The Days of Operating Substanceless “Shell Companies” is Over

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It amazes me how often people contact me with the same magnificent tax planning strategy. They want to setup a company in a no- or low-tax jurisdiction and route revenue to it while actually operating it from wherever they live. Oh, and they want to access the profits through a debit card or loans. The reason, obviously, is to avoid paying taxes in their country of residence. And, of course, they want me to tell them how to do this legally because they are law abiding citizens.

First, where are these people getting their tax planning ideas? Old movies? Second, what they want to do can’t legally be done because its tax evasion.

The good ol’ days of setting up an anonymous substanceless company somewhere, booking revenue to it, and avoiding taxes are over. In fact, this strategy was never actually legal, just feasible due to the legal framework—or lack thereof—that existed at the time.

I’ll give you an example. I was recently contacted by someone who lived in Country A, a high-tax country, who wanted to invest in the U.S. Their plan was to make the investment through a company setup in Country, B, a no-tax country. The plan, essentially, was to have profits from the U.S. investment flow to the Country B company where it could be accumulated tax-free.

This plan has all kinds of flaws!

First, Country B has Economic Substance Regulations (ESR) requiring that the company’s core income generating activities take place there. Given that this genius wanted to operate the company from Country A, where they lived, they would fail to comply with ESR. They could, of course, hire Country B locals to operate the company in order to comply with ESR, but they didn’t want to trust or pay third-parties.

Second, Country A, where they lived, determines corporate tax residence based on where the company is centrally controlled and managed from. If they were managing the company from Country A, which was their plan, Country A would likely deem the company a tax resident and tax it. At the very least, Country A would likely argue that the company had a permanent establishment and profits allocable to it were taxable.

Third, Country B didn’t have a tax treaty with the U.S., which would result in a 30% withholding tax on outbound dividends. Upon learning this, our genius immediately revised their plan—now they’d incorporate the company in a country with a tax treaty with the U.S. This is always every amateur tax planner’s solution. The problem with this is that U.S. tax treaties contain robust Limitations on Benefits (LOB) provisions that aim to prevent treaty-shopping; i.e. setting up a company in a particular jurisdiction to use its tax treaties.

And last, but certainly not least, let’s not forget about the Common Reporting Standard (CRS). CRS is an automatic exchange of information protocol pursuant to which countries exchange financial account holder’s information with each other—Country B would send information on our amateur tax planner’s accounts to Country A.

In short, his tax plan sucked and wouldn’t work.

There are great advantages—including tax advantages—to be had from a properly planned and executed structure. However, the days of doing it “on the cheap” without proper advice and relying on secrecy to hide the fact you are evading, rather than legally avoiding, taxes are over. Today reaping the rewards of a structure require expert advice and a commitment to doing it right.

Have questions? Do not hesitate to contact us!

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