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Offshore Company Formation- International tax planning

Basic Considerations regarding the Formation of Companies in „Zero-Tax Havens“ i.e. in countries that have not entered into Double Taxation Agreements with other countries

Basic Considerations regarding the Formation of Companies in „Zero-Tax Havens“ i.e. in countries that have not entered into Double Taxation Agreements with other countries

Countries, such as Belize, BVI, Cayman Islands, Nevis etc... have not entered into Double Taxation Agreements with other countries, no judicial assistance or Mutual Legal Assistance (MLA) Agreement exist nor do extradition treaties for fiscal offences exist and such countries often do not maintain public commercial registers.  In addition, as a rule these countries do not tax income that has been generated outside of the country (exempted companies, offshore companies / corporations). The presumptive advantages can, however, turn into a "tax trap", if specific prerequisites are not met.

To begin with many countries (USA, Germany, EU countries, Switzerland etc...) have laws for the prevention of “tax evasion” i.e. define laws which give the state the right to impose taxes domestically.  In the case of doubt, the „suspected tax evader“ must provide evidence, that the purpose of a foreign entity is not solely that of tax evasion (reversal of the burden of proof), which has the following consequences in most countries :

- Provision of proof, that an orderly place of business has been installed for a company located in a foreign county (e.g. Belize, BVI, Cayman Islands etc...). In most cases, this includes an office, a serviceable postal address and the foreign-based company must be reachable by telephone, and a lease must be entered into between the foreign company and a lessor.   A mere „Post Office Box“ or a „Registered Office“ does not constitute an orderly place of business and quickly leads to the assumption of a “bogus firm”. 

- The proof, that in a foreign country (zero-tax-haven) the personnel prerequisites are given, to even be able to conduct and realize the businesses activities of the company.   In the event, normally or comparably, for example a company would need 10 employees, to be able to conduct business activities, and the company does not have any employees at all, naturally the tax authority will pose the question - how is the foreign company able to discharge its business. The same applies with regard to the necessary employee qualifications. 

- The proof, that the foreign company has an employed Managing Director (Managing Director Agreement, Earnings Statements). It is indeed quite „odd“, if a foreign company only invests 200 USD per year in its purported Managing Director (place of business supervision as place of the permanent establishment).   In this context the question is legitimate, as to which Managing Director is willing to accept consideration of only approximately 14 USD per month. 

One can deviate from this, in the event a production site has been installed in a foreign country (zero-tax haven), construction works, which last for more than 12 months or a site for the exploitation of mineral resources.  In this event – it is always operations in a foreign country, independent of the “place of managerial supervision”.

One can deviate from this, if for example the official Managing Director of the foreign company is a resident of Denmark, and provides proof, that he is routinely present overseas (seat of the foreign country) to execute the managerial supervision of the business.  In the case, for example of a mere holding company, the “managerial supervision” is not so extensive that the permanent presence of a Managing Director would be required at the foreign company.   In this case, it would be credible, if the client (in this example, a Danish citizen) for example traveled to the country in which the foreign company is located once a month, to discharge the required managerial duties.

-If required, provide proof that the company actively transacts business abroad. 

The screening effects of a Double Taxation Agreement do not apply

The Double Taxation Agreement’s (more correctly: Agreements for the Prevention of Double Taxation), purpose is to prevent companies or persons from being taxed twice - double - in “both countries”. In the event the “screening effect" does not exist (which is the case in “zero-tax havens”, because they have not entered into Double Taxation Agreements with other countries), then the possibility exists that a company or person can be taxed twice - double.  In addition, Double Taxation Agreements define the existence of a domestic and foreign fiscal permanent establishment. As such a mere „activity of auxiliary character”, a consultation, a stock of goods or merchandise (warehouse) or a "permanent agent” does not constitute a permanent establishment in the other contracting state.  In the event, a Double Taxation Agreement is not applicable; it is exactly these activities that constitute a permanent establishment according to domestic laws. Example: Formation of a company in Belize.  This company maintains a stock of goods or merchandise (warehouse) in another country. As a rule, this constitutes a permanent establishment in the other country i.e. the country in which the warehouse is located has the right to impose a tax. Another Case: Formation of a company for example in Cyprus (Has entered into Double Taxation Agreements with almost all countries) and a stock of goods or merchandise (warehouse) is located in a different country. As a rule, this does not constitute a permanent establishment in the other contracting state, because according to Article 5 DBA a stock of goods or merchandise (warehouse) does not constitute a permanent establishment.

Likewise the screening effect is not applicable in the case of “associated companies”. The majority of Double Taxation Agreements define that the tax deducted at the source state is, in the case of dividend distribution, 5 % for companies and 15 % for individuals.  In the event a Double Taxation Agreement does not exist, as a rule the full domestic withholding tax is due, this tax exceeds 30% in many countries. 

