January 12, 2010
There is really a great deal of information out there about offshore corporate structures… frankly it’s mind numbing. Do a search for “offshore corporation” and you will undoubtedly return over a million websites promising you fast incorporation in Panama or the BVI, as well as a host of ‘benefits’ for that particular jurisdiction.
Are these benefits real? Does it make sense to structure a business overseas?
Yes. Planting a flag overseas provides asset protection benefits, and in many cases, significant tax benefits… even if you are a US citizen. It is possible, for example, to generate corporate profits free of tax liability, and to defer personal income tax liability indefinitely.
Let me first back up for a moment and explain some of the lovely US regulations that govern foreign corporations for US taxpayers. (as an aside, you should realize that I am not a tax attorney, nor does this constitute tax advice)
The first is section 957 of the Internal Revenue Code pertaining to “Controlled Foreign Corporations (CFC)”. A CFC is any foreign registered company with more than 50% direct or indirect ownership by a US person.
If a company is deemed to be a CFC, the IRS essentially views it as a domestic US company and expects the foreign company to file a tax return every year.
That’s where places like Panama come in. Some people try to get slick and form a Panamanian company, hiding behind their lawyers as nominee directors. If their name is withheld from a public registry, the US government will never know about their ownership interest… right?
Guess again. Basing your tax strategy around another human being keeping your secrets in just plain absurd. Your lawyer may be a good guy, but when push comes to shove and the US government comes knocking, he’ll sing like a canary.
Let me underscore this point again even more clearly– do NOT expect to hide profits through an offshore company without the government finding out. They will find out. Privacy and secrecy are gone, at least for now.
Fortunately, there’s a big fat silver lining. Most people do not realize that there are perfectly legitimate ways to structure your business interests overseas and realize significant benefit.
Big businesses do this all the time; large multinationals have subsidiaries and affiliate offices all over the world. Consider Boston Scientific, which manufactures products in Ireland and then ‘sells’ them around the world. The company only pays a 12.5% tax to Ireland on its profits from those sales, rather than 30% to the IRS.
You might be thinking to yourself right now– “Great… except I don’t plan on opening a multi-million dollar medical device manufacturing facility in Ireland.” Believe it or not, in many ways it’s even easier for some small businesses to capitalize on this concept, especially if you have an online presence. Here’s why:
A foreign corporation is subject to US income tax, depending on the situation, if any of the following are true–
First, if the foreign company has a permanent establishment in the United States; ‘permanent establishment’ is ordinarily defined by specific tax treaties, but usually includes things like an office, factory, or workshop.
Second, if the foreign company is engaged in a “US trade or business” or has US-source income; income source rules are defined by Internal Revenue Code section 862.
For example, if a business produces inventory, the source of income is where the inventory is produced; if a business performs personal service, the source is where the services were performed. For businesses that sell inventory, the source of income is where the products are sold.
As you can see, these rules clearly favor many types of enterprises, including e-commerce businesses, some service providers, overseas manufacturers, and businesses owned by expatriates.
Foreign corporations that fit these circumstances are not subject to paying US taxes. The company may be subject to tax in its own jurisdiction, but many (BVI, Cayman Islands, Labuan, Singapore, etc.) do not tax corporations on income earned outside of their borders.
In this manner, the corporate entity is free of tax liability. However, when the corporation makes dividend distributions to its owners (US taxpayers), the US citizen will pay tax on those distributions.
Presently, the dividend tax rate is quite low, but you can be sure that the Obama administration will raise the dividend tax in the future. If the corporation does not distribute profits to the owners, however, the individual has no immediate tax payment due and effectively defers his tax liability indefinitely.
Here’s an example– you are a US citizen and own an e-commerce company based in BVI. You have no permanent establishment in the US and have no US-source income by the IRS rules. The company does not pay tax to the US, nor does it pay tax to BVI.
Assume your company nets $1 million annually. You do NOT distribute this income, and rather invest all of your profits with a 20% annual return. At the end of 10-years, your business has accumulated $25.958 million.
Now assume the same business is structured in the US paying 30% to the government. At the end of 10-years, the business will have accumulated $13.536 million.
The compounding power of tax-deferred profits is extraordinary– you make an extra $12,422,575.54 with a properly structured foreign company.
This week I’m going to be interviewing one of the country’s premier international tax attorneys who specializes in offshore business structures. As a personal favor to me, he has agreed to walk you through the regulations and explain how you might be able to realize these benefits.