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Offshore Company Formation: Company incorporation in the EU by EU residents Typical tax traps when founding a company abroad

Company incorporation in the EU by EU residents Typical tax traps when founding a company abroad

The following describes the advantages of a company formation in the EU by clients who as EU residents. In doing so we assume that the client does not relocate his main residence abroad. Afterwards we describe typical tax traps when founding a company abroad that mere incorporation agencies (not tax consultants for international tax law) like to conceal.  

In addition we describe the difference between an incorporation in the EU by clients who have their residency and main residence in the EU (residents of the EU), and incorporations in third countries or typical tax haven countries like e.g. Belize or Seychelles.  

1. General Information  

An incorporation in the EU by EU residents hat generally the following advantages:

  • Positive effect of the EU freedom of establishment, EU legal protection, EC parent subsidiary directive, no negative effect of national regulations on taxation on foreign sourced income, as long as it is not a mere letter box company in the EU country.  

  • No taxation on the undisclosed reserves when relocating to the foreign EU country: Fiscally there cannot be a difference if a Hamburg GmbH is relocated to Munich or to Malta.  

  • The EU freedom of establishment even to specifically capitalize on the differences in tax levels through incorporation of an EU company (European Court of Justice Decision Cadburry Schweppes).

In all cases the foreign company cannot be an unlawful controlled foreign company.   Such a unlawful controlled foreign company is a mere letter box company and/or i fit can be assumed that the company is „remote controlled“ from abroad provided that the existence  of the permanent establishment subject to tax is defined through the „place of management“ (Article 5 double taxation agreement).    

If the foreign location is a production facility, a location for the extraction of natural resources,  an agricultural or forestry business, a construction site that last longer than 9-12 months, or a fixed place of business in which the activities of the company are performed (e.g. hotel): then it is always a permanent establishment abroad regardless of the place of management.     Basis for this is article 5 in the double-taxation agreements:

Article 5 Permanent Establishment

1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on.     

2. The term "permanent establishment" includes especially:

a) a place of management;

b) a branch;

c) an office;

d) a factory;

e) a workshop; and

f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

3. A building site or a construction, assembly or installation project constitutes a permanent establishment only if it lasts more than twelve months.

2. Lox-tax countries in the EU/EEA

Country

Corporate tax

Tax at source for distribution of dividends abroad*

Remarks

Madeira

5%

Depending on respective double taxation agreement

Stipulations in regards to employees and investments

ZEC, Canary Islands Special Zone

5%

Depending on respective double taxation agreement

Stipulations in regards to employees and investments

Malta

5% with the Malta Holding Model, Tax Refund

On principle no tax at source

Required are Malta Trading Company and Malta Holding

Gibraltar

10%

On principle no tax at source, with Holding 1%

Gibraltar does not belong territory under the turnover tax law

Hungary

10%

Depending on respective double taxation agreement

 

Bulgaria

10%

Depending on respective double taxation agreement

 

Ireland

12,5%

Depending on respective double taxation agreement

 

Cyprus

12,5%

Generally no tax at source

 

Liechtenstein

12,5%

Generally no tax at source

 

* Deviating from above, when making use of the EC parent subsidiary directive, no tax at source, provided that parent subsidiary joint-stock companies are in the EU, the subsidiaries are active, the minimum holding period is visibly at least a year and the capital ownership is at least 10%.

More:

  • Slovakia 23%, Czech Republic with 19%

  • Latvia with 15% ˇ        

  • Special case: UK-Agency construction: (80% of the gains can be “relocated” to an offshore company (zero percent tax haven). Though the English limited and the offshore company have to be active corporations, the requirements are relatively high.

3. Intellectual Property (IP)  

Intellectual Property (IP) can be one of the most valuable assets of an organization. Choosing the right location for the centralization and management of IP is a very important strategic business decision. The ideal location to establish an IP structure is one that can serve the organization’s business strategies/model, safeguard and protect its IP and contribute to its tax optimization.  

IP covers a wide range of intangibles including:

  • Copyrights, which may take any of the following forms: literary works, dramatic works, musical works, scientific works, artistic works, sound recordings, films, broadcasts, published editions, databases, publications, software programs

  • Patented inventions

  • Trademarks (and service marks), designs and models that are used or applied on products.

