Using an offshore company in practice
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2021 UPDATE
This article is an archived article. We've kept the content below so you can view it BUT, its important to take into account the current position.
In essence, international taxation works on 3 key concepts:
- Taxation in the country of residence
- Taxation in the source country
- Double tax treaties that alter the taxing rights
In simple terms, the country of residence is where you live (its actually a lot more complex than this and every country has their own set of rules to determine who is a tax resident). But to keep it simple, if you live in country X then you personally are subject to the tax regime there. In many countries this is a worldwide scope of tax.
If you then have income or gains from country y (the source country), in general they would exercise a right to tax those income/gains.
So you potentially have 2 countries looking to tax the income or gains.
Then you have the effect of double tax treaties. In most (but by no means all or at least in all cases), the tax treaty overrides domestic law.
Where does this leave you? Well, it depends. In a simple scenario, you're resident in a low tax state. You trade or at least have income or capital gains from another jurisdiction. Your country of residence may not tax you on those if you are resident in a suitable zero or low tax state. The source country may. If they do, that is a direct cost to you. If your country of residence did tax you, then in most cases you can get a foreign tax credit to offset the foreign tax suffered against your tax liability in the country of residence.
The best case scenario is clearly if your country of residence and the source country don't tax you. This is in part what the recent OECD Pillars 1 and 2 relate to. They won't really effect you if your sales revenue is less than 750M, but effectively they address the problem that in terms of trading income, many international businesses - due to both domestic rules and double tax treaties - aren't taxed unless they have a fixed place of business in that country. This puts many digital service businesses out of the scope. So if they are based in a low or zero taxed country their tax liability, at least at the company level, is limited.
But using an offshore company or actually any foreign company, involves more considerations. Practically all jurisdictions impose some form of CFC rule now. They basically tax foreign companies that are controlled by their residents to the the extent of the shareholding. Some jurisdictions go further and some less - but that's the general rule. So, you need to consider this if you're using an offshore company that you have an interest in the share capital or voting rights (and again it varies by jurisdiction), as this would mean you would personally be taxed on the profits of offshore companies that you have an interest in (again subject to various thresholds and de minimis requirements that differ between jurisdictions)
The impact of double tax treaties cannot be understated. Most jurisdictions impose withholding tax on income derived by a non resident from within their jurisdiction. The reason is simple - without this there would be no effective way to enforce the tax obligation. Double tax treaties mitigate withholding tax significantly. They can reduce it from 25% to 0%. So establishing a company in a suitable treaty jurisdiction can be hugely beneficial.
The key point to understand is there are 3 key factors in international tax; tax in the country of residence; in the source jurisdiction; and the impact of double tax treaties. Simply looking for a low tax company in itself may not result in any tax benefits.
In all cases, it requires an analysis of the tax regime of all 3 if you have income from multiple jurisdictions. Use our Q&A service for personalized tax information on all of these aspects:
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Archived Article:
We know that there are lots of different tax havens that can be used to set up an offshore company such as an IBC. But what exactly are the benefits and in what circumstances are offshore companies used?
Below we illustrate the wide variety of uses to which an offshore IBC can be put. If any of these apply to you, the first step should be to obtain advice from a suitably qualified tax specialist.
Trading Companies
With the breaking down of many trading barriers and the ease of international communications, including the growth of the internet, it truly is a global market out there. More businesses are therefore looking to spread their wings and expand overseas.
In these situations, some significant tax-planning benefits can be obtained.
A simple step is to incorporate an offshore company to form part of your trading group. This would principally be used to purchase or resell goods between the group companies.
So international trading companies could use this set up to establish a re-invoicing strategy and accumulate profits in a low-tax jurisdiction.
Common choices to base an offshore trading company would be Cyprus, Ireland and the Isle of Man in the EU and, further afield, Panama, the BVI and the Bahamas.
Professional Services Companies
Certain individuals providing professional services often use offshore companies. This is partly for asset protection reasons (they are worried about being sued) and partly for tax-planning purposes.
Such individuals include:
- Lawyers
- Doctors
- Designers
- Consultants
- Entertainers
These individuals can often achieve some considerable tax savings by setting up an offshore company.
How does this work? Well in essence the offshore company can enter into a contract with the individual to provide services for clients outside his country of residence. This could then enable personal income to be accumulated free from tax in the offshore jurisdiction.
If the offshore company was to reinvest the money in a tax-free jurisdiction this could enable future income to be generated free of tax.
