a foreign interest is to have
at least a paid-up capital of RM250,000.



In terms of timing for compliance with the above-mentioned conditions, the equity and paid-up capital
conditions for direct acquisition of property must be complied with before the transfer of the
property’s ownership. For indirect acquisition of property, the equity and paid-up capital conditions
must be complied with within 1 year after the issuance of written approval.

With the liberalization of the new Guidelines, the purchase of real property is less cumbersome and
can be completed faster without the EPU approval. The relevant State Government will therefore
continue to be the only regulator in respect of real property acquisition by foreign interests. This
could effectively mean that there could be varying degrees of liberalized foreign investment policies
between states.

+603 2298 7880 +603 2298 7935


Philippines
Exchange of information
On 5 March 2010, the President of the Philippines signed into law the Republic Act No. 10021
otherwise known as the “Exchange of Information on Tax Matters Act of 2009” (the “Act”), which
essentially authorizes the Bureau of Internal Revenue (“BIR”) to exchange information on tax matters
with foreign counterparts to help fight international tax evasion.

In the past, the government found it difficult to comply with the provisions on the exchange of
information set by international organizations due to certain legal restrictions, particularly the
Philippines’ strict bank secrecy laws. The Act, which amended some provisions of the National
Internal Revenue Code of 1997, seeks to strengthen the government’s capacity to implement the
country’s commitments under existing tax conventions or agreements. This comes on the back heels
of the Organization for Economic Cooperation and Development’s blacklisting the Philippines as a
tax haven last year.

A common provision found in the tax treaties is exchange of information provisions, mandating
cooperation between the tax administrations of the two Contracting States. Thus, the competent
authorities are required to exchange such information as is necessary for carrying out the provisions of
the tax treaty, or for the prevention of fraud, or for the administration of statutory provisions
concerning taxes to which the treaty applies provided the information is of a class that can be obtained
under the laws and administrative practices of each Contracting State with respect to its own taxes.

A. Amendments introduced

Prior to the passage of the Act, the authority of the BIR to inquire into bank deposits and other related
information held by financial institutions was limited to investigations pertaining to:

a. decedents for estate tax purposes; and

b. applications for compromise settlements of taxes on the grounds of financial
incapacity.

The amendments introduced by the Act authorize the BIR commissioner to inquire into bank deposits
and other related information held by financial institutions to supply information to a requesting
foreign tax authority. The requesting foreign tax authority must provide the following information to
demonstrate the relevance of the information to the request:

a. The identity of the person under examination or investigation;

b. A statement of the information being sought including its nature and the form in
which the said foreign tax authority prefers to receive the information from the
Commissioner;

c. The tax purpose for which the information is being sought;

d. Grounds for believing that the information requested is held in the Philippines or is in
the possession or control of a person within the jurisdiction of the Philippines;

e. To the extent known, the name and address of any person believed to be in possession
of the requested information;



f. A statement that the request is in conformity with the law and administrative practices
of the said foreign tax authority, such that if the requested information was within the
jurisdiction of the said foreign tax authority then it would be able to obtain the
information under its laws or in the normal course of administrative practice and that
it is in conformity with a convention or international agreement; and

g. A statement that the requesting foreign tax authority has exhausted all means
available in its own territory to obtain the information, except those that would give
rise to disproportionate difficulties.

The Commissioner is mandated to forward the information as promptly as possible to the foreign tax
authority. To ensure a prompt response, the Commissioner shall confirm receipt of a request in
writing to the requesting tax authority and shall notify the latter of delinquencies in the request, if any,
within sixty (60) days from receipt of the request. If the Commissioner is unable to obtain and
provide the information within ninety (90) days from receipt of the request, due to obstacles
encountered in furnishing the information or when the bank or financial institution refuses to furnish
the information, he shall immediately inform the requesting tax authority of the same, explaining the
nature of the obstacles encountered or the reasons for the refusal.

The Act likewise allows a requesting foreign tax authority to study the income tax returns of
taxpayers upon order of the President, subject to rules and regulations on necessity and relevance that
may be promulgated upon enactment of the law.

B. Acts penalized

In order to prevent any potential abuse, the Act penalizes:

a. BIR personnel for unlawful divulgence of information obtained from banks to
persons other than the requesting foreign tax authority; and

b. Bank officers who refuse to supply requested tax information.

The requesting foreign tax authority likewise is mandated to maintain confidentiality of the
information received.

