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E-commerce case study 2:Electronic products to consumer

There are so many variable factors in the situation of each company, including business sector, ownership structure, country of origin, size, capital structure and level of profitability, to name just some, that it is hardly possible to illustrate the principles of offshore e-commerce in any general way. Still, case studies can show typical sequences of steps needing to be taken when going offshore, even if the detail will be different in each case.

The six case studies in this section cover six of the more likely business situations in which offshore has a lot to offer; but the truth is that the Internet has made it possible for almost every business in a high-tax country to get advantage offshore.

Electronic products to consumer Case Study

Company Z is a privately-owned, UK-based retailer of CDs through its network of high street shops, which have been trading for the last 25 years. It has not yet established a web site, and is keen for this to be combined with digital delivery of music to customers if this is possible. Company Z employs Netbased Ltd, a e-commerce consultancy firm, to produce a report on the introduction of a web site and the feasibility of introducing digital products.

Netbased confirms that digital delivery is practicable using Mp3-encoded music, which can be downloaded by individual customers from a Company Z web-site, along with the software to play it. Mp3 (which is short for Motion Picture Expert Group-1/Level3 and was an inter-governmental attempt to create standards for interactive TV) has been hijacked by the independent music industry, and while hated by the major record companies is already used by many independent artists, so that there is a substantial amount of music legally in Mp3 format already (and much more illegally).

The major companies are due to introduce an alternative standard called SDMI through which they will market their mainstream artists, and which Company Z can also sell from its site when it becomes available. Company Z will pay royalties to the suppliers of encoded music according to the number of units sold.

Netbased also point out that a digital music retailer can operate from an offshore location; however digital music downloads are very demanding in terms of bandwidth (amount of telecommunications capacity) so that the offshore jurisdiction would have to offer advanced telecommunications facilities.

Netbased think that it would be good to distance the new company from the existing business, partly so that the record companies supplying Company Z’s high-street business do not react badly, and partly to gain tax advantages. By setting up an offshore company with separate ownership, these two goals are achieved, although there is a disadvantage that any initial losses of the offshore company can’t be offset against UK profits.

The shareholders of Company Z are a disparate group, with various different tax situations, but a majority of them agree to finance a new offshore company, whose profits will not be subject to UK tax; in addition, in the current state of the law, VAT would not be chargeable on supplies of digital music from outside the UK (see our section Tax Law for an explanation). Evidently this would give the new company a price advantage as against its onshore competitors who would have to charge VAT.

The Netbased report proceeds by discussing the relative merits of different offshore jurisdictions and settles on Jersey as being the most suitable, given the strength of its telecommunications and commercial infrastructure, its close links to the UK, and on the other hand its exclusion from the scope of EU VAT. Company Z accepts the Netbased report, and draws up a programme for the digital delivery project in conjunction with a Jersey e-commerce facilities company CI-net. CI-net offers a turnkey package approach including the following stages: An International Business Company*, Z Direct Ltd, will be formed in Jersey, which will pay a maximum of 2% tax on its net income, reducing to 0.5% on income over £10m.

Z Direct Ltd will operate from a small office on the island of Jersey; a dedicated server will be installed with back-up facilities provided by CI-net. CI-net will source and install front-end catalogue and ordering facilities with a secure multi-currency payment processing package.

Bank accounts will be opened in Jersey; and on-line credit card facilities set up with merchant ID; clearance procedures will be agreed with the new bank. Mp3 storage, processing and downloading systems will be sourced and installed. Meanwhile, Company Z will begin compilation of an Mp3 catalogue, which is not as difficult as it sounds, using the Internet itself as well as existing music industry contacts to pinpoint Mp3 sources, and agree licensing deals with them, as well as technical data standards.

Although the costs of all this work are quite substantial, Company Z is pleased by the results, not least because it is now well-placed to expand into other types of downloadable product such as graphics files, video and publications, without inordinate extra expense.

*NB In accordance with Jersey’s commitment to the ‘Rollback’ provisions of the EU Code of Conduct for Business Taxation, the International Business Company vehicle was abolished to new entrants with effect from 1st January, 2006. Benefits for existing beneficiaries of the International Business Company regime will be progressively extinguished by no later than the 31st December 2011.

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