Offshore E-Commerce

Taking Your Business to the World  

Matt Blackman ÓGoldhaven.com 2001

In the last 24 months, the offshore legislative landscape has changed faster than anytime in its history. Thanks to initiatives to curtail global money laundering and a practice dictatorially labeled harmful tax competition by the Organization for Economic Cooperation and Development, the offshore industry is being forced to change the way it does business. While it will be some time before this issue is ultimately settled, one thing is clear. Offshores will no longer enjoy the levels of secrecy they once did thanks to the plethora of new banking laws being drafted around the world. If the traditional offshore centres wish to utilize the global banking system in the years to come, they will have to adopt stringent anti-money laundering laws that require increased transparency.

However, as international business companies (IBCs) and anonymous bank accounts protecting the owners identities are threatened with extinction, a new trend offers offshore centres opportunities unforeseen just a few short years ago. Jurisdictions able to ante up to the technology table are finding themselves in the middle of a high-stakes competition in which the winners will enjoy economic prosperity far greater than thought possible providing traditional offshore services.

The following article is a summary of a keynote presentation by Goldhaven’s Matt Blackman for the Strategy Institute in Toronto on February 19, 2001 that discussed the evolution of offshore e-commerce for offshore centres in the Caribbean basin and Bermuda.

A Star is Born

Contrary to claims by a well-known American political figure, the World Wide Web was created by a 44 year old Englishman named Tim Berners-Lee in 1991 who could not have envisioned in his wildest dreams where his creation would take the world in ten short years. His invention allowed Marc Andreessen of Netscape fame to become the first Internet billionaire. Many more were to follow him while Berners-Lee continued to earn a modest academic salary and drove a 17-year-old VW Rabbit.

In March 1999, the International Data Corporation projected 500 million web users by year-end 2003. Up until recently, the US government produced figures showing that Internet use was doubling every 100 days. It now takes about 6 months for this to occur.  The Internet has the fastest adoption rate of any new medium. It took less than 5 years to get 50 million people connected. It took radio 38 years, television 13 years, and cable 10 years to reach 50 million.

Of the many benefits it provides, the Internet has changed the way the world does business and offshore nations offer a number of advantages to corporate clients over onshore counterparts. Thanks to relatively lightweight and user-friendly legislative infrastructures, pro-business governments and general lack of unwieldy red tape and bureaucracies, offshore centres are ideally suited for the establishment of Internet companies.

But before we discuss these advantages, lets examine market potential.

“To Infinity and Beyond”

At present, business-to-business (B2B) and business-to-consumer (B2C) e-commerce is experiencing blistering growth rates, even after accounting for the stock market and economic slowdowns of late.

Internet research company Forrester Research estimates that business-to-business (B2B) and business-to-consumer (B2C) growth will witness a 1,000% increase between 2000 and 2004 expanding from US$673 billion to $6.789 trillion worldwide.

According to the Gartner Group, B2B alone will grow to $7.3 trillion by 2004, which is nearly the size of the U.S. economy today. Of importance to offshore centers, they also predicted that 61% of these sales would occur outside the U.S.

Chart 1

In 2000, North America accounted for nearly 80% of business conducted on the Internet. By 2004 this will drop to 50%. The European share of global e-business will nearly double from 13 to 23% but the real story is Asia where market share will triple from 8 to 24%.

North America, the dominant user of the Net, now accounts for nearly 80% of its use but this is changing rapidly. By 2004, it will account for just one-half of the e-commerce business conducted globally. Compare this to the Asia Pacific region where business is projected to more than triple in the same period from 8% today to more than 24% by 2004.

Why Consider Locating An E-Business Offshore?

Actually there are a number of compelling reasons other than tax savings to consider.

1.  As mentioned above, there is less government regulation, red tape & bureaucracy, which translate to lower costs of doing business. Smaller governments i.e. bureaucracies mean faster decisions. You generally find fewer roadblocks to doing business. As we shall see, this also translates into lower compliance costs.

2.  Due to greater reliance on foreign businesses offshore governments are generally more cooperative and businesses are afforded greater access to top ministers.

3. There is greater legislative flexibility offshore. We’ll see later where one country actually created specific laws to facilitate specific companies. 

4. There is a growing trend to set up e-commerce free zones to encourage businesses to come to these nations. For example, the Dominican Republic and Belize have established special zones with complete telecommunications facilities, investment and tax incentives to attract e-business. Free zones have been very successful in Panama, Costa Rica, the Bahamas and other offshore jurisdictions.

