Dr. Marcel Widrig is Senior Vice President of Freemont International SA and former Partner and Global Private Wealth Leader at PwC.
The complexity of international tax law can leave wealthy individuals vulnerable to excessive taxation, which requires coherent planning. How can this be achieved and what is the role of tax incentives such as for charitable donations?
As you might assume, the tax affairs of centi-millionaires are generally highly complex, especially in cross-border situations that may occur for family or business reasons. In case their affairs transcend national borders, numerous nexuses into tax systems exist, and conflicting legal and fiscal systems represent a threat to overarching objectives such as asset protection, privacy, and succession planning. In such situations, international tax planning sorts out the conflicting tax systems and attempts to avoid double or triple taxation, typically by using the double tax treaty network or multinational agreements. There are some key elements worth noting about such international tax planning.
It starts with a thorough fact-finding exercise, as it is often not that easy to identify which facts are relevant and which are not. For instance, being the owner of a hunting lodge in Canada may not matter for tax residence purposes, whereas a hunting lodge in Germany may well matter.
In addition to gathering all relevant facts and circumstances, it is equally essential to address the different tax topics being informed on a centi-millionaire’s short-, mid-, and long-term personal plans. This strategy is used to avoid planning in the wrong direction. While short-term plans trigger more income tax–related issues, long-term plans tend to be more relevant for inheritance and gift taxes.
Significant tension arises here in deciding between ‘family over firm’ or ‘firm over family’. As most centi-millionaires build up or inherit businesses, a key question to address is whether these business interests — which are in many cases the main source of income — shall be alienated to a certain extent. The consideration is whether individuals will get regular or periodic benefits, or if the businesses will continue to be held in direct or indirect ownership. In other words, one option is to protect the business from individual interests on a long-term basis (firm over family), whereas another option empowers each individual to do whatever they want with their business interests (family over firm), even if this may endanger the business’ continuation.
In common law countries, trust structures are widely used to shelter assets against excessive taxation, a trend that is typically triggered by estate and inheritance considerations. In civil law countries, respective planning tends towards keeping the business assets in direct or indirect ownership or alienating them entirely by transferring them to foundations or similar separate, long-term holding structures.
It is equally important to create distinct, robust plans for private and business assets. After sorting out the business ownership question, it can be efficient to separate tax planning measures related to business interests, in one instance, from tax planning measures for private assets, in another instance. Ideally, the target business structure should be connected with the private assets structure through some easily adjustable links.
By connecting the two, changes in the market environment or other business-related needs may be taken care of without (or by only minimally) triggering tax consequences at the private level, and vice versa. Further, the individuals enjoy relative freedom to follow their personal goals without interfering with any business restraints.
When it comes to transferring funds from the business to the private sphere of centi-millionaires, designing a long-term distribution plan as well as an investment strategy is advisable. This allows planning reliability for both the businesses as well as the centi-millionaires, who may use the funds for private purposes or reinvest them into new businesses outside the original business assets.
What is of most importance, however, is the regular review of the implemented asset and income structure concerning changes in the facts and circumstances as well as in the applicable tax laws and regulatory rules. Especially given today’s staccato rhythm of ever-increasing anti-abuse and ring-fencing tax measures, such a review is a must.
Governments not only seek to have their resident centi-millionaires paying their fair share of tax but they also encourage them to contribute to social welfare and philanthropic causes. While it is widely accepted to exempt charitable activities from income tax as well as donations to such institutions as income tax deductible or creditable items, the question becomes: where are the limits for such initiatives? An OECD policy brief in 2020 pointed out that especially when very large philanthropic foundations established by ultra-high-net-worth individuals channel substantial funds into philanthropic causes of their choice, governments then have to set limits to ensure that any abuse is prevented, for-profit businesses are not disadvantaged, and the respective tax rules are aligned with the public interest.
In this environment, centi-millionaires often give their charitable donations not to any third-party or governmental philanthropic organization but they establish their own organizations, be they charitable foundations or similar. While this is a costlier approach, it allows centi-millionaires to have a much greater influence on their donations and grants them control over the philanthropic organization. Bearing in mind that most centi-millionaires have an entrepreneurial background, such an approach is understandable. It also emphasizes the fact that once centi-millionaires are in the ‘charitable mode’, they are not passive donors but rather want to actively shape things even at some expense.
In many of these cases, obtaining the tax benefits is not the primary objective, although it is well-appreciated. In essence, philanthropy and the connected charitable donations are in many cases — although often considered least important — a part of the overall centi-millionaire wealth strategy, and one of the major topics for the respective governments is to assure alignment between the centi-millionaire’s charitable ideas and the public interest. In this respect, there is still a difference between US-based centi-millionaires and those based in Europe or Asia since in the US, charitable giving by wealthy individuals is factually a part of the overall social welfare system, but in Europe especially, centi-millionaires mostly rely on the government to take over all major social welfare tasks, thereby typically following their specific charitable interests in culture, art, and education.
When it comes to establishing such charitable organizations, most countries do not allow tax deductible giving to entities abroad, although between EU member states, there is a degree of reciprocity for such cross-border giving. Restrictions like these typically lead to charitable organizations being resident in the same country as their centi-millionaire founders. This is also taken up by several governments that promote establishing charitable organizations for ultra-high-net-worth individuals and families or allowing deductible cross-border giving. The idea behind such initiatives is therefore not only to promote charitable donations but also to attract specialized staff and generate a philanthropic environment around centi-millionaires, which would eventually create additional businesses and help keep centi-millionaires (and their money) in the country. For the centi-millionaires themselves, such initiatives are also very welcomed as next to tax benefits, governmental support typically contributes positively to the overall image of the charitable activity undertaken.
For centi-millionaires, coherent international tax planning is nowadays a must to avoid double or triple taxation. In addition, such planning ideally results in an appropriate and leveled tax load reflecting the fair share of tax payable. Further, it includes philanthropic aspects that lower the tax burden and positively contribute to the society and the image of centi-millionaires — provided an alignment of public interest and individual charity purposes exists. The last point especially will become more and more relevant as inequality of wealth tends to increase and a bad image of the rich could lead to overshooting tax charges for ultra-wealthy individuals.