Offshore Companies: Why and How to Incorporate Offshore
While Asia used to be a large receiver of foreign direct investment (and still is to a great extent), in recent years, there has been a tremendous outflow of capital from East Asian countries such as China and Japan to invest in destinations such as South-East Asia, North America, and Africa. For these reasons, there have been a gradual increase in the number of Asian corporations and business forming holding companies in “offshore jurisdictions” and “tax havens” in order to cope with the increase in investment. In order to attract these corporations and businesses, certain “offshore jurisdictions” have specialized and tailored their laws in order to be attractive for certain industries and purposes. Consider for example the tiny island republic of the Seychelles which has positioned itself as a bridge for investment between Asia and Africa, or the British Overseas Territory of Bermuda which has become a prominent and popular location for those involved in the insurance and re-insurance industry, or the Cayman Islands which has received a lot of attention from famous hedge funds managers such as George Soros.
But why do these businesses invest “offshore” in the first place?
The answer is that there are great benefits to shareholders and investors to do so. The media has never portrayed “offshore jurisdictions” and “tax havens” in a positive light. Recent scandals like the “Panama Papers” have helped to shape in the minds of the public that offshore entities are all scandalous and “shady”; they are illegal and immoral. However, more and more companies are incorporating and moving offshore for reasons that are not illegal or immoral. In fact, having an offshore entity allows great, legal benefits for the shareholders of a company. Generally speaking, there are four main reasons why companies incorporate or move offshore in “tax havens”: i) asset protection; ii) legal, governmental, and banking stability; iii) lower capital requirements; and iv) tax relief.
Some offshore jurisdictions, like the Cook Islands for example, have very strong statutory and case law asset protection regimes for individuals or companies to create trusts for the purpose of safeguarding their assets. A trust is a type of legal relationship where a settlor transfers assets into the legal care of a managing trustee, who seeks to manage the assets for the benefit of a beneficiary (many times the settlor and beneficiary are the same person). Trusts are very beneficial as they allow a settlor to keep certain assets out of the reach of creditors.
When it comes to bankruptcy cases, courts in the United States, the United Kingdom, and Taiwan technically do not have any power over a trust established in another jurisdiction, and therefore cannot force a trustee to release funds from the trust to a creditor. Many jurisdictions, like the Cook Islands or the Isle of Man do not recognize foreign judgments, thus shielding assets held in those jurisdictions from extraterritorial court orders. This means that a creditor would need to initiate litigation in the Cook Islands or the Isle of Man in order to have a reach at the assets of the corporation.
Another consideration for incorporating offshore are stability factors; specifically, legal, governmental, and banking stability. The reputation of legal jurisdictions can vary greatly between countries with some developing (or even developed) countries being perceived as not having a very fair, impartial, and transparent legal system. Any legal system lacking in these areas can create doubts for potential investors who are concerned that the laws of the country they invest in may change unfavorably after their investment is made. It is not uncommon for parties to commercial contracts to decide to have their contract governed by the laws of England & Wales. English contract law, which is common law (or judge made law), has been around for a millennia and is regarded as being sufficiently thorough, transparent, and neutral. This clarity further extends to the company laws of England & Wales which are well regarded worldwide. The United States’ legal system, as a former British colony, is based on English common law. The same is true for the city of Hong Kong. There is no coincidence that the world’s premier financial markets of New York, London, and Hong Kong are all common law jurisdictions. This same legal reliability extends to many “offshore jurisdictions”, such as the Cayman Islands, British Virgin Islands, the Seychelles, and Bermuda, as they are either all current or former British possessions that have inherited English company law. Parties investing in common law jurisdictions can be almost certain that the legal system in their jurisdiction will remain for the most part unchanged, allowing an investor peace of mind.
A similar concern is that of governmental stability. Expropriation can be a serious issue that can affect the shareholders of a company. Expropriation is where the government of a country either directly, or indirectly, takes over a corporation’s assets or equity in order to nationalize the company. Certain countries, like Venezuela, may offer attractive investment packages and benefits to a potential investor but are generally not safe places to incorporate or invest in as Venezuela has a poor reputation at expropriating and nationalizing certain companies and/or their assets (just ask oil giants Exxon Mobil and Conoco Phillips). Thankfully, most “offshore jurisdictions” have great track records at governmental stability. Many have fair and neutral administrative agencies that are transparent and accountable. The administrative agencies in these jurisdictions are neutral and play by the rules. The pro-business environments of these jurisdictions has greatly helped at attracting foreign investment.
