Offshore companies – a term that brings up a lot of negative connotations in relation to frauds, anti-money laundering, and tax avoidance by people who in reality don’t know much about any of these topics. A lot of people still believe, thanks to the media, movies, and lack of knowledge of past fraud cases, that you can entirely absolve yourself from paying taxes by setting up an offshore company on some unknown remote island. While this might have been true up until the recent past for the big and wealthy, governments have understood the mechanisms of tax evasion in the past few decades and have adopted new rules and regulations to promote more transparency.
So, is setting up an offshore company a definite method of reducing your tax liability? The answer depends on a lot of factors and all these factors weigh differently in every unique circumstance. Generally speaking, for large corporations that do business in more than one country, setting up an offshore company is not only desirable from a financial perspective but sometimes mandatory by law – so that they can run an operational business in another country.
However, for new and small business owners, the costs and time required in dealing with setting up an offshore company may outweigh its benefits. And with the development of new BEPS (Base erosion and profit shifting) laws in the developed countries, there might be no point in setting up an offshore company.
So let us first see the various reasons for which people set up an offshore company. You will have to check which of these arguments are applicable to your case and how much benefit they can provide to you.
Motivations to set up an offshore company
Confidentiality – Lots of businesses are not keen on giving away much information about their organization for various reasons. However, in most developed countries, the compliance laws require corporations to give away a lot of information about their business owners available to the government and public. Thus, these companies shift their legal base to countries with lax rules regarding the disclosure of information.
Asset protection – When the assets of big corporations or high net worth individuals are in the name of an offshore corporation, it becomes difficult for people in their home countries or even its government to lay a claim on those assets in case of credit default, bankruptcy, personal lawsuits, etc. Thus, offshore companies act as a barrier to the protection of your assets.
Tax minimization – One of the most important reasons why offshore companies are established. Tax havens across the world have the highest number of incorporated companies. A lot of international business is routed through these zero or low tax countries to pay less tax in the high tax countries. Maximum of the profit is kept in the offshore companies registered in tax havens.
Apart from these, there are various other reasons for which people set up offshore companies like legal requirements, better business laws, ease of business, access to investments opportunities not available in home countries etc. Different countries have different rules for specific types of businesses. For example, Costa Rica may be for certain businesses a far better place to run an online gaming company than any of the European nations.
However, with the recent tightening of rules by the global organizations especially in the wake of the Panama paper scandal, fewer and fewer benefits from the above motivations can still be used in today’s day and age to effectively set up and run an offshore company.
The OECD and G20 have brought out various measures against BEPS due to the loss of revenue the developed countries are facing because of tax havens. Many developed countries individually have also brought out different rules to prevent tax evasion and money laundering from their country. International forums for sharing of information for tax purposes have been created to facilitate a smooth sharing of information between members.
FATCA (Foreign Accounts Tax Compliance Act)
The US government released the FATCA rules in order to identify and prevent tax evasion by its citizens and residents. The USA has made agreements with all the major economies of the world to report and share financial information of each other’s citizens.
With the use of FATCA laws, authorities can withhold taxes on income earned by their citizens in foreign countries if proper information is not provided. If any attempt of tax evasion is noticed by foreign banks or financial institutions, they are required to share the information with US tax authorities.
FATCA has been very successful in curtailing tax evasion and money laundering by US citizens using Tax havens and secret bank accounts.
Similarly, the USA also has FBAR (Foreign Bank account rules) which mandates the detailed disclosure of bank accounts of US citizens outside the USA if the value exceeds $10,000.
CRS (Common Reporting Standards) rules
CRS rules are the international version of FATCA. FATCA is applicable to US citizens only while CRS is applicable to every citizen of all 90 registered countries. It was developed by the OECD (Organization for Economic Cooperation and Development).
According to the CRS agreement, it is the responsibility of financial institutions of member countries to provide information to tax authorities of other countries regarding the assets and incomes of citizens of those countries.
FATCA and CRS have made a huge impact in bringing out transparency in international business and asset holding transactions. Using foreign accounts to hide your wealth is a thing of the past. With more and more tax havens becoming FATCA compliant under the pressure of the USA, the scope of avoiding tax by setting up offshore companies is also diminishing quickly.
