OFFSHORE CORPORATIONS A Brief Introduction
Jan 01, 2016
OFFSHORE CORPORATIONS A Brief Introduction
What Is Offshore Corporation?
An offshore corporation is a legal entity established in a tax haven or offshore financial centre, being protected by specific legislation which guarantees a status of full tax exemption, except for a small yearly license fee, and generally a high level of privacy. It is an entity specifically designed to be used by non residents only.
Legal Vehicles In Offshore Corporation
Offshore Banking
Offshore Investment Funds
Trusts
Offshore Companies
Captive Insurance Company
Other financial service
What Is A TAX HAVEN?
A tax haven is politically stable country with zero or no taxes on foreign earned income, maintains high level of secrecy and imposes few regulations.
Stereotype tax havens are tropical island nations located in Caribbean sea.
Not all OFCs are tax havens.
Categories Of OFC
Functional OFC: conducts business in OFC. Example includes Trusts, Banks, Investment holding companies, Management Companies
Notional OFC: record book entries for economic activity that occurs somewhere else. Example includes trading companies and Captive Insurance companies
Compound OFC: Mixture of Functional & Notional Activities
Size And Growth Of OFC
Tiny specks on a map but amount of assets and funds that flow through them are substantial.
Cayman Island with a population of 32000, was home to more than 31000 Offshore corporation in 1994. Deposits exceeds than all banks located in Manhattan.
In 1991, approximately 100,000 offshore companies registered in Jersey, Guernsey, Sark, and the Isle of Man.
Luxembourg has 4000 mutual funds with $ 363 B of assets.
More than 30% of US firms’ foreign income is booked from Foreign Havens.
Rationales & Mechanism For Going Offshore
Tax and Financing Benefits:
Transfer Pricing
Postponing Taxes
Corporate Financing & Capital structure Management
Asset Revaluation and Leasing
Regulatory Factors
Secrecy
Asset Protection
MNC sells product at low
markup
OFC intermediary
sells product at very high
markup
Subsidiary Company
Transfer Pricing
Parent company and local subsidiary are both located in high tax jurisdictions, tax can be minimized through the use of OFC
If the earnings are not repatriated, Taxes can be saved hugely
Postponing Taxes
OFC can be used to collect profit remittances or realize capital gains
OFC hold such funds & do not repatriate to home country to save tax
Corporate Financing And Capital Structure Management
Offshore holding companies better positioned to issue debt for example securities issued in the Cayman Islands need not comply with the SEC disclosure requirements.
OFC holding company can be used to maintain full control of a subsidiary while gaining tax shields with debt payments.
Parent Company
Emerging Market
Investment
100% equityNo tax shield benefits
Parent Company
Project Equity
Offshore Company
Equity and Debt
Emerging Market
InvestmentTax shield
Asset Revaluation And Leasing
Offshore companies used to revalue fixed or intangible assets before transferring them to subsidiaries in emerging markets.
Regulatory Factors:
Securities
regulations
Capital contribu
tions
Captive insuranc
e compani
es
Other regulati
ons
Securities Regulations
OFCs can be used when a country’s legal regulations do not provide for certain types of securities.
Local Firm
No provision for
incentives or
ESOPs
Assign shares
to Offshor
e company and enter into
individual
contracts
mimicking
ESOPs
Capital Contributions
Offshore companies can be used to control the flow of capital to and from subsidiaries in emerging markets. Capital contribution in the form of debt can be used to avoid reinvestment requirements and restrictions on foreign equity ownership and profit repatriation.
Captive Insurance Companies
A captive insurance company is one that is formed be an organization or group of organizations to manage the parent’s insurance needs.
In the 1990s more than 3500 captive insurance companies in the world most operating offshore and most established in Bermuda, the Cayman Islands and Guernsey.
Other Regulations
OFCs allow corporations to avoid a variety of other regulations.
No minimum reserve requirements for banks in tax havens.
No need to file statements or auditor’s reports with the government.
Avoid trade bans such as US firms that used re-invoicing via companies in Cayman Islands and Panama to evade bans on trade with South Africa and Cuba
Trade with Middle Eastern countries is also routed through offshore trading companies
Secrecy
Tax havens provide secrecy.
