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E-commerce case study 3: Physical products business to business

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.

Physical products business to business Case Study

CompDirect is an established UK based mail order company supplying pre-assembled computer equipment and sundries to companies throughout Europe. Founded in the UK in 1974, CompDirect expanded into continental European markets in the 80’s, and began to develop strongly into Eastern Europe in the mid 90’s. The main functions of the business including management, world-wide procurement, marketing and sales are conducted from the UK head office in London. CompDirect has two subsidiaries, both warehouses with extensive despatching facilities. Comphouse Ltd is based in Bristol and services all of Western Europe, while the more recently opened Comphouse GmBH based in Berlin covers the whole of Eastern Europe. All orders received are processed through the UK head office with despatch details forwarded to Bristol or Berlin as appropriate.

CompDirect has been aware for some time that a small, but rapidly growing proportion of sales in its marketplace is being transacted on the Internet, and that the establishment of a web site with ordering facilities would be beneficial to the business, allowing expansion into a truly global market place. Costs for establishing a web-site are also low compared to those for expansion of current operations.

With growing interests in Eastern Europe, CompDirect is also aware of the need for efficient tax-planning. A new financial director has read about tax opportunities opened up by e-commerce and wants to explore this avenue. He seeks professional advice from a major consultancy firm which recommends a new structure to take full advantage of tax-saving possibilities available offshore both in relation to e-commerce and also to the growing East European involvement.

CompDirect should continue with its present catalogue-based sales operation, but should form a separate company to handle Internet sales and marketing; this new company can be based offshore. A number of criteria affect the choice of an offshore location, including the availability of adequate technical infrastructure to support an e-commerce operation, and well-developed business services.

In fact the choice for CompDirect is fairly straightforward, since Cyprus has a considerable network of double tax treaties with Eastern European countries, and is very frequently chosen as a base by companies for their East European trading operations. It also has good commercial and technical infrastructure. Although CompDirect doesn’t currently intend to form subsidiaries in Eastern Europe, it is aware of this as a future possibility, hence Cyprus is a useful place to be. CompDirect’s longer-term plans also envisage an increase in out-of-EU sourcing, and the company notes that the tax-free zone in Larnaca would be a good location for an additional warehouse should this become necessary.

In order to ensure maximum tax efficiency, it is necessary for the Cyprus company, to be known as CLink Ltd, to be a completely separate entity dealing solely with Internet marketing and sales. CLink will purchase its supplies from CompDirect on an arm’s length basis. Warehousing and despatch, together with payment of local import tax and VAT, will be outsourced to Comphouse Ltd and Comphouse GmBH in the UK and Germany. This arrangement will avoid the danger of creating a taxable presence in either country. In order to escape the UK’s CFC (Controlled Foreign Corporation) legislation, which was tightened still further in the Finance Act 2000, CompDirect will have only a minority shareholding in CLink Ltd, with the bulk of the shares being held by CompDirect’s own shareholders, some of whom already have offshore residence or trust structures.

When orders are placed with the Cypriot company, a statement will be produced including cost of delivery and local taxes, with a copy being e-mailed to both customer and the relevant warehouse. The warehouse will then prepare the goods and provide a tax invoice on behalf of CLink for the goods delivered. CLink will then be invoiced for services provided by Comphouse including payment of local duty and taxes.

CompDirect and their consultants then plan a timetable for the new project: Phase 1 (with assistance from a Cypriot company formation agency) The establishment of CLink as a Cypriot International Business Company (IBC)*.

The opening of appropriate banking facilities

The domain name www.compdirect.com is registered

Phase 2 (with assistance from a Cypriot ISP and a London web-site design agency) Web site designed with on-line catalogue, ordering facilities, shopping cart Secure multi-currency payment processing package sourced On-line credit card facilities arranged, including merchant ID, clearance procedures agreed and installed with CLink’s bank.

Co-location of the web site at the ISP’s server in Cyprus

Installation of a dedicated connection to the Internet for the CompDirect site from the local telecom provider

Creation of all required reporting features of the site

Clink’s gross margin on Internet sales from Cyprus will be around 50%, and with a much leaner overhead structure than CompDirect its net margin should be considerable, once the set-up costs of the web-site have been amortised.

Profits generated in Cyprus will be taxed at 4.5%, and dividends paid to most EU countries and the US will suffer nil or 10% withholding tax. CompDirect, Comphouse Ltd and Comphouse GmBH all expect to benefit from the project by acquiring additional custom from CLink as Internet sales enlarge the group’s overall market.

* As from 1st January, 2003, an offshore company (IBC) no longer has a separate taxation status, and is taxed according to the same principles as a regular company. IBCs are now allowed to trade inside Cyprus. However, a pre-existing IBC which has made an irrevocable commitment not to trade inside Cyprus until 2006 is able to claim the existing low tax rate for the three years 2003, 2004 and 2005.

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