Zero balance accounting in an offshore company: the pros and cons
What is an offshore company?
Technically speaking, an offshore company is one that has been registered outside the jurisdiction of a natural person’s tax residence. In other words, the company is founded in a country different from that where the person has citizenship. For example, a German tax resident will consider France, Belgium and the USA as offshore countries.
Singapore is the best example to illustrate the offshore principle. Back in times of colonisation, when the English arrived in South-Eastern Asia, the region had already been inhabited. So instead they occupied a small island that eventually became the world’s fourth financial centre. In order to bring some life into Singapore commerce, the English established duty-free trade in the Singapore coastal area. Due to the advantageous location of the country, a lively market rolled out along its shore. Goods that ended up in Singapore were then taxed accordingly.. The country still adheres to territorial taxation, which implies that any profit gained outside Singapore is not subject to taxation until it is acknowledged within its territory, i.e. transferred to Singapore.
From a technical point of view, offshore companies can be divided into the following categories:
- Tax-free harbours, such as Belize, BVI, Seychelles, etc.
- Low-tax jurisdictions, such as Singapore, Hong Kong, Latvia, Cyprus, etc.
- High-tax jurisdictions with the corporate income tax rate over 20%.
What should be mentioned is the countries that were once a part of the British Empire – Cyprus, Malta, BVI, Singapore, Hong Kong, etc. – have become prevalent offshore jurisdictions. This can be attributed to the popularity of the English language gained by the UK and USA, as well as the English judicial system, Common Law precedent, and the low or zero income tax regimes.
What constitutes binding reporting for offshore companies?
The following annual reports are compulsory for each offshore company:
- Annual report submitted to the relevant government authority that is in charge of company registration and introduction of their structural amendments.
- Tax return.
So-called tax-free harbours used to operate without any reports. Annual fees were more than enough to keep a company afloat. However, since 2014, the global situation around tax avoidance started to change. Now even tax-free harbours ask beneficiaries to supply information about the location of all accounting records in case of any audits that require documents regarding the offshore company’s business. Of course, no accounting reports are kept in such offshore companies. This fact gives rights for the registration authority of a tax-free harbour to shift responsibility to a service provider who is in direct contact with a client.
Today, millions of companies are registered in tax-free jurisdictions mainly because of cheap maintenance costs. However, their number has declined as banks gradually close accounts of such companies due to extremely high risks in terms of compliance. As bankers often say, it is preferable not to have such a client at all.
The battered reputation of tax havens have forced many companies to shift to low-tax jurisdictions since 2010. All jurisdictions struggle to attract new clients, as does the UK. In this respect, it had an interesting trick with partnerships. The idea is as follows: partners of English or Scottish partnerships carry the tax burden in their country of tax residence. That is to say, their relations are completely transparent for the sake of taxation. That’s why tax payments can be avoided if a partner chooses among the companies from a tax haven. The result is that the company doesn’t pay any taxes, but at the same time is considered to be a British company as opposed to the country with a high corporate tax rate.
Now quick-witted businessmen face another challenge – minimising its maintenance costs. The only way here is to submit zero balance accounts and declare that the partnership carries out no activity whatsoever. All the bank accounts have been opened in other jurisdictions, so all the traces are covered.
Such organisation has a legal right to exist unless its bank account is closed. This is a typical example of aggressive tax planning that is only available for small businesses and start-ups. However, as the business grows, other risks should be taken into account along with cutting taxes to zero and minimising offshore costs.
What risks involve manipulating false zero annual accounts and tax returns?
First of all, these are business risks.
Let’s imagine the following situation: your trading partner has been unscrupulous and refused to pay. And it’s not pennies we speak of, but millions. The case ends up in court, but there is no evidence, since all accounts showed zero balances. One, of course, can try to prove the opposite, but it can uncover the truth about zero balance accounting.
The second problem concerns negotiations with banks to avoid closing the account. Due to new OECD requirements, banks are put under heavy pressure and are therefore forced to require the disclosure of information regarding all business activities and the submission of relevant reports from their customers. It becomes clear that zero accounts cannot be submitted to the bank, which carried out all the actual activity. Eventually, the bank closes the account, and such offshore structures become of no use to anyone and are finally rejected. Meanwhile, a beneficiary is looking to create a similar structure without realising that as the time changes one has to change, too in order to avoid becoming extinct, like some sort of financial “dinosaur”.
Summing up, I’d like to remember a famous line: “to be or not to be…”. Speaking seriously, it’s time to pay taxes or have some organisation that can take charge of asset protection and international trade. Some businesses simply cannot afford extra costs, while others have to get accustomed to a new realm of controlled foreign companies and the automatic information exchange between tax authorities, while looking for new solutions. As the time flies, these solutions can be found in one way or another. For example in 2015, Russian companies began launching small offices to create necessary activity, while continuing to use the benefits of an Agreement between Russia and Cyprus for the avoidance of double taxation.
The main conclusion is that no common “cheap” solution can be found to solve all the problems at once. The business world hasn’t found it yet.
Instead, an optimal solution can be found for the time being from a mid-term prospective. Seeing the whole picture is extremely important in this case. That’s why instead of panicking about a business related problem, one should consult specialists who will do their best to find a solution using a productive mutual dialogue and eventually help to prevent feelings of regret or wishing something was done differently.