To Go or Not to Go Offshore;
Is It for You?
An increasing number of investors from
around the world are flocking to tax havens to establish a business presence
in the form of an offshore trust, International Business Corporation, open
an offshore bank account or even start their own bank. Each year as much
as half the world's stock of money either resides in, or is passing through,
tax havens making them an essential catalyst for world trade. Many are
lured offshore legitimately but some go offshore for the wrong reasons
and do so at great risk. Below are some examples.
Case
1
Mark
has worked for the same company for 20 years. He has reached the top of
the ladder in his department but the pay is good and he can't afford to
quit. He's getting tired of paying taxes and would like to earn extra money.
Last year he and his wife Mary started a home based business doing janitorial
work for small to medium size companies in the city where they live. Most
of the money they receive is either cash or cheque. Mark was surfing the
Internet a few months ago and found an ad for offshore services offering
to set up a company, including a bank debit card and cheque cashing service
for "under $500". The offshore advisor suggested that they could set up
an offshore corporation (Clean-It Ltd.) which would own the janitorial
service. They could then deposit cheques made payable to Clean-It Inc.
and withdraw the money at home using a debit card, which leaves no paper
trail at home.
He assured them that the account would
be confidential so they wouldn't have to worry about prying income tax
inspectors. To add another level of security, the promoter suggested they
set up an offshore trust which would own the shares of the janitorial service
and be the ultimate home of the income. That way, Mark and Mary don't own
anything because the funds would be controlled by an offshore trustee who
is sworn to secrecy so no one will be the wiser. The promoter assured them
that this way all the money Clean-It Inc. earned would be tax free.
Case
2
Frank owns a company that
leases cranes, forklifts and other heavy equipment to construction companies
in a number of countries. With the help of an offshore advisor recommended
by a friend, Frank 'sold' the leasing company to Equipment Leasing Ltd.
(E.L.L.) an offshore company that now buys the equipment and leases it
to other companies around the world. Frank retains a small interest in
the company and the rest is owned by an offshore trust and an International
Business Company (IBC). Furthermore, E.L.L. can sell the equipment after
it has been leased a number of times and retain the capital to buy more
equipment tax free.
Case
3
Peter is a writer who
writes screenplays for well known film companies and is well paid for his
labours. His offshore consultant has helped him set up an offshore company
that now collects his sizable fees. Peter is paid a smaller fee that he
is taxed on at home. His offshore company purchased a villa in the French
Riviera that Peter has exclusive use of while in Europe on business.
Case
4
William is an author who
writes booklets which he sells on the Internet. His market has grown and
he now sells to clients in a number of countries. He realizes that to market
world wide, he needs an international presence. The cost and quality of
printing dictate that his books be printed in a relatively high tax country
which also has very strict avoidance rules so he must be careful not to
trigger unnecessary tax liability. He decides to sell the rights to his
books to an offshore company in a low tax country that has a number of
tax treaties with those countries with which he does business. With careful
planning and some able guidance, his books are printed for his company
in a high tax country which then pays royalties to the offshore company
with only a minimum withholding tax on the royalties. He has even found
a way to have some of the income paid to his company at home (a high tax
country) tax free!
The question is, in the above four examples,
who has gone offshore legitimately and may legally benefit and who has
done so illegally and risks a charge of tax evasion?
It's easy to see that Mark
and Mary in example one have opened themselves up to a whole
heap of trouble. Assuming they live in North America, both Canada and the
U.S. have laws with stiff penalties for tax evasion and that is what they
are doing. They are sending taxable earnings to their offshore company
without declaring it and then bringing it back via a debit card and spending
it tax free. If they don't tell anyone and are very careful about what
they buy, they may get away with it for a while.
The cheques they receive from their clients
are usually under $1,000 and the clients may not know that the funds are
going to an offshore company. If the cheques are over $1,000, the risk
of being caught goes up because the banks must keep records of all such
payments going out of the country for the tax officials.
