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Offshores – out! And who’s in? – 20.06.2018

In the short time that has elapsed since the announcement by ABLV BANK of self-liquidation, a number of remarkable events have taken place in the banking sector of Latvia.

On May 09, amendments to the Law on the Prevention of Laundering the Proceeds from Criminal Activity (Money Laundering) and of Terrorist Financing (AML Law) entered into force in Latvia, prohibiting market participants from engaging in relations with companies that have the characteristics of a shell company, namely:

  1. connection to the company's actual business operations cannot be proven and the company's activity consists of small or no economic value, and the credit institution has no documentary information proving the contrary;
  2. the company neither prepares, nor presents financial reports on their activities to competent supervisory authorities of the state in which it is established.

On May 29, 2018, the Council of the Commission for Financial and Capital Markets of Latvia approved amendments to a number of existing regulations for the effective implementation of new laws, determining the measures that market participants must take to ensure that the actual economic activities of their clients (legal entities) has economic sense and does not contain signs of a shell company.

The regulator's goal is to get rid of the accounts of shell companies and to reduce the share of non-residents' funds in Latvian banks as much as possible.

The policy of non-residents elimination from the banking system of Latvia has been ongoing for several years. To date, its result is a decrease in the share of foreign deposits in the banking system from 53% in 2015 to 29% in May 2018. The volume of foreign money stored in banks in Latvia has more than halved, from 12.4 to 5.2 billion euros.

Despite an increase in residents' funds by 15% (from 10.8 to 12.5 billion euros), Latvian banking system lost 24% of deposits in three years.

The banking crisis in Latvia shows that its system is unfriendly to foreign money. Therefore, it is unfriendly to foreign investments in general. In other words, by rejecting conditionally "bad" foreign money, a negative signal comes in to "good" money as well, and owners of these “good” money start looking for other places to store and apply them.

Returning to the affected depositors - foreign entrepreneurs who were holding their money in Latvia, the development of the situation in the Latvian banking system after the collapse of ABLV clearly points to the door to all the classic offshore companies.

Another country that actively works with non-resident money is Cyprus. Here the situation is completely the same as in Latvia: the Central Bank of Cyprus sent a circular to all commercial banks on June 14th with an order to identify shell companies and to cease all relations with them.

Shell companies, by the definition of the Central Bank of Cyprus, are private companies that meet at least one of the following criteria:

  • has no physical presence in its country of domicile (other than a mailing address);
  • has no established economic activity, little to no independent economic value and no documentary proof to the contrary;
  • is registered in a jurisdiction where companies dare not required to submit to the authorities independently audited financial statements;
  • has a tax residence in a jurisdiction recognized as a ‘tax haven’, or no tax residence whatsoever.

Cyprus banks are required to identify shell companies and report on the work done by July 31, 2018.

This means that in the near future owners of offshore companies with accounts in Cyprian banks will have to urgently seek new opportunities for opening bank accounts.

The struggle with the accounts of "shell companies" is a meaningful action in the sense that it is practically simultaneously launched in two countries whose banking systems are heavily dependent on foreign money.

It's safe to say that any other country that dares to shelter offshore money will go under the same scenario: very soon shell companies money from the growth factor will turn into risk factor, and the regulator will have to start work on cleaning up the banking system. Moreover, Latvia and Cyprus have shown practical example to others of how to deal with the money of shell companies.

The rationale behind the changing of attitude of Latvian and Cyprian banks to shell companies leads to the only possible decision - a complete refusal to use classic offshore companies.

The natural question arises - how to replace solutions that appear impossible to use? After all, the need for foreign structures remains, especially among entrepreneurs in those countries where there is currency control and the exchange rate of local currency is unstable.

Upon examining the definition of shell companies, it becomes clear that now the main criterion by which financial flows are divided into "good money" and "bad money" is the fact of performing independent economic activity.

Accordingly, in order to work according to the rules, businessmen should conduct extensive redevelopment of their business models, for example:

  • a number of functions to be delegated from their local enterprises to their foreign structures;
  • hiring staff to perform the delegated functions;
  • provide staff with working space, etc.

The more complex are the rules of the game, the more complex should be solutions that satisfy these rules.

However, just using more complex solutions is not enough for a long period of time, because sharp change in the rules could rapidly ruin the relationships that have developed over the years and decades. To maintain established relationships, businessmen are required to monitor trends and have understanding of counter-measures before any measure takes effect.

Ideally, every entrepreneur should hire a competent economic adviser who knows and understands the principles of taxation in different countries, the specifics of doing business, the established practices of banks in various jurisdictions, the logic of compliance work, and he himself has entrepreneurial experience. Such people exist, but, firstly, their number is much less than number of business owners who need their support, and secondly, the overwhelming majority of such specialists will choose independence.

There is a natural question: is there any simple and understandable criterion of choice that will guarantee a quiet work for at least the next few years?

Fortunately, the answer to this question is positive and it is not hard to plumb.

Knowing the definition of "shell companies" or "bad companies", it is logical to assume that "good companies" will be those that have completely opposite characteristics, namely:

  • have a physical presence in the country of their domicile;
  • conduct independent economic activity, confirmed by documents, and have an independent economic value;
  • registered in a jurisdiction where companies need to file accounts certified by an independent auditor;
  • has a tax residence in a jurisdiction that is not recognized as a tax haven.

All these characteristics are part of what is commonly called a business reputation.

Business reputation consists of a set of internal conditions created in a certain country for doing business, and an external evaluation of these conditions in comparison to other countries.

The main indicator of business reputation can be considered rating Doing Business, assessing the conditions of doing business in 190 countries.

According to 2018 Doing Business survey, the top ten ranking is as follows (in descending rating value order):

  • New Zealand;
  • Singapore;
  • Denmark;
  • South Korea;
  • Hong Kong;
  • the USA;
  • United Kingdom;
  • Norway;
  • Georgia;
  • Sweden.

All countries, except Georgia, have developed economy and a high standard of living, that is, economic stability. As Georgia - the newcomer of the rating - has yet to confirm its ambitions of the country with the highest business reputation, we exclude it from further consideration.

Next, we exclude Scandinavian countries, which, in addition to high stability, are also famous for high taxes.

For the same reason, the United Kingdom, the United States and New Zealand are subject to exclusion, too.

Korea is famous for its rather complicated tax legislation, which, moreover, is written in Korean. This means that those who rely only on the English translation of Korean laws can miss important details and thereby put the business at risk.

Singapore and Hong Kong are the two jurisdictions remained after exclusions.

Thus, without special knowledge and based only on common sense, we came to a conclusion about which countries should be given priority in creating corporate structures for international business if the goal is reliability and reputation.

It is important to remember that life tasks always have several solutions. Any of these solutions will be correct for certain circumstances, certain period of time, etc.

We are happy to find the optimal solutions for organizing international and global business.

To those entrepreneurs who prefer ready-made solutions, we are happy to offer registration of companies in Singapore - the best country to date for the start and development of any projects.
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