About offshore companies and tax havens. What is the borderline between tax optimisation and tax fraud?

In many cases the Costaș, Negru and Associates team is required to answer difficult questions, namely to offer legal solutions to subjects with taboo connotations in the current economic-legal reality.

In the context of an undeniable mobility at the global leval and at the same time of legislative inadequacies and ambiguities, economic operators are increasingly interested in building complex networks of transactions and interactions between countries.

In these circumstances, more and more residents of states prefer to transfer funds to other states where they find more favourable tax arrangements than in their home state, which are generically referred to as “tax havens”.

Looking at the phenomenon over the last 15 years, it can be seen that most states are trying to capture owners with significant wealth by offering them large tax cuts on capital, wealth and large salaries, as these resources are easy to transfer, easy to relocate to the global state.

We can thus see that there are states that are particularly friendly to non-residents, in some cases we are talking about states that have never in their history levied corporate income tax – Andorra, Bermuda, Cayman Islands, Monaco – or some that have levied it only temporarily – Algeria, the Casablanca region, Danzig, Luxembourg, Panama, Delaware and Nevada – the United States.

Of course, tax havens involve two approaches, of which we show that can be discussed:

  • An acceptable circumvention, within the limits of the law, of the tax obligations that any taxpayer has towards the state budget, who can intelligently optimise his tax burden
  • Tax evasion and/or money laundering offences if they will set up complex schemes to violate the legal provisions in force in a state of residence and use jurisdictional confidentiality to use a tax haven to mask various types of tax fraud, tax evasion and/or money laundering.

In general, when the term ‘tax haven’ is used, the overwhelming majority automatically think of illegal business, but contrary to this quasi-general opinion, companies are a legal instrument for organising business, in practice having the meaning of investments, the advantages of which are ab initio related to taxation.

It should therefore be mentioned that the advantage for taxpayers when they set up certain offshore companies is to avoid paying taxes in their country of residence, but this is a legal and not an illegal option.

What are the advantages of these areas?

  • The autonomy and decentralisation of these jurisdictions implies their own administrative, legislative and executive bodies, as well as their own fiscal policy, so their emerging economy has been supported by offshore companies.
  • Untaxed profits have thus been able to accelerate the reinvestment of profits and increase competitiveness on the international market.

Thus, we are of the opinion that it has been correctly appreciated in the doctrine that “tax havens are the key role in accentuating the movement of capital and the formation of complex networks of transactions and interactions between states, multinational companies, very wealthy individuals and ordinary individuals.”

Before discussing the boundary between tax optimisation and tax fraud, we would like to make a few points of terminology, what is meant by the concept of tax haven and offshore financial centre.

It is important to remember that an offshore company can be a valuable tool for protecting the business and the profits it earns, thus increasing the competitiveness and profitability of some companies. The direct and inseparable consequence of this is the nightmare created for government departments and tax agents who have always wanted to seek effective mechanisms to combat fraud, evasion and tax havens.

What does an offshore company actually mean? Quite simply, starting from the very semantics of this word, i.e. territory far from the shore of residence, we define them as companies that are registered in certain dependent or autonomous states or jurisdictions, which include in their tax legislation either exemption from tax or minimum taxes, as long as these companies do not carry out activities in the territory of the jurisdiction where they are registered.

Thus, if we look at the difference between large financial centres and tax havens, we can see that we are essentially talking about the same concept, but in the case of financial centres, a certain degree of significance is given due to the fact that they are conducted through international offshore centres, whereas tax havens are not regarded with so much importance, e.g. Liberia, Antigua, Marshall Islands.

The essential point to remember in order to differentiate between large financial centres and tax havens is that large financial centres have a high degree of influence that encourages international business, with sufficient leverage and infrastructure. Thus, an offshore financial centre is the financial-banking community that operates a tax haven.

We have often been asked about the differences between tax fraud and tax avoidance law, i.e. what is the borderline between tax evasion/tax fraud and tax avoidance.

Tax fraud is the illegal activity that is punishable under most criminal laws, while tax avoidance is the way in which taxpayers have opened up tax loopholes without committing a crime.

