When a business sets up a company abroad, it often has one goal in mind: lowering its tax burden. This approach involves applying legal strategies to optimize offshore taxes by using structures such as partnerships, foundations, or trusts in jurisdictions with favorable fiscal regimes. These entities are created for legitimate purposes such as estate planning, international expansion, or administrative efficiency.
However, these fiscal benefits are often misunderstood, assuming that offshore companies are completely exempt from obligations. To avoid confusion and understand the reality of these entities, in this article we will explain the aspects related to offshore tax.
What Is Offshore Income?
To begin, we must clearly understand the types of income. Onshore profits are those that a company obtains within the same country where it is registered and where its owner resides. These are usually subject to local tributary liabilities regardless of type or volume. In contrast, offshore income comes from a different country than the onshore one and therefore is subject to offshore tax.
Having offshore income does not in itself imply a breach or corporate tax evasion. What matters is how that earning is declared and whether it complies with what each country’s tributary authority requires, especially regarding income tax. In this respect, transparency is necessary to run within the law.
What are Offshore Taxes?
Based on the above, offshore taxes are fiscal obligations applied to income earned or entities formed outside the fiscal residence of the beneficiary. Their application depends on the legal system of the country where the earning arises or the structure is established, as well as any active double taxation agreements. In certain offshore jurisdictions, foreign profits may be exempt from domestic charges, although those tied to local economic activity are usually taxed.
However, just because income is not subject to tributary obligations in countries that do not have taxes does not mean that it is free from international obligations. Many states require their tax residents to report and pay levies on global income. For this reason, understanding how these rules function and what obligations arise from each offshore setup is important to remain compliant and avoid legal or financial penalties.
Countries That Do Not Have Taxes on Foreign Income
Certain countries that do not have taxes for offshore companies or apply low rates attract businesses whose main economic activity takes place outside their territory. The tributary rules of these jurisdictions (or offshore tax haven countries) are known as offshore fiscal liabilities.
This practice is completely legal and offers a reduced fiscal burden on offshore income and double taxation treaties, making financial management easier for companies. Their purpose is to offer a place for legal incorporation where companies can usually register without needing a physical office or local staff. Depending on the jurisdiction, though, there might be extra requirements like appointing a local representative or a resident director or secretary. This allows them to conduct international activities without generating offshore taxes within that jurisdiction.
For example, registering a company in BVI (British Virgin Islands) does not result in corporate tax payments on profits obtained outside its territory. Other jurisdictions have similar laws; for instance, a Saint Vincent offshore entity is not taxed if its operations do not interfere with the national economy.
Misconceptions about offshore tax haven countries
In the offshore world, several misconceptions circulate, particularly about offshore tax haven countries. Many associate countries that do not have taxes with tax evasion. However, the reality is that the rules of these jurisdictions are established to guarantee the legality of the entities registered in them.
Some jurisdictions have strict laws against money laundry, require registration of real beneficiaries, and cooperate with foreign authorities. This allows a company to have a foreign account, use offshore companies, and remain within the legal framework.
In other words, although tax avoidance has been questioned by governments looking to increase revenue, this practice of offshore tax planning remains legitimate if carried out under clear regulations, punishing concealment and the use of improper activities.
How Double Taxation Agreements Work
The best offshore jurisdictions are characterized by having double taxation treaties with other governments to prevent companies and their income from being subject to duplicate charges by different countries. It means that this prevents the same profit from being subject to both offshore tax and onshore tributary charges, facilitating international trade and investment.
These agreements allow taxpayers to pay in only one country (onshore or offshore). That jurisdiction either gives credit for amounts already paid abroad or waives the charge if the income was already subject to contributions where it was earned.
Each agreement has its own requirements, such as requiring the company to have real activity, meaning more than just a registration document. This is because the tributary authority checks whether there is a physical address, contracts, bank operations, and other signs that confirm legitimate functioning.
Double taxation treaties also define which country has the right to collect. This applies to both corporate tax and Income tax. It depends on the type of income, the relationship between the parties, and the country where the people involved reside.
Implications for Corporate Taxes
Despite the multiple Fiscal benefits of offshore companies, they must comply with rules that limit the misuse of foreign structures. As we have seen, these companies are subject to offshore tax and/or onshore charges, and review by authorities, banks, and compliance bodies, such as:
- FBAR (USA): Required for U.S. citizens or fiscal residents who have signature authority or control over a Foreign account with more than $10,000. It must be submitted annually to FinCEN.
- FATCA (USA): Applies to U.S. individuals and entities with financial assets outside the country. Requires declaration in IRS Form 8938 (this form applies to individuals and some specific companies).
- CFC rules (USA, United Kingdom, Canada, Australia, others): Tax offshore income of foreign companies controlled by fiscal residents. Mainly affect passive income.
- AML/CFT (worldwide): Laws against money laundering and illicit financing. Apply to banks, trusts, and companies in jurisdictions with active treaties. Require identification of real beneficiaries and proof of the origin of funds.
- OECD (International): Promotes automatic exchange of fiscal information. Affects more than 100 countries that share data about accounts, companies, and final owners.
Receive Expert Legal Advice on Offshore Companies
In conclusion, registering a company in a country that does not have offshore tax does not eliminate reporting obligations or protect against penalties for fiscal noncompliance. In fact, authorities in countries with international fiscality apply income tax to foreign profits if the beneficiary resides in their territory.
People who use offshore tax haven countries without showing real activity may be labeled for tax avoidance. If there is no economic substance, the company is disregarded and the income is directly attributed to the owner. Corporate tax is also imposed when the company exists only to retain profits and does not meet requirements such as address, accounting, or valid contracts.
At Kraemer & Kraemer, we advise you in the creation of your foreign company and guide you in the proper compliance with offshore tax so that you act according to the law, reduce risks, and maintain your fiscal situation correctly. Contact us for a personalized review of your current structure or to start a plan that allows you to act with security.