 5. There will always be a greater ability to preserve confidentiality offshore, even with the trend toward transparency. One of the main reasons businesses are attracted offshore is due to greater confidentiality to protect technical and intellectual property, business confidentiality and financial privacy. It is much more difficult to sue a competitor offshore in an attempt to get access to confidential trade and commercial intellectual property in an offshore jurisdiction.

6. Litigation is growing liability in the North America and Europe. Offshore litigation is more expensive and difficult. In order to sue offshore, the plaintiff must often file a bond of $25,000US or more to initiate an action. Lawyers also don’t work on contingency offshore. Government litigation is also a growing liability onshore as recently witnessed in the United States by the governments’ anti-trust action against Microsoft. There is no precedent for this type of action offshore.

7. Offshore you will find lower or no taxes on personal and corporate income, capital gains, sales taxes, payroll taxes, estate taxes. This is a tremendous benefit in attracting employees, management and consultants. Also unlike the deemed disposition that results from moving a company from onshore to offshore and commensurate tax costs, selling or moving a business from one offshore to another does not usually incur tax costs.

 8. According to Daniel Mitchell of the American Heritage Foundation, the average compliance cost paid by all but the biggest 10 percent of corporations was $7,240 dollars for every $1,000 of taxes paid in 1992. In fact it could be argued that taxes are not the biggest savings enjoyed by offshore e-businesses. It is compliance costs.

9. According to Andrea Wilson of First Atlantic Commerce, a credit card processor in Bermuda, this is a tremendous benefit to companies from nations with weaker currencies and who wish to settle in U.S. dollars. This is cannot be normally achieved through banks in these countries. For example, it is not possible for a Canadian merchant to settle and get paid in U.S. dollars through a Canadian bank. Offshore, clients may purchase products in U.S. dollars but company expenses are paid for in local currency.

10. Instead of paying the profits from corporate insurance programs to insurance companies, it makes sense for many companies to self-insure or insure within a group of related or cooperating companies. The larger the company the more cost effective this is. There are many captive insurance options offshore.

11. Being located in a non-industrial nation has its advantages. Your business is not subject to national campaigns to boycott or embargo nations for political reasons. Example Cuba – Trade between U.S. and Cuban companies is restricted by legislation such as the Helms Burton Act. Companies located offshore do not have these restrictions.

12. One big attraction of going offshore is greater corporate freedom. For example, American companies have very specific limitations on the level of encryption they can export. (128k bit). There are no such restrictions offshore. Another is the freedom to move or sell you business. For example, a Canadian wishing to move Taxable Canadian Property offshore will have a hefty tax bill as we saw above. There are ramifications for sale of business or in the event of death onshore in the way of inheritance taxes in the U.S. and capital gains taxes in Canada. Not so offshore.

Corporate Examples

“Bill Gates would be fabulously more wealthy if he had started Microsoft in Bermuda… He may have known a lot about computer programming when he started the company, but his ignorance about tax cost him a fortune.” William Woods BSX - Economist Magazine

According to the Economist article, Mr. Gates and his partners Paul Allen, Craig McCaw and Saudi Prince Al Waleed Bin Talal who set up the satellite company, Teledesic, did so through Bermuda. 

Prince Alwaleed Bin Talal is the Warren Buffet of the Muslim world except that he likes high-techs. He is also a great believer of using tax-efficient jurisdictions. He is a 16% stakeholder in Teledesic. 

Here is a quote from a January 8 Wall Street Journal article entitled As Dot-Coms Go Bust In U.S., Bermuda Hosts An Odd Little Boomlet;

"One thing that always amazes me is, why would anyone who's planning on generating a profit locate themselves in a full-tax jurisdiction?" Paven Bratch, Playcentric.com

The article outlined the benefits to the company.

“Although his Internet company, music and video merchant Playcentric.com, has just 10 employees, didn't go live until September and has yet to turn a profit, it has the structure of a major multinational. Its computer servers are located here, its operating unit is in Barbados, and it has a distribution deal with a big record-store chain in Toronto. The 36-year-old Mr. Bratch figures this setup will save him so much on corporate income taxes and other expenses that he'll be able to undercut Amazon.com Inc.'s prices by more than 45% and still make a bundle.”

THE MURDOCH MODEL – A Multinational Offshore

Rupert Murdoch’s News Corporation is a classic example of a new-millennium global company and serves as a good model.  Murdoch’s empire now extends to businesses in 52 countries. If all those businesses worldwide linked their cable, satellite and broadcast television arms, they could reach an estimated 4.3 billion people simultaneously.

