A tax treaty, also known as Double Taxation Avoidance Agreement (DTAA), is an agreement between two jurisdictions to prevent a person or company from being taxed twice on the same income. This is achieved by taxing income only in the jurisdiction where the person or company is a tax resident, except for income generated in the source jurisdiction through a Permanent Establishment. In this article, we will discuss tax treaties, treaty shopping, and considerations for selecting a jurisdiction for an offshore company.

Tax Treaties

Purpose

In cases where a person may be considered a tax resident in both countries, tax treaties establish rules to determine where the person would ultimately be a tax resident for the treaty's purposes. These DTAAs generally cover several types of taxes, such as royalties, real estate income, capital gains, business income, and employment income. However, they may vary, and some agreements may only cover specific taxes.

Benefits

The benefits of tax treaties can include full tax exemptions or reduced tax rates for qualifying individuals and companies.

Treaty Shopping

Definition

Treaty shopping is the practice of choosing a jurisdiction in which to form an offshore company or become a resident solely to benefit from the jurisdiction's tax treaty network.

Example

For example, if you have income from trading in China, you would first check which jurisdictions have a tax treaty with China. Then, you would send money to an offshore company in a jurisdiction with a favourable tax treaty, either with no withholding tax or a lower rate. Many people choose Hong Kong in this case because it has a tax treaty with China and a more accessible currency exchange process for Renminbi.

Resident Considerations

Residence Clause

Before selecting a jurisdiction, it's essential to consider the Residence Clause found in most tax treaties. Most tax treaties define a resident as someone who is not only liable to tax in that state but also for income from sources in that state or capital situated therein. This means that simply forming a tax-exempt company in a treaty jurisdiction will not allow you to benefit from the treaty.

The Solution

To address this issue, some jurisdictions offer a low-tax company option, such as Belize's International Business Company (IBC). These companies are taxed at a progressive rate from 1% to 3% and can profit from the tax treaty network.

Low Tax Companies

Maintenance Price

The annual maintenance cost of low-tax companies can be significantly higher than that of tax-exempt companies.

Requirements

By law, some low-tax companies, especially those taxed below 10%, are required to have one or more employees, rented office space within the country that cannot be a virtual office or address, and a minimum of yearly expenditures. Without meeting these requirements, such companies would not be able to obtain a residency certificate.

Examples of Low Tax Entities and Jurisdictions

Several low tax entities and jurisdictions offer favourable tax rates for companies seeking to benefit from tax treaties:

1. Seychelles Special Licence Company: 1.5%
2. Labuan LTD: 3%
3. Mauritius Global Business Licence (GBL) Company: 3%
4. Malta LTD: 5%
5. Barbados: 5.5%
6. Hungary KFT or OCC: 9%
7. Ireland LTD: 15.5%

Each of these jurisdictions has its unique features, and businesses should carefully consider their specific needs and circumstances when selecting a suitable jurisdiction.

Conclusion

In summary, tax treaties play an essential role in preventing double taxation for individuals and companies operating across different jurisdictions. Treaty shopping can be a strategic approach to take advantage of tax treaty networks; however, it is crucial to understand the implications of residence clauses and the requirements of low tax companies. By considering these factors and exploring the various low tax jurisdictions available, businesses can find the most appropriate solution for their unique situation.

FAQs

1. What is a tax treaty?

A tax treaty, also known as Double Tax Avoidance Agreement (DTAA), is an agreement between two jurisdictions that aims to prevent a person or company from being taxed twice on the same income.

2. What are the benefits of tax treaties?

Tax treaties offer benefits such as full tax exemptions or reduced tax rates for qualifying individuals and companies.

3. What is treaty shopping?

Treaty shopping is the practice of selecting a jurisdiction in which to form an offshore company or become a resident solely to benefit from the jurisdiction's tax treaty network.

4. What should be considered before selecting a jurisdiction for an offshore company?

Before choosing a jurisdiction for an offshore company, it's essential to consider the Residence Clause in tax treaties and the requirements of low tax companies, such as minimum yearly expenditures and having a physical office space.

5. What are some examples of low tax entities and jurisdictions?

Examples of low tax entities and jurisdictions include Seychelles Special Licence Company, Labuan LTD, Mauritius GBL Company, Malta LTD, Barbados, Hungary KFT or OCC, and Ireland LTD.