Dennis Dimagiba (Manila)
+63 2 819 4912
dennis.dimagiba@bakermckenzie.com


Data Warehousing of assets of taxpayer under Investigation
In a move that perhaps foreshadows a tightening up of tax compliance with respect to HNWIs in the
Philippines, the government promulgated Revenue Memorandum Order No. 26-2010 in order to
institute a system for the development of a Data Warehouse which will contain information on the
assets of taxpayers under investigation that may be utilized in collection enforcement proceedings.
The information will include, among others, the type of assets, the location of the assets, the bank
accounts maintained (including the type of account, the account number, and the name and address of
the bank), Transfer Certificate of Title (TCT) number (in case of real property), name/address of
debtor and all other necessary information.

Dennis Dimagiba (Manila)
+63 2 819 4912
dennis.dimagiba@bakermckenzie.com

Singapore
Mental Capacity Act
The Mental Capacity Act (“MCA”) came into effect in 2010. The MCA is based on the UK’s Mental
Capacity Act 2005 and introduces lasting (or enduring) powers of attorney in Singapore. A donor in
Singapore may now use a lasting power of attorney to appoint a donee/donees to make decisions on
behalf of the donor in the event of the donor suffering mental incapacity. Such decisions may be in
relation to the donor’s personal welfare and/or property and affairs.

Edmund Leow (Singapore)
+65 6434 2531
edmund.leow@bakermckenzie.com



Spain
Spanish Budget for 2011: tax amendments and measures to stimulate investment
and employment
On 21 December 2010 the Spanish Parliament approved the General Budget for 2011 which contains
a number of tax amendments that are generally applicable as of 1 January 2011 in addition to the tax
measures to stimulate investment and employment adopted on 3 December 2010 by the Spanish
Government. The main amendments are outlined here below.

1. Personal Income Tax

a) Two new tax brackets have been introduced for taxpayers earning more than EUR
120,000: taxable income between Euro 120,000 and Euro 175,000 will be subject to a
marginal tax rate of 44% while taxable income in excess of Euro 175,000 will be
taxed at d 45%. The Personal Income Tax maximum rate up to now (43%) will
continue to be applicable to income between EUR 53,407 and EUR 120,000.

It should be noted however that half of the Personal Income Tax collections are
attributed to Spanish Autonomous Regions and these have legal competence to
modify the correspondent tax rates as well which some of them have also announced
for 2011 increasing their tax rates up to 49% even.

b) The 40% reduction of the tax base that applies to income generated over a period of
more than 2 years has been limited and will apply only to income up to EUR 300,000
as of 1 January 2011. Over such amount non-periodic income will be taxed at the
marginal tax rates in full.

c) The 15% tax credit for annual costs including interest (up to Euro 9,015) incurred for
the purchase or restoration of the taxpayer’s primary residence is virtually eliminated
as it will be obly applicable to taxpayers earning less than EUR 24,170. However,
those who have purchased their dwellings before 31 December 2010 and already
benefit from this tax credit will be able to keep it until they have completely paid their
houses.

d) Finally, the 50% reduction of taxable income derived from the rental of dwellings
will increase to 60% while the current 100% reduction that applies to rental income
when the tenant is younger than 35 will only apply when the tenant is younger than
30 from 1 January 2011 onwards.

2. Amendment of SICAV tax regime

Over the last years it has been usual that SICAV’s shareholders cashed back a significant part of their
investment into the SICAV not via dividends but with capital reductions or share premium returns that
allowed them to drain liquidity from the SICAV avoiding capital gains and deferring tax payment on
the capital gains to the moment the SICAV is transferred or winded-up.

Further to the amendment to the SICAV tax regime approved by the Spanish Parliament, as of 23
September 2010, income derived by Spanish resident individuals from collective investment
institutions (including not only Spanish SICAVs but also collective investment institutions and funds
registered in other countries) as a result of capital reductions or share premium returns will be
generally taxed at 19%/21%.


The amendment also establishes that Spanish corporate shareholders of collective investment
institutions will be taxed by Corporate Income Tax as well on all income derived from capital
reductions or share premium distributions, without any deductions.

3. Corporate Income Tax

The turnover threshold to qualify as a SME for Corporate Income Tax purposes has been raised up to
EUR 10,000,000 and the amount of income obtained by SMEs that may be subject to the reduced tax
rate of 25% (instead of the general 30% tax rate) has been also increased from EUR 120,000 to EUR
300,000.