Finally, banking stability in a given jurisdiction should be considered before a potential investor decides to incorporate. How are the banking institutions in a specific jurisdiction viewed? Do they have good internal polices and controls? Are they viewed as locations where a lot of money laundering takes place? Is it easy to set up an Offshore Banking Unit there? These are all questions that should be researched and addressed before incorporation occurs. Some “offshore jurisdictions” do not wish to be viewed as money laundering havens and have taken significant steps to draft and enforce “Know Your Client” provisions in their laws, the most notable being Hong Kong and Singapore. However, other jurisdictions have taken a laissez-faire attitude towards banking regulations. It should be noted though that there is a growing influence and assertion of political pressure by many developed countries on many “offshore jurisdictions” and developing countries to tighten their money control and banking laws. While this is the current trend internationally, there are still some countries that have very minimal banking restrictions and regulations.
Lower Capital Requirements
A minimum capital requirement is the amount of capital that must be placed into the business before the company can begin operations. This can be a major issue for startups and entrepreneurs as larger minimum capital requirements require, generally, more investors in order to get business operations off the ground. More investors generally mean more complex and detailed Shareholders’ Agreements, leading to a more complex separation of powers and share rights. In the long run, some startups decide that it is better not to raise too much capital too quickly, as having too many shareholders in a company early on can place limits on the vision and direction that the Founders have.
The theory behind minimum capital requirements are to allow potential creditors and investors in a business to feel comfortable with making a loan or investment; there is some equity in the company and they can recover the principal of their loan or investment if something goes wrong. There are many studies available that show that such requirements actually hinder the growth of a company, and that governments would be better off finding other ways to protect creditors and investors.
While there is a general downward trend for capital requirements worldwide, some countries still have quite high capital requirements. Thankfully, most “offshore jurisdictions” have very low capital requirements that allow entrepreneurs or investors to form a company very quickly. The capital that would then be placed into the company can be spent on other things that can directly help the company and the founders can get to building their business and delivering a product to their customers.
It is often said that there are only two things any person can be certain of in life: death and taxes. Thankfully, with careful planning, an investor can incorporate in an “offshore jurisdiction” in order to receive tax relief. Most of these jurisdictions have a 0% tax on corporate profit, a 0% tax on capital gains, and a 0% tax on dividends. However, many “offshore jurisdictions” charge an annual fee relating to the number of issued shares. These fees are generally very low compared to any sort of potential corporate tax, and the payment of them ensures good governmental administration. For these reasons, “offshore jurisdictions” and “tax havens” are often seen as ideal places to incorporate a holding company. Dividends from the holding company can then be paid to the shareholders free of tax although certain countries, like the United States, may require their citizens who are shareholders of the company to pay tax on the shareholder’s dividend income when they file their tax return. The great thing is that the shareholders of the holding company can decide to leave the profit in the holding company until they decide that they want a distribution, as compared to receiving a salary which must always be paid each year when it is earned. This is known as tax deferment.
Generally, a holding company will be owned by shareholders who are the final, beneficial owners. The holding company may then be the sole shareholder of several subsidiary companies, each that are conducting business operations in the country they are incorporated in. While the income of each subsidiary (along with the dividend payable to the parent company) may face tax in certain countries, the result is to limit the amount of global taxation on regional income. For example, the United States taxes corporations on their worldwide income. That is why it is generally not a good idea to incorporate a holding company in the United States as all income received from foreign sources will be taxable. However, it is a good idea to have a US subsidiary company doing business in the United States, while having that subsidiary distribute a dividend to the parent holding company. This method could be applied for every country that the business operates in.
Double tax treaties are also very important considerations. Many nations sign these treaties with each other in order to limit or erase the taxation that companies or individuals in their countries may face. Planning a corporate structure around these double tax treaties can help save millions of dollars. Many developed countries see no need to sign double tax treaties with countries that are considered “tax havens”. Thankfully, there are certain countries that have double tax treaties both with developed countries and countries that are “tax havens”. While there is no double tax treaty between Hong Kong (a tax haven) and the United States, Luxembourg has tax treaties with both. It would then be possible to move a dividend at a lower taxable rate (15% down from 30%) from the United States to Luxembourg, and then from Luxembourg to Hong Kong at a 0% rate, thus reducing the tax that would have been paid if the US corporation had paid a dividend directly to the Hong Kong company (a flat 30%). Ireland and the Netherlands, like Luxembourg, are great locations for companies specifically set up for tax funneling, and careful planning can reduce or eliminate tax burdens.
