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Lowtax International Tax Planning/IOFC Analysis

By Lowtax Editorial
11 October, 2011



Offshore, despite becoming something of a dirty word in the last decade or so due to an on-going crackdown by the OECD, and certain nations within it, against ‘harmful’ tax regimes and secrecy laws, is actually in a pretty healthy condition as thousands of companies from Europe to North America and Asia continue to legitimately utilize the various laws and company structures available in the dozens of international offshore financial centres (IOFCs) scattered around the globe to minimize tax.

It is a fact that the OECD’s drive to ‘clean up’ the world of offshore has meant that some of the most attractive features of some IOFCs’ tax regimes have been scrapped in recent years to make way for new laws which have blurred the boundaries between ‘offshore’ and ‘onshore’ in many jurisdictions. However, most ‘low tax’ jurisdictions still remain exactly that, and in today’s globalized economy, many of these territories act as facilitators for investment into the ‘high tax’ and emerging economies, and the (unintended?) consequence of the OECD’s campaign is that the combination of law taxes and increased transparency has enhanced the reputation of many of them.

There are currently more than 40 IOFCs and each one tends to have its own specializations catering to particular industries and types of business, from holding company regimes to banking, investment funds, insurance, wealth management, manufacturing and re-exporting. All of these jurisdictions’ tax regimes are described in detail on lowtax.net, so in this feature we will provide an overview of some of the key jurisdictions around the world and how they have constructed their tax regimes to benefit international investors, including the British Virgin Islands, the Cayman Islands, the Isle of Man, Dubai, Hong Kong, Labuan and Mauritius.

British Virgin Islands (BVI)

The British Virgin Islands are an English-speaking Dependent Territory of the United Kingdom, located in the Caribbean off Puerto Rico and are politically stable.

The BVI’s International Business Company (IBC) regime was introduced in 1984 was outstandingly successful and by the time the legislation was replaced by the BVI Business Companies Act in 2004, which effectively removed the distinction between 'offshore' and 'onshore' companies, more than 600,000 had registered in the jurisdiction, Hong Kong and Latin America being the main sources of clients.

The BVI has significant mutual fund and captive insurance sectors. However, banking activity is, by design, quite minor.

In the British Virgin Islands there is no capital gains or capital transfer tax, no inheritance tax, and no sales tax or VAT. There are stamp duties on certain transactions, and property taxes. Until 2005 the only significant tax in the BVI was income tax, which applied to the relatively few local companies and to individuals.

On 1 January 2007 the BVI BC Act became the sole Business Companies Act in the jurisdiction, creating an environment where financial institutions and corporations can undertake a wide range of structured asset and project finance transactions. A two-year transition period was put in place to smooth the changeover to the new Business Companies Act, which lowered the income tax rate to 0% for both local and International Business Companies. However, local firms are now required to pay annual licence fees, and insurance companies and mutual funds must pay license fees in addition to registration and incorporation fees.

From 2006, new incorporations had to be made under the new Business Companies Act, although companies already on the register were permitted to operate under the old IBC Act or Companies Act for an additional year. Whereas the 1984 IBC Act permitted just one company form, that of the company limited by shares, the BVI BC Act allows several different types of companies to be incorporated, including:

  • Companies limited by shares. Likely to remain the most popular form of BVI company;
  • Companies limited by guarantee not authorised to issue shares. This corporate form is likely to prove useful for not for profit organisations;
  • Companies limited by guarantee authorised to issue shares. This 'hybrid' type of company provides greater flexibility in structuring transactions, as a result of its combined equity and guarantee membership;
  • Unlimited companies authorised to issue shares. This structure provides greater transparency, as it is possible to look through the company to its shareholders; and
  • Unlimited companies not authorised to issue shares. This type of company could be used to ensure effective estate planning.

Under the new legislation, the existing income tax system for employees disappeared. However, in its place, a payroll tax is levied at a rate of 14%, 8% of which is paid by the employer and the remainder by the employee, although the first USD10,000 of income is tax free. The contribution for small business, defined as those employing less than seven people and with a payroll of less than USD150,000 per year, is 10%.

The British Virgin Islands have double tax treaties with the UK, Japan and Switzerland; in the last two cases, this means just that the UK's treaty with the countries concerned has been extended to the BVI. Prior to the introduction of the BVIBC Act, the benefit of these Double Tax Treaties applied only to BVI resident companies, which had to take the form of Companies Act (Cap. 285) Companies.

