A place to stay for the bills

April 1, 2008 – A small CD-ROM containing data from a small bank in a small state plunged a large number of international investors into a major crisis. From which she hasn’t really recovered yet. The capitalists, constantly on the run from the grasp of the treasury, no longer know where to go.
How easy life would be for all those with large savings if they paid their taxes in their country and, above all, protected themselves from dubious providers of supposedly tax-optimal investments. There would be a lot less wealth destroyed and the returns could probably be respectable as well. At any rate, the tax investigators from Bochum are currently booking many a million euros into the state account. The investment of 4.2 million euros for the small disc with the huge data storage has certainly paid off. And anyone who has not yet declared their account in Liechtenstein or elsewhere, paid taxes or turned themselves in, will probably not be able to sleep peacefully any more. One thing is certain: governments like the German, French or American will intensify their pressure on tax havens.
Dispensable thrill
The question for investors is whether the thrill is worth it at all. Although the black money (until it is discovered) in the Swiss or Liechtenstein account remains untouched for tax purposes, the income from it is not particularly lavish because of the rather low interest rates and high administrative costs there. Another disadvantage is certainly that the account holder can not freely dispose of this money. It is more pleasant to live if the investment of money is done with a clear conscience and the night’s rest is not interrupted by disturbances between six and seven in the morning (the most popular time for tax inspectors) before the alarm clock rings. If you really want to make money legally with your money, you can’t help but get smart. So that neither fees eat up returns nor fraudsters make easy prey.
Seemingly carefree, actually money loose
Many investors, among them quite a few doctors, who are very successful in their profession but actually have little idea of the art of investing money, react as if controlled by magic when the slogan “save taxes” appears somewhere. The otherwise risk-sensitive forget all warnings and in fact believe they have found the ultimate investment for their hard-earned capital. In this way, around 40 billion euros per year seep into the shoals of closed-end funds, misguided real estate purchases or other dubious investment opportunities. Lawyers like Dr. Johannes Fiala, Munich, know a song to sing about which bait offers their clients fall for. He rails against “high commission payments for sales lies, also of Liechtenstein capital investments”. And warns against “so-called professional asset management, where hundreds of thousands of citizens fall for apparent all-round carefree packages every year.”
Coats in fashion
Tailor-made insurance shells are currently in fashion. They wrap the assets of an investor and thus protect them from the access of the tax authorities. In its protection, the assets can grow. At least this is what the advertising brochures of Liechtenstein banks say. They entice with the high flexibility of their model, which permits the attitude of existing security deposits, shares, bonds, cash, funds and so on. The investments are supposed to be protected not only from the tax authorities, but also from the claims of creditors in the event of the owner’s private insolvency. The assets thus protected do not go into the bankruptcy estate. Taxes do not accrue until the assets are withdrawn. Until then, the tax is deferred and the compound interest effect can take full effect. After twelve years and when the owner is at least 60 years old, he or she can withdraw the money and only pay taxes on half of the income. And they are not very high, because they are based on the income share. For 65-year-olds it is 18 percent. However, this construction does not work quite so simply. Attorney Fiala, specializing in capital investments, states his concerns: “I only get the bankruptcy privilege if I have no point of reference to Germany when setting up the shell.” Nevertheless, to keep the money safe, the investor should seek the help of a Swiss lawyer. German coats are much more rigid. Here, the insurance company determines the investment form, similar to fund policies. In Liechtenstein, on the other hand, the client or the asset manager he appoints is allowed to make the decisions. This does not correspond to the German regulations for an insurance company. A prerequisite for the protection of the invested assets is also risk protection, for example in the event of death or occupational disability, as is included in a unit-linked policy. A German bank can calmly take over the administration of the assets within the insurance shell. The account is in the name of the Liechtenstein insurance company. Fiala warns against too much euphoria. And against the attention of the tax authorities: “The construction is suspected of abuse of design.” In addition, insurance shells are only suitable for assets of about one million euros or more, if only because of the high costs. The structural costs are simply very high at two to three percent. Liechtenstein fans should also bear in mind that the returns there are significantly lower than those in Germany. Among the most popular tax-saving models are closed-end funds. People who are in the upper spheres of tax progression can hardly save themselves from offers. Doctors are among the most popular victims. They have on average a relatively high income, work very much – and have actually no time to worry about their money matters. For many, the high contributions to the taxman are a thorn in their side: they don’t see why they should have to hand over such a large part of their hard-earned income. But the depreciation models are now a thing of the past, since the legislator stipulates that losses may only be offset against profits from one and the same investment. But for it most offers show too low net yields. Tax advisor Ulrich Rieck of the Kanzlei VRT in Bonn, warns: ” A net yield of six or seven per cent is clearly too little, I warn against this form of the investment of funds. In the portfolios that I manage for our clients, there is not a single closed fund.” The reasons: The capital is tied up for many years. The client invests directly in a company. It is very difficult to almost impossible to sell shares. The transparency of the offers often leaves much to be desired.
