Where to incorporate an International Business – Part 1: Offshore vs Onshore
Flag Theory Weekly Letter – Friday November 16th, 2018
One of the main advantages of international businesses over local ‘brick and mortar’ businesses, especially for digital businesses, is that you may have the ability to pick the best strategic jurisdiction(s) from which to run your business. The first question you have to ask yourself is whether you want to incorporate onshore or offshore, or both.
We define offshore, the aptly named IBC or international business company, as a company that is incorporated in a tax-neutral jurisdiction, is usually not a tax resident in the jurisdiction where it is incorporated and it is not subject to any account filings or other reporting requirements.
For its part, an onshore company is a legal entity that is tax resident in the jurisdiction where it is incorporated and usually subject to certain level of taxes and financial reporting requirements.
Offshore incorporations can offer significant advantages to incorporating ‘onshore’ in a high tax location. However, certain caveats must be considered and depending on your business activity, your business requirements, your suppliers and clients, and your personal situation, incorporating (only) offshore may not be suitable.
Next, we review some of the key facts that you may consider on whether to go offshore or onshore (or both). In the next sections, we will review some of the key aspects to take into account in some jurisdictions that may help you determine if they are suitable for your specific business.
Tax and Ongoing Compliance
Taxes are usually the first reason that leads entrepreneurs to set up shop offshore.
Offshore companies are not usually subject to taxes in the jurisdiction of incorporation and, usually, the corporate compliance burden is minimal. By law, your company must keep accounting records, but you may not need to file them.
No audits and no filings and just an annual renewal fee will be enough to keep your company in good standing.
This makes maintaining an offshore company much less cumbersome and costly than an onshore company.
However, there is a catch. If the offshore company is not properly structured, chances are that it will be considered tax resident in the jurisdiction where it is controlled and managed from. This is because in most jurisdictions, corporate tax residency is determined by the place of effective management. Sometimes this is called controlled foreign ownership, sometimes constructive ownership. The exact tax laws on non-resident companies controlled by the mind and management vary from jurisdiction to jurisdiction.
As a simple example, if you run a Belize company from the UK – this Belize company may be deemed tax resident in the UK and subject to taxes and compliance requirements in the UK. You may be obliged by law to disclose this company and tax authorities may consider it a tax resident company.
In addition, if you or your local entity hold a certain ownership percentage of a company incorporated offshore, and your country of residency has enacted ‘controlled foreign company’ (CFC) rules – the offshore entity may be deemed a CFC and you might be subject to taxes for the income of your CFC even if this income has not yet been distributed.
We’ve enabled a filter in our jurisdiction comparison app Incorporations.io, which lists certain countries that have or do not have CFC laws – however, this is not guaranteed to be accurate or up to date. The implications and requirements of controlled foreign company rules vary between countries, so you must consult a tax advisor in your jurisdiction of residency.
Also, thinking that your offshore company will ‘fall through the cracks’ and your local tax authorities won’t notice may not be the best idea. Most countries are exchanging tax information through the Common Reporting Standard (CRS) under the OECD’s Automatic Exchange of Information (AEOI) framework.
You will be required to disclose your tax residency to the bank in order to open an account, filling out a CRS self-certification form including your tax residency and tax identification number (TIN). If you are a US person, you’ll have to fill out certain FACTA forms as well. The banks are obliged to disclose this information to local authorities who in turn may disclose it to the relevant foreign authorities.
Your personal tax residency and the jurisdiction where you are effectively managing the offshore company from matters and it should be included and carefully planned in any internationalization strategy; there are ways to legally minimize your tax burden.
Another aspect you should consider is where your clients, suppliers and employees/contractors are located – as this can also create various types of tax liability. For instance if a foreign entity is effectively connected income due to efforts (by way of example – sales and management staff selling to US customers), then you may face tax in that country (even if the entity is controlled outside the US, by non-US staff).
[foreign corporations engaged in trade or business within the US are subject to US income tax on income, from sources both within and outside the US, which is “effectively connected” with the conduct of the trade or business within the US. https://definitions.uslegal.com/e/effectively-connected-income-eci/ ]
You might look at the availability of tax benefits under Double-Tax agreements (DTA) in the countries you are effectively operating and/or your stakeholders are located to minimize potential tax liabilities, which are usually not available for offshore companies. For instance, some jurisdictions may levy withholding taxes on payments made to non-resident companies that could be reduced/exempted under DTAs. You should also consider where your workforce is located in order to be able to provide local employee benefits or, instead, set up corporate offshore schemes for employee benefits or retirement benefit plans.
Offshore Protection and Privacy
Going offshore may provide a higher degree of protection and privacy.
In certain jurisdictions, your business assets may be protected by strong asset protection legislation. Sometimes it is simply too cumbersome to bring litigation against an offshore company which may help you avoid frivolous lawsuits. In addition, details of directors and shareholders are not usually available for public inspection – providing a degree of privacy that is not available in onshore jurisdictions.
