Top 20 Intermediary Entities in IOFC

The following points highlight the top twenty intermediary entities in International Offshore Financial Centre (IOFC). The intermediary entities are: 1. International Holding Company 2. International Finance Company 3. Licensing Routing Company 4. Offshore Trading Company 5. Group Administration Office 6. Employee Leasing Company 7. Offshore Banking Unit 8. Captive Insurance Company and Others.

IOFC: Intermediary Entity # 1. International Holding Company:

A holding company in an intermediary jurisdiction allows an entity to hold and manage its investments in foreign subsidiaries. It may be either pure or mixed in nature. A pure holding company is confined to managing and holding investments only, while a mixed holding company can also engage in other commercial activities.

The real economic benefits of a holding company are non-tax in nature, such as the flexibility in group reorganization and global co-ordination, the freedom from exchange controls, the ability to raise group finance abroad and the need to protect the confidentiality of ownership. Unfortunately, they also create operating issues.

These problems relate to the difficulties in communications and maintaining group cohesion, the duplication of staff, additional costs of the holding company, the need for consolidation of accounts, etc. The exchange controls or controlled foreign corporation rules in the home country may also affect the repatriation or taxation of foreign profits.

An international holding company helps in global tax planning. For example, its use helps to reduce the pre-tax profits of operating subsidiaries abroad through deductible expenses and to minimize the withholding taxes on the post-tax profits through tax treaties.

It defers or avoids capital gains tax on the sale or liquidation of overseas subsidiaries and other investments. It also defers the payment of dividends to the home country.

These profits may be accumulated abroad in a strong currency free from exchange controls until either they are needed at home or required for reinvestment abroad. An intermediary entity may also re-characterize the income for tax purposes, or act as a “mixer company” for foreign tax credits.

The tax considerations in the choice of a holding company location include:

i. Wide and appropriate treaty network to minimize the withholding and other taxes in the host countries on the income and gains of subsidiaries.

ii. Availability of foreign tax credits in the holding company for the taxes paid by the subsidiaries (including lower-tier entities), unless the income is not subject to tax.

iii. Low or nil effective corporate tax on the foreign income received, and on the other income earned in the jurisdiction. No capital taxes and stamp duties on capital issues and transfers and no net worth taxes.

iv. Ability to make tax-free reorganizations through the sale or liquidation of foreign subsidiaries or branches. For example, no capital gains tax on the sale or liquidation of the subsidiaries in either the holding or in the host jurisdiction.

v. Deductibility of interest payments on the funds borrowed to finance the subsidiaries against the income received from them, and the deductibility of their losses (including tax consolidation).

vi. No withholding tax on the dividend and other outbound payments made by the holding company.

vii. Stable tax laws and treaties, the ease of tax and corporate compliance requirements and a favourable attitude of the tax authorities. No anti-avoidance provisions, such as anti-treaty shopping, transfer pricing, thin capitalization and controlled foreign corporation rules.

viii. Easy qualifying conditions for the various tax concessions (e.g. the rules for participation exemption or the EU P-S Directive, the ability to operate as mixed holding companies, etc.)

ix. Political and economic stability and a favourable business and legal infrastructure with availability of skilled personnel and professional services.

Some planning considerations are:

(i) The holding company should be set up when the group is incorporated. Subsequent changes can be expensive due to reorganization costs. They may include capital gains tax on the transfer of the investments, the business, stamp and registration duties on share transfers and the need for exchange control and regulatory consents.

The tax planner should also evaluate the likely future changes in the domestic law and tax treaty benefits before making his decision.

(ii) The holding company must have legal and commercial substance to avoid unplanned tax residence in the home country. There should be an appropriate segregation of activities and management functions, and adequate documentation to evidence it.

(iii) Anti-avoidance rules and practices need careful analysis. Many countries impose controlled foreign corporation rules on holding companies to counter the deferral of dividend payments to the home country.

Transfer pricing rules may be applicable on the payments to related companies and they may also impose additional record-keeping requirements. Moreover, several countries have anti-treaty or anti-Directive shopping rules.

(iv) The holding company adds an additional tier in the group structure. The credits for taxes paid in lower-tier subsidiaries may be lost if the home country only grants relief for the first-tier subsidiary (i.e. the holding company). In such cases, it could lead to a loss of foreign tax credits on the taxes paid by lower-tier subsidiaries when the holding company pays the dividend to the home country.

(v) The tax planner should examine the non-tax considerations when choosing an appropriate location from a commercial and management perspective. In particular, he should review the formation and recurring costs, and overheads due to the additional administrative responsibilities and accounting, auditing and other compliance requirements.

In an ideal situation, an investor may use intermediary holding companies to extract profits from the host country at reduced tax cost, hold the funds at nil or no tax cost, and finally repatriate them to the home country at no or reduced tax costs.

If the profits repatriated by the holding company are taxable when received by the home State, the subsequent remittance to the parent company may be made tax-free through an upward loan or other tax-exempt payments. No single country meets these ideal requirements for a holding company location.

Some popular locations are:

i. Zero or low-tax jurisdictions as a base haven for offshore activities if the tax treaties are not needed. (Examples: Bahamas, Belize, Bermuda, British Virgin Islands, Cayman islands, Costa Rica, Dubai (UAE), Gibraltar, Guernsey, Hong Kong, Isle of Man, Jersey, Liechtenstein, Malta, Monaco, Panama.

ii. Treaty havens with special tax regimes. (Examples: Barbados, Cyprus, Hungary, Malaysia (Labuan), Madeira, Malta, Mauritius, Netherlands Antilles).

iii. Jurisdictions with special regimes: (Examples: Austria, Belgium, Delaware (US), Denmark, France, Germany, Ireland, Luxembourg, Malaysia, Netherlands, Portugal, Spain, Singapore, Switzerland, United Kingdom, Uruguay).

International holding companies are used widely by multinational entities since the operational and tax benefits normally outweigh the costs. Many countries provide special incentives to attract them to their jurisdiction, and even encourage their own resident companies to use them overseas. The OECD’s Project on Harmful Tax Practices did not consider them to be harmful.

IOFC: Intermediary Entity # 2. International Finance Company:

An international finance company can serve a wide range of commercial objectives, such as:

i. To accumulate and use the existing group funds with greater flexibility;

ii. To tap external sources of finance;

iii. To perform debt factoring activities;

iv. To act as a borrowing and lending intermediary;

v. To manage adverse currency fluctuations and exchange controls;

vi. To centralise control over funds through treasury management; etc.

