Formation of overseas finance company

"At this stage, or at some earlier stage, Mr Holmes may consider setting up a separate finance company whose responsibility will be to raise adequate finance for the group of companies under the control of Mr Holmes, and to utilise retained earnings in the most efficient way, which will require an understanding of the international money markets. Mr Holmes incorporates Polycon Finance whose personnel have previous banking experience, and which controls the funds of all companies in the group."

As far as raising adequate finance for the group is concerned, careful consideration must be given to Country K's tax and exchange control legislation to ensure that interest payable is deductible against group profits by one means or another and that the investors may receive interest without local withholding taxes. For this Polycon Finance may need to be established in a country which either levies no withholding tax on interest payments to non-residents, or specifically exempts interest on, for example, Eurobond issues from withholding tax liability. It is clear that if Polycon Lens Company is to raise adequate finance for all of its activities, which it may do by means of a bond Issue, that its fund raising opportunities will be affected if the bond holder has to suffer a 25% or more withholding tax or go to the bother of claiming a refund if one automatically is deducted.

Besides tax legislation, exchange control legislation of Country K is a vital consideration when considering suitable locations for the overseas finance company.

The position with regard to exchange gains and losses is of major importance, particularly in the volatile currency markets experienced in recent years. If losses are to be incurred by Polycon Finance, because funds are borrowed in strong currencies, or funds are lent onwards to group companies in weaker currencies, Polycon Finance should have the opportunity of deducting its losses against its taxable profits or those of the group to which it belongs. If such losses would not be deductible, then the currency in which loans are borrowed or lent must be switched to allow losses to be relieved where tax law permits. Conversely, it would be helpful to arrange for exchange gains to be made in a tax-free regime, and although Polycon Finance can never ensure that its loans with group companies are denominated in a currency which will yield them gains rather than losses, loan agreements should be continually reviewed to reduce the possibility of non-tax deductible losses.

If Polycon Finance is used to finance a group subsidiary company with an interest-bearing loan, it should be ascertained whether the interest paid by the group subsidiary company is an allowable deduction against its taxable profits. Some countries consider such interest payments on loans from parent companies or associated companies as distributions, and in addition to refusing their deduction against taxable profits, assess a withholding tax on such payments as if they’re in fact constructive dividends. In such circumstances, it may be necessary to interpose another finance intermediary, which is located in a country with a double tax treaty with the group subsidiary's country of residence, if that treaty contains a clause stating that interest payments should not be regarded as distributions.

Moreover, the tax administration of the group subsidiary company being financed, may consider that the loan is in fact capitalising the subsidiary company and may reclassify such debt capital as equity capital. Some countries have specific rules regarding acceptable debt/equlty ratios whilst others look at the circumstances of each particular case and have no set rules; some countries permit companies to be capitalised entirely with debt capital.

One of the cardinal rules in international financing operations is to ensure that assets and liabilities are matched, wherever possible, in the same currencies. This is a commercial consideration, but the tax ramifications will depend upon the treatment of exchange gains and losses in Country K; Polycon Finance may consider establishing a separate subsidiary to accept risks on currency transactions, in effect to act as a hedging vehicle to ensure that exchange gains and losses do not create any problems in Country K.

Another consideration for Polycon Finance will be whether any potential capital losses on non-repayment of loans made to subsidiaries will be allowed against revenue or capital profits earned by Polycon Finance. Again, where there are risks of non-deductible capital losses, these can be accepted by a separate company established for that purpose.

Many countries subject non-residents to a withholding tax on payments of interest from resident companies; such rates of withholding tax vary from 5% to 35%. Where withholding taxes are a major consideration, it would be advantageous if Country K had entered into double tax treaties with all countries from which interest payments are received; the provisions of those treaties should substantially reduce withholding taxes on interest payments and may entirely eliminate such taxes or provide for full refund of any taxes withheld.

Polycon Finance may have funds surplus to the requirements of Polycon Lens Company and its subsidiaries. It may invest such funds on international stock markets, either directly or through a separate portfolio holding company, which may be treated for tax purposes on a concessionary basis. Alternatively, it may place funds on deposit with banks, or may consider international leasing arrangements whereby assets are acquired by Polycon Finance or a specially incorporated subsidiary company to maximise the tax concessions, and then the assets are leased to group companies at market rents.

A frequent question asked by clients is, what benefit is there in accumulating funds in a tax haven entity, which cannot be distributed to the beneficial owners without adverse tax consequences? Many groups decide to reinvest such accumulated funds to provide for further expansion of their activities, and such funds may be reinvested through the specially incorporated finance subsidiary, Polycon Finance, which may then on-lend to subsidiaries in high tax countries to extract profits in the form of interest payments. The interest income further increases the accumulated earnings of the tax haven company. In this way, tax is continually deferred and after-tax profits increased.

Polycon Finance may need to lend funds to group companies from which heavy withholding taxes will be deducted on Interest payments. In order to avoid such withholding taxes Polycon Finance may need to establish a finance intermediary company in a jurisdiction which is linked into double tax treaties with countries from which interest emanates, and where the provisions of such treaties reduce or exempt withholding tax obligations.

If the finance company needs to capitalise a subsidiary company with a sum on which interest may be disallowed (because Polycon Finance is its parent or associated company, or the debt/equity ratios are considered inadequate), it may be beneficial to arrange a "back-to-back" loan, in which Polycon Finance deposits the sum required with a local bank, and a foreign branch of that bank then lends the money to the group company in which the funds are to be retained. Such a back-to-back loan may also benefit the group if withholding taxes on interest payments made by the recipient company to Polycon Finance are high, or constitute an irrecoverable double tax credit, or again if interest would not be deductible against taxable profits because the loan comes from a non-resident. The "turn" required by the bank (the difference between the interest receivable on the loan and the interest payable on the deposit) should be no higher than one half per cent for substantial transactions, but many banks are now becoming wary of such back-to-back loans because of the effect they have on their bank ratios and lending powers. Moreover, tax administrations are looking more carefully into the tax effects of back-to-back loans.

In the above example, the back-to-back loan may be acceptable to tax administrations; however, if the situation is reversed so that the subsidiary company is putting funds on deposit with a bank, a foreign branch of which then lends the same sum to the parent company. This device may avoid the necessity of paying dividends from the subsidiary to the parent with the tax consequences resulting there from. Such back-to-back arrangement may not be acceptable to the tax administration. They may regard this as a constructive dividend (an up- stream loan) and levy tax accordingly.

Date: 2015-01-29; view: 761