If Mark and Mary or one of their clients
are audited, the risk of detection is high, especially if clients are claiming
the janitorial expenses for income tax purposes. Often tax departments
will check expenses deducted from one taxpayers' income against income
claimed by the recipient. Since Mark and Mary aren't declaring any of the
income, it wouldn't take a Sherlock Holmes to catch them at their game.
If they buy real estate, cars, furniture
or vacations using their debit card, they also greatly increase the risk
of being caught. One of the major weapons used by the US Internal Revenue
Service or Revenue Canada is unsupported life style changes. They look
at the taxpayers' income and expenditures. Again, it doesn't take a genius
to see through a plot if expenditures exceed declared income.
Furthermore, the rules governing trusts
in the US and Canada have been substantially tightened in the last two
years. A new rule in the US in 1996 requires Mark and Mary to appoint an
American trustee to 'oversee' the offshore trust to insure that any tax
owing is being paid. Failure to do this will result in stiff penalties
and fines. If the trust is earning income not declared as received by it,
they risk a 100% tax on the income plus penalties.
Examples two, three and four are a little more
complicated.
If Frank
legitimately leases heavy equipment to companies around the world and has
corporations offshore for reasons other than tax avoidance at home, there
are a number of potential benefits.
The tax haven(s) he chooses will
determine his tax bill at home. He could set up in a tax haven where his
company pays no tax on earnings such as the Cayman Islands, or the Turks
and Caicos Islands, but he might be better advised to also use an intermediary
company in a country with tax treaties with the countries where he leases
his equipment. Rather than lose 25-30% to withholding taxes in the high
tax countries where he does business, this amount could be substantially
reduced. It will cost him more to set up an intermediary company, but the
strategy will reward him with the best of both worlds; complete privacy
and liability protection as well as potential tax savings.
There is another consideration.
If Frank's company is set up in a pure tax
haven to which he travels and sends money, his chances of an audit are
greatly increased, even if he has done nothing wrong. Revenue officials
carefully scrutinize any movement to and from well known, high profile
tax havens. If they see that an individual has made a number of trips and
sent money to such countries, a red flag goes up. If, on the other hand,
Frank has a intermediary company in, for example, the Netherlands, which
has a number of favourable tax treaties owned by another company in, for
example, the Netherlands Antilles, he reduces this risk. Business trips
and money sent to (and from) tax treaty countries don't usually elicit
the same interest from tax officials.
Peter,
the screenwriter, can also benefit from setting up a company in a tax haven
as long as he has legitimate reasons for doing so other than for tax avoidance.
If he sells his work to a number of different companies in different countries,
it could be argued that an international company in a tax haven gives him
greater access to business worldwide with fewer restrictions, even if he
continues to reside in a high tax country. He could sell the rights to
his work to an offshore company for a fee and receive income that is declared
at home. He could take the income as a royalty or dividend which are given
favourable tax treatment, depending on the countries involved. He, too,
may find it beneficial to use an intermediary company in a tax treaty country
as well as a tax haven to reduce taxes and give him protection from future
creditors at home.
In the above two examples, Frank
and Peter must be careful to meet all requirements necessary
to reduce taxes payable at home. For maximum tax savings, the companies
could be structured so not to qualify as Controlled Foreign Corporations
(CFCs). Both the US and Canada have strict laws governing CFCs.
For example, a company qualifies as a CFC
in the US if a US person owns 10% or more of the company or 50% or more
of the total stock is owned by US shareholders. Even if the company is
a CFC, tax on income may be reduced if the income is classified as 'active'
as opposed to 'passive'.
William represents
a growing number of home based entrepreneurs who's success is tied to the
growth of the Internet. They live in high tax countries and have clients
around the globe. How many have given any consideration to the tax implication
of their new found business income?
If William scores a hit with one
publication and sells a million of them for US$9.95, his costs of marketing
and distribution on the Internet could be less than ten percent, for a
net income of $9,000,000. Considering that the Internet is projected to
have in excess of two billion users in three short years, this possibility
is not all that far fetched. In Canada his corporate tax bill if earned
in one fiscal year could be as high as 45 percent; or 38 percent in the
US.