The above is a non-exhaustive list.

The following EU /EEA countries know an IP Box:

  • Liechtenstein: 80% exemption, actual tax charge 2,5%

  • Luxemburg: 80% exemption, actual tax charge 5,76%

  • Netherlands: 80% exemption, actual tax charge 5%         

  • England: Actual tax burden 10%         

  • Spain: Actual tax burden 5-15%         

  • Belgium: Actual tax burden generally 6,8%

  • Cyprus: 80% exemption, actual tax charge 2,5%

4. Provision of a local resident as director (nominee or employed director)

In the following EU countries we can provide a nominee or employed director (Article 5 Double-Taxation Agreement: Place of management as place of permanent establishment for taxes…): Madeira, Ireland, Gibraltar, Malta, Cyprus, England and Liechtenstein (EEA).  

In all other above listed countries we cannot provide a nominee director.   When using a nominee director this trustee relationship should not be recognizable: A local resident (natural person), who is visibly steering the affairs of the company.

The remuneration should not be absurdly low, so one can suspect a trustee relationship because of the low wages.   One can forego the use of a nominee or employed director in the country of incorporation of the company (where appropriate) if:

  • The client or a representative relocates his main residence to the country of incorporation and acts as director himself.

  • There are no “daily decisions” to be made: for example the Danish director proves that he usually is present at the permanent establishment abroad if managing tasks occur.

  • The foreign location is a production facility, a location for the extraction of natural resources,  an agricultural or forestry business, or a construction site that last longer than 9-12 months (depending on respective double taxation agreement), Then it is always a permanent establishment abroad regardless of the place of management. The same goes for a fixed place of business like e.g. a store or a hotel.

4.1. Assignment of a local director and the client becoming second director  

It is possible to design the company structure with the provision of a local director and the client becoming second director, in which they only have joint power of attorney.

5. Office  

Beside the registered office a permanent establishment is required in the foreign EU countries (not a mere “letter box company”).  In case the client does not rent an office, we can realize a link-up to business centers in all countries: Company name plate, individual phone number, personal call reception with the name of the company, post mail forwarding, fax services. Optionally, temporary or long-term rental of fully equipped offices at the business center.

6. Low-tax countries outside of the EU/EEA, but existing double taxation agreement  

None the less, if it is an incorporation outside of the EU and the double taxation agreement is applicable, for the effectiveness for tax purposes a rented office (submission of rental contract) and where necessary employees are required. Even if one meets all the preconditions, negative effects of the national regulations on taxation of foreign sourced income still remain.

There are central:

  • Switzerland (total tax burden dependent on canton from approx. 13% to 28%)

  •  Singapore (has to be Onshore-company: First $100,000: no taxation; $100,001 to $300,000: 8,5% taxes; Thereafter a Flat Rate of 17%)

  • Mauritius (has to be Onshore-company, 15% taxes, effective 3%)

  • UAE/Dubai (no taxation).

In Switzerland, Mauritius and Singapore we can provide a nominee or employed president/ director, as well as a permanent establishment. The UAE/Dubai are a special case, please request our information.  

7. Company formation in tax haven countries, not DTA circumstance

We strongly advise against incorporations in tax haven countries (e.g. Belize, Panama, BVI, Seychelles, Panama, etc.): Suspicion of unlawful controlled foreign company, abuse of law, tax measures.  

These negative effects can only be prevented if:  

  • A business establishment is installed in a businesslike manner in the tax haven country (office/s with rental contract, employees) and the arm’s length principle is abided by.

  • The location of the head of business management in the tax haven country has to be proven. Therefore in the country a local resident has to steer the fate of the company.  

  • The remuneration has to hold-up to the arm’s length principle. Generally this is only possible if the client (or representative) relocates his residency /domicile to the country of incorporation and acts himself as director of the corporation. Nominee solutions offered by offshore agencies (Nominee Director) with absurdly low remuneration, (Mass-Nominee Directors) don’t withstand a review.

  • An economic reason exists

  • The corporation takes part in domestic economic transactions, which excludes offshore companies

Additionally, the existence of a permanent establishment is not defined on the basis of article 5 DTA, but by the domestic tax law.  