SMEs whose transactions with a related party in a given year do not exceed EUR 100,000 are also
released from preparing transfer pricing documentation unless they carry out transactions with related
parties that are resident in a tax haven jurisdiction.

For all kinds of companies, tax free depreciation of fixed assets and real estate used in business
activities and acquired between 2011 and2015 has also been approved.

4. Stamp Duty

1% Stamp Duty that applied to the incorporation of companies and increase of share capital, to
contributions made by the shareholders that do not result in an increase of the share capital and to the
transfer of the registered address or the effective place of management to Spain of a company not
resident in the European Union has been abolished as of 23 December 2010.

5. Chamber of Commerce fee

This formerly mandatory fee based on the profits of companies has been modified so that it will only
be paid by those companies that voluntarily choose to do so.

Bruno Domínguez (Barcelona)
+34 932 06 08 20
bruno.dominguez@bakermckenzie.com

Berta Rusiñol (Barcelona)
+34 932 06 08 20
berta.rusinol@bakermckenzie.com



Taiwan
Alternative Minimum Tax and Tax on Offshore Income
The Taiwan Ministry of Finance (“MOF”) has finally issued the long awaited guidelines for taxation
of offshore income (including capital gains) earned by individuals.

Prior to 1 January 2010, Taiwan individual tax residents were taxed only on their Taiwan sourced
income. However, offshore income will be subject to another tax regime, generally referred to as
Alternative Minimum Tax (“AMT”), as from 1 January 2010.

Under the previous system, individuals were required to file regular income tax returns without
including their offshore income and certain other tax-exempted income, and to calculate their tax
liability under the existing rates. Under the AMT rules, they are now required to add to such income
certain tax-exempted income and deduct from this amount NT$6 million. The AMT rate of 20% will
be applied to the resulting figure. They will then be required to pay the higher of these two amounts.

Effectively, what this means is that, from 1 January 2010, offshore income, if it exceeds NT$1
million, will be included for calculation of an individual’s tax liability under the AMT rules.

People have long been sceptical of the Taiwan government’s political willingness to tax offshore
income. With the release of the guidelines, the MOF has signalled that it will be proceeding with this
plan.

The MOF still faces technical hurdles in enforcing taxation of offshore income. First is the difficulty
of collecting tax information from other countries, due to Taiwan’s unique political standing in the
world and small number (16 only) of tax treaties. Second is the fact that Taiwan does not have rules to
tax the income of offshore companies (CFC rules) and trusts that have been established by Taiwan
residents. This offers planning opportunities for individuals to hold their offshore assets through such
offshore vehicles and thus avoid the application of the AMT rules.

Without going into specifics, additional observations are as follows:

(a) The definition of a “taxpayer” goes beyond Taiwan citizens. Expatriates who stay in Taiwan
more than 183 days during a year will be subject to the AMT and thus will be taxed on their
worldwide income. Depending on the facts of each case, employers who operate a tax
equalization scheme for their expatriate employees might find this burdensome.

(b) Distributions from mutual funds designated for investing in offshore securities will now be
taxable. Such funds have been attractive to Taiwanese investors in the past because
distributions were tax free until 31 December 2009. Under the new AMT, the market for
these products is likely to suffer, and this will particularly affect foreign asset management
companies. While capital gains from the redemption/transfer of shares in mutual funds issued
by domestic asset management companies will very likely be deemed to be domestic capital
gains from security trading and thus will remain tax free, such gains from funds issued by
foreign asset management companies will be deemed to be offshore income and thus subject
to AMT. This disparity will put foreign asset management companies at a tax disadvantage,
and they are already lobbying against this proposal.

There are planning opportunities for high net worth individuals who wish to defer the taxation of their
offshore income. This is because the language of the guidelines and some of the provisions appear


inconsistent as to when particular types of income will be considered “earned”. The issue in this
context is whether repatriation of income and gains to Taiwan will be required for the AMT to apply.

Dennis Lee (Taipei)
+886 2 2715 7288
dennis.lee@bakermckenzie.com

Unlicensed financial institutions are not permitted to perform promotional activities in
Taiwan
On 25 August 2010, the Taiwan Financial Supervisory Commission (FSC) promulgated an
amendment to the existing rules that prohibit a non-Taiwan bank from promoting its services and
products to Taiwan customers or conducting promotional activities through its onshore (Taiwan)
presence.