EU-Parent-Subsidiary-Directive is not applicable

According to the EU-Parent-Subsidiary-Directive dividends can be collected exempt from taxes between associated enterprises – if specific prerequisites are met.  The companies must have their seat in the European Union, must actively conduct business and must meet the “participation threshold”. In addition, the participation/interest must evidently be setup for at least one year. 

No Value Added Tax-ID-Number

Most zero-tax-havens do not impose Value Added Tax and for this reason cannot assign a Value Added Tax ID Number.  This can be disadvantageous for international businesses, if the company transacts business with companies in the EU or in countries which impose VAT. 

Clients from countries with similar statutory provision as the German add-back taxation (Hinzurechnungsbesteuerung)

Germany and the US, as well as other countries, maintain "taxation of fictitious distributions" statutes in their tax legislation provisions.  In the event an individual or a company holds more than 50% interest in a foreign company (the so-called “controlling financial interest”) and in the event the foreign company is established in a low tax country and only generates “passive income” (for example: pure services), then the profit after taxes (dividends) will also be taxed domestically, in the event the dividends are not distributed.  Many countries even tax dividends applying the full income tax rate (to the extent a person is a shareholder) and not with the otherwise applicable reduced tax rate.   However, the European Court of Justice has deemed this practice to be illegal with regard to European companies, i.e. not compatible with the principles of freedom of establishment. Example: A German is a shareholder in a company located in Cyprus, with an interest of greater than 50%. The company in Cyprus only generates passive income. According to the German add-back taxation, the dividends from the Cypriote company, would be taxed at the full income tax rate applicable to a German shareholder, and not taxed with the 25% final withholding tax, because Cyprus is a low tax country.  Due to the fact, that the German add-back taxation is illegal in the EU, the 25% final withholding tax applies, to the extent the dividends are distributed to Germany. In the event, the dividends are not distributed, in that case they are not taxed.  Another example: The same example as above, with the exception the German holds interest in a company in Belize.  In this case the “taxation of fictitious distributions” has full effect.  

In what situation does the formation of a company in a zero-tax haven (Non-DBA-Situation) makes sense?

Of course, in those situations in which the disadvantages listed above do not occur or play a subordinate role in the overall context.   In the event, for example a company is formed on the Cayman Islands, where all characteristics of an ordinary permanent establishment are met (orderly place of business, employed Managing Director etc…), the company actively transacts business and for example a German Stock Corporation holds interest in the company, in this case the place of business is taxed in the Cayman Islands (i.e. no taxation). The distribution of dividends to Germany (shareholder) are not subject to tax collection at the source and the German Stock Corporation, subject to 5% taxation of inter-corporate dividends,  may collect such dividends tax free (domestic German tax law, other countries apply similar provisions).

Formation of a Company in a Zero-Tax-Haven as a mere Tax Model

We discussed the risks above. However, the principle applies „Where no plaintiff, No judge”. If the Tax Authority, located in the state of the client (founder), cannot identify a connection between the offshore company and the actual "beneficiary", in that case such constellations remain undiscovered. The issue is however „the utilization of the dividends”.  If the dividends flow into the home state of the client / founder, a relation to the foreign company quickly becomes evident. In this event, the dividends should either remain in the foreign country or for example flow into a Swiss account.  It is possible to employ an intermediary in the form of a Lichtenstein Institute as a shareholder of the foreign company in the tax-haven state.  The foreign company, or the Liechtenstein Institute, then transacts worldwide investments, purchases for example a house on Lake Constance.  If the client / founder needs money, then he can "pick up" the money in Switzerland or in Liechtenstein. This remains undiscovered, to the extent a maximum of 10,000 Euro is picked-up (Money Laundering Acts of the Countries).  Of course, in most countries this type of „behavior” is deemed to be “tax evasion”, but the risk of discovery is usually low, to extent certain factors are stringently observed:

-No direct money flow from the „zero-tax-haven” into the home country of the client/founder.

-All documents (Trust Agreements, Stocks, Bearer Shares, Account Documents) should, for example, be kept in a safe-deposit box in Switzerland or in Liechtenstein.

- The “impression is to be avoided”, that the “managerial supervision “ is actually “in truth” in the state in which the client resides, a stock of goods or merchandise (warehouse), a representation or a permanent agent may not be installed outside of the zero-tax haven.

On the basis of the described factors, the formation of a company in a zero-tax-haven as a "pure tax model", as a rule is only suited for specific business areas, for example "Internet businesses” (downloading of specific files for fees, gambling, gaming etc…).

Alternatives to the Zero-Tax Haven

As described above, the formation of a foreign company makes more sense for most clients in countries with Double Taxation Agreements and / or in countries in the European Union. The client profits from the „screening effect“ of the Double Taxation Agreements and /or from the effect of the EU-Parent-Subsidiary-Directive and / or the EU Freedom of Establishment.

In some cases, it is better to pay a little tax and to act in a legal manner, than to pay no taxes and live in constant fear of possibly being indicted for tax evasion.