What if William were to sell the
rights of his publications to a company in Barbados which would have the
books printed and distributed by a company in the US to customers around
the world?
Barbados taxes individual and corporate
income at 40% so it can't be classified as a 'no tax' tax haven. However,
international income is taxed at a rate of 1% to 2.5% in Barbados. A number
of favorable tax treaties offer benefits for a Barbados International Business
Company (IBC), Offshore Bank Corporation (OBC) or Society with Restricted
Liability (SRL) doing business with high tax countries. The withholding
tax on royalties paid to a Barbados company by a US corporation is 5% or
10% by a Canadian company.
If William owned a Canadian company that
in turn owned the Barbadian company and the latter was classified as a
foreign affiliate for Canadian tax purposes generating "active income",
the former could receive income from the latter from "exempt surplus" tax
free in Canada.
Many high tax countries (Canada, US,
Australia, etc.) have adopted strict anti-avoidance legislation designed
to curb the use of tax havens or Offshore Financial Centres (OFCs) for
tax avoidance. It is important to note that tax havens were, in effect,
created by high tax countries such as the UK and the US in an effort to
reduce aid to certain 'have not' Caribbean and other under privileged nations
around the world by creating incentives for multinational corporations
to invest. These incentives were not intended to encourage individuals
to move assets to these nations in an attempt to avoid paying tax, but
that has been the net result. However, companies legitimately established
that foster world trade and investment in certain "developing" countries
derive substantial benefits from such incentives when they know the rules.
It is important to remember, according to offshore legal expert Ken Finkelstein,
that as long as a person remains resident the US or Canada, they are subject
to the tax laws of that country. As such, merely setting up a company in
a tax haven will not alleviate nor reduce tax liability for the individual
in most cases. The IBC or other type of corporate structure (if classified
as a Controlled Foreign Corporation) and the individual will be treated
as one person for tax purposes.
OFCs have become an integral part
of the tax planning for corporations doing business world wide. High as
well as medium net worth individuals are increasingly utilizing offshore
corporations to take advantage of investment opportunities unavailable
to them at home. The Securities and Exchange Commissions in the US and
Canada require all investment companies to provide an exhaustive (and expensive)
prospectus before any investment can be offered to it's citizens. Unfortunately,
most of the top offshore funds find the process too onerous and expensive
to file in many high tax countries and therefore are unable to offer their
investment to those citizens. An offshore company, on the other hand, can
easily invest in any fund or investment available world-wide.
These passive investments must be disclosed
in most high tax countries and capital gains taxes paid, but if the investment
is generating over 100% annual return, the net return is still sizable.
The Quota Fund, a derivative fund domiciled in the Netherlands Antilles
returned 78.8% in 1996 with a five year return
of 852%, according to The
Micropal Offshore Investment Funds edited by Robert (Woody)
Milroy. Wouldn't it be good to know when it comes time to retire, that
you have a tidy nest egg awaiting you in your new home on a sunny, tropical
Caribbean Island. If you end up becoming a permanent a resident there,
the tax savings could pay you a handsome dividend if you don't mind relinquishing
your residency at home. (US citizens are taxed on world-wide income, regardless
of residency and now derive 'more limited' tax benefits from relinquishing
citizenship.)
The decision to utilize OFCs is one that
must be given careful consideration but if tax avoidance is the primary
motivation, a number of obstacles must be expected by both the individual
and corporation. If, on the other hand, your goal is to access new markets,
take advantage of business and investment opportunities unavailable at
home or to protect assets from future frivolous litigation, an investment
in an OFC could reap untold future rewards.
The cost of living is easily more manageable than in North America or Europe.
Compared to other cosmopolitan areas in the world, real estate in Panama
is far less expensive, as are the costs of labor and services. There are
many hospitals throughout the country as well as an international airport
with direct connections to more than 28 countries.
Contributed by: Matt Blackman.
|
You can contact us by e- mail: |
|
 |
|
