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A Brief Introduction
An offshore corporation is a legal entity established in a tax haven or offshore financial centre, being protected by specific legislation which guarantees a status of full tax exemption, except for a small yearly license fee, and generally a high level of privacy. It is an entity specifically designed to be used by non residents only.
Offshore Companies
Captive Insurance Company Other financial service
A tax haven is politically stable country with zero or no taxes on foreign earned income, maintains high level of secrecy and imposes few regulations. Stereotype tax havens are tropical island nations located in Caribbean sea. Not all OFCs are tax havens.
Categories Of OFC
Functional OFC: conducts business in OFC. Example includes Trusts, Banks, Investment holding companies, Management Companies Notional OFC: record book entries for economic activity that occurs somewhere else. Example includes trading companies and Captive Insurance companies
Tiny specks on a map but amount of assets and funds that flow through them are substantial. Cayman Island with a population of 32000, was home to more than 31000 Offshore corporation in 1994. Deposits exceeds than all banks located in Manhattan. In 1991, approximately 100,000 offshore companies registered in Jersey, Guernsey, Sark, and the Isle of Man. Luxembourg has 4000 mutual funds with $ 363 B of assets. More than 30% of US firms foreign income is booked from Foreign Havens.
Transfer Pricing
Postponing Taxes Corporate Financing & Capital structure Management Asset Revaluation and Leasing Regulatory Factors Secrecy Asset Protection
Transfer Pricing
Parent company and local subsidiary are both located in high tax jurisdictions tax can be minimized through the use of OFC
Subsidiary Company
Postponing Taxes
OFC
can be used to collect profit remittances or realize capital gains hold such funds & do not repatriate to home country to save tax
OFC
Offshore holding companies better positioned to issue debt for example securities issued in the Cayman Islands need not comply with the SEC disclosure requirements. OFC holding company can be used to maintain full control of a subsidiary while gaining tax shields with debt payments.
100% equity Emerging
Parent Company
Market Investment
Project Equity
Parent Company Offshore Company
Tax shield
companies used to revalue fixed or intangible assets before transferring them to subsidiaries in emerging markets.
Regulatory Factors:
Securities regulations
Capital contributions
Other regulations
Securities Regulations
OFCs can be used when a countrys legal regulations do not provide for certain types of securities.
Assign shares to Offshore company and enter into individual contracts mimicking ESOPs
Local Firm
Capital Contributions
Offshore companies can be used to control the flow of capital to and from subsidiaries in emerging markets. Capital contribution in the form of debt can be used to avoid reinvestment requirements and restrictions on foreign equity ownership and profit repatriation.
A captive insurance company is one that is formed be an organization or group of organizations to manage the parents insurance needs. In the 1990s more than 3500 captive insurance companies in the world most operating offshore and most established in Bermuda, the Cayman Islands and Guernsey.
Other Regulations
Secrecy
Tax havens provide secrecy. Criminal offence to reveal information about investors. Secrecy laws and the issuance of bearer securities protect shareholders identities. For example Virgin group made use of OFCs for maintaining shareholder secrecy. Many of the groups subsidiaries are owned by offshore trusts located in Cayman Islands and the British Virgin Islands.
Asset Protection
Asset protection from lawsuits and creditors. This protection results form several sources. Most OFCs have strict financial privacy laws so potential litigants may not know about the existence of specific assets. In addition many OFCs do not recognize financial judgments imposed by other jurisdictions. Offshore corporations are also used by product manufacturers for protection form product liability lawsuits and by doctors for protection against malpractice lawsuits.
Factors
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Institutional Frictions
Transactional Costs related to investing outside home economy
Institutional Frictions provide several reasons to expect lower level of foreign investment However, research finds that they explain only a small portion of observed home bias The international equity investment that does occur seems un-impacted by relative differences in transaction costs
Further, institutional investors have many ways to reduce these costs, yet they still exhibit home bias
Additionally, there has not been an appreciable increase in foreign investment when countries changed rules and regulations to reduce institutional frictions
Firm Visibility
Awareness of a firm through informal channels like advertising, product usage, news coverage, etc.
Research suggests that foreign investment is highly related to visibility factors Firms that are larger, listed on a major stock index, are followed by a large number of analysts, have overseas listing, or have experienced strong accounting performance are all likely to have a higher level of foreign investment
Investor Understanding
Investors can make informed decisions
Foreign investors can reduce local advantages through devoting substantial resources which is a costly process
Investors feel better off spending their resources to further their knowledge in home market
Firms can mitigate costs by providing information in a form that reduces processing cost for foreign investors eg: disclosures in multiple languages
Investor Protection
Preservation of minority investors interests from majority owners misappropriation including expropriation, tunneling etc.
Asymmetry of information between minority investors and firm insiders, international investors and local institutions working closely with the firm.
Implications
Investor
Protection
Laws imposed by the nation Stricter national laws attract a higher level of foreign investment
Is important once minimum regulations are met. Countries lacking legal protection from govt. do not have an effect on FI even in presence of governance Companies are unwilling to invest in corporate governance in absence of strong legal investor protection
Culture
Cultural attributes impact international equity flows
Countries with similar legal and compatible linguistic systems have higher cross-border equity transactions. Common religion and similar genetic backgrounds create a sense of trust. Societal views of egalitarianism also impact flows. Preference for similar group identity over global optimum exists.
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