Tax planning abroad - problems and challenges

Process of business planning by Russian businessmen has long began to include use of foreign enterprises. These enterprises can be classified according to two main characteristics of activity.

The first implies "offshore" companies, and the second ones are "onshore" companies.

It is necessary to immediately point out that this division is more conditional, but nevertheless, it can help to understand many foreign jurisdictions, at the time of approval of foreign cooperative mechanism.

Distinction and features of offshore and onshore enterprises.

Lawyers of Law&Trust International have been working in the field of tax planning abroad for several years already and will be able to help you with your business abroad, as well as answer all your questions.

Offshore jurisdictions have the following features:

• low image component. Enterprises that are registered in offshores usually have a negative reputation;
• lack of any taxation for businesses that do not operate within a particular jurisdiction;
• not approved Double Tax Treaty between the Russian Federation and offshore jurisdictions;
• taxation in offshore jurisdictions is replaced by annual fixed fees. The fee for the renewal of which is set at the rate within a few hundred dollars;
• in the public information plane there are no data on the managers and holders of shares;
• there is no obligatory condition to make out the accounting documentation according to the established standards, and also to submit it to the appropriate authorities.

Onshore jurisdictions include the following provisions:

• a high reputational component of enterprises, places of registration of which are onshore jurisdictions;
• compulsory taxation is provided for tax residents (enterprises) within the framework of onshore jurisdiction;
• there is a need to keep accounting documentation and submit it to the appropriate authorities;
• presence of the Double Taxation Avoidance Treaty between the Russian Federation and almost all onshore countries;
• there are data on managers and holders of shares in public access.

Such a concept as "offshore" has long been a part of doing business abroad and finds its reflection in many regulatory acts of Russia.

"Offshore zones" concept can be found in the provisions of the Tax Code of the Russian Federation, that implies countries that have a preferential taxation regime and also do not provide data and other information in financial transactions.

It is worth noting that the term "offshore" itself as a general complex of the above features is essentially irrelevant, since according to the RF Tax Code, only those jurisdictions that fall under offshore zones are those that correspond to the list approved by Order No. 108n of the Ministry of Finance of the Russian Federation of 13.11.2007.

So it does not really matter whether they fall under features of an offshore or not, the main thing is that they are on this list.

Hence, proceeding from the above, according to the Tax Code of the Russian Federation, for example, Cyprus, which is a member of the EU, and with which Russia has an Agreement for the avoidance of double taxation, is not an offshore zone.

In calculating possible risks associated with operation of offshore and onshore companies based on what we have already studied, we can conclude that there is no clear determination which zone is better, and each has own advantages.

For the purpose of more practical presentation of the material, we will use the term "offshore relations" in the text below, which means relations associated not only with offshore companies, but also with onshore enterprises.

As for participants in offshore relations, the following number of subjects can be distinguished among them:

1. Beneficial owners, as well as their authorized persons.

Beneficial owner of an offshore company is one owing an enterprise and who is a beneficiary from the activities of this enterprise. It is worth noting that beneficial owner should also not just a beneficiary, (if he is a minor), but also be an operating subject of management, for example, acting as a shareholder or director.

2. Employees or authorized persons of beneficiaries are the same employees of Russian enterprises, who in fact manage offshore companies, various managers and so on.

Those who belong to this category are initially exposed to the fact that there is a high probability of financial losses. There are also possible other difficulties in this area, depending on the involvement of this type of subjects in the company's activities, which we will consider below. Beneficiaries have possible risks even in their relations with shareholders, managers and responsible intermediaries.

We can present another group as the core of an offshore company, and these are its shareholders and managers.

Offshore enterprises can be involved in order to perform various functions in the field of entrepreneurship. It can be an enterprise that is a holding company, or it can sell services, goods or perform some type of work. Also, an offshore company can be used to save personal assets, as well as to hide data about the current owner of the enterprise.

Of course, an offshore company can interact with foreign counterparties or counterparties from the Russian Federation.

An enterprise bears risks that accompany tax legislation, and it is necessary to take into account the foregoing. If a company is registered in offshore, this factor can cause a number of checks both from banks, and from customs authorities and counterparties.

