Many entrepreneurs consider setting up companies in foreign jurisdictions to benefit from potentially favorable tax rates. However, the reality is often more complex than it appears at first glance. This article explores the key considerations for non-resident business owners.
Corporate Tax Benefits
Setting up a company in a foreign jurisdiction can potentially offer lower corporate tax rates, primarily benefiting profits retained within the company. For entrepreneurs looking to reinvest earnings and grow their business, this can be advantageous.
Example: A tech startup founder based in Germany might set up a company in Estonia, where retained earnings are tax-free until distributed. This could allow for faster reinvestment and growth compared to Germany’s typical effective corporate tax rate of 30-33%.
Personal Income Considerations
Extracting money from the company for personal use complicates the tax picture, especially if you are living in a different country than where the company is based:
- Dividends are typically subject to additional individual income taxation. For example in the Netherlands this is called Box 2. In most developed countries this typically ranges from 20-40%
- Salaries, while deductible for the company, you will incur personal income tax and often social security contributions in the country where the work is performed.
Example: If our German entrepreneur decides to pay themselves a dividend from their Estonian company, they would face Estonian withholding tax (typically 20%) and potentially additional taxes in Germany, depending on the specifics of their situation and any applicable tax treaties.
Controlled Foreign Corporation (CFC) Rules
A critical point often overlooked is that setting up a foreign corporation will subject you to controlled foreign corporation statutes of your country of residence. These rules are designed to prevent tax avoidance through offshore companies. They may require residents to report and pay taxes on the foreign company's income, even if it's not distributed.
Example: The UK's CFC rules might require a UK resident director of a company based in a low-tax jurisdiction to pay UK tax on the foreign company's profits, even if those profits aren't distributed as dividends.
Corporate Residency and Taxation
It's crucial to understand that a company's tax obligations aren't solely determined by its place of incorporation. A corporation is taxed by:
- The jurisdiction in which it is operating
- The jurisdiction where the nexus of management and control is located
- Not just the jurisdiction of incorporation
Example: A company incorporated in Luxembourg but managed by directors who make all key decisions from their office in Paris might be considered tax resident in France, subject to French corporate tax rates and regulations.
Practical Considerations
Operating a foreign company involves several practical challenges:
- Compliance Costs: Additional administrative burdens and costs for accounting, legal, and tax services in multiple jurisdictions. In most cases, the company will need to meet certain requirements such as substance in the form of business activity or a director from the country or for example from within the EEA.
- Banking: Challenges in opening and maintaining bank accounts due to increased scrutiny.
- Reputation: Potential impacts on business relationships if associated with certain jurisdictions.
Example: A US entrepreneur incorporating a company in Cyprus might face difficulties opening a bank account due to enhanced due diligence procedures, and may need to hire local professionals to ensure compliance with both Cypriot and US regulations.
Double Taxation Treaties
The network of double taxation treaties between countries can affect the overall tax picture. These agreements aim to prevent double taxation but can be complex to navigate without expert advice.
Example: The Netherlands has an extensive network of tax treaties, which might make it attractive for holding companies. However, the benefits can vary greatly depending on the specific countries involved and the nature of the income.
How do you proceed?
While setting up a company in a foreign jurisdiction can offer potential benefits, it's rarely a straightforward path to tax savings for non-resident entrepreneurs. The interplay between corporate and personal taxation, international tax laws, and practical business considerations creates a complex landscape.
Before making any decisions, we strongly recommend you to:
- Clearly define your business goals and personal financial needs
- Understand the tax laws in both your country of residence and the potential company location, including CFC rules
- Consider the practical aspects of running a business remotely and the implications of management and control
- Contact multiple international tax experts to make sure you get it all right.
