Chapter 11 - Tax Benefits of Offshore Companies

11.1 Introduction

A UK resident company is subject to UK corporation tax on its worldwide income and gains. By contrast a non-UK resident company is only subject to corporation tax on its UK income.

At first glance, therefore, it would seem that an offshore company is an effective way of sheltering income and capital gains from the taxman, as all foreign income and gains accruing to the company should be free of UK tax.

In fact using a directly owned offshore company is not a straightforward option to avoid UK taxes. One of the reasons for this is the issue of 'deemed' company residence. A company is regarded as a UK resident if:

• It is a UK incorporated company, or
• Its central management and control is in the UK.

Various legal cases have indicated that it is the function of the board of directors to run the company; therefore, Revenue and Customs would initially be concerned with where the board of directors meet, when they meet, and whether they actually exercise control over the company and make management decisions.

So if a board of directors meet overseas and review management decisions and strategies, this should constitute overseas central management and control.

However, where there is a controlling shareholder in the UK, there is a risk that the directors will not correctly exercise their authority over the company with the result that HMRC may argue that the company is run by the controlling shareholder in the UK. In these circumstances the company would be classed as UK resident and subject to UK corporation tax.

Tax Efficient Corporations - Analysis

Bermuda corporations - Economic Substance Requirements

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Bermuda does not apply a corporate income tax to corporations, however, there are economic substance requirements that should be taken into account for Bermudian resident entities...keep reading

Bahamas corporations - Economic Substance Requirements

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Although the Bahamas does not levy corporate income tax, it does have economic substance requirements for certain Bahamanian entities. In this report we look at the scope of these requirements....keep reading

British Virgin Islands - Economic Substance Requirements

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Although there is no corporate income tax in the BVI, there are economic substance requirements for certain resident companies...keep reading

Cayman Islands Companies - Economic Substance Requirements

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Although there are no corporate income taxes in the Cayman Islands, there are economic substance requirements, which apply to a number of companies incorporated or registered there. In this article we look in detail at the scope of these requirements...keep reading

11.2 How the taxman Spots Phony Offshore Management

HMRC has stated that it will look at offshore companies to identify if there has been an attempt to create simply the appearance of central management and control in a place.

Therefore, care is needed to ensure that any overseas directors are actually running the company.

In order to pass the central management and control test the majority of the directors should be non-UK resident, and the non-UK resident directors should actively participate in making board decisions.

This therefore means that key business decisions should be taken at overseas board meetings. A UK resident shareholder may therefore establish a non-resident company but it is essential to ensure that the running of the business is left to the non-resident directors.

The central management and control test was looked at by the High court and the Court of Appeal in the 2005 case Wood v Holden. The taxpayer in this case successfully argued that the central management and control of an offshore company was overseas.

The facts were complex, but essentially, a Dutch subsidiary was incorporated which was part of a tax planning scheme. It acquired some shares in a UK company and HMRC felt that, as there was no real business being carried on overseas, the Dutch company should be taxed as a UK resident company.

The appeal commissioners sided with HMRC and took the view that "... the company resides for purposes of income tax where its real business is carried on where the central control and management actually abides...".

However, both the High Court and the Court of Appeal decided this was wrong. They said that the directors who were non-resident were not sidestepped or bypassed, and there was no evidence that UK parties dictated to them. The overseas directors actually executed the board meetings and resolutions.

Therefore in the absence of any evidence showing them deferring to other parties, they and the company were non-resident.

This case reinforced the fact that it is essential that overseas directors actually consider the board resolutions and other transactions in order to evidence the fact that they are not under the control of another person. Note that an overseas shareholder having influence over the directors is fine, but there is a problem when the directors simply accept everything the shareholder says and carry out his wishes without any consideration.

11.3 role of a managing director

If there is a managing director who has exclusive power to run the company, there's a good case for arguing that this person has 'central management and control'.

If you want to use this to argue that one overseas director actually exercises central management and control, it would be advisable to also have this laid out in the company's Articles of Association.

11.4 Recent case on company residence

One of the latest cases to be considered in relation to the residence of an offshore company was Laerstate BV v Commissioners.

This case covers many issues which we have covered above and provides a useful summary of the key points.

The company in question was incorporated in the Netherlands on 1 August 1988 as a wholly owned subsidiary of another Dutch company. Its sole director on incorporation was an individual ('T').

In December 1992 'B' acquired the entire shareholding in the company and was appointed as a director until he resigned on 30 August 1996. Note that for Dutch tax purposes the company was resident in the Netherlands as it was incorporated there.

The company then purchased an investment in December 1992. In October 1996 the investment was sold at a substantial capital gain. B was UK resident as of 1993.

HMRC subjected the company to corporation tax on the gain on the basis it was resident in the UK for tax purposes at the time the gain arose. The company argued it was not UK resident as it was controlled from overseas. The Tax Tribunal held that it was UK resident.

Remember in this case, the shareholder was UK resident and also a director of the company for part of the period of ownership. After he resigned his directorship, 'T' (non-resident) was the director.

As we have stated previously, the courts look at the top level strategic management of the company and won't be fooled by attempts to have nominees exercise 'fake' control from overseas.

It was no surprise then that the Tribunal found that the company was UK resident, as it was controlled and managed from the UK.

The Tax Tribunal specifically said:

"…it was not disputed that for tax purposes a company resided where the central management and control (CMC) 'abides'.

That was a test that did not confine itself to a consideration of particular actions of the company, such as the signing of documents or the making of certain board resolutions outside the UK if a more general overview of the course of business and trading demonstrated that central management and control 'abides' in the UK.

There was no assumption that central management and control was found where the directors met. It was entirely a question of fact where it was found. Where a company was managed by its directors in board meetings it would normally be where the board meetings were held. But if the management was carried out outside board meetings one had to ask who was managing the company by making high level decisions and where, even where that was contrary to the company's constitution.

There was nothing to prevent a majority shareholder, whether a parent company or an individual majority shareholder, indicating how the directors of the company should act. If the directors considered those wishes and acted on them it was still their decision. The borderline was between the directors making the decision and not making any decision at all.

