June 5, 2008 - Phil Hodgen

Tax planning is second in line

International tax planning can get fearsomely complex.

You have at least two (usually more) countries interested in extracting some tax revenue from you, and their laws are usually only barely consistent. It’s a bit like three dimensional chess, except that the rules change from time to time. (And no one in our law firm is anything like Spock in any way whatsoever. Just for the record.)

It’s also a bit of fun. For some people, anyway. There’s a little bit of the “Ooooh, shiny” when we talk about setting up holding companies in small palm-fronded island nations.

I am a tax lawyer. My job in life is to deflect the discussion away from tax. My job is to push companies to think about the business, THEN think about tax. Cart. Horse. Etc.

For privately held companies doing business worldwide (we help these people), talk to the shareholders–the people who started the company. Sooner or later they will dispose of their shares. There’s an exit strategy that every company owner has in his/her head.

  • They get bought out by a third party.
  • They give/sell the company to their kids.
  • They get divorced and the ex gets a piece of the company.
  • They die.

Yeah, the other exit strategy is to go public. But that’s a transformer strategy (transforming stock in a private company into stock in a public company). When it’s all done, the shareholder still has an exit strategy for the shares he/she owns. Going public isn’t a disposition strategy.

The disposition strategy that no one is willing to talk about is death. I talk to entrepeneurs who tell me they plan to run their companies foreverrrrrr. FAIL.

Here’s the simplistic way of approaching things for corporate income tax planning:

  • First, think about the business and how it can maximize its profits from running the business. Where do you need people? Where do you need to control inventory, run quality control, provide customer service, build your widgets?
  • Then, remember that profit is profit. Worldwide. Do your tax engineering for the lowest average income tax cost on company profits. Worldwide. Numerator = taxes paid everywhere, denominator = net profit before taxes. Your metric is to drive that number down slowly, year after year, if you can.

After that, work on the estate tax side of the equation. Why after? Because the company is worth some multiple of its profits. If you focus on the business planning, then the income tax planning, you should be increasing your worldwide pre-tax and after-tax corporate income, thereby increasing the value of the company. You build wealth by building wealth, not by shaving taxes.

One thing at a time. Business planning first because it creates higher pre-tax profit. Income tax planning second because it creates higher after-tax profit. Then and only then, estate and gift tax planning to make sure Mr. Congress doesn’t share too much of your wealth.

This post was triggered because I never really thought about why I do what I do until I saw a recent post, completely unrelated to tax law.

Dave McClure, in talking about web businesses, says in “not safe for virgin ears” language that the problem isn’t exotic “issue du jour” stuff. The major problem people face is “I forgot my password.

Same thing with tax planning. That’s not the most important thing for a business. The most important thing is “I need to make a profit.” That’s boring and repetitive and in front of you every day. It’s much more fun to talk about the Cayman Islands.

Nope. Let’s deal with the “Duh!” stuff first.

Tax and Trusts