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Offshore Companies and Taxation: What You Need to Know

Cost reduction and tax optimization are major challenges that many international business people and investors face. Offshore taxation and its benefits are still a draw for transnational import and export corporations, IP holdings, e-commerce companies, IT sector firms, and multiple brokers. With a duly selected offshore jurisdiction to set up a company, your business will manage to cut taxes and legally save money thereon. Being able to discharge liabilities towards both their own jurisdiction and foreign states comes as an additional benefit for international companies. 

A Guide to the Taxation of Offshore Companies

Do you have to pay tax on your offshore company? If you have to, what taxes do offshore companies pay? What does offshore company taxation look like? What taxation models are characteristic of offshore jurisdictions and zones? Let’s delve deeper into these and related issues.

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Offshore tax – main principles 

To begin with, you should account for the national laws of the incorporation jurisdiction. As of today, 4 offshore jurisdiction types exist, each of which comes with its own perks and benefits.

1

In classic offshore jurisdictions, offshore companies incorporated therein are not taxed if they do not carry out any transactions in the said offshore jurisdiction.

2

Low tax jurisdictions boast low corporate tax rates and special tax regimes.

3

In prestigious offshore jurisdictions, administrative and territorial taxation is common, which secures total tax exemption for companies that generate profits outside of the said offshore jurisdiction.

4

Jurisdictions with traditional taxation systems oftentimes boast preferential tax regimes for certain companies and particular activities.

What else is important are principles for profit source identification that remain a challenging issue in practical terms. Without a single universal solution to fit each scenario, it is no longer possible to do things en masse. Nowadays, every single business, its needs, expansion about to happen, activity types, and taxation issues may only be handled and decided on a case-by-case basis. 

Whether profits originating in a certain jurisdiction shall be taxed is decided with due account of several factors like what actions the taxpayer takes, where they operate, what or who the counterparties are, and what their incorporation jurisdiction is. Mind that transactions carried out by a particular taxpayer and not all the business group members are discussed here. 

As for offshore taxation principles in general, here’s how offshore companies pay taxes:

  • in their incorporation jurisdiction, where the corresponding company has substance
  • in the jurisdiction where the company generates or receives its passive income (withholding tax) in the form of interest, royalties, consultancy fees, income from securities, etc.

Your company may be obliged to pay all the taxes if it has a permanent establishment in a certain jurisdiction. 

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NB: standard tax rates may be amended as provided for under provisions of the corresponding double taxation treaties between signatories thereof.

What taxes do offshore companies pay? 

As for classic offshore companies, they often do not pay taxes at all. To avoid taxation per se, your company needs to operate outside of your home jurisdiction and be managed and/or controlled from such overseas jurisdiction where corporate documents are stored. Yet, before you proceed with company incorporation, be sure to check whether preferential offshore taxation is still an option. The thing is, several offshore jurisdictions have amended their laws and now companies incorporated therein are obliged to pay taxes.

If a company operates locally and has substance in its incorporation jurisdiction, local laws oblige the said offshore company to pay taxes as provided for thereunder. 

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FYI: in many traditional offshore jurisdictions, laws have been amended to include no substance requirements so that these laws would be in line with international regulations that were introduced to combat terrorism financing and economic crime. Offshore companies meeting the substance requirement may benefit from double taxation agreements.  

In the case of classic offshore jurisdictions, any profits originating outside the offshore incorporation jurisdiction are not taxed. Regular jurisdictions, at the same time, have the right to tax income and profits regardless of where they originate from. You should keep in mind that it may be necessary for your offshore company to pay taxes in the jurisdiction where the corresponding income or profit was generated. It is only after that that you may withdraw the corresponding funds to your company account. Beware that major states may impose protective taxes when working with certain offshore jurisdictions.

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NB: be sure to consult the International Wealth seasoned profs to account for all the hidden pitfalls before you proceed with offshore company incorporation. 

Tax justice is an essential factor as far as international tax policies are concerned. The concept was worked out while developing OECD, FATF, and European Commission recommendations. It provides for a greater tax burden for those taxpayers that operate in better economic and tax environments as their profits are higher. In real terms though tax justice discussed above depends on whether certain jurisdictions are ready to reduce income tax and if yes to what degree as well as when such income tax shall be paid. 

You should differentiate between turnover tax and sales tax. While the former is paid on net profits for the corresponding tax period, the latter is the tax paid on sales deals in respect of services or goods sold. This way, a taxable event takes place when a deal is made, and goods or services are exchanged for the corresponding remuneration or sold to the end user. Alternatively, it may result from customs duties, import duties, or excises. 