Example
Steve, a freelance computer programmer is UK resident and UK domiciled. As a UK resident he'll be taxed in the UK on his worldwide income.
But Steve, being a canny chap, uses a Bahamas IBC to bill some of his clients for work that he actually carries out overseas during his various international contracts.
There are some hoops he'll have to jump through in terms of ensuring that the company does not get classed as a UK-resident company (and therefore itself fall within the UK tax net) and avoiding the anti-avoidance rules. However, these can often be overcome and the end result would be that Steve can divert income offshore that would otherwise have been paid to him personally and which then falls outside the scope of UK taxes.
Note that if Steve was to transfer funds to the UK from the offshore company to his personal account (or for his personal benefit) there would then be a UK tax charge.
Using an Offshore Property Company
Investing in property using offshore companies has become increasingly popular as more investors look at investing in overseas property.
The principal advantages of investing via an offshore company are to:
- Avoid inheritance taxes
- Avoid capital gains tax
- Provide the opportunity for a future sale of shares, rather than the underlying property
The procedure is actually remarkably simple. You or the offshore company obtain the funds (usually via a mortgage) which are then used to purchase the property in the name of the IBC.
In terms of you providing funds to the IBC, a straightforward loan would be a good option, depending on the domestic tax legislation. The amount loaned to the IBC could then be extracted tax free in the future.
The rental income would probably not be taxed in the offshore IBC (provided a jurisdiction such as Panama, the Bahamas, or the British Virgin Islands is chosen), however the rental income will often still be taxed in the country where the property is located.
Any tax charge here can usually be minimized by the payment of interest by the IBC, which should be a tax-deductible expense.
Therefore rather than paying cash for a property, the company usually obtains finance for the purchase, from an offshore lender, and the interest payable would further reduce any tax charges. In the UK using an offshore company to own assets is also popular from an inheritance tax perspective. This is because owning UK assets via an offshore company can enable the UK assets to be taken out of the estate of a non-UK domiciliary.
Example
Elle, a lifelong resident of Canada, is looking to invest in UK investment property. If she purchases the property in her own name this will constitute a UK asset for inheritance tax purposes and, as such, on her death UK probate would be required in addition to a potential tax payment.
If she uses an offshore company to hold the property instead, she will then own shares in an overseas company (a foreign asset) as opposed to a UK property. The shares would not fall into the UK inheritance tax net.
In terms of income tax and capital gains tax, the position of the offshore company would be similar to owning the property personally as a non-resident:
- UK income tax would be levied on the rental profits
- The company would not be taxed on any gain arising when the property is sold.
If you were considering becoming resident in the country where the property is located (for example, retiring there), this will further increase the benefits of using an offshore company to purchase the property before obtaining residence.
By purchasing the property before obtaining residence, it's usually easier to sustain the company's non-resident status and the tax benefits that go with it (in particular, capital gains tax benefits).
If you are both resident and domiciled in the UK, the opportunities to make property investments using offshore companies are more restricted.
Example 2Let's say Daisy (UK resident and domiciled) wants to buy a property in Bulgaria. She decides to purchase the property via an offshore IBC located in the British Virgin Islands (BVI). The BVI company will own the Bulgarian property but Daisy will own all the shares in the company.
As far as UK tax goes, as a UK domiciliary she would still be subject to UK inheritance tax on her worldwide estate. This would include the Bulgarian property.
If Daisy carefully structures the BVI company so that it is non-UK resident (for example, if she ensures there are overseas directors actually exercising control overseas) the company would be able to dispose of the property free of any UK capital gains tax. Similarly the company would not be subject to income tax on any rental income, as the income is overseas income of a non-resident company.
However as Daisy is UK resident and domiciled, anti-avoidance provisions would apply and any gain on which the company would normally be taxed if it was UK resident will be taxed in her hands.
Similarly, S720 can apply to offshore companies as well as to trusts. This means that the rental income earned by the BVI company could also be taxed in Daisy's hands, unless one of the exemptions applies (for example, if the company is not used to avoid UK tax).
So for UK tax purposes, both UK capital gains tax and income tax could be paid by Daisy on the company's gains and income.
As well as the UK tax, the company will may have to pay Bulgarian withholding taxes on its rental income.
However, the UK taxman would allow Daisy to deduct any Bulgarian tax she pays from her UK tax -- so the overall effect is that Daisy will be subject to UK tax on all the income and gains of the BVI company.