Specifically, the new rules explicitly forbid any Taiwan branch of a foreign bank from conducting any
promotional activities or client solicitation pertaining to opening offshore bank accounts or accepting
deposits/funds from Taiwan residents for or on behalf of its head office, affiliates, or any other foreign
institution that is not licensed under Taiwan laws.

Illegal activities include (but are not limited to) providing business premises for promotional events,
holding seminars, arranging business visits, assisting in verifying identities of clients, or any other
promotional or client solicitation activity for the purpose of opening offshore bank accounts with
unlicensed financial institutions, or accepting deposits/funds from Taiwan residents for unlicensed
financial institutions.

It is also unlawful for any employee of a foreign bank’s Taiwan branch to enter into any agreement
with any unlicensed financial institution to perform any prohibited promotional or client solicitation
activity for or on behalf of any unlicensed institutions.

In addition, according to the new rules, Taiwan branches of foreign banks are obliged to inform the
chief audit executives of their head office of these forbidden activities in order to prevent their
affiliates or departments who do not have licence in Taiwan from conducting any promotional
activities relating to opening offshore bank accounts or accepting deposits/funds from Taiwan
residents in Taiwan.

Any violation of these new rules may subject the responsible person of a foreign bank’s Taiwan
branch to imprisonment for between 3-10 years, and/or a fine of between NT$10-200 million.

In practice, clients in Taiwan will often need to open offshore bank accounts for the purpose of
accepting services, or purchasing products, from offshore financial institutions who are likely to be
unlicensed in Taiwan. In our view, the new rules simply reaffirm the FSC’s longstanding policy of
disallowing unlicensed financial institutions from carrying out any direct client solicitation or
promotional activities in Taiwan with respect to unlicensed financial products or services in Taiwan,
including offshore asset management and foreign insurance policies. These rules in effect further
discourage the unlicensed promotion of offshore financial services or products in Taiwan. Unlicensed
banks are not permitted to promote their banking services in Taiwan; unlicensed securities firms are
not permitted to advertise their securities services or products in Taiwan; and unlicensed insurance
companies are forbidden to directly solicit business from Taiwan residents in Taiwan.



While the content of the new rules is not anything new, their explicitness signals a new boldness by
the FSC to enforce its policies more diligently. In light of this more stringent policy, we anticipate
(and have already observed) a growing assertiveness by the FSC to monitor and penalize unauthorized
activities of unlicensed financial institutions in Taiwan.

Michael S Wong
+886 2 2715 7246
michael.wong@bakermckenzie.com

Sabine Lin
+886 2 2715 7295
sabine.lin@bakermckenzie.com


Ukraine
Companies in Ukraine made liable for corrupt practices
Starting from 1 January 2011, a company in Ukraine, other than a state-owned company or an
international organization, may be subject to liability up to its liquidation for the acts of corruption
committed by its individual director, attorney in fact or shareholder (each, the “authorized person”).
Such liability of the companies has been introduced by the new anti-corruption legislation of Ukraine
consisting of the Law “On Framework for Prevention of and Counteraction to Corruption” and the
Law “On Liability of Legal Entities for Corruption” (collectively, the “Anti-Corruption Laws”),
which were adopted by the Parliament of Ukraine in June 2009.

A legal entity may be held liable under the Anti-Corruption Laws only when its authorized person has
committed a corrupt act which qualifies as a crime under the Criminal Code of Ukraine (e.g., giving a
bribe or intrusion into the courts’ activities) and provided that it has been made on behalf of a
company and for its benefit. We note that a company would be subject to the foregoing liability
regardless of whether the authorized person had actually been found guilty and prosecuted for the act
of corruption pursuant to legislation of Ukraine. A company would also suffer sanctions if the court
proceeding was not completed, inter alia, due to the authorized person’s death, or adoption of an
amnesty law by the Parliament of Ukraine applicable to such authorized person.

In addition to the liquidation of a company for corrupt practices such as terrorism financing, under the
Anti-Corruption Laws, a company may also be subject to a fine up to approximately USD 32,000 (if
calculated at the date of this newsletter), a prohibition to engage in certain business for up to a three-
year period, or seizure by the state of the company’s property or moneys generated as a result of the
authorized person’s crime. The fine and seizure of properties and moneys may be applied to a
company in combination with liquidation or prohibition to engage into certain business.