In the event that the same person is a beneficiary and a shareholder, then possible liability for this person is in form of financial risks and occurs much earlier than for the other persons.

Jurisdictions of a number of countries in this case provide for subsidiary punishment, which is borne by a shareholder due to debt of an enterprise, for example, in bankruptcy. Other possible risks depend on his involvement in management of an enterprise.

Director of an offshore company is a natural person or legal entity that acts as a fictitious, dummy figure, or someone who actually manages a company.

This person, as main person of an enterprise, is responsible for all the activities of the enterprise, thus, he can be prosecuted for administrative as well as for criminal violations. In addition, under bankruptcy, or other financial troubles, he is assigned with subsidiary financial responsibility.

It is also worth paying attention to such a figure as a "shadow director".

The foregoing means someone who is not a director by himself, but manages an enterprise in real time. If an enterprise is managed by a shadow director, then it is revealed when his enterprise inflicts harm to third parties in form of non-payment of taxes or failure to comply with the norms of a contract, and nominee director of this enterprise reports his nominee position in order to avoid punishment. In this case, shadow director will be treated as an ordinary director for the purpose of punishment and prosecution.

An attorney of an offshore company is a person that in most cases performs his work according to a general power of attorney, but it also happens that this power of attorney is issued only for certain legal transactions or deals.

What about the risks, they depend on his involvement in a company's activities, and they are similar to the risks of a shadow director of an offshore company.

Counterparty of an offshore company may be natural persons or legal entities that have formal contractual relations with an offshore company.

Counterparties are highly dependent on the norms of currency, tax and antimonopoly legislation, which implies their connection with relevant risks. Above can include the content and execution of business operations, role of tax agent, checking a counterparty and so on.

The above-mentioned subjects are obligatory subjects of offshore relations, but not key ones, as their functions are more of administrative type, helping to ensure work of enterprises. So it is logical to further explore what kind of risks they provide for other offshore entities, namely beneficiaries of offshore companies.

As for offshore services market, and specifically its professional persons, it is necessary to distinguish the following.

Shareholders and nominee managers (directors) are a sequence of subjects that are noted in the registers of shareholders and directors that manage an enterprise in favor of beneficial owners.

Beneficiaries are at the same time at risk of losing control over a company in the event of illegal actions by nominee persons.

Further, there are professional intermediaries, that are enterprises registering offshore enterprises and keeping them.

Professional intermediaries usually act as shareholders and nominee managers, so the risks for beneficiaries and them are similar.

As for the types of risks and liabilities that are borne by offshore participants, here we can note the following:

• financial risks entailing possibility of financial and property deprivation;
• administrative risks. Entire danger is connected with responsibility provided by administrative and tax legislation. Possibility of restrictions and administrative prohibitions is also present;
• reputational risks. Risks, most often manifested in disclosure of an offshore status of enterprises;
• risks of criminal liability and possible deprivation of a company.

If to consider the highlighted risks in more detail, then it is necessary to start with financial risks.

The most popular financial risks are of two types:

1) When unforeseen tax liabilities arise during the analysis of taxation issue.

Such a system of risks is most typical for those countries where taxation is developed at a high level: the Netherlands, Switzerland, Great Britain. In addition, risks are also noted in the fact that offshore enterprises enter into transactions with enterprises that are registered in the territory of these countries.

In this situation it is necessary not only to be aware of tax legislation of this state, but also to thoroughly study behavior of auditors that will conduct analysis and research a company's business activities.

Above will concern not only tax deductions, but also the very nature of economic transactions that could be concluded with the purpose of "laundering" finance. In this case, it may entail not only financial but also other consequences.

Also, you should always study in detail the legislation of a country of registration of an offshore company, and analyze counterparty firms that can be transformed as tax agents.

For a better understanding of the situation, let's give an example. There is a Swiss company, and according to its activities, it must make payments to a firm YHU for a certain range of services provided. But Swiss company prepares these payments as expenses while forming its tax base so that income tax is reduced.