Of course if she wanted to avoid tax when she sold the property, she could also become non-resident and dispose of the shares in the BVI company. Given that Bulgarian property is typically purchased by non-residents via a company, there could be a good market in such company disposals. As a non-UK resident, Daisy would then be outside the scope of UK CGT, provided her absence abroad lasts for five complete tax years.
You would have to be careful, though, and thoroughly review the overseas country's tax rules. Portugal and Spain, for example, have rules that actually penalise property purchased via an offshore company by incurring an extra tax charge based on a percentage of the property's value.
Investing or Doing Business in Eastern Europe
Many people are now looking to trade or invest in Eastern Europe, which is braced for a long period of economic growth and development.
A key concern will be extracting cash tax-efficiently from these countries particularly where a locally incorporated company has been used (for local planning or regulatory reasons). The withholding taxes on dividend and interest from East European countries will then be a significant issue.
A popular option here is to establish an offshore company in Cyprus, which has double tax treaties with Bulgaria, the Czech Republic, Hungary, Poland, Romania, Russia and Yugoslavia.
These treaties are pretty unusual in the sense that they are the only treaties the East European countries have with a tax haven country.
We've already looked at the benefits of Cyprus and this is therefore another reason why Cyprus offshore companies are ideal vehicles to extract income such as dividends, interest and royalties from East European countries with minimum tax being paid.
The tax agreements Cyprus has with these countries often stipulate a low or 0% withholding tax which, combined with the low taxes in Cyprus, makes this a highly effective set up. Cyprus is often used to hold shares in a Russian trading company, for example, to allow dividends and royalties to be extracted with only a 5% withholding tax.
Offshore Royalty and Patent Companies
If you have designed a new process or product you could consider using an offshore company. The offshore company could purchase the right to use a patent by you and be given the right to license it to other interested parties.
The offshore company can then enter into agreements with licensees around the world who may then manufacture or otherwise use your patent allowing a tax-free roll-up of funds offshore.
Often royalties paid out of a high-tax area attract withholding taxes at source. In many cases using a holding company may allow a reduction in the amount of tax withheld at source.
Again, Cyprus is another popular EU choice here and a patent could be assigned to a Cyprus offshore company allowing it to exploit the rights and benefit from the nil or 5% withholding tax for royalties stipulated in most of the Cyprus double tax treaties.
Other countries that are popular locations for holding patents and copyrights include The Netherlands, the UK, Madeira, Cyprus and Mauritius.
Avoiding Inheritance Tax
Today's internationally mobile individuals often have properties or other assets located worldwide. A common planning technique is to hold these via an offshore personal investment company. This has advantages that in certain countries (the UK being a prime example) non domiciliaries would not be subject to inheritance tax on the value of the property.
This also has practical benefits in that it ensures that on death the property is passed on in accordance with the deceased's wishes and without long bureaucratic procedures in different countries with different inheritance laws. It is also much easier to transfer shares in the holding company to the chosen heir. So, in Dubai for instance, in order to avoid any issues of forced succession as regards local property, overseas property investors would typically use a company to purchase the Dubai property, and then leave the shares in the company to their family.
Investment Companies
Using an offshore company could also be considered if you have international investments.
An offshore company can invest funds worldwide. Although generally returns or interest payable are subject to local taxation, there are a number of ways to avoid or greatly reduce the taxation using tax-free bonds, bank deposits that pay interest gross and double tax treaties.
Another aspect for investments will be potential capital gains tax on sale. Luckily most offshore companies will be exempt from capital gains tax in the tax haven concerned (as practically all the tax havens covered in this book contain some form of CGT exemption).
If you're looking at investing in the EU, you should also see Chapter 9 on the impact of the EU Savings Tax Directive.
Employment Companies
Often, particularly with the growth of e-commerce, there are individuals trading via companies incorporated in a high-tax country who are looking to live offshore.
One option for them to 'have their cake and eat it' is to use an offshore employment company. Using this they would move overseas and become an employee of the offshore IBC. The IBC would charge the trading company in the home country for the services provided (which should be tax deductible) and the IBC would accumulate income-tax free. This could then be extracted by the proprietor.
Multinationals use this on a larger scale and use offshore employment companies as a vehicle to provide expatriate staff, working outside both their home country and the IBC country, with almost tax-free remuneration.
