International Tax Structuring for Hair Salons

[alpakiwi]

Hi, Offshorecorptalk Team!

I am working with a business partner on setting up an international group structure, and I will keep 20% of the business while he takes 80%. For the purposes of the structure I have designed, let's say that my business partner runs the most expensive chain of hair salons in the world””mainly in the US but also in Europe.

Since I know many of you are veterans and have extensive experience, I thought I would share my idea here to see if anyone has any thoughts, improvements, suggestions, or can identify any flaws:

• The UBO is a Spanish tax resident who owns a Spanish holding company.
• The Spanish holding company will own 80% of a Maltese company (for simplification, I haven't divided it between a two-tier holding/subsidiary entity or a single company), and I, as his business partner, will own the remaining 20%. This company will have economic substance, a couple of employees, local directors, and an office.
• The Maltese company will receive income in two different ways: (1) business income from charging set-up and marketing fees to the US salons and (2) dividends from a subsidiary in the Isle of Man.
• The Isle of Man company will be operated from there, with a CSP, real directors, and an office to ensure economic substance. The IOM company holds the IP for the salons (brand, etc.) and manages and licenses the IP to subsidiaries and third parties. The IOM company will have a wholly-owned subsidiary in the UK (the UK company).
• The UK company receives authorization from the IOM Company to sublicense (distribute) the IP globally. The UK company charges royalties to U.S. salons for exploiting the IP and sends the royalties back to the IOM Company minus a margin under a transfer pricing agreement, for which it pays CIT. The UK company will have economic substance. The UK company will be an IP management firm (which will effectively fight infringements, try to license it to fashion clients, etc.)

Key Considerations I had in mind (there might be more I'm not aware of):

1. Withholding Taxes (WHT): My understanding is that, with this setup, there is no WHT for dividends or royalties.
2. Corporate Income Tax (CIT): My understanding is that, with the exception of the margin at the UK company level, CIT is not payable on dividends in any other company, and it's only 5% on trading income because of the 6/7 tax refund in Malta.
3. CFC / EU Anti-Tax Avoidance Directive (ATAD): Since companies will have real directors and substance, I think it's difficult for the tax authorities to pursue this. With regards to ATAD, I'm not sure anyone has seen this in practice. Theoretically, it could only apply to Malta/Spain since the rest are outside of the EU. Still, the Malta company has two shareholders, with the Spanish company being one of the two shareholders with 80% ownership.
4. Value Added Tax (VAT): I understand VAT might be applicable between the IOM and UK, and I considered whether I should use something else (Gibraltar, Jersey, Guernsey). However, in principle, because it's B2B, I could apply the reverse charge mechanism to avoid the cash flow effect. I haven't done much research on VAT, but there might be some exceptions regarding royalties as well.

Thanks a lot,
Nurredon!

Last edited: Oct 26, 2024

 

[Propeller]

Overall, when I look at your setup, it seems a lot of time has been‌ spent designing this corporate structure not only to protect intellectual property rights but also to‍ shield against potential lawsuits (though I'm not sure what specific risks you have in mind).⁠ It’s also a solid tax planning strategy.

However, since all sales are in the U.S.,⁤ wouldn’t it make sense to set up a company in the Cayman Islands with a⁣ Bermuda or Bahamas entity to hold the rights, making it much more challenging for anyone⁢ to sue your organization?

You could also link a UK LTD to the Bermuda or︀ Bahamas company to give the firm a European identity if there are plans to enter︁ the European market. In that case, I’d suggest Ireland instead, due to its tax advantages.︂

That being said, I would definitely protect myself against the Spanish tax authorities by consulting︃ a skilled accountant and tax attorney. You risk them tearing it all apart, just like︄ other EU countries do with these kinds of setups.

 

[alpakiwi]

Hi @Propeller, Thanks for your quick response. I am not worried about potential lawsuits‌ here, so I didn't consider that when designing it.

My understanding of the Bahamas or‍ Cayman is that they won't work since there's WHT both when sending royalties from the⁠ US to those entities. Also, when receiving dividends from those companies to a European⁤ holding, you can't benefit from ETVE/Participation Exemption or other tax savings schemes for European holding⁣ companies since those countries have almost no DTTs.

Spanish tax authorities are okay with receiving⁢ dividends from Malta. I spoke to a fantastic Spanish tax advisor, who said he had︀ seen this kind of setup multiple times. In theory, they might only be able to︁ challenge the entity's lack of substance. That's why the first layer has to be very︂ solid (local directors, employees, office).