After audit, tax authorities re-qualified these deductions in favor of YHU as payments in favour of beneficiaries of Swiss enterprise. This ended with the fact that deductions were taxed on dividends at a rate of 35%, payment of which was attributed to Swiss company, and its tax base was increased by withdrawing payments towards YHU firm.

2) Disadvantages of transactions, which include foreign companies in regular order, lay in violation of the norms of legislation, as a result of which transactions can be recognized as invalid and losses may occur within the limits of an agreement with counterparties.

When studying the provisions of Russian legislation, it is necessary to pay attention first of all to the whole system of restrictions, which is formed by Russian norms for foreign enterprises.

Rules of the laws of foreign jurisdictions inform about a different kind of restriction that is reflected in corporate norms of different jurisdictions, which fix an order and established form of transactions.

When onshore enterprises are considered, managers usually study documentation that is given to them for signing, and then if he refuses to endorse given transaction, if it causes fear or is not subject to the activity of an enterprise, consequences can be transformed into lost profit assets for an enterprise.

Therefore, beneficiaries and their offshore enterprises are the most vulnerable to financial risks.

Next, we will consider the most common risks associated with administrative liability.

To begin with, administrative responsibility in connection with violation of the norms of both domestic legislation of the Russian Federation and violation of legislation of other states can be referred to.

As for Russian legislation, an offshore company may have problems in the event that office of an offshore company on the territory that is under the control of Russian jurisdiction, personnel operates there or production is under way there. A good example of above would be a violation of the norms of the Code of Administrative Offenses of the Russian Federation regarding procedure for registering an enterprise with tax authority, that entails a fine. Or, it could be non-presentation (non-reporting) of information necessary for implementation of tax control. Another good example is violation of currency legislation of the Russian Federation and acts of the bodies of currency regulation.

Basically, individuals or legal entities are punished for this type of violation in the form of a fine, and limitation period for bringing to responsibility in accordance with the norms of the Code of Administrative Offenses of the Russian Federation is one year from s date of commission of an offense, and for those violations that still in duration, term is counted from the moment of detection.

Subjects of these violations are legal persons, that is, enterprises themselves, as well as natural persons, officials.

According to the Tax Code of the Russian Federation, offshore enterprises bear a tax liability when they have tax liabilities under the law.

If a company carries out its activities in the territory of the Russian Federation, is not registered for tax and accounting according to the Tax Code of the Russian Federation and, accordingly, does not pay taxes, then it naturally incurs all liability that is provided for by law.

It is also worth noting such a norm of RF legislation as "Failure to keep and (or) transfer taxes by tax agent", which is indicated in Article 123 of the Tax Code. According to this rule, Russian counterparties also fall under tax liability, which, when deducting profits from a subject in Russia in favor of an offshore firm, do not make deductions to the budget, when the foregoing is provided by law.

For example, there is a firm that is registered on the territory of the Russian Federation and it has received a loan from a Cypriot enterprise, when a Russian citizen put his signature from Cyprus part. Further, Cypriot company receives interest on this loan without paying taxes to the treasury of the Russian Federation, according to Art. 11 of the Agreement between the Government of the Russian Federation and the Government of the Republic of Cyprus dated 05.12.1998 "On avoidance of double taxation with respect to taxes on income and capital".

But, tax authorities of the Russian Federation concluded that permanent representation of agency type was formed in accordance with Clause 9, Art. 306 of the Tax Code of the Russian Federation under the wing of Cypriot office. According to this, a tax was to be paid to the budget of the Russian Federation at a rate of 20 percent, when Russian firm paid a percentage of profits to Cypriot enterprise.

As a result, Russian company was charged with a late payment fee and fined.

As to terms of bringing to responsibility, then it is three years from the moment of committing a crime, and for those tax violations that are stipulated by Art. 120 and 122 of the Tax Code, starting from the first day after the end of tax period.

Regarding administrative restrictions, they take place in presentation of internal rules of law of specific states. Administrative restrictions may be bringing to different types of liability or other costs that we considered above.