In any case, the geographic position of the main taxpayer’s profitable transactions shall be established. The jurisdiction where the main investment and management decisions are made is only one of the factors that influence the primary source of income. 

Tax payment principles European companies follow in case of offshore transactions 

Most rules and regulations that govern controlled foreign corporations (CFCs) are designed to prevent tax evasion. Most often, CFCs shall include their profits in tax returns submitted by resident shareholders. This way, the taxable base of the jurisdiction where investments come from is efficiently protected.  

Oftentimes, income sources are determined following the permanent establishment (PE) concept stipulated in the corresponding tax agreements. In reality, however, many states experience difficulties with formulating rules for profit taxation, say, for non-resident companies. With the transactions such companies make, it is much more difficult to calculate expenses born before the taxable base is determined. The reason for the above is that CFC rules provide for submitting the above data in those jurisdictions where the company’s beneficiary owners reside.   

Several essential aspects spring to mind when analyzing the taxation principles European companies apply when making deals with offshore companies:

  • in the absence of substance requirements, many jurisdictions tend to use the concept of the place of effective management
  • when you manage an offshore company from a different jurisdiction, such jurisdiction may have the right to tax your business regardless of its official tax residency
  • each foreign company shall not only rent an office and hire employees but also substantiate its actual incorporation objective
  • to be eligible for preferential tax rates, a business shall have a detailed business plan in place as it is not only difficult but also dangerous to set up a company for the sake of tax benefits only nowadays. 

To answer the question of what taxes offshore companies pay please keep in mind that there are situations where businesses may be obliged to pay taxes and fees in 2 jurisdictions at the same time. You should carefully compare expenses to set up an offshore company that may face real economic substance requirements with the money you can potentially save on tax payments. It is by far not always that an offshore company is the best solution for you, yet they generally come with higher confidentiality and fewer expenses.     

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FYI: if your business is in an EU-blacklisted jurisdiction, be ready to deal with potential transfer pricing restrictions. Tax authorities have the right to amend the value of contracts made by and between affiliated companies (say, in the EU and offshore jurisdictions) and implement capital controls restricting the movement of capital. 

Offshore taxation: busting the myths  

In light of recent changes, many traditional offshore jurisdictions came up with substance requirements. This means, your company may become a full-fledged foreign resident. Even today though you can find states allowing you not to pay taxes in the incorporation jurisdiction if your income originates outside of it. 

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Turn to the International Wealth experts if you would like to find your way through taxation jungles.  At International Wealth, we study and consider each situation on a case-by-case basis, with due regard to the multiple factors and criteria involved.

International Wealth customers often wonder whether one offshore company is enough to save on tax payments. Unfortunately, the solution is by far not always efficient due to multiple restrictions, the EU blacklist, and actions taken by tax authorities and central banks of the corresponding jurisdictions. Please remember that every case is unique and it makes perfect sense to consult the International Wealth industry wizards about your particular circumstances and how you can best use them to your benefit. A thorough analysis is necessary as regulatory authorities may come with very different blacklists for different jurisdictions . 

As far as popular myths about offshore company taxation go, several things deserve your attention:

  • beneficiary owners, directors, and shareholders are the individuals who mainly benefit from offshore company transactions and operations
  • not every foreign bank accepts companies from certain jurisdictions like the Seychelles, Nevis, Ukraine, or Russia as customers and the matter does not concern applicants from offshore jurisdictions only
  • setting up a company abroad and choosing a servicing bank afterward is risky, it is better to do it the other way around
  • just like offshore companies, onshore or mid-shore businesses shall always pay taxes as provided for by the laws of the corresponding jurisdictions
  • simply leaving your offshore company behind is a bad idea that may result in major penalties and liabilities in the future and if you fail to meet them your business won’t be able to operate. 

According to offshore taxation principles, funds can’t go from an offshore jurisdiction to the ultimate beneficiary thereof if all tax liabilities in the incorporation jurisdiction and the jurisdiction where the company’s income originates from are not discharged.

If in need of an export and import structure involving offshore companies, you are welcome to message International Wealth at [email protected]. With many years of work experience and multiple international connections, the International Wealth experts are here to assist you with building the most efficient business structure possible. 

Transnationals actively use offshore companies to optimize profit taxes originating outside such offshore jurisdictions nowadays. For more information on offshore taxation and the principles thereof please contact the International Wealth team. You are welcome to order an individual tax planning strategy for your business to benefit from the experience major market players boast.

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