Since the OECD recommenced its offshore tax transparency crusade with the publication of its black/grey/white list, the BVI has entered into numerous Tax Information Exchange Agreements (TIEAs) to avoid being branded as an uncooperative tax haven. In addition, an amendment to the tax agreement with the UK was signed in 2008, and double tax agreements with seven Nordic countries were signed in 2009. The jurisdiction was placed on the OECD's 'white list' in July, 2009.

The BVI is a reasonably cheap jurisdiction compared to its local rivals, and has quite strong professional services. The government is responsive to the needs of business, and its legislation is mostly flexible and straightforward.

Cayman Islands

Like the BVI, the Cayman Islands are an English-speaking Dependent Territory of the United Kingdom. They are located in the Caribbean between Cuba and Central America.

The Cayman Islands government has constructed a regulatory regime that is highly favourable to offshore operations, especially since there is no taxation other than stamp duty and import duties.

More than 92,000 companies are registered in Cayman, which also is the largest offshore banking centre in the world with about 250 banks and deposits worth about USD1.725 trillion. It is the second largest captive insurance base after Bermuda, with assets worth USD57.4bn.

The Cayman Islands trust sector is thought to manage more than USD500bn. Mutual funds are a growing sector, especially since the opening of the Cayman Islands Stock Exchange in 1997, and the jurisdiction has emerged as a predominant registration base for hedge funds.

The Companies Law 1961 is based on English law and is the main law governing companies in Cayman. The law has been updated, revised and consolidated several times, with the most recent revision being the Companies (Amendment) Law, 2011, effective April 27, 2011, which has introduced a number of enhancements to the Companies Law (2010 Revision) such as enabling Cayman Islands companies to hold treasury shares and improving existing provisions, including the merger/consolidation regime.

There are four company types which are commonly registered in Cayman under the Companies Law: Ordinary Resident Company, Ordinary Non-Resident Company, Exempted Company and Exempted Limited Duration Company. Registration and on-going annual fees are paid by Cayman Islands companies, and there are also registration and annual licence fees for banks and trust companies, insurance companies and mutual funds and their administrators.

Trusts can be exempt, like companies and limited partnerships, but must then be registered with the Registrar of Trusts, and pay a fee of KYD500. The Governor gives a 50-year undertaking to the Trustees that no taxation will be imposed on the trust.

Not having any taxes, the Cayman Islands did not, until recently, enter into any Double Tax treaties with other countries. It has now, however, entered into limited tax treaties with the UK and New Zealand, and signed a comprehensive tax treaty with Japan in 2010 in addition to several tax information exchange agreements, which have ensured that the jurisdiction no longer features on the OECD's 'grey list' of territories which have not substantially implemented the internationally agreed tax transparency standard.

The Cayman Islands has entered into a mutual legal assistance treaty with the USA, although the treaty specifically excludes fiscal matters. In November, 2002 the Cayman Islands also signed a Tax Information Exchange Agreement (TIEA) with the US.

The Cayman Islands have quite a good reputation in the Western hemisphere, but in Europe have tended to exemplify 'tax havens', largely perhaps as a media stereotype rather than as a matter of objective reality. The truth is that Cayman has tried hard with a large number of statutes to keep up with the international pressure for offshore centres to keep themselves clean, even accepting in 2001 the need to allow investigation of fiscal wrong-doing, at least when criminality is in evidence both internationally and in Cayman itself. The prevailing attitude in Cayman however is still to protect confidentiality in the absence of demonstrated criminality.

Isle of Man

Located in the Irish Sea, the Isle of Man is an English-speaking dependency of the British crown but has never formed part of the United Kingdom.

The Island has strong banking, investment fund and captive insurance sectors, with a well-developed advisory and financial infrastructure.

In 2006, the jurisdiction moved towards a zero tax rate for all businesses, except companies holding banking licences and those receiving income from land and property in the Isle of Man (which includes rental income, extraction of minerals and property development). Prior to this change, companies in the insurance, fund management, space and satellite technology and shipping sectors already enjoyed a zero rate of corporate tax (extended in 2005 to companies in the manufacturing, film, e-gaming, tourist accommodation, agriculture and fishing sectors).

The 0% tax regime is intended to stimulate inward investment by businesses establishing on the Island, and provide a consistent treatment across all sectors of the economy as part of the Isle of Man’s commitment to a diversified economy. However, the future of the '0/10' system was subject to some uncertainty, having attracted the attentions of the European Union's Code of Conduct on Business Taxation.

To avoid further criticism of its 0/10% regime, the Manx government announced in February 2011, that it was withdrawing the attribution regime for individuals (ARI) under which distributions of trading profits to residents shareholders of resident companies are taxed as capital distributions, thus making them liable to personal taxation. It remains to be seen, however, whether this move will ultimately be enough to satisfy the Code Group and certain EU member states which continue to object to the ‘0/10%’ tax system.

