The existence and prosperity of the Offshore Financial Industry is firmly based on the demand made by multinational companies and high net worth individuals to find ways to legally reduce their tax burdens and, in the latter case, to protect their assets. The industry is able to meet these demands because of the existence of tax treaties and so-called Tax Havens.
As suggested by Dr. Barry Spitz – a leading expert in international tax laws, former professor at Rice University in Houston, and editor of the Spitz Tax Havens Encyclopaedia published by Butterworths – the term Tax Haven should be used to refer to a jurisdiction –
- where there are no relevant taxes; or
- where taxes are imposed only on local profits, but not at all, or at lower rates, on profits from foreign sources; or
- where special tax privileges are granted to certain types of taxable persons or events.
These special privileges could be in the form of a local tax holiday accorded to certain types of enterprises under an investment incentive program or they could be derived from tax treaty provisions.
By extension, this basically means that even high tax countries will become Tax Havens if they can be used to reduce the tax burden of a taxable person or event. And indeed, it is not uncommon to see places like London, New York, Sydney or Tokyo becoming temporary Tax Havens for specific short-term recurring and non-recurring taxable events such as concerts, shows, football games, tennis tournaments and other similar events.
In addition to these temporary Tax Havens we have about 41 jurisdictions that are considered permanent Tax Havens. Interestingly, some of these are Tax Haven designated areas or zones located within a high tax country (e.g. The International Financial Services Centre in Dublin, Ireland, the Labuan Territory in Malaysia, or the cantons of Fribourg, Zug and Vaud in Switzerland).
Having defined the term Tax Haven, we can now define the term Offshore Company.
The word offshore, as used in this context, was initially used by professional tax advisers of the United States of America to denote a Tax Haven located off the shores of the United States. Over time, the meaning of this word has changed and today it is used to refer to any Tax Haven wherever it is located. The term Offshore Company therefore denotes a company located in a Tax Haven.
Subject to company law provisions of the relevant Tax Haven, an offshore company could be –
- private or public;
- limited by shares or guarantee; and
- for taxation purpose, either resident, non-resident, or exempt.
Non-resident and exempt companies are not subject to local taxes, but in order to qualify as non-resident, a company is usually required to exercise its management and control functions elsewhere than in the jurisdiction where it was incorporated or where it maintains its registered office. The concept of exempt companies was introduced by some Tax Haven jurisdictions in order to solve the serious fiscal problems encountered by many high tax country residents who were directors or shareholders of non-resident companies.
One common factor for resident, non-resident, and tax exempt companies is that they are usually governed by one and the same company law. However, many Tax Havens have enacted new legislation for their exempt companies and this is the reason why they have one company law for resident and non-resident companies and another one (usually called an International Business Companies Act or Ordinance) for exempt companies. Unfortunately during this process these Tax Havens lost one very useful form of company, namely the company limited by guarantee. Many of these Tax Havens also enacted legislation for Limited Liability Companies based on one of the United States models for that type of company. For the legislators in the United States to have selected the term Limited Liability Companies to denote this type of company was most unfortunate for English common law jurisdictions since in those jurisdictions companies limited by shares or guarantee are also considered to be limited liability companies. The term Associations with Limited Liability or Limited Liability Associations should have been used instead in these jurisdictions.
International Tax Planning
Offshore companies and trusts can offer significant tax minimisation opportunities since locating a taxable person in a Tax Haven may reduce the tax burden of such person with regard to a taxable event in a high tax jurisdiction by removing the link between that person and the taxable event. In order to achieve the desired result, one or more companies or trusts must be used in conjunction with, or even better, as part of an international tax plan.
According to Dr. Spitz, international tax planning is concerned with finding ways to legally reduce tax burdens and the term “tax avoidance” is used to indicate that a taxpayer has lawfully reduced his tax burden by arranging his affairs in accordance with an international tax plan. Tax avoidance therefore differs fundamentally from “tax evasion” which is used to indicate activities deliberately undertaken by a taxpayer to attempt to free himself in an illegal manner from tax burdens to which he would otherwise have been subject to.
Generally speaking, international tax planning consist of arranging the affairs of a taxpayer in such manner as to reduce his tax burden by using one or more tax treaties concluded between two contracting states for the purpose of avoiding double taxation. How this can be achieved is beyond the scope of this article, but examples of various tax planning techniques are included in our International Tax Planning Primer
In July 1963 the fiscal committee of the Organisation for Economic Co-operation and Development (the OECD) published a model convention for the avoidance of double taxation in respect of taxes on income and capital, and in may, 1966, this same committee published a model convention for the avoidance of double taxation in respect of estate and inheritance taxes.
These two model conventions together with their amendments have exercised a considerable influence on most tax treaties concluded in recent years.
Briefly stated, a company may qualify for tax treaty benefits –
- if it is subject to taxes in the jurisdiction where it is resident;
- if it is owned by residents of one of the contracting states;
- if at least half of its income is paid to residents of the contracting states.
Residence of Companies
One of the principle provision of a tax treaty is to limit its application to persons who are resident in either or both of the contracting states. To use tax treaties effectively it is therefore important to be able to establish in which jurisdiction a person is resident for tax purposes.
In the case of companies there are three connecting factors that will have to be investigated in order to establish the place where it is resident for tax purposes. The first one is the place of incorporation or registration of the company, the second one is the place where its management and control is exercised, and the third one – applicable mainly in civil or Roman law jurisdictions – is the centre of its economic interests. A company will become a resident of the jurisdiction where its directors are holding board meetings by the simple fact that such action is considered to have the effect of removing the connecting factor between the company and the jurisdiction in which it is incorporated or registered.
It is therefore important that the documents establishing the company be drafted in such way as to prevent the unintentional transfer of its residency of origin to an other jurisdiction.
Modern offshore company legislation usually permit a company –
- to have only one shareholder;
- to be managed by only one director; and
- to conduct meetings by telephone.
Unfortunately, it is not clear whether the Courts of every country would recognise the doctrine that one person can constitute a meeting (e.g. in England see East v. Bennet Bros., Ltd.,  1 Ch. 163). These Courts could very well rule that if a company can be managed by only one director, such director would not need to hold a meeting since there would be no one else to agree or disagree with him (e.g. in England see Parker and Cooper Ltd. v. Reading,  Ch. 975;  All E. R. Rep. 323). Basically such ruling could mean that the company concerned would face the risk of being unable to prove where it is resident for tax purposes as it could be disallowed by the relevant Court to produce minutes of board meetings to substantiate its claim of where it is resident for tax purposes. Obviously a company which permits the holding of board meetings by telephone would also encounter difficulties in unequivocally establishing where it is resident for tax purposes unless it can provide evidence that during each of its board meetings a quorum of directors was only present in the place where it claims to be resident for tax purposes.