It’s possible to save tens or even hundreds of thousands of dollars moving your business offshore… when done legally
Dateline: Kuala Lumpur, Malaysia
More than two million people have visited our site in the last year, and my guess is that a very, very small number of them have actually take action to go offshore.
I see this all the time: people buy a book or come to an event, I personally introduce them to a banker, and a year later, they call me and ask me to introduce them again because they forgot to finish the process.
Going offshore with your business seems like a scary thing to a lot of people. If you’re a citizen or resident of a high-tax western country, you may incur reporting requirements for any offshore company you establish.
For instance, the IRS in the Land of the Free requires you to disclose your interest in all foreign companies you own, as well as complete a tax statement for each company’s profits.
That said, starting an offshore company doesn’t involve much more than starting a domestic company. The most important element is that you get the right tax advice in your country of residence (and, if you’re a US citizen, your country of citizenship no matter where you live).
Sadly, the internet is full of offshore providers who boast that they can form a company on some rock within 48 hours, and that your new offshore company will “pay no tax”… only for you to find out later that while the company jurisdiction doesn’t tax your income, the country where you live probably will.
That’s why I always advise people to get advice from a local tax attorney before they start operating their offshore corporation. When people contact me for help starting an offshore company. I often refer them to my trusted contacts in their country.
That said, there are several legitimate ways to reduce or eliminate tax your domestic business would otherwise incur by moving your business offshore.
IMPORTANT: Before we discuss these case studies, let me remind you that I am NOT a tax attorney or accountant in any jurisdiction, and that you should always seek professional counsel before taking any action. If you need help, feel free to contact us .
Let’s start by discussing the two typical strategies used by individual entrepreneurs to reduce their tax burden at home.
Strategy #1: Moving overseas for non-Americans
In most countries, leaving your home country is enough to get yourself off the tax roll. I have a number of Europeans working for me, and in some cases all they had to do was file a one-page form to indicate that they were leaving for greener pastures.
Once that form was accepted and their ties to their home country were cut, they were no longer responsible for paying taxes there.
Other countries like Canada, the United Kingdom, and Australia make things a little more difficult, but the same procedure – known as “becoming tax non-resident” – is possible with some effort and by abiding by some basic rules.
In these cases, an individual who is deemed to be non-resident for tax purposes can set up an offshore company in a zero-tax jurisdiction and live tax free. Countries like the British Virgin Islands, Nevis, Seychelles, Belize, and others allow companies to earn money and pay no taxes at all.
While these zero-tax countries don’t always offer access to the best banks, and don’t work in all circumstances, they can be great for selling e-books or consulting services or any number of other products.
Let’s examine a case study:
You live in Vancouver, Canada and sell digital products such as e-books and online courses. You use a trade name to do business and all of your profits are subject to Canadian personal income tax.
You sell C$100,000 per year in products and net C$89,401 – the top of the 22% federal tax bracket – after minimal expenses. By living in Vancouver, you will pay C$16,539 in federal income taxes and C$6,342 in British Columbia province tax for a total of C$22,881 in income taxes. This does not include deductions or tax credits, nor does it include social taxes.
By moving your business offshore and physically leaving Canada to live elsewhere (or as a perpetual traveler ), you can save almost C$23,000 per year.
Some countries may impose a one-time tax on the value of any goodwill you move offshore, but this may not be significant for a small businesses run by one person.
Those numbers are relatively similar in other western countries like the United Kingdom or Australia. If you are willing to leave your country and work in a zero-tax, low-tax, or territorial tax country, you can save tens of thousands of dollars per year just on your first $100,000 in income.
Strategy #2: Moving overseas for US citizens
US citizens can not simply “leave” for tax purposes; they are required to pay tax on their worldwide income no matter where they live.
However, as a nod to expat employees who work overseas, the IRS allows US citizens physically present outside of the United States to exempt their first $100,800 per year in income in 2015 (double that for married couples). This is called the Foreign Earned Income Exclusion,
or FEIE .
You may also be able to claim a foreign housing tax credit; ask an accountant that specializes in expat tax.
US citizens do not need an offshore company to save on personal income tax up to the $100,800 or $201,600 level so long as they meet one of two tests:
1. Be physically present outside of the United States more than 330 days in a 365 day period, or
2. Maintain a permanent “bona fide residence” outside of the United States, with no intention to return, and spend approximately eight months outside of the United States in a calendar year
I’ve heard tax guys suggest that doing the work overseas is the most important part of the equation. That’s not necessarily my advice, and when it comes to US tax, I advise speaking to a professional.
However, here is the problem for Americans abroad: unless you are an employee of a foreign company, you will be required to pay Social Security and Medicare tax (MedFICA) on your earnings, including those earnings exempted by the FEIE.
If you do qualify for the FEIE, you can establish an offshore company and hire yourself as an employee. This way, your salary of up to roughly $100,000 will be exempt from both state and federal income tax as well as social security taxes.
Basically, the difference between earning money overseas as a self-employed individual and earning money overseas as the employee of your own company could be 15.3% of your earnings up to $100,800.
That’s why the minimal cost to set up an offshore company could be well worth it, even if you don’t plan on making a lot of money right away. If you assume $2,000 for company formation in an offshore jurisdiction, you’d only need to make $13,071 before you broke even with tax savings.
In total, a US citizen earning $100,000 as an employee of his or her company overseas would save $21,295 in federal income tax and $12,168 in social security and Medicare taxes (net of the self-employment deduction). If we assume the entrepreneur lived in California, he or she could save another $6,937 in state taxes for a grand total of $40,400 saved.
The one challenge here is that entrepreneurs must allow for their business to deal with them “at arms length”. A business earning $1,000,000 per year with only one employee would have a hard time replacing that employee for merely $100,800 per year, and may be forced to pay more in tax.
There are many unique aspects to US taxes for expat entrepreneurs. My goal is not to recommend any particular strategy, but to show you how someone with the right legal strategy can save a lot of money by living overseas.
Strategy #3: Remaining a resident in your country
This strategy is the diciest of all no matter where you are from. For entrepreneurs who wish to run a business overseas but do not wish to move, there are times when tax savings – although rarely tax elimination – are possible.
In general, a one-man business can’t use an offshore company to save on taxes. Governments aren’t stupid, and if your employees (including yourself) and your operations are based in New York City, for example, New York City isn’t going to allow you to offshore your operation and skip out of New York tax.
However, some countries do allow owners of larger businesses to allocate some of their profits overseas. This is how companies like Google and Apple pay so little tax in any one country.
Let’s say you are one of ten employees in the company you own, and each of you has an equal role in making the company profitable. If you live and work in Australia, and your nine employees live and work in Hong Kong, it could be reasonable to have a Hong Kong company that hires the workers there.
This type of situation should be examined on a case-by-case basis, but it’s possible to pay yourself a salary in Australia – subject to Australian income tax since you live there – while retaining the rest of the company’s earnings in Hong Kong.
The problem with this type of structure is that what amount is “reasonable” is always hard to establish, and most business owners will tend to underpay themselves in order to minimize tax, which can cause problems with the taxman.
There are all kinds of legal strategies to minimize and even eliminate taxation using offshore companies and other structures. You can learn more about how they work here .
In general, though, the easiest way to save substantial money by going offshore is to leave your home country and become either a perpetual traveler not subject to tax, or a resident of a country that doesn’t tax your offshore income.
For US citizens and those unwilling to move out of their high-tax country, things get a lot dicier and the risks become higher. There are countries and situations in which the only benefit of going offshore is for asset protection, not tax benefits.
Again, make sure to consult tax counsel of your choice before taking action.
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Category: Personal Finance