Russians – How To Avoid Tax on Offshore Profits

Russia recently passed a Controlled Foreign Corporation Law.

 

A Controlled Foreign Corporation (or CFC) Law is an onshore law which purports to tax income or capital gains made by Companies incorporated Offshore but which are controlled from onshore.

 

Essentially how a CFC law works is if management and control of a tax free Offshore Company is seen to lie in your hands, or if you have the capacity to own the overriding majority of shares in the tax haven Offshore Company, then you are required to declare in your local tax return profits made by the nil tax Offshore Company.

 

How CFC laws came about was around 30 years ago the big western countries began to realise that certain of their citizens were using nil tax Offshore companies to avoid having to pay tax at home on their non-local sourced (ie international) income. In particular the CFC laws target the use of Nominee Shareholders and Directors. If you live in a country which has a CFC law (regardless of whether you are the director/shareholder of the Company or not) and if you have the capacity to own and control the company by reference to shareholdings then you would be required to declare and pay tax at home on your Offshore Company’s earnings.

 

TWO IMPORTANT TAX PLANNING ISSUES TO CONSIDER:

 

  1. 1.      Management and Control

 

The first thing to note is you will need to refrain from nominating yourself as Director and Shareholder of your tax free International Business Company (“IBC”) because this places management and control of the Company in your hands.

 

Generally speaking, and particularly where CFC laws are in place, an Offshore Company which is seen to be managed and controlled from Onshore can be taxed onshore.

 

Hence when setting up a tax free Offshore Company, if you want to minimise the chances of the Company being taxed “onshore”, Management and Control of the Company will need to be, and be seen to be, taking place from Offshore. How that can be achieved is by deploying a Nominee Shareholder and or Nominee Director as part of the Corporate structure.

 

There are a number of features that can be built into the Corporate/Legal structure of your IBC to ensure that your ownership rights are protected (and which will prevent the Nominees from running away with your property or money). For more information on that and how a Nominee Service can work for you please click on these links:

 

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/

 

  1. 2.      The Impact of Russia’s CFC Law on the Shareholding Structure

 

The bottom line is with Russia having recently passed a Controlled Foreign Corporation a nil tax Offshore Company or IBC by itself won’t be of much use to you. Why? Because Russia’s new CFC law requires you to declare and pay tax at home on the income of any Offshore Corporation that you control or have the capacity to control (And if you fail to report the IBC’s income to the Russian authorities you will be committing an act of tax evasion. Tax evasion is a crime punishable by imprisonment).

 

There is a potential solution however. The solution is to set up a Foundation as well as an IBC.

 

Why set up a Foundation?

 

As discussed if an IBC alone is used you will still be liable to declare and pay tax at home on your IBC’s earnings

 

It would be wise then to set up a Private Interest Foundation to own the shares of your tax free Offshore Company.

 

We International Tax Planning Lawyers used to use Offshore Trusts for such purposes back in the noughties but the problem there is that you have someone (ie a Trustee) holding property for the benefit of 3rd parties who are inarguably beneficial owners of that property and probably/potentially entitled to the income/capital of the Trust (which can have tax consequences onshore).

 

A Foundation is very similar to a Trust in that it’s set up by a Founder (like a Settlor in the case of a Trust) and managed day to day by a Councillor (like a Trustee in the case of a Trust) who manages the Foundation property for the benefit of the beneficiaries of the Foundation. A key advantage of a Foundation is that it’s a separate legal entity in its own right (ie the Foundation actually owns the assets held by the Foundation – unlike a Trustee who holds property for someone else ie the beneficiaries) and generally speaking the beneficiaries are not entitled to the income or capital of the Foundation until it’s actually received.

 

What this means as a beneficiary is that you should be able to defer paying tax at home on the income of investments held by the Foundation enabling you to reinvest 100% of that income not just the after tax component. (One jurisdiction ie Seychelles has even taken this a step further by specifically stating in their law that the legal and beneficial owner of any asset held by the Foundation is the Foundation itself).

 

Prices start from as little as $1,600. For more information Foundations please visit this page from our website:

http://offshoreincorporate.com/private-interest-foundations/

http://offshoreincorporate.com/seychelles-foundations/

 

Local conditions can have an impact. Hence it would be wise to seek local legal/tax/financial advice before committing to set up an IBC or Foundation.

 

 

Can a UK Agency Company Do Business in the UK?

The UK Agency Company is commonly used as a below-the-radar way to (tax effectively) do business from Offshore with EU clients.

 

UK companies can be used to act on behalf of offshore companies in a variety of transactions. Typically in such arrangements the UK Company operates as a “nominee” or “agent” or “bare trustee” for the offshore company. Whatever legal term is used to describe this sort of arrangement, the outcome will be that:

 

a)     the offshore company’s existence is not normally disclosed to the third parties who deal with or contract with the UK nominee company.

 

b)      it is the UK company that raises invoices, and enters into contracts, and receives trading income on behalf of the undisclosed offshore company.

