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A Complete Guide to Hollow Corporations | What are hollow corporations?

What are hollow corporations?

This is a model for a company that outsource majority of their production activity. A compatible U.S. buzzword is “virtual business”. There are few references defining what is “hollow corporation”. Business glossary defines it as a business in which “important elements are outsourced to subcontractors“.

How does it work?

This type of structure is widely used in both software and outsourcing business.

This type of business model has its pro’s and con’s in both software and outsourcing business, the most important pro’s are:

The main con of such business model is legal implications that may arise in case of possible lawsuit or due to some regulation.

  1. Payments are transferred without VAT (e.g. France) and/or changing currency. It means that no VAT can be applied. This results in low logistics expenses and (often) lower taxes.
  2. Payments are made to a 3rd party who processes all the necessary paperwork & other activities involved in making sure payments are made on time.
  3. Provisional invoices can be issued, providing job/product/service clients with a tax report for easier planning.
  4. Company remuneration is paid to a separate company that incurs all operating expenses of the parent company.

Hollow corporations are not legal entities and as such are not subject to any tax jurisdiction other than the ones that they operate in, they are only subject to the tax laws of the country they operate in.

Hollow corporations have no physical presence.

It is common to have a web site of corporation that has a company logo and slogan.

Businesses of this type are awarded government contracts in the USA that require the recipient to be a legal entity. The entity requirement can be overcome by using corporations located in USA protectorates (e.g. Puerto Rico).

The biggest difficulty faced by hollow corporations is the need to have a physical presence in the country they do business in.

Virtual companies are often favoured by international clients for outsourcing business activity due to their ability to operate anywhere in the world and tax planning opportunities only available to them.

Hollow corporation are subject to double-taxation.

What are the possible risks?

According to IRS taxes are owed by “U.S. shareholders” of “controlled foreign corporations”. The controlled foreign corporation rules were first enacted in 1962 as subpart F of the Internal Revenue Code (“subpart F”). The subpart F rules intend to make it possible for U.S. companies to compete on the same basis as foreign-based companies that have a differential tax advantage relating to their operations outside the United States. In general, the subpart F rules impose two separate layers of U.S. tax on the “international operations” of a foreign corporation that own (directly or indirectly) at least 10% of a U.S. corporation.

The tax of the United States is determined by the federal income tax law, which is one layer of U.S. tax. The top rate of federal income tax in 2009 is 35%. Due to the Unitary Taxation System, the U.S. federal income tax is imposed on dividends received by a foreign corporation from a related U.S. corporation without the application of the tax credits available to resident corporations.

In addition, the subpart F rules impose a second layer of U.S. tax on the international operations of a foreign corporation that are attributable to certain income of the foreign corporation. This layer of tax is imposed on “super-taxable income”.

Super-taxable income is “income” that is subject to U.S. tax under an income tax treaty. It is often possible for a foreign corporation to achieve qualifying income by eliminating or reducing deductions.

Any provision included in a foreign corporation tax treaty is present in the tax treaty with the U.S.

There are several ways in which a foreign corporation may be able to eliminate or reduce deductions. These include deductions for:

  1. Unavoidable financial losses related to those items (if the foreign corporation can convince the U.S. authorities that such losses are not avoidable).
  2. Loss of market share or operating losses of a foreign corporation during a taxable year that exceeds the average operating income of the prior three taxable years (similar to the rules applicable to corporation in USA).
  3. Interest deductions related to certain loans given to affiliates of the foreign corporation.
  4. Expenses and losses related to foreign income from services performed by a foreign corporation if the foreign corporation has entered into an income tax treaty with the United States and only if the foreign corporation can convince the U.S. authorities that the services were outside the United States.
  5. Expenses and losses related to foreign income from services performed by a foreign corporation if the foreign corporation can convince the U.S. authorities that the services were outside the United States.
  6. Expenses related to assets used in the active conduct of a trade or business if the foreign corporation can convince the U.S. authorities that the services were outside the United States. Examples of such expenses include:
  7. Income of a foreign corporation that the foreign corporation can prove was derived by a foreign corporation without the active participation in the operations by shareholders that own directly or indirectly at least 10% by voting power or value of the foreign corporation. Foreign corporation tax treaties often include a “carve-out” for interest income from loan to a U.S. shareholder.
  8. Income of a foreign corporation that was derived with the active participation in the operations by U.S. shareholders if the foreign corporation can prove that:
  9. Income of an active trade or business in which a foreign corporation is engaged, if the foreign corporation can prove that it is impossible to undertake such active trade or business due to actions taken against the company by governments or companies in the country in which the business is located).

Special rules apply to a foreign corporation controlled by a U.S. person, such as the corporation provides for the payment of a dividend to a U.S. person that is treated for U.S. tax purposes as a dividend received by the foreign corporation.

Advantages of hollow corporations:

Hollow corporations with no physical presence can conduct business with people in many countries.

Privacy – a no-physical entity that an individual may use to conduct transactions without a paper trail, or without being sued.

Exploitation of the differences between tax jurisdictions.

