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Offshore Company Formation- International tax planning

Why form a company in a foreign country with a tax accountant specialized in international tax law?

Why form a company in a foreign country with a tax accountant specialized in international tax law?

The prospect will find numerous agencies specialized in foreign company formations in the internet. As a rule, however, these companies do not employ Tax Accountants specialized in international tax law.  Frequently, such formation agencies are not – or only insufficiently - versed in international tax law, or are not permitted to provide advice on legal or tax matters in countries as a consequence of the Legal Advice Act. Formation agencies - or even Tax Accountants – located in the forming countries (for example: Cyprus, Belize etc…) often are only knowledgeable in domestic tax law. If one takes a look at the relevant internet offers, it quickly becomes apparent, that a great deal of the providers publish incorrect or insufficient information, working according to the strategy “The cheaper the better”.

The following factors, among others, are to be observed within the scope of international tax planning / company formation in a foreign country: 

-Most countries have laws for the prevention of tax evasion and/or have laws that formulate the right to impose taxes domestically.  It is not in the interest of these countries, that companies and individuals have their income taxed in foreign countries, even though “in truth” the managerial supervision is located domestically and / or the activities are transacted / performed domestically and / or “in truth” the taxpayer resides in country and/or a production site is not installed in the foreign country. In many countries, (for example: USA and Germany) “tax evasion” is, in fact, a criminal offense.  For this reason, it is somewhat naive to believe, that the right to impose taxes can be relocated to a foreign country, by simply investing a few hundred Euro for the formation of a company in a foreign country. It is true, that almost everything can be done, however domestic tax laws must be observed and – to the extent a production site is not installed in a foreign country, or no site for the exploitation of mineral resources or construction works, whose duration is greater than 9-12 months exist (in the event a Double Taxation Agreement exists this will always constitute a permanent establishment), the impression must be avoided that the foreign company is just a „bogus company”.  

- The permanent establishment in a foreign country:

1. Managerial supervision

A production site, a site for the exploitation of mineral resources or construction works, whose duration is greater than 9-12 months, always constitutes the establishment of a place of business in the formation country - at least in the event of a DBA-situation (Double Taxation Agreement).  Otherwise the definition of a permanent establishment is based, among other things, on the “place of managerial supervision”. As a rule, this means that a resident of the formation country (ordinary residence) acts as the Company Director. Either the client relocates his ordinary residence to the formation country and acts as the Director of the company himself OR a citizen of the formation country is hired to take the position of Director OR the client himself acts as the Director, and provides proof that he is present in the formation country to perform customary managerial supervision OR our Law Firm in the foreign country provides a Nominee Director.

In the event, a Nominee Director is provided the following factors must be observed:

-The responsibilities of the Nominee Director should be performed by an Attorney or Tax Consultant in the formation country of the company (in the case of a legal entity as a Trustee Director of a Law Firm). This ensures, that the trustee relationship is not disclosed for "incidental" grounds. Only attorneys can effectively protect the trustee relationship from third party access.  It goes without saying, that attorneys will demand the corresponding fees and will not just demand a few Euros for their services as a Trustee Director.

Under certain conditions, it can even be required or useful, that a person in the formation country is employed as the Director of the company, i.e. with an employment contract between the company and the Director, payment of payroll taxes and social security contributions; to the extent they are collected. We are also able to provide such an “employed Director”.

The so-called "Formation Directors” are “absolute nonsense”, who resign after the company has been registered and transfer the company and position to the actual beneficiary.  In this situation, the "actual Director” can quickly be identified. A Trustee Director must of course be registered and reachable during the entire agreement term.

One “can” deviate from such an arrangement, if the foreign company is formed in a country, which has not entered into a Double Taxation Agreement and / or a Mutual Legal Assistance (MLA) Agreement.

An “Offshore Director is also “absolute nonsense”, an example of this is that a legal entity acts as the Director of an English Limited in Belize. Such a constellation is “asking for it” i.e. asking to be accused of “Avoidance Abuse” and of course, such a company will not be able to open an account or be issued a Value Added Tax ID Number.

2. The place of business in a foreign company

A “Post Office Box” or an "Answering Machine" does not constitute an ordinary place of business. Accordingly, "Registered Office Addresses” do not meet the prerequisites for a proper place of business.

The minimum requirements of a proper place of business are:

-Serviceable postal address, also for registered mail

-Reachable by telephone during normal office hours, personal call reception with the name of the company.

It does not always have to be “large offices”, but it must not be a post office box. The configuration / structure of the place of business is to a high degree dependent upon the company activities.  If one assumes that a company can only perform its business activities, if it has 3 offices and 4 employees on-site, then a pure virtual office would indeed appear rather odd. In this situation a “sense of proportion” is required, everything must be plausible. 

3. The company account in a foreign country

Many formation agencies offer "help in opening an account”. This means, in plain English, that an account is not opened, for example an English bank will not open an account, if the Director resides on Belize (unless he is present at the opening of the account, which is not probable).  Also many banks will not open a company account, in the event only bearer shares are issued (with the exception that the owners are present at the opening of the account or in certain countries such as Switzerland or Belize.  However, in these countries the owners must at least be disclosed to the bank and often must be present at the opening of an account.) “Just fill out a few forms” and the opening of an account is done, is, in most cases, nothing but a fairytale and has nothing to do with real-world business practices. 