There is no capital transfer tax, no surtax, no wealth tax, no death duty, no capital gains tax and no gift tax in the Isle of Man. Value-added tax is collected by the Isle of Man Customs & Excise at the same rates which apply in the United Kingdom (currently 20%).

There are a number of business formats available in the Isle of Man, including Limited Partnerships and Limited Liability Companies (LLCs). There is an active trusts sector, and in 2001 the island began to offer on-line gambling licences. The Companies Registry consists of seven distinct registries, each with their own legislation, fees and statutory filing obligations.

Until recently, the Island had only one Double Taxation Agreement, which was entered into with the United Kingdom in 1955. This treaty is very similar to the equivalent agreements between the UK and Jersey and Guernsey.

A TIEA and an arrangement amending the 1955 Double Taxation Arrangement between the UK and the Isle of Man, signed in Douglas on September 29, 2008, entered into force on April 2, 2009. The provisions of the TIEA also took effect in the UK and the Isle of Man on April 2, 2009. The agreement amends the provisions of the 1955 double taxation treaty by adding provisions on the taxation of income from pensions and a mutual agreement procedure.

The Isle of Man was one of the first international financial centres to make a commitment to the OECD principles of transparency and exchange of information and has since then taken the lead among smaller international financial centres in implementing these principles.

Besides the UK, the Isle of Man has double tax avoidance agreements in force with a number of countries, including Australia, Denmark, Estonia, the Nordic Countries, Ireland, Malta and New Zealand. It is in active tax treaty negotiations with a number of other countries.

Dubai

The Emirate of Dubai extends along the Arabian Gulf coast of the UAE for approximately 72 kilometres. The emirate is strategically located between Africa and the Middle East and between the Far East and Europe making it a gateway to over 1.5 billion consumers located in countries surrounding the Red Sea and the Gulf.

Dubai's enormous oil revenues mean that the government has no need to raise income through direct taxation. Accordingly Dubai is a "no tax" emirate characterized by an almost complete absence of taxation. There are no withholding or capital taxes. Only oil companies and the domestic banking sector are subject to income tax.

Jebel Ali, home of a huge man-made port, has the largest free-trade zone in Arabia (the JAFZ), housing an ever growing list of international corporations which use the zone for both manufacturing and as a redistribution point and which calls itself home to 5,500 companies from over 120 countries.

The JAFZ was established in 1985 with the specific purpose of facilitating investment. Accordingly, the procedures for setting up in the zone are relatively simple. Its legal status is quite distinct: companies operating there are treated as being "offshore", or outside the UAE for legal purposes.

The option of setting up in Jebel Ali is therefore most suitable for companies intending to use Dubai as a regional manufacturing or distribution base and where most or all of their turnover is going to be outside the UAE.

There is freedom from corporate taxation in the JAFZ for a period of 50 years, a concession which is renewable. In addition, there are no import or re-export duties, no personal income taxes, no currency restrictions, and no restriction on hiring foreign employees. 100% foreign ownership is permitted. There is exemption from all import duties and 100% repatriation of capital and profits is guaranteed.

The Dubai International Financial Centre (DIFC), another no-tax free zone, was established in 2003 with the aim of attracting asset management companies, banks, and other financial service providers. Companies which establish headquarters in DIFC are permitted to do business with locally-based high net worth individuals but are not allowed to enter into the retail market in Dubai. The DIFC has a separate set of laws called the Commercial Code, comprising a comprehensive set of regulations like company law, legislation on property rights, including laws on security and collateral, title to goods and securities, commercial transactions and contracts, and insolvency.

Other free zones include the Dubai Investment Park, the Dubai Internet City, the Dubai Airport Free Zone and the Dubai Media City.

Dubai (the United Arab Emirates) has a number of double tax treaties with high-tax countries and is often used in international tax planning by major corporations. This tax treaty network covers more than 50 countries and includes treaties with China, France, Germany, India, Indonesia, Italy, Luxembourg, Malta, Malaysia, the Netherlands, Singapore and South Korea.

Although corporate income tax is not levied in the UAE the provisions of the treaties do not state that such income must be taxed to qualify for benefits. Thus dividend income paid by a UAE company to a company which has a double taxation treaty with the UAE may not be taxable in the hands of the foreign parent corporation. However it is wise to study the text of the treaties themselves before assuming anything about the tax treatment of untaxed income flows originating in Dubai.

