Last updated October 27, 2020
Dateline: Kuala Lumpur, Malaysia
Even before I made my first dollar, I had an anti-tax streak in me. I found it incredibly unfair that the government could swoop into your million-dollar idea and steal a major portion from it.
And they would keep coming year after year demanding tribute.
If indeed you have a million-dollar-a-year idea and you live in a country where you pay 36.5% of your income in taxes, that tribute payment is not a small amount of money either.
For 365 days of the year, you are being robbed of $1,000 every single day. And if you live in a jurisdiction where your taxes are even higher (as the OECD average top marginal tax rate is 42%), they may be taking even more.
So, when it comes to giving startup tips, the best advice I can give from a tax perspective is to go to the most beneficial tax jurisdiction for your business model that you can from the very beginning.
But not everyone can take that startup tax advice.
The problem that most people with a “pre-revenue startup” face – where they are barely getting started and may not have even established the company yet – is that nothing feels real other than the dream.
The realities of taxes and regulations are but a distant possibility that has not really been considered to any serious degree, even if you could stand to lose hundreds of thousands of dollars for not setting everything up sooner.
On the other hand, if you already have a small business that is making income and you’re seeing a portion of your revenue being siphoned off to bureaucrats every year, it hurts. And that pain can be incredibly motivating to look for better options overseas.
Behavioral economist Daniel Kahneman’s research has pointed out how we feel loss twice as strongly as equal potential gains. Meaning that if I took $100 from your wallet right now, you would have twice as strong of an emotional reaction as me giving you $100.
Because of this psychological quirk, it’s unsurprising that looking to legally avoid taxes when you have yet to even receive a pre-revenue startup valuation is pretty low on the priority list.
In this article, we’ll take a look at whether or not you really need to get over this quirk or if there are factors that make it worth keeping your startup at home in the beginning before moving your business offshore. Then, we’ll examine the strategies you can use to optimize your business structure as soon as possible.
Startup Tips for Going Offshore
The early stages of your enterprise will partially define the future constraints and developmental possibilities of your business. If you decide to have an offshore business, you can optimize your tax situation from the get-go and prevent major expenses further down the line.
However, most people don’t think this far into the future. Because of this, many run into roadblocks that can make it almost prohibitive to take a company offshore once it has surpassed the startup phase.
For example, in some cases, governments have expressly designed their regulation to make it difficult to transfer ownership of some assets to other entities.
To visualize this, imagine that your company (“Company A”) has ownership over some intellectual property – let’s say a piece of software or a book. If you create another entity (“Company B”) in another jurisdiction, it is often legally impossible to simply give the intellectual property to this new entity.
Instead, you have to give Company A what is determined to be “fair value” from Company B, to “buy” it. So, even if they’re both your companies and you are their sole owner, you will have to transfer money between them and this money would be taxable as revenue.
I’ve heard of many self-published authors who didn’t set up the company structure efficiently in the beginning and then their books became extremely successful and they spent the money thinking that the good times would continue. Later, when they tried to move the book’s intellectual property to a better tax jurisdiction, they were wholly unable to pay the ransom price.
In short, their intellectual property is trapped under that corporate entity until they save up for the purchase price.
This would be among the prime business tips – early, seemingly inconsequential, decisions you make have a ripple effect into the future which will completely change the options available to you.
The Challenges of Startup Business Funding
From a tax standpoint, it makes the most sense to start your business offshore as it’s easier than having to migrate your company abroad.
But taxes are not the only factor to take into account.
If you don’t have the capital to start and run your business as a sole owner, you will need funding. And in many cases, going for offshore business opportunities may cut you off from funding opportunities at home.
Here’s the challenge you’re going to face if you want investors: your investors, or potentially your business partners, or other people that share equity or have warrants may not entirely be on the same page with your offshore tax plans.
If you have a business that you own 100%, taking your business offshore and legally reducing your tax rate to as low as zero is relatively straightforward. Even if you have a business partner, it can work out so long as you are both on the same page.
Where it becomes difficult is when one business partner wants to stay in the US or stay in Australia and the other one wants to move offshore. It becomes a lot more difficult to plan for that and more difficult planning means more expense, which means you’re probably less likely to do it, especially if you’ve got a small business that isn’t turning a lot of profit yet.
If you’re looking for startup business funding or loans, your potential investors, venture capitalists, bankers, etc., aren’t likely to look too kindly at a business structure that they’re not overly familiar with.
And even if they are familiar with foreign corporation structures, their bylaws might not allow them to invest in such ventures out of a matter of principle. If they ever need to sue you or enforce a portion of their contract, they will want to do it under a legal system familiar to them, or that might benefit them.
As such, unsurprisingly, if third parties with their own vested interests control a portion of your business, then you won’t have complete freedom over what you do with your company.
It’s like anything where there are too many cooks in the kitchen.
Investors might actually force you into unprofitable decisions – they might frown upon you purchasing office real estate, rather than renting, for example. So, the costs just keep on piling up and the benefits of having investors wear off with all the caveats.
I prefer to pay a bigger upfront cost and eliminate ongoing expenses. That is why I usually buy instead of rent, or why I’ve never taken a dollar from investors. I prefer to be able to make my own decisions as I see fit, rather than having to bend the knee to third parties.
