It is important to think about how to avoid double taxation when setting up a company overseas. It means ensuring it does not have a double tax residence. Typically entrepreneurs focused on business development tend not to pay attention to the question of where their company is managed from. In this article we present very practical pointers on what to look out for to avoid paying taxes in two countries.
Registration of a company overseas – the start of an adventure
There is no requirement to leave Poland to register a company abroad. All administrative formalities can be completed from home by taking advantage of professional services available at the destination of your choice. The first hoop is often an extensive KYC process, this includes passports, place of residence, PEP checks, etc. The next steps are outlining the purpose of the company’s activities, designating a management board and shareholders. All this tends to be sufficient in common law countries. For example in the UK a company will go live within a day. On the other hand it will take more time to incorporate a company in Cyprus or Malta. Those countries also give you the opportunity to utilise off-the-shelf companies.
In Germany, Switzerland and Luxembourg the situation is slightly different. The legal systems there are analogous to that in Poland. In other words, a company is established through a Notary Public and subsequently registered in the commercial register. On the continent, off-the-shelf companies are not used, although until recently they were still common in Poland. However, take Switzerland as an example, the sale of off-the-shelf companies is banned. That said, even there, the procedure of incorporating a company can be done remotely using a power of attorney drawn up in Poland. All that is needed is the support of a local lawyer and the company’s capital to be paid. Without a certificate of payment of capital by the founder of the Swiss company, the Notary Public will not proceed with the preparation of the deed of incorporation. The capital is paid into a temporary bank account and only upon completion of this step (with the appropriate certificate) can the company be established with a Notary Public. Finally, it is registered with the commercial register – this usually takes about 2 weeks.
When does the entrepreneur need to get involved in person?
Once the company has been set up, it is time to open a bank account, nowadays it is a quite complicated process and can sometime take more time than creating the company itself. It is helpful to have one of the two, either a good relationship with a local bank or an abundance of patience. It is at this stage that the client is required to get involved personally. The bank may require a telephone conversation or even a meeting with the client. Some banks send their representatives to their prospective clients’ headquarters (in Poland) – but these are not the types of banks that a start-up taking its first steps in its expansion would be looking to use, these are much too expensive.
Many countries carry out enhanced KYC checks before opening a bank account for their prospective clients. Such rules apply in the UK or the Netherlands for example. It is therefore a good idea to check how realistic it is to open a bank account in the chosen country before starting the process of setting up a company.
Carrying out real activities – an antidote to the risk of double tax residence
Once the company has been incorporated, the founders are required to be truly involved. Despite the fact that in today’s day and age a lot of work can be done online, tax legislation hasn’t moved with the times and the economy. Furthermore, contractors will check if the company in question has an office in the country of registration and if it genuinely carries out business there. As an example, it is at least advisable or as in the USA, France, Germany or Italy required to have an office and employees. Local contractors expect a full-size office and a local team before starting cooperation.
What does starting a business overseas look like in practice
Once they’ve identified the possibility of doing business overseas, most entrepreneurs will try to keep costs low for as long as possible. Therefore, the entrepreneur will delay incurring the costs of doing business in the country of registration of the company until they are convinced that it makes financial sense. Sometimes because of the potential savings this practice is drawn out, sometimes it happens because of convenience, given that all management and decision-making activities are carried out in Poland. This is when problems start occurring…
Company headquarters vs location of management functions – hurdles!?
In this article we have written about registering a company. This is a technical detail related to where the company was established and registered. The registered office is one aspect (although typically, a company’s registered office is in the country where it was registered), the other is the location from where management functions are carried out. The latter is the decisive factor.
The location of management functions means the country or city from which the company is managed and those are the problem areas… From a tax perspective this is of particular importance, as it determines the country where all of the company’s income is taxed. In other words, it indicates the company’s tax residence. Arguably, in many countries basic rules define the place of residence (office) of a company as their tax residence. However different criteria are also used in tax law, for instance what country is a company actually managed from? This is also the approach taken by the Polish tax system.
What does that mean?
From a Polish perspective, it means that it is not enough to register a company abroad in order for it to not be subject to taxation. Corporate income tax (CIT) will be levied in Poland, if a foreign company is effectively managed from Poland, despite being registered overseas. That company would then have dual tax residence and that’s one of the hurdles.
What actions create the risk of double tax residence?
Case 1 risk of double tax residence – key decision making
This means that it is not possible to make operational or strategic decisions regarding the running of the company from Poland. If the Polish members of the board who make those decisions are permanent residents in Poland, then the Polish tax authorities may identify the company as taxed in Poland and order income tax to be levied in Poland.
The situation is the very similar if foreign board members are based from the overseas offices, but act on instructions of people in Poland.
Case 2 risk of double tax residence – omission of the company’s management board in negotiations
It is not dissimilar to when a business is run and contracts with clients are negotiated by those who are not members of the board, such as the founders of the overseas company, and the company’s management board only gets involved at in the stage of signing a contract that had been negotiated in advance. Unfortunately, this situation is quite popular and not recommended. The same applies to the third option below, using a power of attorney.
Case 3 risk of double tax residence – power of attorney vs. management
Yet another situation occurs if the management board of an overseas company grants a power of attorney to perform tasks or contracts to a Polish proxy who carries out these activities in Poland. Then there is also a risk that the Polish authorities will identify that the company as physically managed from Poland and that it should therefore be taxed there.
How to avoid the risk of double tax residence?
In order to avoid the risk of a company being considered to have tax residence in two countries, it must not be managed from a location other than said company’s registered office. Some of the recommendations seem obvious and prosaic, such as that the company should have physical premises – an office, not just a virtual address.
It is also important that board meetings, in particular those during which key decisions are made, take place at that address. The company’s registered office, should also have staff remunerated and empowered to make real time decisions regarding the running of the company.
The makeup of the company’s decision-making bodies is also quite important. If the company’s board is made up of Polish residents only, it will be difficult to convince the authorities that decisions are made at the overseas registered office rather than in Poland.
Taking all of the above into consideration, it is particularly important not only to register a company abroad, but also to determine how it should be managed. Mistakes in this area tend to lead to serious consequences, including the necessity to tax all of an overseas company’s income in Poland.