The tax advantages arise from the ability to provide finance through debt, and not equity, to group companies.

Thus,

(a) The interest costs are claimed as a tax-deductible expense against the high-taxed profits in the host country; and

(b) The interest income is received with low or nil withholding tax and accumulated in a tax-free or low-tax jurisdiction.

The ideal location requires a low or nil withholding tax on inbound interest receipts, low or nil corporate tax on the interest income, and nil withholding tax on their subsequent redistribution as interest or other passive income.

Non-tax considerations include no exchange controls, a strong currency, efficient financial and banking facilities, access to international capital markets, ease of transfer of funds, etc. Such conditions are rarely found.

Many countries have anti-avoidance tax rules to disallow non-arm’s length interest rates and high debt-equity ratios under their thin capitalization or transfer pricing rules, stringent exchange controls and/or currency restrictions.

It is often difficult to minimize withholding taxes under tax treaties, and also pay low or nil taxes on the interest income accumulated in the same jurisdiction.

To achieve both these objectives, two intermediary companies may be needed under a stepping-stone conduit structure:

(a) A base company for tax-free accumulation of interest income from the loans made to the conduit finance company; and

(b) A conduit company

(i) To receive the interest on monies lent to the various host countries at minimum withholding tax under tax treaties, and

(ii) To pay the interest with nil withholding tax to the base company.

The income in the conduit company may be exempt or subject to a corporate tax on the small interest spread on the back-to-back loans. Many jurisdictions with nil or low tax would suit as locations for the base company.

There are also several suitable locations for conduit companies (Examples: Denmark, Luxembourg, Malta, Mauritius, Labuan (Malaysia), Netherlands, Netherlands Antilles, Singapore, Sweden, Switzerland).

IOFC: Intermediary Entity # 3. Licensing Routing Company:

An offshore licensing company can help:

(i) To reduce, or even avoid, the withholding tax on cross-border royalties, and

(ii) To accumulate the royalty income in a nil or low-tax jurisdiction.

Some examples of commonly used tax structures include:

(a) The intellectual property rights are sold to a base company in a tax-free jurisdiction before they acquire a significant commercial value. The base company licenses a conduit company located in a country that imposes no withholding tax on outgoing royalties.

This conduit company sub-licenses the rights to various user-companies and receives the royalties from them at nil or low withholding tax under its tax treaties. The royalty income is passed through to the base company, subject to a small profit margin on which the local tax is paid as a “throughput tax” or “turn.”

(b) The intellectual property rights are sold to an intermediary royalty routing company in a treaty country for a loan consideration. The intermediary then licenses the rights to the host countries and collects the royalties, subject to reduced withholding taxes under treaties.

The accumulated royalty income is set off against the amortisation of the cost of the property rights, and the interest deductions on the loan. The royalty income is paid to the home country as loan and interest payments.

Licensing companies in a base country could face various limitations. For example, they may need to repatriate the income under the exchange control rules in the home country. The home country may tax the offshore passive income under the controlled foreign corporation rules. The transfer of property rights to a base company abroad may lead to a taxable gain.

Most treaties require the beneficial owner of the royalty income to be a resident in the other Contracting State. There may be restrictions on the tax deductions granted in the host country on the payments to related parties abroad. The tax treaties may contain other anti-shopping provisions.

Popular locations include Bermuda, Denmark, Guernsey, Hong Kong, Ireland, Isle of Man, Jersey, Luxembourg, Malta, Netherlands, Switzerland, and the United Kingdom.

IOFC: Intermediary Entity # 4. Offshore Trading Company:

International Trading Company:

An international trading company acts as an intermediary entity that buys from, and sells to, third parties. There are no transfer pricing concerns since they are not related party transactions.

The company can choose a low or nil tax country as a base and retain the administration and day-to-day operations in a branch located in an “onshore” jurisdiction. Care is needed to ensure that the intermediary company does not become a tax resident in a high-tax jurisdiction due to the location of its management and control.

Several offshore centres encourage their use for international trading activities (Examples: Barbados, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cyprus, Dubai (UAE), Gibraltar, Guernsey, Hong Kong, Iceland, Isle of Man, Jersey, Malta, Mauritius, Panama, Singapore, Switzerland, Uruguay).

Group Selling Company:

A group company located in a base haven re-invoices the goods or services sold by related operating entities in high-tax jurisdictions to third parties. There is no physical movement of goods through the intermediary company since they are shipped directly by the operating companies to the ultimate customer.

The company receives either a service commission or is invoiced by the operating companies at an agreed lower price to provide a profit margin. This income is accumulated free of tax in the base haven, while the profits of the related operating entities in the high-taxed country are correspondingly reduced.

The risk factors relate to the transfer pricing legislation and the possibility of tax residence in the high-taxed jurisdiction of the supplier due to the presence of effective or central management.

Moreover, the initial transfer of the business to the base company could amount to a disposal of part or all the business and make the operating company liable to capital gains tax.

Some tax planning considerations include:

(a) The base company must have commercial substance (e.g. warehouse facilities) and should bear the entrepreneurial risks of the business. It must hold the directors’ and shareholders’ meetings in its jurisdiction to demonstrate local management and control and, preferably, have a majority of local directors.

It must have local presence to select its customers and to perform any after-sales or warranty services. It should also have and be seen to exercise the authority to conclude all contracts. All related party transactions should be conducted on an arm’s-length basis.

(b) The operations should avoid a permanent establishment in the ultimate country of sale. No sales representatives should conclude contracts or have the power to conclude contracts in the country of sale. The base company should send the sales invoice to the customers for payment directly by them. It is preferable to choose a treaty haven as an intermediary location.

Some jurisdictions for group sales companies include Belize, British Virgin Islands, Cyprus, Dubai (UAE), Guernsey, Gibraltar, Hong Kong, Jersey, Isle of Man, Labuan (Malaysia), Madeira, Malta, Mauritius, Netherlands, Netherlands Antilles, Panama, Singapore, Switzerland, United Kingdom and Uruguay.

Group Purchasing Company:

A group company purchases goods from third parties for subsequent sale to other group companies at the cost plus a profit margin. As a centralized buying organization, it can make bulk purchases and obtain better price and purchase terms. The group purchasing company located in a tax-free or low-tax offshore jurisdiction retains the profit mark-up.