Many countries have enacted laws for withholding taxes from the income earned in their country until payment of tax in foreign countries is proved according to double tax avoidance treaties. Thus, even if you are using an offshore company for doing business in a high tax country, you may be subjected to withholding taxes in the high tax country. To get a refund of the tax withheld, you will have to provide proof of payment of tax in another country.
The mechanism of these rules is that if you are getting paid by your client or bank in respect of your business activity, they are required to withhold a certain percentage of the payment and submit it to the revenue authorities. Then, you will have to file a return with the tax authorities to get a refund of the said payment.
For example, Spain has a withholding tax of 21% on interest and dividend payments to any foreign entity. Thus, transferring money to offshore companies will attract tax in the home country.
Taxes on remittance to home country
You may be able to avoid paying tax in your offshore tax haven but sooner or later you will need to bring the money back to your home in order to utilize it. When you bring back the money to your home country, they will be subjected to tax, negating the tax savings in the offshore country.
All the high tax countries have made rules regarding taxes on remittances from tax havens in whatever form they come. You may pay yourself a salary as an employee of the offshore company or pay a dividend as the owner of the offshore company, both will be subjected to tax in the home country.
For example, Belgium taxes the dividend received by holding companies from offshore companies in tax havens or other countries with advantageous tax systems at normal Belgian corporate tax rates.
Rules requiring economic substance
Economic substance rules require companies to prove that any income earned within a country is as a result of business activities performed in that country. Thus, if you set up an offshore company just for tax avoidance in some tax haven jurisdictions but your business activities are performed in a high tax country, then you will be subjected to a tax of the country in which you are operating your business.
The countries which are non-compliant with the OECD rules and frameworks are ‘Blacklisted’ by the group. The blacklisted countries face severe restrictions in doing international business. If you register your company in any blacklisted countries, it will be difficult for you to run your business as international banks won’t do business with you and your prospective clients may be apprehensive about doing business with you. Also, companies registered in blacklisted countries seldom get investors’ interest. Your transactions with countries will also be thoroughly scrutinized.
Many tax haven countries are now forced to comply with OECD regulations in order to avoid being blacklisted. Tax havens such as the Cayman Islands and British Virgin Islands (BVI) have enacted rules to avoid being blacklisting.
Similarly, the EU has released a list of ‘non-compliant countries’ with NOONS (no or only nominal tax rates) regarding the economic substance rules. These countries now face sanctions in doing business with EU countries and getting capital from the EU.
Global Minimum Tax
OECD is working on enacting a global minimum tax of 15% on all the corporations in any part of the world. If materialized, this will virtually end the concept of tax havens and thus any tax planning and creative structuring using tax havens will simply become useless.
Thus, offshore companies aren’t a magic spell that can be used in tax planning in each and every circumstance. Unless there is some real economic need there to create an entity abroad like a warehouse, staff office, etc., you shouldn’t bother too much at the beginning stages of building a business and instead contact a local tax accountant that can maximize their business expenses to reduce your taxes. Getting involved in a complex international structure for tax savings will get you tax authorities knocking at your doors for explanations which aren’t healthy for a small and new business.
The above rules and regulations are one of the reasons why we at Wanderers Wealth don’t help those that are living full time in a high taxing country and run all their business operations from said place. It would simply be way too hard to justify to your tax authorities why you need an offshore business if you’re managing it and controlling it from your home country 100% of the time. Let’s not talk about the evident fact that you would be creating a Permanent Establishment in your home country anyway and therefore, you would have to pay taxes as if the business was incorporated in your home country.
This is exactly why unless you don’t plan on expanding into other international markets and are in need of a business presence in another country we don’t usually recommend setting up an offshore company if you don’t plan on moving abroad to a tax-friendly country. If you’re still unsure whether or not it is a good idea to set up an offshore company for your business make sure to contact us.
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NOTICE: The content of this article is not to be considered as a legal opinion or tax advice. Wanderers Wealth does not hold itself out as a legal or tax advisor. If you want to receive a legal opinion or tax advice on the matter in this article please contact us directly and we will refer you to a legal practitioner.