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Offshore Company Formation: Double Taxation Agreement
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International tax laws in almost all countries differentiate between DTA and non-DTA relationships. A Double Taxation Agreement (DTA), correctly described as an agreement on the prevention of double taxation, is an internationally recognized agreement between two countries that regulates to what extent taxation laws affect the parties to the agreement with regard to income earned within their territories. The DTA is designed to prevent the double-taxation of natural persons and legal entities who earn income in both countries. A DTA also describes the conditions for setting up a permanent establishment in the home country and/or the foreign country.
Excerpt of Article 5 of a DTA:
(1) For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.
(2) The term “permanent establishment” includes especially :
(a) a place of management ;
(b) a branch ;
(c) an office ;
(d) a factory ;
(e) a workshop ; and
(f) a mine, quarry or any other place of extraction of natural resources.
(g) A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.
(3) the term “permanent establishment” shall be deemed not to include:
(a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise ;
(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery ;
(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise ;
(d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise ;
(e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character ;
(f) the maintenance of a fixed place of business solely for any combination of activities mentioned in sub-paragraphs (a) to (e) of this paragraph, provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.
(4) Notwithstanding the provisions of paragraphs (1) and (2) of this Article, where a person – other than an agent of an independent status to whom paragraph (6) of this Article applies – is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts on behalf of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph (4) of this Article which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.
For most of our clients, this means that they are protected by an existing Double Taxation Agreement prior to setting up a Permanent Establishment in the home country (client’s country of residence), as long as only a representative office, an advisory office (for support activities) or a storage warehouse is established in the home country. In contrast, most countries stipulate that in cases where no DTA exists, a representative office, a storage warehouse or an advisory office does constitute a Permanent Establishment in the home country. This would mean that global taxation or primary taxation of the foreign company would not take place in the foreign country at all but in the client’s home country, even if the “place of management” is located in the country of residence (i.e., in the foreign country). The formation of a true offshore company (with no DTA) must be carefully considered in light of these factors.
As most countries have DTAs with Cyprus, Switzerland, Singapore or the United Arab Emirates (UAE), the benefit of forming a true offshore company in these countries is often clear. Cyprus taxes active companies at a rate of only 10%. As a member of the EU, it also benefits from the EU Freedom of Establishment law.
Singapore does not tax foreign-earned income, and the UAE imposes no taxes on any income whatsoever. In Switzerland (Zug), the total tax burden for active companies equals about 15.5%. It is also possible to form a foreign company under a DTA scenario in which the company is subject to little or no taxes.
If, due to other considerations, an offshore company is nevertheless required, it should be structured as strictly as possible with regard to the law, and no representative or advisory offices or storage warehouses should be established in the client’s home country. Offshore companies do generally offer certain benefits: No international law enforcement treaties, no fiscal extradition agreements with other countries, generally no public commercial register, and Exempted Company status (for companies that only generate earnings outside the country of residence).