Example
Cedric lives in Spain and owns his own Spanish trading company (Spainco). He has had enough of the high taxes and decides to move to Cyprus, a fellow EU member. Spainco will continue to be subject to Spanish tax, however Cedric can now charge the company a market rate for his services. These payments would be a tax-deductible expense for Spainco.
Assuming Spainco has trading income of €500,000, if it paid €300,000 to Cedric's offshore company (Cyprus IBC) Spainco would then have taxable profits of only €200,000. The €300,000 paid to Cyprus IBC would be subject to significantly lower rates of tax (typically 10%).
Best Places for Offshore Companies
You are literally spoilt for choice when considering where to incorporate an offshore company. The table below looks purely at the tax rates applicable to some of the more popular offshore IBCs.
Corporation Tax Rates Country Corporate tax rate % Bermuda 0 Cayman Islands 0 Channel Islands 0 Isle of Man 0 Cyprus 10 Barbados 1 Vanuatu 0 Bahamas 0 British Virgin Islands 0 Nevis 0 Anguilla 0 Ireland 12.5 Gibraltar* 0 Panama* 0
*Note in these countries the 0% rate only applies to foreign-sourced income.
The following is a list of the most popular locations for offshore companies together with the key factors to consider:
Anguilla - No corporate taxes on company profits
- Tax exempt for 50 years
- Flexible company name rules
The Bahamas
- No corporate taxes on company profits
- Excellent selection of local professionals
- Long-standing reputation as a stable offshore provider
- Guaranteed tax exemption for 20 years
Bermuda
- No corporate taxes on company profits
- Does require disclosure to tax authorities
- Investment income derived from abroad may be taxed
- Relatively expensive place to incorporate
British Virgin Islands - Politically stable established destination (over 300,000 IBCs)
- No corporate taxes for a non-resident company
- Fast and low-cost company incorporation
Cayman Islands - Long-established offshore infrastructure
- Exempt companies pay no corporate taxes
- Exempt for 20 years
Cyprus - Full EU member
- Large number of double tax treaties (48 at the last count) which provide for reduced or 0% withholding taxes on dividends, interest and royalties paid to a Cyprus company
- Excellent banking and commercial infrastructure
- Low incorporation and ongoing fees
- Beneficial ownership is disclosed to the Central Bank of Cyprus only, which is bound by secrecy
- Non-resident companies pay corporate tax at 10% only on income derived in Cyprus
Isle of Man
- Well developed professional and financial infrastructure
- Disclosure to local tax authorities
- A new 0% rate of corporation tax
- Handy for UK expats as filing etc is all in English
Labuan - One of the leading offshore centres in Asia
- Well-developed financial and professional infrastructure
- No tax for a non-trading exempt company and only 3% or RM20,000 (around $5,000) if the company is trading
- Can claim alternative treatment and avoid tax on overseas trading income
- Disclosure to tax authorities required
Liechtenstein
- Politically stable
- Strong banking and financial services
- High levels of privacy and strict confidentiality laws
- Close ties with Switzerland
- Joint stock companies are exempt from income tax, property tax (with the exception for real estate) and capital gains tax.
St Kitts and Nevis
- The major source of revenue is tourism followed by offshore financial services
- St Kitts Nevis LLC (limited liability company) can be used for any business venture or professional practice anywhere in the world outside St Kitts
- Combines the corporate advantages of limited liability with the partnership advantages of pass-through taxation
- No St Kitts tax for non-residents
Panama
- One of the oldest offshore centres in the world
- Strong secrecy laws
- Minimal reporting requirements
- Bearer shares can be issued
- No tax for non-residents
Which One is Best?
This is the $64,000 question and, not surprisingly, the answer is not clear cut.
A lot depends on the purpose to which the company is put and the country in which you will be resident.
If you want to trade in China, for example, a Cayman or Mauritian company could be ideal. If maximum asset protection is required, a St Kitts company is often a good choice because the authorities require a $25,000 bond to be put up before a plaintiff can have a suit filed. This clearly puts off many litigants.
However, a good overall offering is the Panamanian IBC. The combination of low set-up expenses, zero taxation and a stable economy is hard to beat.
In addition it offers a guaranteed exemption from Panamanian taxes provided income is derived outside Panama. Other countries such as the Bahamas and Belize offer similar guarantees, however they have limits to the tax-exempt status (typically 15 to 20 years).
Panama offers a permanent exemption, which makes it more suitable for long-term tax planning.
