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One of the most popular forms of using foreign companies in international tax planning is that of a holding company. Holding companies are, generally speaking, companies set up for the sole or main purpose of owning shares in other companies. The latter companies may have a variety of activities.
1. Reasons for setting up foreign holding companies
a. Non-fiscal motives
There are various reasons for the use of foreign holding companies for the ownership of shares in other (investee) companies. These motives can be tax driven, but there may also be other reasons for using holding companies, for example:
Confidentiality: investors may prefer not to be disclosed as participants in certain business ventures. In those cases the use of a holding company in a jurisdiction not providing disclosure of direct shareholders may be advisable (or companies can be used in jurisdictions providing such disclosure, but ownership can be hidden, e.g. through so-called ‘nominee shareholders arrangements’ or by holding shares in such companies via entities in jurisdictions providing the desired non-disclosure).
b. Tax motives
There are various ways in which tax savings can be achieved through the use of foreign holding companies. These are amongst other:
Tax-free collection of dividends and gains
In situations where a direct participation in a company by a (corporate or individual) investor leads to immediate taxation over the related benefits from such investment (dividends and gains) for the investor, a foreign holding company can be used for the tax-free collection of such income. In that way, tax deferral can be obtained for the income in question. After all, as long as the holding company does not distribute its profits or shares in such company are not sold, the investor should normally not be liable to tax in his home country (see, however, also the section ‘Issues to consider’)
Reduction/avoidance of tax in the investee country
Many countries (under circumstances) levy tax over benefits derived from shares in resident companies by foreign shareholders. This can be in the form of (withholding) tax over dividend distributions and/or in the form of taxation over gains upon the sale of shares in resident companies realized by foreigners
In cases of investments in companies in such countries (hereafter ‘investee countries’), it may be advisable to structure such investments through holding companies in countries with which the investee countries have double tax treaties. These treaties may provide for reduction of withholding tax over dividend distributions paid by companies in the investee countries to companies resident in the tax treaty countries. These treaties may also provide for protection from capital gains tax in the investee countries over gains upon the sale of shares in companies resident in the latter countries
Tax sparing credits
Under normal circumstances, countries will levy tax over dividend income received by resident shareholders from local companies.
The same will apply to dividends from foreign companies received by these shareholders. Any withholding tax levied over dividends paid by these foreign companies can usually (with some restrictions) be deducted from tax due in the shareholders’ countries of residence.
Certain treaties provide for so-called ‘tax sparing credits’ (‘TCCs’). These TCCs stipulate that residents of countries (hereafter; country X) receiving income from certain treaty countries (hereafter; country Z) may deduct a so-called ‘notional withholding tax’ at a certain rate (e.g. 10%) from tax payable over such income in their home countries (X). If the actual tax paid/withheld in the treaty state (Z) is effectively lower than the rate of the notional withholding tax (the income may even be fully exempt from –withholding- tax), this may be a reason to structure (foreign and local) investments through a holding company in such country (Z). It may reduce the investor’s tax burden over repatriated profits.
It speaks for itself that such structure is only feasible if withholding tax over dividends from the investee company to the holding company (in Z) can be kept limited (ideally it could be avoided; in EU-context this can often be realised via application of the so-called ‘EU Parent-Subsidiary Directive’).
Since acting as holding company requires relatively little human efforts, investors have a rather high flexibility when it comes to using foreign holding companies. After all, the risk that the tax authorities in the home countries of the investors can successfully argue that these companies have a taxable presence in these countries (e.g. in the form of management and control or a permanent establishment) is relatively low. Nevertheless these structures always have to be set up with the outmost diligence, most preferably in co-operation with a tax specialist in the investor’s home country.
Investors receiving salaries in their capacity as directors of local companies will usually be subject to tax in their home countries over such salaries, at progressive tax rates.
When receiving a director’s salary in his capacity as director of a company, based in a country with which his country of residence has a tax treaty, an investor may enjoy the following fiscal benefits; usually, the tax treaty in question will allocate the right to levy tax over such salary to the country of establishment of the foreign company. However, it may be that the latter country will not materialise this taxation right and will effectively not levy tax over the salary. If, based upon the tax treaty and/or domestic law of the investor’s country of residence, such country will grant tax exemption for the salary in question the investor may derive a significant benefit from the use of the foreign holding company, by implementing the afore-mentioned directors’ fee arrangement. After all, the country of establishment of the company paying the directors fee will exempt such income from taxation, as well as the home country of the recipient of the income.