Anti-Money Laundering is currently a very hot topic in many circles. Money laundering is the process by which money gained from criminal or illegal acts is transferred over and over again, in order to make it difficult for authorities to track where the money originally came from. Terrorist groups, drug cartels, or corrupt political powers may set up shell companies and continue to transfer money back and forth in order to “clean” or “launder” the money. Tax havens and offshore jurisdictions, which favor investor secrecy, have traditionally been a safe harbor for these kinds of activities. While this has always been a sensitive subject, the recent publication of the “Panama Papers” has achieved a new level of public awareness into these happenings. There will now be, more than ever, more pressure applied on offshore jurisdictions and tax havens with the purpose of making them more cautious about who they let invest in their jurisdictions. More and more offshore agencies, such as the International Monetary Fund, are requiring banking institutions in these jurisdictions to make quarterly reports on their operations and their anti-money laundering provisions and practices. It should be noted that the Financial Action Task Force, which is an international organization created by the G7 to fight money laundering, initially placed many offshore jurisdictions, such as the Cook Islands and the Cayman Islands, on a list of non-cooperative jurisdictions that have refused to take action against money laundering. In recent years, many offshore jurisdictions have been removed from this blacklist as they have made significant improvements in combatting money laundering by passing various legislation and regulations. Thanks to increased public awareness, international pressure, and governmental oversight, investors can rest assured that their investments in “offshore jurisdictions” and tax havens will be safe and secure.
How to Incorporate Offshore
Offshore incorporation is easier than you may think. It is best to consult with an attorney and tax specialist to consider where to incorporate, focusing on the main points listed above. Next, your trusted attorney should draft the Articles of Association (or Articles of Incorporation as it is called in some jurisdictions) and the Memorandum of Association together which list the basics of the company and can best be considered as the organization’s core documents or “constitution”. The Articles and Memorandum will set out the purpose of the corporation, the rights of shareholders, circumstances and procedures for new share allotments, the different classes of shares, the dividend policy, and transference of shares. Depending on the more founders and investors involved, the more complicated the Articles and Memorandum will be, probably requiring the drafts to exchange hands many times with tweaks. It is our opinion and recommendation that you make sure you select a trusted attorney or representative who is good at negotiation.
In addition to the Articles and Memorandum mentioned above, there may be one or more additional Shareholders’ Agreements. Shareholders’ Agreements are contracts between the various Shareholders/members of a company where they agree to restrict each other’s activities and/or rights in accordance with the agreed upon terms. As these Agreements are contracts, and not corporate documents, Parties usually use the law of an established jurisdiction such and England & Wales or Hong Kong to govern the document.
Once the core documents are ready, the documents will need to be filed in with the appropriate governmental office in that jurisdiction. Many offshore jurisdictions require the use of a registered “agent” to handle and process these documents. Documents such as a register of members and directors will need to be filled out and filed with the government through the agent. Depending on the jurisdiction, there may “Know Your Client/Due Diligence” requirements that require the provision of proofs of address and color copies of passport photographs for anti-money laundering purposes. Often, these documents will need to be provided for the ultimate beneficial owner of the firm. If your company structure is quite large, we would highly recommend allowing extra time in the process to gather, certify, and collect these documents. Our firm has experience in working with agents from many different agencies and companies and can walk you through this process.
While there are many benefits to going offshore, there are also many risks. Certain jurisdictions are set up for certain types of companies, and not effectively planning tax issues can be a stumbling block for future growth of your business. It is imperative that you consult with experienced attorneys and properly plan your business before rushing in. We have seen individual and corporate investors come to us asking us for help after becoming entangled in a mess because they rushed to incorporate offshore via a cheap website service, or have incorporated in a country that taxes worldwide income, like the United States. At the Taipei office of Zhong Yin Law Firm, our attorneys have many years of experience between them helping companies incorporate, integrate, and operate in “offshore jurisdictions”. We can help avoid these problems and pitfalls in a cost-effective way. Please feel free to contact us if you have any questions or need help to go offshore.