So what will offshore companies be good for, if all money will be “white”?
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From the Managing Director's desk

So what will offshore companies be good for, if all money will be “white”?


23/06/2014

So what will offshore companies be good for, if all money will be “white”?Anyone who has not come across the difficulties in the opening and operating of bank accounts for foreign companies – and I’m not just speaking about offshore companies here – in recent years has either been as fast asleep as Sleeping Beauty or simply has not needed a bank account. If you have come into contact in any way with your previously smoothly operating bank, then you may well have noticed that things have changed. They ask questions which become more and more ridiculous, dealing with matters totally irrelevant from the point of view of business logic, going into the most minute detail of the beneficiaries’ private lives. This is because the focus has turned to the beneficiary: it is impossible to open a bank account for a private company without revealing the identity of the individuals behind it, irrespective of the fact that the owners may be legal entities. Is there any chance to rebel and not comply with the conditions dictated by the banks? The answer is quite simply no. If we don’t bow down to the banks’ dictatorial regulations, then we’ll be out before our feet can touch the ground, and we can admire the sign on the outside of the branch wall.

So where has this all come from and why is the change so drastic? We have discussed this several times in the columns of the LAVECO Newsletter, so I will skip the detailed history.  In about the year 2000, the countries with high tax rates began to realise that their tax systems could not compete with the offshore mini-states who continually filter out capital and a significant amount of income with their advantageous conditions. This led to a war being waged against them, trying to turn the world’s financial system on its head. And what is the best way to impose one’s will on mankind worldwide? The media really plays a massive role these days, but if we can’t access our money through our bank cards for even just one day, then we feel the effect straightaway, as not even Facebook will pay the electricity bill or employees’ wages.

The struggle against unfair tax competition was then seasoned with the fight against the financing of terrorism, which was revitalised following the terror attacks on New York in 2001. Although they haven’t been able to show too many results in the obstructing of terrorism financing, the fight goes on. And the theatre for that fight is the banking and financial world.

This is a worldwide chain. At the head of the list is the OECD, which systematically amends the recommendations regarding the world financial system, and which everybody then follows slavishly. First of all come the regional central banks, such as the European Central Bank. They prepare their own recommendations based on the OECD recommendations (basically, they copy them!), and then forward them to the national banks and supervisory bodies of the member states. The national banks pass them on to the commercial banks. Within the banks, the legal department, or rather the so-called compliance department, then elaborate the client regulations and send them out – or not – to the branches. The “or not” appears here as in numerous cases the staff in the branches have no idea how the compliance team has decided. Within the banks this is a mystical body – overly mystical – that mere mortals can have no dealings with. You are not allowed to speak with them, and even within the bank their telephone numbers are strictly confidential. I can let on here that once, through conspiratorial methods, I managed to get hold of contact details and actually spoke to the head of compliance at one of the banks. It was an amazing experience: after half an hour he lost his temper and shouted at me that how dare I suggest that his bank was operating accounts – possibly hundreds of them – for non-existent entities because of faults with their administrative system. I received no thanks for my practical observations, and he had obviously decided that he and the bank’s several thousand employees would continue the pursuit of Bin Laden.

It is not by chance that my attitude towards the work of the compliance department I held in such high esteem is now so ironic. To be honest, though, I don’t actually blame them. Here too, the problem begins at the top. The top management of the banks placed huge amounts of power, unsupervised, in these people’s hands, and basically were blissfully unaware of the damage their rigid and obtuse regulations were causing the banks

At this point, we reach a new level on the road to achieving transparency in the financial world. At a meeting of ministers from the OECD countries held in Paris on May 7th 2014, outlines for the guidelines for the automatic exchange of information were drawn up, and the world’s financial centres were instructed to implement the guidelines without delay. Without delay obviously will mean years here, but the command has been given and the process has begun. (You can read the full text of the declaration by following this link: http://laveco.com/uploads/files//oecd.pdf). But why worry about that while they were picking up their salaries and bonuses, and the chairman’s velvet chair was so comfortable.

Such worldwide solidarity regarding the exchange of information on an international scale may come as something of a surprise. The truth is, though, that it is not. If we think about the EU directive on the taxation of interest, or the FATCA dictated by the USA, then really this is merely the next step, as could have been predicted in advance. These days, it is not only Facebook which is capable of the instant sharing of information, but the financial world’s software is more or less standardised in such a way as to facilitate the exchange of certain types of information not only between domestic authorities, but also internationally.

The Swiss, who probably felt the greatest pressure in recent years as a result of the attacks by the US, decided to take the bull by the horns. 3 or 4 years ago they developed their “White Money Strategy”, the essence of which is that only taxed funds will be admitted into the banking system, and in the future all money flows will be strictly checked. In the case of private individuals, they generally require proof from the country in which the person concerned is resident for tax purposes that the funds being deposited have been taxed. The situation is more complicated where companies are concerned. To begin with, they are no longer happy to open accounts for foreign companies, particularly if they are conspicuously offshore. They look very closely at the transparency of the corporate structure and the business activities. More and more banks are insisting on audited financial balance sheets being placed in deposit with the bank. Company formation jurisdictions which can not meet this requirement will be in trouble. In the case of the BVI, justifiably popular in recent decades, the details of neither the directors nor the shareholders are recorded in public registers, and it is not necessary to file annual balance sheets, let alone have them made publicly available.

