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05 May 2005
On February 22 and March 30 2005 a presentation was given by the Office of the High Commissioner of Aruba for the members of the Aruba Financial Centre Association and the Aruba Association of Tax Consultants, regarding the current status of proposed amendments to legislation concerning Aruba exempt companies and the introduction of so-called 'check the box' rules for fiscal transparency.
Further, in March 2005 it was reported by the Aruba minister of finance and economic affairs that the imputation payment system as introduced in Aruba's tax legislation as of January 1 2003 would be amended, approval having been received from the EU Code of Conduct group. Pursuant to the proposal, the amendments concern the list of qualifying activities under the system.
The free zone legislation is also to undergo some technical amendments, which will take effect on January 1 2006. This update outlines the features of the proposed amendments as announced to date.
The Aruba exempt company (AEC) is a particular form of limited liability company that is often used in international structures. It is exempt from Aruban profit tax and dividend distributions by an AEC are not subject to the Aruba dividend withholding tax, which was introduced in 2003. Certain international developments - in particular discussions about harmful tax competition attended by the EU Code of Conduct group - have forced the Aruba government to re-evaluate its AEC legislation. In any case, the Aruba government has committed itself to changing the current fiscal regime governing AECs by December 31 2005.(1)
During the aforementioned presentations, it was indicated that in certain circumstances the government intends for AECs to remain exempt from domestic profit tax and dividend withholding tax whereby no filing of tax returns is required. As an alternative, AECs could opt for fiscal transparency. This development should allow all business currently conducted by AECs to be continued after December 31 2005 with no or minimal negative consequences. Certain rules will be set for exempt AECs becoming taxable entities and vice versa.(2)
After January 1 2006 AECs may continue to be incorporated and considered tax exempt if they engage solely in allowable activities.
The amendments would allow for AECs to remain exempt from profit tax and dividend withholding tax in a limited number of cases. A so-called 'activity test' would be used to determine which AECs qualify for tax exemption. The following allowable activities have been mentioned:
The proposal also stipulates that an AEC will become liable to tax in Aruba if in any year an exempt AEC engaged in holding activities receives more than 5% of its income from shares or other profit participations from a participation located in a jurisdiction in which it is not subject to a tax on profits of at least 50% of the tax rate valid in Aruba at that time (eg, in 2005 a minimum tax rate of 17.5% would be required).
An AEC that engages solely in one or more of the aforementioned activities will be exempt from profit tax on the proceeds of such activities. Any deviation from the allowable activities triggers the immediate loss of tax-exempt status. The AEC also immediately becomes subject to domestic dividend withholding tax. Where the allowable activities are engaged in again in a subsequent year, the AEC can revert to its exempt status. However, the exemption from dividend withholding tax remains inapplicable. Once the dividend withholding tax exemption has been lost, it cannot be reclaimed.
Effectively, pursuant to the proposal, no specific actions need be taken in connection with tax-exempt status by existing AECs that derive profits solely from the qualifying activities under the amended AEC regime. However, such AECs must keep accounts and (if requested) submit information to the tax authorities as stipulated in the Aruban General Tax Act (among other requirements).
On the basis of the proposal, limited liability companies and AECs incorporated after December 31 2006 may elect to be considered fiscally transparent from an Aruban tax perspective (the possibility to 'check the box'). When fiscally transparent, income, assets and liabilities will, for Aruban tax purposes, be allocated to the participants (ie, shareholders) on a pro rata basis.
In the case of non-resident participants, the profits of such a fiscally transparent entity would be tax exempt in Aruba, unless and to the extent generated through a trade or business conducted in Aruba via a permanent establishment or permanent representative of the non-resident participant (whether this is to be the case will be significantly determined by the policy unveiled by the competent authorities in so-called 'safe harbour' rules to be created along the guidelines set by the Organization for Economic Cooperation and Development (OECD)). Where participants are resident in Aruba, the profits made through the transparent entity may be subject to tax at the level of the participants depending on its fiscal position in view of the fact that the income, assets and liabilities will be allocated directly to them. The fiscally transparent entity would also be exempt from dividend withholding tax in Aruba.