The mere fact that B was resident in the UK during the relevant period did not of itself mean that the company was resident in the UK. The question was whether he was exercising central management and control in the UK, as he had authority as a director of the company to do. It could not be said that, on the facts in this case, all acts of central management and control of the company took place outside the UK.

B's activities as a director of the company in the UK went much further than ministerial matters or matters of good housekeeping. His activities in the UK were certainly concerned with policy, strategic and management matters, and included decision-making in relation to the company business in that period.

Accordingly, in the period to 30 August 1996, when B resigned as a director, central management and control of the company was exercised in the UK.

In relation to the time after B ceased to be a director, only T could sign for the company in a way that would bind a third party. The issue was whether T acted on B's instructions without considering the merits of them, or whether he considered B's wishes and made the decision himself while in possession of the minimum information necessary for anyone to be able to decide whether or not to follow them.

On the facts found, it could not be said that T made any of those decisions. The decisions were those of B; T signed the necessary documents but no change could be detected in the way the company was managed before and after B ceased to be a director of the company (or before he became a director).

B predominantly made those decisions in the UK and so the company was resident in the UK during the time after B ceased to be a director on 30 August 1996 until at least 31 December 1996."

Therefore this case provides a good indication as to how the Tribunal looks to identify where the 'real' control as opposed to 'apparent' control is exercised from.

It also reinforces the importance of the position of the directors in terms of identifying the central management and control.

It's not just a case of looking at where the shareholders of a company meet. Instead you look to see where the 'controlling mind' of the company's business is to be found.

You would therefore look at the constitution of the company to see who has the power to manage the company's business. Usually this will be the directors.

As such, provided the directors have not been usurped from their position of control, the case law tends to show that the place of residence is the place where the board meets.

Because establishing where the management and control is carried out can be difficult to ascertain, HMRC published some draft guidance on this matter in 2010.

HMRC has specifically stated that it is not the number of UK directors meetings versus the number of overseas meetings that is important. Instead, what is important is what activities are actually carried out at the board meetings.

HMRC also confirmed that the location of a director's tax residence doesn't impact on the residence of the company. Instead it is the location where the management and control are carried out that is important (which is not necessarily the same as the country of tax residence of the director).

How to Establish an Offshore Company as Non-Resident

Clearly you should ensure that detailed professional advice is taken based on your specific facts. As a general rule you should ensure there is an active board which meets and takes decisions.

Some of the key points to bear in mind include:

• Hold at least six board meetings a year (Although three or four should be acceptable).
• Keep full minutes which show the directors exercising central management and control.
• Hold meetings in a fixed place (at least usually).
• Do not hold any board meetings in the UK. In addition you should ensure there is not a quorum of directors resident in the UK (to avoid accidental UK meetings).
• Do not allow directors to participate in directors' meetings by telephone/video conferencing or by using e-mail from within the UK. In addition, where directors' resolutions are passed in writing, don't sign them in the UK.
• If the board wants things done in the UK it needs to delegate the activities to be performed by people in the UK and then supervise what they do at the regular (overseas) board meetings.

11.5 Apportionment of Capital Gains

UK tax anti-avoidance provisions require the gains of a non-resident 'close' company to be apportioned amongst the member shareholders. Capital gains tax is charged on those who are resident and domiciled in the UK.

Before 6th April 2008 these apportionment rules did not apply to non UK domiciliaries. However, the changes to the remittance basis from April 2008 means that if a shareholder is UK resident but non UK domiciled, they will be subject to the remittance basis on any gains realised by the offshore company. As such they can avoid having gains attributed to them under this section by retaining the proceeds overseas.

The definition of a close company can be complex, however in simple terms it applies to a company that is controlled by its directors or five or fewer shareholders.

Example

Jack and Jill are the sole shareholders of JackJill Ltd, a company registered in the Cayman Islands. They hold 50% of the shares each and are both UK resident and domiciled. Assuming they allow non-resident directors to run the company and can satisfactorily show that the company is not centrally managed and controlled from the UK, the attribution of gains legislation would mean that any gains of the offshore company would be attributed to Jack and Jill (50% each).

However, if Jack was non-UK domiciled and subject to the remittance basis the gains could only be attributed to him to extent he actually brought the gains into the UK.

11.6 Benefits in Kind

If the taxman is able to assert that the company is being managed by the shareholder or that the directors of the company are accustomed to act on his directions, he will be classed as a shadow director and income tax will be payable on any benefit in kind received by him or his family. One of the key benefits in kind that may apply is the accommodation charge. This levies a charge on an employee where he or she is provided with accommodation by an employer.

However, in the 2007 Budget a change was announced to the tax treatment of overseas property companies. The effect is to remove the benefit-in-kind tax charge for investors who buy overseas holiday homes using a company. (In many countries, investors are forced to buy property through a company).

There are certain conditions that have to be satisfied. (For example, the company must own no other assets.) On the other hand, this change removes one of the main drawbacks of using a company to invest in overseas property. However, it doesn't alter the fact that the investor will still have to pay corporation tax instead of income tax or capital gains tax, which may result in a higher tax bill in many circumstances.

11.7 Using a Non-Resident Trust AND Company

For the reasons stated above, offshore companies that are directly owned by UK residents are not actually that common in practice. Instead, offshore companies owned by offshore trusts are used more frequently. Such arrangements are often popular from a non-tax angle due to the practical advantages of owning the trust investments through one or more wholly owned offshore companies. This gives the trustees the benefit of limited liability.

The residence of the company is not a key issue in these circumstances as the only persons legally entitled to exercise control of the company are the non-resident trustees.

However, following on from the Wood v Holden case, care would need to be taken to ensure that the company really is run by either the trustees or directors. If they were to stand aside and let a settlor/beneficiary give all the instructions, it could be contended that the company residence is the same as that of the settlor or beneficiary.

Provided the beneficiaries were non-resident, they would suffer no UK taxation charge on distributions from the trust, and the company/trust would also suffer no UK tax charge if the assets held were overseas assets. If the beneficiary is a UK resident, the main problem would be the UK anti-avoidance legislation. There are limited ways of escaping this, and if one of the exemptions applied (for example, the motive test), this could be claimed on the tax return.

