STEP

Title Research

Sophisticated solutions

  • Author : Joseph Field
  • Date : July 2010
ABOUT THE AUTHOR: Joseph Field TEP is Senior International Partner and Senior Resident Partner – Asia at Withers Bergman

T he view of offshore finance centres is very different in Asia than it is in Europe or North America. While there are a number of Asian countries, only a very few have sophisticated tax systems, and of the ones that do, tax ‘lite’ seems to be the rule rather than the exception. Hong Kong and Singapore impose income tax at under 20 per cent on domestic income, and no tax on offshore income (whether or not remitted). There are no death duties. Taiwan has traditionally not taxed offshore income (although it has begun to from this year), and while South Korea and Japan tax heavily, tax planning is very limited and thus the use of offshore centres is somewhat exceptional. Most of the rest of the countries in Asia have relatively unsophisticated tax systems and residents often invest abroad paying little or no tax.

Recently, Hong Kong and Singapore have signed agreements with the OECD promising to upgrade their international tax cooperation, but what the effects of this will be remain to be seen. Hong Kong has already begun to implement the entry into force of exchange of information agreements, but since it only has data on domestic taxpayers’ domestic income, the value of such agreements is somewhat open to question. Singapore is moving more slowly in implementing the OECD guidelines.

Offshore companies

As a result of the relative simplicity of the Asian tax regimes, the use of offshore companies is flourishing in Asia, and many jurisdictions that have a less than savoury reputation in the West are well thought of in Asia. Indeed, many of the Pacific jurisdictions are widely used by Asian investors because they are proximate in terms of geography and time zone, particularly when compared to European centres. Nonetheless, my personal suspicion is that the most popular offshore jurisdiction remains the British Virgin Islands, which has become almost a generic term for offshore jurisdiction. Many clients come to us and ask us to form a ‘BVI’ not knowing where the BVI is, but simply wanting an offshore company.

Why do people in Asia use offshore companies? For many of the same reasons that other people do; limited liability and anonymity. The preservation of anonymity is highly prized in the East and Asian families will go to great lengths to preserve their privacy. Often, layers of offshore companies are employed to insure that the identity of beneficial owners is preserved. This is a feature that is of much greater importance to Asians than perhaps to other investors. The notion of tax evasion is not inculcated into the Asian mind because in many places, there is no tax on the assets owned by offshore companies, and the concepts of ‘level playing fields’ and ‘tax equality’ are meaningless. It is for this reason that the negative fiscal reputation of many offshore jurisdictions is not of any great relevance in many Asian countries.

Possible problems

While there are cultural, legal and social differences among Asian communities, the use of offshore companies – and particularly BVI companies – is almost universal. In most instances, this type of operation proceeds smoothly, but problems do arise. Increasingly, as these types of entities are used for international investment, issues relating to ‘thin capitalisation’, ‘sham corporations’ and inappropriate ‘self-dealing’ are beginning to appear, and often, when such companies are created, investors may not appreciate that in the event of trouble, either in the country of investment, or in the event of litigation, that these issues may arise and create serious problems.

A second major issue which is often ignored is probate. While probate is a concept that is well understood in India, Hong Kong and Singapore, where the English system of justice prevails, it is unknown in Shari’ a (Islamic law) and civil-law countries. As a result, when investors from such countries purchase an offshore company (particularly in a former or current British territory like the BVI), there is often a great deal of surprise expressed when it is explained that upon the death of the founder of the company, the shares may be ‘locked up’ in court in a public judicial proceeding for as long as three years. For many clients, the use of trusts or foundations to hold the shares of these companies becomes a far more interesting exercise.

A final issue which is becoming far too common in using offshore companies relates to litigation in far away and often poorly understood jurisdictions. It is apparent enough that where people use special purpose vehicles (SPVs) created in the Bahamas, Jersey or the BVI that should commercial problems arise, it is likely (unless otherwise provided in the contract, itself) that recourse will be solely to the jurisdiction where a company is founded. This is particularly true where two companies have a dispute and both are incorporated in say the BVI. Often, Asian investors (and particularly those who do not come from a common -law jurisdiction) are surprised at the complexity and cost of such litigation.

New complexities

While there may be a number of generic problems which are beginning to emerge for Asian investors with respect to the use of offshore companies, there are also a number of new and complex problems which arise as a result of the prosperity and broadening horizons of these investors – particularly when the investment is industrial, rather than passive in nature. Specifically, when a Hong Kong manufacturer of children’s clothing decides to build a plant to process cloth in Hungary, or distribute their wares in Western Europe, they may be confronted for the first time by an onerous and complex tax system. This problem may become much more complex when it is suggested that instead of going ahead with simply opening up a distribution centre in Paris, that it may make more sense to have, for example, a Spanish holding company and several national companies, or indeed that it may be reasonable to set up an international trademark company and to charge a royalty for the use of the trademark, thus reducing the taxable income of his European operating companies.

On a more personal note, the acquisition of family homes in the United States, the United Kingdom, Italy or France can pose a whole range of unanticipated problems. Death duties are not widespread in Asia, but they certainly exist in Europe and the United States. Often, it is relatively easy to avoid these onerous charges, but sometimes the cure is worse that the illness. This is particularly true where there may be some rental income involved. In Continental Europe, forced heirship rules are often not understood and upon the death of the owner, family members may be surprised to learn that there may be obligations to distribute a significant part of the property in question in equal shares to children.

More recently, tax rules in the United Kingdom, and as of this year in the United States, may require children occupying or using property owned by the family or by trusts the family has created, to pay an annual ‘use tax’ for the privilege of benefiting from such structures. In the US, this can also involve complex reporting obligations, as well.

Sophisticated solutions

While it may well be that for many families in Asia, the issues confronted by offshore centres over the last ten years are of little or no interest, they are nonetheless part of the world, and as offshore jurisdictions come increasingly under the microscope, it will affect how Asian families use these structures to protect family wealth or investments. As noted, there is a real sensitivity to confidentiality and as the protections traditionally offered offshore disappear, the use of more creative and somewhat more sophisticated solutions have appeal in Asia. It is not so much that the offshore world has lost its appeal, but rather, these countries may not be able to offer what they once did and more sophisticated solutions onshore may well offer a better alternative.

There will always be a demand for a simple BVI holding company in Asia, but increasingly, the demand for onshore solutions, particularly involving tax saving structures established in more traditional onshore jurisdictions, will increasingly find appeal.

As much of the world’s wealth moves to Asia, Asian investors will play an increasingly important part in the world’s economy. As their investment reach extends to more established economies, the use of both simple offshore and complex offshore and onshore solutions will also grow. Asia, for the most part, has a highly sophisticated and Western-educated class of next-generation planners and administrators, and many of the structures we use today are likely to be expanded and moulded by the rising class of young Asian entrepreneurs.


Advert

Article Search

Browse jurisdictions by clicking on the map regions below

© 2010 Society of Trust & Estate Practitioners