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From the Managing Director's desk

Laveco Newsletter 2015/4 - Why will it still be worth operating offshore companies in the future? - Part two


02/12/2015

<-- First part of the LAVECO Newsletter

And what if none of this happens?

Miért éri meg a jövőben is offshore céget működtetni?Naturally, anyone has the right to claim that this is just a well constructed conspiracy theory, which has nothing to do with reality. If, dear reader, you feel this way, good for you. I won’t begin to back up America’s attempts to be “the world’s policeman” with examples from history, even though there have been numerous cases since the end of the second World War. But instead, let’s all forget about what went before, as if it had never been written. There is no manipulation in the system, everything happens irrespective of outside interests in the spirit of justice, with the world’s financial system being returned to its normal path and people being forced away from low taxation and towards higher rates.

I wonder if this is really possible. I have serious doubts. The game rules of the economy have remained unchanged for thousands of years, and whether the market is manipulated or in free competition, market mechanisms will prevail and competition always guides participants towards the most efficient solutions. Those who wish to be the winners in the future will look for the tools, methods and possibilities which will allow them to be more successful than their competitors. The law on profit is not going to change in the future either; it may, at most, be distorted by the entrance of monopolies, but even here, the effect will only rarely be complete.

Over the last 25 years I have met many successful businessmen, and have noticed these 5 typical characteristics. The majority of them combined a mixture of all 5. Naturally this is very subjective, but is certainly worth thinking about.

  1. Freedom, or the desire for freedom. A businessman with creative intentions can not be squeezed into a restrictive framework. In order for creativity to be allowed to develop, the individual requires a certain amount of freedom, both in the physical and financial senses.
  2. Ability to take risk, while also striving for security. This may seem contradictory, but that is not at all the case. There is risk involved in start up companies, especially in the early stages. It is impossible to move on from the starting point without taking some risk. At the same time, once the enterprise has reached a certain level, then the desire to place assets securely and to diversify the portfolio appears straightaway.
  3. Striving for efficiency. The majority of these people don’t just want to do something businesswise, they want to do it well: better, more organised, more cost-effective etc.
  4. Discretion. If there is something worth talking about, then it is not necessary for everyone to know about it. The taxman doesn’t necessarily represent the greatest danger to a successful business or businessman, but rather competitors, or even friends, business partners or family members. While the taxman writes letters, a well placed „acquaintance” can immediately start acting for us, or even against us.
  5. Tax optimisation. Planning and regulating the payment of taxes, managing the process, rather than being dependent on it. A successful businessman never merely goes with the flow, but always tries to get the most out of every current. They want to regulate how much tax they pay and where and when they pay it.

Over the last 30-40 years, what we generally describe as “offshore solutions” have contributed significantly to the realisation of the above. The phrase includes company formation, the opening and managing of bank accounts and the possibility for the discrete operation of a business. I wonder if this is really going to change in the coming period just because the automatic exchange of information is apparently going to start in 2017. I really don’t think so. The characteristics listed above will continue to appear in the philosophy of successful businessmen, as without these they can not be successful. If I wanted to illustrate the resulting change, it would be like taking either one or both of the axes of a graph, and pushing one away from and the other closer to the existing curve on the graph. The shape of the graph wouldn’t change, just the distance from the axes would be altered. Those who recognise this, remaining well orientated, will continue to be successful in the future, while those who don’t will lag behind or drop put completely.

In the past the offshore world was the area, in both the physical and virtual senses, which provided opportunities for the realisation of the above. They are currently trying to remove this from the system through administrative regulation. Can this, I wonder, succeed, bearing in mind the economy’s general conformity to the laws? I doubt it. At most, everything will return, just with a different hat on, while the core elements bear remarkable similarities to the previous ones. The OFFSHORE 2.0 era is starting/has started.

Held prisoner by the banks

Miért éri meg a jövőben is offshore céget működtetni?In parallel with the real processes taking place in the business world, or rather partly out of synch with them, there are also financial processes. The carrying out of these financial processes is all but impossible without the involvement of the banks. The banks are playing more and more important roles these days, be it in the life of a private individual, a family, company or group of companies. From time to time they are literally masters of life and death, with the entire financing of a situation, transaction or event depending entirely on them. Our bargaining power with the banks, unless we are talking about a very, very big company, is very weak: generally the banks dictate.

We witness this, and very often struggle with this, in regard to each foreign company structure. I have written about the peculiarities of this situation on many occasions in earlier editions of the LAVECO Newsletter. About how the banks ignore all reasonable business logic when creating the regulations concerning which clients to accept, and in regard to the evaluation of the risk involved with client transactions.

