Re-invoicing is the utilization of a low or no tax company to act as an intermediary between a business established in one jurisdiction, typically a high tax jurisdiction, and its customers outside its home jurisdiction. The domestic business sells its products, with a small profit, to the non-or low taxed company which intern marks the product up to the original selling price, and sells the product to the customers outside of the onshore company’s jurisdiction. Profits of the intermediary accumulate at zero or low tax rate while the small profits of the onshore business are taxed at its jurisdictional rates.
International re-invoicing strategy, example
An onshore business sells $1,000,000 of goods annually to a company established outside the jurisdiction where the onshore business is established, for example a British company sells to a Spanish company. Assuming that operating expenses and cost of goods are $500,000, the British company earns $500,000 on its sales before taxes. Taxes average say 45% or $225,000 thus reducing net profits to $275,000.
To utilize an international re-invoicing strategy the British company would use a non taxed company, such as a company established in Belize, Panama, or any other tax haven location, to serve as an intermediary between the British company and its Spanish customers. The British company sells its goods to the Belize company on credit for $600,000. The Belize company in turn sells the goods to the Spanish customer for $1,000.000. The Belize company thus earns $400,000 in profits. Since there are no taxes in Belize on international transactions, the $400,000 of profits has no taxes imposed on it.
The British company shows a small profit of $100,000; gross sales of $600,000 less cost of goods sold of $500,000. Assuming a 45% tax, the British company would pay $45,000 in taxes, while making a $55,000 profit. This strategy allows the British business to show an economic rational to its taxing authority for its business practices.
Is this legal?
The attack on using this strategy consists primarily of attempts by various taxing agencies to “prove” that the onshore company and the non-taxed company are in fact one in the same, claiming that the entire strategy is nothing more than a sham attempt to create the legal fiction of separateness where it does not exist. Attacks also include the claim that there is no business purpose to the non-taxed company other than avoidance of taxes.
The primary defense of the strategy is that the non-taxed company must operate with sound business purpose at every level. Thus the strategy must be implemented in substance rather than just written form. It is vitally important that the non-taxed company actually conducts business and is not a “shell” company. It must have an economic rational and must perform an economic function independent of the on shore company. Documentation is an absolute requirement with written records to substantiate business transactions.
In addition to the non-taxed company having an economic rational the on shore company must also have a viable economic rational. Since the primary economic principle for any business is making a profit, the on shore company should make a profit and pay taxes on this profit to its home taxing authority. The size of the profit can be flexible but a profit non-the-less should be made.
These points are the bases of legality of the strategy and no short cuts can be taken. Therefore, in the final analysis all entities should have a good economic rational for existence and both substance and form are import to the effective utilization of an international re-invoicing strategy.