What You Need To Know To Create An Offshore Taxes Strategies
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How to Hold Retained Earnings in an Offshore Corporation
The theory of an offshore corporation is straightforward. Since it is not a US corporation, the IRS has no right to tax them. The IRS therefore taxes the shareholders, not the company.
The US claims to have authority over everyone with a US passport, wherever they are in the world. There are a number of laws that control how and when US citizens pay tax on earnings in offshore corporations. One of them is the Controller Foreign Corporation rules.
The Controller Foreign Corporation (CFC) rules limit deductions and control the taxes on retained earnings upon distribution:
⇒ Passive income like dividends, interest, and investments is not active income, so no US tax deferral is applicable. Passive income is taxable on the investor’s personal return.
⇒ When retained earnings are distributed from a CFC, they will be taxed at the marginal rate of the investor. Long term capital gains rates are not applicable.
⇒ Losses in an offshore CFC do not move through to the shareholders. Losses cannot be deducted until the offshore company has been liquidated.
⇒ US heirs pay tax on the value of the shares in the CFC when they were originally acquired, not when they were inherited.
Maximizing tax benefits offshore is accomplished by generating retained earnings in an offshore corporation. This allows the accumulation of an essentially unlimited amount of tax differed income.
⇒ Operating a business through an offshore corporation allows a salary of up to the Foreign Earned Income Exclusion (FEIE) amount, over $100,000. The offshore corporation eliminates self-employment and payroll, which saves approximately 15% in most cases.
If a business nets a profit that exceeds the FEIE amount US taxes are payable on the income over the Foreign Earned Income Exclusion (FEIE) amount unless those profits are retained as earnings within the company with the taxes deferred.
The Active Financing Exception also allows multinational companies to create “friendly” offshore banks that actively invest and lend in the group’s international divisions. The bank profits can then be retained indefinitely offshore, or until the parent company makes the decision to repatriate the funds back into the US.
In order to Retain Earnings in an Offshore Corporation the investor must:
⇒ Be living and working abroad and qualify for the FEIE.
⇒ Operate with an offshore corporation.
⇒ Generate active / ordinary business income over the FEIE amount.
⇒ Pay the investor a salary of up to the FEIE amount.
⇒ Retain the profits over the FEIE amount in a company bank account.
⇒ Pay US tax on the retained earnings when they are taken out as dividends or other payments.
⇒ An exception could to pay out retained earnings in the future as salary when those salaries are under the FEIE.
Retained earnings in an offshore company create the opportunity for essentially unlimited tax deferral on profits. Plan well so the investor and heirs will reap the benefits for generations.
U.S. Treasury Relaxes Tax Rules For Offshore Profits
Treasury Department Implements 2017 Tax Law & Eases Minimum Tax Burdens On Us Multinationals
US multinationals will from now on, be a bit less exposed to specific US taxes. Treasury issued new rules for the implementation of two parts of the 2017 TCJA. The first one in question is GILTI.
Global Intangible Low-Taxed Income Tax (GILTI)
GILTI affects US-based firms involved in foreign operations. It is meant to prevent US companies from booking profits in very low-tax jurisdictions – thereby evading US taxes. It was expected to raise more than $112 billion over a period of ten years for the US Treasury.
The new rules will allow firms to treat some assets as 50% exempt for expense allocation purposes under GILTI. The changes will also enable firms subject to GILTI to increase their use of foreign tax credits to support research and development in the US.
Under GILTI firms must pay a tax rate of a minimum of 10.5%. If they pay less abroad, the difference goes to the US Treasury. The law was aimed mainly at technology-and pharmaceutical companies who succeeded best in moving their intellectual property off-shore and into tax havens. The law proved perilous for firms faced with higher foreign tax rates, Proctor & Gamble and United Technologies Corp. being a case in point. These firms found that the limits on foreign tax credits resulted in them owing GILTI even if they paid tax rates higher than the US rate.
Base Erosion And Anti-Abuse Tax (BEAT)
This law makes it harder for firms to stack their US operations with deductions and to push profits to related entities abroad. This tax was expected to raise over $150 billion for the US Treasury over the course of ten years.
The 2017 TCJA lowered taxes for corporate entities – estimated corporate tax collectors collected up to 33% less than they would have been if not for the 2017 tax law.
