If you own a company with interests abroad, you may have wondered if you can take advantage of the lower corporate tax rates some countries have adopted. After all, they’ve often changed their policies and tax rates in order to garner international investment.
In the 1980s, for example, Ireland had a 50% corporate tax rate. Now the rate is 12.5%.
Foreign direct investment, or FDI, is money that one company transfers to another company with the same parent firm. This is much of what countries are trying to attract with their low tax rates. FDI was designed to bring needed capital into local economies.
So, you could set up a company in a low-tax-rate country and transfer capital into that company’s accounts. Then, the capital would be taxed at the low rate. When there are legitimate business purposes for such a company and the underlying transactions, this would likely be legal.
Using shell companies is rarely legal
Unfortunately, many of the destination companies in low-tax-rate countries are not legitimate. They are shell companies with no actual business activity. When FDI is transferred into a shell company, it is generally for the purpose of evading taxation in the home country. This is called “phantom capital.”
A recent study by the International Monetary Fund points to just how extensive the problem is. Worldwide, the IMF estimates that 40% of all FDI is phantom capital. That’s $15 trillion — more than the economies of China and Germany combined.
And, nearly 85% of the world’s phantom capital is hosted by just 10 countries, including Ireland.
Are Ireland and the other countries making bank on phantom capital? Not really. After all, their tax rates are quite low. According to Forbes, host countries often don’t collect any taxes on phantom capital, although they do earn some income from financial management and accounting services for these foreign investors.
The fact that about 40% of the world’s FDI is phantom capital makes it extremely difficult for world leaders to gauge the real impact of FDI on the countries that seek this investment.
Before you consider setting up a fake company in order to lower your tax rate, discuss your options with a tax attorney. The penalties for tax evasion are extremely serious, and an experienced tax attorney can help you find options to minimize your tax burden without breaking the law.
