This is because until 2000 the UK Inland Revenue allowed a foreign tax credit only against the income which had been taxed, and only up to the level of UK tax (30%). The EU parent-subsidiary directive ensures that for subsidiaries in EU member states there won't be a problem (normally, there is no withholding tax on dividends), while for countries with which the UK has tax treaties (more than 100 countries) the rate of withholding tax on dividends is reduced to a figure between nil and 25%.

For situations in which the tax charge in the sales subsidiary's jurisdiction is at a higher rate than 30%, the traditional method used by companies such as Alpha-Pharma was the 'mixer' company. These were intermediate holding companies placed in regimes which have a 'pass-through' for dividends. For example, for the UK the Netherlands was a good location for a 'mixer' company. The principle is straightforward: one subsidiary remits profit taxed locally at 20%, while another subsidiary remits profit taxed locally at 40%, and if the amounts of profit are the same, then the two dividend streams can be mixed to produce a blended rate of 30%, which will incur no additional tax in the UK parent's hands. Without mixing, the effective rate of tax paid would have been 35%, in this example.

The UK's Finance Act 2000 has put a stop to offshore 'mixing', but now allows a degree of mixing to take place onshore, although with some caps on the rate of tax credit that can be mixed. Probably this is a more logical way of doing things, and certainly more transparent; but the UK's larger international public companies had to complain loudly before the Chancellor backed off his more extreme original proposals, which would have banned mixing altogether.

Another trap for public companies with many overseas subsidiaries is the UK's Controlled Foreign Company legislation. Basically, this says that if a controlled foreign subsidiary makes profits which are not remitted to the UK, (an easy and traditional way of escaping UK tax, if the subsidiary is a lower-taxed regime than the UK) then they will be taxed as if they had remitted the money. But there is a let-out for unremitted profits if they can be shown to be 'permanently employed in the businesses' of the subsidiaries concerned. In the case of Alpha-Pharma, the total amount of these balances (reserves) is £9bn and the company makes no allowance for any tax payable on these reserves. Obviously a careful balancing act is needed here by financial management, since in some countries local taxes might be payable on retained profits, which could not be set off in the UK - therefore, if local tax is likely to be paid at a higher rate than in the UK, it may be better to remit the profit as a dividend, and use the excess tax credit through offshore or onshore mixing.

Alpha-Pharma's overseas tax charge for 1999 was £673m on profits of £1,783m, an effective rate of 37.8% - this may suggest that there could have been scope for more effective management of subsidiary balance sheets, the use of offshore regional holding companies and the remittance of a greater amount of profit to the UK, but only a very close examination of each subsidiary's books and the overall tax comp would say for sure. It may be that in a year in which Alpha Pharmaceuticals PLC merged with a comparable, far-flung company, there just wasn't enough time to restructure everything in the most tax-efficient way possible. It's interesting that the overseas tax charge in 1998 was 22% of profits, and in 1997 it was 19% of profits, suggesting but not proving that tax planning had been more effective in previous years.

A further potential problem for multinationals which both manufacture and distribute, as does Alpha-Pharma, is that their manufacturing is likely to be concentrated into a smaller number of countries (20 in Alpha-Pharma's case) than their sales. In the 'good old days' before tax inspectors began to wise up, this meant that there were multiple opportunities for tax optimisation through effective transfer-pricing techniques: if a manufacturing plant is in an incentive zone with a 5-year tax holiday, then it should charge the maximum possible price to sales and distribution companies in high-tax countries. Nowadays there are complex transfer-pricing rules between and within countries, so that the possibilities are much more limited - but not completely absent. National price regulation controls do of course limit the options of drug and pharmaceutical companies in many markets. As with some other types of tax planning, the major corporate restructurings and acquisitions undertaken by Alpha-Pharma in the last few years will have made such sophisticated techniques much more difficult to optimise. Good tax planning requires stability of long-term corporate goals.

Executives of a public company are pretty limited when it comes to minimising tax on their salary and benefits, since any kind of behaviour which could be considered even slightly exotic would be heavily frowned on by shareholders, remuneration committees and, in the UK, the dreaded ABI (Association of British Insurers) which represents (over-represents, for many) the interests of corporate shareholders.