Some planning issues to consider include:

(a) It must comply with the anti-avoidance regulations in the tax jurisdictions affected by its operations. In particular, the re-invoicing to related companies should follow the transfer pricing rules.

(b) It should have commercial substance and specialist buying skills, and not be confined just to the re-invoicing activity for the purchases on behalf of the other group companies. Offshore centres that do not levy any tax under their domestic law may be unsuitable since they do not give substance, have few useful treaties, and are subject to closer scrutiny by the tax authorities.

(c) The offshore company must not become resident in another jurisdiction through the location of its management and control. Moreover, the purchasing company should not have a permanent establishment in the country of sale. Normally, the country of purchase is not a permanent establishment under treaties.

IOFC: Intermediary Entity # 5. Group Administration Office:

Several countries offer special tax concessions for group administration offices, Headquarters Company (see Glossary) or co-ordination centres of multinational groups.

They may perform some or all of these activities:

i. To hold the group’s interests in the region (“holding centre”).

ii. To act as a treasury centre (“financing centre”); or

iii. To provide centralized managerial or technical support services to affiliated companies (“administrative or service centre”).

An administrative office is generally based in a country other than the country of the parent company or the country of operation. Their role is to co-ordinate international or regional activities of part or all the group companies, and to provide centralized support services to them.

The examples of centralized support services include:

(a) Administrative services, such as planning, co-ordination, supervision, budgetary control, financial or accounting services and computer services;

(b) Assistance and services in the field of production, buying, distribution and marketing; and

(c) Services such as recruitment and training. In recent years, several multinationals have moved their “back office” administration activities to lower-cost offshore centres.

The decision to form companies for group administration, co-ordination or control is generally taken on business and commercial considerations. It is not wholly tax-driven. They provide the benefits of the economies of scale and better risk management through centralized operations at a cheaper or more convenient location.

Successful centres require trained support personnel, efficient communications and travel connections, central regional location and an efficient and low-cost commercial infrastructure.

Several countries tax the group service income at a special concessional tax rate. They levy a tax based on a deemed income, which is computed as an agreed percentage (normally 5 to 15%) of the administrative expenses incurred by them.

A deemed income approach may be suitable when the group activities are likely to be consistently profitable. Otherwise, the administration centre may be paying taxes even when the group activities are making losses. In such situations it is better to avoid a cost-plus approach.

Some of the locations for co-ordination or service centres commonly used for an international or regional headquarters company include Australia, France, Malaysia, Mauritius, Singapore and Uruguay, depending on the region. The Netherlands or Ireland for a distribution company and the United Kingdom for “back office” services are popular in the European Union.

Other suitable locations include Cyprus, Dubai (UAE), Germany, Gibraltar, Hong Kong, Malta, Monaco, Netherlands, Portugal, Switzerland and the United States. A treaty haven is preferred when there is a risk of tax on the service income in the host State when there is no permanent establishment.

IOFC: Intermediary Entity # 6. Employee Leasing Company:

An employee leasing company located in an offshore centre may be used to employ “mobile” expatriate employees within a multinational group. They are then hired out as secondment services to the operating subsidiaries in other jurisdictions at their cost plus a profit mark-up.

Many multinational companies “tax-protect” their employees on overseas assignments.The use of an employee leasing company can minimize the personal taxes payable by the expatriate employees and reduce their currency risks. It can also be used to provide other employee benefits for working abroad, such as tax-free pensions, flexible social security arrangements and freedom from exchange controls.

Suitable locations include well-established havens that provide for either tax exemption or low taxes on employment income and pensions of expatriate personnel (Examples: Cyprus, Guernsey, Hong Kong, Isle of Man, Jersey, Malta, Mauritius, Monaco).

IOFC: Intermediary Entity # 7. Offshore Banking Unit:

An offshore banking unit (“OBU”) is a bank that restricts its activities to financing offshore operations of nonresidents. Besides traditional banking transactions, its services normally include treasury functions and fund management, dealing in foreign currencies, the issue of letters of credit, special financial instruments, custodial services, etc. Many of these banks also provide offshore trust services.

Major centres include the Bahamas, Bermuda, Cayman Islands, Gibraltar, Guernsey, Hong Kong, Isle of Man, Jersey, Liechtenstein, Luxembourg, Panama, Singapore and Switzerland. Malaysia has established Labuan as an offshore banking centre. Mauritius has licensed several offshore banking units under its offshore legislation. Bahrain is an active centre in the Middle East.

Many offshore banking units offer private banking services to high net worth individuals. Their main activity is investment advisory services and the management of assets of private clients using the privacy and flexibility available in various offshore financial centres.

Often, these banks act as trustee companies, and provide global investment advice and services through their onshore offices. Switzerland is the world’s largest offshore private banking centre. London, New York and Zurich are important bases for onshore advisory services.

IOFC: Intermediary Entity # 8. Captive Insurance Company:

A captive insurance company is a wholly-owned company that provides an in-house capability to insure the risks within a multinational group. The insurance premiums are paid by group companies to a captive insurance company located in a base haven for reinvestment or for payment as premiums to reinsurance companies.

Although captive insurance is a form of self-insurance of group risks, it is a bona fide international insurance activity that aggregates the unrelated risks within the group and offers the advantages derived from the economies of scale.

Its benefits include:

i. It has the ability to write a policy to suit the operational needs within the group. In particular, it can provide insurance cover that may not be available from commercial sources for certain risks (e.g. nuclear risk, professional liability, labour strikes, product liability, etc.).

ii. The insurance costs are reduced since the in-house company does not have to incur marketing and commission expenses. However, the administration costs of a captive insurance company may need substantial annual premium revenue to justify its expense.

iii. The reinsurance premiums can be kept low through the pooling of group risks and retaining an acceptable risk level under self-insurance. Moreover, unlike the premiums payable to an insurance company in advance, they are generally paid to a reinsurance company in arrears.

iv. The captive insurance company based in an offshore centre usually benefits from the relatively freer regulatory requirements and little or no tax on its income and reserves. The premiums paid by the operating companies on an arm’s-length basis are usually fax-deductible in their tax jurisdictions.

Onshore insurance and financial institutions also use offshore centres to set up reinsurance companies. The contracts agreed with the reinsurer help to limit their own financial exposure on large future claims.