This means they won’t show up on an asset search, which is the first thing a litigious attorney will look for. Finally – most offshore jurisdictions do not allow for contingency fees (where a lawyer only takes a fee contingent upon a certain outcome. Contingency fee arrangements oftentimes lead to lawyers taking a large percentage of profits for successfully suing a wealthy defendant.
Certain legal entity types, such as LLCs, are more suitable for protection purposes. LLCs ownership is divided into membership interests rather than shares and membership interests may not be confiscated by a court order. Some LLC legislations also provide you with charging order protection. Finally, there does not need to be a director in an LLC (which are either member managed or manager managed) – meaning a person doesn’t need to have the same liability which comes automatically with a directorship role.
In a corporation, decision-making is subject to rigid procedural formalities and a failure to comply with these may allow plaintiffs to pierce the corporate veil and trigger personal liability. LLCs are not subject to these decision-making procedural formalities and are governed by their operating agreement, which can be customized and adapted to the needs of their members, as long as they are not against the laws.
Some offshore jurisdictions have made available other powerful asset protection vehicles such as Trusts and Foundations. Trusts are legal agreements whereby a settlor cedes the legal ownership of their assets to a trustee, who has a fiduciary duty to manage these assets for the benefit of persons or for a specific purpose.
You can review offshore trusts and their key legal aspects and uses via incorporations.io/trusts/:
If properly drafted and settled in the right jurisdiction, a trust may protect intangible assets held by the trustee as a foreign court may not have jurisdiction over the trustee holding assets offshore.
However, foreign trusts are not recognized in many jurisdictions, as several countries with a legal system based on civil law may not differentiate between formal and beneficial ownership, and the trust could be disregarded.
Foundations may be more suitable in these cases as they have the legal personality separated from the founder and its board, but unlike corporations, they don’t have owners or shareholders and their assets are administered by a management board or council for the benefit of persons or for a specific purpose, whether charitable or non-charitable. For an overview of some foundation structures, you can check out incorporations.io/foundations.
Business Banking
Due to the fact that an offshore company’s ownership records are not public, and your company may not be tax resident anywhere, means that well-established banks may perceive you as high-risk. These are some reasons why your banking options might be more limited – especially for small businesses where the bank may not see a balanced risk-reward by onboarding you.
The banking landscape is changing dramatically with regard to the regulatory requirements of all financial institutions.
Onshore Banks are increasingly rejecting companies that can’t provide a Tax Identification Number. If the offshore company is not tax resident in any jurisdiction, and does not submit financial accounts to any relevant authority, it is becoming increasingly difficult to access to certain banks – especially in Europe.
Even offshore banks, those with an international banking license, are under pressure from their correspondent banks and relevant authorities to enforce heavy scrutiny on transactions that exceed certain thresholds or take place with certain ‘high risk’ jurisdictions.
That being said, at the time of writing, it is still possible for offshore companies to obtain accounts in the most reliable banks located in well-reputed financial centers such as Hong Kong and Singapore.
However, banks first and foremost require a strong introduction (which is where our firm can help). They will also want to see a solid business, and you may be required to park from 20 to 50 thousand dollars as a minimum balance to maintain the account, and you will need to prove your business background and provide invoices, contracts, bank statements, and other supporting documentation during the due diligence process.
If you have a shell IBC and just few hundred or thousand dollars to deposit in the bank, your options may be limited to small offshore banks.
If you have an IBC conducting a real and legitimate business – and you can prove that – and you have the ability to place a decent deposit in the bank account – then you will have access to solid top-quality transactional banking options in ‘onshore’ banks, as long as you are not conducting regulated activities such as money service businesses or high-risk activities such as FOREX or securities dealers.
Credit Card Processing
Your business structure is of special importance if your business needs to accept credit card payments.
Merchant accounts usually need to be located in the jurisdiction where your company is incorporated and credit card payment aggregators are increasingly rejecting offshore companies due to stricter regulatory compliance requirements.
Payment aggregators that are still accepting offshore companies are either becoming really selective with the companies that they are onboarding or charging large fees, from 5% to 15%, depending on the business activity and turnover.
In addition, if your business requires access to well-known USD payment service providers such as Paypal – then only incorporating an offshore company will definitely not work for you.
On this matter, we’ve found significant confusion between internet entrepreneurs. Even if your preferred Paypal-like payment service provider is available in your offshore jurisdiction, it may only deal with local currency and allow withdrawals to local banks.
Offshore banks – that is, banks that hold international banking license – may be prohibited from dealing with local currency, and domestic banks usually do not open accounts for offshore companies. You may open an account for your offshore company with an ‘onshore’ payment service provider – but you may not be able to withdraw funds to your bank account.