How many types of tax can apply depending on place of operations – Double taxation is avoided when a corporation uses countries with no tax treaties.

International companies can have multiple corporations in various tax jurisdictions. For example, a corporation in Hong Kong separate from a corporation in the USA.

How does a hollow corporation work?

A corporate form potentially has greatest protection for the assets of the owner. As a result, hedge funds and other investors choose to incorporate offshore as a shield in the event of a lawsuit.

Hollow corporations can add value to a business. The articles of incorporation and bylaws may allow the directors to bind the corporation to non-solicitation, non-compete and confidentiality agreements with employees. These agreements will prevent the employees from stealing the trade secrets and/or knowledge from the corporation and leaving and using it for the benefit of a competitor. It is wise to have a no poach policy against your competitors.

A good way to ensure that you protect your business and keep it from being sold to a competitor (and then being consolidated and eliminated) is to incorporate it. One of the great advantages to incorporating your business is that as it grows and becomes more profitable, it has the potential to grant profit sharing to key employees.

Hollow corporations can be used in a way to keep your business ownership and profits private, if you choose to do so.

The biggest disadvantage of a hollow corporation is the subjective process wherein the multiple jurisdictions may seek to impose taxes and require the collection of mandatory taxes (e.g. Value Added Tax, Sales Tax, etc. ).

There is added cost of maintaining a corporation in addition to the tax they charge on income. There are fees involved with setting up the corporation, annual fees, and the paper work that accompanies the corporation’s existence. As a result of the “stigma” associated with hollow corporations, it is not easy to handle transactions in a way that shareholders remain anonymous.

When it comes to taxation, a possible disadvantage of a Hollow Corporation is that the corporation can be liable for various taxes depending upon the multiple jurisdictions that the corporation operates.

As technology has advanced over the last 20 years, many individuals have turned to alternate forms of conducting business. In most cases, the use of a “Hollow Corporation” is an example of a move toward a more advanced type of business structure. The days of old corporate structures are quickly fading away as the world enters the new millennium.

The most prominent benefit to using a “Hollow Corporation” is that there exists the ability to separate the owners of the business structure from the business assets themselves. One of the many benefits of this is privacy. The privacy of the owners can be preserved and protected to ensure that assets are not visible to third parties.

“Hollow Corporations” can be operated from anywhere in the world – using virtual offices. As long as the corporation has a functioning address and officers with a presence at that address, the corporation will be viewed as legitimate by the jurisdictions government.

Hollow corporations provide their owners the ability to: diversify their portfolios, shrewdly grow their capital, invest without having to comply with and/or endure any limits on investment, take steps to minimize the taxes that they will pay from year to year, earn the greatest possible income, and more…

Another way a corporation will achieve some level of protection is by becoming a corporation without ever handling money. The money is sent to a brokerage house for management and an investor is sent back a percentage of the earnings. This is essentially the same as paying someone a salary and having that salary invested.

What is a compliance statement?

A compliance statement is a document incorporated in an offshore corporation which may provide evidence that the corporation does not violate laws of any foreign jurisdictions and also demonstrates the company’s compliance with the tax rules, tax laws and tax treaties of a foreign jurisdiction or jurisdictions.

HM Revenue and Customs generally want to see a compliance statement if it is claimed that a company was incorporated outside the United Kingdom and/or has an annual turnover of over £200,000 (the threshold for filing a UK Corporation Tax return).

A compliance statement found on the internet may be off-shore; it is difficult to tell as they do not have a registered office or can be located offshore in a country that is not a member of theEuropean Union or the United Nations or a member of the Commonwealth.

Also typical of off-shore compliance statements may be references to entities in multiple jurisdictions.

The UK HM Revenue & Customs’ view:

A compliance statement may be the end of the story for a UK corporation tax return.

If there is no compliance statement, HM Revenue & Customs might ask for it or they may issue a letter requiring the more complete submission of information about the business structure prior to deciding whether to file an information return and pay corporation tax.

A compliance statement may be the end of the story for a UK corporation tax return.

If there is no compliance statement, HM Revenue & Customs might ask for it or they may issue a letter requiring the more complete submission of information about the business structure prior to deciding whether to file an information return and pay corporation tax.

HM Revenue & Customs’ use of the compliance statement:

A compliance statement is not a tax return. HM Revenue & Customs use compliance statements to look for potential errors in how a company has been incorporated or operated that may require additional compliance work in the future.

The statement is not intended to validate that a company is not responsible for reporting UK corporation tax. It is not a guarantee of tax compliance or a guarantee that the company is in compliance with tax treaties or various laws or regulations.

There are many positive aspects to incorporating a corporation offshore. The company will pay lower rates of corporation tax, it can provide anonymity for the shareholders of the company, and it can provide for a level of privacy for the owners of the company.

Diversity and privacy:

A “Hollow Corporation”, especially an offshore corporation may offer maximum diversity to a private owner and even provide privacy and anonymity to a business. This may be especially important to people who choose to incorporate offshore and engage in global business activities.

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