The fundamental concept behind business being conducted in a corporation or trust structure is simply limitation of risk. In order to encourage business enterprise, legislation was first adopted in American and European countries to limit potential losses by adventurous entrepreneurs to their stipulated capital. In current times, virtually all free-world countries have adopted this concept.
Since a properly structured corporation or trust is an entity legally considered “distinct from its owners”, systems have necessarily been developed in each country to tax entity profits in manners unrelated to taxation of the shareholders or trustees. And this process of differing approaches to taxation has now resulted in evolution of global opportunities for residents of any high-tax country to achieve tax benefits through business structure in other zero or low-tax countries.
The first countries to commercially exploit this potential were islands off the coasts of Europe and North America (i.e. “OFFSHORE”) which were characterized by no or low-tax rates, by relatively simple compliance requirements, and with financial sectors in place to handle monies incoming from high-tax countries. Now, the terminology Offshore Financial Center (“OFC”) also extends to numerous non-island countries who meet these characteristics (e.g. Luxembourg, Monaco, Andorra).
Optimizing tax benefits from an offshore structure strategy is always dependent upon (1) the tax regime of the OFC and cost factors relating to structure registration and maintenance, (2) tax legislation in the country of shareholder or trustee residence, (3) the domicile of any beneficial owner, and (4) “anti-avoidance” legislation of countries in which business is conducted. Obviously, accountants and attorneys play a critical role in providing guidance to achieving such optimization.
Definition of TAX RESIDENCY is the central issue. Most countries attempt to tax any individual who spends over six months within their border. Therefore, to encourage travel, international trade and cross-border investment, many countries have adopted “double taxation treaties” — to determine which jurisdiction has taxing rights and protect individuals from double economic taxation.
With regard to corporations and trusts, tax residency issues also arise, usually involving whether activity is “established” OR “managed and controlled” within a country’s jurisdiction. Since a company is generally considered to be managed and controlled wherever its Directors habitually meet and reside, it’s rarely the case that an owner-manager or trustee ONSHORE can safely act as Director of a company OFFSHORE without creating tax liability in the home jurisdiction. For this reason, OFC logistics typically involve engagement of a Director from a fiscally neutral country to “manage” in accordance with the views of their client.
When profits are ultimately distributed to owners or beneficiaries they will generally become taxable at that point in the recipient’s country; therefore, optimal tax leverage may involve also accumulating monies offshore— which, if properly structured, may defer (and in some circumstances may permanently avoid) taxes on earnings from reinvested funds. This is more difficult for U.S. residents than for citizens of many other countries, and is a complex and costly process, but evidences the wide potential of strategic tax planning for the right persons in the right circumstances by the right advisors.
Coordination of all aspects in an offshore business strategy is dependent upon sophisticated interpretation and adaptation of the varying, interrelated regulations. Experts within each country are absolutely critical. However, the benefits which can be derived from an effective OFFSHORE strategy can be vast.