The motive test is an important aspect of one of the key anti-avoidance rules that attributes the income of offshore trusts and companies to UK resident individuals. The anti-avoidance provisions will not apply if the transfer overseas were not made for the purpose of avoiding tax or if there were a real commercial reason for transferring assets to an overseas company or trust.

Therefore for an individual to take advantage of this rule, and claim that income from an offshore company or trust should not be attributed to them, they would need to show that there was no tax avoidance motive in the transfer of any asset overseas. Essentially, the companies were located overseas for sound commercial reasons. This can be a difficult provision to satisfy.

In order to be non-resident for income tax and capital gains tax purposes under the current rules, the trustees would all need to be non-resident if the settlor was UK resident.

Example

Peter, a UK resident and domiciled individual wishes to purchase a business and property in Ibiza. One option would be to establish a trust, and transfer funds to the trustees. They would then either purchase the property directly, or via a wholly owned company.

The transfer of funds from Peter would, however, be a problem from an inheritance tax perspective. As Peter is UK domiciled, the settlement is an immediately chargeable transfer, taxable at 20% for amounts above £325,000. (This assumes that he has made no previous gifts). However, the advantage of using a discretionary trust route is that the property would then be excluded from his estate for inheritance tax purposes. The drawback is that the trust would be subject to a separate regime of UK taxation. For inheritance tax purposes, the trust is subject to UK inheritance tax if Peter were domiciled in the UK when the transfer was made. This would undoubtedly be the case.

In these circumstances one option to exempt the trust from UK inheritance tax would be for the transfer to the trust to be of 'relevant business property'. The transfer to the trust would then be exempt from UK inheritance tax, and the trust itself would not suffer an ongoing inheritance tax charge, as business property relief (BPR) would exclude the property from the inheritance tax charge.

Relevant business property includes a sole trader business, assets used in a partnership and shares in unquoted trading companies. Therefore in this case it would be far better for Peter to purchase the business and property directly and subsequently transfer this to the trust/company.

Provided any transfer was made shortly afterwards, there would be unlikely to be a capital gains tax charge as any increase in value would be minimal.

The trust would then be exempt from UK inheritance tax as the assets transferred would qualify for Business Property Relief.

11.8 Using an Offshore Company AND Trust:
Non-UK Domiciliaries

Many non-UK domiciliaries choose to use this structure to minimise their UK tax liabilities.

Example

Paul is a non-UK domiciliary and wishes to purchase a property in the Isle of Man (IOM). He decides to use an offshore company to own the property with 100% of the shares in the company owned by a non-resident IOM trust. The tax implications are as follows:

Capital Gains Tax

As non-residents the trust and company will not be subject to UK capital gains tax. Provided the beneficiaries are non-UK domiciled, any distribution to the beneficiary should be taxed on the remittance basis (provided they are subject to the remittance basis on their income and gains).

Income Tax

Any income distributions would be taxed on the remittance basis (provided this is claimed). There are anti-avoidance provisions in place so that income earned by the trust is not subject to UK income tax on beneficiaries, unless it is remitted to the UK (again provided the remittance basis is claimed).

Inheritance Tax

The Isle of Man trust is only subject to UK inheritance tax on UK assets, as it was established by a non-UK domiciled individual. By using the offshore company to hold any UK property, there will be no UK inheritance tax on the property, as the trust will hold shares in an IOM company, which are treated as non-UK assets for inheritance tax purposes.

Recent Changes To the Anti Avoidance Rules

The 2013 Finance Bill included a number of changes that will impact on UK residents owning offshore companies. Of key importance will be the changes to how income and capital gains of offshore companies will be taxed on UK resident shareholders.

The main new provisions are:

• Introduction of a new exemption which excludes gains from "economically significant" activity carried on outside the UK, broadly the provision of goods or services on a commercial basis involving the use of staff, premises, equipment and addition of economic value commensurate with the size and nature of those activities.
• A general motive exemption for gains on disposals where neither the disposal of the asset nor the acquisition or holding of the asset by the non-UK company formed part of a scheme or arrangements to avoid capital gains tax or corporation tax. This exemption is not restricted to trading companies so should protect investment holding companies set up for reasons other than UK tax avoidance, for example a local company set up to acquire foreign real estate.
• The de minimis limit for attribution of gains will be increased from over 10% to over 25%.

The changes will take effect from Royal Assent to Finance Bill 2013 but with retrospective effect from 6 April 2012.

Whilst the above rules all apply to capital gains of offshore companies, there will also be an additional exemption for income of offshore companies. The new exemption applies when the imposition of UK tax liability would constitute an unjustified and disproportionate restriction of the individual's freedom of establishment or movement of capital in EU law.

11.9 how to use your Spouse's Offshore Status

Even though you may not be non-resident or non-domiciled, this does not necessarily prevent you from taking advantage of certain offshore tax planning opportunities. You may be able to reap rewards if you are lucky enough to have a spouse with some type of 'offshore' status.

The most famous example of this is BHS boss Philip Green. In the past he has routed hundreds of millions of pounds in dividends through his wife. Thanks to her non-UK resident status, these amounts have been completely tax free.

You too could use similar techniques to reduce your UK tax bill if you have a spouse who is either non-resident or non-domiciled.

If your spouse is non-domiciled, chances are he or she will either have been born overseas to foreign parents or, if born in the UK, the parents will be foreign and your spouse will have demonstrated substantial links with the home country (for example, by owning property and having close family ties, etc). Furthermore, your spouse will make it clear that he or she does not intend to remain in the UK permanently.

Ideally, your spouse will also not have been UK resident for the last 17 years. In these circumstances he or she will be deemed UK domiciled for inheritance tax purposes. Despite this, there are still lots of tax benefits that can be obtained thanks to being non-UK domiciled, especially if you have not been UK resident for more than 7 of the last 10 tax years.

If your spouse is non-UK resident a significant proportion of the year will have to be spent overseas.