With regard to offshore enterprises, administrative restrictions are seen in a number of the following laws: Federal Law No. 117-FZ of August 20, 2004 "On the accumulative mortgage system of servicemen's housing", where it is stipulated that an offshore zone can not be a place of registration of asset holder; Federal Law No. 111-FZ of July 24, 2002 "On Investments" and Federal Law No. 395-1 of 02.12.1990 "On Banks and Banking Activities", which prescribes a special procedure for banking transactions with banks of offshore zones. Other types of such restrictions are tax restrictions. So, in some CIS countries, a tax rate was fixed, which is withheld by a local firm at the source with each deduction to an offshore company.

Also, in theory, sanctions may be imposed on local firms when processing transactions with offshore companies. But, it is not necessary to worry, these mechanisms are practically not applied by the state bodies due to violation of the main ambushes of freedom of civil turnover.

In this type of situation, both counterparties and offshore companies act as subjects.

Reputational risks. This kind of risks are considered the highest for owners of offshore companies. Companies that operate in offshore jurisdictions are doomed to have a negative reputation in the eyes of counterparties and government agencies. Although these risks do not entail legal responsibility, this type of risks can significantly affect the activities of an enterprise and its relations with other persons.

Restrictions associated with reputational risks include:

• possibility of rejection from joint activities and transactions with offshore companies by counterparties. It can come out of corporate policy of a company, or general policy of the state about offshore jurisdictions, and companies that are registered there;
• customs restrictions. Here the problem lies in the system of filling in customs declarations and processing of goods that cross the state border on behalf of offshore suppliers, which entails customs adjustments to the customs value.
• bank restrictions. The central bank of the Russian Federation and Rosfinmonitoring exercise constant control over transactions that offshore companies perform through Russian banks. In order to ensure own security, banks are more attentive to such operations and may even lay down unreasonable demands and request additional documentation.

So, in a letter of the Central Bank of the Russian Federation of March 13, 2008, No. 24-T "On raising the effectiveness of work to prevent questionable transactions", there is a request to more carefully implement Russian banking facilities for export-import transactions involving those non-residents that are registered in offshore zones and at the same time they have accounts in the banks of Estonia, Cyprus, Latvia and Lithuania.

As for the possibility of losing control over enterprises, we note the following. We have already discussed the fact that administration of foreign firms is associated with the possibility of using service firms and their services for registering and supporting the work of an enterprise, as well as providing fictitious, nominee directors and shareholders.

Services of professional and experienced intermediaries are always requested even with actual management of an enterprise by its director and availability of shareholders.

Intermediaries perform different types of work, acting role as a separate registering entity, which documents all relevant changes in the work of an enterprise, as well as representation of interests on behalf of an enterprise in the state of registration.

At the same time, beneficiaries risk losing control over management of an enterprise. "Safeguards" and guarantees for such sad consequences are trust documents that legally formalize relationship between a beneficiary and nominee persons. The foregoing can be a declaration of a nominee director, a trust declaration, as well as an agreement that establishes the rights and obligations of these subjects. For example, a service contract.

Reputation of an intermediary company in the financial market, as well as positive feedback, will help you make the right choice of a professional and quality intermediary.

Criminal risks. The main criminal legal risks stem from a composition of committed crimes, which are enshrined in the Criminal Code of the Russian Federation.

Thus, Article 199 of the Criminal Code of the Russian Federation "Evasion of payment of taxes by an organization" contains the risks that arise in this situation: in the event that a foreign enterprise after its activity in the territory of the Russian Federation has a duty to pay taxes to the treasury of the Russian Federation and if the firm does not provide tax declaration or other documents provided for by the tax legislation, or if it introduces false data there, these actions, coupled with large non-payment of taxes, involve bringing to criminal liability.

According to the law, subjects who commit such crimes and are criminally responsible may be any person who has reached the age of 16. It can be either managers or shareholders, as well as those who acted as organizers, accomplices or instigators of this offense.

It is also worth considering the risks provided by Art. 199.1 of the Criminal Code of the Russian Federation. Responsibility for violation of this rule arises if enterprises that are registered on the territory of the Russian Federation make financial allocations towards a foreign firm, when these taxes should be paid to the budget of the Russian Federation.