Finally, according to the Anti-Corruption Laws, a contract entered into as a result of corrupt practices
may be declared null and void by the court.

Andriy Nikiforov (Kyiv) Natalia Vilyavina (Kyiv)
+38 44 590 0101 +38 44 590 0101
andriy.nikiforov@bakermckenzie.com natalya.vilyavina@bakermckenzie.com



United States
IRS creates new taxation regime under the Voluntary Disclosure Penalty Framework
for PFICs
Under US tax rules, US-based mutual funds and investment funds are taxed in such a way that the
taxpayer must report income and gains from the fund on an annual basis. Thus, when the fund is sold,
very little tax, if any, is owed. The purpose of these rules is to avoid the use of funds in such a way
that taxation, which should otherwise occur on an annual basis, is in some way deferred until a later
date allowing items that would normally be taxed at ordinary income to be converted into capital
gains. 1

Example #1: US mutual fund reflecting application of current tax rules.

Investment Sale
1/1/2002 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 Totals
EXAMPLE 1
US Mutual Note 1
Fund
Current Tax
Rules

Value of Fund 500,000.00 535,000.00 572,450.00 612,521.50 655,398.01 701,275.87 750,365.18 802,890.74
Growth Note 2 4% 20,000.00 21,400.00 22,898.00 24,500.86 26,215.92 28,051.03 30,014.61 173,080.42
Income Note 3 3% 15,000.00 16,050.00 17,173.50 18,375.65 19,661.94 21,038.28 22,510.96 129,810.32
Turnover Note 4 33% 6,600.00 7,062.00 7,556.34 8,085.28 8,651.25 9,256.84 9,904.82 57,116.54

Taxable
Income:
Non-qualified 15,000.00 16,050.00 17,173.50 18,375.65 19,661.94 21,038.28 22,510.96 129,810.32
dividend
Short-term 6,600.00 6,600.00
capital gains
Long-term 7,062.00 7,556.34 8,085.28 8,651.25 9,256.84 125,868.70 166,480.42
capital gains

Tax:
Dividend Tax 35% 5,250.00 5,617.50 6,010.73 6,431.48 6,881.68 7,363.40 7,878.83 45,433.61

1
Facts and assumptions used in the examples:
1. Initial investment of $500,000 made on 1 January 2002, which is assumed to be the start date for the
mutual fund. This latter assumption eliminates the potential impact of unrealized gains inside the mutual
fund at the time the individual invests in the fund.
2. Annual growth of the fund’s assets is assumed to be 7%: 4% growth in the value of the portfolio
securities and 3% income attributable to interest and dividends.
3. Assume that no dividends are actually paid from the fund; all earnings on assets are invested inside the
fund.
4. To highlight the benefit attributable to investing in a foreign mutual fund before the enactment of the
PFIC rules, we assume that the income earned by the fund (3% annually) would constitute nonqualified
dividends if distributed annually to the funds shareholders.
5. The voluntary disclosure filing period is assumed to be 2003 through 2008.
6. The entire fund is sold on 31 December 2008.
7. It is assumed that inside the fund one-third of the assets are sold each year producing a short-term capital
gain in 2002 and long-term capital gains in each subsequent year. This allows us to demonstrate the
required inclusion in income for a shareholder in a US mutual fund for the internal capital gains realized
by the fund.
8. In all of the examples, generally, it is assumed that ordinary income and short-term capital gains are
subject to tax at the top marginal rate.


STCG Taxed 35% 2,310.00 - - - - - - 2,310.00
as ordinary
income
LTCG Tax 15% - 1,059.30 1,133.45 1,212.79 1,297.69 1,388.53 18,880.31 24,972.06

Total Taxes 7,560.00 6,676.80 7,144.18 7,644.27 8,179.37 8,751.92 26,759.14 72,715.67

Note 1 The initial investment occurs at the time the fund is started, on January 1, 2002. All shares sold December 31, 2008. The fund is
an income oriented fund with a large concentration in fixed income holdings
Note 2 The annual increase in the value of the portfolio including realized and unrealized gains.
Note 3 Income from interest and dividends earned by the fund on its portfolio assets. All dividend income assumed to be nonqualified.
All income is reinvested by the fund.
Note 4 This is the portion of the increase in value of the fund that is realized each year through the sale of securities. After the first year
of the fund, all gains are assumed to be long-term capital gains.

