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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