Certain formalities should be fulfilled when opting for transparency under the 'check the box' rules, such as an annual declaration about the (direct) shareholders of the company, and annual filings of balance sheets and profit and loss accounts.
In principle, a transparent vehicle under the 'check the box' rules may not have bearer shares. Certain exceptions apply for existing AECs based on grandfathering rules.
Liability for taxes and stipulations when losing transparency
The transparent vehicle will be personally liable for the taxes due by the participants if such taxation results from the permanent establishment. In certain circumstances a transparent vehicle may lose its transparent status, such as in case of the placement of bearer shares or if certain formalities are not fulfilled. In principle, liability to tax will arise against a rate of 150% of the applicable tax rate over the non-taxed profits. A 'step-up in basis' may apply for Aruba profit tax purposes, but not for dividend withholding tax purposes.
Grandfathering for existing AECs to 'check the box'
The draft legislation provides for a grandfathering period during which the possibility of 'checking the box' will also be available to existing AECs in the period before the aforementioned fiscal regime (tax exemption) is effectively abolished (ie, before January 1 2006), up to and including July 1 2006. Thus, an AEC electing fiscal transparency before July 1 2006 will be considered to be transparent as per December 31 2005 in order to avoid any potential adverse tax consequences resulting from the change in the fiscal regime. For (current and future) activities that do not qualify for exempt AEC status, requesting fiscal transparency in a timely manner may provide a solution, as long as there is no permanent establishment or permanent representative in Aruba to which profits must be allocated.
Domestic legislation affords certain exemptions from profit tax and import duties in the free zones to qualifying enterprises. It was already policy that financing activities were not allowed in the Aruba free zones. However, in connection with the EU Code of Conduct, it has been found necessary to include a more explicit prohibition of such activities in the free zone legislation.
It was reported that the imputation payment system in Aruba's tax legislation would undergo some amendments, which have been approved by the EU Code of Conduct group. These amendments concern the list of qualifying activities under the system. As of January 1 2003 the imputation payment system was introduced in domestic tax legislation as part of the new fiscal regime, whereby, among other things:
The regime was intended to dispel the image of Aruba as a tax haven by modernizing its fiscal legislation in line with generally accepted standards set by the OECD and enabling it to enter into treaties for the avoidance of double taxation.
The imputation system aims to reduce the tax burden on distributed profits. Resident and non-resident shareholders of a qualifying limited liability company (the so-called 'imputation payment company'(IPC)) will be entitled to an imputation payment equal to 33/65ths of formal dividend distributions if certain strict conditions are met. Corporate and individual qualifying shareholders may claim an imputation payment. In order to qualify under the imputation payment system the IPC and the shareholders must meet certain conditions and fulfil certain formalities. One of the conditions is that the IPC should be engaged in one or more of the allowable activities laid down in the relevant land decree. The amendments to the regime concern these allowable activities.
Allowable activities for the IPC
Under the announced amendments, the list of allowable activities will be amended and the definitions of some qualifying activities will be changed. For instance:
The new list would include the following allowable activities (subject to certain conditions):
An IPC may not qualify as a bank or other financial institution subject to supervision by the Aruba Central Bank.
For further information on this topic please contact Angel Gomez Osorio at Loyens & Loeff's Curaçao office by telephone (+599 9 434 11 00) or by fax (+599 9 465 15 18) or by email (firstname.lastname@example.org).
(2) In principle, a step-up in basis will apply for profit tax purposes (not for dividend withholding tax purposes) when an exempt AEC becomes a taxable AEC, whereas in the reverse situation profit tax will be due on any 'untaxed' (hidden) reserves.
(3) However, companies subject to tax under the offshore regime for fiscal book years commencing before July 1 2003 will, in principle, be grandfathered until the end of the fiscal book year commencing before July 1 2007.
(8) In deviation from this rule, the IPC will be allowed to earn qualifying benefits from a subsidiary company that does not meet this subject-to-tax condition provided that these benefits do not exceed more than 5% of its total income from shares or other profit participations.
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Angel Gabriel Gomez Osorio