International tax advising for family companies in the evolving digital economy

Author: Pablo Alarcon, academic co-director of the Master in Global Taxation

Historically, international tax advisors strictly managed accounts for multinational corporations. Recently, however, there is increasing demand from family companies and single family offices for the services that these professionals can provide.

Business experts in the 1970s believed that family companies would fall into obscurity within the decade. Contrary to their predictions, however, family companies have become increasingly relevant in today’s global market, forming the backbones of major economies. For example, in China and India, these companies represent more than 80% of the GDP.

Today, in our modern and increasingly digital world, even startups can share profits with passive investors while still maintaining familial control. The question is, are startups family companies? The answer depends on whether or not—and to what extent—the owner prioritizes family, both in terms of company control and management decisions.

Family companies

A family company can be defined in a variety of ways, but definitions tend to focus on two main characteristics:

1. The development of the business for the benefit of the family’s interests.
2. The preservation and growth of family wealth, both for the family and for future generations.

In light of these characteristics, some say that family companies are more human-centered, but also more conservative and old-fashioned than listed corporations, which tend to focus on promoting business success and maximum short-term efficiency.

Being more conservative equates to less debt appetite and a higher rate of profit reinvestment. Combined, these traits make for a solid chance at survival during difficult times.

How family companies manage their taxes

It’s interesting to consider how taxes are handled in typical family companies. They are not just another expense to add to the profit and loss account. Rather, taxes have a negative bias, as they are an obligatory payment to an unwanted partner. Saving money on taxes should not only be a professional aim, but also a personal success and something to celebrate.

Tax advisors have long been highly valued professionals within family businesses, as they occupy a role that is closely tied to the success of the company. Their reputation is further bolstered by the fact that they provide strategic advice regarding company development and family wealth management.

For the past century, family companies’ tax advising services have typically been limited to the domestic arena. Even when companies did wish to export their goods and services, managers lacking international experience, and tax advisors limited in their knowledge of international tax law served as a barrier to expansion. Furthermore, it was not uncommon for an advisor to be a family friend, which meant that his or her expertise often went unquestioned, even when it proved less than adequate.

The tax management needs of a modern family company

All of this changed when family companies started to grow and started requiring high-quality advice on complex international affairs. Sometimes, this change was spurred by an internationally educated family member taking over company leadership. In other cases, this change occurred as a result of family investments that went international. Today, international tax advice is essential to families and is a must for quality wealth management.

The best way to monitor this growing need is to examine the changes happening in traditional single family offices, which were created to deliver services to the family and increase the family company’s wealth.

As cultural critic Peter York once said:

“The world has more billionaires than ever… and billionaires have so much private business to transact, so many investments, different asset classes—art, property, equities—to look after in so many time zones and tax jurisdictions that the old systems of lawyer, banker, accountant, aren’t enough. If you’re really rich, you warrant an office…” 

(Quote from LSE Research Online: “Family offices and the contemporary infrastructure of dynastic wealth,” Glucksberg, Luna and Borrows, Roger (2016))

The essential characteristics of a single family office

A single family office^[1] is the conceptual name given to the human and material resources dedicated to serving the family company’s side interests, as well as the family members in medium or large family companies.[2]

Family office duties vary based on family priorities, but the following are considered standard:

• Providing administrative and legal advice to the family with regards to their investments, both as a whole and individually.
• Managing the family’s side investments, including financial investments and private equity investments.
• Managing the family’s special interests, such as art and culture, charity ventures, or other philanthropic activities.
• Providing up-to-date tax advice in areas of great importance, such as:

1. Tax consequences of family members who live in other jurisdictions or have different nationalities. This mainly affects income tax and estate tax planning.
2. Taxes on international financial investments. Specifically, finding tax-efficient vehicles to defer or reduce taxation on revenue
3. Advice on the tax efficiency of private equity investments, either directly or through the use of international holding entities located in the best jurisdictions from a tax perspective.
4. The most tax-efficient options for investing and holding real estate abroad.
5. The tax advantages of philanthropic activities in jurisdictions of interest. Also, how to avoid international tax burdens on investments and art
6. Managing the special tax treatment of charity institutions in the international arena.
7. Monitoring tax reporting obligations worldwide and coordinating with local advisors.
8. Reconciling the Tax “arm’s length principle” that applies between invested companies, family members and some of the key relationships, with the family operations reality.