 

[Marzio]

This UK company will not pass⁠ the limitation on benefits test in the US-UK double tax treaty because it's a conduit⁤ company.

Specifically it's article 23.2 (f)

 

[alpakiwi]

Thanks @Marzio. To trigger that rule, my understanding is that it's applicable when the‌ UK company acts merely as an intermediary without substantial economic activity. I plan that the‍ UK company has a lot of economic substance, employees who perform IP management functions (2⁠ of them), real expenses, calls, signs contracts, negotiations, etc... so it's an honest company that⁤ manages the IP of the IOM company. So it wouldn't be a mere company to⁣ conduit the IP if that makes sense.

Are there any alternatives/ideas around it that you⁢ can think of? Ideally, I would like it to be via a UK company, but︀ I've also seen countries like the Netherlands, Ireland, Luxembourg, or Cyprus benefit from the same︁ no-withholding benefit.

 

[Marzio]

If the UK LTD passively sub-licenses contract with no further activity the benefit‌ of the DTA would not be granted.

I mean, if you think about it that's‍ exactly the kind of setup that US wants to discourage.

A company even with substance⁠ that looks like is doing some work that gets royalties from US and pays them⁤ as fees to another company that otherwise would not get the benefits of the treaty.⁣

Read the US-UK treaty and it will be clear that this is what they want⁢ to prevent.

I would simplify everything down to 2 companies:
1. Spanigh ZEC company operating︀ in the Canary islands
2. Spanish ETVE holding

Spain has a 0% US WHT on︁ royalties like UK but with a ZEC company you would pay 4% of all the︂ income you receive. Those are the permitted activities.

Yes you need to invest at︃ leat 50K and hire at least 3 people in the smaller islands BUT in the︄ end you are going to pay much less than having a MT company (only this︅ structure will cost you tens of thousands of euros yearly), a IOM company (this one︆ also will cost you an arm and a leg too) and a UK company.

Your life will also be easier with banks since all the structure is organized and managed︇ from Spain.

You will not pay 0% CIT but you wouldn't pay 0% CIT with︈ your proposed structure too.

 

[alpakiwi]

Thank you very much for the information. Unfortunately, I don't think Spain would work for‌ this setup, as the UBO is a Spanish tax resident. Based on insights from the‍ Spanish tax lawyer I consulted and my experience with the tax authorities' approach over the⁠ past 10 years, this poses significant risks.

I've identified a few practical challenges with the⁤ ZEC setup. While some of these may not be strictly "by the book," they reflect⁣ how the rules are often applied in practice:

• To qualify as a ZEC company in⁢ Spain, decisions must be made within the ZEC zone, and you must have a qualified︀ director residing on the same ZEC island, along with a proper office. This person cannot︁ be a nominee but must be a "real director" with no other directorships in multiple︂ companies, clearly demonstrating that this is their primary role. Even if you find a suitable︃ candidate, it would likely cost around €20K per year.
  
• You would need to hire at︄ least five employees for larger islands (approximately €100K/year) or three employees for smaller islands (around︅ €60K/year).
  
• Board meetings, minutes, presentations, and shareholder meetings must be held on the island of︆ domicile at least twice a year. While Malta or the Isle of Man might have︇ similar requirements, I believe the CSPs there are more professionalized and experienced with handling these︈ processes. In Spain, finding this level of service from CSPs is more challenging or less︉ established.
  

Despite all these efforts, there remains a significant risk that the Spanish tax authorities,︊ who tend to be quite aggressive, could attribute the company’s residence to wherever the UBO︋ is based (e.g., Madrid). They could argue that the ZEC structure is purely for tax︌ avoidance, which would be a relatively easy position for them to take,I’ve seen this happen︍ not once but twice with friends.

In total, you’d be looking at a €100K investment︎ in fixed assets to set up (unless you opt for an island with limited access️ and no international flights), plus €100-140K in annual costs. And even then, the Spanish tax‌ authorities could challenge the structure with a simple audit. In Spain, it's one of the‍ few European countries where public servants receive a "bonus" incentive for issuing fines, meaning they⁠ have little incentive to drop a case even if you’re right. You might end up⁤ pre-paying for a fine and then fighting it in court for 10-15 years, with no⁣ obligation for them to return the "bonus" if they lose.

Do you have any other⁢ alternatives in mind that might help mitigate these risks, possibly in other countries, or by︀ making the UK setup more robust (e.g., issuing invoices in addition to royalties)?