I have also referred numerous times to the all-powerfulness of the compliance departments. Just the other day, a banker I have known for 20 years came to see me. He has worked for various banks, experiencing both small and large financial institutions, but basically always working with international clients. So the field is not unknown to him. Not long ago, after an absence of 7 years, they enticed him back to a bank where he had earlier spent many happy years. He thought he would just carry on where he had left off. On his first day, however, the management called him in for a chat. It was made clear and in no uncertain terms that everything had changed over those 7 years, that compliance now dictated the terms and that he should bear that in mind and not try to arrange his affairs according to his past experience, as that could land him in serious trouble.

I have also had the chance to chat to a number of lawyers working in the compliance field, naturally about matters related to my profession. To summarise, I can state that it is not the most talented lawyers who occupy the positions of compliance officer around the world. The majority of these people have absolutely no business experience whatsoever, and as such they tend to approach the cases placed before them with the mentality of a Russian bureaucrat. That’s the way it is, like it or leave it, we can expect this for the foreseeable future. At the same time, the banks will be an important factor, indeed, a key factor, in future business processes. The banks decide who they will and who they won’t open and operate accounts for, and which transactions they are willing to accept.

Future trends

So, who do the banks like? It’s a difficult question, so let’s look at the easier approach. Who don’t the banks like or want, and will turn away, either immediately, or after a little umming and ahhing?

To begin with, every stranger is treated as suspicious. In this globalised world, where information and money can travel thousands of kilometres in a fraction of a second, a foreign individual or company is seen as suspicious, risky and dangerous. At least, that is, according to the evaluation systems employed by a significant number of banks. And this will only get worse; in the internet age we are becoming more and more distant from each other, or more exactly, the banks from us.

The “unwanted” are the companies which fewer and fewer banks are willing to work with. In general, it is the low tax jurisdictions, where, to this day, the companies registry still does not keep records of company directors or owners, and there is no requirement to prepare audited annual financial statements. This category includes the world’s most significant offshore jurisdictions, including the British Virgin Islands (BVI), Belize, Panama, Seychelles etc. Their fate in the future is still not clear, but today it would appear that a slow, but certain death awaits these jurisdictions. Especially if all they really do is “manufacture paper” there, and it is not even possible to open accounts with local banks with these documents. Such a banking infrastructure is missing, for example, in the BVI, but even in Panama, where it exists, the requirements for the opening of new accounts are so strict that nobody wants to go there anyway. The situation is no better in Belize, while in the Seychelles the local branch of Barclays showed the door to all existing offshore clients on October 31st, 2015, and has no intention of accepting new ones.

Also “unwanted” are certain company activities. In addition to discriminating against offshore companies, the banks also consider many activities as risky, or “sensitive”. Even if they do not reject the account application of a certain company, it is 99% certain that they will not accept, for example, companies involved in financial type activities, or which deal in similar areas. This includes activities such as collecting deposits and the like. FOREX transactions are unacceptable in cases where the company would be handling its clients’ money. They are wary of recruitment agencies, and activities involving large numbers of clients. Enterprises dealing in electronic equipment, and in particular mobile telephones, can expect incredibly tough checks. Furthermore, just about everything to do with internet sales or services is highly suspicious. Yes, in the internet era, when everybody is on the net, the banks do not accept foreign companies which carry out their transactions via the internet.

There are undoubtedly numerous fraudulent enterprises hiding behind the internet, that is an undeniable fact. Logically, therefore, the banks would ban a significant number of these companies from the system, not wishing to maintain a business relationship with them. A company operating adult sites, dating sites, internet pharmacies or sites selling electronic equipment is likely to find itself in an extremely difficult position when it tries to open a bank account for a foreign company in just about any bank in the world. It is at this point that the penny drops for many people: we really are seeing the end of an era, and what was possible with the banks 5 or 10 years ago, is out of the question today, as many doors have closed while no new ones have opened. Just like the banker returning after 7 years, clients also have to face up to the changing requirements.

In the last edition of the LAVECO Newsletter I described the very extreme example of a Maltese bank with 4 conditions for the opening of accounts:

  1. the company must be registered in Malta
  2. the company must have a real office in Malta (substance)
  3. the company’s beneficial owners must be resident in Malta
  4. the company must carry out its business activities in Malta

This is all very well, though it is certainly not “global banking”, but rather a typical “local banking” approach. This bank will be incapable of serving international clients, or maybe doesn’t even want to, which is why it sets its clients such strict conditions.

The future can quite clearly be seen from the above, and especially from the first 2 points: the bank and the company must be in the same country, which must also be the place of management of the company. If they really want to adhere to this principle, then the number of players on the world stage is going to drop dramatically. The small jurisdictions without the necessary infrastructure will be incapable of meeting the requirements. If you recall what I wrote a couple of paragraphs earlier: “Our bank doesn’t want you, because you are registered as a company in a low-tax jurisdiction.” What we are seeing now is: “We can’t accept your low-tax company, even in the country in which you were registered, as we do not have the necessary banking infrastructure.” The noose is clearly tightening.