BEAT was initially meant for foreign-owned firms. Before 2017 these firms participated in asset-stripping by deducting costs in the US against its 35% tax rate by making payments to their parent companies to push profits into lower tax rated countries. These arbitrage opportunities still exist despite the TCJA.
The companies bemoan the fact that the tax hits transactions that are not at all intended to avoid taxes, so Treasury officials added an exception to its final rule for assets that US firms buy in deals that qualify as tax-free for regular tax purposes.
The final rules will apply to tax years ending on or after December the 17th 2018, although taxpayers can still apply 2018 rules to tax years that have ended.
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U.S. Owners Of Offshore Companies Are Obligated To These Tax Liabilities
The IRS clarified the rules for transfer and consent agreements contained in the sections mentioned above and in Regs. Secs. 1.965-7(b)-(c).
| SECTION 965 | |
| THE TAX CUTS AND JOBS ACT (TCJA) OF 2017, P.L. 115-97 | |
| Accordingly, the US moved from a global to a territorial tax system. | |
| Some owners of foreign entities are US taxpayers and are subject to a once-off Sec.965 transition tax on untaxed foreign earnings. | |
| Sec.965 applies to US shareholders as defined by Sec.965(b) in certain foreign corporations (CFC) or a foreign corporation with a corporate US shareholder. | |
| Accumulated post-1986 earnings and profits which not been taxed before, now obligate taxpayers to pay a transition tax of as of November 2,2017 or December 31, 2017 in the foreign corporation’s last tax year beginning before January the 1st, 2018, as if the earnings had been repatriated to the US. | |
| Various elections in respect of a Sec.965 payment can be made by taxpayers: | |
| Sec. 965(h): To pay the tax in installments | Sec. 965(i) To defer payment for an S corporation shareholder until specific triggering events occur. |
| The taxpayer can pay its tax liability in installments over eight years. | When the ‘event or events’ occur, the IRS further alleviates the burden on taxpayers by allowing transfer and consent agreements – if the requirements are met. |
| INSTALLMENT AMOUNTS: | TRIGGERING EVENTS: |
| Described in Sec.965(i)(2)(A) and Regs. Sec. 1.965-7(c)(3)(ii): | |
| 8% of the liability for the first five installments | Corporations cease to be an S corporation |
| 15% of the liability for the sixth installment | In the event of a liquidation, sale, exchange, or disposition of sustainably all of the S corporation’s assets |
| 20% of the liability for the seventh installment | The cessation of the S corporation’s business |
| 25% of the responsibility for the eighth installment | The C corporation ceases to exist |
| When an acceleration event occurs, ALL THE REMAINING INSTALLMENTS become due. | When any share of the S corporation stock is transferred by the shareholder |
| ACCELERATION EVENTS? | IN SUCH AN EVENT THE ENTIRE AMOUNT OUTSTANDING BECOMES DUE, UNLESS: |
| · Addition to the tax due to failure to timely pay any installment | · A transfer agreement is entered into by eligible parties |
| · Bankruptcy, liquidation sale, exchange or disposition of all or a substantial portion of the taxpayer’s assets | · The S corporation shareholder makes a Sec.965(h) election to pay in installments instead of immediately |
| · When a resident alien becomes a nonresident alien or when any taxpayer stops being a US person | |
| · A person becomes a member of a consolidated group | |
| · When the IRS determines based on material misrepresentation in a transfer agreement, that an acceleration event has occurred. | |
| CONSENT AGREEMENTS: | |
| For Sec.965(I)(4)(D) the requirements are highlighted in Regs.Sec.1.965-7(c)(3)(v)(D) | |
| · Make a timely election on the tax return | |
| · Make timely payment of the first installment | |
| · The consent agreement must be filed timely, within 30-days of the triggering event | |
| · Copy of the agreement must be attached to the shareholder’s tax return | |
| · The shareholder must sign the agreement under penalties of perjury | |
| · The agreement must be titled “Consent Agreement Under Section 965(i)(4)(D) and its terms must include the following: | |
| o A statement of compliance with all the conditions and requirements of the Code sections and Treasury regulations | |
| o The name, address, and TIN of the shareholder | |
| o The amount of unpaid deferred net tax liability for Sec. 965(i) | |
| o A statement disclosing that the leverage ratio of the shareholders and all subsidiary members of its affiliated group after the event exceeds or not, 3-to-1. | |
| o All further information and additions required by the IRS | |
New Guidance
IN TERMS OF Q&A 2;3 AND 5
- Transfer and consent agreements must be filed with the IRS at: COMPLIANCE SERVICE COLLECTION OPERATIONS, at Memphis CSCO,5333 Getwell Road MS 81, Memphis, TN 38118.