Determining News Corporations tax affairs isn’t easy due to its complex structure. The group lists approximately 800 subsidiaries, including some 60 incorporated in the Caymans, Bermuda, Dutch Antilles and British Virgin Island. In the U.S., many of the unlisted subsidiaries are incorporated in Delaware where there is no obligation to file publicly available account statements.

The most profitable of News Corporation’s British operations in the 1990s was not Sunday Times, or its successful BSkyB Television business. It was News Publishers, a company incorporated in Bermuda. In the seven years ending June 30, 1996 it made 1.6 billion pounds in net profits. “This is a remarkable feat for a company that seems not to have any employees nor any obvious source of income from outside Mr. Murdoch’s companies.” March 20, 1999 Economist.

For the four years ending June 30, 1998, News Corp and its subsidiaries paid A$238 million in corporate taxes on income of A$5.4 billion or 6% tax. This is all the more amazing when one considers that the basic corporate tax rates in Australia, the U.S. and Britain, the three main countries in which the company operates are 36%, 35% and 30% respectively. U.S. media giant Disney paid 31% over the same period.

News Corp., in its 1997 fiscal year, reported paying $103 million in worldwide taxes on operating income of $1.32 billion, an effective tax rate of 7.8 percent, according to company documents. By contrast, American-based competitor Walt Disney Co.'s effective tax rate was 28 percent. Viacom Inc., the parent of MTV and Paramount Pictures, paid 22 percent. Time Warner Inc., a U.S. media and entertainment company that is roughly the same size as News Corp., paid taxes at a 17 percent rate.

That pattern has persisted through the 1990s. News Corp.'s tax rate has averaged 5.7 percent in this decade, while those of Walt Disney, Time Warner and Viacom have averaged from 27.2 percent to 32.5 percent.

OFFSHORE E-BUSINESS EXAMPLES

There are many possible offshore companies. Here are just a few to consider.

Electronic transfer – Software design & modification, music, intellectual property, digital security, online virtual storage.

Publishers – E-books, newsletters, magazines, copyright.

Online brokerage – Stocks, bonds, commodities, funds.

Leasing – Ships, aircraft, equipment, specialty.

Consulting – Corporate, graphic design, advertising, computer, architectural, legal, accounting, marketing.

Travel bookings – Airlines, car rentals, conferences & events.

Translation services, virtual greeting card & gift certificates.

Basically one can now take a successful regional or domestic business to a global market place assuming the product has global appeal.

A business that conducts electronic sales online is the simplest example of an e-business. However, as the business model becomes more complex to include sales agents in various countries and the production and delivery of physical products globally, a multi-jurisdictional solution becomes necessary. Also as complexity increases, the size threshold increases. Put another way, the more complex the type of transactions it conducts, the larger a company must be to justify the cost of a setting up a complex offshore e-business structure. This fact can be lost in the rush to take advantage of lower tax regimes without giving sufficient thought to the profitability of the business model. We will be discussing these revenue thresholds below.

Country and Business Considerations

In their publication, Tax Havens of the World, Walter and Dorothy Diamond outlined 30 considerations according to a survey of international companies operating in offshore financial centres in the 1970s. Here is a summary.

1) guarantees against expropriation, 2) fair treatment by government, 3) investment concessions, 4) low taxes, 5) political and 6) economic stability, 7) tax treaties, 8) minimum of currency restrictions, 9) freedom to import raw materials and 10) minimum of government controls. Others include bank secrecy (11), free remittance of profits (12), local capital availability (19), communication and transportation facilities (22) and (23), security of property rights (26), and promotion by government (30).

The Diamonds are currently updating this list. According to a recent survey of his subscribers, the first seven in order of priority are as follows:

1. Tax & Investment Incentives. 

2. Export Credit/Risk Insurance. 

3. Duty Exemption/ Tax-Free Zones. 

4. Low Inflation and Interest Rates. 

5. Economic Stability. 

6. Political Stability. 

7. Advanced Telecommunications Infrastructure

Telecommunications has moved up the list considerably from twenty-two to seven.  The survey was not restricted to e-commerce businesses, which explains why advanced telecommunications was not at the top of the list.

For an e-business, telecommunications are of primary concern. Here is a list of other considerations of importance to the e-commerce entrepreneur today.

1) Telecom quality, costs, bandwidth – This is the greatest challenge facing businesses today offshore due to the lack of telecommunications competition.