Dubai also belongs to the unified customs area of the Gulf Co-operation Council which came into effect on January 1, 2003 and covers Kuwait, Qatar, Oman, Saudi Arabia, Bahrain, and the United Arab Emirates (including Dubai).

Dubai’s attractions as regards tax are fairly evident, and the emirate stands out particularly as a re-export base for the Middle Ease North Africa and Asian regions. Many of the economies of the region served by Dubai are still at a relatively early stage of development, so there is plenty of long term scope for diversification and expansion in the future. Another important consideration is Dubai's rapidly developing role as a supplier to such emerging markets as India, the CIS, Central Asia and South Africa.

Hong Kong

Hong Kong's spectacular economic success is largely based on a whole hearted adherence to free and open trade, the values encompassed in a British common law legal system and a laissez-faire, non-interventionist attitude on the part of government. As such there are few if any significant barriers to investment by foreigners.

Hong Kong is not an 'offshore' jurisdiction as such, but has low tax rates which are levied only on Hong Kong-source income. The government has consistently followed business friendly policies and continues to do so.

Companies pay a standard income tax rate of 16.5% on assessable profits while businesses other than corporate entities pay a rate of 15% on assessable profits. All taxpayers are subject to the same corporation or unincorporated business tax rate irrespective of their residential status.

Special concessionary rates of profits tax which are substantially less than the standard rates apply to the following businesses or sources of income: trading profits and interest income derived from debt instruments issued in Hong Kong with an original maturity of between three and seven years; the re-insurance of offshore risks; life insurance businesses; an entity whose business is to grant rights to use a trademark, copyright, patent or know how; shipping operations; the sale of goods on consignment from Hong Kong on behalf of a non-resident; an entity whose business is to rent out a film, tape or sound recording for use in any cinema or television program.

In Hong Kong there is no capital gains tax, no withholding tax, no sales taxes, no VAT, no annual net worth taxes and no accumulated earnings taxes on companies which retain earnings rather than distribute them.

Individuals pay the lower of 15% of "assessable income" after the deduction of allowances, or a progressive rate up to 17% on "assessable income" after the deduction of allowances. No tax is levied on investment income or capital gains, whether the individual is resident or not.

Hong Kong is actively expanding its network of double taxation treaties and 16 comprehensive DTAs are in force, including with Austria, France, Japan, mainland China and the UK among others. Hong Kong also has signed double taxation agreements concerning aviation and shipping income with a number of countries including Canada, Germany, China, Mauritius, the Netherlands, Russia, the UK and the US.

Furthermore, dozens of types of goods and services traded between Hong Kong and China have been liberalized under the Hong Kong/China Closer Economic Partnership Arrangement (CEPA).

After signing the first CEPA agreement in June 2003 for implementation in 2004, the Central and Hong Kong governments have signed several yearly Supplements, with the eighth phase of CEPA liberalisation measures by virtue of Supplement VII implemented in January 2011. The number of types of goods eligible for CEPA’s tariff-free treatment has expanded from 273 on January 1, 2003, to 1,592 on January 1, 2011.

On the whole, Supplement VII will expedite and facilitate Hong Kong service industries to enter and expand in the Chinese market, and foster service industries' integration. Moreover, most of the market liberalization and facilitation measures cover the industries in which Hong Kong has a competitive edge, and as such will help consolidate Hong Kong's status as an international financial, trade, shipping, logistics and high value-added service centre.

The following services are among those which have been liberalized under previous CEPA rounds: legal services, construction, information technology, convention and exhibition, audiovisual, distribution, tourism, air transport, road transport, and individually-owned stores.

So, as China opens up to the world through its membership of the WTO, Hong Kong is both the natural conduit for Chinese exports towards the West, and the obvious base for international companies taking part in opening up China's expanding economy. Other Asia-Pacific countries and cities such as Shanghai or Singapore may mount effective competition to Hong Kong as financial/trading hubs, but they will probably not be able to replicate Hong Kong's unique blend of Western expertise and Chinese knowledge.

Labuan

The island of Labuan is 92 sq km in size and is part of Malaysia and thus is well located in the centre of the ASEAN region. The government sees Labuan's future in terms of its financial sector, and in 1990 created the Labuan Offshore Financial Services Agency (although 'Offshore' has since been dropped from the title) alongside a batch of 'offshore' laws. A stock exchange was established in 2000, aiming particularly at the listing of Islamic financial debt issues, and has had considerable successes.

Malaysian taxes are moderately high, although on a territorial basis, but Labuan offshore companies pay either 3% if they trade or nil if they don't. There are many incentives and exemptions which make it possible for most mainland Malaysian profits to be repatriated through Labuan without tax. Many expatriate workers can take advantage of personal tax incentives.