In the non-US context, there is no mechanism to force a taxpayer to realise the income on an annual
basis.

Example #2: Foreign mutual fund demonstrating the application of the tax rules in effect prior to the
enactment of the PFIC rules in 1986. The result is compared to Ex. 1, showing the tax savings from
using a foreign mutual fund, pre-PFIC rules.

Investment Sale
1/1/2002 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 Totals
EXAMPLE 2
Foreign Note 1
Mutual Fund
Pre-PFIC
Rules
500,000.00 535,000.00 572,450.00 612,521.50 655,398.01 701,275.87 750,365.18 802,890.74
Growth Note 2 4% 20,000.00 21,400.00 22,898.00 24,500.86 26,215.92 28,051.03 30,014.61 173,080.42
Income Note 3 3% 15,000.00 16,050.00 17,173.50 18,375.65 19,661.94 21,038.28 22,510.96 129,810.32
Turnover Note 4 33% 6,600.00 7,062.00 7,556.34 8,085.28 8,651.25 9,256.84 9,904.82 57,116.54

Taxable
Income:
Non-qualified -
dividend
Short-term -
capital gains
Long-term 302,890.74 302,890.74
capital gains

Tax:
Dividend Tax 35% - - - - - - - -
STCG Tax 35% - - - - - - - -
LTCG Tax 15% - - - - - - 45,433.61 45,433.61

Total Taxes - - - - - - 45,433.61 45,433.61

Tax Savings To Foreign Mutual 7,560.00 6,676.80 7,144.18 7,644.27 8,179.37 8,751.92 (18,674.47) 27,282.06
Fund (Pre PFIC Rules)

Note 1 The initial investment occurs at the time the fund is started, on January 1, 2002. All shares sold December 31, 2008. The fund is an
income oriented fund with a large concentration in fixed income holdings
Note 3 Income from interest and dividends earned by the fund on its portfolio assets. All dividend income assumed to be nonqualified. All
income is reinvested by the fund.
Note 4 This is the portion of the increase in value of the fund that is realized each year through the sale of securities. After the first year of
the fund, all gains are assumed to be long-term capital gains.

Using the above example, using a non-US mutual fund creates a net saving of approximately
US$28,000. Thus, the US created a set of rules called the Passive Foreign Investment Company, or



PFIC rules. The purpose of these rules is to allow a taxpayer to elect to have a fund taxed as if it were
a US fund or defer the tax until a later point. However, when it defers, it will be subject to an interest
charge and a conversion of income. Generally, a PFIC is defined as any non-US corporation needing
either an income test or an asset test. 2

Example #3: Foreign mutual fund demonstrating application of the look back taxation rules
applicable to section 1291 funds. The result is compared to Ex. 1 to show the additional tax cost of
using a foreign mutual fund under the §1291 regime.

Investment Sale
1/1/2002 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 Totals
EXAMPLE 3
Foreign Note 1
Mutual Fund
(PFIC)
§1291 Fund
500,000.00 Note 5 572,450.00 612,521.50 655,398.01 701,275.87 750,365.18 802,890.74
Growth Note 2 4% 21,400.00 22,898.00 24,500.86 26,215.92 28,051.03 30,014.61 153,080.42
Income Note 3 3% 16,050.00 17,173.50 18,375.65 19,661.94 21,038.28 22,510.96 114,810.32
Turnover Note 4 33% 7,062.00 7,556.34 8,085.28 8,651.25 9,256.84 9,904.82 50,516.54

Taxable
Income:
Non-qualified - - - - - -
dividend
Short-term - - - - - - -
capital gains
Long-term - - - - - - -
capital gains
PFIC Other Note 6 - - - - - 43,354.72 43,354.72
Income

Tax:
Dividend Tax 35% - - - - - - -
STCG Taxed 35% - - - - - - -
LTCG Tax 15% - - - - - - -
Tax on PFIC 35% - - - - - 15,174.15 15,174.15
Other Income
PFIC Deferred Note 7 - - - - - 92,394.11 92,394.11
Tax
Interest on Note 8 - - - - - 24,410.93 24,410.93
PFIC Deferred
Tax

Total Taxes - - - - - - 131,979.19 131,979.19

Additional tax vs. (6,676.80) (7,144.18) (7,644.27) (8,179.37) (8,751.92) 105,220.05 66,823.52
domestic mutual
fund

Note 5 In this example tax returns are filed for the tax years 2003 through 2008 under the VDP.
Note 6 This represents the current portion of the gain from sale of the §1291 Fund (the “excess distribution) allocable to 2008 and taxable
as ordinary income.