The Benefits of a Non-UK Domiciled Spouse

If you are UK resident and domiciled and your spouse is UK resident but non-domiciled, this opens up some interesting tax planning opportunities.

Many people want to use an offshore company to hold UK or overseas assets. As we have seen, for a UK resident domiciliary many of the advantages of using offshore companies are eliminated by anti-avoidance legislation. If, however, your spouse is non-UK domiciled, that person can be used to hold assets or to use offshore companies and trusts in a tax effective manner provided they are subject to the remittance basis.

Some of the key opportunities could include:

• Establishing an offshore company to hold UK assets, in particular property that is not occupied by any directors or shareholders (subject to the new anti avoidance rules aimed at properties valued at more than £2 Million). The main benefit would be to take the assets outside the scope of UK inheritance tax (IHT). Non-UK domiciliaries only pay IHT on their UK assets. But if a UK property is owned by an offshore company, the property is no longer regarded as a UK asset. You would need to be careful to ensure that the company is controlled overseas and that no property owned by the company was occupied by UK resident directors or shareholders. (Otherwise, a UK income tax charge could arise).

• Another benefit is that it is much easier for a non-UK domiciliary to use an offshore company to avoid UK capital gains tax. For UK resident domiciliaries, there are strict anti-avoidance rules which class gains that occur for many offshore companies as being those of UK resident shareholders.

  However, if you arrange for a non-domiciled spouse to own the shares, the company can sell assets and realize gains without tax being paid personally by the shareholder provided the proceeds aren't brought into the UK. Again this assumes that the spouse has the benefit of the remittance basis. If not they will be taxed the same as you, a UK domiciliary.

• Holding overseas assets. If you plan to buy overseas assets it makes sense to hold these via your non-domiciled spouse. Not only would these assets then be outside the scope of UK inheritance tax but in addition the remittance basis could apply to overseas income and gains. This means that your spouse (in reality, you as a couple) would only be taxed on any overseas income or gains brought into the UK. This means you could buy or sell shares or property and reinvest the proceeds overseas without paying a penny in tax.
• Establishing an overseas trading company. If you want to establish a company to trade overseas, provided the company can be established as controlled from overseas (for example, using overseas directors), having your spouse as the shareholder means that dividends could be received free of UK income tax, provided the cash is retained overseas.
• Establishing an offshore trust. As we have seen, this is much easier if the settlor (the person who creates the trust) is a non-UK domiciliary.

As from 6th April 2008, though for a non UK domiciled spouse to utilise most of these tax advantages they would need to claim the remittance basis of tax as opposed to the arising basis of tax.

This would then mean that you would need to consider the impact of the loss of allowances for your spouse (personal allowance and the capital gains tax annual exemption) as well as the £30,000 annual tax charge if they have been UK resident for more than seven of the last ten tax years (rising to £50,000 once they have been UK resident for more than 12 years).

Remember for inheritance tax purposes, you can also be deemed UK domiciled if you've been UK resident for the previous 17 years, and also for three years after you actually lose your UK domicile. So you have to be careful to ensure that your spouse, although born and domiciled overseas, is also not UK resident for 17 of the previous 20 years.

Non-Resident Spouse

You can have a spouse who is non-UK domiciled or non-UK resident, even though you are UK resident. For example, one spouse could work overseas while the other remains in the UK.

As non-UK residents they are largely outside the UK tax system. In many cases it's only if they have UK business assets or property investments that there is any tax at all.

If a couple have significant assets it often pays for the non-resident spouse to hold them so that they can be sold in the future free of UK capital gains tax. This applies to both UK and overseas assets. The only caveat is that if the assets are acquired before the non-resident spouse leaves the UK, he or she would need to remain non-UK resident for at least five complete tax years to avoid capital gains tax forever. (This assumes a departure before 6 April 2013. For departures after this date they would need to remain non resident for more than five tax years).

In terms of UK shares, having a non-UK resident spouse is very attractive and is something that one of the UK's most successful businessmen, Philip Green, has used to his advantage. He's a UK resident but his wife is resident in Monaco. Dividends from the UK companies he runs are paid to his wife who is the shareholder and, because she's non-UK resident, they're completely tax free. In addition -- and in practice this is an important point -- because she's a resident of Monaco, which is a tax haven, there is also no overseas tax.

If your spouse is non-UK resident there is no point paying dividends to her -- that would be taxed in the UK at 25% (or higher if she is in the 'Super' tax band) -- only to be taxed at a higher rate in another country. It is critical to find out the tax rate applying in the other country. If your spouse can obtain residence overseas in a tax haven of some description, you will stand the best chance of significantly lowering your tax bill.

A property investor is well advised to put property assets in his or her spouse's name to avoid capital gains tax on a future disposal.

In terms of income tax, a non-resident is exempt from tax on non-UK rental income. Therefore, if overseas rental properties are held by the non-resident spouse, income tax can be avoided in full, even if the rental income is subsequently transferred into a UK bank account. (This is unlike the position for non-UK domiciliaries above, who would be taxed if the cash was brought into the UK.)

The only tax that would not be directly affected by non-resident status is inheritance tax. To avoid this, the overseas resident spouse also has to obtain non-UK domicile status.

Transfers between Spouses

Where spouses are UK resident there is not normally any rush to transfer assets as you can transfer free of tax pretty much up until the time you decide to sell. Does this apply to transfers between a UK resident and a non-UK resident? Revenue and Customs and the courts have both looked at this issue and agreed that just because one spouse is non-UK resident, such does not mean that the exemption for inter-spouse transfers should not be available.

Example

Neil has a UK property with a £500,000 gain. His wife is working in Cyprus and is a tax resident there. He transfers the property to his wife who then sells it. As she's a non-UK resident the gain is exempt from capital gains tax provided she spends more than five years abroad. She can then pass the proceeds into a joint account and effectively 'gift' some of these to her husband. In this case, the property gain would also be exempt from Cyprus tax.

You would need to be careful to ensure that ownership is actually transferred and that your spouse really is non-UK resident. Also a non-resident spouse is outside the scope of many of the anti-avoidance provisions. Therefore, offshore companies and trusts could be formed more effectively, for example, to hold property investments or even shares. As the spouse is non-resident, showing that any overseas company is controlled from outside the UK should be pretty straightforward.

