Offshore Tax Compliance and Tax Residence

Offshore tax compliance aspects are often left misinterpreted and misunderstood by company owners. That is why many law-abiding clients are concerned whether the investor’s onshore tax and/or legal residence (and the likely legislation amendments) can impact the offshore company’s tax compliance. They compare taxation systems, seek legal expert advice on their tax strategies. 

If you still think that tax planning remains a DIY exercise, please consider how different the world has become.  Global AML measures have contributed to greater international tax transparency. The development of a new world-wide standard of automatic information exchange is in progress. The BEPS (base erosion and profit shifting) Action Plan is designed to re-adjust international standards in taxation. The worldwide recession is rolling out. Tax havens are pressed to re-adjust their taxation policies. Bankers are getting more biased towards clients from some jurisdictions.  

Proper customized assistance in choosing banks, applications for second citizenship, registration of foreign companies, tax planning has become more critical for a successful offshore strategy. You are welcome to request a free individual consultation and order fee-based services of our professional experts on any matters related to offshore jurisdictions.

Regulation of activities of foreign companies

This article discusses such nuances of offshore tax compliance as tax residence, legal residence,  taxation system, sources of income, DTAs, other aspects that make a difference.

First of all, it is important to understand that there is no place on earth where taxes can be legally absolutely avoided. If there are certain tax obligations, they are binding. 

There are countries with the territorial principle of taxation which is tied to the income obtained by resident companies or individuals only within this country, so any other income is tax-exempt. 

Corporate and common laws of some offshore countries prescribe taxation of certain types of income (e.g., interest, dividends, royalty, capital gains) received in their offshore zone by companies that are not their tax residents. 

The most popular tax system in the world is residence-based: taxes are tied to the place of tax residence, no matter in which country the income is generated.  

There are also combined tax systems. Awareness of their nuances is important for the right choice of the jurisdiction, tax residence, business entity type, tax compliance.  

Let us explore whether the laws of the country of tax residence of an investor or businessman can regulate an offshore company. We will also look into the rules defining tax residence and the principles of running registered business units (permanent establishments) abroad. 

The Legal Status of an Offshore Company 

Any legal entity registered in another jurisdiction (offshore, midshore, or onshore) is considered an independent legal entity. This means it is not subject to laws and regulations of the country of the owner’s tax and/or legal residence. No country of an owner’s residence can interfere with the activities of an offshore company. They also cannot require reports from the other jurisdiction’s authorities, unless the company conducts business in their territories. 

Each offshore company is an independent commercial entity with no additional obligations on the part of the ultimate owner. 

If you are a shareholder of a private company registered in an offshore zone, there is an obligation to declare in your country of residence all dividends received from the ownership of offshore securities. They are treated as your local income.

In such a situation, you as an investor/business owner must pay all taxes on the profits received under the established tax regime in your country. 

As you can see, your offshore company is not subject to regulation by the jurisdiction of your tax residence. However, your business may face quite serious tax-related, banking, or reputational challenges. Let us look at some examples:

1. Tax-related limitations: impossibility to apply Double Taxation Agreements; the offshore duty (for example, in Ukraine it is 100%); limits set for the total amount of expenses that can be qualified as transaction costs with an offshore company.

2. Banking restrictions: Europe is particularly wary of companies registered in offshore zones and can regard even standard transactions as suspicious; it is impossible to open an offshore company’s bank account within the EU.

3. Reputational constraints: accountants, lawyers, auditors from the EU member states have certain prejudices against offshore companies.  

All of the above-mentioned observations are worth thorough further analysis. Such obstacles can be eliminated yet at the early stage of company formation through competent business structuring. This is how you can avoid many costly mistakes, protect your assets and personal information as much as possible, and feel free to enter new markets, find partners, and open corporate bank accounts. 

If you decide to follow our advice and rely on our experts’ professional help, you are welcome to refer to us by writing to the e-address given at the top of this page. 

We will help you plan/optimize taxes, design an effective business scheme relying on the advantages of a classic offshore entity, open a bank account for an offshore company in a professionally selected jurisdiction.

Having discussed some obstacles and restrictions, let us see how you can choose the right jurisdiction for incorporating an offshore company not liable to pay worldwide income taxes in a situation of its legal presence/residence in different countries.  

How to Choose the Tax Residence

Your registered offshore company’s activities are subject to regulations of the fiscal authorities of the jurisdiction where it is registered as a tax resident. It is easy enough to get the residence status if the company is established and files tax returns in the country where the corporate tax is payable. But what if this tax is not levied in some jurisdiction? 

Examples:

The commercial profit of entity N located in country A may be taxable in jurisdiction B in the following situations:

  • company N is a tax resident of country B;
  • company N is a tax resident of country A and has a permanent establishment (registered office) in country B.

The difference is that in State A company N will pay the tax on the total income, while in jurisdiction B it will pay the tax only on the profits of its permanent establishment (registered office). However, even in this case, your state (which you consider your home country) cannot regulate activities of your offshore (or foreign) company, nor can it influence in any way the work of the permanent establishment.  

Tax Residence and DTA

When choosing the tax residence, it is very important to be sure of the company’s ability to apply provisions of the Avoidance of Double Taxation Agreements (DTA). 

For example, a company in Hong Kong can use the Hong Kong-China DTA, so can be defined as a resident of Hong Kong, either registered in that jurisdiction or managed and controlled from Hong Kong. 