- IN TERMS OF Q&A 7All agreements will be deemed timely filed if they are submitted within 30-days of the acceleration or triggering event.
- In the event of the death of a Sec.965(i) transferor and its related triggering event, the transfer agreement may be filed by the unextended due date of the transferor’s final tax return
- The consent agreement must be filed by the S corporation shareholder and not the S corporation
- If the S corporation has more than one shareholder, all the shareholders must submit their own consent agreements to be permitted to pay the tax in installments.
- The taxpayer is still required to make a timely Sec.965 election
- The signed election statement must be attached to the taxpayer’s tax returns
- Form 965-A or Form 965-B must be updated for the triggering event, election, and installment payments.
- In the event of a Sec.965(h) election, excess remittances in the year of a Sec.965(i) triggering event cannot be refunded or credited to the next year’s income tax until after the tax year’s income tax liability is paid in full, including the Sec.965(h) installments, BECAUSE the previously deferred Sec.965(i) net tax liability is immediately assessed as an addition of tax in the year of the triggering event. The Sec.965(h) defers the payment only – not the obligation.
- For a Sec.965(h) election in the year of a triggering event, the tax payments must be applied to the tax liability first without Sec.965 and the first Sec. 965(h) installment after that to any succeeding Sec.965(h) installments.
- When the tax year liability is satisfied, the taxpayer may receive a refund or credit to the next year’s income tax if any excess tax remittances remain.
IN TERMS OF Q&A 8
- The S corporation and the transferor remain jointly and severally liable for the taxpayer’s Sec 965(i) net tax liability even if a Sec.965(h) election was made.
- They remain accountable for payments of the net tax liability, penalties and additions to tax or related amounts.
- The election does not alter the liabilities of the S corporation or transferor, as discussed in Sec.965(i)5) and related Treasury regulations.
Exceptions to the rule: For a covered acceleration defined in Reg. Sec 1.965-7(b)(3)(iii)(A)(1); when an eligible Sec.965(h) transferor and an eligible Sec.965(h) transferee defined in terms of Sec.1.965-7(b)(3)(iii)(B)(1) enter into a transfer agreement with the IRS.
The new regulations modernize the US tax system. It provides a deliberate transition away from a worldwide toward a territorial system to protect the US tax base and provide clarity to taxpayers so that they can grow their businesses.
Complex Offshore Tax Avoidance Strategies and Who Uses Them
After the big scandal that Panama Papers caused a year and half ago, the most recent leak, named Paradise Papers, exposed more of the tax avoidance schemes the ultra rich use. The names of a number of huge celebrities, large corporations, public figures and even the British Queen Elizabeth II were mentioned in the Paradise Papers scandal. It is evident from the documents that the tax strategies used are extremely elaborate and specifically designed by savvy and creative tax advisers to maximize the wealth of the rich. So let’s look at 5 of these tax strategies.
Trust and estate tax
The first successful and completely legal tax strategy, that was revealed as part of the Paradise Papers is related to trusts. These can be onshore and offshore. Here’s how it works:
- Set up a trust
- Appoint trustees to run the trust
- Become a main beneficiary
- Have the trustees determine amount and frequency of cash out payments to you as a main beneficiary.
In papers the financial assets belong to the trust, which is what the tax bodies see, but in reality you own them without having to pay tax. Offshore trusts serve the same purpose and are organized in almost identical ways. One of the notable names in the Paradise Papers who used this tax strategy is Lord Ashcroft who was a beneficiary of a trust containing $450 million.
Asset protection
Many rich individuals choose asset protection offshore as a main tax strategy. This can be risky if done by someone who is not experienced and knowledgeable enough. When asset protection is done smartly, it can save you a lot of money, which otherwise you would have to pay in taxes, but it can also put you in big trouble if you do not report what you are required. These are the main points you need to know about asset protection:
- It should be done in good times, before a claim arises.
