Tivot Sandwich
Tivot Sandwich is a base erosion and profit shifting (BEPS) corporate tax tool. This is an accounting and finance term that refers to the legal framework enabling companies to reduce their tax burden. They do this by exploiting the legal framework of Tivot and - more broadly - the United Nations of the Auroran Continent. It was originally developed by Governor Eliri Drzevili of Tivot following independence from Salovia. They enlisted the advice of Edwin Ita and Kaha Marama of Ita Marama (an audit and accounting agency originating from the Oan Isles). It was the vision of Drzevili to transform Tivot into a global financial centre.
Originally it built on the core strengths of Tivot as a nation such as political stability, proximity to major markets and its strong transshipment industry. Furthermore, through the Auroran Continental Assembly, the country was able to gain greater access to the markets of the Auroran continent. Although Aurora experienced tumultuous situations namely the Auroran-Pacific War, the treaties and laws of the Auroran Continental Assembly were carried over to the UNAC, enabling the country to become a major financial centre and in turn cement the Tivot Sandwich. Although other countries have BEPS tools, they do not have the geography, history, politics, legal system and geopolitical clout to accomplish what Tivot achieved with the Tivot Sandwich.
History
Following the Posolic Wars, the Grand Republic of Salovia in 1834 was recognised as an independent and legitimate state. Tivot was a province of this new nation. Thus, Tivot's political and legal systems and economic structure developed in the context of being part of Salovia. Under Grand Chancellors Mikhail Karanovi and (his successor) Orev Saloko, the government of Salovia began rebuilding infrastructure and establishing institutional mechanisms for the functioning of the state. Their policies rebuilt the economy of Salovia. The effect of their policies was felt throughout the nation including in Tivot. Infrastructure such as the Port of Triklov was repaired and expanded. Coupled with trade treaties with nations such as Ayaupia, Puntalia and Lapimuhyo, Tivot became a hub for Salovian trade with the outside world, developing a reputation as a transshipment centre. In becoming a major transshipment centre, the nation laid the foundations to become a major financial centre in the years to follow.
The Auroran Imperial War broke out in 1970 and lasted until 1975 between the Bursil Accords and the Ribenstadt Pact. As part of Salovia (which was part of the Bursil Accords), Tivot benefited from the influx of skilled workers, companies and increased trade relations with other Bursil Accords member nations such as Great Morstaybishlia. Furthermore, most of the action took place far from Tivot, allowing it to remain relatively stable and prosperous. After the Auroran Imperial War, the Tivotian Governor Eliri Drzevili announced the province's intent to hold an independence referendum on their status. Despite Salovia declaring secession to be illegal, the referendum was held on October 23rd, 1975 alongside Blueacia, and on January 1st, 1976, the nation was founded with the backing of Salovia's rival powers Ethalria and Great Morstaybishlia (despite the fact that they were on the same side during the AIW).
Declaring independence allowed Tivot to escape the ravages of the decades-long Salovian Civil War that ensued shortly after the AIW. In a bid to cement its role as a global financial centre and to disentangle its economic fortunes from the quagmire of Salovia, now-Chief Executive Drzevili, enlisted the help of Ita Marama, an Oan auditing firm to develop the policy mechanisms that would make Tivot attractive to foreign nations. Edwin Ita and Kaha Marama proposed the following policies:
- Modernisation: Tivot had to modernise its taxation, intellectual property (IP) and company legislation to bring it in alignment with Auroran nations such as Great Morstaybishlia.
- Liberalisation: Tivot was to make it as easy as possible for foreigners to start and operate companies in the country. This included lowering the time and costs involved in registering a business, getting an address and opening a bank account among others. Furthermore, corporate taxes were to be lowered and companies would have more discretion over their internal records.
- Internationalisation: Tivot was to establish treaties with other nations making trade and the movement of skilled workers easier and less restrictive. Capital controls were to be lifted or severely curtailed.
- Stabilisation: Tivot was to abandon the Salovian net'a in favour of the Kirib as legal tender.
