What is ATAD3, and how will it affect your capability to get a bank account for your offshore company?

by Viktoria Soltesz, Founder PSP Angels

Let’s face it, no one likes to pay taxes.

Entrepreneurs often seek to lower their tax expenses by establishing offshore entities or outsourcing certain part of the operations to lower tax jurisdictions. By doing so, companies can be exempt not only from accounting and bookkeeping, but also from tax obligations.

The differences between countries in terms of regulatory and taxation practices via lawful and unlawful tax reduction methods have always been the interest of the global companies. However, the trend got more accurate with the globalisation and the increased usage of the internet to provide services to international markets.

Setting up an offshore entity in order to reduce tax costs was a classic case of the 80’s. The biggest accounting firms instantly specialised in tax planning and started to advise on the right setup. Their clients not only became the forefront users of the “offshore” loophole but actively looked for unique jurisdictions to further exploit various regulatory gaps. The once well-kept secret of the rich quickly became public knowledge when the Internet allowed more and more companies to offer their services worldwide. Companies discussed their tax treatment on the online forums and got hints and tips of their counterparts of how to eliminate supervisory checks and dues.

Being “local” expanded to “international” overnight and the regulatory and taxation framework can hardly keep up with the various creative ways of tax planning. Today even the smallest self-employed based companies can benefit about these unethical practises. Businesses targeting the global scale can not only take advantage of the different taxes but also the regulations.

However, there is a very thin line between the unethical but completely legal tax optimization, and illegal tax evasion.

During the tax optimization a business is planning their global operations in a way that the lowest tax jurisdiction collects most of the group’s profit, legally. The headquarters, the sister companies and IP rights are set in a way in various jurisdictions, that after providing actual services between companies of the group, the tax can be reduced. This practise using legitimate means to reduce tax liability, such as taking advantage of tax laws, regulations, and incentives to minimize the amount of tax owed. Tax optimization might be unethical but is definitely not illegal and is a common practice among individuals and businesses alike.

On the other hand, tax evasion is the illegal non-payment or underpayment of taxes by not reporting or falsely reporting taxable income or using illegal means to reduce tax liability. Companies usually issue fake invoices or agreements for services which has never taken place, with the goal to make the tax ”disappear”. Classic case is when the offshore tax haven company offers management services for the actual company for millions of euros. It is a criminal offense and can result in severe penalties such as fines and imprisonment.

The AML (Anti-Money Laundering) measures were established in the 1980s. The first international AML standard was issued by the Financial Action Task Force (FATF) in 1989. The purpose of these measures was to combat money laundering activities and to ensure that financial institutions and other regulated entities had systems in place to detect and report suspicious transactions. Since then, AML laws and regulations have been continuously evolving and expanding globally to address new and evolving money laundering threats for all business which are connected globally thought the internet.

European Anti-tax Avoidance Directive 3 (ATAD 3) is part of this measures introduced by the European Union to tackle tax avoidance and promote tax fairness. It aims to prevent companies from artificially shifting profits to low-tax jurisdictions. ATAD 3 introduces additional measures to tackle

cross-border tax avoidance, including rules on controlled foreign companies and exit taxation. The directive aims to ensure that multinational corporations pay their fair share of taxes in the EU and prevent the erosion of the EU’s tax base. ATAD3 combats the tax benefits given to companies who cannot prove their solid existence on the given market.

This effectively means that they must report on their substance, and, if insufficient, that they may face a denial of tax benefits under a tax treaty or EU Directive. ATAD3 will likely become effective in 2025.

Banking compliance for companies operating in offshore territories can be more complex due to the added regulatory and compliance requirements imposed by the country where the company is based. Banks are required to comply with a number of regulations, the Bank Secrecy Act (BSA) and AML, which are all designed to prevent money laundering and other financial crimes. Offshore jurisdictions are often considered high-risk due to the potential for tax evasion and other illicit activities. As a result, banks may be hesitant to do business with companies based in these jurisdictions and may impose stricter due diligence and compliance requirements. These may include additional documentation and reporting requirements, as well as increased monitoring of transactions to detect suspicious activity. Companies operating in these tax havens have a harder time to find banks willing to work with them.

As a rule of thumb, company substance should be provided if the company is operating in a low tax country, to justify why they are paying taxes in this jurisdiction. This means the company must have a local office with a utility bill on the name of the company, or at least a director who lives in the same country where the company is incorporated in, in order to prove that they are exercising the management and control from that country and that is the reason that they are paying less taxes, locally. Therefore an offshore entity, without substance, can easily face a banking decision which denies opening a bank account or executing any transaction for them.

There are still certain banks and financial institutions who still have their risk appetite for offshore companies, but obviously the higher risk results higher fees and less reliability – because these banks and financial institutions are also lacking certain regulations which safeguards the companies’ funds.

When setting up a new structure or finding the relevant financial institutions to assist with the flow of funds supporting the company’s operations, we always have to keep in mind what is the benefit versus the cost. Many times, we see that setting up an offshore jurisdiction might benefit us in terms of easier bookkeeping and lower taxation while it also results increased banking, financial and exchange costs and risks.

It is recommended to have a payment consultant on board when planning taxes, establishing a new company, or evaluating the payment flow. Using a professional can cut short time on research and application but also can give more insights on the due diligence process when evaluating or entering new agreements with unknown financial institutions.

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