11.10 Personal Service Companies

With the advent of email and the Internet, many people trading through UK companies want to move abroad. One way for them to 'have their cake and eat it' is to use an offshore employment company.

They would move overseas and become an employee of the offshore company. The offshore company would charge the UK trading company for the services provided to the UK company.

The UK company should be able to claim this expense as a tax deduction, and the offshore company would receive income on which no tax would be payable. Funds could then be extracted from the offshore company by way of a dividend.

Multinationals use this on a larger scale and use offshore employment companies as a vehicle to provide expatriate staff, who work outside both their home country and the offshore jurisdiction, with almost tax-free remuneration.

Example

Paddy runs his own business through a UK company (Paddy Ltd). He is fed up with the British climate and taxes and decides to move overseas.

He settles in the Bahamas and establishes a company in Panama. He still provides services for Paddy Ltd and invoices the company accordingly. Assuming he is the only employee, and the company has profits of £200,000 before paying him, he may decide that the market rate for his services is £150,000 and raise an invoice for this amount from the Panamanian company.

The UK company's taxable profits will be reduced to £50,000, and the £150,000 received by the Panamanian company will not be taxed.

An alternative scenario would be for Paddy to remain an employee of the UK company and perform his duties overseas.

As discussed previously, a non-UK resident individual performing employment duties offshore will not be subject to UK income tax. National insurance should also not be due provided the individual is not UK ordinarily resident. As above, the company should also be allowed a tax deduction for the salary paid.

Note that in both of these situations, it is absolutely essential that a market rate is used. HMRC has some complex rules known as the transfer pricing rules that could otherwise apply.

11.11 Transfer Pricing Rules

These rules apply where a UK resident is dealing with a non-resident and are intended primarily to prevent companies from manipulating prices to reduce UK taxable profits.

Without these rules it would be easy for a multinational group to arrange for its overseas companies to charge increased amounts for parts, stock or services so as to reduce taxable profits in the UK.

Therefore when a UK resident is dealing with offshore entities, an 'arm's length' rate must be used. This means that if you move offshore and invoice a UK company or charge a salary, the rate you charge must be the same as what would be charged by an unconnected third party providing those services.

You would also need to retain evidence of the third party rate, in case HMRC ever enquires into the matter.

Under self assessment it is for the company to establish and support the fact that an arm's length basis is used. However, HMRC accepts that there may be circumstances where establishing the arm's length rate will be difficult. The transfer pricing provisions therefore provide for a procedure known as 'advance pricing agreements' (APAs).

An APA is a written agreement between a business and HMRC which determines a method for resolving transfer pricing issues in advance of a tax return being made.

It's important to adhere to the provisions of the APA as not only are there potential penalties at stake, but the tax authorities could also restrict the deduction the UK company can claim if it is felt that you have charged an excessive amount.

Advanced offshore arrangements should be carefully considered. They frequently involve a complex interaction of many taxation issues, and professional advice will need to be taken.

11.12 Types of Offshore Entity

When looking at the various options available to you to structure your affairs, you will find that there are a number of unique entities -- both onshore and offshore -- that can be used. It can be difficult to understand the differences between the various options, so we'll look briefly at each.

UK Limited Company (Ltd)

This is your bog standard company used by traders and investors. It can be used to hold pretty much all assets and can carry out most activities.

When you form the company, you will need to provide some details to both Companies House and later HMRC. Note that any UK incorporated company is automatically classed as UK resident and is therefore taxed in the UK on its worldwide income.

UK Ltd companies are very cheap to form, and the administration is not too onerous. You will need to file annual accounts in a suitable format, and also submit the annual return (which contains details of the company and shareholders).

In terms of asset protection, it can be a good way to hold assets separately although, as we have seen, the courts can ignore the company where the arrangement looks like a sham, so you will need to ensure that there is commercial substance.

If you are looking to trade overseas, a UK company has the advantage of looking highly professional and would not draw attention to your activities, unlike companies registered in certain tax havens. Therefore, using a UK Ltd nominee company is popular, to combine a professional front to minimise taxes.

The Ltd company is separate from its shareholders. It can therefore sue or be sued in its own name and will be treated for tax purposes separately from its directors and shareholders. One of the main purposes of forming an Ltd company can be to minimise UK taxes.

UK companies pay UK corporation tax as opposed to income tax and for most, this will mean paying corporation tax at 20% as opposed to 40% income tax. Provided only limited profits are extracted from the company (for example, only enough to use up the basic-rate tax band) there would be no further tax to pay. Given that income tax is as high as 45% for high earners (from April 2013), using a company can have significant tax advantages.

UK Limited Liability Partnership (LLP)

This is a cross between an Ltd company and a normal partnership. It was primarily introduced for the large professional firms that carried on a trade as a partnership (for example, lawyers, accountants and surveyors) but who wanted the benefit of limited liability protection.

Therefore, an LLP allows the members to protect their personal assets from any creditors, but for tax purposes, it is treated just like any other partnership. The LLP will be taxed on a 'pass through' basis with each partner being treated as owning a share in the partnership assets. The profits of the partnership would then be attributed to the partners, irrespective of whether the partners actually take their share of the profits out of the partnership.

For asset protection purposes, it offers pretty much the same protection as an Ltd company. In tax terms, the tax liability will depend on the partners' residence and other taxable income.

If an LLP is used with a mixture of UK and overseas partners, it would be only the UK partners that would be taxed in the UK, with the overseas partners being taxed in their country of residence. Where there are mixed residence partnerships an LLP may therefore be preferred to a UK company. Mixed residence partnerships also offer certain capital gains tax advantages (covered in the next chapter).

International Business Company (IBC)

This is the name typically given to an offshore company that has been formed outside the UK. There are three main reasons that an IBC may be used.

• To avoid UK taxes
• To hide assets
• To trade overseas, either by UK or overseas residents

Rather than using a simple offshore bank account, many people use an offshore account with the account holder being an IBC -- the aim being to sever the link between the individual and the offshore assets.

