While efforts to hunt down offshore companies may appear to be yielding results, there’s been no slackening of demand for setting up companies abroad. However, tax avoidance and tax evasion, as the primary motives for doing so, are giving way to other objectives - comments István Csővári, tax partner at Jalsovszky Law Firm.
Automatic information exchange, restrictions on bank secrecy, tightening of anti-money laundering rules and strict KYC rules... These are just some of the measures being deployed by developed countries around the world to stop hot money being hidden away in tax havens. Meanwhile, in developed countries income tax rates have fallen. In Hungary, for example, earnings can be withdrawn from companies with single-digit corporate tax and only 15% personal income tax. But has this removed the need for businesses to transfer their income streams and activities to foreign companies? Not in the least. Why not?
The reasons for setting up foreign companies these days have more to do with business and security considerations than taxation issues. On the one hand, Hungarian entrepreneurs often like to see the more easily mobilizable part of their company assets stashed safely abroad, due to the level of "country risk" that they associate with their home country. On the other, the option of establishing foreign companies is commonly used in business as a means of encouraging investment. Foreign investors (for example US-based) are more willing to invest through a company that operates in a legal environment that they understand, which in turn makes them feel more relaxed about the venture. But other business considerations could also lie behind the decision to set up a foreign company: the buyers of many services, for example, prefer to be in a contractual relationship with a local company, or at least one that’s been founded in a country with a familiar legal culture.
Tax considerations do remain a factor in these cases of foreign company establishment, but the objective has changed. Rather than achieving a clear tax advantage, in many cases the aim is for the company to not be "worse off" than it would be in Hungary, or to be able to postpone its tax payment obligation. Another important aspect is the need to avoid domestic tax risks associated with foreign operations. Where?
When choosing the country in which to establish such a company, besides taxation, the main criteria are legal certainty and financial stability. As regards tax, the general rate of corporate tax, exemption from withholding tax on the withdrawal of profit, and for holding companies the tax exemption of received dividend and the gains realised on the sale of shareholdings, are key factors. It is particularly important that a double taxation treaty should be in effect between the foreign country and Hungary. Without this, the tax advantages resulting from a foreign country’s lower tax rates may prove to be of limited or no benefit. The main destination countries are currently the following: United Arab Emirates
The Emirates are in a special situation. Although companies established there enjoy total tax exemption, Hungary has nevertheless concluded a tax treaty with them, so incomes earned in the Emirates incur no additional tax liability in Hungary. The classic European holding countries (e.g. The Netherlands, Luxembourg, the United Kingdom, Sweden)
Due to the exemption from dividend and capital gains tax, companies established in these countries are particularly suitable as holding companies (that is, for holding shares in other companies). However, if free liquid assets in the form of bank deposits or securities are accumulated by the holding company, then the yield realised on these assets is often liable for corporate tax at a higher rate of around 20-25%. Malta
Malta has not been affected by problems similar to those associated with the Cypriot tax and financial system, while the country continues to offer an attractive tax regime. Dividend and the capital gains on the sale of shareholdings are tax-free, and the 35% tax on the profit from other activities can be lowered to an actual rate of 5% with a special system of tax refunds. Lichtenstein
This dwarf state could become popular again soon. Financial security and stability are assured in this Alpine country, and Lichtenstein was taken off the blacklist of offshore locations several years ago when it introduced a 12.5% corporate tax rate and concluded a double taxation treaty with Hungary. Hong Kong, Singapore
These countries operate territorial tax systems, which, put simply, means that only activities performed abroad are taxed. Extra caution needs to be exercised with respect to their use, and to the activities performed, especially due to the reclassification risks described in more detail below. How?
When setting up and operating companies abroad, special care must be taken to ensure that companies which are formally established abroad, but actually run from here, are not reclassified by the tax authority as being of Hungarian domicile. This was the essence of the highest-profile tax case of recent years, the Docler case, which gained notoriety in connection with the tax audit of György Gattyán’s group of companies. If the tax authority does manage to classify a foreign company as being of Hungarian resident, then its worldwide income can be put to Hungarian taxation.
For a long time, in order to avoid reclassification, it was enough for the majority of a foreign company’s directors to be foreign. When this requirement was fulfilled, one of the seats on the board was often filled by the actual company owner. Relying on this is now risky in the light of recent developments in international taxation practice, especially in cases where the foreign directors hold similar posts at several hundred other companies, making it obvious that they can’t have an actual role in the management of the foreign company. For this reason, it’s safer if the Hungarian company owner doesn’t have a seat on the foreign company’s board at all, and it can be proven that the foreign directors genuinely participate in the company’s management. But if the owner is unable or unwilling, under any circumstances, to relinquish control of the foreign company, and wants to be a director, then it’s advisable for him or her to visit the company’s registered office a few times every year, and postpone the signing of company documents and other tasks until such visits.
The type of activity for which the foreign company is set up also has significance. If the activity, by its nature, entails the drafting, conclusion and negotiation of a relatively high volume of contracts, or other tasks that need to be performed on a regular basis - such as agency or commercial activity - then to avoid the reclassification risks the foreign company must also have an appropriate physical infrastructure and personnel.