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The process and details of offshore company formation

What is an offshore company?

There are many misconceptions surrounding the concept of an offshore company, so it’s worth clarifying what the truth is. The most commonly heard belief is that this is a company established in an exotic country for tax evasion purposes – however, this is a complete exaggeration of reality.

The term means that the company is incorporated in a country where, under local law, their income from doing business abroad is tax-free. However, the tax liability is the same, but the amount is usually set at a fixed annual fee, which in the case of international companies can result in significant tax savings in the long run.

Therefore, even a company founded in Hungary can be an offshore company if it carries out economic activity exclusively abroad – of course, this is not financially worthwhile at all because of the domestic tax system. An important addition is that it is not an economic activity to maintain an office or to employ administrative staff: so an offshore company can safely maintain an office in the country where the company was established.

In Hungary, a foreign company currently qualifies as an offshore company if it is more than 50% owned by a Hungarian company and does not pay at least 4.5% income tax in the country of incorporation. If the majority owner of a foreign company is a private individual with Hungarian citizenship, then we are no longer talking about an offshore company.

Benefits of offshore companies

The two most frequently mentioned benefits for offshore companies are tax optimization and tax avoidance. Of the two, however, the latter is not true: non-payment of tax is prohibited and a criminal offense. Tax optimization, on the other hand, means that we pay the tax within a completely legal framework according to a tax system that reduces the amount to the minimum allowed by law.

This is because tax systems work differently in different countries. Moreover, it can help us to know the relationship between the country where we are a citizen and the place where we set up an offshore company: we often come across agreements between countries that have been concluded to avoid double taxation, including we may be able to choose which country’s system we want to tax. Thus, of course, it is possible to choose the taxation that is more favorable for us.

The other best benefit is the protection of property. Ensuring that our investments, bank accounts, or other assets are owned by our offshore company can provide extra security. In addition to the often more favorable tax system, countries supporting offshore companies are much stricter with regard to the private sector and find it difficult or impossible to allow access to confidential financial data in the case of foreign bodies, malicious business associates or ex-wives.

What are the disadvantages of an offshore company?

Of course, it’s not just about the benefits, the offshore company alone isn’t the overriding solution. If that were the case, everyone would run their business through offshore companies, but as we can see, this is not the case.

According to domestic regulations, if the managing director of an offshore company concludes a contract in Hungary (ie in Hungary) or acts on behalf of the company, he must pay tax on his profit according to domestic rates. But we must also pay attention to paying at least 4.5% corporate tax: if this does not happen, the foreign company will be considered a controlled foreign company. This means that the total income of a foreign company can be taxed according to the Hungarian tax system.

You also have to pay attention to the rules of “income from a low-tax state”. This applies if you want to withdraw dividends from a foreign company where the corporate tax rate is less than 9% and / or you do not have an agreement with Hungary to avoid double taxation. In such a case, the dividend to be levied is subject to a higher tax.

Of course, if we follow all these rules, we do not have to fear disadvantages.

Who should start an offshore company?

As already mentioned, not everyone should get involved in starting an offshore company. However, there are some types of businesses where this company structure can almost always be a good choice. Let’s look at these in a row.

Online businesses

If most or even all of our revenue comes from online sources, an offshore business can clearly be a good solution. After all, we are not tied to a place, we don’t have to pay special attention to doing business outside the country, as it is already an international marketplace, so we can operate the business from any country.

For example, we may record revenue in one country, operate the website from another, and pay taxes in a third country where it is most convenient for us. Thus, even administrative processes can be simple despite international operations, if the well-functioning model only needs to be maintained after the initial design of the structure.

Intellectual property protection

Not only the creation but also the preservation of trademarks and various intellectual property is playing an increasingly important role in the modern economy. In such cases, it is not enough to just obtain trademarks or patents, but it is worth keeping them under the jurisdiction of a country that takes maximum care of their safety. 

In addition, it is not a disadvantage if, for example, in the case of the lease of a patent, we have to pay as little tax as possible after the utilization.

Cryptocurrencies

Most states have put their hands on a financial instrument that has been almost completely unknown for a few years now, or are preparing to do so. It is therefore worth keeping revenues from cryptocurrencies in a state where we can do so completely legally, but with a significantly lower tax burden,

The process of starting an offshore company

Whatever the company, the following 5 steps are worthwhile before founding it:

  1. Define our business goals and the most important reasons for us to move offshore
  2. Talk to an international tax expert who is at home on the subject
  3. With the help of an expert, choose in which country (ies) you want to start a company
  4. Determine the type of company to be founded
  5. Let’s start the company

During the process, of course, it is worth consulting an expert, as a poorly chosen decision at the start can have serious consequences. However, if we pay attention to the details and follow all the rules, we can continue to operate our new company on extremely favorable terms.