In February 2010, new laws which, it is hoped, will substantially improve Labuan’s competitive edge in international financial markets came into effect. These new laws allow for the creation of Labuan foundations, limited liability partnerships, protected cell companies (insurance and mutual funds), shipping operations, Labuan special trusts and financial planning activities. These complement the existing available range of products and services and aim to provide investors with a wider choice of financial products to maximise investment opportunities.

In pursuit of foreign investment, Malaysia has signed many double tax treaties, of which more than 60 are in force, mostly having low rates of withholding tax on outgoing payments. All Malaysian tax treaties follow the OECD model treaty with some modifications; however the US treaty provides reciprocal exemption to international shipping and air transportation businesses only.

In many cases, Malaysian tax treaties include 'tax sparing' provisions, whereby a dividend that is distributed out of profits which have been exempted from tax under Malaysian tax incentive regimes is deemed to be have been paid out of profits that have been subject to tax. This enables the recipient to claim a tax credit on the exempt dividend in his home country. There are no anti-treaty shopping provisions in the treaties.

Asian countries on the whole, however, have accepted Labuan in treaty-based tax planning, largely no doubt because they are all themselves hungry for inward investment.

Labuan offshore companies can make use of Malaysia's good double tax treaty network, and as a result the island has become the preferred conduit for FDI into a number of local countries including Korea and Malaysia itself.

Mauritius

Mauritius, situated in the Indian Ocean, has been an independent member of the Commonwealth since 1968, and became a republic in 1992.

Apart from encouraging tourism and financial services, the government has tried hard to create a manufacturing sector with a range of investment incentives, free trade zones and a freeport, although these are being phased out as part tax reforms aimed at simplifying the system for all users.

Until 1998, the Offshore Company and the International Company (equivalent to an IBC) allowed zero taxation across a range of offshore activities including banking, shipping, insurance and fund management, as well as in the free trade zones. Since a raft of new legislation in 2001 these two types of company are known as Global Business Companies Categories 1 and 2 (GBC1 and GBC2).

Mauritius has decided to be a 'respectable' IOFC and there is now a flat tax rate of 15% in almost all areas. A GBC1 (old Offshore Company) also pays corporate income tax at 15%, but if it was incorporated before 1st July 1998 it pays 0%. GBC1 Companies are also exempt from stamp duty, land transfer tax, and capital gains (morcellement) tax. There are no withholding taxes or equivalent deductions on dividends or other payments made by GBC1 companies to non-resident shareholders (residents aren't normally allowed to hold the shares of such companies).

The domestic and offshore sectors have traditionally been quite firmly separated, although recent legislation, particularly in the banking sector, has begun to remove the distinction between 'onshore' and 'offshore.' Export-oriented domestic manufacturers and service providers get favoured treatment.

GBC1 Companies are regarded as being resident, and are therefore able to take advantage of Mauritian Double Tax Treaties. The tax treaty with India is particularly favourable, and Mauritius is a favoured location for holding companies for those trading with or investing in India.

GBC1 Companies can also utilise the unilateral foreign tax credit which is 80% of the Mauritian tax rate (leaving a residual liability of 20% of the Mauritian tax rate = 3%).

Mauritius has entered into a considerable number of double-tax treaties (unusually for a low-tax jurisdiction). The treaty with India, which had underpinned the emergence of Mauritius as the dominant channel for FDI into India, came under attack from Indian tax authorities in 2002 as a result of alleged abuses by Indian-resident investors. After a series of high-profile court hearings, the status quo appeared to have been restored. However, rumblings from the Indian authorities with regard to the alleged 'abuses' are still continuing in 2011.

Nonetheless, Mauritius has tax treaties with more than 30 countries, and they can be combined with the offshore regime to give a good result, especially for trade and investment in India.

To summarize…

There are many other offshore jurisdictions to pick from and lowtax.net contains a wealth of information on the tax and legal regimes of over 70 jurisdictions, both on- and off-shore. Choosing the right one will depend on a number of factors, including the nature of the business, where its main markets are located and the location of its base of operations, to name but a few. Expert professional advice, however, is essential in making such decisions.

Offshore tax regimes are to a certain extent in a state of evolution as IOFCs adjust their tax laws to suit the requirements of the OECD, the G20, the European Union and other onshore multilateral groups. This is likely to remain an on-going process; but, as this small sample of jurisdictions shows, with careful planning it is still possible to achieve significant tax savings through formation of an offshore company.




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