These policies laid the groundwork for the Tivot Sandwich. But the full potency of the Tivot Sandwich arose when Tivot joined the Auroran Continental Assembly. The ACA lowered trade barriers and facilitated the easy movement of people, goods and services. Companies and high net worth individuals looking to lower onshore taxation expenses started looking to tax havens to avoid these taxes.
In the process, two classes of tax havens (more accurately known as offshore financial centres or OFCs) emerged: sink OFCs and conduit OFCs. Sink OFCs were the final destinations for shifted profits because of their highly opaque business practices and virtually non-existent tax rates. Countries such as Blueacia, Frorkstolm and the Necraties Islands fulfilled this function. However, because the modern financial system was becoming even more complicated and policymakers were wary of these tax havens, many of them struggled to sign the treaties needed to shift corporate tax liabilities easily.
Thus, Tivot positioned itself as a conduit OFC between onshore tax jurisdictions and sink OFCs. Due to its international reputation and the careful work of building its institutional mechanisms starting with Chief Executive Eliri Dzrevili, Tivot was able to gain the trust needed to enter into corporate tax liability treaties with both onshore and offshore jurisdictions. Tivot developed a highly sophisticated structure that involved taxation, company and IP law to develop the base erosion and profit shifting (BEPS) corporate tax tools that came to be known as the Tivot Sandwich.
The country maintained a policy of avoiding military, political and economic conflict and maintaining commerce with as many nations as possible, further building its trust. During the Auroran-Pacific War, Aurora was divided between the Ribenstadt Pact and the Bursil Alliance. To both ensure the neutrality of the Auroran Central Bank and to protect it from the fighting taking place between Ethalria and Great Morstaybishlia, it was moved to Tivot where it remained. Despite being nominally part of the Bursil Alliance, the reality was that Tivot was a neutral financial broker. This proximity to the ACJ and the practical neutrality that this created, Tivot banks were able to act as conduits for taxes between warring states, further cementing the relevance and necessity of Tivot as a conduit OFC especially for Frorkstolm and the Necraties Islands which were overseas dependencies of Great Morstaybishlia and were thus subject to embargoes and sanctions by Ribenstadt Pact member states.
Overview of tax, company and property law
The Tivot Sandwich makes use of a combination of company, tax and property law. This law arises both through domestic legislation as well as through bilateral or multilateral treaties between nations.
Although the nations of the world are diverse and have many differing legal systems, almost all of them possess some of the basic features described below. The first is that most nations charge taxes especially the following to generate revenue for their governments and to regulate sectors of their economy:
- Personal income tax is charged on the income made by natural persons.
- Corporate income tax is charged on the profit generated by for-profit companies.
- Capital gains tax is charged on the profit made from selling an asset.
Different countries charge different amounts of these taxes and have different rules for how they are to be paid. Some nations offer exemptions on the above taxes depending on the situation.
In most nations there are at least two class of legal persons: natural and juristic. Whereas natural persons refer to living sapient creatures, juristic persons refer to organizations of natural persons. These are typically characterized by perpetual succession and they can exercise all the rights of a natural person unless explicitly barred or it is not feasible for them to do so. Most countries have the following juristic persons:
- Companies are commercial entities. They have shareholders who have control over the company in terms of its founding rules. Shareholders control the equity of a firm and get paid in dividends according to the number of shares they have in the business.
- Personal liability limited companies are those in which the shareholders are not personally liable for the debts or actions of the businesses.
- Unlimited liability limited companies are those companies whose shareholders are personally responsible for the debts and actions of the company.
- Trusts are legal entities in a similar fashion to companies. They are distinct in that new shares cannot be created. Usually a trustee manages the assets controlled by the trust for the benefit of a closed list of beneficiaries. There are usually restrictions on how the money can be used because in most cases are not taxed on their income. It cannot directly generate income through conducting business but only the passive influx of income through owning assets.
Property rights refer to the right of a legal person to dispose (or alienate), acquire, use, modify and enjoy an asset. Intellectual property (IP) rights allow legal persons to own their original ideas and creations. This means that original ideas, inventions and discoveries of a legal person can be protected from exploitation by others, and creators can generate revenue and recognition from their creations. Income from intellectual property includes rent through the payment of royalties by other companies using the intellectual property, income generated through using the IP by oneself or capital gains from the sale of the IP asset to others.
