These days it finally seems like offshore companies will become a part of history. Far from demonizing offshore companies we simply would like to highlight on the recent and not so recent changes in OECD legislation and most of all what is coming in the next years to make a point on the future of international tax optimization using offshore companies.
Panama Papers: a before and after?
The most recent developments have been around the Panama Papers that suppose a leak of information on over 200.000 offshore companies, created mostly without any substance in no-tax jurisdictions, which include not only Panama but other so-called “tax havens” such as the Bahamas, Seychelles, British Virgin Islands etc. The reasons to use an offshore entity may be perfectly legal and being a shareholder or partner in an offshore company is nothing illegal at all as long as you declare the income such as dividends received in your country of residence. In most high tax jurisdictions you are also required to declare the participation / holding of shares in an offshore company even if you do not receive any direct income / dividends from of the company.
Offshore companies are used to protect assets for privacy or security reasons such as for many wealthy individuals in Latin America, but also for tax optimization on international business activity and unfortunately for some to launder money or evade taxes. However the nature of an offshore entity is nothing fraudulent itself. What makes it fraudulent is the abuse of them when banks are permissive with compliance and/or when shareholders do not declare their income in their home country.
With the repeated leaks of such information there is clearly a risk for those using offshore entities for fraudulent activities to be exposed. The leaks together with the tightening standards of banking compliance around the globe make it no longer worthwhile for most criminals to use offshore structures. The damage in the image of offshore companies or so-called mailbox companies is also causing even the most genuine activities to refrain from using them.
Looking ahead and coming back to OECD regulations we are expecting the implementation of the “Common Reporting Standard for automatic exchange of tax information” also called CRS by 2017-2018. Most people among us will have heard about it as the “Automatic exchange of tax information”. As the the words say, personal information, such as name, ID, birthdate, country of residence (note fiscal residence) all together with your account balance are automatically reported to the tax authorities of your country of residence. Much of the concept follows the FATCA regulations passed by the US. Few countries remain without a commitment to implement it within the next few years. 54 countries will apply the measure as of 2017 and some 34 countries have agreed to implement CRS as of 2018. Some countries haven’t, among them Panama and the United States…
What changes will CRS bring to the offshore world?
CRS if properly implemented and abided by the relevant countries and authorities will make offshore bank accounts known to your tax authority at home. Anybody holding an account directly as person or through a corporate entity as beneficial owner will be reported as part of the automatic exchange of information. There are of course limits and also certain restrictions. First of all only accounts with a minimum balance are concerned. Currently this balance is set at 250.000 USD, but this is handled differently between pre-existing accounts and new accounts opened after the CRS implementation date. Further for corporate entity accounts only shareholders or beneficial owners holding more than a substantial % of the shares of the company are concerned. We recommend reading about the details of the CRS at http://www.oecd.org/
It becomes clear that “hiding” your participation or income of entities abroad through undeclared offshore accounts finally becomes part of history. This is a big step towards fighting tax evasion and will probably change the world of “offshore companies”substantially.
The implementation of CRS together with the OECD’s anti-abuse rules and substance requirements will underline the importance of adapting your international structure to follow these regulations. Andorra is already requiring sufficient substance to even register your company. Further banks are insisting on compliance with FATCA and Andorra has committed to implementing CRS by 2018.
What is the future of operating a company in a low tax jurisdiction?
The future lies clearly with projects that maintain a minimum level of substance in the country where the company is registered. Substance means “operating cost” which will of course filter many small projects or make them choose some of the last “havens” that do not plan to abide by the CRS yet (Panama and yes, the United States of America)…however it is expected that most jurisdictions will at least formally commit. Andorra has the great advantage of affordable cost in office space, human resources and other operating costs. Some other jurisdictions such as Switzerland or Gibraltar will alter your budget significantly if a proper substance has to be maintained. This will position Andorra further as a highly competitive location for your international entity.
What is the future for individual shareholder and beneficial owners of offshore entities?
Keeping your profits within the company or receiving dividends / transfer payments from your entity in an offshore account will be reported following implementation of CRS. This will mean that probably as soon as 2018 many individuals with residences in high-tax jurisdictions will need to declare this income properly to the relevant authorities. A tremendous step towards normalizing the taxation on income from offshore entities that so far remained undeclared.
This will probably lead to an increasing demand for alternative residences from those individuals benefiting from the entity abroad. Changing residence may be a solution, but sometimes involves the cost of exit tax and taxes on hidden / latent reserves. Andorra is a very attractive destination as low tax jurisdiction on personal income and dividends. Further it offers itself with a competitive corporate taxation rate, but with must-have-substance…. Andorra has no offshore entities as such and all companies are treated as domestic requiring a minimum substance.
So what is next?
If traditional offshore business entities or mailbox companies (with no substance) are scrutinized by tax authorities worldwide, are rejected for account openings and transactions by global banking compliance, are chased by the global press and associated bank accounts will be reported to your local tax authority, then we may assume that the offshore activity will substantially reduce or potentially die off.
Andorra may be a great alternative however it requires the mentioned substance. This comes at a price and even may involve relocation for some of the shareholders or executives, but the advantages for legal tax optimization may be well worth the efforts.