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Although not on frequent basis, foreign companies are also used for ownership of employee participations. Under this scenario, a company (OC) that wants to reward certain employees with profit participations , would set up a special purpose vehicle (SPV) to be owned (wholly or partially) by selected employees. The SPV would own (options) on shares in OC.
1. Reasons for setting up foreign employee profit participation companies
The main reason for setting up foreign employee profit participation companies is reduction/deferral of taxation over employee profit shares and therewith to grant an incentive to the employees’ dedication and commitment to the profit position of their employer.
2. Important characteristics for a country to be regarded as tax advantageous jurisdiction for employee profit participation companies
A country should meet the following criteria in order to be regarded as tax efficient jurisdiction for employee profit participation companies:
it should have a broad tax exemption system for holding company income, especially in terms of the minimum percentage that a company is required to own in the capital of another company, in order to qualify for tax exemption for benefits from such company
it should have a large double tax treaty network, in many cases providing for reduction of (and preferably exemption from) withholding tax over dividend payments made to holding companies established in such countries by subsidiaries of such companies and protection from taxation over gains upon the sale of shares in foreign companies by investee countries.
Many countries levy withholding taxes. These taxes are usually levied over payments of dividends, interest and/or royalties made by residents of those countries. The rates of these taxes vary, but in some countries they may rise to 30%. The availability of double tax treaties, which may provide for reduction of such withholding taxes in case of payments to companies in countries that have tax treaties with the countries of residence of the paying parties, is an essential element in international tax planning.
ideally, the country of establishment of the holding company would not have withholding taxation over dividend payments (or it should be relatively easy to circumvent such taxation)
ideally, the country of establishment of the holding company would not levy tax over gains upon the sale of shares in local companies by non-resident shareholders either.
It is safe to say that, within the EU, Cyprus is by far the most attractive jurisdiction for employee profit participation companies. It combines a general income tax exemption for profits from the sale of securities with a very broad tax exemption system for dividends, which does not include a minimum capital participation requirement. Cyprus does not levy withholding tax over outbound dividends.
3. Issues to consider
Before deciding to incorporate a foreign employee profit participation company, other issues need to be considered as well. Below you will find an overview of a few of these issues.
First of all, the employees’ home country/countries may have so-called ‘CFC (controlled foreign corporation) legislation’, under circumstances leading to immediate taxation over profits realized by foreign holding companies (even without distribution of such profits) in certain countries (so-called ‘blacklisted countries’) owned by such employees (although CFC legislation usually only applies in case of majority shareholdings). Therefore, it is always advisable for employers to liaise with local tax specialists before setting up this kind of companies for their employees.
Companies should also be prepared for a possible challenge of the structure by the tax authorities in their home countries. The risk of such challenge depends on various factors, such as the attitude of these authorities in general towards foreign holding company structures, their available audit tools and policy etc. Tax authorities could e.g. argue that the management and control of a foreign employee profit participation company is de facto exercised in the country of residence of the employees. A way to reduce the risk of success of such challenge may be the appointment of a majority of directors resident in the foreign company’s preferred country of establishment on the board of directors of such company. This is also an aspect that should be discussed with a tax specialist in his home country.
Another risk is that the tax authorities in the country/countries of residence of the employees will ‘pierce through’ the profit participation company’s ‘corporate veil’ and will immediately levy income tax (and, possibly, social security premiums) with all the share-owning employees over the income received by the employee profit participation company corresponding to their respective shareholdings (treating such income as income from employment directly earned by the employees).
This is one of the reasons why this kind of structures should always be guided by local tax specialists in the country/countries of residence of the employees.
4. What we can do for you
Consulco has been involved in the set up of a number of employee profit participation companies in Cyprus (including one for a major NASDAQ quoted Scandinavian Group). We have the know-how, expertise and experience to guide this kind of structures in the field of audit, legal services and taxation and to supply the required domiciliation services for this kind of companies.
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