Optimization of Corporate Taxation Using Offshore Companies

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Today, the words ‘offshore’ and ‘offshore company’ have acquired a rather negative meaning: they evoke inadvertently associations with tax evasion, use of illegal schemes, money ‘laundering’, and other improper activities. This is favoured largely by news programs and declarations of the country’s first officials, appeals to “drive business out of the offshore shadows”. But is it indeed illegal? Can an entity reduce its tax burden legally in this way?

First of all, it should be noted that in developed countries, the terms ‘tax optimization’ or ‘tax planning’ are not ‘prohibited’ at all. They are considered to be a logical desire of a business subject to taxation to minimize its costs in ways permitted by the law. However, for example, the Russian Federal Tax Service deems such actions to be a cause for the company’s very thorough examination, if not as a crime.

In the world, international tax planning (ITP) is used widely. It means the taxpayer’s activities and/or registration in different states. Each country has its own tax policies. Therefore, it is reasonable to place the business in a country where you would pay less taxes.

Conditionally, jurisdictions used for the purposes of ITP and protection of assets can be divided into three groups.

The first group is classical offshore zones. Those are countries which provide offshore companies registered and not carrying out activities therein with the complete exemption from any taxes in exchange for a small fixed yearly fee, and which do not require any financial reporting. As a rule, those are small island states. The most widely known of them are the Bahamas, British Virgin Islands, Seychelles, Belize, Mauritius, Nevis, Panama, and Marshall Islands.

The second group includes jurisdictions with low tax rates for particular types of companies. They are often considered to be offshores, and the companies registered in them can be called offshore companies, or also non-resident, or exempt companies. Basically, such states do not require any financial reporting from corporations, in some cases charging minimum taxes on their activities. The most vivid examples of those states are Cyprus, Netherlands Antilles, Gibraltar, Hong Kong, Liechtenstein, Luxembourg, and Uruguay.

The third group comprises jurisdictions with inherently high respectability. In a number of cases, they offer various tax privileges, if some (often strict) conditions are complied with, and they are in no way offshore zones. Such jurisdictions are mainly chosen for improving the business image, adding to its respectability, and also for the subsequent potential entry into financial markets of those developed states. Such countries include the Netherlands, United States, United Kingdom, and Switzerland.

However, in this article, we are going to focus on ‘classic’ offshore companies with the following characteristics:

  1. They are non-residents in relation to the territory of their registration. Their ‘control and management centre’ is located abroad.
  2. Exempt from taxes and pay a yearly registration fee.
  3. Simplified company registration and management procedure.
  4. The use of nominal shareholders and directors is possible. The requirements to general shareholders and board of directors’ meetings are formal. The offshore company is managed using the services of a secretary company.
  5. There is no currency exchange control, and the requirements to financial reporting are minimized. Audit is not required, with rare exceptions.
  6. Corporate ownership can be performed anonymously, at high guarantees of confidentiality.

The goals and options of using offshore companies are quite varied. Here are some of legal ones:

  • trade using transfer pricing;
  • investment of funds and receipt of dividends;
  • performance of business activities;
  • purchase of foreign real estate and other assets;
  • imports of equipment (privileges on VAT and duties when imported as a contribution to authorized capital);
  • banking activities, insurance;
  • protection of business against illegal takeover (function of ‘safekeeping’ or ‘custody’), including by means of hiding the real owner. For this purpose, the least transparent jurisdictions are used: Bahamas, Panama, British Virgin Islands, Belize, etc.

However, there are also illegal, dangerous goals:

  • artificial transfer pricing;
  • reduced tax burden as the only goal, without business purposes – this goal will be also dangerous in many developed states, e.g. in the Czech Republic;
  • deliberate criminal activities: financing of terrorism, legalization of illegal income, etc.;
  • concealed ownership and management of business and assets by public officials or politicians – persons whose status prohibits such activities.

There are multiple schemes for reducing taxes in international business:

  1. The simplest option of using an offshore company in trade activities is to run import or export deals through it. By regulating the contract price, the company’s owner thus regulates the amount of taxes and duties paid. It is obvious that transfer pricing is involved here, which may cause a problem due to international regulation of prices established between companies belonging to one group.
  2. A low-tax company can be used as a holding. For instance, for Russia, a traditional jurisdiction for establishing a holding is Cyprus. This is due first to the beneficial tax treaty with Russia stipulating the low dividend tax at source in Russia for payments to Cyprus, and second to the low tax rate applicable already in Cyprus.
  3. Often, offshore companies are used for the ownership of copyrights, trademarks, patents, and other kinds of intellectual property. In this case, license payments (royalties) directed from the transnational corporation’s jurisdiction of core activities are accumulated in the offshore zone in tax-free regime.
  4. An offshore company can be used as a financial one, providing loans (as a rule, to associated companies) and getting them with interest in return. Interest is also accumulated in tax-free regime.
  5. For raising and investing funds in international markets, offshore investment funds are used (for instance, in the British Virgin Islands). Large international banking structures create subsidiary offshore banks, and thus lead a part of their business in tax-free regime.

It is important to note that when registering and cooperating with an offshore company, it is worth resorting to the services of a respectable legal agency, so as to guarantee the legality of your activities and avoid any issues with public authorities.

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