-Taxes must not be paid in tax-haven countries?

Also in this case, a great deal of nonsense is published in the internet.  In reality, there are only very few "zero-tax havens”, like for example the Cayman Islands. In fact, many countries (Belize, BVI, Nevis etc…) offer the formation of so-called offshore companies (as a rule International Business Companies, IBCs), i.e. companies who only transact business and generate revenues outside the country, however onshore companies (companies, who transact business domestically) are indeed taxed. Offshore companies must of course provide proof, that they only transact business outside of the country, and they must of course keep their books in order. In addition, there are a series of other taxes (withholding tax, capital gains tax, inheritance tax, property tax, income tax etc…) that may be of interest to our clients and may under certain circumstances be levied in “tax-haven countries”.

- Are tax-haven countries always the most suitable countries for the formation of a company?

Certainly NOT. Tax-haven countries are defined as countries that have not entered into Double Taxation Agreements, Mutual Legal Assistance (MLA) Agreements, or extradition treaties for fiscal offences with other countries that at a minimum do not tax revenues that have been generated outside of the country.

The “screening effect" is not in effect against double taxation, specifically due to the lack of a Double Taxation Agreement. If a company, located in a tax-haven country is, for example, a stockholder of a company in Germany or the USA, in that event dividends distributed to such company in a tax-haven country are subject to the full withholding tax in Germany or the USA; while Double Taxation Agreements, as a rule, limit the withholding tax rate to 5%. Double Taxation Agreements also define under which circumstances the prerequisites for the existence of a permanent establishment are met and that a stock of goods or merchandise (warehouse), a permanent agent or a representation in another contracting state as a rule do not constitute a permanent establishment.  Should, for example, a company in Belize maintain a stock of goods or merchandise (warehouse) in another country, this warehouse as a rule does constitute a permanent establishment in the other country, i.e. taxation of the proceeds generated there.

Also the EU Parent Subsidiary Directive does not apply to tax-haven countries. This can have substantial disadvantages for associated companies; because in the case of the application of the EU Parent Subsidiary Directive the dividends distributed between the companies are tax-free (this fact of course is only advantageous to clients from EU states). 

Companies in tax-haven countries do not receive Value Added Tax IDs. This could result in substantial disadvantages, if these companies want, for example, to transact business with European companies.

In addition, if one considers the fact that for example Cyprus (EU Member, Double Taxation Agreement with almost all countries) has an income tax of only 10% or the Canton of Zug in Switzerland has a total tax burden of 15.5% for companies or that the EU special economic zones (Maderia, Canary special economic zone) entice with income tax rates below 5%, one should ask oneself the question, if the formation of a company in a tax-haven country is really the correct alternative. 

Factors, such as "economic and political stability”, play also a major role. Example Belize: As long as the British military protects Belize against territorial claims of its neighbor Guatemala, investments can reasonably be made. If the protectors withdraw, one can assume the worst will happen. Should one decide to make an investment, one should take out an insurance policy against imminent domain.

Of course, good reasons may exist with regard to forming a company in a tax-haven country. Specifically the fact that Mutual Legal Assistance (MLA) Agreements, and extradition treaties for fiscal offences do not exist and that many tax-haven countries do not maintain a commercial register, can be very helpful in certain constellations.

And of course there are also clients, who setup an “actual company” in tax-haven countries, with offices, employees and an employed Managing Director who maintains his ordinary residence in the foreign country. In such cases, of course, the situation is to be assessed differently. 

- Tax Planning within the scope of “associated companies”

Within the scope of associated companies, it is of extraordinary importance, if the EU Parent Subsidiary Directive is applicable and / or if a Double Taxation Agreement has been entered into and / or if the respective country levies withholding tax on outgoing distributed dividends.  This - and other details - must be considered in international tax planning. 

-Tax Planning within the scope of Holding companies

Numerous details must also be observed in the formation of a foreign holding:

  • Location of the subsidiaries (DBA-Situation, EU, Non-DBA Situation?)
  • Advantages and disadvantages of individual holding locations, with regard to the high priority objectives
  • How are non-holding-activities taxed in the seat country of the Holding?
  • Does a holding privilege even exist (for example Cyprus, Switzerland, Spain), i.e. no taxation on the distribution of incoming dividends (for example, Cyprus, Switzerland, Spain, the Netherlands) or low taxation?
  • How are outflows /dividend distributions of the Holding taxed, if they are distributed out-of-country or distributed in-country (withholding tax)?
  • How are interest and license payments of the Holding taxed?
  • How are deductions due to losses from sale and write-downs to the lower going concern value addressed?
  • How are deductions of expenditures for interests / stockholder debt financing addressed?

Conclusion

International tax planning is a very complex subject and belongs in the hands of trained specialists. “Just forming a company on the fly for a few hundred Euros" can have fatal consequences for the client. Good advice costs good money. And a waterproof company constellation, which would standup to subsequent verification - is simply not feasible for a small amount of money.

 

 

 

 

 

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