As with UK companies, IBCs can be used for practically any purpose, including holding overseas property and shares, bank accounts and other assets.

Unlike UK companies, an IBC usually has much lower disclosure requirements with hardly any form filling, no annual accounts or returns and no annual general meeting. It is usually exempt from local taxes if set up in the correct jurisdiction.

Bearer Share Companies

There are a number of jurisdictions (such as the British Virgin Islands) that permit you to form a special bearer share company. This will cost you more than a standard company -- but what benefit do you get for the extra cash?

A normal company lists the owner of the shares on the share certificates and when you want to transfer ownership of the shares, you need to notify Companies House.

A bearer share company is totally different. The owner of the company is the person who happens to be holding the share certificate. This means that, provided you do not have the bearer certificates in your possession, you can state that you don't legally own a particular company.

Note the company will still need to pay tax on any profits generated. The only real benefit is in terms of privacy. It would make it more difficult for anyone to argue that you owned a company if bearer shares were used.

Limited Liability Company (LLC)

LLCs are available in a number of jurisdictions, although the United States LLCs (in particular, the Delaware LLC) are the most popular. The LLC is similar to the UK LLP, although there are some important differences.

An LLC is a cross between the UK's LLP and a company. Unlike an LLP an LLC can opt to be taxed as a corporation in many jurisdictions and would therefore be subject to corporate tax on its profits.

Individuals who own an interest in an LLC are known as 'members' as opposed to shareholders.

The LLC structure is known to be very flexible and reporting requirements are not onerous, with few requirements to keep minutes or have records of formal resolutions (although this is often advisable).

LLCs also benefit from limited liability protection, thus ensuring that your personal assets are kept separate from your business assets.

Unlike an LLP, the minimum number of people needed to form an LLC is one, with a few exceptions. If you did set one up with just one member, this would be akin to a one man limited company, albeit with low disclosure and documentary requirements.

HMRC usually classes LLCs as 'opaque' entities for UK tax purposes. This means that they are treated as companies and have a separate legal personality. They can also be classed as having ordinary share capital for UK tax purposes providing certificates of LLC membership interests are issued.

Note that for US tax purposes, LLCs are by default classed as transparent and taxed like sole traders or partnerships (i.e., with the LLC members directly taxed on the profits).

Trusts

Trusts were traditionally one of the most popular entities for holding assets. They were particularly useful as they allowed an individual to legally give away assets but still exercise an element of control over them (as a trustee) and in some cases benefit from the assets (as a beneficiary).

In terms of avoiding UK taxes, they are much less attractive now than they used to be due to the number of anti-avoidance provisions that operate to negate the tax benefits.

Offshore trusts would usually be used in combination with another entity such as an IBC or a foundation. Typically the trust would be used to hold the shares of an IBC. Alternatively, if a foundation structure were used, the trust could be the beneficiary of the foundation.

Foundations

The use of foundations has gained in popularity over the past few years, given its unique characteristics. The foundation is essentially a cross between a trust and a company because it's a separate legal entity that doesn't have owners.

Foundations are useful because they have a separate legal personality. Therefore when applying for an offshore bank account, it is often necessary to state the beneficial owners. If a foundation is used, it is the foundation itself that is the beneficial owner. Foundations are popular primarily for asset protection purposes.

In UK tax terms, they would likely be treated in a similar way to a company.

Protected Cell Companies (PCCs)

Protected cell companies are something of a new development. There are very few jurisdictions that permit them (including Guernsey, Bermuda and Mauritius) and although aimed at big business and the structuring of finance for multinational companies, they could be tailored to a smaller operation if required.

A protected cell company is a company that is split up into different sections. Each section is separate from all the others and rather than simply transferring assets to the company, you transfer assets to the particular cell of the company. Each cell is independent and separate from every other cell.

Therefore, rather than holding assets in separate companies, you could establish one PCC and put different assets in each cell. In terms of any creditors each cell would need to be approached separately and the assets of one cell could not be used to satisfy liabilities of another cell.

They are principally asset protection tools and, given the right circumstances, where there is a diverse range of assets involved, they could be useful.

UK Tax Treatment of Overseas Entities

If you are planning on using an overseas trust or company, it is essential to ensure that you know exactly how it will be treated by the UK taxman.

There are, broadly speaking, two ways in which an overseas entity could be classed. It could either be classed like a UK partnership or LLP (known as 'transparent') or like a UK limited liability company (known as 'opaque').

The difference is crucial, as it will impact directly on how any overseas profits are taxed in the UK.

In the case of a transparent entity, such as an LLP or a partnership, the profits are taxed in the hands of the members. In other words, the members are treated as earning the profits, irrespective of whether the profits are actually paid out to them.

An opaque entity, on the other hand, is treated as earning the profits. Therefore, the members are only taxed on the amounts they actually extract from the company.

In order to decide whether an overseas entity is transparent or opaque there are a number of tests that the UK tax authorities will apply. In particular, they will look at the following:

• Does the overseas entity have a separate legal existence?
• Does the entity issue share capital or something that is similar to share capital?
• Is the business carried on by the entity itself or by the members who have an interest in it?
• Are the members entitled to share in the entity's profits as they arise or does the amount of profits to which they are entitled depend on a decision of the entity or its members? (For example, in a UK company, the dividend needs to be declared by the directors)?
• Who is responsible for any business debts -- the entity or the members?
• Do the entity's assets belong to the entity or to the members?

Of key importance will be the impact of foreign law and in particular the authorities who will look at the distribution of profits from the entity and who actually carry out the business. Essentially, it is a case of looking at where the true rights of ownership and control arise.

However, rather than assess each overseas entity on a case by case basis, the UK taxman has already looked at a long list of foreign entities and determined their UK treatment.

While this should be regarded as a general overview only, I've highlighted the UK treatment in Appendix II.

Therefore, if you are considering whether or not to use an offshore entity, it is important to try to establish whether it enjoys opaque or transparent tax treatment.

