Offshore taxes are directly related to the question of the ability of countries to exercise their right to tax the worldwide profits and income of their citizens and permanent residents; a major aspect of offshore taxing that makes it a matter which is almost solely dependent on the fiscal system of a country. In essence, an offshore jurisdiction could not be rightfully called a tax haven if it also claimed the right to place offshore taxes on the profits and earnings of the offshore corporations (IBCs) that it registers or imposes withholding offshore taxes on offshore bank accounts or taxed the funds invested in offshore vehicles such as trusts, hedge and mutual funds and offshore foundations.
In reality, based on the characteristics attributed to offshore tax havens, as long as a country has a tax regime that accommodates foreign investors and nationals of other countries with preferential offshore tax treatment and opportunities, that country can be considered an offshore tax haven in the sense that favorable and low offshore tax systems are a magnet to foreign corporations and capital. Also, a tax haven that does not refrain from taxing offshore income earned by offshore companies including bank accounts held by foreign firms and individuals cannot be truly identified as a tax haven. However, the chances of this occurring, with the exception of offshore tax havens that are signatories to the EU Savings Tax Directive, are quite slim since offshore tax havens are practically obliged to refrain from taxing offshore income of their registered corporations because double taxation has to be avoided in favor of a country’s international clients, even in the cases where tax treaties do not exist.
Currently, about 2,500 bilateral income tax treaties exist. These treaties establish a framework that assists in preventing international tax confusion, especially where offshore activities are concerned and offshore taxes are imposed. Through the establishment of tax treaties, where offshore taxes apply, offshore tax havens are normally the ones to give up their right to tax offshore corporations. In some instances, the country or countries where the income of an offshore corporation is earned are given some rights to tax such as in the example of an American offshore company that provides its services in Canada. But this is made possible by the United States only if it is willing to relieve double taxation on offshore income by either giving credit for the taxes paid in Canada or by giving exemption and deductions from those taxes in the U.S. However, in the majority of cases where offshore tax havens are concerned, it’s almost always the offshore tax havens that give up their right to levy taxes on offshore income by taxing neither the passive nor active income of offshore companies.
The latter is usually achieved by offshore tax havens by statutorily prohibiting offshore companies from conducting active business within the jurisdiction. This is stated in most international business company, international trust and insurance and offshore foundation acts and includes the property and real estate owned by these entities. The property and real estate of offshore tax free trusts and foundations should not be located in the jurisdiction, but offshore. Within the context of offshore taxation, this is the basis on which offshore vehicles are exempt from all domestic and offshore taxes on worldwide generated income, profits and interests.
But, offshore taxes may apply to an offshore company that decides to own property or operate in the jurisdiction; though offshore tax exemptions are frequently given as an incentive for settling and investing in the country. This is the case in offshore tax havens such as Dominica, Belize, St. Vincent and Anguilla where offshore tax exemptions are given to offshore companies for a number of years, as well as in the Cayman Islands where there are normally zero taxes apart from import and stamp duties, although exemptions are given on these two taxes in certain situations.
Contrary to EU countries including Cyprus, Guernsey and Isle of Man where a withholding tax on offshore personal bank accounts is imposed as a result of the EU Savings Tax Directive, offshore tax havens such as Panama, St. Vincent, Cayman Islands and the British Virgin Islands provide offshore tax free accounts for personal, private and corporate purposes.
Although offshore tax can be applied by countries such as the U.S which impose tax on offshore bank accounts held in tax havens by its citizens, the principle strength of most offshore tax free jurisdictions lies on strong protection of bank confidentiality and privacy. Offshore tax havens are often branded as conduits for tax avoidance, but in reality, one of the main reasons expressed for setting up offshore tax free companies and entities include the ability to achieve privacy in personal and family matters where Wills, succession and estate matters are concerned. A Will established through an offshore tax free trust or foundation is kept private from public scrutiny and guarantees several asset protection as well as offshore tax free benefits. For example, property and valuable possessions placed in an offshore trust can be legally shielded from transfer and inheritance tax by just transferring the necessary trust documents to the name of the intended beneficiary to those assets. In several countries, domestic income and estate taxes can be legally avoided by establishing an offshore tax free trust. For the U.S citizen and permanent resident who set up an offshore tax free trust through a will, if the settlor is American and dies before the trust’s funds are allocated to U.S beneficiaries, the trust automatically ceases to be subject to U.S. tax on offshore income until the funds are received.
Similarly, offshore tax free accounts do not only provide privacy and tax savings on funds, but facilitate international offshore trade. Offshore tax free accounts allow businesses to establish presence on the global market by simply subscribing to the variety of offshore tax free bank services and products that are made available through offshore tax free online, personal, corporate and private banking facilities. Offshore accounts also make it possible to open accounts in different currencies so that transfers can be made internationally without losing funds and time through currency conversions, fluctuating rates and bank to bank transfers.
Offshore tax free entities and laws vary from one tax haven to another. Most offshore tax havens provide similar offshore financial services but many of these, especially offshore tax free companies, are structured according to the offshore laws of other jurisdictions or formed by combining the advantages of two or more offshore entity types. This is the typical example of the U.S. LLC or Limited Liability Company, a hybrid entity which was created by combining attributes of a Partnership and Limited Liability Company for carrying out both international and local trade. Like an international business company an LLC is an offshore tax free company, but will be liable to tax on offshore income if business is actively conducted within the U.S. However, unlike tax free offshore companies, the ‘directors’ and ‘shareholders’ of an LLC are not regarded as such and are referred to as members, thus providing a legal and smart way of avoiding tax on dividends. Offshore tax free LLCs were officially formed under the Wyoming Statute in 1988 and allow both local and residents irrespective of nationality to incorporate in the U.S. Similarly, tax free offshore foundations are modeled according to the Liechtenstein Foundation, which has proved for several decades to be an effective asset protection mechanism. Tax free offshore foundations in Nevis were created under the Nevis Multiform Foundation Ordinance and are endowed with a relatively large significant amount of mobility where the domiciliation, redomiciliation and the continuance of this offshore tax free foundation type are concerned.
With regards to the jurisdiction of incorporation, the only expenses to which offshore tax free companies are subject are annual renewal fees and costs incurred for amendments to the company once it has been created. Renewal fees cover stamp duty and company maintenance costs which must be dealt with so that offshore companies remain in good legal standing in their respective jurisdictions of incorporation. All tax free offshore companies are supposed to pay these fees in order to prevent being struck off the jurisdiction’s Register. Maintaining good standing the jurisdiction is also important for opening bank accounts, building new business relations with other international companies and receiving credit from both offshore and onshore banking institutions.
The laws governing the payment cycle and rate of annual fees differ from one offshore tax haven to another. In Dominica for example, offshore tax free companies incorporated between January 1st to June 30th are required to credit funds to the registered agent’s account for payment to the Registry before May 31st deadline to avoid penalties, while companies incorporated between July1st to December 31st are required to do the same before November 30th. In Barbados, renewal fees on offshore tax free companies are levied based on the profit made by the company for each financial year. So, in Barbados, an international business company that makes a profit of Barbados Dollars (BDS) $10,000 pays 2.5%; 2% on profits between BDS$10,000 and 20,000; 1.5% for profits between $20,000 and $30,000 and 1% if profits are over $30,000. Meanwhile, in Gibraltar a capital duty of 0.5% is applied to the authorized share capital although there is no minimum authorized share capital and no limit or maximum capitalization.