2
The threshold on the income test is if 75% of the income is from a non-US source. The asset test is a 50% greater of the
assets are subject to these rules. These rules primarily attack investment funds outside of the United States typically
structured as Luxembourg SICAVs or unit trusts or some other fund vehicle.


Note 7 This is the tax attributable to the portion of the excess distribution that is allocated to each year in the holding period prior to the
year of sale.
Note 8 This is the compound interest charge related to the tax determined for each year in the holding period of the section 1291 Fund
prior to 2008.

Benefit of New Protocol
Including Penalty and Interest
Sale in 2008

2003 2004 2005 2006 2007 2008 Totals

EXAMPLE 3
§1291 Fund
§1291 tax and Interest - - - - - 131,979.19 131,979.19
Interest on deficiency to 4/15/2010 - - - - - 5,385.87 5,385.87
Accuracy penalty - - - - - 26,395.84 26,395.84
Interest on penalty - - - - - 1,077.17 1,077.17

Totals - - - - - 164,838.08 164,838.08

Thus, while imperfect, the election to be taxed annually is designed to create “rough justice” with the
equivalent onshore fund.

There was a further option for taxation being a “mark-to- market”, but this was limited to certain
publicly traded investments and needed to be timely made.

Example #4: Foreign mutual fund applying the section 1296 mark-to-market provisions. The result is
compared to Ex. 3, to show the savings from electing mark-to-market taxation (§1296).

Investment Sale
1/1/2002 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 Totals
EXAMPLE 4
Foreign Note 1
Mutual Fund
(PFIC)
§1296 Mark
to Market
500,000.00 Note 5 572,450.00 612,521.50 655,398.01 701,275.87 750,365.18 802,890.74
Growth Note 2 4% 21,400.00 22,898.00 24,500.86 26,215.92 28,051.03 30,014.61 153,080.42
Income Note 3 3% 16,050.00 17,173.50 18,375.65 19,661.94 21,038.28 22,510.96 114,810.32
Turnover Note 4 33% 7,062.00 7,556.34 8,085.28 8,651.25 9,256.84 9,904.82 50,516.54

Taxable
Income:
Non-qualified - - - - - - -
dividend
Short-term - - - - - - -
capital gains
Long-term - - - - - - -
capital gains
§1296 Gain / Note 9 37,450.00 40,071.50 42,876.51 45,877.86 49,089.31 52,525.56 267,890.74
(Loss)

Tax:
Dividend Tax 35% - - - - - - -
STCG Taxed 35% - - - - - - -
LTCG Tax 15% - - - - - - -
Tax on §1296 35% 13,107.50 14,025.03 15,006.78 16,057.25 17,181.26 18,383.95 93,761.76
Income

Total Taxes - 13,107.50 14,025.03 15,006.78 16,057.25 17,181.26 18,383.95 93,761.76



Tax savings Note (13,107.50) (14,025.03) (15,006.78) (16,057.25) (17,181.26) 113,595.25 38,217.43
vs. §1291 10
Fund taxation

Note 9 The increase in value for years prior to the VDP filing period (2002) is not subject to tax since the initial year of filing in this
example is the year 2003.
Note 10 The saving is attributable to the compound interest charge component of the §1291 fund tax and the tax on the appreciation in
value for years prior to the VDP filing period.

Benefit of New Protocol
Including Penalty and Interest
Sale in 2008

2003 2004 2005 2006 2007 2008 Totals

EXAMPLE 4
§1296 Mark to Market
Tax 13,107.50 14,025.03 15,006.78 16,057.25 17,181.26 18,383.95 93,761.76
Interest on deficiency to 4/15/2010 5,717.76 5,177.87 4,239.71 2,992.95 1,694.81 750.22 20,573.33
Accuracy penalty 2,621.50 2,805.01 3,001.36 3,211.45 3,436.25 3,676.79 18,752.36
Interest on penalty 1,143.55 1,035.58 847.94 598.59 338.96 150.04 4,114.67

Totals 22,590.31 23,043.49 23,095.79 22,860.24 22,651.28 22,961.00 137,202.11

In the context of banks outside of the US, the use of investment funds is incredibly important,
particularly for smaller clients. The reason being that these funds allow for diversification that
otherwise might not be possible in an account. Further, it allows for an additional fee level that might
not be able to be possibly obtained. In the authors’ experience, some 40% to 50% of most accounts
held by banks outside the US, particularly wealth management institutions, will be in the form of
offshore investment funds that will be classified as PFICs. As discussed and illustrated above,
unfortunately from a US tax perspective, these are incredibly destructive.