- Late planning can cause more problems and extra charges.
- Personal assets should be moved in trusts and business assets in business entities such as partnerships and corporations.
- There are many laws protecting the trusts, but the control over assets should be balanced and best crafted by an experienced tax advisor.
A famous name that was named in relation to this tax strategy is of the Canadian Prime Minister Justin Trudeau.
Corporate tax avoidance
A glaring case in point for corporate tax avoidance is Google. They used an extremely sophisticated tax strategy to allow them segregate their worldwide income into different entities, wisely set up and managed in locations where tax rates are extremely low or non-existent. Here’s what they did:
- Google created a company in Ireland, named Google Ireland Holdings and signed off its intellectual properties to it. Ireland has low corporate tax rates.
- The company is managed in Bermuda, which is a well known tax haven.
- They proceeded with creating a series of child companies, having various rights and ownerships of properties and assets.
- The child companies cover business in different continents, which means the income is not centralized.
- The affiliates pay royalties to the parent company and the royalties are then moved to Bermuda.
- There is a minimal number of staff in Ireland, because the management is located in Bermuda. This makes the turnover in the Irish entity just a fraction of the real figure and therefore minimizes the tax.
Of course, Google are not alone in the use of corporate tax avoidance strategy. In the Paradise Papers it was revealed that Apple used the same approach by only changing the location from Ireland to the English Channel island of Jersey.
Sophisticated tax strategies and schemes
These are designed specifically for the ultra rich, like the Brexiter Arron Banks, by elite tax advisers, lawyers and accountants. Some of them include:
- Income Defense Industry – managed by very expensive tax professionals who craft bespoke strategies for the well-off.
- Family Offices – their main purpose is to convert one type of income to another that is taxed at a lower tax rate.
- Bermuda-based re-insurers – protects assets in shell companies offshore, converting short-term profits (taxed at 40%) to long-term ones, also known as capital gains.
- Partnerships instead of corporations – favored by the tax laws.
- Charitable trusts – it is a way of asset protection and helps offset the income tax.
Offshore SDIRA and Investments
Self Directed IRAs are not much different from the any other retirement fund but offer further asset protection. When you are setting up an offshore SDIRA it is important to familiarize yourself with all the rules and requirements. One of the best practices is to use the help of an experienced tax advisor as they will be able to direct you appropriately and point out details that you may miss.
Paradise Papers causes quite a lot of commotion in the public, mainly because of the unfair treatment the wealthy receive. At the same time, however, most of the tax strategies outlined in the leak are completely legal. The issue lies in the fact that the ordinary taxpayer can’t afford the masterminds behind these elaborate schemes.
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Tax Consequences for Offshore Companies With U.S. Owners
For many years, U.S. companies and their residents could own foreign companies that were inactive business and at the same time could access extremely lower tax rates while the income generated was not returned to the United States. This was before the Tax and Employment Cuts Act was effectively in place, as Accounting Today recently reported about the impact of the Trump tax reform on international companies with U.S. owners.
Active business income occurs when almost all of the company’s gross profits come from its commercial activities. But on the other hand, we have what is known as a passive activity, which will occur when a company has income specifically from investors or rental, and when this was not managed by a U.S. resident. However, companies will have a limit on how much passive activity they can have. If they overcome it, they will run the risk of becoming passive companies.
Both concepts are very important within the tax field. Any distraction or the simple fact of not operating the right way can cause a company that has always been qualified as active to be considered passive.
Initially, a company that qualified as an active business could develop its operations in a foreign jurisdiction that had a very low tax rate and this way would only be forced to pay those taxes that were exclusively from the jurisdiction. A practical example could be the case of Ireland, where the tax rate is very low (12.5%). This would allow the company to redistribute those excess savings in its business, in order to grow. Companies frequented this type of operation because during 2017 it was registered that the highest tax rate that companies had to pay was 35%, and for individuals 39.6%.
The difference between the tax rates paid in countries such as Ireland and the national tax rates in the United States was too big. To adapt to the payment of the corresponding rates in the United States, generated many losses for the companies. In this way they avoided losing money and in return they could use it to further develop their business.
For companies considered passive, this did not happen. The passive income of these companies that came from abroad was considered Subpart F. This income was linked, on a mandatory basis, to U.S. taxes and regardless of where it will go next.