Nearly half the captive insurance companies in the world today are based in Bermuda. Bermuda is also the third largest reinsurance market in the world. Other major centres include Barbados, British Virgin Islands, Cayman Islands, Guernsey, Ireland, Isle of Man, Luxembourg, Turks & Caicos Islands, South Carolina and Vermont (USA).

IOFC: Intermediary Entity # 9. International Shipping Company:

The flag of the ship is the flag of its country of registration. Offshore centres provide flags of convenience for international shipping operations (see Glossary). They have low registration fees and minimal regulations on ships registered in their country.

Moreover, they levy low or no taxes on the profits from shipping operations and/or ship-owning activities. A company incorporated in the country of the flag usually owns the ship. It is common to set up a separate company to own each ship.

The countries commonly used as shipping havens include Panama, Liberia, Bahamas, Cyprus and Malta. Other major jurisdictions are British Virgin Islands, Cayman Islands, Gibraltar, Isle of Man and Madeira (Portugal). A very high percentage of the world’s shipping today is on the “open registries” in these countries.

Similar facilities are also available for aircraft operations and registration and for yacht registration in certain offshore centres. Aircrafts are frequently registered in neutral offshore jurisdictions (Examples: Cayman Islands, Ireland) when they are leased or purchased by carriers in emerging markets but financed by banks in onshore financial centres.

IOFC: Intermediary Entity # 10. Offshore Fund:

An offshore fund is an investment company or a mutual fund (i.e. unit trust”) located in an offshore financial centre. These collective investment schemes accumulate the income and gains in an offshore fund, usually tax-free, on behalf of the investors.

The investors are taxed on this income in their own country as capital gain on realization when they ultimately dispose off their “rolled-up” investments in the fund. Thus, they benefit both from the deferral of the tax on the income until the sale of the units and the lower tax rate, which is applicable in many countries on capital gains.

The popular locations are Bermuda, Bahamas, Cayman Islands, Guernsey, Hong Kong, Ireland, Jersey, Luxembourg, Singapore and Switzerland. Ireland and Luxembourg have the benefit of the UCITS (Undertakings for Collective Investment in Transferable Securities) Directive that provides marketing access within the European Union.

Jersey and Guernsey have Designated Territory status under the UK Financial Services Act and, therefore, provide investor protection similar to the United Kingdom.

Some jurisdictions have enacted special provisions to curb tax avoidance through tax deferral. For example, the United States taxes the investor’s gain as income, and not as capital gain, on disposal; other countries tax the investors annually on their underlying income from the foreign investment funds (Examples: Australia, Canada, Germany, Netherlands, New Zealand, United Kingdom).

IOFC: Intermediary Entity # 11. Offshore Trust:

Trusts account for 40% of all the funds held in offshore financial centres today. There are over 50 countries that have foreign trust legislation.

Some well-known offshore trust centres include the Bahamas, Barbados, Bermuda, British Virgin Islands, Cook Islands, Cayman Islands, Cyprus, Gibraltar, Jersey, Guernsey, Isle of Man, Labuan (Malaysia), Liechtenstein, Malta, Mauritius, New Zealand, Singapore, Turks & Caicos Islands and United Kingdom.

Common Law Trust:

Trust is a common law concept. Under common law, a trust can be set up to settle the assets over to the trustee/s, who manages them under the provisions of a trust deed. A trust may be either specific (individual beneficiaries have rights over the income and/or capital), or discretionary (individual beneficiaries have no specific distribution rights).

Although the settlor is no longer the legal owner, he maintains an indirect control over the trustee/s on the distribution of income and capital through his “letter of wishes”. He can also appoint a protector (or guardian) to protect the interests of the beneficiaries.

A protector usually has the right to remove and appoint the trustee/s or to change the residence of the trust. He may also have veto powers over the trustees. The identity of the settlor may be kept confidential through a declaration of trust. A discretionary trust allows the beneficiaries the right to benefit from the trust assets without ownership.

Trusts serve a wide range of purposes.

They include:

(i) Estate and succession planning;

(ii) Maintenance and accumulation of funds for family members,

(iii) Asset protection,

(iv) Charitable trusts and

(v) Purpose trusts with or without specified beneficiaries.

A purpose trust can be set up for a particular purpose, which may or may not be charitable. The use of trusts has now extended to several special applications. They are often used for commercial purposes to hold investments directly or indirectly in business activities. The use of trusts can assist in pre-immigration tax planning in several countries (Example: Canada, South Africa).

The use of trusts may also provide anonymity of ownership. Many jurisdictions do not require trust registration and public disclosure of its assets and ownership without a legal injunction or Court order. Many offshore centres with trust law permit the use of their treaties for treaty shopping in tax planning.

The primary use of trusts today is still estate and inheritance planning, and the management of investments. They allow the settlor to transfer the legal ownership of his assets without the effective loss of control over their use. They can be administered in perpetuity or for defined periods according to the wishes of the settlor.

They provide tax shelters against inheritance tax or estate duties. They allow the assets to be passed to the next generation without probate procedures. Thus, substantial income and capital gains may be accumulated in a trust located in a tax-privileged and confidential environment.

Asset protection trusts (“APT”) provide for the protection of assets against creditors. The use of an international jurisdiction separate from the settlor’s residence allows for the protection of income and assets from political, fiscal and legal risks.

APTs are widely used as a security against legal contingencies such as bankruptcy, insolvency, fraud, malpractice suits, and claims from potential creditors, and even family members. The well-established jurisdictions for APTs include the Bahamas, Belize, Cayman Islands, Cook Islands, Cyprus, Gibraltar, Jersey, and Turks and Caicos Islands.

Many offshore banks provide services as a trust company. They act as trustees for settlements, debenture holders, pension funds, and/or as executors and administrators of estates.

In addition, they provide management services, such as overseeing investment holding companies, and even trading companies. They maintain legal books and ensure local statutory compliance and reporting. They act as nominee directors and secretaries.

Both onshore and offshore trusts are widely used for tax planning. Certain countries have enacted anti-avoidance measures for their resident taxpayers. For example, in the United States a grantor trust of a US tax resident is tax neutral, and its income is treated as the taxable income of the settlor.

In the United Kingdom, the income of a foreign trust set up by a person, who is UK domiciled and ordinarily resident, is taxable in his hands if he has the power to enjoy the income or capital. However, a UK trust with nonresident settlors and nonresident beneficiaries is usually tax-exempt on its income, excluding the income of the UK trustee.