Jurisdiction Reputation and Stability
Reputation matters, and it is clear that your public image, credibility and customer confidence will probably not be the same if you run your business with a German AG, compared to a Belize IBC.
It’s true that there are offshore jurisdictions that are more reputable than others – however they are still all offshore companies and there still exists an ‘offshore stigma’. Although most offshore companies are used for legit and legal purposes – political corruption and money laundering scandals haven’t helped the public image of them.
If your clients are located in certain high-tax countries, they may have issues wiring money to a bank located in an offshore jurisdiction, or they may directly want to avoid doing so to not raise additional scrutiny from their banks or tax authorities.
Implications of this reputational aspect vary depending on your business activity and stakeholders. For instance, on the one hand, trying to run a Business2Government (B2G) activity with a Seychelles IBC may not be the best idea; on the other hand, running an offshore fund from the Cayman Islands might not have any reputational impact.
Whether offshore or onshore, you will also want to establish your business in a politically and economically stable jurisdiction. You want to avoid any social unrest or crisis that can lead to capital controls and undesired political situations that can have an enormous impact on your business. On this note, most offshore financial and corporate services centers are politically and economically stable.
Regulated Activities
If you are planning to launch a business whose activity is regulated, such as financial services, insurance or gaming, then there are several factors at play that you must carefully analyze in order to choose where you should headquarter your business.
What are the specific services you wish to provide? What are your target markets? What are the regulatory, licensing and compliance requirements that you must meet in order to operate? These are some of the questions that you and your team must ask yourselves.
This topic is comprehensive and specific to your business activity nuances, and out of the scope of this article, but by way of example – if you are planning to launch a money service business to cater to the needs of European clients, provide virtual accounts and payment services in Euro currency and partner with a licensed card issuer to provide to your customers prepaid cards, it may make sense to set up within the EEA, rather than setting up an Anguilla IBC.
Fundraising
You must consider whether your business roadmap includes raising funds from venture capital or private equity or issuing an IPO, when incorporating your business. The fundraising landscape varies among jurisdictions and your structure should be one that your investors are comfortable with. For instance, you may want to set up a corporation in the UK, Germany, Singapore or Hong Kong if you are planning to raise funds rather than a protective ring-fenced Cook Islands LLC.
Group Structure
Offshore companies are still powerful vehicles for certain business activities or for a certain purpose within a given business group structure.
For instance, you can hold certain business assets offshore such as an IP, for better protection or for operating certain areas of your business and/or business investments with tax-neutral entities.
You can also use vehicles such as foundations, or trusts, for certain purposes, which in certain cases could lead to a better protection, optimizing your legal tax strategy and maximizing planning and control efficiency of interrelated entities, while maintaining confidentiality and protecting beneficial owners.
On the other hand, you could use tax-transparent ‘onshore’ companies such as US LLCs or UK LLPs, to process credit card payments within a group structure. Certain LLCs and LLPs are usually treated as a partnership for tax purposes and therefore are not subject to tax at the corporate level, but are rather taxed at the member level, whether individual or corporate.
You could set up operating entities in ‘onshore’ jurisdictions to conduct certain aspects of your business and enjoy a better reputation, or for establishing physical offices and/or employing your workforce, among others.
Jurisdictional arbitrage in a global business is powerful. Setting up in the most suitable jurisdiction for each different part of your business can have a significant, positive impact on the development and preservation of the business and its assets.
You need the help of professionals for doing that. Laws, taxation, reputation, banking options, legal entity types vary among jurisdictions.
Each entity-making part of this structure must be setup correctly; there must be a substance, reason for said structure, and it should be legally covered. The proper legal agreements, such as transfer pricing arrangements between entities, should be in place.
If your business is properly structured you will be able to leverage the best of the ‘offshore’ – asset protection, privacy, low tax and reasonable corporate compliance burden – and ‘onshore’ worlds – access to top banking options, payment service providers, merchant accounts and credit card processing and better reputations – while minimizing the above-mentioned downsides.
Finally, where is the best place to incorporate an international business?
To summarize, that’s best answered by determining what your company’s particular needs are, your business activity, your suppliers and clients’ location, your tax residency status and more. There are many variables to consider – banking, customer/vendor payment options, the UBOs (ultimate beneficial owners) citizenship and tax residency, amongst others.
In the next article, we will review the key aspects to take into account in some jurisdictions, which may help you determine if they are suitable for your specific business.
If you are a global entrepreneur and are looking for a jurisdiction(s) to incorporate your international business, you need to figure out where will work best based on your specific needs. We can help you with this – contact us, it will be a pleasure to assist you.
In the meantime, you can check out our jurisdiction comparison tool: Incorporations.IO where you can compare different jurisdictions and legal entity types side by side, including their more relevant legal requirements and tax aspects.
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