2) Is the Country on OECD or FATF blacklist? If so expect changes in the legislative and business landscape, many of which will not be positive.

3) MLAT or Tax Treaties with which countries? Generally these are advantageous to global e-commerce companies.

4) Legislation to protect you as a foreigner? Will your business and personal property be protected from expropriation or other violations?

5) What other similar businesses are already there? As Dan Atridge from IBM once said a number of years ago, it is easy to spot the pioneers. They are the ones lying face down in the path ahead of you with arrows in their backs. Do you really want to be a pioneer?

6) Local workforce, level of skills, wages. Are qualified employees available to help run your business? What will you have to pay them including benefits, payroll taxes etc.?

7) Legal and professional support. This is another major challenge facing businesses offshore. It is essential to have local attorneys who understand international law and they are not always easy to find offshore.  

Personal Considerations

Standard of living, Cost of living and accommodation rentals - What will it cost to maintain a similar lifestyle to which you and your family are accustomed? What about your employees?

Lifestyle, social conditions, family and friends - A number of businesses fail offshore simply because one member of the family (usually the wife) is unable to be away from family or friends at home. It’s a good idea to spend a few months actually living in your chosen jurisdiction first before making a final commitment.

Telephone Calling Rates 

Telephone calling rates are important if you use the phone to order or sell products or services. Here is a list of telephone rates based on a 10-minute phone call made during a business day. I have colour coded the rates; green being the cheapest to red, the more expensive. Bahamas is in a category all its own. In fact, it was the only country on the list that I had to phone an operator to get the rate. All others were available on the Net. A number of people from the Bahamas have reported less than average telephone service, periods ranging from a few months to longer to get lines installed and Internet service that does not support a good sized e-business.

Chart 2

Internet and Dial Up Service Costs

Here is a list of Internet rates from various jurisdictions to allow comparison. Again nations were rated from green to red, green being most cost effective with greatest bandwidth choices to red, the more expensive with fewer bandwidth selections.

Chart 3

An Offshore Example

Bermuda must be considered the premiere North American region offshore e-commerce jurisdictions today. The government has placed a high priority on providing a solid and affordable Internet infrastructure to Bermuda businesses. As a result, the nation is one of the few to offer affordable Internet access thanks to true telecommunications competition and a government committed to high bandwidth availability for business. 

On Dec 12, 2000 360networks and its subsidiary TeleBermuda International unveiled their new US $22 million cable landing station in St David's, Bermuda. The new station will serve as a central hub for the 360americas fiber optic network, connecting Bermuda, South America and the United States. Upon scheduled completion in early 2002, 360americas will span 29,000 kilometers (18,000 miles) and provide total system capacity of 1.28 terabits per second. The network will link the United States, Bermuda, Brazil, Argentina and Venezuela.

Here are the advantages of operating an e-business from Bermuda;

Bermuda has one of 6 global C&W E-Commerce hubs and offers the greatest bandwidth and fibre-optic service of any of the North American region offshore centres. Rates are still about 5 times US/Canadian rates.

E-Legislation – Bermuda has passed private bills to create legal framework for e-commerce companies plus the Electronic Transactions Act 1999 and the Code of Conduct 2000. There are no personal or corporate income, sales or capital gains taxes.

Cable and Wireless and 360networks subsidiary, TeleBermuda International provide true competition. Both companies are now allowed to compete locally and local companies internationally for Internet services.

A number of Bermuda companies offer credit card processing options in various currencies plus access to professional services.

Seventy percent of Fortune 100 companies have offices in Bermuda. This statistic alone speaks volumes.

There are more than 11,000 companies registered in Bermuda, but only 350 currently have physical presence there. The majority of companies are virtual companies.

Bermuda is a world leader in the insurance business. It offers a corporate cell structure evolved from insurance. This is very useful in setting up an e-business that operates from Bermuda.

Challenges – Work permits & rents. Costs of a one-year accommodation lease in will buy a better place in many onshore jurisdictions. Lease rates range from $10,000 to $40,000 US per month for suitable accommodation. Work permits also very difficult to obtain.

SIMPLE E-BUSINESS STRATEGY 

Below is an example of a simple e-business operating from two jurisdictions. Due to the high cost of locating staff (and the owner) in Bermuda, the example utilizes Anguilla. Although telecommunications costs are higher than in Bermuda and there is only one telecom provider, Anguilla is developing a strong e-commerce infrastructure, provides good Internet expertise and offers more affordable housing.