Another issue relates to the possible attack by the present and future creditors on the settlor and the trust, under the English Statute enacted in 1571 during the reign of Queen Elizabeth I. This law (or a similar legislation) is still applicable in many countries.

The legislation can sometimes set aside the transfers made into the trust. The trusts may also be constrained by “forced heirship” rules in civil law countries, where common law trusts are not recognized.

Trusts under Civil Law:

So far only a few civil law jurisdictions have signed the Hague Convention. The primary purpose of The Hague Convention on the Law Applicable to Trusts and on their Recognition (“Hague Convention”) is the recognition of the common law trust.

The Convention specifies the essential characteristics of a trust, the applicable law and their recognition within an international legal framework. In a civil law country, the adoption of the Convention means that a trust is not treated under its laws as a similar civil law entity.

Although trusts are not generally accepted in several civil law countries, many of them have changed their position and begun to use them. Today, many civil law jurisdictions recognize common law trusts under their domestic law (Examples: Denmark, Madeira (Portugal), Malta, Monaco, Sweden and Switzerland).

There are also a few civil law jurisdictions that provide special trust legislation under their domestic law. For example, some of them have trusts under a “mixed” legal system combining both common and civil law concepts (Examples: Cyprus, Israel, Malta, Mauritius and Seychelles).

Liechtenstein enacted a common law type trust structure under its domestic law in 1926. Japan, as a civil law jurisdiction, has a special trust law for investment purposes. Several Latin American countries have enacted laws onfideicomiso (Examples: Argentina, Colombia, Ecuador, Panama, and Peru).

Under afidei commissum, a person (fiduciary) acts as a close associate of another person (fidei commissary) and the law imposes upon him a duty to act solely in the interests of the fiduciary. Wakfs or Islamic Trusts are permitted in a few offshore centres (Examples: Belize, Cyprus, Malaysia, and Mauritius).

Some common law countries also have trusts under special civil law regimes. For example, the State of Louisiana in the United States has a trust structure based on a contract or a will. The province of Quebec in Canada provides for a fiduciary arrangement dealing with dedicated property which has been disposed by the settlor but not acquired by the fiduciary.

Scotland has a trust law that provides for an unconditional transfer of property under a document (called a “back bond”) with a special provision for it to be returned to the settlor. The settlor, as a truster, transfers the property to a trustee who accepts a voluntary obligation to comply with his intentions.

IOFC: Intermediary Entity # 12. Foundation:

A Foundation has been loosely described as the civil law equivalent of the common law trust. According to an OECD Study published in 2006, there are foundations in nearly 40 countries.

Unlike a trust, they are created by contract and not based on equity. Therefore, foundations are preferred in civil law jurisdictions where the equity principle of trusts is not recognized and the transfer of assets to a trustee is deemed as a gift.

Public foundations are usually set up for charitable purposes. They were originally established in the middle Ages to endow a monastery or other religious institutions in perpetuity. Some jurisdictions permit private foundations as family foundations or for other non-charitable purposes. Most of these jurisdictions provide for strict confidentiality on beneficial ownership.

Civil Law Foundation:

A civil law foundation is incorporated and managed like a company. Unlike a company it has no shareholders, but beneficiaries like a trust. It holds assets in its own name for the purposes set out in its constitution, and its administration and operation is carried out in accordance with contractual rather than fiduciary principles. It is not subject to a perpetuity period, and may be re-domiciled.

A Council or board appointed under the constitution administers the foundation assets. A foundation may also have an advisor, whose role is set out in the constitution. For example, the advisor may have powers to appoint and remove members of the council, or beneficiaries; or (rather like a protector of a trust) the advisor’s consent might be required before the Council carries out certain acts.

The board designates the beneficiaries and their rights. Once the founder has legally transferred the ownership of the assets to the foundation, he has no further founder’s rights.

The continuing relationship of the founder with the foundation is governed by its constitution and its by-laws. The founder may be an individual or a corporate body. He does not have to be named in the charter or in any public document.

The founder may specify his wishes, which would normally be followed by the board, in the regulations and bylaws or in a separate letter of wishes. The provisions relating to the beneficiaries may take the form of supplemental by-laws that do not have to be registered or deposited anywhere.

They can be enforced through an advisory council of which the settlor is a member. Like a trust, the foundation is independent of its founder, but he may reserve various powers. It may be easier for a founder to retain control over the decision making of a foundation than for a settlor to manage the trustees of a discretionary trust.

Unlike a trust, a foundation is a distinct entity with its own separate legal personality. It can hold assets, contract with third parties and sue or be sued in its own name. It is, in that respect, similar to a company.

However, unlike a company, it has no shareholders but instead has beneficiaries who receive distributions from the foundation like a trust. In other words, a foundation has some of the features of a company and some of the features of a trust.

Although most jurisdictions follow broadly the above structure, there are differences. For example:

(i) Liechtenstein:

A foundation (“Stiftung”) is a separate legal entity with no owners, shareholders or participants but beneficiaries. It is more like a discretionary trust but the settled assets are not treated as trust property.

The settlor may be an individual, a company or a partnership that gives the foundation its constitution and specifies the form of administration and benefits. He can also remain anonymous by nominating a local advisor to act on his behalf. The foundation can have a limited or unlimited life depending on the purposes specified by the settlor.

The foundation may be formed as a religious (e.g. ecclesiastical) foundation, as a non-profit body to support charitable, artistic, scientific or social activities, or as a family foundation. Commercial activities are limited to the achievement of its non-commercial aims.

(ii) Panama:

A Panama foundation cannot conduct business activities, but it can own shares of a company engaged in business activities, or any activity which will increase the asset value. Therefore, it can hold bank accounts, securities and real estate.

Confidentiality is guaranteed. As the regulations of the foundation are contained in a private document, which is not registered, there is no disclosure of beneficiary (ies). The charter must name the beneficiaries and also their entitlement.

It must also specify how the assets should be distributed on dissolution. The founder can be a named beneficiary. These foundations are generally used as asset protection trusts and for estate planning.

(iii) Netherlands Antilles:

The Netherlands Antilles foundation is commonly used to control shares in companies. The existing shareholders transfer the shares tax-free to the foundation, which then issues them with transferable certificates of participation to the beneficiaries.

