What is an Offshore Tax Haven?
What is a Tax Haven: In short, an offshore tax haven is a foreign country that limits — if not excludes — the taxation of income generated from certain assets, accounts and earnings that are generally taxable forms of income (e.g., employment, investment or corporate income) in non-haven countries. For example, the United States currently has a 21% corporate tax rate. Therefore, income earned by a US Corporation will typically be taxed at 21% (previously it was 35% and there is a current push to move it back up to 28%). But, let’s say the US Taxpayer does not want to pay 21% on the corporate earnings. Instead, the Taxpayer decides to create a company offshore in a country that does not levy tax on corporate earnings — and usually exempts all taxes on dividends or capital gain generated from the corporation as well. This would artificially reduce the Taxpayer’s tax rate from a US tax perspective — and an example of an offshore tax haven scenario. The Internal Revenue Service is aware of most offshore tax havens and has limited the ability to relocate a US business offshore — by implementing tax rules such as deemed sales, Subpart F and GILTI. Nevertheless, many US taxpayers still try to circumvent US tax rules by creating foreign trusts and other companies to avoid U.S. tax. Let’s go through the basics of an offshore tax haven scenario.
Taxpayer has a US Business
Jane is a hardworking and diligent entrepreneur. For the past 15 years, she has worked hard to develop her own business — and in recent years her sweat-equity investment paid off — and her corporation is doing incredibly well. When Jane goes to visit her Tax Advisor, he informs her that she has jumped from the net effective tax rate of 10/15% — to nearly 35%. Jane is dismayed to think that one out of every three dollars is being paid-out for income tax — in addition to social security and other taxes she has to pay. Jane realizes that US Social Security will probably expire before she even gets the opportunity to enjoy it in her later years — and she decides she wants to move the company offshore to a tax haven. She considers countries such as Turks and Caicos, Malta and Brazil.
Controlled Foreign Corporations & US Tax
Since Jane is a US person who has full-ownership over her corporation, if the company is moved offshore, it will become a Controlled Foreign Corporation (CFC). As a controlled foreign corporation, Jane will become subject to taxes such as GILTI, FDII and Subpart F Income. Thus, Jane loses the benefit of having her money in an offshore tax haven because as a US person owner of the company — the US can still exert its tax influence over her.
Corporate Anti-Inversion Rules
The US government is aware that companies want to move overseas to invert — and then generate foreign sourced income sufficient to avoid having significant U.S. tax liabilities. As a result, the United States Tax Code limits the ability to invert — and penalizes taxpayers who do not invert correctly.
IRC 367 Limitations on Transfers
If Jane was to move her US assets into a foreign company, she does not receive the same tax-deferred benefits that she would receive if she was transferring the same US assets into a different US company — and some of the transfers may become subject to an immediate capital gain tax — and other taxes — as a result of the transfer being treated similar to a sale.
GILTI refers to Global Intangible Low Taxed Income — but despite the complexities of the phrase, it essentially just means nearly all income earned from a foreign company — unless otherwise exempted such as Subpart F or High-Taxed exemption — is taxable. GILT is income that is generated from a foreign company and it is immediately taxable — even if it is not repatriated. While there are some limitations in place and methods for reducing th tax implications — most service companies with limited assets get hit with significant tax — unless they make certain elections, in which their tax returns then become infinitely more complicated and complex.
Subpart F Income
As part of moving offshore, Jane imagines that she would begin investing into foreign funds in order to generate passive income offshore. But, certain income from foreign investment sources such as mutual funds, ETFs and/or SICAVs are considered Subpart F Income — and immediately subject to tax, whether or not the income is repatriated to the United States.
Moving a Business Offshore is Complicated
The United States continues to increase enforcement and reporting requirements for US persons who want to move offshore. Any company ore Person that is considering moving overseas must evaluate the tax ramifications before doing, so that they are not (unpleasantly) surprised.
Golding & Golding: International Tax Lawyers Worldwide
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
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