We could look at each of the world’s most important company formation locations from this point of view; I’m sure it would make interesting reading. At this point, however, the question is not “who doesn’t?”, but rather “who does?”, who will stay afloat and be capable of providing clients with acceptable solutions? Note that I didn’t say “ideal” solutions, as those no longer exist. The goal is the provision of acceptable solutions which actually work.

While the list which follows is not exhaustive, I would like to mention a few countries which will be able to satisfy even the strictest expectations from the points of view of taxation, transparency and banking and additional infrastructure.

  • Hong Kong. One of the world’s biggest financial centres, Hong Kong continues to follow the English common law system, even now that it is part of China. According to the principle of territorial taxation, profit arising from Hong Kong sources is subject to tax at 16.5%, whereas profit earned outside Hong Kong is exempt from tax. Annual audited balance sheets, prepared according to International Financial Reporting Standards, must be filed with the local tax authority. Although the account opening procedure can be a little difficult, Hong Kong banks are prepared to open accounts for companies registered in Hong Kong which have actual business ties with Hong Kong, mainland China or the Asian region. Hong Kong has signed, and is signing, agreements for the avoidance of double taxation with more and more countries.
  • United Arab Emirates. In the country of free trade zones, exemption from tax is considered something of a cultural tradition in business life. It has been compulsory since September 2015 for all companies in the Emirates to prepare bookkeeping records, but the company is free to choose the format, and, in the absence of a local tax authority, it is the company which must store the records for 5 years. There are a couple of banks in the Emirates who are open to cooperation in the case of companies whose directors and/or owners are not resident in the Emirates. The UAE is continually signing new agreements for the avoidance of double taxation.
  • Cyprus. In international comparisons, the Cypriot infrastructure is of an exceptionally high standard, with solid foundations for the future based on the island’s 40-year history in the international financial world. Profits are taxed at the rate of 12.5%, annual audited balance sheets have to be filed with the tax authority, and numerous banks are open to cooperation. Cyprus is one of the last remaining places where it is currently still possible to open accounts for foreign companies, not just locally registered ones. Cyprus has signed more than 60 agreements for the avoidance of double taxation.
  • Liechtenstein. A mini-state within Europe with strong foundations and a complete financial infrastructure capable, like Cyprus, of providing services to foreigners. The rate of corporate tax is 12.5%, and again every company and foundation is required to prepare an audited annual report. Liechtenstein has entered agreements for the avoidance of double taxation with relatively few countries. The banking infrastructure in Liechtenstein is considered to be one of the most secure in the world. The aptitude of the bankers and the country’s financial culture are unparalleled in Europe, and indeed throughout the world.
  • Bulgaria. Although this small country does not currently appear on the list of international financial centres, its economic and tax policies over the last 10 years have made Bulgaria very competitive, competitive enough, in fact, to even compete with Cyprus. Corporate tax in Bulgaria is 10%, irrespective of the size of the profit. As a member of the EU, companies are required to file with the local tax authority annual audited reports in line with international standards. Bulgarian companies are able to take advantage not only of agreements for the avoidance of double taxation, but also the benefits of the EU directives. The Bulgarian banking system appears relatively stable, and the large international banks present in the country offer very good possibilities for local companies in the field of the opening and managing of bank accounts

I would have liked to mention Malta as 6th on the list, but Malta today has become a country where bank accounts can not even be opened for local companies. The attitude of the Maltese banks has changed drastically in the last year or two. It is practically impossible to work with them. Malta is starting to exclude itself from the market.

Of course, the list and categorisation above are extremely subjective. I would also be happy to talk about the banks in the small Caribbean countries. However, these days their contribution to the international market is relatively small, and they are rather difficult to work with, responding quite slowly to clients’ requests.

It is also difficult to mention companies registered in the USA. Following 2011, banks around the world systematically closed the foreign accounts of American entities, considering them too much of a risk. However, such a company without an American bank account is worth precious little, and at most can be used for holding purposes, though even here in certain cases it is necessary to report to the IRS in keeping with the FBAR regulations.

The systems in the countries listed above meet the relatively strict expectations in regard to transparency. A typical characteristic of these jurisdictions is that the details of the company directors, and in some cases shareholders, are available on public records. Annual reports, in one form or another, are also obligatory in each of the countries listed, and this also serves to reinforce transparency.

Automatic exchange of information, the secret which everybody wants to know

Miért éri meg a jövőben is offshore céget működtetni?I don’t want to bore everyone with a detailed description of my own personal opinion. I still believe that this whole concept was doomed to failure from the start: either everyone signs up worldwide, or the large countries are going to fight over the spoils, and who wins and loses what.