All this, because the positive effects of the EU freedom of establishment / EU legal protection don’t apply or rather no double taxation agreement exists.

The national regulations on taxation on foreign sourced income take full effect.

8. What do national regulations on foreign sourced income mean?  

One advantage of an incorporation in the EU by EU residents is that national regulations taxation on foreign based income are unlawful. Underlying principle for this is the respective decision by the European Court of Justice. All member states have amended their laws accordingly.   Taxation on foreign sourced income means: 

The foreign company’s gain is charged to the partner / shareholder, even if no distribution of dividends takes place (notional distribution assessment). 

It is taxed with the full income tax rate and not with the rate for taxes on dividends.    

Requirements are:

  • The country is a low tax country in accordance with the national laws on taxation on foreign sourced income (in Germany: less than 25% tax burden, in other countries between 10-25% taxes)

  • The foreign corporation only realizes “passive gains” in accordance with the active catalogue on taxation on foreign sourced income. Typically these are only services. Active gains are typically production sites, or if a business establishment exists that was installed in a businesslike manner thus with offices, employees at the foreign business establishment.

9. To prevent that an incorporation abroad doesn’t become a tax trap

9.1. Formation with nominee or employed director

  • With nominee director (5 DTA: place of management as place of permanent establishment): Natural person in the country of incorporation, that is „actively managing” and visibly steering the fate of the company. Alternatively: Employed director in the country of incorporation with employee contract for corporation, payment of wage tax and social security contributions.  

Typical tax traps would be:

  • Foreign legal entity as director (nominee director)

  • Assignment of (nominee) director, who clearly does NOT steer the fate of the company.

  • The remuneration of the (nominee) director cannot be absurdly low, so one can suspect a trustee relationship because of the remuneration. Mere incorporation agencies offer nominee directors for e.g. 400 USD per year – or less. It is not believable that the director of a company receives annual salary of only 400 USD.

  • Though assignment of a natural person, but this person not being a resident of the country of incorporation (assignment of so called “mass nominee directors” with cheap incorporation agencies).

  • Assignment of a nominee director, but general power of attorney for the client (trustor), whereas the trustor/client signs all relevant signatures (e.g. on contracts).

9.2 Incorporation abroad and business location abroad (permanent establishment):

A mere registered office is not a permanent establishment within the rules of violation (suspicion of letter box company). There should be at least a head office (deliverable mailing address, individual phone number, personal call reception with name of the company, not an answering machine, fax services, mail forwarding) in the company’s country of incorporation. The contract should be signed by the director (with trust the nominee director or the employed director) of the foreign corporation. Mandatorily to avoid are structures with a simple “registered office”, so a “mere letter box company”.

If rented offices and/or employees are required depends on various factors. There is also a big difference if the incorporation takes place in a third country or in the EU:

  • The EU freedom of establishment even allows for strategic use of the differences in tax levels through incorporations of foreign EU companies (Decision of European Court of Justice Cadburry Schweppes), though required is more than a simple letter box…

9.3 Account for the corporation abroad and account authorization

A solution has to be found with which our clients have sole access to the assets/account of the foreign corporation. On the other side when assigning a nominee or employed director he would need limited access to the account to be able to handle ongoing payments (government fees, head office, etc…).  

For this we offer as ideal solution our two-account system: 1. Main Corporation Account: Here all revenues are received. Account authorization has according to the shareholder’s resolution only the client.  2. Account: Director Account: Here the director and respectively the client have account authorization. The client ensures that through transfers by the main shareholder to the director account sufficient funds remain on the director’s account to pay the director’s ongoing expenses.

10. Nowadays the nondisclosure of the company structure is no longer possible

Due to the international treaties on information exchange in tax matters between the countries, the G20 agreements and the new CRS (OECD Common Reporting Standard), structures abroad and/or accounts can barely be kept a secret. Therefore, it is vitally important today to realize a “legal structure”, which withstands a review! This is why incorporations in so called zero tax havens (like e.g. BVU, Belize, Panama, etc..) and/or incorporations with only a mail box as head office and/or a local director, who visibly does not steer the fate of the company should not be considered. Who cuts back expenses in the wrong area, will quickly be taught a lesson here.  

   

 

 
 
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