Still, it is possible to take advantage of some exemptions, or just lower taxation, in certain circumstances. For example, expatriate fiscal regimes exist in a number of countries traditionally considered to be high-tax nations. 

The UK

The UK, for example, is no tax haven, but it does have relatively low tax rates compared with some other European countries, and it offers exemption from tax for income not remitted to the UK for people who are resident but not domiciled in the UK (meaning, roughly, anyone that doesn't have a UK origin). For expatriate executives with assets to invest, or foreign income, a UK posting or residential base therefore offers very good tax planning opportunities. 

Foreign income is exempt from tax for such individuals as long as the income is not remitted to the UK. Therefore they can safely make offshore investments knowing that the income will be reinvested without deduction - the ideal way of turning income into capital without taxation. There would also be the possibility that they could be paid offshore (tax-free) for their international duties, while paying UK tax only on income relating to their UK duties. But this is where the moral guardians will step in, and what would be easily possible for a private company (there is nothing even remotely illegal about it) would not be permitted to a public company executive. Perhaps that's why they have to have such high salaries, poor dears, although it is the shareholder who suffers at the end of the day.

American citizens, and nationals of the very few other countries that tax world-wide income on the basis of citizenship, won't be able to take advantage of this UK possibility, but for all other nationals, it is available.

The Netherlands

Another country where tax benefits are there for the taking is the Netherlands. A foreign national working in the Netherlands will be taxed as a resident or as a non-resident, or may be able to take advantage of the '35% ruling'. There is no precise statement of what constitutes residence, but the criteria include the length of time spent in Holland during a tax year, ownership of real property, family or other personal connections. If an individual is registered in a municipal register then there is a presumption of residence.

The 35% ruling applies to foreign nationals assigned to work in the Netherlands for a company which operates the Dutch withholding tax scheme on its payroll. This can be a Dutch subsidiary of a foreign company. The ruling also applies to Dutch nationals if they have been absent (non-resident) for a period of at least 8 years before returning to work in the Netherlands. In order to qualify under the ruling, an employee must have skills which are not easily found in the Netherlands; by and large, senior employees find it easier to fall under the ruling than do junior employees. Under the ruling, which can apply to one individual for up to 10 years, a substantial part of a person's Dutch earned income is tax-free. Individuals benefiting from the 35% ruling may also apply to be treated as non-resident for Dutch tax purposes.

Dutch tax residents pay tax on their world-wide income, while non-residents pay tax only on their Dutch-source income. There is no capital gains tax as such in Holland.

It is clear that an expatriate working in or from Holland needs to try to fall within the 35% ruling, and to maintain non-resident tax status. This being the case, an expatriate individual can maintain existing offshore or foreign interests, or set up new ones, without much concern for Dutch tax law. However, if for any reason an expatriate becomes Dutch tax-resident, then it can be seen that there are considerable dangers that foreign assets will become entangled in the Dutch tax net, with a danger of capital taxation when residence ceases. 

It would seem therefore that, for instance, a German executive of Alpha-Pharma who worked part-time in London and part-time in Amsterdam would be able to craft himself a fairly tax-efficient package (if allowed!)

Denmark

Denmark is a notoriously high-tax country, with personal tax rates standing at a daunting 59% for income in excess of approximately US$36,000, with a further levy for social insurance contributions which brings the maximum taxation deductible to approximately 63%. A person is subject to Danish tax if he is resident there and is presumed to be resident there if he spends more than 6 months in the country in the tax year. But the government has introduced a special expatriate tax regime. Those who qualify may have their personal income tax rate fixed at 25% with a further contribution for social insurance that brings the minimum rate to around 32%, but the special tax treatment is only granted for a relatively short period, the maximum being 3 years; interesting for Alpha-Pharm though is that the benefits can be applied for in respect of approved research and development projects even if these are outside Denmark. A Danish R& D executive working in Germany part-time for a few years could probably achieve a satisfactorily low tax rate while still being based in Denmark.

