i. Why Incorporate?
The primary attraction of incorporation is to limit the liability of the investor. First introduced in the nineteenth century, limited liability enabled shareholders to form companies in which their potential losses were limited to the amount of the share capital that they had either paid for or had undertaken to pay for. Because the company was a distinct legal entity, creditors were only able to make a claim against the assets of the company and not the personal assets of the shareholders.
ii. Using Companies to Mitigate Tax
Profits received by a company are taxed at the corporate income tax rate rather than the personal rate applicable to its shareholders. So a resident of a high tax country may set up a company in a jurisdiction with a low or zero rate of corporate tax and arrange for profits to be booked into the name of that company. This generates a saving equal to the difference between the corporate rate of tax and the shareholders’ personal tax rate. Anti-avoidance legislation in the shareholder’s country of residence may seek to reduce or nullify the effectiveness of such arrangements but
skillful structuring may make that anti-avoidance legislation inapplicable.
If the company makes a distribution of profits, usually in the form of dividends or royalties, then these distributions are generally taxable in the hands of the recipient. Accordingly, the greatest advantage is achieved by letting the profits roll up within the company account so that potential tax can be deferred or avoided. If profits can remain untaxed offshore, then tax is saved both on the original profit and the investment income generated by reinvesting those profits, so the benefit is cumulative and substantive. And if distribution of the profits can be delayed until such time as the recipient has moved to a jurisdiction with a lower, even zero, tax rate then any potential tax liability can be avoided completely.
iii. Where to Incorporate?
The answer depends upon the intended use of the company and upon a client’s own personal or business circumstances. A number of factors must be considered: the tax regime, political and economic stability, reputation, communications, language, legal system, confidentiality, exchange controls, banking facilities and, most importantly, cost – in terms of both incorporation and management fees.
It is particularly important to remember that the tax and other benefits obtained will depend not only upon the tax legislation in the country of residence – and possibly the domicile – of the beneficial owner, but also upon any relevant anti-avoidance legislation in any country in which the client intends to do business.