I’m sure, by now, you have seen the numerous posts by scheme promoters trumpeting how you can avoid paying any tax by setting up a Belize or BVI company. However, the reality is that simply setting up an offshore company is not a remedy for avoiding tax. Do Offshore Companies Pay Taxes? Let’s dig in and take a look at reality.
Defining an Offshore Company
Actually, defining the term is relatively easy as any company located in a jurisdiction, other than your own, is offshore. However, the modern use of the term typically refers to those entities based in one of the tax haven countries such as Belize, Panama, or the Cayman Islands.
In some ways, it’s actually used as a negative term as tax activists typically decry the role that “offshore companies” play in the global economy. Subsequently, the term has become synonymous with tax evasion which is terribly unfair.
The vast majority of entities based offshore are used for perfectly legitimate reasons and are an essential part of the regulatory landscape for everything from insurance companies to banks.
Are Offshore Companies Exempt from Tax?
Yes and no. The offshore scheme promoters will often tout the fact that a Belize or Panamanian company is not subject to taxes. On the face of it, this is actually correct as those governments do not (at this time) actually levy any form of taxes on International Business Companies (IBCs) based within their borders.
However, this doesn’t necessarily mean that the company, and be extension you as owner, might not be liable for taxes in your home country. Often that is a complex question that depend upon your tax residency.
What is Tax Residency – Do Offshore Companies Pay Taxes
In a distinct difference to actual residency, countries have implemented laws that decide whether you fall into their tax system based on a whole range of factors. For example, a U.S. citizen is taxed regardless of where they live in the world. Therefore, the U.S. tax residency rules will catch your in their net if you hold citizenship. In the New Zealand context, tax residency is based upon a range of rules that include everything from the number of days that you spend in-country to having “significant connections”.
Ultimately, your tax residency dictates where you file and pay your personal taxes. In some cases, it can be exceedingly complicated to determine and may require advice from a professional tax advisor depending on your circumstances.
How Does Tax Residency Factor into Offshore Companies
I know what you’re thinking. If I setup a company in the British Virgin Islands, then surely the companies tax residency is the one that matters. This was the case many years ago, but countries became wise to that loop whole and it was subsequently closed.
Many jurisdictions have what are known as Controlled Foreign Company (CFC) rules which effectively stop your ability to dodge your local taxes. The rules differ from one country to another, but effectively, CFC regulations mean that if the company is controlled, managed, and operated from your home country then it is tax liable.
Subsequently, the CFC rules have, largely, closed the loophole that existed around the domiciliation of offshore entities. In short, if you operate a company based in a tax haven then you are probably going to be liable for tax as if it was a domestic entity.
How Do I get Around Offshore Company Tax Residency Rules
I should probably add this question to an FAQ page as it comes up at least a few times per month. The reality is that you don’t really get around those rules, but you need to learn to structure your companies within them.
One way of ensuring that your offshore entity remains a tax resident in its registration jurisdiction Is seeking substance. Again, every country is different, but most have tests in place to check the actual substance of the company.
In practical terms, this will mean you need to establish an actual office in your location of choice (Panama etc), employ staff, and ensure that all management decisions are undertaken by senior staff in that location. Basically, your management of this company needs to be totally handed off to a third party.
It is a highly costly and difficult exercise to establish substance and it’s something that you will need expert advice upon which considers your individual circumstances.
Ultimately, establishing and utilizing an offshore company requires planning and an understanding of the tax and business issues that you face. In most cases, using one of these entities for solely taxation minimization is a bad idea and often fraught with personal risk. Instead, these types of vehicles should be utilized as part of a broader offshore strategy that includes everything from tax to asset protection and privacy.
Hopefully, this article has dispelled a few of the myths around do offshore companies pay taxes. If you require any advice or assistance, please reach out to us here at OCBF and we can assign you a specialist to talk through your circumstances with.