Special purpose entity to reduce tax liability

Special purpose entities can be registered in high tax states, as Germany and Spain as well as in low or 0% tax states. However, more often they are related to tax havens and offshore jurisdictions.

Special purpose entity (SPE), also called special purpose vehicle (SPV), is a financial entity created for a specific and temporary objective. These companies are usually created by large corporations with the objective to transfer the risks, avoid responsibilities, protect the identity of the beneficial owners of the parent company, and lower income taxes. Commonly, the form of registration used for these companies is sole proprietorship or Ltd.

Are special purpose entities legal or illegal?

Registering a SPE is completely legal as long as it is used for legal activities and sales of factual services or goods. The governments of many countries spend millions hunting and checking special purpose entities and those that are created only as flow-through companies for self-billing purposes receive very high fines.

Recently the American company Walmart was involved in a scandal related to special purpose companies and illegal tax planning. As we all know Walmart doesn’t own any supermarket on the territory of Spain. However, a SPE was registered on the territory of this country with the objective to avoid paying taxes and fictitiously increase the expenses of their subsidiary in Argentina. As we can see this Spanish company was created as shell company whose role in this tax planning would be to lower tax liability of Walmart using double taxation agreement signed between Argentina and Spain.

All special purpose entities or special purpose vehicles can be classified into two groups according to the country of its incorporation:

Offshore special purpose entity

Offshore special purpose entities are those companies registered outside of the fiscal residence of final beneficiary, generally in jurisdictions with 0% tax rate for non-resident companies and tax havens. The most common countries for SPEs incorporation are: Hong Kong, Panama, Belize, Seychelles, St. Vincent and the Grenadines and Costa Rica.

These companies usually are created for the following purposes:

  • To protect parent company from the risk it can carry before signing a contract or making a new strategic move.
  • To transfer part of the profits from parent company to a SPE in order to avoid paying taxes, (flow-through) strategy.
  • To carry out linked operations and increase the sale price of the product in order to create competitive advantage and lower the tax liability of a parent company.

Offshore special purpose entity

Onshore special purpose entity

Onshore special purpose entities are those companies registered within the territory of a fiscal residence of final beneficiary. These entities are obliged to present annual returns and pay taxes on its incomes. So, what are the benefits of onshore special purpose entity?

Commonly, the form of registration chosen for onshore SPEs is sole proprietorship and in this case the goal of this company is to accept and lower tax burden of parent company. Since the tax rate for sole proprietorship is lower than corporate tax the main operations are carried out by SPE.

When a special purpose entity can be considered a shell company?

The fiscal agencies consider that a SPE carries out fraudulent operations and was registered only with the purpose of being used as a shell company when:

  • A special purpose entity doesn’t have any physical means to produce, deliver or sell a product or service that it supposedly sells. That is, an office, team of employees, warehouse, or machinery.
  • A special purpose entity claims to have a high turnover and small number or 0 of employees.
  • It hides identity of directors and final beneficiaries of a parent company.
  • A special purpose entity sells large volumes of goods to one single person.
  • It purchases goods and services at a price much higher than an average market price.

However, it doesn’t mean that all the companies that fall under these 5 points are fraudulent companies or carry out illegal activity. Each case is unique, and it is very important to investigate well the activities and the structure of a company in question. Of course, the trust of population in offshore special purpose companies has been shattered but there are still a lot of sole proprietorship companies that have never been involved in money laundering, carry out legal activities and seek for tax saving only.

In order to fight illegal tax planning and fraudulent transfer of tax liabilities the governments of many countries have eliminated the option of registering a SPE with bearer shares. This practice helps to identify the identity of beneficial owners and create more transparent and secure business environment.