Belgium

Belgium, on the other hand, seems a very appealing location as high-tax regimes go. Although personal income taxes are high, the government has granted a special expatriate fiscal regime for foreign employees with a specialist skill, an academic background and management expertise who are required by a co-ordination center* or other Belgium corporation. The purpose of these incentives is to encourage multinationals to invest in Belgium by minimizing salary costs for foreign executives. Although in theory the assignment given to the foreign employee must be temporary, in practice the special tax regulations apply for an unlimited time period. The application for non-residential fiscal status should be applied for within 6 months of arrival. The foreign executives must prove that their primary economic interests are maintained outside Belgium.

For activities conducted outside Belgium, that portion of income that relates to activities conducted outside Belgium is not taxable in Belgium since the applicant qualifies for taxation as a non-resident. Amongst a number of other deductibles, any income which represents the re-imbursement by the employer to the employee of moving expenses is not taxable in Belgium, and any sum paid to an employee to compensate for the higher tax rates payable by the employee than would have been payable in the foreign jurisdiction is not taxable in Belgium. 

*Co-ordination Centres

Co-ordination centres, present in a number of traditionally high-tax countries, can be a viable way of minimising tax and would possibly be able to deliver benefits to the executives of Alpha-Pharma plc as well as to the company. Favourable tax treatment is accorded to these so-called co-ordination centres, which are also found in France, and Spain among other countries. Usually the co-ordination centre pays tax at an agreed rate on its costs and expenses regardless of its profit levels. If the co-ordination centre takes on group services such as telecommunications provision, travel fulfilment and treasury, it can make a substantial profit. 

Belgian co-ordination centres seem to be particularly attractive. Although the co-ordination centre pays normal Belgium corporate income tax rates of up to approximately 39% what differs is that instead of the co-ordination centre being taxed on its trading profits it is taxed on between 4%-10% of its total "business expenses" (with the percentage being a matter for negotiation with the fiscal authorities). Furthermore salary and financial costs are excluded from "business expenses" for the purposes of the assessment. Thus a co-ordination centre which has high business profits, high financial and salary costs but low business expenses (other than salary and financial costs) will pay considerably less corporation tax than other Belgian corporate entities. 

Foreign executives and researchers of Alpha-Pharma working in a Belgian co-ordination centre would also be exempted from the requirement to obtain work permits and enjoy special income tax rates and benefits. 

As a large, listed pharmaceuticals company, Alpha-Pharma would have no problem in setting up a co-ordination centre (the entity applying must be part of a multi-national group with subsidiaries in at least 4 different countries for a period of at least 2 years.)

Furthermore, there are no withholding taxes on outgoing dividends, royalties or loan interest remitted by a co-ordination centre unless the recipient is a resident individual or non-profit making exempt company. In Belgium withholding taxes stand at between 15%-25% so the absence of a withholding tax levy on the activities of co-ordination centres would be a substantial fiscal concession for Alpha-Pharma (of course if the profits are remitted to the UK then there will be no withholding tax anyway under the EU participation exemption). 

Of course, all this may be of no interest to Alpha-Pharma since it is going to have to pay UK headline tax at 30% when the profits arrive at head office. But as noted above, low-taxed income streams are useful for 'mixing' purposes - so it is not a foregone conclusion that Alpha-Pharma is right to have its executive team and treasury in London, as is currently the case. 

The US

When it comes to foreign expats looking for taxation favours from the US, they will have a hard time finding any. The US taxes foreign nationals based on a residence qualification, using a 3-year formula totalling the number of days in the current year plus one third of the number of days last year, and one sixth of the number of days in the previous year. If the total is more than 183, then an individual is declared a tax resident, and this applies whatever the person's visa status.

Tax-resident foreign nationals in the US are taxed just about on the same basis as a US national, that is to say, on their world-wide income, comprehensively defined. There are tax credits under double tax treaties for some foreign tax deductions. 