Foundations were initially formed for non-profit or welfare purposes, but they may now also be used for the management of private settled assets (similar to a trust). A private foundation may hold assets, manage funds and make distributions. The settlor and beneficiaries do not have to be disclosed.

(iv) Austria:

Austria permits civil law foundations for non-charitable purposes (private foundation), such as private wealth management and family estate planning. The foundation can be used for holding and financing investments in shares of companies.

It can be controlled by the founder either as a member of the management board or if he is a beneficiary through an advisory board under the charter. The beneficiaries have no legal rights to receive benefits or funds but are entitled to information.

The foundation is a legal entity (unlike a trust) and owns the funds transferred by the founder. The liability of the foundation is limited to its funds. Its legal concept is similar to a company without shareholders but with beneficiaries.

IOFC: Intermediary Entity # 13. Hybrid Company:

A hybrid company is a company with two classes of members:

(i) Voting members as shareholders, who own the shares but have no right to dividends or capital; and

(ii) Guarantee members as beneficiaries, who do not own the shares and have no voting rights, but can benefit from the discretionary distributions made by the company.

The guarantee members agree to contribute to the debts of the company up to a specified maximum amount (typically USD 100 or less). The rights and obligations of the two classes of members may be varied, as required, by the directors.

A hybrid company may be used as a “quasi-trust” or family foundation in certain offshore tax jurisdictions. The control rests with the shareholders (usually professional managers), who act like trustees, while the benefits flow to the guarantee members as beneficiaries similar to a discretionary trust. The company receives the assets as a gift from the founder, who may retain certain special rights under its bylaws to control it.

The professional managers usually act as both shareholders and directors. They own the assets as shareholders but their sole purpose as voting members is to elect the directors to manage the company.

The directors may elect new guarantee members under the advice given to them in a letter of wishes by the founder. The guarantee membership may or may not be transferable, and usually ceases on death or resignation. The terms and conditions of membership and the details of the members can be kept confidential.

The guarantee members have no reporting requirements since they do not own the shares. Moreover, there is no requirement to disclose the identity of the guarantee members in the annual return as shareholders. As the guarantee membership only provides discretionary rights, it is not an asset for exchange control purposes.

The company can also be set up to conduct commercial activities, which are actively managed by the settlor or founder as a director. The settlor or founder may also be a beneficiary. Some of the other uses include exchange control planning. Unlike a trust, a hybrid company is acceptable as a corporate entity in civil law countries.

IOFC: Intermediary Entity # 14. Protected Cell Company:

The Protected Cell Company (PCC) legislation was first introduced in 1997 in Guernsey. By 2007, it has been copied in nearly 40 jurisdictions. The primary objective of a PCC is to achieve “cellular ring-fencing” of certain assets and liabilities within a single corporate entity. It can be regarded as a corporate group with common directors and administration.

What is a PCC?

A PCC is a normal limited liability company with subdivisions or “cells”. Each cell is an independent sub-entity capable of either operating independently from all other cells or operating together with the other cells, but independently of the company itself. These cells can contain separate classes of capital that are protected from creditors of other cells.

The only legal entity is the company. The company issues shares of each cell to individual the assets of each cell are represented by the proceeds of the share capital and reserves attributable to that cell. The company also issues shares that are not cell shares.

Therefore, each cell is allocated its own assets (the cellular assets) by the company while its own non-cellular assets are held in a core cell. The protected cells are themselves part of the company’s capital structure. The uncommitted capital as non-cellular assets in the core cell may be treated as additional capital for creditor protection.

A PCC ensures that the cellular assets are kept separate and separately identifiable for each cell. There is segregation of the assets within each cell and the liabilities arising from those cell assets are also separated with the liability of each cell restricted to its own creditors.

This segregation of assets and liabilities provides a simple ring-fencing under a separate balance sheet for each cell. The cell creditors have recourse to the assets of the cell and also may make a claim on the non-cellular assets.

However, they do not have any claims on assets in other cells. Non-cellular assets may be used, to cover administration costs incurred for all cells, such as company licence fees, secretarial fees, etc. A PCC arrangement would normally provide that such costs are to be met pro rata by the subscribers to the cellular assets.

Generally, the PCC legislation requires that its structure is fully disclosed. The company should inform third parties that it is a Protected Cell Company; otherwise, the directors can be held personally liable. It must also disclose its non-cellular assets. The responsibility and liability on directors and managers of PCCs are often more onerous than non-PCC companies.

Benefits of a PCC:

A PCC may provide several benefits, such as:

(a) A PCC avoids the expense of setting up and managing separate companies to achieve limited liability protection for each activity or owner. It helps segregate assets with different risks and avoids claim or liability in one cell affecting another cell.

For example, a company may split the investments with different risk profiles (e.g. guaranteed products, high-risk products and products with different returns) by placing their assets and liabilities in separate cells.

(b) Each cell can have different investment objectives or investor base or other purposes for which assets and liabilities need to be kept separate, and be given a distinct name. For example, if a PCC invests in more than one jurisdiction it may create a cell for each jurisdiction.

A PCC may also hold investments in various sectors and consequently create separate cells, such as a technology cell, a pharmaceutical cell and an infrastructure cell under an umbrella fund.

(c) A PCC can theoretically have as many cells as it has subscribers. The subscribers may acquire shares in one or more cells. The company may also allocate the shares of a cell to a particular subscriber or to a group of subscribers. Thus, the company may set up a PCC with as many cells as it wishes or is authorized to create under its constitution.

Taxation of PCC:

As the company is a single legal entity, it files a single tax return with a single tax liability, which must be managed centrally by the company. A single tax assessment is raised on the PCC, and the liability apportioned between the different cells and the core cell. The tax statement prepared by the owing company provides the details of the liability of each cell.

Generally, the company computes the taxable profits of the entire company and then apportions the profits and losses between the operating cells and the core cell under the agreed arrangements set out in the articles of association or in the other relevant agreements entered into by the company.

Any profits attributable to the individual cells, as opposed to the core cell, are computed on the basis that each cell carries on a separate business.

The tax compliance and payments can be complex. Amongst other things it affects the allocation of relief for operating losses and depreciation allowances. Business losses attributable to the core or to a particular cell are potentially relievable against the profits attributable to the core or other cells.

A payment by one cell to another or to or from the core for the benefit of being able to claim relief for these losses may be complex. In some cases, the receipt of income in one cell may result in other cells being taxed.

