Circumvent transfer pricing restrictions by using multiple companies?

[JustAnotherNomad]

Say you have a company A in high-tax country like the UK, say the company makes $1M in profit (just to have a round number).
Salaries of non-resident employees are not taxed in that country. You live in a low-tax country (say you live in Bahrain, just to keep things simple), but you can't just pay a $1M salary for your director job. Say that $200k is an acceptable salary in country A, now there's only $800k profit left.
You set up another company B in a lower-tax country like Cyprus and hire real staff for some substance. You have this company own company A. Company B invoices company A for the work, with proper transfer pricing documentation.
Say that they get 75% of the profit, and that this is the market rate, now you get another $750k out of company A, with only $50k left. On those $50k, you pay corporate income tax, then distribute the dividends to the parent company and from there onwards into your pocket, tax-free (assuming there is no withholding tax on dividends).
But now you also have $750k in company B. You pay your staff - and then you also pay yourself a market-rate salary, say another $200k.
Repeat with additional companies if necessary.
Would this work? I would assume that limitation on benefits clauses could cause trouble for the dividends, but other than that? Why shouldn't you be able to use multiple companies, possibly in multiple countries, and then pay yourself a high salary from each of them? Of course assuming you have proper substance in each country.
Something I'm missing?

 

[Marzio]

Say that they get 75% of the profit, and that this is the market rate

If the transaction is at arms lenght you are not circumventing anything.

Why shouldn't you be able to use multiple companies, possibly in multiple countries, and then pay yourself a high salary from each of them?

The problem is that this will involve from you part an enormous amount of work to hire, train and pay people up to a level that the transfer pricing is not questionable.

For example hiring people to develop IP in Cyprus that you then license to the UK company.

Invoicing the UK company for a $750K consulting service will never fly.

 

[JustAnotherNomad]

A $750k consulting service should be (I'm not a lawyer) absolutely fine if you have proper documentation/contracts. Company A could be a simple sales front (reseller) that works on a commission basis, this is quite normal.
It's all about the responsibilities of company A and B.

I have also heard about cases where company A buys a quota of hours at a discount from company B (say 20k hours at $80 per hour instead of $100). Unfortunately company A miscalculated how many hours they would need, so they end up paying for more hours than they needed... In theory, this could also be a violation of transfer pricing restrictions, but as long as it doesn't happen every year, all the time...

 

[Marzio]

A $750k consulting service should be (I'm not a lawyer) absolutely fine if you have proper documentation/contracts

I guess it's fine if you have an established brand and the consultation is about a very high value topic.

A could be a simple sales front (reseller) that works on a commission basis, this is quite normal.

A billing company is a good option when the parent can't have access to payment gateways, is that your case?

 

[Sols]

I don't think transfer pricing is your only concern. Transfer pricing is part of the puzzle here. But on transfer pricing, you aren't describing anything that's really at an arm's length distance. Are companies A, B, C, and so on owned by the same person? Then they're all considered the same grouping for transfer pricing purposes. An effective tax authority questioning this would look at where the flow begins and ends. The middle steps are almost irrelevant.

However, since you're moving money to lower/zero tax jurisdictions, you probably need to consider BEPS as well. That is, are you artificially lowering the profitable basis of any company in chain and shifting profits to some other entity (usually with lower tax)?

I'd recommend solving something like this in another way, such as forming an LLP instead of LTD if we're talking about UK. There are simpler ways to lower your tax burden than a series of companies.

 

[JustAnotherNomad]

A billing company is a good option when the parent can't have access to payment gateways, is that your case?

I don't think that's a good option. Practical issues such as access to banking aside, the client would have to sign the contract with the company providing the services, not the billing company, right? You don't typically sign contracts with PayPal as a customer, your contract is with the merchant.

I don't think transfer pricing is your only concern. Transfer pricing is part of the puzzle here. But on transfer pricing, you aren't describing anything that's really at an arm's length distance. Are companies A, B, C, and so on owned by the same person? Then they're all considered the same grouping for transfer pricing purposes. An effective tax authority questioning this would look at where the flow begins and ends. The middle steps are almost irrelevant.

In my example, company A (high-tax country) would be owned by company B (lower-tax country without WHT, such as Cyprus), B would be owned by a person (or holding company) in a zero- or low-tax country.
Why would the middle steps be irrelevant?
A buys and resells services purchased from the parent entity, which has substance in another EU country. Why would the tax authority in country A have to check anything beyond that?