11.13 Overseas trading

If you want to do business in another country, the options you must include:

• Incorporate a new company offshore and use it to carry out the overseas business, or
• Establish a branch of the existing UK company and carry out the trade via the branch.

Note that in physical terms, the two would look more or less identical. For example, there could be overseas premises, staff and equipment.

The main difference is in the ownership. If the overseas trade was owned by the UK company, it would be a branch. If it was owned by an offshore company, it could be a subsidiary.

Deciding whether to use a branch or subsidiary will have significant implications on how the profits from the overseas trade will be taxed.

Old Rules

Prior to 19th July 2011, the main difference between a branch and subsidiary is that the profits of a branch will be classed as part of the UK company's taxable profits, along with its UK trading profits.

The branch profits will usually be separated from the UK trading income if the branch is actually controlled from overseas. Therefore, it could be taxed as income from an overseas 'possession', as opposed to trading income. This difference is not all that important, however, and the key point is that all profits of the overseas branch will be subject to UK corporation tax.

By contrast, if an overseas subsidiary is used and provided the company is non-UK resident, the profits of the overseas subsidiary should not be subject to UK corporation tax.

The company will be non-UK resident if it is not incorporated in the UK, and its central management and control is overseas.

In addition, provided the overseas company does not fall within the controlled foreign company provisions (see below) the only time that the UK company will be subject to corporation tax is when the overseas company declares a dividend.

This would therefore give the UK company an element of control over when it incurs a UK tax charge. (An example of this is during an accounting period of otherwise low income).

Another key difference is that if a branch is used and it sustains a loss, this can often be offset against other UK trading profits. If you use an overseas subsidiary and the subsidiary incurs a loss, the opportunities for it to utilise its loss are restricted.

The fact that losses are given more flexible relief in a branch means that, where an overseas operation is expected to incur losses in the first few years of trading, it is often advisable to initially trade overseas using a branch (with full relief for losses in the UK) and then transfer the trade to an overseas subsidiary when it is about to become profitable (to eliminate UK tax on the profits).

Finally, if you use a subsidiary, it will be classed as an 'associated company' which would reduce the tax bands for calculating the UK company's corporation tax. In other words, a higher corporation tax rate may be payable on a slice of the company's profits.

New Rules

As of 19th July 2011, there has been a significant change to the tax treatment of foreign branches of UK companies. If an (irrevocable) election is made, all profits and losses can remain permanently outside the scope of UK corporation tax. There are certain conditions that have to be met but if an election is made:

• The election has to apply to all foreign branches.
• Capital gains and income profits and losses are covered.
• Assets utilised in the overseas branch are, for tax purposes, transferred to it from the UK company at a no gain/no loss value at the outset of the election taking effect.

Inevitably there are detailed anti-avoidance provisions to prevent abuse. Certain types of businesses are excluded from the new rules, including:

• Long term insurance businesses, being primarily life assurance and permanent health insurance,
• Companies which derive their income mainly from making investments,
• Certain international air transport and shipping companies, and
• The profits of close companies which stem from capital gains.

Additionally, smaller companies can only make the new election if their foreign branches are situated in territories that have a double taxation treaty with the UK that includes a non-discrimination clause.

A small company is, broadly, one with no more than 50 staff and with either annual turnover or a balance sheet of less than €10 million.

So if you have a small company and are setting up a branch in a country with which the UK has a treaty, you would need to weigh up the fact that making the election is irrevocable, not just for that branch but for all future branches.

Losses will not be allowable for offset against UK profits but branch profits will not be taxed.

If, however, the foreign jurisdiction levied tax on the profits that would fully cover any UK liability under the double tax relief provisions, it may be preferable not to make the election. This would then ensure that losses were still available.

11.14 UK controlled foreign company (CFC) rules

I mentioned above that the UK company would not be charged tax on the profits of the overseas non-UK resident subsidiary... provided the UK CFC rules don't apply. The CFC rules are therefore very important for any company that wants to set up an overseas subsidiary.

If the CFC rules apply, the UK company will have to pay tax on the overseas company's profits, provided the percentage of profits apportioned is at least 25%.

You should note that the UK CFC regime will not apply if you are an individual owning an overseas company.

Before falling within the CFC rules a company would firstly need to meet the definition of a 'controlled foreign company'.

A CFC is defined as:

• A non-UK resident company, and
• A company controlled from the UK, and
• A company subject to overseas tax which is less than 75% of the equivalent UK tax.

Therefore the CFC provisions are going to apply to overseas companies established in countries with low tax. What you would need to do is calculate the company's profits and find out what the overseas tax charge is.

You would then calculate the UK tax liability and, if the overseas tax paid is less than three-quarters of the UK tax, the overseas company could fall within the CFC provisions.

Before getting into the nitty-gritty of the new regime applying from 2012, it is worthwhile noting that the big news for small companies is that the de-minimis profits limit will be raised from £50,000 per annum to £500,000 per annum. Most small companies will therefore fall outside the CFC rules.

The New CFC Rules

The aims of the new CFC regime, are to:

• Target and impose a CFC charge on artificially diverted profits, so UK profits are fairly taxed,
• Exempt foreign profits where there is no artificial diversion of UK profits, and
• Not tax profits arising from genuine economic activities undertaken offshore.

Overview of New Regime

The new regime is targeted at situations that pose the highest risk of artificial diversion of UK profits. A proportionate approach is adopted so that, where a CFC charge applies, it will only apply to those profits which have been diverted artificially from the UK. Genuine foreign profits are exempt from the charge.

The regime also seeks to recognise that most CFCs are held for genuine commercial reasons and do not pose a risk to the UK tax base. Consequently, a number of exemptions will apply, including a general purposes exemption providing companies with the opportunity to demonstrate that they have not artificially diverted profits from the UK.

The new regime will in many ways operate in a similar way to the existing regime. It will identify low taxed foreign companies controlled from the UK.

The existence of a number of exemptions will remove from the CFC regime those CFCs that do not artificially divert profits away from the UK. The exemptions, however, are being modernised.