Obviously, when you run your own business, you call the shots and so therefore you can do whatever you want and you can make sure that you get things done and move the company offshore. If you have two partners or even more and you agree to all move offshore together that will work too. But you have to make sure the people in your business are in agreement or at least okay with it.
Investors, on the other hand, may not need to follow you offshore. You can take money from certain places without them having to live the Nomad Capitalist lifestyle. But they need to be okay with the structure.
When Offshore Startups Are Worth It
I understand the hesitation of going for an offshore business strategy. After all, it’s not the normal thing to do when starting a business and will undoubtedly raise some eyebrows when you tell your friends and family about it.
Besides, there are costs and requirements for going offshore. If your business is not going to easily scale up to a certain size, the setup costs might offset your savings.
This is one of the reasons we don’t target people below a six-figure income at Nomad Capitalist. For a good portion of people, it simply doesn’t make financial sense to go offshore.
They might not even meet the bare minimum requirements necessary to set up a bank account or business in the jurisdiction that they want.
But if you have the cash and the business know-how and you’re confident that your pre-revenue startup is truly a multi-million dollar idea, then the optimal tax strategy is to avoid the startup taxes and set up an offshore business.
If that’s not your situation, it usually makes more sense to accept from the outset that you will waste money at first on taxes until your financial capacity can match your ambition.
This will allow you to find investors onshore and accumulate your economic firepower. Then, once you have paid some hefty tax bills, you will have the motivation and capacity to properly take advantage of an offshore plan.
Doing it this way is not the most optimal route from a taxation standpoint, but it may be the only approach available to you and that is fine. The key is to plan ahead knowing that you will eventually go offshore.
If you do not keep this in mind, you may never follow through on the beneficial tax strategies for startups and you will end up deferring to the easiest (and least profitable) methods of arranging your business.
Creating an offshore business strategy is not cheap and often isn’t straightforward. The rewards more than pay for themselves, but only if you actually have the financial resources to warrant such strategies.
It Will Get Worse Before It Gets Better
One thing often overlooked about success is that the amount of effort you put in isn’t equally distributed. Oftentimes, the suffering is front-loaded and all the blood, sweat, and tears are shed when you’re first starting out.
The same is true with offshore business strategies. You need to know how to structure your taxes, where to bank, where to live, how to organize the business model, and more. Everything more or less has to be working from day one or it won’t work at all without major issues.
The easiest thing you could do is simply establish a company in the jurisdiction that you were born in and run your business from there. That’s the path of least resistance.
But much the same could be said about sitting on the couch and eating chocolate cake while watching TV.
If you want great results, you need to put in the effort. If you have a clearly thought out plan and do the things nobody else is willing to do, you will get the results that nobody else could get.
But effort without a clear purpose will just lead you to a flurry of activity that might not even lead you down the path you want. It’s important to know from the outset what steps you need to take and when.
It’s crucial in these cases to think actuarially. Assign probabilities to scenarios and potential payoff and costs.
For example, “If I have a chance to make a million dollars and I have to pay $365,000 in taxes, what am I willing to pay to avoid it? What are my chances of actually earning the million dollars? How much would it cost for me to set everything up in a tax-neutral jurisdiction, and what would be the ongoing costs?”
Answer all those questions accurately and you can easily calculate the exact monetary amount at which it makes statistical and financial sense to enact a certain phase of the plan.
Of course, I’m simplifying matters, as these points are far more nuanced. But having good answers to all these questions will help you build a solid foundation to create a workable offshore plan.
If you never take the time to calculate, research, or honestly answer any of these questions, you will never be able to optimize your taxes. You’ll simply have to accept whatever taxes your government has decided to saddle you with because you have not given yourself any other options.
The Best Tax Strategies for Your Business
The best tax strategies for small business owners primarily revolve around simply having offshore businesses in lower or even tax-neutral jurisdictions.
Now, you can always optimize your taxes locally; if you find a good enough accountant, they will be able to deduct or arrange your finances in better ways.
But unless you change your tax jurisdiction, this strategy has diminishing returns. Past a certain point, your high-tier accountant will simply not be worth the man-hours to find you ever-smaller deductions that you aren’t already utilizing.
It’s a bit like looking for oil – where a certain well you have been tapping for years might still have some oil, but the cost of extraction is not worth the reward you would get for doing so.
In circumstances such as those, it makes far more sense to use your money and resources to search for a deeper, untapped well; rather than try to use an almost depleted one.
The problem though is that exploring new possibilities carries a cost to set everything up. As such, unless you’re already a savvy businessman with deep pockets, it might not make financial sense to go searching for more lucrative opportunities.
Perhaps it might not be the most efficient means of organizing your business affairs, but while you’re still learning the ropes and scaling your business, it makes sense to go for easier options. The caveat being that the easier tax options will ultimately eat into your bottom line.
If you are running a startup business in your home country, understand that it is likely not the optimal structure for your business in the long-term. And with that understanding, prepare an offshore business plan that will be enacted once finances are strong and stable enough to permit you to go offshore.