In this article International and offshore tax specialist Daniel Feingold outlines most commonly found issues with setting up and using an offshore company
1. Withholding Tax
It is important to understand that most countries have what is called a withholdingtax on rental income.
The agent or the tenant is normally obliged to deduct this tax and pay it over to the local tax authority. In practice, this sort of informal withholding is collected by the property owner having to pay the withholding tax over to the local tax authorities when filing their annual local tax return.
Another type of withholding tax is usually due, when you sell your property.
The property purchaser is obliged to withhold, 5% or 10% of the purchase price. This is handed directly over to the tax authorities in the country where the property is situated.
Examples of this include Spain where the purchaser must withhold 5% and the US where the purchaser must withhold 10% of the purchase price.
In both situations the only way to get the money back if your capital gains tax is less is to file a local tax return.
Offshore Companies do not avoid withholding taxes either on income or capital gains.
The other factor that is often missing in the advice that people are getting in these standard solutions is the UK tax perspective.
They can sometimes avoid Inheritance taxes.
The one tax they are usually good at avoiding is local wealth taxes, because these are applied only to individuals.
However the cost or running an Offshore Company is often as much as the annual wealth taxes!
2. Don’t forget the UK Tax Perspective
It is all very well if your company can avoid local taxes supposedly, but you need to understand the UK tax law as well.
Offshore companies can create many UK tax problems – remember this!
There has been a long history of attack on the use of offshore companies. After all, if it was so simple to use offshore companies, then the use of onshore local standard UK companies wouldn't be such a regular occurrence!
3. The Anti-Avoidance Rule
When using an offshore company, it is also vital to understand that there is an anti-avoidance provision, which is now called section 739 of the Income and Corporation Taxes Act of 1988.
This is an anti-avoidance rule going back to 1936.
The objective of the rule is basically to look through any transaction where a person transfers their rights or their money to a person based outside the UK.
This can involve the transferring of rights or money to a company, trust or an individual with the objective of avoiding UK income tax.
This means that even if you set up an offshore company, then the rental income that is coming through that offshore company could still be taxable on you in the UK using this anti-avoidance rule and therefore be subject to UK income tax.
In other words, the offshore company will have no affect whatsoever for UK income tax purposes.
4. Charging of Capital Gains to Shareholder
There is also a parallel provision for capital gains tax that is section 13 of the Taxation of Chargeable Gains Act 1992.
This provision creates a “look through” if an offshore company sells a property for instance, and realizes a capital gain, and a UK shareholder has at least a 10% interest in that company.
The legislation will attribute a corresponding proportion of the capital gain the company makes to that individual. In other words, a “look-through”.
Even if you simply put the shares in the name of your wife and your children, it will not work because the legislation will “look-through” that and charge the tax on you..
Every UK resident shareholder will end up getting a tax bill when the offshore company sells the property. The effect is there will be no tax benefits whatsoever for UK capital gains tax purposes from using an offshore company.
5. Central Management & Control
Another very common and key problem with offshore companies is a concept of English tax law that is known as central management and control.
This is an approach that the HMRC are using more and more.
If an offshore company only has UK directors and it is run from the UK then HMRC will argue that the company's residence is actually in the UK for tax purposes. This is because its central management and control is in the UK and therefore it should be taxed like a UK company.
This means that if the company receives rental income then it will be charged to UK corporation tax.
There has been a case on this issue of company residence, the “Wood and another v Holden” case, which has just been decided (on 26 January 2006) in the Court of Appeal in favour of the taxpayer. However as things currently stand we do not know whether the HMRC are taking the case to the House of Lords.
The basis of this ruling shows that if a company is genuinely run from abroad then it will not be resident in the UK, but the strategies used by the company to achieve this are unlikely to be practical for the average property investor.