Can the formation of "offshore" companies offer tax benefits to an internationalizing US business, and are many companies overlooking the benefits of structures using US "onshore" entities?
The business press has left some of our clients with the sense that they are missing-out on great benefits though "tax haven" structures. Yet, clients often assume that such structures are used mainly by the likes of Tyco and Enron, are complex and risky, and may not be a good way to win friends at the IRS.
Offshore entities can be useful in some situations that have little to do with US tax savings. For example, companies investing in China or India can benefit by holding their local investment through an intermediate company established in Hong Kong (for China) or Mauritius (especially for India but also for China) or some other low-tax jurisdiction. The Hong Kong or Mauritius entity can more easily be sold -- local law restrictions on transfer of ownership may not apply since only the ownership of the "offshore" entity is transferred. The shares of the local Chinese or Indian company do not change hands. Even if the shares of the local company are later sold, the local withholding tax on capital gains may be reduced for a payment made to a jurisdiction like Mauritius than for a payment made directly to the US.
If a US company is not investing or forming an entity in another country but is exporting, licensing or otherwise selling to other countries, offshore entities offer at least the potential of deferring the impact of US tax. It would be difficult to reduce US taxes simply by routing payments though a third jurisdiction such as the Cayman Islands, no matter how attractive its tax laws. This is mainly since the US taxes a US company's or individual's income on a worldwide basis, even if the income source has nothing to do with US activities (this is not true for tax systems of most other countries). Parking income in low-tax country may be possible, though this defers but does not reduce the US tax burden (and will still require current US tax payments on many types of passive "subpart F/controlled foreign corporation" income, even if funds are not actually distributed back to the US).
Too great a focus on "offshore" structures can also cause US companies to overlook the benefits of US "onshore" structures. This can be as simple as the use of a US limited liability company for exporting US goods. Net income would then be taxable to owners of the LLC but would not be subject to the added US corporate tax that would apply to a corporate entity.
US exporters can also continue to achieve significant US tax savings through the formation of a separate US international sales corporation under special IRS rules. This technique is available to certain partnerships, S corporations and LLCs, which establish an export sales corporation and then pay it a commission of up to 50% of the export net income. The commission is deductible by the company paying the commission and is not taxable to the export corporation. The accumulated income in the export corporation is subject to a 15% dividend tax when distributed to the payer of the commission. Though there are a few other wrinkles, a savings of 10% or more off US taxes can easily be achieved so long as a company's exports are of US origin.
Better yet, the set-up costs are modest, and your family and friends won't likely be reading about your IRS troubles in the local business press!
CIRCULAR 230 DISCLOSURE: ANY STATEMENTS REGARDING TAX MATTERS MADE HEREIN CANNOT BE RELIED UPON BY ANY PERSON TO AVOID TAX PENALTIES AND ARE NOT INTENDED TO BE USED OR REFERRED TO IN ANY MARKETING OR PROMOTIONAL MATERIALS.
