Offshore companies and foreign economic transactions

If entrepreneurs from different countries enter into a contract, they can choose the law that will apply to the transaction and the court that will decide the disputes that arise.

Published 2023-03-26, by Bethany Hall, University of Warwick PGCE student

Offshore companies and foreign economic transactions West Hockey Umpires

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In doing so, both the law and the court may refer to a third country - for example, the London Court of Arbitration (LCIA) and English law may apply to a transaction involving entrepreneurs from many other countries.

In recent decades - with the development of the Internet, visa facilitation, cheaper flights - travelling (both real and virtual) has become much easier, as has running a business that is not tied to a particular physical location.

Offshoring example

An entrepreneur started manufacturing low voltage electrical equipment using the following structure: his goods were manufactured in China, the management company was registered remotely in Hong Kong which is also where all the accounts are filed. The goods were sent from China with the help of logistics brokers to the warehouse. The equipment was sold through the "Low Voltage Appliances" storefront. The online giant handled the orders itself, making deliveries and returns to customers. The entrepreneur (business owner) himself and several of his employees lived in the USA.

The entrepreneur accessed the online shop from a tablet. One day he bought the same tablet for his son, and to distinguish them, he changed the name of the device on his tablet in the system: from his name to "baba" ("dad" in Chinese). However, the name in the Amazon account was also automatically changed. The online shop found this suspicious and blocked sales until the entrepreneur confirmed the name change (which, in fact, did not happen). The entrepreneur could not get any other response from tech support.

Stocks, transfers, logistics, payroll - everything was blocked for about a month until the entrepreneur was able to get through to one of the top managers. Only then was the problem resolved.

Many modern entrepreneurs perceive the state as a service in the analogy of a bakery: you can choose the one that is cheaper and tastier rather than the one that is closer to home. This phenomenon is called jurisdictional competition.

"With services, it's simple. You choose the one that is better, more convenient, cheaper: you can go to this bakery and you can go to another. And the choice - in terms of the flow of capital, businesses, information and people - is determined by simple economics. When deciding where to open an office and do business, we simply consider the costs and benefits of different jurisdictions: Cyprus, Atlanta, London, Prague, etc. Clearly, many factors are taken into account, but first of all, the level of resistance of the business environment".

While traditional trading nations like Switzerland, the Netherlands and Hong Kong attracted entrepreneurs with low taxes and absence of formalities, the newly independent (and dramatically impoverished) ex-British colonies began to compete in uncompromisingly attracting capital from all over the world. Thus came the offshoring - countries that levy no tax on non-residents and guarantee total anonymity to company owners. Cayman Islands, Belize, British Virgin Islands - everyone has heard of these countries, but not all offshore owners can find them on the map.

Onshore vs Offshore

The two types of comfortable jurisdictions described are called 'onshore' and 'offshore'. Onshore refers to countries which do not give special treatment to non-residents. As a rule, these countries prefer to operate a legal business which is not tied to the location. For example, if a company (say, an online shop) operates all over the world, it is logical that the head office would be opened in the country with the most favourable regime. Offshoring is not used for tax evasion or to hide shady capital.

Offshore, unlike onshore, offers zero income tax for non-residents, i.e. for firms not actually operating offshore. An entrepreneur can pump money into an offshore firm and still pay no tax on income or profits. There are, however, some nuances. 

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Typical problems

For the untrained entrepreneur, using offshore brings more problems than real benefits.

The first problem: the offshore in a transaction is a marker that will immediately scare away all state-owned and non-profit organisations, as well as raise serious questions from the tax authorities and banks.

Second problem: the offshore is easy to lose: due to problems with the island authorities or due to the shenanigans of the nominal owners.

The third problem: money lying offshore has to be spent on something, and when you try to transfer it to a civilised jurisdiction the first problem arises again.

As far as the onshore is concerned, it is quite a legal tool in transactions. It allows for more seamless logistics, simplified foreign exchange controls, and in some cases tax savings. In addition, many onshore, as well as offshore, belong to former British colonies (Malta, Cyprus, Hong Kong), which means that common law (English law) applies there. The use of such onshore allows the full use of common law instruments (e.g. advanced shareholders' agreements), as well as the adjudication of disputes in the British courts, which are famous for their incorruptibility (as well as the unaffordable time and cost of the process).

At the same time, foreign companies (both offshore and onshore) impose a number of restrictions on the entrepreneur. They deny access to government procurement, support and subsidy programmes, loans from state banks and funds from state investors. The advantages of common law transactions are also not unlimited: a court may refuse to enforce a foreign arbitration award.