However, it is important that this kind of structures be guided by a tax counsel in the investor’s country of residence (and the country of establishment of the company paying the director’s fee)
For people who are considering relocating to another country, the use of foreign holding companies may also be advisable from tax planning point of view.
As mentioned before, the tax systems of many countries provide for taxation over gains upon the sale of shares in local companies by foreign residents. This would mean that these countries maintain a taxation claim over the (pending) profits upon the sale of shares in local companies, after emigration of shareholders of such companies. Tax treaties between the new home countries and the ex-states of residence do not always provide a solution for such problem.
The use of foreign holding companies for the ownership of shares in the ‘future ex-home countries’ can in many cases solve this problem, as the tax systems of the ex-home countries will usually not provide for taxation over the sale of shares in non-resident companies by foreigners/ex-residents.
Yet, there are countries, such as Sweden, whose tax systems even provide for taxation in those cases, so it is advisable to have these structures being guided by local tax specialists.
2. Important characteristics for a country to be regarded as tax advantageous holding jurisdiction
A country should meet the following criteria in order to be regarded as tax efficient holding jurisdiction:
it should have a broad tax exemption system for holding company income (dividends and gains from the sale of shares)
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 established in treaty countries and protection from taxation over gains upon the sale of shares by foreign companies in these subsidiaries in the latter companies’ states of residence.
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 home states of the paying parties, is an essential element in international tax planning. So is the capability to choose the right jurisdiction for each individual investment.
For investments into the European Union (EU) it may be beneficial if the country of establishment of the holding company is an EU-Member itself, leading to access to the so-called ‘EU Parent-Subsidiary Directive’. The EU Parent-Subsidiary Directive under circumstances provides for withholding tax exemption for dividend payments between EU-companies
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.
3. Issues to consider
Before deciding to incorporate a foreign holding company, other issues need to be considered as well. Below you will find an overview of a number of these issues.
First of all, the investor’s home country 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 (these may be so-called ‘blacklisted countries’) owned by such investor. Also for that reason, it is always advisable for investors to liaise with local tax specialists before setting up foreign holding company structures.
Furthermore, if a foreign holding company is considered for the ownership of an investment that is already directly owned by an investor, the investor should ascertain that the transfer of such investment to the foreign holding company in question would not trigger immediate taxation in the investor’s home country. Certain countries have facilities to effect such transfers tax-free (in EU context there are even Directives that may provide for such exemption), but advice from a local tax specialist is highly recommendable for a proper implementation of the holding company structure.
Investors should also be prepared for a possible challenge of the holding company 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 argue that the management and control of a foreign holding company is de facto exercised in the country where the investor/owner of the holding company is based. A way to reduce the risk of success of such challenge may be the appointment of a majority of directors resident in the holding company’s preferred country of establishment on the board of directors of such company. This is also an aspect that an investor should discuss with a tax specialist in his home country.
4. What we can do for you
Consulco has an office in one of the most prominent and favorable jurisdictions for the establishment of holding companies in the entire EU, Cyprus. This country has an extensive double tax treaty networks and, being member of the EU, companies in this country may be entitled to the benefits of the EU Parent Subsidiary Directive, which may lead to withholding tax exemption for dividends between EU-companies.
In addition to that, Consulco has an office in the United Arab Emirates (UAE) where we are licensed to set up and manage companies in the so-called Ras Al Khaimah (RAK) zone. These companies are comparable with offshore companies in the sense that they are in principle not subject to any tax over any of their income, but (unlike typical offshore companies) they may be eligible for the benefits of tax treaties concluded by the UAE.
Consulco has almost twenty years of experience in advisory on the use, the set up and the management of holding companies, including typical offshore companies such as BVI companies, Seychelles companies etc. In addition, we have significant experience in working with holding companies in venerable onshore jurisdictions such as The Netherlands, Denmark, Austria, Luxembourg and The UK. Consulco has unique knowledge of and expertise in the use of holding companies in international tax planning and should be your number 1 provider of choice when you want to set up such company in Cyprus, Malta, the UAE or other jurisdictions.
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