International Tax Planning: The New Economic Substance Requirement
Recent initiatives by the Organization of Economic Cooperation and Development (OECD) are having a seismic effect on international tax planning. OECD Action 5, which has been adopted by almost all credible offshore financial centers (e.g., Cayman Islands, British Virgin Islands, Barbados, Bermuda, Bahamas, Liechtenstein, Isle of Man, etc.) requires all companies registered in a jurisdiction to have economic substance in that jurisdiction.
Economic substance is generally defined as carrying on significant commercial activity – earning income, maintaining local physical assets, employing local personnel, performing local management and decision making. The effect of Action 5 is the elimination of shell companies registered in foreign financial jurisdictions for tax avoidance purposes.
In addition, and of greater significance, the OECD Anti-Abuse Campaign has resulted in the elimination of tax-free international business companies (IBCs) as an element of international tax planning.
In order to avoid inclusion on OECD black lists and grey lists (which results in exclusion from international commerce and banking) almost all foreign financial centers have adopted new tax regimes that impose at least a minimum income tax on all companies registered in their respective jurisdiction, irrespective of whether their income is earned domestically or from foreign sources (e.g., Barbados – 5.5%, Liechtenstein – 12.5%).
The tax applies to income earned from commercial activities as well as investments, including capital gains, interest, dividends, rents, royalties and distributions.
The net result of these two initiatives is that generally, tax havens have been abolished. Every company will be taxed somewhere in the world. The initiatives are not, however, all-inclusive. Trusts are excluded, as are pure holding companies and certain commercial activities. The intricacies of the new foreign tax laws make the requirement for proper guidance from qualified tax professionals more important than ever before.
Legal and effective international tax strategies that take into account the new international landscape are available and can be evaluated and implemented by qualified tax counsel.
It is also important to note that the OECD initiatives have no effect on proper, tax-compliant, asset protection planning, which is not dependent upon secrecy or upon the various tax regimes of foreign financial centers. Foreign trusts, including asset protection trusts, are specifically not included in the OECD initiatives and continue to be tax-exempt under the new foreign tax regimes.
For more information on the new Economic Substance Requirements and how Valsen Group can be if assistance to you, contact us.