However, since you're moving money to lower/zero tax jurisdictions, you probably need to consider BEPS as well. That is, are you artificially lowering the profitable basis of any company in chain and shifting profits to some other entity (usually with lower tax)?

Isn't BEPS mostly about substance? In my example, there would be staff in country B that would provide the necessary substance. Not just a nominee director, but people actually performing services for the company.
I don't see why that should be considered artificial?

I'd recommend solving something like this in another way, such as forming an LLP instead of LTD if we're talking about UK. There are simpler ways to lower your tax burden than a series of companies.

Isn't taxation of partnerships often quite complex if you have some operations in the country where the partnership is incorporated?

I don't think it would be profit shifting if the UBO who is also an employee of company A took a salary that isn't taxed in country A, as long as the salary is not excessive.
Now the same person happens to also draw a salary for work that is done for company B.
Could the tax authority of country A really claim that both salaries would have be seen together, and that they would therefore be considered excessive and thus profit shifting?

 

[Sols]

In my example, company A (high-tax country) would be owned by company B (lower-tax country without WHT, such as Cyprus), B would be owned by a person (or holding company) in a zero- or low-tax country.
Why would the middle steps be irrelevant?

If the companies have different owners (genuine owners, not nominees/holding companies that you control), you're in a better position to defend the setup. But as a general rule, passing money around in companies all under the same control is not considered being at an arm's length distance.

A buys and resells services purchased from the parent entity, which has substance in another EU country. Why would the tax authority in country A have to check anything beyond that?

Because of transfer pricing regulations.

As always in these discussions, don't mistake getting away with something as being the same as something being completely legal. Your series of companies may each individually be so uninteresting that no one ever looks more closely at it. Your example is very convoluted and unless the amounts are very high, you may get away with it simply on that basis alone. However, that's not the same as holding up in in audit or a court if questioned.

Isn't BEPS mostly about substance? In my example, there would be staff in country B that would provide the necessary substance. Not just a nominee director, but people actually performing services for the company.
I don't see why that should be considered artificial?

If you zoom out and look at the structure critically: what are you doing? What are you trying to achieve? Why is the flow of funds like this? You're trying to lower the corporate tax burden by shifting profits, i.e. what BEPS regulations were designed for. Substance is only one of many considerations in BEPS.

Isn't taxation of partnerships often quite complex if you have some operations in the country where the partnership is incorporated?

Generally speaking, partnerships themselves aren't taxed. But if you form an LLP and meet the conditions for permanent establishment, UK corporate tax might apply for trading income from UK.

I don't think it would be profit shifting if the UBO who is also an employee of company A took a salary that isn't taxed in country A, as long as the salary is not excessive.
Now the same person happens to also draw a salary for work that is done for company B.
Could the tax authority of country A really claim that both salaries would have be seen together, and that they would therefore be considered excessive and thus profit shifting?

Yes. BEPS regulations weren't written by amateurs who didn't think more than one step ahead.

 

[JustAnotherNomad]

But as a general rule, passing money around in companies all under the same control is not considered being at an arm's length distance.

I'm talking about quite a normal use case. You have a company in country B that delivers some services. Let's say it's a marketing agency. The company has local employees and pays its taxes, all is fine.
There's a non-resident UBO and he receives a salary for work he does for the company, which is a deductible business expense. This is also fine in country B, the UBO doesn't live in country B.

Now company B wants to expand into a new country. So a subsidiary in country A is set up as people in country A would be skeptical of a foreign business.
Company A resells the services offered by company B. The transactions are at arm's length, as confirmed by a tax lawyer specializing in transfer pricing in country A (e.g. company A is a pure reseller, receiving a 25% commission for the sales).
So far surely this should be fine? The value is created in country B, there are only sales activities in country A. Company B has proper substance, both are EU companies (well, now I used UK as an example, it could also have been Spain or any other European country with high taxes).

Now the last thing being added is that the UBO, who is also the UBO of company A, also draws a salary from company A. Why shouldn't this be fine?

If you zoom out and look at the structure critically: what are you doing? What are you trying to achieve? Why is the flow of funds like this? You're trying to lower the corporate tax burden by shifting profits, i.e. what BEPS regulations were designed for. Substance is only one of many considerations in BEPS.

I think having a subsidiary of an EU company in another EU country is rather normal?
The only potential profit shifting I see is the salaries from both countries, as they go to the UBO and would escape taxation in the EU. But why shouldn't one be able to pay a (modest) salary for work that is performed for the companies?

