Deoffshorization: what do you need to know when working with offshore companies?

Understanding offshores and their “reality”

Business, no matter where it is located, always wants to optimize its tax burden and improve operating conditions, and the first thing that comes to mind in this case is working with offshore zones.

However, not everything is so simple in 2023, the deoffshorization process has already become so global and thorough that the big question arises: “is offshore profitable or not?” Let's figure it out.

In the general understanding, “offshores are territories with a special tax regime that provide companies with many advantages, including ultra-low or no income taxes. Even 5-6 years ago, this scheme worked very simply: you registered a company in a tax-free island zone for a non-resident, you conduct all your active activities outside this zone and do not pay local taxes. There is no financial report, everything is as legal as possible, and confidential. After all, previously no offshore company had registers of beneficial owners, and the registers of directors and shareholders included nominees. These were the “golden times” for everyone who wanted to do business “without unnecessary questions and tax worries.”

But, soon international organizations began to note massive criminal schemes that passed through such offshore countries, and, as a result, tax injustice - a complete lack of taxes. And here the concept of “deoffshorization” has already appeared.

What does deoffshorization mean?

Deoffshorization is a set of measures aimed at reducing or eliminating the use of offshore jurisdictions for tax optimization, tax evasion or ensuring confidentiality. This strategy is a response to global initiatives to combat tax evasion and money laundering, including introducing transparency in financial transactions and tightening requirements for companies using offshore companies.

As a consequence, deoffshorization standards include reviewing ownership structures, changing tax strategies, and compliance of tax-free or low-tax countries with new international regulations.

The new standards for doing business in offshore zones are the most important thing that every entrepreneur needs to know today.

Basic standards for the deoffshorization process

Deoffshorization is a rather lengthy process, which began actively in 2015. Thus, international regulators annually review their rules, add new requirements and are increasingly striving to bring the entire world business to global transparency.

One of the key initiatives toward tax fairness is the MLI Convention. This is a multilateral convention developed by the Organization for Economic Co-operation and Development (OECD) within the framework of the BEPS Action Plan to combat base erosion and profit shifting, which was signed by more than 100 countries, including Ukraine. This document covers such important aspects as tax rules for permanent establishments, transfer pricing, working with related parties, and preventing abuse by applying the provisions of bilateral tax treaties.

The BEPS plan, in turn, stands for Base Erosion and Profit Shifting. This is an MLI-related initiative of the Organization for Economic Cooperation and Development, aimed specifically at developing measures to combat tax evasion and the artificial redistribution of profits between jurisdictions.

As a result, by 2023, offshore business is already faced with certain requirements within the framework of these documents:

·        Introduction of public registers of beneficiaries

Initiation of the public registers of beneficiaries is one of the key requirements within the deoffshorization process. It aims to increase transparency of ownership of legal entities and prevent the use of offshore jurisdictions for money laundering, tax evasion and other illegal activities.

Public registers of beneficiaries allow any interested party to find out who the actual owner of a foreign company is, which eliminates the concept of “confidentiality”.

Thus, today public registers of beneficiaries have been introduced in most countries of the world under pressure from international regulators. According to the FATF, by October 2023, public registers of beneficiaries have been introduced in 153 countries, including all OECD member countries.

·        Mandatory financial reporting

If before the process of deoffshorization companies could not report on their finances, then with its onset even classic offshore companies such as Panama, Seychelles, Belize, BVI, Cayman Islands introduced requirements for storing annual accounting records and preparing and submitting a minimum annual financial report to the regent. These requirements, quite likely, may become more stringent over time and lead these jurisdictions to prepare full-fledged financial statements and submit them to the Regulator.

By introducing this rule, global regulators have overcome the concept of “secrecy.”

·        Introduction of Substance requirements

Substance (or real presence) is also an important element of deoffshorization. As a result, many countries require companies registered in their jurisdiction to have an actual economic activity and residence. This is aimed at preventing the creation of "paper" companies for tax evasion purposes.

So, now almost all of the previously most attractive jurisdictions require that a company have a physical office, hire full-time employees and have a local bank account. Of course, the requirements vary from country to country, but the general provisions are that if a company does not have a real location in the country of registration, it cannot claim any tax benefits. Today, the EU wants to adopt the minimum substance requirements at the documentary level; a draft Directive has already been prepared. Its use is expected in 2026.

·        Application of CFC rules

Control over foreign companies and their taxes is a fundamental element of deoffshorization. Many jurisdictions are introducing CFC rules as part of the BEPS Plan, providing tools to effectively monitor companies' financial activities and prevent tax evasion.

Thus, in Ukraine, the CFC Law began to be applied in 2022. CFC rules oblige individuals and legal entities, residents of Ukraine, who control foreign companies, to provide information about their foreign assets, and annual income, under conditions, pay taxes on them (18%). In particular, controlling persons are required to notify the State Tax Service about the acquisition/disposal of a share in a CFC, about the establishment/liquidation of a foreign company, submit an annual CFC report along with the financial statements of the foreign company and tax return, as well as pay taxes in Ukraine on foreign income (if not applicable tax exemption). Thus, states not only control where and who has what business, but also collect unpaid taxes from hidden income.

·        Automatic exchange of financial information CRS

With increasing international cooperation in the fight against tax evasion, many countries are introducing automatic exchange of financial information. This mechanism provides tax authorities with information about the financial transactions and assets of citizens in foreign jurisdictions and allows for global control over businesses.

To date, more than 110 countries, including Ukraine, have joined the CRS Automatic Exchange of Financial Information Standard. And from 2026, tax authorities will exchange not only information about bank accounts, but will also gain access to crypto assets abroad.

And then the circle closed. Deoffshorization is taking on new forms and is becoming a more complex and stringent process that requires compliance with high standards of transparency and policy regulations. Companies seeking to further operate in global markets must take into account all these modern trends and carefully analyze the possible consequences of tax reforms and changes in global financial practices.

If you have difficulties adapting your business to the new legal requirements of the country of registration, contact our lawyers and we will help you adapt favorably to the current legal rules.

It is also worth remembering that if you do choose an offshore as the place of registration of offshore  company, before making such a decision it is important to conduct a thorough analysis, consult with legal experts and take into account all aspects related to legality, finance and reputation. This is the only way to ensure the sustainability and success of a business in the context of global deoffshorization.

If you still have questions about deoffshorization, use the services of our lawyers for individual consultation, who will be able to thoroughly check and analyze your business for compliance with the current requirements of the registration jurisdiction.