Tax Efficiency of Investments

Each jurisdiction globally taxes to discourage certain activities (i.e. short-term trading, gambling, etc.), and subsidizes activities it wants to encourage. The CFA is a global exam and does not test specific jurisdictional rules. Candidates need only learn the basic elements of common tax regimes.

Tax Havens

Tax havens are jurisdictions with very low or no taxes. These havens are set up to attract foreign capital with attractive tax and regulatory systems. Often regulatory burdens are much lighter, making conducting business in the tax haven easy for foreign investors. Many investors need to make large purchases of real estate, donations, or create firms that will hire local employees or benefit the local economy in order to gain this kind of residency.

Territorial Tax Systems

These jurisdictions impose tax only on income or gains sourced within the jurisdiction itself. Taxes paid by residents in these jurisdictions tend to be more than those imposed by tax havens, and less than those imposed by worldwide tax systems, although this is not always a hard rule.

Worldwide Tax Systems

This system is the most likely to give rise to double-taxation. Under a worldwide tax system, a resident of a particular country will pay taxes on their income and or gains regardless of where it was earned. Residency status is often an important issue and can determine the amount of taxes owed.

Double-taxation can often be alleviated through tax credits where applicable. The United States is known as a country that imposes worldwide taxation on income regardless of residency, making it difficult, if not impossible, to avoid double-taxation.

Wealth managers should always begin their analysis of a family&apo;s financial situation by understanding their jurisdiction, its rules, and the limitations those may impose on after-tax portfolio gains. When cross-border issues come up, managers should begin by understanding the home country's jurisdiction. After that, looking at residence jurisdictions and finally, any investment in foreign jurisdictions should be examined. The curriculum gives many wonderful examples for candidates to read.

Question

Dale Cardiff is a 32-year computer programmer, currently living in the island nation of Aruba. Cardiff is living and working as a non-citizen resident in Aruba and enjoys paying very little taxes on his earnings. Last year he calculated that he paid about 1% in total of his previous year's wages. Cardiff purchased a villa overlooking the sea in Aruba, and earned his residency status a full year later, with the potential for full citizenship within three more years. His home country of the United States taxes his income earned in Aruba at a higher rate. Cardiff's accountant informed him because of his high earnings, that Cardiff last year paid around 39%. Based on these facts, Cardiff's home country and residence country can most accurately be described as what kind of tax regime?

1. Territorial, worldwide.
2. Worldwide, tax haven.
3. Territorial, tax haven.

Solution

The correct answer is B.

Cardiff's home country is the United States, which is taxing the income earned by Cardiff despite that income not being sourced in the United States, this is known as a worldwide tax system. Aruba in this question appears to be set up as a tax haven. Cardiff purchased a property in exchange for preferential treatment and pays very low taxes.

A and C are incorrect. Answers with Territorial tax systems aren't quite applicable here, since Aruba would be the only possible fit, as it taxes locally-sourced income from a non-resident. But too many other aspects of tax havens exist to make territorial a relevant answer.

Reading 8: Topics in Private Wealth Management

Los 8 (c) Discuss and analyze the tax efficiency of investments