General Principles Relating to the use of Offshore Tax Havens For a tax liability to arise there has to be something called a "connecting factor" between a taxing jurisdiction on the one hand and a taxpayer or taxable event on the other. What do we mean by connecting factor? For a trust the connecting factor could be where it was created, the law which governs it, where it is administered, and the residence, domiciliary or citizenship of the beneficiaries. For an individual taxpayer the principal connecting factors are residence (where you live), domicile (where you were born or where you have been resident for a very long time) and citizenship. Whereas for a company the key connecting factors are all to do with central management and control, beneficial ownership (by which is meant who really owns it), the place of incorporation, and its registered office address. Offshore tax planning is, therefore, all about removing or changing these connecting factors. What does this mean in practice? A company located in the British Virgin Isles whose shares are owned by a Bahamian discretionary trust and whose directors manage the company from the British Virgin Isles clearly has no connecting factors with a UK taxpayer (unless, of course, the taxpayer was the settlor of the trust). Trusts, then, serve as an highly effective means of severing or preventing the formation of any relevant connecting factor with a high tax jurisdiction such as the UK. The trusts are, in many ways, only half of the picture. The other half of most offshore tax plans involves the use of an offshore company. Background to offshore companies Before looking at the role of offshore companies and tax planning it is, perhaps, worth setting out a few basic facts relating to their structure and make-up. In fact, offshore companies are in many respects very similar to onshore companies in their structure. Company Name There is great flexibility in terms of company name. Whichever jurisdiction you establish the company in the appropriate Registrar will, clearly, have to approve the name before incorporation. Occasionally a name may be refused because it is considered undesirable or because it is similar to an existing company name in the same jurisdiction. Nowadays most jurisdictions limit the use of the following words: · International · Bank · Trust · Insurance · Holdings · Group The use of such words in a company name may be subject to minimum capital requirements, local licensing or other local regulations. Company names may end in different ways. For instance, in the Isle of Man the word limited (Ltd) may be used whereas in the British Virgin Islands the initials IBC ñ which stand for International Business Company ñ may be employed. Registered Office The registered office of the company must, almost without exception, be located within the jurisdiction of incorporation. This is the legal address of the company to which all official documents should be sent. The company statutory records should be maintained at the registered office but accounting and other records can, obviously, be maintained elsewhere. Memorandum and Articles of Association Generally known as the 'Mem & Arts' the memorandum and articles of association basically set out in considerable detail the objects which a company has been established, share structure and so forth. In the old days companies were not supposed to carry out any activity not detailed in its Mem & Arts ñ however modern legislation means that in most jurisdictions companies can trade in any way they wish. Share Capital As in the UK share capital will divide into authorised and issued. The authorised share capital will be the amount available for issue. For instance the authorised capital could be £1 million e.g. one million times £1 shares. However, the issued share capital (e.g. the shares actually paid for) might only be £2 e.g. two times £1 shares. Do note that duty may be due on either the authorised or issued share capital. Shareholders The shareholders are the legal owners of the company and they may be either individuals, companies or trustees. In some jurisdictions it is possible to have bearer shares whereby whoever has share certificates is deemed to own the company. Not all offshore jurisdictions require an annual return ñ but some do. These annual returns may, in turn, require details of shareholders but it is important to stress that the beneficial ownership of any registered shares is never required in a true offshore tax haven. It is quite common practice for the true owners of a company to appoint nominee shareholders to act on their behalf. That is to say professional advisers are paid an annual fee to hold the shares in their name thus keeping the identity of the real shareholders secret. The Company's Offices The responsibility for the day to day management of a company belongs to the directors. Much as it is common practice to have nominee shareholders it is also common practice to use professional, nominee directors to take legal responsibility for the affairs and transactions of the company. Clearly by appointing nominee shareholders and nominee directors the beneficial (or true) owners of the company can keep their involvement confidential. Audits Depending on the tax jurisdiction it may or may not be necessary to complete annual accounts and/or and annual audit. The Role of Offshore Companies An offshore company, just like an onshore company, is a separate legal entity. So far as the UK is concerned providing that company is located offshore and managed offshore it is not liable for UK taxation. However, it must be stressed that if the Inland Revenue believes that management and control of the company is actually taking place within the UK then that company will be deemed to be resident. When the Inland Revenue wishes to attack an offshore company it will invariably try and prove that either its control and management are being undertaken within the UK or else that its beneficial owners are UK residents. If, therefore, as a UK resident you intend in some way to use an offshore company it is vitally important to ensure that you are not at risk in either of these areas. Assuming that all goes well and your offshore company is not liable to any UK taxation how might you use it? Here are some different examples: · It can be used to purchase property. In the UK there are three taxes to consider in relation to property: capital gains tax, income tax and inheritance tax. If an individual invests in British property then it is very difficult to avoid any of these taxes ñ but all three can be mitigated if an offshore company established in a zero or low tax jurisdiction actually conducts the purchase. Certainly no capital gains tax will come into play if and when the property is sold. However, if the property is rented out, rental income may be liable for a degree of UK taxation. · The purchase of overseas property. Much in the same way that offshore companies can be used to buy UK property they can also be used to buy properties overseas both to hide the true ownership of the property and also to reduce or avoid taxation. · As trading companies. Here we run into the issue of transfer pricing which we will deal with separately. However, in principle an offshore company can be used to provide either services or products all over the world in such a way as to escape local taxation. They can also be used to reduce taxation in a particular country. This is done by interposing an offshore company in an international transaction. Thus coffee from Brazil may first be purchased by an offshore company before being sold on (at a profit) to an onshore company. If the onshore company had purchased the coffee direct in Brazil it might have made a greater profit which would clearly lead to higher taxation. Instead, the interposing of an offshore company reduces the onshore companies tax liability. The offshore company does not, of course, have any tax liability. · Offshore companies can be used by consultants and freelancers to sell their services overseas. For example an oil engineer might contract his services to a company located in an offshore jurisdiction. This company would then sell the engineer's services on in different parts of the world. 70% of the money earned by the offshore company might remain in the offshore jurisdiction with only 30% being paid to the engineer in his onshore location. By this means tax can be deferred and possibly completely avoided. · Offshore companies can be used to hold copyright, know how, licences, and franchises. For instance an inventor might sell his idea to an offshore company who in turn would sell it on around the world. In this way the inventor would reduce his own profit from the invention and thus the tax he would have to pay ñ while the offshore company (again) would not pay any tax at all. · Offshore companies are also frequently used to own ships and yachts. · Offshore companies may be used in complex tax saving structures involving double taxation treaties, tax credit mixing and so forth. Form with Speed, Repent at Leisure Nothing could be easier than forming an offshore company. Open any of the Sunday newspapers or countless magazines and advertisements from the leading company registration agents offer offshore companies within hours for relatively low fees. However, those who form offshore companies without fully considering all the tax implications are likely to regret it. For in order to make an offshore company truly effective it is vital that: · It is formed in such a way as not to reveal the true owners identity. · From day one the shares are held in the correct way ñ possibly by nominee share holders or possibly by a trust. · Appropriate directors are appointed ñ if necessary nominee directors.