In case of deliberate non-payment of this tax in a particularly large amount, criminal responsibility is provided in the form of a fine in the amount of from one hundred thousand to three hundred thousand rubles or in the amount of a wage or other income of a convicted person for a period of one to two years, or forced labor for up to two years with deprivation of the right to hold certain positions or engage in certain activities for up to three years or without the foregoing, or arrest for up to six months, or imprisonment for up to two years with deprivation of the right for to hold certain positions or engage in certain activities for up to three years or without it.

Subjects who, according to official documents, are responsible for calculating taxes bear responsibility for this type of crime.

One of the most popular crimes of this category is tax evasion by an individual, which is stipulated in Art. 198 of the Criminal Code of the Russian Federation.

If a subject receives profit from a foreign firm and does not declare it, or declares it in a smaller amount, then there are no necessary tax deductions to the budget of the Russian Federation accordingly. When these actions are performed in the form of non-payment in a large or especially large amount, criminal responsibility is provided, which is prescribed in the sanctions of Article 198 of the Criminal Code of the Russian Federation.

Subjects that are responsible for this crime are persons who at the time of an offense were sixteen years old, who did not declare their income or did not declare it in full, and did not pay tax on it.

Articles 174 and 174.1 of the Criminal Code of the Russian Federation provide for liability for legalization of criminal proceeds.

Responsibility for violation of this norm comes in the event that legal entities and individuals in the territory of Russia perform activities together with foreign enterprises, while their financial means or other property was obtained by criminal means, and activities of these entities were directed to provide them with legal status, or use illegal finances and property for any business or economic activity.

Arising questions on this norm are well interpreted in the Resolution of the Plenum of the Supreme Court of the Russian Federation of November 18, 2004, No. 23 "On judicial practice in cases of illegal entrepreneurship and legalization (laundering) of money or other property acquired through criminal means".

But, it is worth noting that failure to perform duties of tax agent, or if above funds were obtained as a result of tax evasion are not subject to Articles 174 and 174.1 of the Criminal Code of the Russian Federation.

Responsibility for legalization of criminal proceeds is for persons who participated in economic activities with property acquired by criminal means and who reached the age of 16.

Let us give an example. An enterprise “Yantar”, which did not have a license from the Central Bank of the Russian Federation, represented itself as a financial and credit organization. According to the instructions of managers, employees who were knowingly aware of the absence of a license made internal and external monetary transactions in cash and non-cash settlements. Action of all subjects of this scheme falls under part 3. of Art. 174 of the Criminal Code of the Russian Federation (amended as of June 13, 1996) as legalization (laundering) of money acquired illegally, that is, performance of financial transactions and other transactions with funds acquired knowingly by illegal means, as well as use of these funds to carry out entrepreneurial and other economic activities, committed by an organized group, on a large scale. (See cassational ruling of the Supreme Court of the Russian Federation of June 13, 2006 in the case No. 5-о06-23).

The last norm that we will consider will be Art. 193 of the Criminal Code of the Russian Federation, which provides for non-return of funds in foreign currency from abroad.

This article deals with actions by which an enterprise that is registered on the territory of the Russian Federation pays a foreign firm for goods, which is in the documentation, but has not really been delivered, or for services that were not really implemented. An obligatory element is non-return of financial means, as a result of which a "full" crime occurs.

The risks for these actions are borne by the managers of Russian enterprises.

In conclusion, it can be said that responsibility for consideration of offenses, as well as composition of their participants, is similar for both illegal activities of onshore and offshore enterprises. Of course, onshore and offshore jurisdictions have significant discrepancies. Thus, offshore jurisdictions are much easier to examine, pay taxes, and maintain documentation. Negative side of offshores is numerous risks, accompanied by loss of reputation, as well as deductions, which are unprofitable for those who are not going to work in offshores with large financial turnover. Onshores, for their part, are more "legal", and conducting business there means to have a good reputation both for state bodies and for other enterprises.

For any questions of tax planning and optimization, Law&Trust International is ready to provide highly qualified support.