 

c)       the UK company receives a commission from the offshore company for its nominee services. The amount of the commission will be quite small – typically 1% or 2% – bearing in mind that the business activities are managed and controlled by the undisclosed offshore company which carries on the trade or business in the name of the UK Company. Because all the UK company is doing is granting the offshore company the right to use its name, and because the UK company takes no other part in the business activities and receives a full indemnity from the offshore company, it cannot justify receiving more than 1% or 2% of gross fees or gross profits on arm’s length or commercial principles. Obviously each case needs to be considered on an individual basis.

 

d)      the UK nominee company only declares for UK tax purposes and statutory accounting purposes its commission. This is the correct approach assuming an appropriately drafted nominee agreement is in place between the UK Company and its offshore principal. It is also assumed that the offshore principal’s trading activities do not take place in the UK; that the offshore company’s management and control is located outside the UK; and that the beneficial ownership of the offshore company is non-UK resident.

 

e)      the UK company can register for VAT in the UK. In this regard it is normally essential that trading activities take place in at least two non-UK but EU countries, or that the UK nominee company is involved in “triangular” trading.

 

  • If the UK Company is involved in a triangular trade it is entitled to apply for a UK VAT number which eliminates VAT for all parties in this transaction.

 

  • The UK Company receives a commission of say 2% on the gross margin.

 

  • The UK Company would receive 100% of the sales revenue into its bank account.  On instructions from the offshore principal the revenue is then paid from the UK Company’s bank account to the offshore company’s bank account less the 2% commission.

 

One question I’m commonly asked is Can a UK Agency Company Do Business in the UK?

 

Technically yes a UK Agency Company can do business in the UK.

 

However, ideally, the UK agency company should not trade with other UK companies as this would be regarded as generating UK sourced income, which would be subject to UK assessment in full.

 

If activities are anticipated with UK companies, these should/could be concluded directly with the offshore principal company rather than via the UK agency company; this would not create any concerns or issues from a UK perspective as this would not trigger undue inspections or unallowable deductions like in many other countries.

 

The other option if you are looking to business in the EU Common Market via Offshore – and a significant proportion of your clientele is from the UK – is to set up an Irish Agency Company (which is a little more complicated than, but can be used in the same way as, a UK Agency Company)

 

 

Why Do I Need A Foundation?

When reviewing a new client’s individual needs/aspirations and in coming up with a bespoke Offshore Corporate Structuring Plan I often recommend that the client set up a tax free Offshore Private Foundation.

 

Often (a little too often for my liking, truth be told) I’m asked Do I really need a Foundation?

 

Typically a Foundation is set up to hold the shares of a tax free Offshore Trading Company  (or low tax Offshore Trading Company). Consider:

 

  1. The Foundation is set up purely so that you should not have to declare and pay tax where you live on your Tax Free Offshore Company (IBC)’s profits
  2. The Foundation doesn’t do anything. It just holds the shares of the IBC
  3. The money revolves in and through the IBC
  4. The Foundation doesn’t receive any money unless or until:

(a) You decide to sell the business (ie the IBC); or

(b) You’ve moved your place of tax residence to somewhere which will not tax you:

(i) on dividends paid to the Foundation; or

(ii) on distributions paid to you by the Foundation.

 

If you DO NOT Have a Foundation in place to hold the shares of your IBC and you live in a country which has CFC laws you will be required to declare and pay tax at home on all the IBC’s profits. Failure to so declare would be an act of tax evasion the penalty for which is imprisonment.

 

The IBC should not have to declare income in or pay tax where it’s incorporated. Why not? Because IBC jurisdictions do not tax their Companies on what they earn outside of the country of Incorporation.

 

What is a Controlled Foreign Corporation Law?

 

A Controlled Foreign Corporation (or CFC) Law is one which purports to tax onshore income or capital gains made by Companies incorporated Offshore but which are controlled from onshore.

 

Essentially how a CFC law works is if an individual owns or has the capacity to own the overriding majority of shares in an Offshore Company (the percentage of which varies from country to country) the that person is required to declare in his local tax return profits made by the Offshore Company.

 

How CFC laws came about was around 30 years ago the big western countries began to realise that certain of their citizens were using nil tax Offshore companies to avoid having to pay tax at home on their non-local sourced (ie international) income. In particular the CFC laws target the use of Nominee Shareholders and Directors. If you live in a country which has CFC laws (regardless of whether you are the director/shareholder of the Company or not) if you have the capacity to own and control the company by reference to shareholdings then you would be required to declare and pay tax at home on your Offshore Company’s earnings.

 

There are several ways to get around CFC laws. Historically clients used commonly to deploy an Offshore (Discretionary) Trust to own the shares of the Offshore Company. However with more and more “Onshore” tax systems claiming tax from any Trust with an onshore resident beneficiary discerning clients these days choose to establish Private Foundations (in particular Seychelles Foundations) as the ultimate holding entity as such entities should not caught by CFC laws or by CFT (Controlled Foreign Trust) Laws. For more detail click on these links:

 

http://offshoreincorporate.com/private-interest-foundations/

 

http://offshoreincorporate.com/seychelles-foundations/

 

http://offshoreincorporate.com/seychelles-foundations-fact-sheet/