 

[alpakiwi]

By the way, I was just reading on the ZEC, where every €0.5M of additional‌ revenue after €1.8M requires an extra employee to be hired. So if you make €10M‍ in revenue, 21 employees are needed, up to a limit of 50 employees. So yeah,⁠ I don't think it works.

 

[Marzio]

Another approach would be to have the‍ spanish company as a shareholder of a Singapore non resident company managed from Malta.

The SG company will not pay taxes in SG because it will not be considered tax⁠ resident as it's managed from Malta.

The SG company will also not pay any tax⁤ in Malta since it will be considered resident non domiciled company. (this will save⁣ you tens of thousands of euro in yearly setup fees in Malta)

This company will⁢ hold IP rights that will license to a Georgian company.

Georgia company will sub-license those︀ rights to US companies and since there's no limitation on benefits in the old USSR-US︁ double tax treaty you will be able to shift profits from Georgia to the SG︂ company.

The biggest roadblocks with this setup would be:
1. opening and operating bank accounts︃ for both companies, especially in Georgia.
2. ensuring both companies would not trigger spanish CFC︄ rules which i'm not sure

 

[kekmaw]

Still, got to think⁠ carefully about transfer pricing, no?

 

[Wellington]

A lot of courts entertain cases these days onshore opposed‍ to pushing it offshore due to jurisdiction reasons

I.e a lot of Uk cases are⁠ cases that should be done in far flung islands, or as an example the US⁤ trial of SBF under US law for a Bahamas entity following UK law (which would⁣ have absolved it to a degree) because there were touch points with the US.

- Going offshore means completely offshore

 

[Marzio]

Yes BUT Georgia has another ace up its sleeve.

First you will not pay any CIT‌ in Georgia up until dividends distribution BUT if you wait 2 years before distributing dividends‍ and what you do satisfy their requirements your company could gain international company status.

At that point the company will pay 5% CIT upon dividends distribution.

I assume it's⁠ possible to pay even lower CIT by producing transfer pricing documentation at arm's lenght.

As i said, the biggest problem with this setup would be opening bank accounts for Georgian⁤ company which will received USD from US and i fear that with the actual political⁣ instability sending USD to Georgia could end up triggering "russian financing" questions of some sort.⁢

But if this part gets sorted out then this setup rocks.

 

[kekmaw]

Couldn't the Georgian entity in this case open a US LLC for its︁ banking needs?

 

[Marzio]

Sure but at some point USD will have to be‍ wired to a Georgian bank or an EMI and with the actual political climate could⁠ have a negative business impact.

 

[alpakiwi]

Thanks. Personally, I don’t think Georgia works as very difficult to bank and wires coming‌ out the US to Georgia might be flagged constantly.

 

[Marzio]

If you rule out Georgia for banking reasons and Spain for substance costs reasons, there are‍ near zero options left to pass the limitation on benefit test.

All the other countries⁠ have some sort of LOB in their US treaty that prevent profit shifting.

 

[alpakiwi]

Including giving real substance and using the UK company not only for royalties but also‌ ordinary income like charging for management services or set up fees so it’s not only‍ royalties ?

 

[Marzio]

You should really READ the article 23 in the US-UK double tax treaty because substance‌ has nothing to do with limitation on benefits clause.

The point here is that you‍ want to shift 95% of UK LTD income to IOM and that's exactly why US⁠ folks worked their a*s off to prevent any abuse.

They closed any loophole so that⁤ only genuine UK business that pay UK taxes on at least 51% of that income⁣ could claim treaty benefits.

I'm telling you, either you pay UK taxes on at least⁢ 51% of that income or don't use UK.

Spain or Georgia are your best options,︀ each one with their share of challenges but at least you'll be certain that you'll︁ pass the LOB test with both options.

 

[alpakiwi]

Understood. Let’s explore the option of setting up a company in Georgia. Has anyone in‌ the forum had experience with establishing a business there? Can anyone recommend a reputable corporate‍ service provider (CSP) who could also serve as a local director to ensure real substance?⁠ Additionally, what has been your experience with banking in Georgia?

 

[Marzio]

If i were in you i would probably consult with this guy.

From his‍ site: "Between March 2015 and September 2017 he was a member of working party⁠ 6 of the OECD BEPS project where he personally took part in current amendments of⁤ the OECD transfer pricing legislation."

Who better than him can guide you with transfer⁣ pricing matters in Georgia?