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The abolition of the corporation tax imputation system by the Steuersenkungsgesetz (Tax Reduction Act) diminishes the degree of discrimination against foreign dividends. This means that internationalization could also become significant to small and medium-size enterprises. The author discusses the establishment and utilization of an offshore company (domiciliary company) in a tax haven. The basic principle in the establishment of an offshore company is simple: it is a question of transferring highly profitable business activities to more favorable tax jurisdictions ("tax havens"). Frequent advantages are the confidentiality of business relations and anonymity of shareholders. Apart from familiar tax havens, foreign companies may also prove useful in individual cases by allowing exploitation of the advantages of specific double taxation treaties and reducing the overall tax burden in international business relations through the intermediary of a foreign company. It is patently obvious that any structures that merely involve construing conceptual models on paper will not satisfy the stringent requirements of German tax law. The particular danger for a German taxpayer lies in the fact that matters of relevance for tax purposes may not be examined until many years later in the course of a government tax audit. Companies existing merely as an accommodation address - considered cheap at the time - later prove, not infrequently, to be an extremely expensive investment.

Dr. Ulrich Eder is lawyer, tax advisor and managing director of DUE FINANCE Wirtschaftsberatung GmbH Steuerberatungsgesellschaft in Duesseldorf, Germany. DUE FINANCE advises international corporations and persons on a wide spectrum of tax and business issues, in particular with regard to financing, taxation and internationally structured transactions. DUE FINANCE reserves the right to monitor all e-mail communications through the firm's network. We will treat a request via e-mail as authority to reply by e-mail. PGP key available. DUE FINANCE - Tomorrow’s financing today. Additional Resources Expatriate Search Tools  Expat Classified Ads  Tax Havens  2nd Passports  Moving to Europe  Regional Directory  World's Newspapers  Offshore Investments  World Reference Desk  Offshore Investment Articles  Offshore Real Estate Quarterly  The Due Finance Website Contact author Dr. Ulrich Eder .

Recognition of the Offshore Company
 

The starting point for the tax audit is recognition by the tax authorities of the foreign company. Here the principle applies that a company must satisfy the legal requirements of the country where it has its actual domicile (domicile theory). The internationally much propagated "theory of incorporation" - according to which it suffices to comply with the laws of the country in which the company was incorporated - has, in spite of various court cases, not yet been recognized in this country. It does not suffice to have the domicile in a foreign country in the Articles if the actual place of management is in Germany. Management in this case is the focal point of the company's ultimate management (Sect. 10 Abgabenordnung (Tax Code)), i.e. the location of decision-making power that determines ongoing business management. The specific risk with an offshore company arises where the German principal behind the company makes the crucial decisions, so that his German place of residence establishes unlimited tax liability for the foreign company.

The starting point for the tax audit is recognition by the tax authorities of the foreign company. Here the principle applies that a company must satisfy the legal requirements of the country where it has its actual domicile (domicile theory).

If, according to the Articles, a company has its domicile in a foreign country but its management in Germany, the matter of legal capacity under civil law is determined - according to controversial but accepted legal precedence - by German law. In this case, the foreign capital company is not recognized due to its lack of registration in the commercial register, with the corresponding disadvantageous consequences of German tax. 

These disadvantages can be avoided by choosing the correct structure. This may be served e.g. by a foreign (straw) director who is verifiably assigned responsibility for ultimate management of the business. Also frequently encountered are structures whereby main business management tasks are agreed only at shareholders' meetings held at regular intervals, for the purpose of which the German taxpayer goes offshore. In this event, it is necessary to ensure that all individual steps are documented in a reliable and trustworthy manner capable of withstanding any subsequent government tax audit.
 

Avoidance of Taxation in Germany of Offshore Profits According to the "Welteinkommensprinzip" (principle of income-source neutrality), all income of a German taxpayer is liable to German income tax. For this reason, an offshore company only makes sense if foreign income is either reinvested in the foreign country so that it does not flow to Germany or is exempt from German taxation under a double taxation treaty. This is rarely the case with pure tax havens, as Germany does not normally enter into double taxation treaties with tax havens. The situation is different with regard to countries like the United Arab Emirates (UAE) where, by making the proper arrangements, tax-free income earned there can remain completely free of tax under the DBT ruling.

An offshore company only makes sense if foreign income is either reinvested in the foreign country so that it does not flow to Germany or is exempt from German taxation under a double taxation treaty. This is rarely the case with pure tax havens, as Germany does not normally enter into double taxation treaties with tax havens.

The non-taxation of non-inflowing dividends is pierced by special kinds of "direct taxation" (“special tax liability on German parent company's share of passive non-distributed income of a US subsidiary") to the detriment of the German taxpayer. Such rules exist only in Germany and in the USA. The Law on External Tax Relations (Außensteuergesetz) provides for highly complex rules in Sect. 10 according to which the veiling effect of the foreign offshore company can be pierced and its profits attributed to the shareholder. 