Generally speaking, partnerships themselves aren't taxed. But if you form an LLP and meet the conditions for permanent establishment, UK corporate tax might apply for trading income from UK.

Yes, that's what I mean. As soon as the partnership has a PE in country A (there would have to be some sales staff), it would probably be debatable how much income is attributable to that PE.
So I thought it might be better to just use a Ltd. company, it would probably also be easier to sell later?

Yes. BEPS regulations weren't written by amateurs who didn't think more than one step ahead.

And I didn't think they were. I'm just trying to find out if something like this could be fine. I'm not asking about "flying under the radar", I'm thinking about actually being compliant with all regulations.

 

[Mike Forman]

You set up another company B in a lower-tax country like Cyprus and hire real staff for some substance. Say that they get 75% of the profit, and that this is the market rate, now you get another $750k out of company A, with only $50k.

But now you also have $750k in company B. You pay your staff - and then you also pay yourself a market-rate salary, say another $200k.
Repeat with additional companies if necessary.

Of course assuming you have proper substance in each country.
Something I'm missing?

Company B will be the shareholder of company A and at the same time will also bill company for an amount equal as 75% of the profit? At the same time the shareholder (co B) will also receive dividends. This is for sure already asking for an investigation by tax authorities in the jurisdiction of company A.

It would be better to have a holding that is not involved in providing services to the companies it holds, this would be considered as dividends.

Substance of company B is more then just hiring two people in an office in Cyprus.

If tax authorities smell some tax avoidance they will not just send you an email and ask you for a transfer pricing agreement. They will contact the related jurisdictions obtaining from those companies :


Jurisdiction B will have to cooperate and will ask you those questions or bring you a visit to get those
:
-general ledger
- the names of employees working for that company, their salary and the income tax paid.
- the top 5 clients (if only one client which is your own company this is clearly the same company group)
- bills received and sent to company A and all wire transfer statements between those companies
- The rental office contract, proof of the owner and ask if it's a shared office
- the names and addresses for the decisions makers and if they can make independent decisions
- UBO


If jurisdiction of company A figured out there are more related companies they will ask also the billing and transactions between company B and the other companies.

This may result in a tax investigation from jurisdiction B if they believe as well there is some tax avoidance.

A better way is to use multiple companies where no company with the same director / shareholder does direct business with a related company.

In this scenario company B has a different shareholder and director and will bill company A. Company C of which you or a relates company (not A!) is a shareholder will bill company B and can provide the actual services. Company B can have limited substance (a decision maker and office). Just be prepared that every jurisdiction will ask you questions once an investigation has started.

Having these non related company layers avoids a lot of complex TP and will reduce significantly triggering a tax investigation.

We are in an investigation with multiple countries involved and they are very agrressive not only getting all information from the one started the investigation already sending claims which are ten times higher than the actual total group profit made.

Once they are on to you don't expect tax authorities to play the game correct or fair. You believe you had to pay limited tax and they believe you had to pay 10x more tax then what you actually would have paid if you had reported/declared all in jurisdiction A.

Rule number one is to avoid doing business with related companies (same shareholder / director / ubo ) that are located in low tax jurisdictions (Cyprus, Malta, UAE, HK,..)

Consult a GOOD tax lawyer (in each jurisdiction) would be my advice and present them your structures while asking the right questions to make sure everything is covered. It's worth the investment of 5-10k

 

[JustAnotherNomad]

Company B will be the shareholder of company A and at the same time will also bill company for an amount equal as 75% of the profit? At the same time the shareholder (co B) will also receive dividends. This is for sure already asking for an investigation by tax authorities in the jurisdiction of company A.

Wow, why? I thought this would definitely be fine since it shouldn't even trigger the new "Unshell" EU rules, see this post:

Estonia, Lithuania and Latvia for a holding company

No worries hap¤#". After reading the replies you got which are misleading. I would say get proper tax advice before you land yourself in hot water. Your activity is "Holding business" so you are directly impacted. GAAR is real. Please read the below link fully. You otherwise risk losing tax...

www.offshorecorptalk.com

The way those rules read, it seems like they want the parent company to actually conduct business, not just be a holding company?

It would be better to have a holding that is not involved in providing services to the companies it holds, this would be considered as dividends.

But then you need substance for that. How do you get proper substance for a pure holding company?
"Yes, the company is owned by a holding company in Cyprus."
"Ok, what is the company's activity in Cyprus?"
"Well, owning the shares of the company in your country. There's one guy, we have an office in Cyprus"
"What does he do all day long?"
"Well, nothing really, it's just a passive holding company"

I don't think that would go over well with the tax authority in the other country...

