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Thursday, 25th April 2024 |
| Taxing the change to e-finance |
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| The transition from 'bricks' to 'clicks and mortar' will have profound effects for an e-finance company's strategy, according to Pat Wall. |
The best way of thinking about the impact that e-finance can have on the tax base is to contrast a traditional ‘bricks and mortar’ financial operation with its internet based alternative.
Take a mythical US based multi-national bank with branches in a number of European countries. It will have a physical presence, staff and an IT infrastructure in each branch. It will be subject to banking regulation in each country and will be subject to tax on profits, capital gains. The administrative burden alone is significant.
The mythical internet-based alternative has an ecommerce hub in which it locates the servers to provide the retail banking services online, it centralises its customer support and business administration. Instead of having branches in each country, it gives its customers access by logging on to the bank’s internet site over which it delivers the services the customer needs and reduces its physical activities to marketing.
Profound impact
A traditional US bank with a branch in France will have what is known in tax terms as a permanent establishment. The existence of a PE gives the French the right to tax a portion of the profits and may also create other tax obligations such as French payroll deductions, transactions taxes and withholding taxes for the Bank. The US will tax all the profits of the bank with a credit for the French tax. The internet model eliminates the PE. The bank achieves the same economic result but avoids the French profits, transactions and payroll taxes. The US government is happy because its tax take goes up at the expense of the French.
The US government would not be so happy if the mythical US bank were to locate its internet banking business in a tax haven. This would result in double ‘non-taxation’ in both France and the US would now lose out. Of course it is not that simple. The tax authorities would look long and hard at where the internet banking business is really managed and controlled and almost certainly apply controlled foreign corporation (CFC) rules in an attempt to tax the offshore profits. But it can be done!
The traditional bricks and mortar model suffers from a number of inefficiencies: there is duplication of resources between head office and the branch, physical infrastructure is costly, there are numerous regulatory authorities to satisfy and the tax obligations and costs are multiplied. No wonder the internet based alternative is so attractive - it eliminates duplication by centralising operating and customer management, it eliminates the need for a costly branch structure, reduces the number of regulators and, if located in a low tax jurisdiction, can also minimise tax.
Of course the decision to locate an e-commerce financial services operation offshore will not be driven by tax considerations alone. Low tax will be a factor and good treaty coverage is vital. But the location must also have the necessary IT infrastructure and skills. It must be on the ‘information superhighway’ not down some boreen or perched on some craggy island (no matter how tropical)!
Typically, the key tax issues can be resolved. The elimination of cross border withholding taxes can be achieved with a good tax treaty network and it is normally possible to limit the activities within a jurisdiction to marketing or ancillary services thus avoiding the creation of a PE.
The example of the mythical retail bank can be extended to cover a host of financial services in other areas. Insurance, leasing, customer funding and investment banking can all be conducted online. Most financial services can be ‘digitised’ in other words converted to electronic messages. In theory a financial service can be delivered from any location to any other.
Tax regime
The growth of e-financial services represents a tremendous opportunity for Ireland. Our low tax regime has passed the scrutiny of the EU and does not offend the OECD definition of a ‘harmful tax regime’. The 12.5 per cent tax rate available from the 2003 is a powerful incentive for financial services companies to locate here. Ireland currently has 37 tax treaties with another 4 still in negotiation. While we have a dividend withholding tax it is not applied in treaty situations. Foreign dividends are taxable at 25 per cent but credit for underlying foreign taxes usually eliminates any Irish tax.
Non tax advantages of Ireland include the purpose built IFSC and other high tech locations, a skilled IT and financial services workforce, state of the art telecommunications and a pro-business Government attitude both to Financial Services and ecommerce. It is be hoped that recent difficulties which really emerged from a national culture of avoidance in the 70s and 80s will not impinge on the political consensus so vital to our success in the 21st century.
E-commerce hub
There are many practical examples of financial services companies beginning to exploit the advantages of Ireland as an e-commerce hub for Europe. Ireland boasts Europe’s first and largest internet bank, a number of Italian life companies are running very large ebusinesses out of Dublin. In addition to that we have a number of industrial banks making significant use of ecommerce technology to provide asset and customer finance on a global basis, we have the emergence of applications service providers focused on the B2B market and international payment service providers.
For all of the reasons that Ireland is now the world's largest software exporter, chiefly our relationship with the US, we stand on the threshold of a new age. We have the onshore advantages of membership of the EU and OECD, high regulatory standards and a tax treaty network combined with the offshore advantage of a low tax rate. We are the natural US gateway into Europe and can become the dominant ‘offshore’ e-commerce domicile for financial services. |
Pat Wall is partner in taxation with PricewaterhouseCoopers.
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| Article appeared in the April 2000 issue.
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