Suppose that you have a business company registered in a foreign country located on a small island in the middle of nowhere. Should you report this fact as this: ‘I have a foreign company’ or as this: ‘I have an offshore company’? The phrases ‘offshore business’, ‘offshore company’, ‘offshore bank account’ and other phrases containing the word ‘offshore’ may sound suspicious to some people. They will hear negative connotations in such phrases.
Geographical and economic meanings of the word ‘offshore’
Why is it so? It is the legacy of the past. In the geographical sense, an offshore country is a country sitting of the shores of the continents, an insular country, plainly speaking. However, somewhere around the middle of the 20th century, the word ‘offshore’ acquired an economic meaning in addition to the geographical one.
How did that happen? Small insular countries often struggle for natural resources because their territories are rather small. The sea and the favorable climate allow the people of the countries to feed themselves but they do not exactly prosper. We will put it in plain words again: many island states are quite poor (but not all of them and this is worth bearing in mind). This means that they need foreign funding badly and their governments do everything they can to attract foreign investments.
Instruments for attracting foreign investors: zero or low taxes
What instruments did insular countries use for attracting foreign investors? One of the most powerful instruments was offering the foreign investor a highly favorable taxation system. ‘If you register a company in our country’, said the Government, ‘we will charge you no taxes at all’. Doesn’t such a proposition sound attractive for an entrepreneur whose home country takes away one third, one half, or even more than half of his/ her earnings as taxes?
Some offshore countries charged zero taxes while others charged low taxes but they had to benefit somehow from the foreign investor, didn’t they? Therefore, they obliged foreign company owners to pay company registration fees. Besides, the company registration had to be extended every year and thus the fee was due every year. The offshore country did not get much from the foreign entrepreneur but it got at least something. The entrepreneur, in his/ her turn, also benefited greatly because much less money was payable in taxes. Guess who was on the losing side? It was the entrepreneur’s home country’s fiscal authorities. They could not rip him/ her off any longer because the company that he/ she was using for making business deals was located in a foreign jurisdiction. Thus, their revenues decreased.
Instruments for attracting foreign investors: lax reporting requirements
When you can legally pay nothing or little in taxes, it brings you lots of positive emotions so this opportunity was really attractive for foreign investors. Other instruments that offshore countries used to entice foreign entrepreneurs were probably a bit less powerful and a bit more questionable but they used them anyway. If a company domiciled in a certain jurisdiction is not liable to any taxation in this jurisdiction, why should it bother reporting its financial operations to the authorities of the country? It would make no sense.
Now, if you do not have to report your international business operations in the country where your company is registered, you might be tempted to skip reporting in those countries where the reports need to be filed, in accordance with their legislations. An important condition has to be satisfied, however, for you to be able to avail yourself of this opportunity. Namely, nobody should know that you have an offshore-registered company and you use it for making international business deals. This brings us to the last main advantage that offshore countries used to offer even though they are unable to do so any longer.
Instruments for attracting foreign investors: confidentiality of personal information
Previously, the company owners’ personal information was highly confidential if their companies were registered offshore. The same goes for offshore bank account holders: no-one outside the jurisdiction knew that they had offshore bank accounts. As was to be expected, this opportunity attracted those who wanted to evade taxes and those who had to launder criminal money.
The international community tolerated the fact for some time but then a global fight against terrorism started. The fact that some offshore zones were used for laundering money to finance terrorists was absolutely intolerable and thus an international de-offshorization campaign was launched.
The second reason why the campaign was started was somewhat less noble. The fiscal authorities of large countries were unhappy to see billions of tax money passing by and ending up in the pockets of the entrepreneurs and in the treasuries of small island states. Thus, they decided to make the small countries toe the line.
Today, personal information confidentiality is unavailable in whatever country you choose to register a company or open a bank account. This opportunity is gone mainly thanks to terrorists. When we have to choose between democratic liberties and personal security, we naturally opt for staying alive rather than feeling free and proud.
As far as zero taxes are concerned, this opportunity is available in some jurisdictions but certain requirements need to be met (see below).
Foreign companies vs offshore companies
Zero-tax jurisdictions still exist but they charge zero taxes under an important condition. The condition is as follows: the company domiciled in the offshore country has to perform all its business operations elsewhere. If your offshore company engages in business on the territory of the country where it is registered, the taxes are probably going to be even higher than they are in your home country.
This is how we can discriminate between offshore companies and foreign companies. What is an offshore company? It is a company registered in a foreign country (not the country where the founder lives) and that does business outside the foreign country. What is a foreign company? It is a company registered in a foreign country engaged in business operations on the territory of the country. The difference is rather insignificant and both phrases are used interchangeably today.