The changing landscape of international tax law

This list of tax-related duties could go on forever, but the point is that taxes are no longer a domestic nuisance that can be dealt with by speaking to local tax authorities every once in a while.

We live in a highly complex and constantly evolving world where there are hundreds of tax offices and hundreds of thousands of rules which change frequently. Additionally, there are countless anti-avoidance provisions and unexpected penalties that could make your life a nightmare.

In this regard, we have to add that most conventional countries are following the terms of OECD proposed rules against tax Base Erosion and Profits Shifting (BEPS).   The EU Commission has also published a directive against tax avoidance (EU) 2016/1164 with a similar aim against aggressive tax saving strategies that are deemed to go beyond what is considered acceptable.

We live in a time of great opportunity for international taxation and there are plenty of options for legitimate tax planning, as well as free choice of acceptable tax saving ideas.

Moreover, most of these conventional jurisdictions have recently introduced general Anti-tax avoidance rules (GAAR) that will be used as a guideline when challenging artificial tax planning strategies that do not have a real business purpose.

On the other hand, we live in a time of great opportunity for international taxation and there are plenty of options for legitimate tax planning, as well as free choice of acceptable tax saving ideas.

Family companies and family offices know this well. In today’s world, strategic international tax advising is a must, both for risk management and efficient tax planning of the family´s personal assets and investments.

Beyond this, all evidence suggests that we are on the brink of a monumental global change in the traditional international tax framework, which is currently based on standard bilateral tax treaties. Single family offices must be prepared for the new landscape of rules and regulations, which are already changing the principles of the international tax world.

We should think of a potential future tax environment in which tax residence is no longer the main reference. We will have to live with different points of connections based on a more sophisticated definition of business profits. This is not science fiction, it is the reality in today´s digital economy and some countries like the UK, with “diverted profits tax”, follow a similar principle for digital economy profits.

The evolving role of international tax professionals

As a result of the changing global landscape, single family offices are hiring senior international tax professionals with years of experience to manage these growing tasks and provide international tax advice on all decisions that the office makes. These international tax experts are in charge of a significant portion of the projects under study since the international tax features of the alternatives take priority over other, less relevant issues.

Why hire a senior international tax advisor or a team of professionals instead of outsourcing these services? Because there is a high value placed on confidentiality and personal trust in a single family office. Keeping a low public profile when it comes to taxes is essential for high-net-worth families. They believe that their international tax strategies are some of their most intimate secrets and should not be strewn across the desk or visible on the laptop screen of a junior advisor at any firm that is not used to this dynamic. Besides, reputational issues are also relevant for family companies and offices, another reason why experience and confidentiality are highly valued.

That said, it’s not easy to be a successful international tax advisor at a family company or office. Family companies and single family offices are complex organizations with unspoken rules. Professionals need to be familiar with these quirks in order to perform well in this unique ecosystem. These offices and companies expect much more than top technical knowledge alone; only those who master appropriate social skills will be able to deliver advice successfully and earn their place on the family’s short list of trusted individuals.

Pablo Alarcón is an associate professor and academic co-director of the Master in Global Taxation LLM at IE Law School. He has developed his professional career as tax partner of relevant Law firms in Spain and has been Secretary of the board and Director of an international Private Bank in Spain. Since 2010 he is senior Partner at Alarcón-Espinosa Abogados where he provides international legal and tax advice to his clients, mainly family companies/offices and private clients.

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^[1] Single family office as opposed to multifamily offices, mainly dedicated to wealth preservation and growth.

[2] The threshold depends on the country, but a reasonable reference could be €50M and beyond inside wealth to the family company.

Note: The views expressed by the author of this paper are completely personal and do not represent the position of any affiliated institution.