This topic came up in a conversation at a networking event we hosted in Kuala Lumpur yesterday.
In recent months there has been a growing trend for companies located in offshore financial centres to migrate to other offshore financial centres.
The process of migrating
Migrations can broadly be achieved in two different ways:
1. the migration of a company’s corporate registration or
2. the migration of a company’s tax residence.
The process of migrating a company’s registration between offshore financial centres is typically straightforward, with filings needing to be made in the respective outbound and inbound jurisdictions to ensure that the company is de-registered in the outbound jurisdiction at the same time that it becomes registered in the inbound jurisdiction. Where a company is carrying on a regulated activity, the consent of the regulators in both jurisdictions is typically required, and whilst this adds time to the overall migration process it is by no means a barrier to the migration occurring.
Migration of a corporate registration is the more common approach as it moves the corporate seat of the company, and, in effect, its tax residence (to the extent that the relevant jurisdictions have the concept of tax residence, as not all do).
Tax migration can be achieved in a less formal way, and in some instances can occur unwittingly. Tax migration is generally effected where a company registered and resident in one jurisdiction desires to become tax resident in another jurisdiction. This can only be achieved where the other jurisdiction has legislation that recognises foreign companies as tax resident. For example, both Guernsey and Jersey have a “central management and control” rule, which is broadly in line with the UK common law corporate residence “central management and control” rule. This rule causes a foreign company to become tax resident in Guernsey/Jersey where its overall strategic management and control becomes located in that Island.
Where applicable law allows, tax migrations can therefore be effected by having board meetings in the inbound jurisdiction. The company would then need to make any applicable tax filings in the outbound jurisdiction. One downside to tax migrations is that, whilst the company’s tax residence is migrated to the inbound jurisdiction, its corporate seat remains in the outbound jurisdiction. The company can therefore be subject to the laws of both the outbound and the inbound jurisdictions and both sets of laws need to be considered when the company carries out any transaction. It is often therefore simpler and more cost-effective in the long-term to migrate the company’s corporate registration (and therefore its tax residence) rather than just its tax residence.
Why are more migrations occurring?
The recent trend of migrations seems to be driven by the economic substance requirements that have been adopted by various offshore financial centres in response to concerns raised by the EU that offshore financial centres can be used in structures designed to roll up profits in a low/no-tax jurisdiction where there are little or no actual operations in that jurisdiction justifying those profits.
Economic substance requirements adopted by each offshore financial centre are broadly the same and so migrations are certainly not occurring because of substance rules arbitrage – no offshore financial centre is perceived at being “better” or more beneficial than another due to a difference in substance requirements. What is driving the current migration trend and the choice of inbound jurisdiction is simple practicality – businesses are asking themselves the question “given my operations and where my group of companies is focused, which jurisdiction is easier for me to locate substance?” Both the geographical location of the relevant directors and other personnel as well as transport links are crucial.
Essentially, companies appear to be migrating to jurisdictions where they can most readily comply with substance requirements.This is particularly the case where a corporate group structure involves companies registered in various offshore financial centres. In these cases, it is better from a substance perspective to locate all relevant companies with their personnel and office space in a single jurisdiction than to have them, and their substance, spread out over multiple jurisdictions.
The situation is not just limited to migrations. New structures that are being established are tending to be focused on one offshore financial centre, rather than being spread over multiple jurisdictions. The rationale for this is the same as that for migrations, i.e. substance is important and it is more practical to consolidate substance in a single jurisdiction.
This is particularly relevant in the case of intellectual property. Substance requirements are typically increased for a company that owns and exploits intellectual property for a separate revenue stream (“IP company”). Further, where an IP company is perceived to be a “high-risk IP company” (very broadly one that receives intra-group income from exploiting IP that it did not create and instead acquired from a company in its group) then it is subject to even higher substance requirements involving the need to qualified and experienced staff resident in the relevant jurisdiction who help maintain and exploit the intellectual property.
IP companies that cannot readily satisfy substance requirements in one offshore financial centre may want to migrate to another offshore financial centre where, although the substance requirements are essentially the same, they can more readily consolidate the substance of their operations.
This consolidation of substance is not limited to IP companies though, and applies equally to businesses operating in the financial services sector that are also subject to substance requirements. For example, a fund manager may want to migrate to Guernsey so as to be geographically closer to UK/European operations or target investors.
What does the future hold?
Whilst substance requirements will likely continue to develop further over time, substance is only one of a number of international tax changes that are relevant to offshore financial centres. The Organisation for Economic Co-operation and Development (“OECD”) has recently released two proposals which could, if they come to fruition, cause further migrations and consolidations offshore.
The two OECD proposals both relate to future developments in international tax to address tax challenges from the digitalisation of the economy.
The first, Pillar One, seeks to create a new taxable nexus concept largely based on sales that goes beyond the existing concepts of residence and permanent establishment/physical presence. Pillar One also addresses the allocation of taxing rights between jurisdictions by going beyond current transfer pricing methodologies. In general, the Pillar One proposals look to reallocate profits and taxing rights to jurisdictions in which the users/customers are based, or in which marketing occurs.
Pillar One focusses on consumer-facing businesses, but further work is needed on the overall scope of the proposals – digital businesses that don’t sell directly to consumers are still likely to be caught if they ultimately have a consumer-facing platform or product, and it may well be that financial services businesses are excluded. What is interesting is that Pillar One makes proposals that are taking direct taxation towards a destination principle of taxation, and so what could ultimately arise from Pillar One is effectively a VAT-style corporate tax.
The second, Pillar Two, is a global anti-base erosion (“GloBE”) proposal for the development of a set of rules to address ongoing base erosion and profit shifting risks from structures that are perceived as allowing multinational enterprises to shift profit to jurisdictions where they are subject to no/low taxes. In this regard the GloBE addresses similar issues that substance requirements address.
However, the GloBE addresses them in different ways and the proposals include taxing the income for a foreign branch, permanent establishment or controlled entity where it is subject to tax below a global minimum corporate tax rate and the imposition of withholding taxes where a payment to a related party is not subject to tax at or above the minimum rate. The proposals also cover amendments to applicable tax treaties to prevent the allocation of taxing rights under treaties from overriding the proposals, and also to restrict treaty benefits where payments are not subject to a minimum tax rate.
Both Pillar One and Pillar Two proposals involve a significant change to international taxation and are designed to disincentivise multinational enterprises from engaging in profit shifting. However, Pillar Two seems to ignore the crucial role that offshore financial centres play in the finance industry, especially in the efficient deployment of capital that benefits OECD and developing nations. A lot of further work is needed on both proposals, and their ultimate effect on offshore financial centres remains to be seen, but it is likely that whatever rules are implemented could cause further migrations and consolidations between the offshore financial centres.