Differences Between An Offshore Foundation And An Offshore Trust

 

I’m often asked What is the difference between a Tax Free Offshore Foundation and a Tax Free Offshore Trust?

 

Bottom line is if your reason for wanting to set up an Offshore Trust is to try and avoid tax at home on the earnings of the Trust (or to build a bullet proof fence around any assets to be held by the Trust) you might want to consider setting up a Foundation instead. The disadvantage of a Trust is it’s caught by local Controlled Foreign Trust laws. Put simply if you have the means to remote control an Offshore Trust or are a presently entitled beneficiary of an Offshore Trust chances are you would be required to declare locally and pay tax on the Trust’s earnings or at least your share thereof.

 

A Private Offshore Foundation is very similar to an Offshore Trust in that it’s set up by a Founder (like a Settlor in the case of an Offshore Trust) and managed day to day by a Councillor (like a Trustee in the case of an Offshore Trust) who manages the Offshore Foundation’s property for the benefit of the beneficiaries of the Offshore Foundation.

 

Moreover a nil tax Offshore Foundation may get you around the tax issues as it’s a separate legal entity in its own right (ie an Offshore Foundation actually owns – both legally and beneficially – any assets held by the Foundation – unlike an Offshore Trust where the Trustee holds property for someone else ie the beneficiaries) and by law the beneficiaries are not entitled to the income or capital of the Foundation until the Foundation Council actually resolves to pay a distribution to the Foundation Beneficiaries. What this means is potentially you can defer paying tax at home on income of investments held by the tax free Offshore Foundation enabling you to reinvest 100% of that income not just the after tax component.

 

This can enable you to access the power of compounding on those investment earnings meaning your net worth will grow MUCH faster than what it would were you to pay tax each year on your investment income.

 

Local laws can have an impact hence you should seek local legal/tax advice before committing to set up a nil tax Offshore Foundation or nil tax Offshore Trust.

 

US Backs Down on Taxing Offshore Residents

 

In an embarrassing about face the American Internal Revenue Service (IRS) has stated it will be substantially diluting key features of its offshore voluntary compliance program (“OVCP”) which was hitherto designed to force US citizens with undisclosed Offshore Bank Accounts, (or Offshore Companies or Offshore Income or Offshore assets) to declare the existence of same to the IRS.

 

The changes came about after considerable pressure was applied by tax payer groups concerned that various Americans (in particular long term expat Americans who would in any other tax system be regarded as non-residents for tax purposes), unaware of their obligations to report the existence of their Offshore Income, (or Offshore Company or Offshore Bank Account) could be treated the same way as criminal tax evaders.

 

The IRS has said that the changes are intended for US taxpayers whose failure to disclose their offshore assets was “non-willful,”. There are also other important modifications to the 2012 OVDP.

 

The original ie 2012 procedures were available only to non-resident non-filers, and taxpayer submissions were subject to different degrees of review based on the amount of the tax due and the taxpayer’s response to a “risk” questionnaire. Under the new arrangements, the procedures are available to a greater number of US taxpayers living outside the US who have unreported Offshore accounts and, for the first time, to certain American taxpayers residing in the US.

 

The changes include an elimination of the requirement that the taxpayer should have USD1,500 or less of unpaid tax per year; the abolition of the risk questionnaire; and a new requirement for the taxpayer to certify that previous failures to comply were due to non-willful conduct.

 

For eligible American taxpayers residing outside the US, all penalties are to be waived. For eligible US taxpayers residing in the US, the only penalty will be a miscellaneous offshore penalty equal to five percent of the foreign financial assets that gave rise to the tax compliance issue.

 

Since expatriating in 2001 I’ve met many Americans who, upon hearing that their non- American expat counterparts were not required to declare and pay tax at home on Offshore  earnings, simply assumed the same rules applied to them (as indeed they should if they’ve permanently departed America though that’s an argument for another 60 seconds). Hence the changes as effect such US persons are to be applauded as a common sense approach given the lack of criminal or unlawful intent on the part of parties concerned.

 

As of 1 July however the US Foreign Account Tax Compliance Act will come into effect, at which time banks will begin to report to the IRS the existence of Offshore Bank accounts held by US persons. Persons who wish to avoid this reporting requirement should speak to their Lawyer or Offshore Company Provider or Offshore Bank Account Provider ASAP about setting up a Seychelles Private Interest Foundation (or an Offshore non FATCA effected bank account) as a potential means of avoiding US reporting requirements.