Gains on disposal of holdings in almost any kind of offshore or mutual fund are likely to be taxed as income under US PFIC (Passive Foreign Investment Corporation) rules, and trading activity in shares could well result in capital gains tax or income tax charges, depending on where and how the acquisitions were made. In addition, expatriates, once declared resident, are not likely to be able to make use of the various pensions-related tax-breaks for share acquisition available to US citizens, unless the residence is for a long period; and at the same time will almost certainly not be able to obtain tax deductions for US tax purposes on continuing contributions to pension plans in their home country. 

To add to the unattractiveness of the US to foreign expatriates, the IRS can feasibly impose taxation on those who have resided for a long period in the US but have ceased to be US-resident.

It needs to be said, however, in relation to the US, that wealthy US citizens and corporate executives seem to be able to do a good job of minimising their tax bills, with professional assistance, so that an expatriate executive sentenced to a period in the US may be able to contrive a good result - but it won't be cheap or easy.

Share Option Schemes

Alpha-Pharma has a UK-based share options scheme, although for senior executives of the company the very low limits set on 'approved' UK schemes mean that most of their options will be 'unapproved'. 

For unapproved UK share options, income tax is due on gains realised on exercise of options; in addition, the employer must account for National Insurance due on the extent to which an option is 'in the money'. A recent ruling (to help dotcoms which were drowning in future liabilities) allowed employers to put this liability onto the employee; but this is unlikely to happen in a public company of any size.

In a company such as Alpha-Pharma, share options are an unsatisfactory (anyway, expensive) way of rewarding expatriate executives, who can get stung all ways around if they are not very careful to reconcile the tax regime in their home country (or next country) with that in the UK. 

The tax situation as regards share options for expats resident in countries such as the US and Australia is also quite bleak. The US would tax foreign share options on exercise, if not before, and in Australia too, an expat resident would be charged income tax under Australian law. There is no separate capital gains tax in Australia, but capital gains are taxed as income. Expats with share options are at a particular disadvantage in countries where they may be taxed on their worldwide income; this would also involve tax on their share options and it might be double tax at that. 

Ideally, a company would offer share options related to divisional performance, which could be flexibly converted into different instruments as a person moved around the company. Sometimes this can be achieved with 'tracker' stocks; but large companies dislike divisional incentives as much as they dislike minority shareholders; and anyway the tax consequences are horrendously complicated.

The ideal solution for such an expat executive residing and working in the UK or (as a non-resident) in another high-tax country would be to have his performance-related rewards paid to him elsewhere, and ideally offshore, but as noted above most large public companies turn their faces against such schemes for corporate governance reasons.

No doubt Alpha-Pharma has to toe the line, but to whose benefit? Not the company's, not the shareholders' and not the executives. We have noted a number of cases in this analysis where the need to be politically correct drives companies into practices that hurt all concerned - that seems to be ridiculous, but there is little chance of it changing while current models of public corporate structures persist.

Part IV: Taking Advantage of Free Zones and Export Processing Zones in the Procurement and Assembly Process 

Any company with sales of a large number of product lines into a large number of different markets needs to manage its supply pipeline according to a number of competing criteria:

1) Manufacturing plants need to be large to take advantage of scale;
2) They would ideally be close to the final market, and therefore small;
3) The procurement pipeline should be as cost-effective as possible and in particular unnecessary tax or duty costs should be avoided;
4) Maximum advantage should be taken of regional or national incentive structures to minimise tax or duty on-costs.

The USA is Alpha-Pharma's biggest single market by far, so that manufacturing scale is assured wherever manufactories are sited. Mexico immediately presents itself as a suitable location for manufacturing. As a member of the World Trade Organisation, Mexico has eliminated most export permits, substantially reduced export taxes and direct export subsidies, and eliminated fiscal incentives for exports. Still, a variety of export-incentive programmes - including special temporary import programmes - exist to encourage export sales. The legislation promoting in-bond facilities in Mexico (maquiladoras) makes the country an attractive place to manufacture for export to the United States. Because of Mexico's membership of NAFTA, products manufactured - at low cost - in Mexico will enter the US without any customs duty.