Comment:

A PCC offers statutory safeguards with respect to segregation of assets under the umbrella of a single legal entity, and also pools resources and reduces administrative costs. The PCC structure does not prejudice the creditors’ interests as it will be the same as if they were dealing with the cell as a separate company.

However, the statutory obligation to inform the creditors of the cell structure must be complied with to avoid them assuming that all the assets legally held by the company on behalf of the cells would be available to them.

PCCs were initially set up to allow formation of several offshore “rent-a-captive” insurance entities with separate assets and liabilities within one company. An external professional company owned and ran it, while each client had his own cell captive, which he rented.

Some of the other uses of PCC include applications such as collective investment schemes (e.g. umbrella funds or hedge funds), asset securitization, etc. For example, special purpose vehicles (SPVs) can be set up to deal with the separate pools of underlying assets or liabilities.

PCCs allow the segregation of ownership in different funds within an umbrella fund. PCCs are also used by insurance companies to isolate high-risk investments. Other applications include structured finance and similar capital market issues.

The concept of protected cell companies is relatively new and the legislation is largely limited to offshore jurisdictions. Some commentators are concerned that the Courts in many onshore countries, who currently do not have PCC legislation, may refuse to recognize the cell legislation in another country.

Therefore, it may not quite provide the ring fencing of assets and liabilities in such jurisdictions. Despite this legal concern new uses for PCCs are being developed, particularly where there is collective or group element.

Update: In 2006, Guernsey and Jersey introduced the Incorporated Cell Company (“ICC”). An incorporated cell company (“ICC”) is an extension of the concept of a protected cell company with several differences. An ICC is a company, which has within it incorporated cells or ICs.

An IC is a company in its own right. Unlike a protected cell company, each IC is ring-fenced by virtue of its separate legal existence apart from other ICs and the ICC itself. It is effectively a ‘company within a company’.

IOFC: Intermediary Entity # 15. Islamic Banking:

Recent years have seen a rapid growth in Islamic banking. This trend is expected to continue in future, particularly with the large cash surpluses generated by oil revenues in Muslim countries in the Middle East. One in four persons in the world is a Muslim with a global population of over 1.6 billion.

Besides the Middle East, there are large Muslim populations in South and South-east Asia (e.g. Indonesia, India, Bangladesh, Pakistan, Malaysia and Brunei). Today, Islamic banking is not confined to Muslim countries but has spread over Europe, the US and the Far East, drawing funds from both Muslims and non-Muslims alike.

Broadly, three Sharia rules set Islamic finance apart from conventional banking. Firstly, there is a ban on involvement with industries considered sinful, such as gambling and alcohol. Secondly, there is a ban on Riba, which means that Muslims are prohibited from taking or giving interest.

Thirdly, there is an injunction to avoid Gharar or excessive risk-taking. The Islamic financial system employs the concept of participation in the enterprise, using the risk funds on a profit and loss sharing basis.

Islam prohibits Muslims from taking or giving interest, regardless of the purpose for which such loans are made and regardless of the interest rate charged. However, it is more than simply “no interest”.

It covers all aspects of business and the way one earns income. Interest is Haram (unacceptable): its prohibition is commanded by God. A permitted transaction must involve an asset. It is not enough simply to give money and get more money back. Investment must also be ethical or socially correct.

Companies involved in gambling or casinos, companies involved in production, packaging or distribution of alcoholic items, banks, finance companies, insurance companies, pork-related companies and defence or ammunition companies involved in armaments are forbidden.

Islamic banking refers to banking activity consistent with Islamic law (Sharia) principles and guided by Islamic economics. As mentioned, the basic principle of Islamic banking is the sharing of profit and loss and the prohibition of interest (Riba). The Islamic concepts commonly used in Islamic banking are profit sharing (Mudaraba), safekeeping (Wadiah), joint venture (Musharaka), cost plus (Murabaha), and leasing (Ijara).

Many international banks today offer an Islamic alternative to a transaction, which would otherwise be unacceptable in conventional form. What would be a purely financing transaction is done in a manner which is Halal (acceptable), by restructuring it so that it conforms to Sharia rules.

Trading of tangible goods or assets is encouraged in Islam. Islamic mortgages may be offered based either on Murabaha or Ijara principles. In Murabaha, a financial institution buys and re-sells the home to the consumer immediately, accepting payment of the price over a lengthy period.

In Ijara, the institution combines a sale with renting the property to the consumer like a regular mortgage product whilst also complying with Islamic principles.

Thus, in an Islamic mortgage transaction, instead of the client borrowing from the bank to buy a house, the bank buys the house and rents it to the client. The bank retains ownership until the loan is paid while the client pays the purchase cost in instalments to the bank.

Similarly to provide a car loan, an Islamic bank either buys the vehicle and then sells it immediately at a higher-than-market price to the client on deferred payment terms, or retains the ownership of the vehicle until the full payment is received.

Under the fixed repayment term, the bank cannot give a discount for early payment or levy additional penalties for late payment. As the property is registered in the name of the buyer on purchase, the bank would normally obtain adequate collateral to protect itself against default.

While interest-based finance products do not comply with Islamic law, Islamic banking has developed several alternative financial instruments. In a Murabaha transaction, the conventional interest is effectively reclassified as capital gain.

A Mudaraba transaction is a profit sharing arrangement where the bank provides the venture capital finance and the investor provides the labour; both parties share the profits but losses are borne only by the investor. In a Wakala structure, the bank as the financier or Wakil legally acts as an agent of the investor.

Both parties share profits and losses in a Musharaka or joint venture. In recent years, Sukuk has been used by western banks to raise Islamic funds. It is a Sharia compliant bond instrument.

While it is possible to avoid interest in Sharia compliant transactions, they often lead to tax implications. Normally, interest is a tax deductible expense but equity is not. Islamic products may be treated as equity and not debt instruments, and the financing cost may or may not be tax-deductible.

The Murabaha sale price (including the bank’s profit) converts the interest income and expense into part of a capital transaction, and the capital gain may be taxable. Moreover, stamp duty may be levied on the sale by the bank to the customer at the higher Murabaha price.

Under Ijara, stamp duty is payable twice, once when the bank purchased the property and again under the transfer of title which gave ownership to the customer at the end of the transaction. Apart from conventional taxation, Islamic instruments also need to provide for Islamic tax or Zakat.