Three-Step Approach

The new regime will follow a three-step approach:

• Identifying CFCs
• Exempting CFCs that pose a low risk to the UK tax base
• Calculating a CFC charge when profits have been artificially diverted from the UK

The first step is to identify a CFC. For the purposes of the new regime, a CFC is a company that is under UK control, is resident outside the UK and has profits that are taxed at a lower effective rate than if the company were resident in the UK.

Having identified a CFC, the second step is to see whether one or more of the exemptions apply, including:

• Excluded territories exemption. HMRC will publish a list of those jurisdictions where they are happy that the local corporation tax will be no less than 75% of the UK equivalent liability. Any companies resident in these jurisdictions will not be CFCs.
• Low profits exemption. If the overseas company's profits are less than £500,000 it will not be a CFC.
• Low profit margin exemption. This exemption applies to CFCs whose accounting profits are less than 10% of their costs. Cost cannot include any related party expenditure.

Safe Harbours

Next we move onto the business trading income "safe harbour". Here the CFC needs to meet a variety of tests.

These include having:

• Business premises available locally
• Incurring no more than 20% of overall expenditure on supplies from UK sources
• Invoicing no more than 20% of total turnover to UK customers
• Limited connection to UK-orientated intellectual property rights, and
• The management costs of the CFC being at least 80% incurred outside the UK.

There is an exemption for CFCs that only let property in the foreign jurisdiction.

There is a new exemption for finance companies set up in low tax jurisdictions which meet a number of criteria. This reduces the rate of UK corporation tax that might be levied down to just 5.75%.

There will also be a new 'gateway test' which will allow companies to be ruled out of the CFC regime.

When Will the New CFC Rules Apply?

The new UK controlled foreign company rules are due to come into effect for accounting periods starting on or after January 1 2013.

11.15 UK corporation tax planning after you've left the uk

If you trade via a UK company, the general rule is that it is subject to UK corporation tax, even if the controlling directors or shareholders are non-UK resident.

As the company is a UK company, it is classed as UK resident and is subject to UK corporation tax.

In terms of actually extracting cash from the company, this can be easily achieved by paying dividends.

If the shareholders are non-resident they can effectively receive dividends free of UK income tax so long as they are non resident for more than five tax years (at least in respect of profits generated whilst the shareholders were UK resident).

However, the profits out of which the dividends are paid will still have been subject to UK corporation tax.

If the aim is to reduce the corporation tax on the company profits you need to look at additional options.

Salary/Bonus

The simplest way to reduce the company's profits is to pay salary or bonuses to employees/directors. The salary/bonus would not be subject to income tax, provided the directors are non-resident and carry out their employment duties overseas (aside from any incidental UK duties).

The company is permitted a tax deduction for all expenses incurred "wholly and exclusively" for the purposes of the trade.

In order for the company to substantiate a tax deduction for salary or bonus payments it would need to be linked to a benefit received by the company and for the purposes of its trade. This usually means that the salary/bonus payments need to be:

• Genuine services provided by the employees/directors to the company, and
• Calculated at an arm's length rate.

Essentially, you would want to be able to argue that the company would make these payments even if the employees/directors were otherwise unconnected with the company (e.g. not shareholders).

You could, for instance, look at paying both a market value salary for the duties undertaken by non-resident directors, as well as a bonus arrangement related to their specific fields of responsibility.

Note that employment income can be subject to UK national insurance (13.8% paid by the employer and up to 12% paid by the employee). Reciprocal agreements with other countries, as well as EU agreements, can affect your national insurance liability. However, long-term emigrants can usually receive salary/bonus payments free of UK national insurance.

Offshore Company

The other option would be to use an offshore structure, such as an offshore company, and recharge amounts to the UK company. In terms of the company itself you would need to ensure:

• It is controlled and managed from overseas. There should be no issue with this if the controlling directors and shareholders are non-resident.
• It has no UK trade (as even if non-resident, profits from a UK trade could still be within the scope of UK tax). The location of the trade is usually where the key revenue generating activities are undertaken.

The simplest way to use an offshore company is for the directors to provide services via the offshore company to the UK company. This is a form of service company. Similar considerations apply as above (i.e., in terms of transfer pricing) and you would need to ensure that the rates charged for the services provided are market related.

The offshore company would receive the receipts free of UK tax. The UK company would obtain a tax deduction for the payments.

If you were seeking to transfer part of the trade of a UK company to an offshore company, this could avoid UK tax (subject to the transfer of any goodwill -- see below). The offshore company would recharge for the services to the UK company which would be free of tax in the offshore company. A British Virgin Islands or Isle of Man company is often used for this purpose.

HMRC usually accepts that a service company used to employ staff, own or lease business premises or provide other administrative services is genuine, assuming that the company recharges the UK company at an appropriate mark up (e.g., 10-15%).

Another option would be to use an offshore holding company. You would achieve this by using a share for share exchange to place the new offshore company as the holding company of the UK company. A management recharge from the UK to the offshore company would be deductible for corporation tax purposes but again you would need to ensure that it related to genuine services provided by the offshore company to the UK company. A management recharge of 100% of the profits, for instance, would not be acceptable.

Goodwill

An important issue on a transfer of any aspect of the trade would be whether there was a transfer of goodwill from the UK company.

The transfer of the trade from the UK company to the offshore company would be a disposal for capital gains purposes. This isn't a specific rule that applies to transfers to offshore companies but rather is a general rule that applies to the transfer of any assets out of a company.

Therefore, irrespective of the disposal consideration that is actually transferred from the offshore company to the UK company, the capital gain realised by the UK company would be based on the market value of the assets transferred. You would therefore need to value the assets transferred to the offshore company. This would include plant/machinery and any land or property, but usually goodwill is the largest asset transferred.

However, if the value of the goodwill is represented by the personal services carried out by the directors, they may be able to argue that it is effectively personal goodwill. If this is the case, they may be able to argue that there is no disposal for CGT purposes.

Aside from this, a transfer of back office operations with a recharge to the UK company would usually be acceptable.

In terms of actually transferring the revenue generating activities, the best option may be to undertake new activities in the offshore company, where there could be no argument of a transfer of goodwill. The profits may then arise free of UK tax in the offshore company.

About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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