On June 30th, 2000, Mexico issued amendments to its temporary regulations on the taxation of maquiladoras for 2000. The regulations relate to an agreement between the US and Mexico entered into late last year which lays down 'safe harbour' rules for minimum acceptable levels of taxation on 'maquiladora' Mexican processing plants used by US corporations. If a processing operation stays within the regulations, then the US company concerned maintains exemption from the Mexican asset tax and from the danger of creating a permanent establishment for Mexican taxation purposes. For labour-intensive operations, the 'safe harbour' level of Mexican tax under the new rules amounts to 6.5% of the maquiladora's costs and expenses.

It seems evident that Mexico would be a highly cost-effective location in which to manufacture Alpha-Pharma's products for the US and Canadian markets - but not necessarily the most cost-effective. Other Central American manufacturing locations have free zones, and in some cases highly favourable trade deals with the US, so it would be necessary for Alpha-Pharma to check its options carefully before going for Mexico.

Many US states have also fought back by offering a range of incentives to incoming manufacturers: almost all states have extensive programs of incentives which typically include some or all of the following:

• Industrial property tax exemption - Exempts a manufacturing establishment from state, parish, and local property taxes for a period of up to ten years.
• Enterprise zone - Provides a tax credit for each net new job created in specially designated areas. Also may provide for a rebate of state sales/use taxes on building materials and operating equipment. Local sales/use taxes may also be rebated. Credits can be used to satisfy state corporate income and franchise tax obligations.
• Restoration tax abatement - Encourages restoration of buildings in special districts by abating Ad Valorem taxes on improvements to the structure for up to ten years.
• Inventory tax credit - Provides tax credits against state corporate income and franchise tax obligations for the full amount of inventory taxes paid. When credits are in excess of tax obligations, a cash refund may be made.
• Freeport law - Cargoes in transit are exempt from taxation as long as they are kept intact within their smallest original shipping container. Most manufacturers can bring raw materials into a state without paying taxes on them until they are placed in the manufacturing process.
• Foreign trade zones - Foreign Trade Zones make it possible to import materials and components into the U.S. without paying duties until they enter the US market. Goods shipped out of the country from FTZs are duty-free.
• Workforce development and training - Develops and provides customized pre-employment and workforce upgrade training to existing and prospective businesses.
• Construction or improvement of facilities - Gives investment tax credit 10 percent or more of the cost of tangible assets, including buildings and structural components of buildings located within a designated economic development zone.

In fact, tax and manufacturing cost levels in the US are so high compared with the maquiladora solution that even this extensive range of incentives is unlikely to tip the balance; and what is true of the US is even more true of Canada. It's therefore quite likely that Alpha-Pharma could achieve a lowest-cost supply pipeline for the US market by locating manufacturing in Mexico: it's not clear from available information whether or not the company does this.

What is true of the US is also true of other parts of the world, with variations. For any given destination market there is almost always a nearby free zone offering substantial manufacturing and labour cost advantages; in some cases the free zone is in the destination country itself, but more often it is in a neighbouring country, sometimes an 'offshore' jurisdiction. Given the high portability and compact nature of Alpha-Pharma's products, the group could probably make extensive use of free zones; so far as it's possible to interpret the company's public statements, it seems that Alpha-Pharma has a preference for larger, integrated production facilities. If these are placed in high-tax countries, the group may be getting a sub-optimal result in terms of production costs.

Although Alpha-Pharma manufactures almost all the products it sells, many of them are licensed from other pharmaceutical companies, and in turn Alpha-Pharma licenses products of its own to other companies. This means that there is a considerable two-way flow of royalties between Alpha-Pharma and other companies based in Japan, the US and the EU. The company needs to be careful that these flows are tax-efficient: withholding taxes on royalties are often higher than on some other types of cross-border flow such as dividends or interest payments. Quite frequently, it pays to make such licensing arrangements through offshore companies in jurisdictions which have tax treaties with the countries in which revenues are sourced - in this way it is often possible for the revenue concerned to reach the ultimate head office with little or no deduction en route. Of course, in a UK public company headline tax of 30% is going to be charged eventually in any case, but the availability of lightly-taxed overseas income flows can be useful for 'mixing' purposes either offshore or onshore.