If tax authorities smell some tax avoidance they will not just send you an email and ask you for a transfer pricing agreement. They will contact the related jurisdictions obtaining from those companies :

Yeah, that's what I would want to avoid. That's why I thought such a setup with two EU companies could work well as I was hoping it would be considered a legitimate cross-border operation.

A better way is to use multiple companies where no company with the same director / shareholder does direct business with a related company.

Then how do you do that in a legal way (without forging documents etc.)? Find a friend with a company that you interpose?
You have a company in a high-tax country that is billed by a non-related company in another country, and then you bill that company from your offshore company?
Then I'd be worried that the guy with the non-related company could get into trouble for something like money laundering or assisting in a tax fraud.

Once they are on to you don't expect tax authorities to play the game correct or fair. You believe you had to pay limited tax and they believe you had to pay 10x more tax then what you actually would have paid if you had reported/declared all in jurisdiction A.

That's my biggest fear. I have experienced this before (on a much smaller scale) and I've also heard from partners that they've had similar cases.
Someone I know was living in two high-tax countries at the same time (similar level of taxation). His company was audited and the tax authorities then tried to decide, in which country his salary should be taxed.
That cost him over $20k in lawyer fees, just for representation in a case to figure out WHERE he should be paying 50-60% in taxes.
So I definitely want to make sure to avoid something like that.

Consult a GOOD tax lawyer (in each jurisdiction) would be my advice and present them your structures while asking the right questions to make sure everything is covered. It's worth the investment of 5-10k

I'd be happy to pay the money, but it's almost impossible to find good lawyers who can set up international structures.
You're often left with BIG4 or similar firms, and then it gets really expensive very quickly, and you also don't know if they will report you for aggressive tax planning.
That's why I'm trying to come up with a structure myself, which I'd then only have to get checked - that should be much cheaper and hopefully also safer.

A bit of the background for my question:
I've lately had a few clients from a high-tax EU country and I see some potential for growth there - but I'd need local staff for sales and handling clients. Sure, maybe I could work with contractors up to a certain limit, but it would probably make more sense to just hire someone. And then there would at least be a PE, so I might as well set up a company. That would also make it easier to find local clients, instead of with a company from another EU country (even if both are in the EU, having a local company is still much better for marketing). If it went really well, that would also give me a chance to sell that company to a competitor in that country later.
And also, larger clients will definitely do due diligence on a company. I'm working on a new contract now and they're asking for balance sheets and stuff like that. I don't know how others get contracts with their offshore companies - maybe everyone here only works B2C. But for a large B2B contract in the EU, I can't just turn up with a BVI or UAE company.
Thus my idea to have two EU companies - one in the high-tax country only doing sales, and another one in Cyprus or some other lower-tax country where I could have people actually doing the work.

But it would have to be 100% compliant and above board - an investigation would probably completely destroy any potential tax savings. It would have to be set up in a way that a tax inspector can look at it and go "I see, that makes sense", and be done with it. Not go "well, this looks interesting.... let's see what we can find here...".

The alternative would be to keep billing from a foreign company, but that would probably limit the potential growth a lot.

 

[JustAnotherNomad]

@Mike Forman In case it wasn't clear, I actually live outside the EU. But I have some EU clients and looking for a way to grow there without paying the ridiculous amounts of taxes...

 

[JimBeam]

@Mike Forman In case it wasn't clear, I actually live outside the EU. But I have some EU clients and looking for a way to grow there without paying the ridiculous amounts of taxes...

Advise your client to move to him (including family) and his business to more tax favorable location (if both are possible).
If it's possible for him/family and his business - the best deal in EU is currently Bulgaria (10% CIT + 5% dividends, effective 14.5%). Other solution is UAE/Dubai (9% CIT).

Doing what you have proposed might just lose his time and money and on top of that expose himself to high risk of getting in serious trouble.
He will get gray hair with all of the lawyers and dealing with all these things to make it work.

The other way of him to succeed in the west is to go into debt!
Yes! He needs to buy stuff for his business and not with cash - with credit!
Because, if he buys it with cash - it means they are cheap for him (in his range).
He must buy things he can't afford (that are more expensive than he's earning and out of his range).
For eg. he earns 1M year - he shouldn't by 750k office/property - he should by 2.5M office/property.
But that flips the game entirely.