Finally, many offshore IBCs have limits as to the business that the IBC can carry out. For example, a Bahamas IBC company cannot engage in business with Bahamians or own property in the Bahamas. By contrast a Panama Company has none of these problems.
If you're looking at international trading you'd be looking at countries that have a good double-tax treaty network and a low rate of tax -- Ireland and Cyprus are good choices.
It's also worth remembering that all of the countries will be affected by the new information sharing provisions as outlined by the OECD. However, as has been reiterated in other parts of the book, if you're using the offshore company to avoid tax you should be adhering to the disclosure requirements in your home country anyway.
Using Protected/Segregated Cell Companies
Over the past few years a new form of corporate entity has been developed in a number of offshore jurisdictions. Places such as the Seychelles, Bermuda and the Channel Islands have introduced the concept of the segregated or protected cell company. It was primarily designed for the offshore insurance market but creative tax planners have adapted it to other situations, such as trading or property investment.
With this setup there is a single parent company -- the segregated cell company (SCC) -- within which there are subdivisions called 'cells'. This means there are two distinct 'layers' to the company -- the SCC itself and the underlying cells.
The SCC has its own assets, which are non-cellular and separate from the individual cells.
Each cell is an independent entity capable of operating separately from all other cells. Importantly there is a segregation of the assets contained within the cell. This is important in terms of asset
protection, as creditors of one cell can't look to the assets of another cell, or of the company. There is, therefore, a complete segregation of assets and liabilities of each cell.
Crucially, though, in legal terms there is still only one company and one legal entity.
Each cell is identified by a unique name and can issue shares ('cell shares'). The proceeds of the issue of cell shares are classed as cell share capital, whereas the proceeds of the issue of shares other than cell shares are classed as the company's non-cellular assets.
A protected cell company may pay a dividend (known as a 'cellular dividend') in respect of cell shares.
A cell company is therefore one legal entity that has protected and distinct 'layers' or cells. Its main benefit is in terms of asset protection.
An alternative to a cell company is to have a number of subsidiary companies. The downside to this is the risk that a claim may flow from one asset of one company and affect another one.
Cell Companies and Their Uses
Many property developers looking to develop multiple properties have traditionally used a separate subsidiary company for each development. This has a few disadvantages, especially in terms of tax, however the overall aim is to protect the group.
Given the litigious nature of property development, having each development in a separate entity makes sense.
Another option, though, would be to use a segregated cell company, with each cell undertaking a different development. This would achieve the asset protection advantages while minimising the costs and admin burden.
You could also use the cell company for trading purposes, eg to hold different trades within the same company.
Tax Implications
Given that there is no specific guidance on the use of these entities and how they fit within the tax regime in many developed countries, I've set out some of the uses and opportunities that could be considered. Clearly, though, you will have to review the implications in your home country jurisdiction in detail.Here are some of a cell company's potential advantages:
Tax Returns
As the cell company is the only legal entity there may only be a requirement to submit one tax return.
Associated Companies
To get separate legal protection for two or more activities you would usually form separate corporations to carry out each activity. In some tax regimes, each corporation would be 'associated' for tax purposes with the other companies. This would result in a splitting up of the available tax bands. This could easily lead to an increase in the rate of corporation tax payable. For example, instead of paying 20% tax on up to £300,000 of profits, the company would pay 20% on only £150,000 and tax at a higher rate on the remainder.
Using a cell company could potentially eliminate this associated company tax problem.
Losses
If you use a cell company to carry on completely separate activities within the same legal entity, in many jurisdictions you should be able to offset the losses of one cell against the profits of another.Asset Transfers
Assets should be able to be transferred within the company with no tax implications. This is unlike the position that applies to groups of companies where there are lots of anti-avoidance provisions that could apply.
In this case there is only one legal entity and the transfer of an asset within this is not taxed in many jurisdictions.
Residency Provisions
This is an even more aggressive interpretation of the provisions. Under normal circumstances an offshore company is resident in a country if it is controlled from there.
What if a segregated cell company had non-cellular shareholders overseas? These shareholders would actually control the activities of the company and, as such, the company should be non-resident.
For example, one of the cells could invest in UK property or other assets, and on the basis that it was non-resident it would be exempt from UK tax on any gain arising.
In terms of managing the particular cell, it may be possible to argue that a director of the cell was not controlling the company, and therefore having a UK resident director of the property investment cell may not affect the non-residency status. While there would be other provisions to consider (eg anti-avoidance rules) the potential benefits are clear.
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