Overview of UNAC law
The UNAC succeeded the ACA and the Auroran Union in 2017 following the passage of the Charter of the UNAC at the Auroran Reunification Summit which was held in Aura, Emberwood Coast at the invitation of President Nimona Poole. In that process, laws and directives passed under the AU and ACA were incorporated into the Auroran statute books insofar as they were not repugnant to the new treaty. Furthermore, treaty obligations referring to taxation, companies and IP rights remained in force despite disruptions caused by the APW. Furthermore, through the passage of laws by the Council of the UNAC and Auroran Parliament, the taxation, company and IP laws of the continent have matured. Moreover, UNAC laws can be scrutinized and are enforced by the Auroran Court of Justice whose power to set precedents adds to Auroran law through case law.
The basic tenets of the shared law of the member states of the UNAC is as follows:
- Double taxation: A company originating in one UNAC member state and conducting business in another cannot be taxed in both jurisdictions for the same transaction.
- Corporate freedom: Natural and juristic persons of member states should not be arbitrarily restricticed from establishing or owning shares in companies in member states. Juristic persons in one country that are lawfully registered shall be recognised as valid entities with respect to domestic and UNAC law.
- Cross-national property rights: The right of juristic and natural persons to own property in different member states shall be respected and cannot be violated unlawfully or arbitrarily by member states.
- Cross-national recognition of IP: Patents and other relevant forms of IP registered in one member state shall be recognised insofar as a novel creation of similar nature has not been registered in another member state. Natural and juristic persons shall have the right to exercise and enjoy property rights with respect to IP in member states as long as that IP is lawfully registered.
These basic tenets are exploited by the Tivot Sandwich to create a regulatory framework that enables companies to use Tivot to escape taxation.
Overview of Tivot law
The Republic of Tivot is a member state of the UNAC and is thus subject to the laws of the UNAC insofar as these laws are applicable to it. Thus, it also accepts the jurisdiction of the ACJ. The legislative branch of Tivot consists of the elected National Senate. It passes laws which are in turn executed by the executive branch composed of the Chief Executive and other executive officials.
Tivot law shares many of the features of taxation, company and IP law described in the previous section (refer to the section on Overview of taxation, company and property law for more information). Tivot's corporate tax rates are some of the lowest in the UNAC and is one of the easiest countries in the UNAC to establish a company. Tivot also protects the privacy of juristic and natural persons, enabling juristic persons to conceal a lot of information about their internal operations, beneficial owners (natural persons who are the ultimate beneficiaries of the company) and financial transactions from the public and foreign governments. Furthermore, the government of Tivot tries to ask as little information from companies as possible.
Mechanisms of the Tivot Sandwich
First layer
A legal person will establish a holding company in Tivot. This company will take ownership of a controlling stake in an onshore child company. The child company is the main company that operates in an onshore jurisdiction. The holding company will make some form of loan to the child company. The value of this loan will be greater than or equal to the total profits that the child company has made. The loan repayments by reducing the profit also reduce the taxable income. Thus, this reduces the total corporate income tax paid by the child company to the tax authorities of the onshore jurisdiction. Because the holding company is located in Tivot it is charged taxes in Tivot despite the fact that the "interest income" it made from its child company originates from an onshore destination.
This is where the "no double tax" rule comes into effect. Only one jurisdiction enforces the tax. Because the holding company is located in Tivot, it pays taxes to the Tivot tax authorities. Because Tivot charges low taxes, the holding company pays very low taxes on the income generated from the child company.
Second layer
The child company may undertake research and development activities in the onshore jurisdiction which generate intellectual property (IP). This IP is then filed at a patent office. If the patent office recognises the IP, then it is also recognised in Tivot. The child company can then use the IP to create goods and services for sale. Furthermore, it can also rent the IP to other companies for royalties or it can outright sell the IP to other entities.