Let’s assume that I am wrong, and the exchange of information begins in 2017. Even in the best scenario this will only be partly true. There is an entire group of countries which will only join in 2018. The process can be followed on the OECD website, where they constantly update the list of participating countries and agreements which have been signed.

Despite this, nobody is currently able to say anything for certain. If we speak to 10 bankers, then we get 12 different versions from them. In theory, everybody develops their system on the basis of the OECD handbook, though there are wide divergences in the interpretation of the regulations and recommendations. The OECD itself gives the banks a huge degree of freedom. One example of this is in the documents which can be accepted from the client for identification purposes. In the case of proof of address, which can be crucial from the point of view of future reports, it is left entirely up to the banks to decide what they consider acceptable. In the past, the client could take an electricity bill into the bank as proof of address, and this will remain the case in the future. The bank can, of course, refuse to accept the document, if they suspect that it is not genuine. This will undoubtedly be a crucial point, as residential address will determine which countries reports should be sent to, or whether, dependent on the terms of the agreements entered, it is necessary to report to the country in question.

It is still very early days in the process, so nobody can or even dares to issue hard and fast rules. Nor do we receive any written information from the banks. Anything we find out is always by word of mouth, and is always accompanied by the stock phrase that this may be amended or changed in the future and that the legal team are working on it.

What does seem to be relatively certain is the timing. The first reporting period will cover the 2016 calendar/financial year (the two can be read as one, as the report refers to the calendar year). For accounts closed in 2016, the details at the time of closing will appear in the report. Otherwise, the situation or details as at December 31st, 2016 will be reported. The first reports will be sent to the tax authorities in September or October, 2017.

Who are they going to be reporting on? According to the bank we have spoken to, if a beneficial owner (controlling person) holds 25% of the rights in a company, then a report will be filed. In the case of companies, if less than 25% is held, then no report will be prepared. In the case of personal accounts, it is more straightforward; as accounts are usually held by 1, but maximum 2 individuals, they can not escape the reports in this way.

In the case of Trusts, there is a reporting requirement in regard to the Settlor, Trustee and Beneficiary(ies). As the Trust itself is not a legal entity, the handbook issued by the OECD deals separately with the reporting requirements for Trusts. There is a requirement to report on the Settlor, but if we think about it, the Settlor can be an individual, but it can also be a company, such as an offshore company. The Trustee is of no particular interest here, as these are generally professional companies or individuals who are resident in some tax-free jurisdiction. The ones affected most by the reporting requirements are the Beneficiaries. Reports are only prepared on the Beneficiaries if they receive some form of distribution from the assets or income of the Trust. If there is no such distribution, then there is no report; even if the Beneficiary receives a certain amount in their personal account, provided that it comes as a loan.

With this bank, the treatment of the Discretionary Trust described above also applies to Discretionary Foundations, where it is the Foundation Curatorium, and not the Beneficiaries themselves, which decides who receives what from the Foundation’s assets. It was not by chance that I wrote about the Panamanian foundation in the last edition of the Newsletter. This is the most developed vehicle in the field of offshore asset protection, and will be used to great effect in the future too.

Not the final word by any means

I’ve been hearing it at the end of every year for the last 20 years: this will be your last year, the whole offshore industry is going to die off. The first such prophet of doom came into my office around Christmas 1995. Now, a month before Christmas 2015, I have just read that local entrepreneurs in Wales are in uproar and all want to go offshore. They are doing this in protest against the tax avoiding behaviour of large multinationals, such as Google, Amazon and Facebook. In the meantime, 20 years have gone by and people are still talking about offshore. Fortunately.

This goes to show that the world economy is alive and well and will not be closing its doors. Market forces are working, general laws thousands of years old are still valid, tax competition is, and will remain, one of the major factors of competition. Those who wish to remain successful will have no option but to take advantage of these possibilities, because if they don’t, one of their competitors certainly will.

As this analysis is designed at the same time to act as an advertisement for LAVECO Ltd., please allow me to plug the company a little. This time I don’t want to talk about our 8 offices around the world or the fact that we’ve been around for 24 years. Instead, I want to mention why clients come to us: because we give exactly what it says on our website. That’s the least we can do. More and more clients are coming to us who bought companies somewhere else, but then found out that they couldn’t help them open bank accounts, give advice or even order a certificate of good standing. Today, a client came to me who wanted to dissolve a company purchased elsewhere. I wonder what they could have done to this poor chap, if he had so little trust in the previous service provider that he even wanted us to arrange to have his company closed.

It looks more and more likely that in the OFFSHORE 2.0 era, the services of the “DIY” companies will no longer be sufficient. But then that’s what we are here for, so feel free to contact us in the future as well.

With warmest regards

László Váradi
Managing Director
LAVECO LTD.

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