Many South African businesses seek to make use of offshore financial centres as a platform for international expansion and many South African business owners seek to make use of offshore financial centres as a platform to consolidate personal wealth.
An offshore base can provide a better entry point for foreign investors, it can improve the ease of doing business on an international basis and can create the possibility of retaining profits offshore. But using offshore financial centres is by no means straightforward; it is essential to choose the right jurisdiction, create the right structure and get the right advice.
If any of these benefits are to be realised, your offshore expansion must be properly planned and implemented. Here are some of the factors that you will need to consider:
Tax residency – The tax residency of incorporated entities is generally determined, whether under domestic law or the application of a double taxation agreement (DTA), by the place where the entity is effectively managed. That is the place where the key management and commercial decisions that are necessary for the conduct of the entity’s business are made.
Under South African tax law, the place of effective management (POEM) test is used to determine whether an incorporated entity is tax resident in South Africa. It does not matter if your company is registered in the UK, Mauritius or Delaware, if its POEM is found to be in South Africa then SARS can tax it.
You must ensure that the effective management of every incorporated entity in your structure takes place in the relevant jurisdiction where it is intended to be tax resident, or you may incur an unplanned tax liability in an unintended jurisdiction.
- Economic substance – – Designed by the OECD / G20’s Inclusive Framework to prevent base erosion and profit shifting (BEPS) from high-tax jurisdictions to low-tax jurisdictions, South Africa’s ‘economic substance’ legislation came into force in 2019. Any businesses wishing to take advantage of the fiscal and commercial benefits of expansion via an offshore financial centre will now need to demonstrate that:
- The company is properly directed and managed in the jurisdiction
- The company has adequate physical presence, employees and expenditure in the jurisdiction proportionate to the level of activity in that jurisdiction
- The company must conduct core income-generating activities (CIGA) in the jurisdiction, which are determined with reference to the relevant activities of the company and its functions within the group
Failure to meet the requirements can result in the exchange of information between the relevant jurisdiction and other countries’ tax authorities, financial penalties and, ultimately, striking off the companies register.
Transfer pricing– International businesses have considerable freedom to establish business operations where they choose and will take a number of commercial factors into account when deciding where to locate, which may include the local tax regime. They can reduce the amount of tax they pay if they genuinely locate economic activities in countries with low tax rates. Transfer pricing rules are used to determine the profits that should be allocated to those countries, which are then taxed at the tax rate charged by that country.
The rules require multinationals to calculate their taxable profit as if transactions between companies within the group were carried out at the prices that would be charged between two entirely independent companies – known as the “arm’s length price”. Under these rules, a company’s taxable profit is based on a combination of:
- The activities and functions it performs (for example manufacturing, distribution, research and development)
- The assets it holds (including tangible assets such as plant machinery and intangible assets such as patents and trademarks)
- The business risks it bears
Transfer pricing rules around the world are a complex web of jurisdiction tax laws, regulations, rulings, methods and requirements. Tax authorities, including SARS, can and do challenge transfer pricing arrangements and other forms of international tax planning, A robust transfer pricing policy is therefore essential to defend a group structure in possible audits from domestic and offshore revenue authorities.
Double Tax Agreements (DTAs)– When businesses or individuals expand their operations across international borders, it brings DTAs into play. When a business or an individual invests in a foreign country, the issue of which country should tax the investor’s earnings may arise. DTAs, generally known as ‘tax treaties’, are intended to facilitate cross-border trade and investment by demarcating taxing rights of countries. They affect returns to foreign investment by determining when a branch is liable for income tax, the treatment of capital gains, or by changing the taxation of dividend, interest and royalty flows from the country where the investment is made, to the country where it has been initiated.
Corporate groups often include intermediate holding companies, which can be used for purposes such as the coordination and centralisation of certain group activities, group financing or holding intellectual property. It is therefore important to choose an offshore financial centre that has an extensive tax treaty network, ideally containing treaties with low or zero withholding tax rates with source countries. Some OFCs, such as Mauritius, also do not levy any withholding tax on the outflow of income.
- Governance infrastructure – Good governance infrastructure is generally manifested in a country’s accountability, government effectiveness, regulatory burden, political stability, rule of law and control of corruption. Good governance is often an important direct determinant of location choice and the presence, or lack of, the various elements of governance has the potential to affect a country’s attractiveness to foreign investment. Below are some important factors:
- Countries open to international trade provide a good platform for global business operations and reflect their competitivenesso Countries whose legal systems are rooted in English Common Law are generally considered to better at protecting shareholders, upholding contracts and preserving property rights.
- Countries with a vibrant financial sector, with sound regulation and independent oversight of financial services, encourage economic investments
- The protection of property rights is vital for businesses and individuals to pursue new investments and ensure that they will see profit from their endeavours.
All these factors should be carefully considered before making a strategic choice of a jurisdiction (hub) for international expansion. To launch an international business expansion from South Africa, you will need advice on the regulatory tax and exchange control requirements, whilst managing the landing of your clients in the new location by having the required skills and a credible presence to grow the business from the offshore financial centre.
Whatever your decision, you should always ensure that you have a detailed paper trail of the expansion, including notes and documents, to demonstrate that decisions were taken by the right people in the right jurisdictions and to ensure compliance with all the economic substance and tax residency requirements.
Another key consideration is the structure of the group, including the use of holding companies to control the interests in different operations of the group or trusts for wealth preservation and succession planning. These elements should be factored in at the earliest possible stage but commercial strategy, rather than tax strategy, should always be seen to drive the decision-making process.