Thus, the location of its effective management is a fundamental factor determining the tax residence jurisdiction.  

Please note: According to the Model Tax Convention on Income and on Capital of 2017, the choice of the tax residence needs to be mutually agreed by both Contracting States with consideration of the location of the actual top management of the ‘permanent establishment’.

When defining the location of the top management of an offshore company, all relevant facts and circumstances must be taken into account. Their inventory should include all persons in any way connected with making key decisions. In other words, the location of the top management cannot be established by the location of only one director or CEO. Also, the director’s lack of the necessary competence is a direct indication that there is some beneficiary / top manager, who is the actual decision-maker.  

The location of an offshore company, including for tax purposes, is defined by the following factors:

  • the place of residence of the majority of the Board members;
  • the place where major decisions are made and shareholder meetings are held;
  • residence of the beneficiaries (if the management body cannot make control decisions);
  • residence addresses of other controlling persons with a general POA to manage the offshore company;
  • the location of the parent company controlling the offshore entity, etc. 

The above-said is another proof that the company you registered in the offshore zone cannot be controlled by your jurisdiction. In legal terms, it is one of all legal entities subject to another jurisdiction (which one is qualified according to the criteria mentioned above). Given that companies in classic offshore zones cannot conduct activities within boundaries of their jurisdictions to qualify for zero tax rates, the provisions of the DTA also cannot be used. 

Please note: The authority to make key decisions about the company does not automatically mean that such a person belongs to the category of managing and controlling directors.

As a foreign investor or business owner, you have the right to use a wide variety of offshore jurisdiction strategies and policies to build an effective business structure. 

Our professional profile includes the design of tax planning schemes to help you optimize expenses and protect our clients’ assets. You are welcome to rely on our services.

How Are Permanent Establishments Regulated?

The world is becoming increasingly transparent in terms of financial information. Corporations with their divisions/ permanent establishments registered as offshore companies/entities should analyze their corporate tax residence(s). The main criterion is their compliance with the tax rules (which are different in different jurisdictions and need to be thoroughly monitored). Having accumulated the most comprehensive and detailed information, business groups will be able to revise and re-engineer their tax residence. Thus they will be able to reduce the fiscal burden by moving to a jurisdiction offering more favorable conditions, taking certain measures (eg., preparing the required documents) for tightening the safety of their property and capital.  

Such a focus on the topic of permanent establishments, tax residence and compliance, jurisdictions’ regulations, and top management’s location is a very important point of discussion. For major corporations, this is one of the promising ways to tax burden optimization. The right choice of jurisdictions will provide them with long-term benefits and interesting incentives.  

A permanent establishment is a business entity that is taxed internationally.

As in the case of an individual offshore company, your state cannot interfere with a permanent establishment’s activities or regulate its business processes. Such an entity is subject to the laws of the jurisdiction in which it was registered while being subordinate to the parent company. 

Other advantages of setting up permanent establishments (PEs) in offshore and other countries are as follows:

  • an international corporation establishes a proper permanent presence in a foreign country;
  • if it generates local income, the host country may tax it at the rates of the PE’s jurisdiction of incorporation;
  • the proof of a PE’s permanent place of business can be an office, factory, workshop, branch, mine, well, and other facilities;
  • recruitment of the local sales agents may be sufficient to create a PE (in which case the authority must be exercised regularly, not on an ad hoc basis);
  • technical and management services can also be regarded as a form of a permanent establishment, including the business trips of staff to other countries.  

Construction and consulting projects, sales agents, digital sales and e-commerce can use this type of a legal entity as part of their international tax planning schemes. You can delegate the design of an efficient and relevant structure to our experts and thus spare your business of extra high costs, including the administrative and maintenance expenses.  

Company Registration in an Offshore Zone, Popular Countries 

Finally, let us share a brief list of tax havens, which are popular with foreign business owners. According to our estimations, doing business is quite prestigious and interesting in BVI, Nevis, Belize, Seychelles, the Isle of Man, and Jersey. Luxembourg and Liechtenstein offer unique incentives and benefits to international investors. The Marshall Islands are highly reputable, it is a very developed international financial center with the possibility to establish both resident and non-resident offshore companies. 

Please note: we can assist you in opening accounts for a company in classic offshore zones, including the Caribbean banks, as well as with VIP payment systems, non-banking facilities.

If you are looking for the perfect tool for offshore company asset protection and tax optimization, please contact our experts. We design each structure following the principle of customer-specific services and products. There are simply no one-size-fits-all solutions. An offshore company is an entity with rather cheap maintenance rates, great flexibility, minimum obligations, and a simple annual renewal procedure. You can delegate the full service of an offshore company to our experts for higher efficiency. 

Is my offshore company regulated by my home state?

No. An offshore company is created under the laws of the jurisdiction in which it is established. The country of your tax residence cannot affect the activities of such a legal entity, as it is a separate legal entity with full independence. However, companies in the offshore zone may face tax and other restrictions.

Does the regulatory policy depend on the tax residence of the offshore entity?

If the offshore entity is registered in one jurisdiction but qualifies as a tax resident of another country, its activities are regulated by the jurisdiction of the tax residence. The company may also have tax residence in more than one jurisdiction.

Why is it beneficial to register permanent establishments abroad?

Many countries with low or zero taxes offer special conditions for permanent establishments of foreign companies. Registration of a permanent establishment is an effective business tool with minimum requirements and (quite often) preferential taxation.

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