More than two-thirds of Islamic finance business currently originates in the Middle East. Bahrain has the largest number of offshore Islamic investment banks in the Muslim world. Several countries are encouraging Islamic banking institutions (Examples: Malaysia, Singapore, Brunei, Indonesia, Bahrain, United Arab Emirates, and United Kingdom).

The major markets for Islamic finance include Egypt, Malaysia, Turkey, Indonesia, Iran, India and Pakistan, as well as Europe and North America. In France, United Kingdom and the United States, Islamic communities form the second largest religious base.

This Islamic finance market is growing at an estimated rate of 15% to 20% per annum. Islamic products that are tax-neutral offer future growth opportunities for offshore financial centres.

IOFC: Intermediary Entity # 16. Offshore Electronic Commerce:

There are more than 100 offshore jurisdictions, which currently provide tax-free or low-tax regimes for e-commerce. The Internet enables many commercial activities that do not require physical market presence to be provided from in a lower cost/low tax offshore jurisdiction.

So far, they have largely focussed on activities, such as banking, betting and gambling and certain IT enabled services. However, there is widespread acknowledgement that in future this demand will create a shift from high-tax jurisdictions for many other types of activities.

E-business is redefining commerce, transforming industries and eliminating constraints of time and distance. The benefit of e-commerce is that a business may operate offshore using the Internet without the need to have a substantial presence in any one country.

For example, businesses that sell downloadable (e.g. digitised goods) products and services can reach a global market relatively easily without the overheads normally associated with them. In offshore e-commerce, the location of the computer server needs clear rules about the legal and tax issues involved in an electronic contract.

Many offshore centres have enacted laws that provide for legal recognition of electronic contracts, electronic writing, electronic signatures and original information in electronic form.

Data protection laws are also required to establish the principles that govern the collection, use and disclosure of personal information, such as accountability, identifying the purposes for the collection of personal information, obtaining consent, limiting use, disclosure and retention, etc.

The legal model contract provided by the United Nations Commission on International Trade Law (UNICITRAL) is commonly used. Its purpose is to enable electronic commerce to be put on the same legal footing as paper-based commerce, as well as to remove any legal impediments to the use of electronic communications.

On a technical level, the requirements of an offshore e-commerce operation require a server, adequate communications facilities, and various software services.

They include ISP & web hosting services, secure transaction facilities, e-commerce software expertise, website development, and corporate services such as tax advice and company formation. Particularly important is the communications infrastructure and the availability of high quality, relevant technical services.

Internet is essentially distance insensitive. As mentioned, e-commerce trading operations do not require a fixed place of business in foreign countries since customers can order goods by accessing the seller’s website over the Internet.

Companies who sell products that are, or can be, stored in digital format can transact electronically. Internet also removes any geographical barriers to basing the business offshore.

The size and value of goods sold has no bearing on e-commerce as delivery management can be automated with instructions automatically transmitted to the location where the stock is held once payment clearance is confirmed. Using an offshore location can also reduce infrastructure costs, such as office space and distribution expenses, and ensure worldwide service to customers, around the clock.

Therefore, electronic commerce presents a trading model for global enterprises. It enables businesses to offer products and services over the web. Products can be displayed to customers through a database-driven online catalogue, which is integrated with the back-office functions of stock control and warehousing. Online ordering can be integrated with an order entry system.

Electronic payment systems enable credit card payments using online clearance through a payment service provider. Other benefits include lower overheads associated with paper-based processes and a faster, more responsive service to customers.

Once the value of an electronic or information good or service has been established, the marginal cost of marketing, producing and transmitting an online product is relatively low.

A whole range of retail financial services, such as electronic banking, can also be provided from offshore using the Internet. Some of the other functions include treasury management, travel and transport services, publications including books, magazines, newspapers, directories, betting and gambling operations, professional services, distant learning courses, etc.

They may be provided to a customer in a high-tax area without incurring local import duties, VAT or sales taxes.

Offshore providers also benefit from other competitive advantages, such as:

i. Profits are less highly-taxed, or untaxed, allowing cheaper products.

ii. Offshore jurisdictions are usually less highly regulated than high-tax countries, and provide more flexibility in planning, marketing and delivering products.

iii. Financial products can take advantage of a low-tax environment to deliver higher returns to customers.

iv. The cost base of an offshore location is often more favourable than that of an onshore location.

Relocating e-commerce activities may require tax planning using tax treaties. It may be possible to avoid tax in the high-tax country particularly for trading transactions, since simple warehousing and delivery functions are usually not enough in many countries to create a taxable presence under a tax treaty.

However, many offshore financial centres in base havens do not have double tax treaties, not least because they usually have very low or no taxes. Some companies may avoid tax by earning profits in subsidiary companies in offshore centres and not remitting them to the parent company. Many high-tax countries have controlled foreign company laws as well as transfer pricing rules to counter such tax avoidance.

Besides technical facilities/support and tax, practical considerations in selecting an offshore centre for e-commerce activities include a strong regulatory regime and political stability, and an appropriate business infrastructure. As the popularity of the Internet increases in future globally, e-commerce opportunities offer a major growth opportunity for offshore financial centres.

IOFC: Intermediary Entity # 17. Film Production Company:

Certain jurisdictions provide special tax incentives for film production companies, and grant tax concessions for pre-production expenses. (Examples: Australia, Guernsey, Ireland, Isle of Man, Liechtenstein).

IOFC: Intermediary Entity # 18. Limited Liability Company or Limited Duration Company:

Many offshore jurisdictions permit limited liability company (“LLC”) or limited duration companies (see Glossary). Another recent development is the availability of limited liability partnerships, which restrict the liability of partners (“LLP”).

IOFC: Intermediary Entity # 19. Bond Marketing Company:

Bond marketing companies raise loan capital or debt finance from foreign investors for use by the parent company. They are set up as a subsidiary in an offshore financial centre, which does not levy any withholding tax on the interest paid to nonresidents.

The treaty with the parent country ensures that no withholding tax is deducted on the interest paid to the subsidiary. As a result, the interest can be paid to the investors abroad with no tax withholding. The commonly used jurisdictions include Denmark, Luxembourg, Netherlands and Netherlands Antilles.

IOFC: Intermediary Entity # 20. Foreign Exchange Loss Conversion Company:

Certain countries do not permit the tax deduction of exchange losses on the repayment of a foreign debt. It is possible to establish a foreign exchange conversion subsidiary in an offshore centre to claim this deduction.