EU vs Offshore companies
In the age of globalization and technological boom, starting an online business, while travelling the world on a regular basis has become a hot trend. Digital nomad entrepreneurs are at the forefront of combining these two options to create successful businesses they can operate from anywhere in the world.
Once you have decided to start your location independent business, comes another question, whether to incorporate it in “onshore” (in this article – EU) or in offshore, (so called tax havens) jurisdictions? In era of transparency, exchange of information and constant development of new regulations entrepreneurs should evaluate all possible future risks before making their final decision. In this article, we will list the main risks and disadvantages which one might face when incorporating offshore entity. To begin, we would like to make it clear that with definition “offshore” in this article we understand classical offshore jurisdictions (Panama, Seychelles, Belize, BVI, etc.) as well as USA LLC’s, UK LLP’s, Scottish partnerships and other similar structures which combined with offshore entities become “transparent” and “tax exempt”.
Even though, offshore concept with 0 % taxation and 100% confidentiality might seem very attractive, we will illustrate main disadvantages which one must consider before (not) choosing such an option.
- Legal risks.Offshore companies are not illegal per se. However, in context of this article and with regards to digital nomads and their remote business management, we see several legal risks. One of them being – income declaration in country of persons’ tax residency*. With Foreign Account Tax Compliance Act (FATCA), Automatic Exchange of Information (AEOI) and Common Reporting Standard (CRS) in force it is just a question of time when person will receive a notice from tax authorities from country of their tax residence with regards to undeclared income. This leads us to the next „offshore“ disadvantage:
- Bank account opening.Considering above mentioned reporting requirements, banks rather choose not to work with offshore companies at all instead of going through complicated (read expensive) compliance procedures just to open and maintain accounts for offshore companies. Of course, there are several private banks which could accept such companies, but only in cases with high initial deposits (starting from EUR 100,000) and with activity status as „passive entity“ – in the meaning that company has very few transactions which usually is for holding companies. These types of private banks are usually very expensive, and I would never recommend them for digital nomads. Another option is classical offshore banks, but then we return to point Nr. 1 with regards to reporting or to problems with correspondence banks if jurisdiction hasn’t signed any of the information exchange agreements. There are still several payment operator providers who could open accounts for offshore companies, however, this is not a long – term solution, because they also have to follow reporting requirements and sooner or later one of your partners will require to create a contract where they will require IBAN from licensed credit institution.
- Business limitations. Another sufficient disadvantage is that offshore companies does not have a Tax ID Number which makes it difficult to take part in public procurement in most of OECD countries and attract customers / business partners from reputable jurisdictions. The offshore concept can provide you with privacy, but the major drawback to this benefit is that it also makes it difficult for the potential financial partners or investors to determine what your business is actually worth, which in a long run might be very painful for digital nomad with a great business idea when he decided to search for investors.
Thanks to freedom of establishment and free movement of goods, there are plenty of advantages of setting up European company. EU Company will simplify way to run business across more than one EU country and you can reorganize your activities under a single European brand name and run your business without setting up a network of subsidiaries. Double-Tax Treaties can be applied with a tax resident company to reduce or eliminate withholding tax on dividends, interest and royalty payments.
In our previous posts we have described how digital nomads could manage their business in EU from beach in Thailand or mountain peek in Alps. It is safe to say that none of EU jurisdictions comes with such disadvantages as offshore entities. Once managed properly there are no legal risks. Also, it is much easier for EU companies to open and maintain bank accounts, because in most of EU jurisdictions are publicly available Commercial Registries which helps banks to oversee the structure of the company and persons involved in it. The same goes for business limitations – all EU companies are welcome to participate in public procurement in each EU member state.
As of the main disadvantages for EU companies, it is commonly considered that EU has one of the highest tax rates in the world. It is not incorrect. There are several member states where Real Tax rate can reach over 50% (France – 57%, Belgium – 56%, Austria – 54%). However, if structured and managed properly EU tax regimes might become very beneficial for the company owners. We believe and expect that everyone will pay its fair share of taxes; however, with our, Gate to Baltics, assistance we might be able to help not to overpay them. There are several jurisdictions in EU where only distributed profit is taxed (Estonia, Latvia) which allows company to reinvest in to business development, without paying huge taxes. Also, there are jurisdictions within EU where corporate income tax is as low as 12.5% (Cyprus) and there is no withholding tax on dividend payments (might be subject of individual income tax in country of tax residence). Since in this post we are focusing on digital nomads, we would like to recommend company formation in Estonia due to state of the art e-governance system and their Commercial Code which allows to manage company from abroad as long as you have a local “contact person” in Estonia.
In conclusion, we would like to make ourseleves crystal clear that in no way we are comparing EU companies, especially Estonian and Latvian companies, with offshore entities. The sole purpose of the post was to illustrate that this is the end of an era for offshore entities as we have known it. As obvious it might seem to people from EU, there are still a lot of solo entrepreneurs out there who are trying to hold on to “old fashioned” offshore solutions, because “it is crazy to pay so high taxes” – just check digital nomad forums. We have to admit that from perspective of a digital nomad who is all the time on the move and does not feel related to any particular country, it might seem unfair to pay 30 – 50 % from their income to country where they haven’t spent more than a period of Christmas holiday while visiting their parents. However, we believe that in 21stcentury there are more intelligent ways how to manage your business operations, than going to the “dark side” and working with offshore companies.
Setting up a business always is a complicated task. It becomes even more complicated when person is all the time on the move and has a lot of confusions about his tax residency. Therefore, before company registration, we always recommend consulting with professional tax advisor who could illustrate all possible options and risks and explain in detail issues related with tax residency.
*Tax Residency - Tax residence is determined under the domestic tax laws of each jurisdiction. There might be situations where a person qualifies as a tax resident under the tax residence rules of more than one jurisdiction, and therefore is a tax resident in more than one jurisdiction. For the purposes of the CRS, the Account Holder (or Controlling Person) must disclose all its tax residences in the required self-certification. Kindly note that the mere right to reside in a given jurisdiction (on permanent or temporary basis) or the fact of holding citizenship of a given jurisdiction does not automatically mean that a person shall be considered a tax resident in such a jurisdiction or that, upon obtaining residency or citizenship, the tax residency is extinguished in the former jurisdiction(s) of tax residence." (Source: OECD)