Criminal offence to reveal information about investors.
Secrecy laws and the issuance of bearer securities protect shareholders’ identities.
For example Virgin group made use of OFCs for maintaining shareholder secrecy. Many of the group’s subsidiaries are owned by offshore trusts located in Cayman Islands and the British Virgin Islands.
Asset Protection
Asset protection from lawsuits and creditors.
This protection results form several sources.
Most OFCs have strict financial privacy laws so potential litigants may not know about the existence of specific assets.
In addition many OFCs do not recognize financial judgments imposed by other jurisdictions.
Offshore corporations are also used by product manufacturers for protection form product liability lawsuits and by doctors for protection against malpractice lawsuits.
Factors that Influence Cross Border Equity Investment
By-Group 9Abhishek Garg A021Suprav Sarang C001Shweta Dhotar C022Vipul Malviya C038Kushal Modi C041Gurupdesh Cheema C053
THE BENEFITS OF INTERNATIONAL EQUITY
INVESTMENT
Offers more opportunities than a purely domestic portfolio
Attractive investments overseas
Impact on efficient portfolio with diversification benefit
Risk-return tradeoff: may be greater :basic rule-the broader the diversification, more stable the returns and the more diffuse the risk.
International diversification and systematic risk
• Diversifying across nations with different economic cycles• While there is systematic risk within a nation, it may be
nonsystematic and diversifiable outside the country
National stock markets have wide
differences in returns and risk.
Emerging markets have higher risk and return than
developed markets.
Cross-market correlations have
been relatively low.
23
THE NEW EFFICIENT FRONTIER
E(r)
A
B
C
Theoretical ConclusionInternational diversification pushes out the efficient frontier.
Factors influencing international Equity investments
Institutional Frictions
Transactional Costs related to investing outside home economy
Foreign currency exchange rate risks
Tax reporting in home as well as foreign country is costly (filing standpoint & potential for additional taxation)
Domestic rules that limit the percentage of foreign investment in a company or industry
By holding global portfolio and assuring compliance for each investment can create additional cost for foreign investors
Practical Implications Of Institutional Frictions
Institutional Frictions provide several reasons to expect lower level of foreign investment
However, research finds that they explain only a small portion of observed home bias
The international equity investment that does occur seems un-impacted by relative differences in transaction costs
Further, institutional investors have many ways to reduce these costs, yet they still exhibit home bias
Additionally, there has not been an appreciable increase in foreign investment when countries changed rules and regulations to reduce institutional frictions
Firm Visibility
Investors must be aware of a firm in order to invest in it
Awareness of a firm through informal channels like advertising, product usage, news coverage, etc.
Research suggests that foreign investment is highly related to visibility factors
Firms that are larger, listed on a major stock index, are followed by a large number of analysts, have overseas listing, or have experienced strong accounting performance are all likely to have a higher level of foreign investment
•Investors can make informed decisions
•Reduced information asymmetry
•Foreign investors can reduce local advantages through devoting substantial resources which is a costly process
•Investors feel better off spending their resources to further their knowledge in home market
•Firms can mitigate costs by providing information in a form that reduces processing cost for foreign investors eg: disclosures in multiple languages
Investor Understanding
Investor Protection
Preservation of minority investors’ interests from majority owners’
misappropriation including expropriation, tunneling etc.
Possible transfer of funds from minority investors to majority investors.
Asymmetry of information between minority investors and firm insiders,
international investors and local institutions working closely with the firm.
International investors run risk of govt. expropriation or self dealing.
Implications
Investor protection concerns may cause observed home bias
Protection can be categorized into: Laws imposed by the nation
Stricter national laws attract a higher level of foreign investment
Voluntary corporate governance• Is important once minimum regulations are met.
• Countries lacking legal protection from govt. do not have an effect on FI even in presence of governance
• Companies are unwilling to invest in corporate governance in absence of strong legal investor protection
Cultural attributes impact international equity flows
• Countries with similar legal and compatible linguistic systems have higher cross-border equity transactions.
• Common religion and similar genetic backgrounds create a sense of trust.
• Societal views of egalitarianism also impact flows.• Preference for similar group identity over global optimum
exists.
Greater ease of analyzing firms in a similar culture-
Culture
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