Over the years, I have probably heard most of the possible questions regarding the offshore sector. However, one question I still regularly receive from readers is Do Offshore Companies Pay Taxes. On the face of it, it might seem like a simple question to answer given that the companies are typically located in offshore jurisdictions that have no taxes.
Unfortunately, the reality is rarely that simple so let’s dig into the critical pieces that will help you understand your circumstances and whether you can pay an effective tax rate of zero percent.
Why the Offshore Jurisdiction Matters
There are literally hundreds of offshore jurisdictions available where you can form a company with little effort and with fairly low costs. However, they are not all created equally when it comes to taxation, and this is why it pays to seek professional advice before you select a specific country to form your company in. In fact, some of the countries with low or no tax regimes might surprise you and even western countries may have regimes that you can design a company structure around.
On the flip side, some of the traditional tax havens like Panama and Belize are now tightening their tax and substance rules as they come under pressure from the OECD. Unfortunately, most western governments hate competition, and this is why they pressure smaller economies to levy taxes.
Subsequently, Belize is now requiring financial records to be kept for inspection and I’m regularly hearing that they are actually requesting access to this confidential financial information. Like most tax havens, Belize does not tax worldwide income, but new laws introduced last year now requires IBCs to lodge a tax return annually.
Ultimately, they are looking for any locally sourced income that they can tax, but unfortunately, they have now moved towards tightening the guidelines. One of the requirements is that you MUST be paying tax somewhere. To receive a tax exemption for your offshore company, you are now forced to jump through a bunch of hoops.
Obviously, this is just a single example, but the reality is the days of zero tax and hiding your income and assets in a tax haven are slowly disappearing. International pressure is being brought to bear on these countries, and it is changing how you have to go about offshoring your operations.
Where Are You a Tax Resident?
If you ever consult or work with me on a project, it’s likely the first question you will hear me ask is where you pay tax. The reason I ask this question upfront is your country of tax residency is a key component on how you can structure your offshore affairs. Some countries have a very regressive view of offshore structures and may treat them as domestic companies despite them being in a far-flung jurisdiction.
For instance, New Zealand has a Controlled Foreign Company (CFC) regime where if the company is simply a shell, and you are the primary operator/management, then they treat it as a local entity for tax purposes. This means that you get stung for tax regardless of your offshore company being located in a zero-tax country. However, don’t stress as there are exemptions in most CFC countries to get around these rules, but they are costly and take time to develop.
The reality is that your tax residency status is likely to be requested from you every time you open a bank account or deal with a professional. Ten years back no one was asking for a tax residency certificate but now it has become commonplace. This is why it’s critical to structure your affairs based on your current and future tax residency status.
Does Your Company Have Substance?
I know what you are thinking…what in the hell is substance and what does it have to do with an offshore shell company. Well, let me tell you as it’s probably one of the most important concepts that you will need to understand if you are going offshore.
Assuming your tax residency is in a place like the U.S or New Zealand, and they have a CFC tax regime, the only way you are getting out of paying tax is by either moving your tax residency to another country or by having an offshore company that has ‘substance’.
Simply put, substance is where an offshore company actually has a presence and real operations as compared to being a shell company. The definition changes depending on the tax rules of your home state, but the idea is fairly simple. An offshore company with ‘Substance’ would very likely have an office, real operations and staff, bank accounts, and a management team all offshore. This would likely give it the substance to be considered a real company by your home tax jurisdiction.
Unfortunately, it also means you can only play a small role in its actual operation because if the entity is seen to be managed solely by you from the home tax jurisdiction, then it will likely not have substance. So, the days of just using nominee directors and claiming that you don’t run the company are effectively over.
Developing substance can be quite expensive, depending on the country you choose, given that you will need a real office and some level of staffing and management. However, if your current tax bills are quite large then it makes sense to move your operations offshore and use local staff and management and this is something we often undertake for clients.
How Your Offshore Company Can Pay Zero Taxes
Now that I’ve explained the key components that you need to consider, and why a simple structure may not work for you, the time has come to tell you how to actually achieve a low or no-tax outcome with an offshore entity.
Firstly, the easiest way to do it is to ensure that you are earning enough to be able to move your tax residency to a country that only has territorial (local) taxes. This largely solves many of the problems and I have assisted clients in moving all around Asia including places like Thailand.
If you can achieve a move, your next step is to ensure that you have some local investments that generate an income that you will need to pay tax on in your new home. It doesn’t have to be a huge investment as the goal is simply to create a taxable income stream where you pay tax on it locally. The reason is that this will allow you to get a tax residency certificate that you can present to all who request it. Given your new home doesn’t tax offshore profits, then you are effectively living a no-tax lifestyle.
Finally, pick wisely where you choose to set up your company as you need to not only consider a tax haven’s current status but what may happen in the future. Assuming you moved your tax residency, then you will not have to obtain economic substance for your company.
However, if you do need to establish substance then you will need to budget for opening an office and arranging staffing and management. You will also need clear business and management plans and procedures in place as, if requested, you need to be able to document your arms length relationship with the company.
This is where it pays to have the help of a professional as there is a myriad of traps and, depending on where you are living, the case law may need to be checked for relevant decisions of avoidance and substance. A professional can help guide you and also has the contacts to be able to put most of what you need in place for substance.
Do Offshore Companies Pay Taxes
Do Offshore Companies Pay Taxes – The simple answer is in most cases they do not. However, I think I’ve established in this guide that it is certainly more complicated than that. The question really shouldn’t be whether the company pays taxes, but it should be about the individuals behind it who are ultimately receiving the profits.
It is absolutely possible that you can structure an offshore company to obtain substance and pay both zero tax for yourself and the company. If you would like assistance, or want to talk through your personal circumstances then please contact our consulting arm for a free discussion: