Recently, a national business magazine featured an article on international tax havens. While offshore tax shelters have lost their luster as a means to shelter the wealth of individuals, having largely gone out of style in the 80s and 90s, it appears that more entrepreneurs and businesses (especially startups) are electing to be headquartered in foreign countries that have more forgiving corporate tax rates than the U.S. corporate rates.
It is interesting to note that it is not only startups that are organizing corporations in tax shelter countries. Businesses that are already in existence, including private equity firms, have begun to relocate U.S. companies or divisions to tax haven countries.
Take, for example, a U.S. company that wants to commence franchise operations in Asia or Latin America. If the company is a U.S. company, it will have to report income and pay tax on its worldwide income. If the same company is a Bermuda corporation, it may not pay tax on its franchise income generated from business outside of Bermuda. If enough of the franchise income is generated outside the United States, an offshore entity begins to look attractive in terms of tax savings.
It is important to recognize the difference between a company having its headquarters in a foreign country and a U.S. company with an affiliate or subsidiary in a foreign country. The distinction is that the U.S. company with an affiliate or subsidiary will likely fall under the tax rules for reporting income and paying tax on the foreign entity if that entity is a controlled foreign corporation.
The United States, since 2009, has begun to aggressively track down those individuals and entities that have not been reporting foreign income or holdings, and has imposed severe penalties on underpayments of tax as a result of failure to report. Amnesty programs and reduced penalties are available under the 2011 Offshore Voluntary Disclosure Initiative for those companies who have failed to disclose and report their worldwide income, but, as the United States begins to extend her taxing arm on worldwide income, more and more U.S. companies may consider relocating to a tax haven country.
An illustration of this would be a U.S. company with significant franchise operations overseas, including Asia, the Middle East and Latin America. Let’s assume the franchise income generated by these three global markets equals or exceeds the franchise income generated in the United States. If only federal tax consequences are considered, it may make sense from a tax savings perspective to move the operations to a tax haven country such as Bermuda, Cayman Islands, Ireland or The Netherlands.
Certainly, such factors as economic and political stability in the tax haven country need to be closely scrutinized before relocating a company’s headquarters outside of the United States.