Because on many occasions the acquisition value of the fund is unknown, the manner in which they
are taxed is extremely onerous, and the valuation structure is highly unfair. Further, in the context of
PFICs, very few taxpayers or their professionals were actually aware of these rules and, as a
consequence, certain practitioners ignored the effect of PFICs treating them all as capital gains
investments. Other practitioners were very careful to try and administer as best as possible. Lastly,
some practitioners were using a “mark- to-market” approach as if an election that could had been
made was made allowing for treatment.

Unfortunately, this disparate result and lack of knowledge of these rules and their taxation created
disparate results for taxpayers. It also created a situation in which taxpayers not complying with the
law [found themselves in a better position] than those who made good faith attempts to comply with
the law. In view of this, in early August the IRS created a system designed to be “fair” to all
taxpayers by effectively admitting that the PFIC taxation regime does not work and created a
substitute that was understandable and fair for everyone.


Economically, the result of this is a substantial saving for many taxpayers. Taking a look at the
example above, and applying it to this new system, the following is gleaned:

Example #5: Foreign mutual fund subject to the mark-to-market provisions as modified by the new
protocol. The result is compared to Ex. 4, to show the savings compared to the normal mark-to-
market rules under §1296.

Investment Sale
1/1/2002 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 Totals
EXAMPLE 5
Foreign Note
Mutual Fund 1
(PFIC)
New Protocol
Mark to
Market
500,000.00 Note 5 572,450.00 612,521.50 655,398.01 701,275.87 750,365.18 802,890.74
Growth Note 4% 21,400.00 22,898.00 24,500.86 26,215.92 28,051.03 30,014.61 153,080.42
2
Income Note 3% 16,050.00 17,173.50 18,375.65 19,661.94 21,038.28 22,510.96 114,810.32
3
Turnover Note 33% 7,062.00 7,556.34 8,085.28 8,651.25 9,256.84 9,904.82 50,516.54
4

Taxable
Income:
Non-qualified - - - - - - -
dividend
Short-term - - - - - - -
capital gains
Long-term - - - - - - -
capital gains
Mark to Market Note 72,450.00 40,071.50 42,876.51 45,877.86 49,089.31 52,525.56 302,890.74
Gain / (Loss) 11

Tax:
Dividend Tax 35% - - - - - - -
STCG Taxed 35% - - - - - - -
LTCG Tax 15% - - - - - - -
Tax on M to M Note 20% 14,490.00 8,014.30 8,575.30 9,175.57 9,817.86 10,505.11 60,578.15
Gain / (Loss) 12

Interest on 2003 Note 7% 1,014.30 - - - - - 1,014.30
tax 13

Total Taxes - 15,504.30 8,014.30 8,575.30 9,175.57 9,817.86 10,505.11 61,592.45

Tax savings vs. Note (2,396.80) 6,010.73 6,431.48 6,881.68 7,363.40 7,878.83 32,169.31
§1296 Mark to 14
Market

Tax savings vs. Note (15,504.30) (8,014.30) (8,575.30) (9,175.57) (9,817.86) 121,474.08 70,386.74
§1291 Fund 15

Note 1 The initial investment occurs at the time the fund is started, on January 1, 2002. All shares sold December 31, 2008. The fund
is an income oriented fund with a large concentration in fixed income holdings
Note 11 Under the new protocol the entire appreciation in the value of the fund is taxable in the first year of the VDP filing period, 2003.
Note 12 This is the tax rate mandated by the new protocol applicable to gains reported during the VDP filing period, 2003 through 2008.
Note 13 Under the new protocol the tax calculated for the first year of the VDP filing period, 2003, is subject to an interest charge of 7%.
Note 14 The saving is attributable to the mandated tax rate for gains on stock subject to mark to market rules under the new protocol.
This benefit is offset somewhat by the taxation of the amount of appreciation attributable to years prior to the VDP filing period


Baker mc kenzie dec newsletter 2nd part

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