One of the changes brought about by the new tax reform is the possibility of reducing, even a little, the high rate that U.S. residents had. With the new reform, the percentage will decrease to 37%. The companies managed to benefit more from this new reform since their percentage decreased to 21%. This new percentage means that the difference in percentages with countries such as Ireland is considerably reduced. In turn, greater compliance on the part of residents could generate a major shift towards the United States for those people who own a business.
For companies, this change within the new international tax law was extremely beneficial. The tax in force in 2017 decreased considerably and the payment of the same was no longer such an impediment for companies. On the other hand, the modification of the rule was not entirely beneficial for U.S. residents.
A very important aspect of the audit is the filling out of the corresponding forms and FBAR. Most seriously, companies could be fined with penalties of $10,000 per form if they fail to complete them properly and on time.
The main novelty with respect to the tax return was that those shareholders who held more than 10% of the shares of a CFC or those national entities that held 10% or more of foreign companies would be obliged to include those profits generated in the return. This generates many inconveniences for companies but at the same time this would allow the state to have a more rigorous tax control of how much profits companies create.
To put it more simply, repatriation consisted of two parts. One established a percentage of 15.5% applied to cash earnings, and the other applied a percentage of 8 % to non-monetary earnings. For smaller taxpayers, this could have a very strong impact. That is why the possibility of paying this new tax over eight years was introduced. This was a great benefit to the residents of the United States. This tax is heavy for those taxpayers and the fact that they were able to pay their taxes within eight years was a great relief for them.
This reform brought with it something very difficult to manage: The GILTI tax is primarily the power to tax the profits of any entity and individual, and that come from their CFCs, in those countries where the tax rate does not exceed 13.125%. The main purpose of this is to convince them that all those profits need to be distributed outside the United States. Those foreign CFC offices that have more than 10% profit on foreign assets will have to pay tax on the United States tax percentage (21% for companies and 37% for individuals). Only U.S. entities will be able to claim a reduction of up to 50% on the GILTI. This allows them to tax on a percentage of 10.5% and not 21%. Likewise, those companies that integrate this type of taxes, will be able to claim up to 80% of the taxes that were paid to the GILTI.
In addition, C type companies will have to pay the new tax called BEAT (Base Erosion and Anti-abuse Tax). It will only be applied to those that exceed five hundred million gross profits over a period of three years. The objective is to establish a 10% withholding on the alternative profit and thus generate retroactive deductions for different payments made to offices abroad.
How to Avoid Falling into an Offshore Tax Fraud
Offshore tax planning is a very successful and completely legal way of minimizing U.S. taxes. This is the very reason many people are tempted to start offshore ventures in an attempt to save money. As a result, however, a lot of dishonest so-called tax attorneys and CPAs emerge, promising wonders, but in reality, just delivering an offshore tax fraud. In this article, we’ll give you the basics to help you recognize the features of a fraudulent offshore structure and avoid it.
What is a good offshore practice
⇒ Incorporating an international business.
⇒ Creating an offshore asset protection structure, such as a trust.
⇒ Choosing a jurisdiction that does not tax you locally.
⇒ Using an experienced tax attorney or CPA to help you with choosing the right business structure for your needs and individual case.
What are the offshore tax fraud indicators
⇒ An advisor who tells you to open an offshore foundation, register it as a charity and promises you won’t need to pay taxes is leading you to an offshore tax fraud. Only U.S. licensed charities (with a 501 (c)(3) status) are eligible for charitable deductions.
⇒ Anyone who guarantees you can have the complete privacy of accounts and finances by going offshore is not being honest and leading you to an offshore tax fraud. A good tax attorney or CPA will create a tax plan for you that will be reported to the IRS but will have certain components that will protect the privacy of your assets from creditors.
⇒ Don’t believe a person who convinces you to use nominee directors that he or she presents to you with the idea to save on taxes. It won’t work and is definitely an offshore tax fraud.
⇒ You need to be able to back up the economics and transactions in your tax plan. If you can’t the chances are you have fallen into an offshore tax fraud.
⇒ The 2% plan is another type of an offshore tax fraud because it lacks economic substance in the eyes of the IRS.
⇒ If your offshore corporation has no employees and operations outside of the U.S. it is an offshore tax fraud.
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.
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