In the following, we will focus our attention to show you that there are more than 40 jurisdictions in the world that are tax havens, among the most used are:

  • In Europe: Ireland, Isle of Man, Jersey, Cyprus, Liechtenstein, Switzerland, Portugal, Alderney, Guernsey, Gibraltar;
  • In the Pacific: New Zealand, Hong Kong, Vanuatum Sangapore, Malaysia, Western Samoa, Nauru, Cook Islands;
  • In the Caribbean: Bahamas, Bermuda, Cayman Islands, Antigua and Barbuda, Belize,
  • In Africa and the Indian Ocean: Liberia, Marshall Islands, Mauritius,
  • In the USA: Delaware, Wyoming, New York, Nevada, Utah.

For example, we show that if you want to set up a company in the United States, you can choose to be a 100% shareholder/partner in a company registered in any of the selected states, even if you are not a U.S. citizen and/or do not live in the United States.

By choosing a tax haven, these companies will significantly reduce their tax or duty expenses, These companies, by choosing a tax haven, will significantly reduce their expenses in paying taxes or fees, which results in economies of scale. Of course, the impact of the chosen tax haven will be reflected depending on the company’s field of activity and the tax treatment applied separately by each individual jurisdiction.

There may be certain restrictions on the type of business entity a non-resident can form, but these do not include LLCs and corporations. In addition to residents, non-residents wishing to incorporate a company in the United States will need to meet a number of additional requirements, including obtaining an E-2 visa, an ITIN (Individual Taxpayer Identification Number), as well as designating a registered agent in the state in which the company is incorporated, and establishing an effective mailing address.

The reporting requirements are the same even for non-residents, who have to ensure that they pay their taxes in full and on time and submit their tax returns annually.  Failure to file or report them is to be avoided, as it will result in fines and penalties and may even lead to the dissolution of the company.

Costaș, Negru and Associates has frequently provided legal advice on the legal form a company can take – either an S Corporation or a Limited Liability Company (LLC), each with its own distinct characteristics and a different tax regime depending on the state where it is to be incorporated.

In fact, by way of example, we show that Delaware is the most popular choice in the US for registering and operating a company, due to the fact that it is business-friendly, granting tax breaks to companies.

Thus, the State of Delaware:

– does not impose sales tax and out-of-state income tax;

– registration fees are lower than in other states;

– franchise tax is lower compared to other states.

From a data security standpoint, companies registered in this state do not have to list the identity of shareholders/partners in their articles of incorporation, so this data remains confidential.

In fact, although Florida’s sales and excise taxes are above the national average, the total corporate tax burden is only 6.97%, the sixth lowest in the US.

Florida has no corporate income tax and the personal income tax rate is 0%. The advantage for non-residents is that they are not required to file a tax return in the state.

In the event of legal disputes, the particularity is that Florida has a body of law that protects companies and allows them to focus on their business rather than entering into a legal framework. They also have a separate court system, the Court of Chancery, which resolves such disputes expeditiously.

From a data security point of view, companies registered in this state do not have to list the identity of shareholders/partners in their articles of incorporation, so this data remains confidential.

Therefore, although we have dealt with this subject comprehensively, we show that the interest of investors in operations through tax havens (where profits are taxed at low or almost non-existent rates) is understandable, as they will be able to retain almost all the profits generated.

Basically, in a state where operations in offshore areas can be used, it will be easier to avoid paying taxes that would otherwise be due to on-shore states.

This article was prepared for the blog of the law firm Costaș, Negru & Asociații by Ms. Larisa Mărginean of the Arad Bar Association.

Costaș, Negru & Asociații is a civil law firm with offices in Cluj-Napoca, Bucharest and Arad, offering assistance, legal representation and advice in several practice areas through a team of 17 lawyers and consultants. Details of the legal services and the composition of the team can be found at https://www.costas-negru.ro. All rights for materials published on the company’s website and via social media belong to Costaș, Negru & Asociații, reproduction of which is permitted for information purposes only and with correct and complete citation of the source.

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