Reality Check: Do Offshore Companies Pay Taxes?
Watch one too many movies, and it’s nearly inevitable that you’ll come to a rather uncharitable conclusion about offshore companies. Does “tax evasion” and “criminals” sound about right? Do Offshore companies pay taxes…let’s dig in.
Think again. Most offshore companies aren’t only established for completely legitimate (and legal) reasons, but their US-based owners aren’t riding into a Ferrari-colored, IRS-free sunset, either.
The “too long; didn’t read” version? It’s complicated. Whether offshore companies pay taxes (and, if so, which ones) depends on the jurisdiction. Whether you, as a business owner, pay taxes depends on your citizenship and where you live — or, if you’re a US citizen, it doesn’t, and you’ll definitely pay taxes.
Curious to learn more about offshore taxation? Yes, we thought so!
What Are Offshore Companies?
Offshore companies can simply be defined as business entities registered in a jurisdiction other than a company’s or person’s home country, country of residence, or base of operations. In other words, while business unfolds in one jurisdiction, the company and its financial operations are based in another. For example, a company based in the United States might establish an offshore subsidiary in Belize to take advantage of more favorable tax laws.
While offshore companies have a shady reputation, the many legitimate and legal applications include:
- Lower operational costs
- Greater access to new and growing markets
- More flexible regulations, including industry-specific ones
- Protecting assets, especially when facing economic instability
- More favorable privacy laws
And yes, lower tax rates (and sometimes zero corporate tax) are another factor that contributes to the decision to set up an offshore company. That’s why they’re usually formed in jurisdictions with especially favorable taxation systems, more commonly known as “tax havens.”
Do Offshore Companies Pay Taxes?
Offshore companies are subject to the taxation structures of the jurisdictions they are based in — and those vary greatly. Let’s take a “virtual tour” of some of the most popular offshore destinations to get a better idea of what’s possible.
The Cayman Islands
The Cayman Islands, one of the most well-known tax havens, don’t direct tax profits, capital gains, or income. Setting up an offshore company there also allows business owners to take advantage of strong privacy laws and a lack of foreign exchange controls.
The Seychelles
Strong privacy laws, simple paperwork, and especially low business registration and maintenance costs partly explain why the Seychelles have long been a popular offshore destination. The country also doesn’t tax foreign income for International Business Companies.
Hong Kong
In Hong Kong, only income derived from the city is taxed. Meanwhile, Hong Kong doesn’t have capital gains tax, VAT, or withholding tax on dividends.
British Virgin Islands
The British Virgin Islands don’t charge tax on income, capital gains, or profit for offshore companies. They also don’t require offshore companies to file yearly returns or financial statements, and have a strong focus on privacy.
Belize
Like the Seychelles, Belize allows for the registration of International Business Companies. They don’t pay taxes in income, capital gains, or dividends, and Belize makes the incorporation process simple and quick.
Other Offshore Jurisdictions
Each offshore destination is unique — with its own laws — and not all have tax conditions as favorable as the countries we’ve looked at so far. Cyprus, for instance, has a corporate tax rate of 12.5%. While that’s favorable compared to other EU countries, it’s certainly not nothing. Georgia has a 15% corporate tax rate, but with added incentives and no capital gains for non-residents.
So, do offshore companies pay taxes? That varies. However, all popular offshore destinations offer favorable conditions and distinct advantages.
Do People Who Own Offshore Companies Pay Taxes?
Let’s get to the meat of the matter! Whether the question of do offshore companies pay taxes or not is certainly interesting, it’s not the only thing you should be asking.
Many countries have territory-based taxation systems. That roughly means that you’ll pay various kinds of taxes because you live there — and not just because you’re a citizen. The US is different, as one of the few countries to have a citizen-based taxation system.
To tap into a common pain point for any US expat, United States citizens and residents have an obligation to report income from anywhere in the world. That includes offshore companies.
Key obligations US citizens, residents, and some entities should be aware of include:
- Form 5471. This form requires you to give the IRS detailed information, including financial statements, transactions, and the company structure. It applies to any US citizen or resident with a 10% or greater interest in a company.
- Form 926. This form applies when you transfer assets to your offshore company.
- FBAR (FinCEN Form 114). This report applies to any US citizen or resident with assets exceeding $10,000 in foreign accounts, and includes detailed information to prevent fraud and money laundering.
“US persons” — citizens, residents, and sometimes legal entities like companies — with offshore companies are always obliged to pay federal taxes on the derived income. In some cases, state taxes also apply. That depends on the regulations of the specific state you are domiciled in.
Some offshore destinations will allow you to claim a tax credit for US taxes paid on the income earned in that jurisdiction, lowering the tax burden a little. This varies from one offshore country to the next.
A Final Words on Do Offshore Companies Pay Taxes
If you were hoping to avoid US taxes by establishing an offshore company, this reality check might be a little disappointing. However, if you were simply curious, learning the answer to the question “Do offshore companies pay taxes?” might leave you wondering what the point is if you still have to pay tax.
The main financial benefits offshore companies offer are tax deferral (until income is distributed to shareholders), a streamlined reporting process, greater asset protection, and deductions that might not be available to US-registered companies. However, an offshore company doesn’t change your tax status if you personally live in the United States — and if you’re a US citizen living abroad, you’ll also still have to pay federal taxes on the income your offshore company generates.
Comments are closed