As a consequence, the BVI company, unlike its counterparts in, say, Hong Kong, Cyprus, Malta or the United Kingdom, does not satisfy the OECD requirements. So, the Swiss foresaw something which is now beginning to happen: only taxed income will be allowed into the system, as everything will be transparent. That’s all very well, but it does raise the question as to why then, there is a need for low tax companies. I deliberately avoided the word offshore here, as the term will take on a much broader meaning in the coming years: any company which is not registered in the country of the beneficial owner will be an offshore company.

Lets have a bit of fun with that thought: imagine the scenario if tomorrow they remove the BVI from the system because it does not meet the OECD requirements. All the banks close existing accounts and no longer open new accounts for BVI companies. Will then, I wonder, businessmen stop wanting to establish structures which are efficient from the points of view of tax and costs? Hardly. Even if this means having to establish a more complex structure involving additional expense, there will always be entrepreneurs for whom it is worth applying offshore solutions.

I fear that the OECD’s expectations will not materialise. All the while that there are differences in the tax rates of 2 countries, then capital will flow irresistibly towards the more advantageous system. This stems from the very logic of the capitalist system itself: if competition cannot be removed from the field of the transportation of goods, then why should it be possible to remove it from the field of taxation? In reality, tax competition will become even more acute. All the time that there are differences in the rates of profit tax of up to 25% between EU member states, capital will be attracted to the country with the lower rate. It is very noticeable how Italian entrepreneurs have discovered Bulgaria, with its corporate tax rate of a mere 10%. So, tax competition will always be there, at most the 0% tax rate countries, the so-called zero tax havens, such as the BVI, will be missing from the equation.

The other important factor in future systems will be spending. Making money is one thing, but what is the point if we don’t use it for anything? Here, the role of offshore banking solutions will take on an even greater role than in the past. It is not by chance that the well-to-do seek discreet financial solutions. In numerous cases, it is not wise to show even – or rather especially - close friends and family exactly what, when, with or on who we are spending. Even if this is all being done from taxed income, as it may awaken further questions or demands among those closest to us. I have a feeling that the super rich still won’t be using money from personal accounts to fill up their yachts and jets, and those secret girlfriends will not be supported using the joint private credit card.

The OECD bit off a huge chunk when they began to turn the globalised world financial system on its head. The project is well-planned and the focus is clear: the identification of the true beneficial owners behind corporate structures and the taxation of any possible untaxed funds through the taxation of undistributed income in the country in which the beneficial owner is resident for tax purposes. Basically, this follows the Controlled Foreign Company (CFC) model, also favoured by the OECD. If I am the beneficial owner of a low tax company, then I have to pay tax in the country in which I reside as a tax resident on undistributed income. Naturally, the legislation of each individual country defines CFCs in a much more sophisticated manner, but that’s the gist of it. This is not a new phenomenon, as CFC legislation was introduced into the tax laws of many countries decades ago. So what changes will the future hold? Companies registered in low tax countries, where the annual tax was a fixed sum and annual accounts were not required, although qualifying as CFCs, offered an excellent opportunity for the non-payment of taxes on undistributed income. There was no public record regarding their income, so, in self-assessment tax systems, it was possible to write just about anything in the tax return. This, in theory, will all change significantly from now on. If and when the automatic exchange of banking information operates properly, the tax authorities will have access to a direct and authentic source as they can receive information on accrued income from the banks. Even if the system does not allow for the complete collecting of information, the tax authorities will have access to information on income arising from both within the region and worldwide.

At this point many readers will, justifiably, ask themselves whether there is any point in applying offshore solutions in the future. It is impossible to give an answer to this question at the current time, as many elements of the future system are still unknown. What we can say with complete certainty, and which is the most important, is that these solutions will still not be banned in the future, they will just be more regulated. What isn’t banned can be used. So what we need to do is find creative solutions, legal and acceptable to all parties, and which are still worth operating from the financial point of view. It is also clear that certain earlier structures will no longer be viable in the future, and these will either have to be modified or replaced with completely new ones. What is also certain is that in practice the banks will not be able to put into effect everything required by the OECD immediately. To establish and put into operation the complete package will require somewhere between 2 and 5 years. In the meantime, the world economy will generate those solutions which will replace the earlier offshore techniques.

Here at LAVECO Ltd. our heads are full of new ideas on a daily basis. My colleagues continually come up with more and more creative plans to provide the solutions to the demands they come face to face with. I am often amazed at the amount of points overlooked by the legislators, but not by our clients. But maybe that is only natural. The bureaucrat is a bureaucrat, and the businessman is a businessman. Each one is in his place, and they very rarely swap.

I hope you enjoy reading this and it will provide food for thought.

 

László Váradi
LAVECO Ltd.

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