More benefits than the tax effect
From a tax perspective, foreign real estate funds have been interesting in the past. Especially in countries with which Germany had a double taxation agreement, the profits were only subject to tax in the country of investment, which was usually lower than the local tax. In Germany, it only increased the progression and not the total income. Whereas in the USA, Austria and Italy there were tax allowances for foreigners investing in real estate, the rules have changed in some cases. Italy, like the Netherlands, is abolishing the tax-free allowance, while Austria has lowered it. For Dubai, which collected no income tax at all, the double taxation agreement expires in two years. But problems arise (at the latest) when the shares are inherited. That is why experts warn against such a plant. This is because the tax conditions can change several times during the long investment period, so that you may end up with a loss. Therefore, the rule should be: Closed-end funds should pay off even without the tax effect.
Flexible variant
In contrast, open-ended real estate funds that invest abroad can be handled more flexibly. The risk is more manageable because they can be resold any day. In addition, the capital invested remains protected. The progression proviso also applies to this income until 2009, when foreign income from open-ended real estate funds will become tax-free. Rental income from German real estate funds will then be subject to the 25 percent final withholding tax, while gains from the sale of the funds will remain tax-free as before after a ten-year speculation period. Another popular tax-saving scheme is to buy or invest in listed property. The reason is the high depreciation possibilities allowed by section 10f of the Income Tax Act. According to the bill, investors who want to rent out the property are allowed to deduct nine percent of the renovation costs per year for the first eight years and seven percent for four years after that. Investors and landlords can deduct the costs in their income tax return under the heading of renting and leasing. The providers of such tax-saving models make a living from wonderful sample calculations based on these benefits. Those who buy and finance such a property on their own usually know what they are doing. However, those who participate in a project often do so in ignorance of important information. In order to be able to assess an offer, investors should take a close look at the initiator of the project. What is his track record? Who is the developer? How good is the building fabric? Often the refurbishment costs are higher than the property itself. A thorough inspection of the property and its location is essential. What does the rent index look like? Apart from everything else, location is the most important factor. The house should be located in a metropolitan area in a very good location. In order to be able to calculate in the long term and to be safe from unpleasant surprises, interested parties should only agree to a fixed price. Only when the investor has all the information, commissions to be paid are taken into account in the invoice, the personal situation is sufficiently appreciated and the lawyer or tax advisor has given the green light, should the signature take place. If all the conditions are met, the investor can legitimately enjoy the friendly treatment from the tax authorities.
A gift remains a gift
Tax advantages can also be used if the assets and family cohesion are large enough. Then parents can transfer parts of their assets to their children. They use the allowances in the gift tax as well as the amounts provided in the income tax for children including the basic allowance. According to this, sons and daughters are each allowed to receive 8,501 euros of tax-free investment income per year. This amount is made up of a basic tax-free allowance of EUR 7,664, a savings tax-free allowance of EUR 750 and the lump-sum amounts for income-related expenses and special expenses of EUR 51 and EUR 36 respectively. However, the IRS requires the appointment of a supplemental guardian by the guardianship court. This tax-saving model also has its pitfalls. Those who use it should pay close attention not to cross the line. Otherwise, the child support is gone. And not only that: the assets once transferred remain with the child, even if he or she might want to buy a fancy car for them: a gift remains a gift.
Zero bonds for tax foxes
Zero bonds are more interesting for tax foxes. Zero coupon bonds are characterized by the fact that you buy them at a very low price, there is no interest. Rather, interest and compound interest accumulate in the price until the year of final maturity. The income from this is currently still treated as interest for tax purposes, but from 2009 it will be regarded as capital gains, which will then be subject to the 25 percent final withholding tax – and will no longer be tax-free. In return, the income is no longer included in the tax assessment. “However, investors must bear in mind that fluctuations in capital market interest rates are reflected more strongly in the bond price than in the case of bonds with a current coupon,” says tax consultant Rieck, pointing out that zeros are sensitive. “For those who stick it out until the end of the term, though, it’s not a problem.” Unfortunates who have not had a happy hand in managing their assets in the past and are still carrying around legacy liabilities will be allowed to offset losses against income from the zero bonds in the years between 2009 and 2013. For investors who have a few euros left over for the piggy bank, Rieck has another tip in store: he recommends buying bonds with high interest rates that mature before the turn of the year and selling them again in 2009. Then only 25 percent final withholding tax is due on the interest and it is not subject to the high income tax rate.
Marlene Endruweit m.endruweit@netcologne.de
(zm 98, No. 7, 01.04.2008, pp. 88-92)
Courtesy ofwww.zm-online.de.

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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