The problem is that if it sells the IP, the child company will get income. This income will be charged capital gains tax. If the child company gets royalties from the sale of this IP, they will be charged corporate income tax. Thus, the child company can pay the holding company for the loan in the first layer of the sandwich using IP instead of cash.
This fulfills two functions. Firstly, all the rent and capital gains from the IP will go to the holding company which will boy very little tax on both. Secondly, the child company will incur two expenses: the loan repayment expense and the rent for using the IP. These expenses will reduce the taxable income in the onshore jurisdiction, lowering the tax obligations of the child company. This second layer only works for companies that generate a high amount of IP. Most companies will only use the first layer, but the second layer is usually used by STEM companies.
Third layer
Companies that are capital intensive, i.e. That use a lot of machinery and physical property etc., can take advantage of a third layer of the Tivot Sandwich. The holding company can own all of the property, plant and equipment of the child company. The child company then rents the PPE from the holding company. This is incurred as an expense which lowers the taxable income and thus lowers the taxation paid. Again, capital gains from selling the PPE go to the holding company. Depreciation and impairment of the assets is recognised on the holding company's income state as an expense, lowering the holding company's taxable income, further lowering its effective tax rate. Coupled with the fact that the Tivot tax rates are so low. At this point the holding company is paying next to nothing in taxes.
Fourth layer
In the fourth layer, a trust is set up. The shares of the holding company are owned in whole or part by the trust. The trust is then managed for the benefit of the beneficiaries. The trustee can be the investor or a trusted ally. A beneficiary can be either the investor (if they are not the trustee) or a trusted ally (such as a relative. Trusts pay no taxes. Thus, investors who use this structure pay no taxes for the income generated from the child company.
This fourth layer has some challenges. Trusts are limited into the payments that they can make to beneficiaries. A trustee cannot also be a beneficiary. Thus, this layer is used by investors as a way of preventing their dependants (usually their children) from spending all the money when they die and they place the family's assets under a trusted person. Investors who are willing to forego the benefits of the income generated by the trust may find trusts useful as a barrier against taxes, but the fourth layer is only advisable for investors with dependants or who want their money to support a charitable cause.
Case studies
Café Pay is a financial services company from the Oan Isles that provides mobile and online payments. Café Pay generates income in the Oan Isles that it shifts to the Safe Pay Holding Company. Safe Pay is in turn owned by various companies. This takes advantage of UNAC laws allowing companies in different member states to own companies in other member states. The biggest shareholder is Quicksilver Holdings. Quicksilver Holdings is located in a sink OFC specifically Blueacia. This shows how Tivot acts as a conduit for the final destination of the money which is a sink OFC.
Tivot law hides the details of the owners of the Tivot company, but information regarding Quicksilver Holdings was leaked through an investigation by Oan News in 2015. This demonstrates how Quicksilver took advantage of the Tivot law allowing companies to hide details about their owners.
Because Safe Pay is located in Tivot, the IP is recognised by Tivot authorities even though it is registered in the Oan Isles. This builds on the UNAC rule recognising IP from member states. The royalties and capital gains from the IP go to the Safe Pay Holdings Company in Tivot. Thus, Café Pay's income sheet does not show royalties and capital gains as income.
Benefits for Tivot
Given that the total taxes paid to the Tivot government are so low, it might seem that the scheme is not beneficial to the country. Tivot benefits from this through the employment of consultants, accountants, lawyers and information technology personnel who maintain and advise on the systems and mechanism required to administer this scheme on behalf of their foreign clients. Furthermore, the government of Tivot still charges various fees that foreign companies are willing to pay due to the fact that taxes and tax avoidance consulting in their own countries is bound to be vastly more expenses than what is paid in fees to the Tivot government. A system like this needs scale to be profitable given the fact that per company income is nevertheless low. Thus, Tivot benefits from the incredibly large number of companies who use its systems. Foreign companies also rent office space. Coupled with the small amount of land available this makes Tivot property highly valuable. Furthermore, Unlike other OFCs, the financial services sector is only one part of their economy together with transshipment and other industries, thus it is not solely dependent on its tax benefits to raise income.