International tax planning, whether for business or personal purposes, often requires involvement of low-tax jurisdictions. Provided you fulfill your obligations under tax laws of both countries, dealing with tax havens is absolutely within the law. When it’s not within the law, it becomes a “tax haven abuse” and leads to non-pleasant consequences. Herewith, it is worth to know what offshore transactions constitute concern of your home tax authorities.
Taxation of Worldwide Income
Every country has its tax specifics, but the key trend is the same. Countries taxing worldwide income of their residents, always want to be aware of all sources of your income and want you to pay proper taxes on every income from every source. For these purposes, most often they oblige you to submit the according personal reports annually. Except for a few countries, only a part of income not related to your home country neither by its source nor by your residence is tax-exempt.
As a matter of example, you may accumulate savings in an offshore bank account while working overseas as a non-resident. This is legal. When you return home, you again become a resident of your home country and need to declare the interest on your offshore account to meet your home tax obligations.
Transactions and Activities Beyond Concern of Tax Authorities
When it comes to individual transactions with tax havens, tax authorities are generally not concerned about such transactions as tourist expenditure on travel and accommodation; genuine gifts and inheritance from close relatives, where source of the funds has no connection to residents of your home country; earnings from your overseas employment (providing they are exempt from your home taxes); repatriation of offshore savings by former residents accumulated while working overseas; transfer of assets and capital to the country by immigrants, investments in real estate in a tax haven (provided rental and capital gains are properly reported and taxed in your home country).
Same as tax authorities do not question your right to take advantage of tax benefits available in low-tax jurisdictions when conducting offshore business activities. Thanks to modern communication methods and general people’s mobility, it is possible now to provide many services from remote locations.
It became so common and popular to make some transactions offshore, that many low-tax jurisdictions even acquired certain specialization and profile, for example, in financial holding activities, or as location for investment funds, captive insurance business, licensing and franchising, ship management and maritime operations. Even in case of trading and producing enterprises, no one is surprised to learn that they have offices, subsidiaries or parent companies in traditional international offshore financial centers.
Concealment is the Main Concern of a Taxman
What always makes a concern of your home tax authorities is concealment. It implicates that you intend to use secrecy laws to conceal the true ownership of assets and avoid declaring the related offshore income.
You surely have the right to protect your privacy, but if your only aim is to avoid taxes that would otherwise be payable, then no simple or complex arrangements, interposing offshore companies and trusts, trustees or nominees, offshore accounts in the most secret jurisdictions will make it legal.
Inappropriately used offshore legal entities may be disregarded for tax purposes. Under the sham doctrine, a civil law concept, only the real intention of the parties to a transaction prevails in case it deviates from the formal wording of the contract or deed. What it means is that any alleged transaction by the offshore entity should be able to prove it on the basis of reliable documentation (contracts, balance sheets and other books and records), otherwise it might be recognized as “simulated” or sham.
Revenue authorities can also disregard certain transfers of income-producing assets (shares, other securities, intellectual property rights, cash and so on) to a foreign entity, which is subject to a privileged tax treatment (meaning to substantially lower tax rates or tax exemption), if the taxpayer is not able to prove the transaction had genuine business or financial purposes.
“Not Wholly Artificial” Test
Whatever offshore transactions you undertake, as a taxpayer you are supposed to be able to justify them on the basis of genuine economic and financial reasons. That is to say, you should be able to prove that the main purpose of incorporating offshore rather than in your home country was anything but avoidance of your home taxes; that the offshore company is not a “wholly artificial arrangement”, a company on paper, created solely for tax evasion, instead, it has a real business purpose, sometimes including a real business office in the country of incorporation; at least, that tax optimization was not the only aim.