To this point, there are true tax-havens located within the European Union: Cyprus with only 10% income tax, the EU-special economic zones Madeira and the Canary special economic zone with approx. 5% income tax or for example England with 19% income tax for small to medium sized enterprises.   Even Switzerland entices with low taxes, for example: 15.5% in the Canton of Zug.

Which offshore country is the right one?

First, it must be checked (compare to the above discussion) if an offshore company (Definition: Not a DBA-Situation, Zero-Tax-Haven) is in fact, the right legal form for the client. In the vast majority of cases, this question must be answered with a NO, with regard to fiscal practice.  Accordingly, EU companies (Cyprus, England, Madeira etc…) or companies with DBA-Situation (for example: Switzerland) are much more suitable. In the event, however, one comes to the conclusion that an offshore company is a suitable option, then various considerations play a role in the selection of the location.

  • Are exempted companies offered, i.e. companies which only conduct business outside of the country the company is located in and as such are tax-free?
  • Total Fiscal Situation: Income taxes, corporation income tax, capital gains tax, withholding tax, gift tax or inheritance tax for individuals and companies?
  • How robust is bank secrecy, is this anchored in the constitution?
  • Have Mutual Legal Assistance (MLA) Agreements, agreements regarding information exchange in tax matters been entered into? (In the case of US citizens or US companies only Nevis can be considered)
  • Are bearer shares permitted, to the extent the client wishes to issue bearer shares?
  • Is there a publicly accessible commercial register?
  • In the case of actual plant relocation / immigration: What are the conditions for foreigners (Prerequisites, Visa etc…), are there minimum wages, social security insurances, how high are the unit labor costs, are subsidies available for the establishment of new business?

What?

Who offers it

Excellent bank secrecy

Andorra, Bahamas, Cayman Islands, Isle of Man, Mauritius, Panama, Singapore, Nevis, BVI

Suited for holding companies

Cayman Islands, Hong Kong, Isle of Man, Vanuatu, UAE

Zero-tax-haven Exmp. Status

Belize, Cook Islands, Grenada, Mauritius, Seychelles, BVI, UAE

No income taxes from foreign sources

Costa Rica, Hong Kong, Seychelles, UAE

No taxes on capital gains

Andorra, Bahamas, Cayman Islands, Vanuatu, UAE

Captive Insurances 

Bahamas, BVI, Cayman Islands, Hong Kong, Isle of Man, Mauritius

Ship’s register and administration

Bahamas, BVI, Cayman Islands, Mauritius, Panama, Vanuatu, Singapore, Hong Kong

Individuals:

 

No income taxes

Andorra, Bahamas, Cayman Islands, Vanuatu, UAE

Low income taxes

BVI, Hong Kong, Isle of Man, Mauritius

No inheritance tax

Andorra, Bahamas, Cayman Islands, Isle of Man, Mauritius, Panama, Singapore, Nevis, BVI

Bearer shares

Bahamas, BVI, Cayman Islands, Mauritius, Panama, Vanuatu, Singapore, Hong Kong

Advantages and Disadvantages of Tax Locations in the Caribbean and the Bermudas  

Country

Advantages

Disadvantages

Taxes

Bahamas

Bank secrecy regulated by law, no automatic information exchange in tax matters with EU states.

Since 2006 Mutual Legal Assistance in tax matters, however not automatic, rather only upon request. Taking up residence: At least 150,000 B$ must be invested in the country

No income taxes, corporate income tax, capital gains tax, withholding tax, gift or inheritance tax on individuals and companies

BVI

Bank secrecy regulated by law, no automatic information exchange in tax matters with EU states.

Cost of Living corresponds with the US Level.

Income tax 3-20%, corporate income tax 15%, foreign proceeds are tax free

Cayman Islands

Bank secrecy regulated by law, no information exchange in the event of tax offences, seventh largest banking center worldwide, high political stability 

In the case of taking residence an investment of at least 180,000 USD is required, Cost of living approx. 18% higher than the USA

Pure Zero-Tax-Haven

Dutch Antilles

DBA with the Netherlands permits the transfer of profits to the Antilles at a favorable tax rate, no extradition treaties for fiscal offences

Information exchange agreement with OECD, no statutorily regulated bank secrecy, high taxation of residing legal entities

Non-Residents pay for all revenue generated on the Antilles approx. 3% income tax, no property tax, no inheritance tax, no withholding tax on dividends and interest. Offshore companies pay until 2020 5.5%, in addition tax privileges for certain companies exist

Bermudas

Tax haven for companies

No statutorily regulated bank secrecy, residence permit for foreigners is practically not possible, purchase of real property not possible, extremely high cost of living. 

No income, corporation or withholding tax

Barbados

No currency restrictions, preferential custom's tariffs

Information exchange agreement with OECD

Non-Residents pay income tax of 1-2.5%, no capital gains tax, inheritance, gift, property or withholding tax on dividends and interest. An IBC pays, provided 100% is held by a foreign entity, 2.5% corporation tax. Domestic companies pay no taxes.

 

 

 

 

 

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