The legal regulations often compete with the double taxation treaty and are applied extremely rarely in practice - which should comfort the taxpayer. Moreover, it is possible to find an arrangement in this case also which takes account of the interests of the taxpayer and avoids special tax liability even with tax havens. 

While a transfer of assets that does not affect tax acquires particular importance when relocating functions to industrial areas in foreign countries, the problem with pure offshore companies does not arise in this form. But here too the transfer of intangible assets in particular (trademarks, licenses, know-how) can affect matters of fiscal profit realization. It makes sense to choose an arrangement by which value is added to the intangible assets mainly in the foreign country. 

Duties of Information and Set-off

The possibilities offered by foreign company law for the anonymity and confidentiality of the shareholders and the company's internal affairs can be exploited in many ways to benefit the shareholder. However, this does not extend to the tax savings resulting from concealment of shareholding relations and the covering up of financial flows back into Germany. Instead, the fiscal authorities have various areas of control available to regulate the taxpayer's duties to provide and procure information. 
 

The starting point for this is Sect. 160 Tax Code according to which expenses of the taxpayer are not taken into account for tax purposes if the taxpayer cannot or will not name the payee on demand. The background to this rule is the fear that "payments without receipts" are withdrawn from fiscal control, i.e. tax is not paid on them in Germany in spite of the existing tax liability.  This also applies especially if payments were made for services difficult to comprehend or value objectively. These include license fees, payments for consultancy services and similar. The taxpayer is not able to comply with the duty to name the payee by simply giving the name and address of the offshore company. If an offshore company without any business activities of its own is used as an intermediary for payments, legal precedence states that the recipient of the payment is the third party behind it, i.e. normally its shareholder.

The starting point for this is Sect. 160 Tax Code according to which expenses of the taxpayer are not taken into account for tax purposes if the taxpayer cannot or will not name the payee on demand.

In practice, it is of little benefit to the taxpayer that the German tax authorities are unable to investigate in the foreign country themselves. If a matter requiring investigation and assessment for tax law purposes concerns activities in a foreign country, then, under Sect. 90 para. 2 Tax Code, the taxpayer must clarify the matter himself and procure the necessary evidence for the fiscal authorities, not merely make a statement to that effect. He must take care to ensure, already at the time of entering into the transaction with the foreign company, that he later disposes of the relevant information and evidence e.g. required for any subsequent government tax audit. The name of the recipient suffices only if the tax authorities are able, without major effort and without having to undertake their own supplementary investigations into the matter, to document the amounts received by the payee. 

For offshore companies, Sect. 17 Außensteuergesetz defines additional information duties. Legal precedence requires duties frequently almost incapable of fulfillment. The main duty in practice involves that of naming the "actual payee". This primarily involves refuting the suspicion that a payment to an offshore company would later return in concealed form to the payer. Analysis of the extensive legal precedence nevertheless shows that the existing fine boundaries between the duty to give a name and legitimate lack of knowledge allow scope for successful countering of excessive research and general interrogative activities. 
 

Even in the case of complete transparency of the business relations with the offshore company and disclosure of all payees, there is still a final hurdle to overcome for recognition for tax purposes: the assessment of current business relations by means of comparison with a third party.  The structuring of fiscally acceptable rules must be based on Sect. 1 Außensteuergesetz according to which terms and conditions must be agreed in a manner similar to those agreed under the same or similar conditions between independent third parties. An extensive interpretation of this dealing-at-arm's-length principle is to be found in the regulatory manual of the tax authorities and is known under the concept of "administrative principles". This (undoubtedly outdated) statement from the year 1983 is supplemented by international and national regulations and a very extensive body of case law.

Even in the case of complete transparency of the business relations with the offshore company and disclosure of all payees, there is still a final hurdle to overcome for recognition for tax purposes: the assessment of current business relations by means of comparison with a third party.

Proper Procedure for Establishment of an Offshore Company 

In spite of the fiscal requirements outlined above in simplified manner, the principle of freedom of business disposition as part of the market economy requirements and fiscal scope continues to apply. To this extent, the businessperson is free to relocate and export part-areas and functions in order to maintain competitiveness nationally and internationally. In view of the potential financial relief, it is worthwhile not only for a large corporation to make the requisite investment in internal and external advice for such a measure. 

Alongside fiscal aspects and the need for the divestment of part-areas that makes sense from a business management point of view, the legal requirements in the foreign country must also be taken into account for the incorporation of an offshore company. Added to this is the early inclusion of funding considerations in order to establish a sound basis for the future. The work of an external consultant can be subdivided logically into the following stages:
 

.Contact Dr. Ulrich Eder