A lot of people are looking to benefit from using offshore companies. Those benefits come from difference of taxation and administration regimes in jurisdictions involved in international business operation. The governments, however, are very aware of possibility for residents and non-residents to use loopholes and avoid certain domestic taxes that would be otherwise payable.
That is why each country develops and implements anti-avoidance measures, both on national and international levels. Anti-avoidance rules may equally refer to tax exempt and low-tax companies from tax havens as well as companies incorporated in developed countries with high taxation.
Many countries conclude tax treaties on a bilateral basis to prevent double taxation of their citizens on the same income (profit, capital gain, inheritance etc). Such tax treaties are also known as double taxation agreements (DTA) and double tax treaties (DTT). Tax treaties provide mechanisms for tax authorities to exchange tax information between each other to prevent both double taxation and tax avoidance or evasion.
Exchange of Tax Information
Besides double tax treaties there also exist bilateral Tax Information Exchange Agreements (TIEA). The purpose of TIEA is to facilitate access by the tax authorities of one country to business and tax records, books and accounts, information from banks, as well as shareholding and beneficial ownership details in the other country, and thus make it easier to detect and prevent avoidance of tax.
Many of such agreements have been signed between tax havens and highly developed countries. Obviously in most cases the information is flowing one end only, as tax havens hardly need to inquire any information from tax authorities of the other party to the treaty.
Controlled Foreign Corporations
Controlled Foreign Corporation (CFC) is generally a corporation incorporated and existing under the laws of one country, but owned and controlled by a taxpayer of the other country. The control test normally requires 50% of stock value or voting rights holding. The qualifying CFC-company is subject to joint taxation with shareholders at the shareholders’ home tax authorities. In practice that means implementation of so called anti-deferral regime, when the shareholder is treated as receiving its share of the CFC-company income on a current basis even if the company does not make any distributions to its shareholders.
In some countries CFC regulations are less broad. Thus in Denmark CFC rules apply only to a foreign subsidiary being a low taxed financial company. The latter is defined by 50% share of financial income and 10% share of financial assets in total income and assets accordingly, and 3/4 income tax ratio comparing to the Danish tax.
Japan has a similar anti-deferral regime for so called “tax haven subsidiary”, which is any foreign subsidiary paying income tax at a rate less than 25%.
Transfer pricing refers mainly to setting the prices for goods and services transferred between the related parties, such as “parent-subsidiary” or “brother-sister” companies. Transfer Pricing Manipulation (TPM) is a matter of particular importance for tax authorities when it comes to international transactions, as managers tend to use TPM to shift the income from a high-taxed jurisdiction to a low-tax area. Tax administration in its turn requires the transfer prices to be set basing on an arm’s length principle and that the appropriate contemporaneous documentation be provided to prove the prices are market-based.
Thin capitalization regulations mainly touch companies with foreign parent corporation, which are consequently not free in their capital structure choice. The company is considered to be thin capitalized when it’s capital is made up by loans from shareholders rather than stock investment and its debt-equity ratio exceeds certain thresholds. It is widespread to impose limitations or deny interest deductions on inter-company debt for thin capitalized companies.
Flow-Through Entity Regulations
This definition mostly refers to foreign parent-subsidiary companies relations. Any company, which is not the final beneficiary of the distributed dividends and acts solely as an administrator to provide a tax-free link between two other jurisdictions, can be recognized as a “flow-through entity” (FTT). Whereas such or similar regulations exist any dividends received from or being distributed to a foreign flow-through entity are subject to taxation in that country, i.e. regular tax exemption provided by a holding company status will not work here.
Withholding Tax on Payments to Tax Haven Residents
A number of countries with high taxation do not provide for other anti-avoidance measures, but introduce a high rate withholding tax on income received from their source by residents of low tax jurisdictions. It may refer to a particular type of income (e.g. interests) or any payments in favor of such legal entities in general. Withholding function is normally levied on a paying source. As to what jurisdictions are considered low tax, certain countries maintain specific “black lists” naming each and every jurisdiction believed to be a tax haven. Many countries instead have a certain rule to define a low tax country, for example it may be any country with effective corporate tax rate of less than, say, 20% or 25%, or less than 3/4 of their own tax, etc.
The above list is not restrictive but a good start for a preliminary analysis.