 

How to Bring Offshore Money Onshore

 

Often I’m asked how can I access money earned by my Tax Free Offshore Company?

 

There’s 3 ways to bring home money from a nil tax Offshore/International Business Company:

 

1. Set yourself up as an arms’ length consultant and have the IBC pay you consulting fees periodically. This means you would only have to pay tax on what you bring into your home country (and even then you should be able to minimise tax payable on that as a lot of what otherwise-might-be personal expenses could be written off as business costs, eg home office, utilities, car, phone, electrical/office equipment, stationery, computers travel etc etc etc). The rest of the IBC’s income can remain offshore and be (re)invested offshore in tax friendly investments. Say your target capital base is 3 million Euro and every year you can leave at least half the IBC’s income offshore. Because you’re not paying tax yearly on all the IBCs income instead of taking 20 years to accumulate 3 million Euro with the power of compounding you could be able to accumulate 3 million within 5 to 7 years. This is what many clients do ie they pay a little bit of tax at home each year on their overseas earnings but most of their income is kept offshore and reinvested offshore.

 

2. Bring back the money as a loan. Yes this can be done but great attention to detail will be required particularly with respect to lending parties, loan terms and documentation. The loan would need to be seen arms length ie seen to be on commercial terms.

 

3. Use an anonymous debit card and withdraw cash from automated teller machines. This can still work in some places though it should that some of the bigger countries now have the ability to trace and connect one to such withdrawals

 

Note unless you live in a country that does not have CFC laws (and/or unless or are structured in a tax effective/compliant manner) you may still be required to declare and pay tax at home on your IBC’s earnings. Local law can impact on such plans and hence you should seek legal/tax advice before committing to travel down such a path.

 

 

 

HOW TO SET UP AN ONLINE BUSINESS OFFSHORE

Offshore Companies are commonly used to own/operate online businesses.

 

In principle here’s how it can work:

 

  1. A nil tax offshore company (commonly an International Business Company “IBC”) is incorporated
  2. The IBC owns/operates the web based business (eg ownership of the web-domain and the website/artworks or trademark/s or any sole distributor rights are held by or transferred to the IBC)
  3. An Offshore account (which received payments via a merchant account) is set up in a nil tax banking centre
  4. Ideally the server is located in a country which does not tax business on the basis of server location (eg Singapore etc)
  5. Customers contract with and pay the IBC. All such monies are banked free of tax in the first instance
  6. You or your local company would be contracted by the IBC to manage sales inquiries/delivery of product,to manage marketing or to oversee website maintenance/whatever.
  7. Ideally the product would be delivered online or delivered directly by the manufacturer to your customer.
  8. You would invoice the IBC periodically (eg monthly) for the services you provide which income would be assessable income in your home country – though a smart Tax Accountant should be able to assist you to claim a series of expense against this income (eg home office, equipment, travel, phone/internet/utilities etc) to significantly reduce the amount of tax payable on this income.
  9. Often there is some kind of intellectual property (“IP”) created or behind the website based business (even if it’s just the website/design). It may be advantageous to you down the track if ownership of the business and the IP were held by 2 different entities. What you can do there is set up a 2nd IBC to own the IP. The first IBC (ie the Trading Company) pays license fees periodically to the 2nd IBC which fees wold be receipted tax free. This could be advantageous if you wanted to, down the track, bring ownership of the web-business onshore or if you wanted to sell the business but keep a passive (potentially tax free) income stream
  10. Ideally once you start to grow (and to add substance) you would be wise to set up your MD/Board and or a sales team onshore to take orders and receive income in a low tax onshore environment (eh Hong Kong, Ireland, Singapore, Cyprus etc as per the Amazon/Google model)

 

To minimise the chances of the IBC being taxed onshore ideally (a) a Seychelles Private Interest Foundation should be set up to shift underlying legal and beneficial ownership of the Company away from yourself and (b) the IBC should be (and be seen to be) managed and controlled from offshore. How this can be achieved is by including a Nominee Director etc as part of the Corporate structure. See these pages for details of how that can work:

http://offshoreincorporate.com/faq/should-i-engage-nominees-or-should-i-direct-and-hold-the-shares-in-my-offshore-company/

http://offshoreincorporate.com/faq/how-can-i-protect-my-underlying-ownership-of-my-offshore-company-where-a-nominee-is-engaged-to-act-as-director-or-shareholder/

 

Local laws can have an impact hence it would be wise to seek legal/tax advice before committing to travel down this road.