The chart below assumes that the business is selling software or related products electronically.

Chart 4

COMPLEX E-BUSINESS

A structure for larger companies with presence in a greater number of jurisdictions is outlined below. As long as the server and Internet access is achieved through a jurisdiction with a strong infrastructure with sufficient bandwidth, the actual mind and management could be located elsewhere in another low tax jurisdiction.

Chart 5

Revenue Thresholds

While the benefits of setting a business up offshore are obvious, the critical size of the company is not. At what point does establishing the company offshore make sense? To answer this question it is essential to look at the type of company.

Thresholds for owner-operated businesses depend on a number of factors including desired lifestyle and to a certain extent the philosophy of its owners. For those wishing to move to a warm climate and less stressful existence, a business earning as little as $US100,000 per annum may be sufficient to provide owners with an acceptable standard of living, especially considering that income earned will be taxed at a lower tax rate. For many such a move may depend on more than sheer economics.

Generally however, Lynwood Bell of Hansa Bank and Hansa.net, which provides services to offshore companies, a business income of US$250,000 to $500,000 is the minimum recommended to merit such a move.

For companies that have products to distribute worldwide, the threshold is far higher. Bermuda based Ebiz.com which assists companies in establishing offshore and marketing products globally have targeted companies with minimum revenues of US $50 million to $1 billion, which represents 90% of the companies in North America.

Other Jurisdictions to Consider

A number of offshore centres have instituted changes designed to attract e-businesses. Here are a few examples.

British Virgin Islands - Registered Agents can search company registries and reserve names online. Ireland for companies marketing in EU.

Anguilla, Dominica – Anguilla’s ACORN system permits incorporation online. Dominica also permits registration of companies online.

Antigua, St. Kitts/Nevis – Specialize in online gambling. Antigua has been called the “proto-typical” Internet gaming base and has the largest concentration of websites among the Caribbean nations according to a FinCEN report.

Bahamas, Caymans – Major sources of business have traditionally been the sale of IBCs and banking. Bahamas has 17,000 registered IBCs but this number is expected to drop with new anti-money laundering legislation. Both nations have been slow to attract e-business.

Among a number of offshore centres there has been intense competition to attract e-business. Breaking monopolies is essential to the ultimate success of these jurisdictions if they are to compete with Bermuda.

SUMMING UP 

E-commerce provides for efficiencies never dreamt possible in the old-fashioned world of business. Benefits of conducting business online are many, including a 50% reduction in working capital per unit sales, a 20 to 40% overhead advantage thanks to reduced physical space requirements, a 5-10% purchase cost reduction and a reduction in document errors from 20% to 1%.

It is estimated that in the United States today, 45% of economy amounts to transaction costs, which can be greatly reduced using an e-business model. The Internet is allowing business to benefit from greatly increased efficiency will reducing costs. Such cost savings are compounded when the company is located offshore.

Offshore centres offer distinct advantages over high-tax nations in the form of lower taxes even greater savings are enjoyed thanks to drastically reduced compliance costs. As the reader saw in the case of Murdoch’s companies, these factors alone translate into substantial savings. In an increasingly competitive world, such differences will make the difference between success and bankruptcy. Businesses failing to take advantage of such benefits risk becoming statistics in the growing e-business battles for greater efficiency.

Establishing an e-business offshore however, depends on the availability of affordable and dependable bandwidth and technical expertise to insure the business can operate at optimum efficiency 99.999% of the time and herein lies the challenge. At present, offshore centres offering this type of service are in short supply but this situation is expected to improve quickly as the benefits for countries meeting this challenge are immense.

Many companies make the mistake of establishing onshore with little thought of the long-term success and profitability of the company. This can be a huge mistake. By the time they become successful and owners realize that high taxes and compliance costs are making it difficult to compete, it is too late to move offshore. The tax costs at this point are prohibitive.

Whether your business is suitable to having an establishment offshore is something only you can decide. The fact that a business has been successful in a region is no guarantee that it will be successful globally but if your competition is forging into new global markets you will either have to follow or find a different niche in order to remain in business. As e-business dissolves geographic boundaries, global competition will heat up. Those who are late may not survive.

Setting up a business offshore can be extremely rewarding if properly planned and implemented. Companies, both large and small, that think and act like multinationals will be the ones that lead the global e-business charge. Once the hurdles are overcome your company will be positioned to become a highly profitable competitor with benefits that will make it hard to beat! The decision is yours.