The primary attraction of incorporation is to limit the liability of investors. First introduced in the nineteenth century, limited liability enabled shareholders to form companies in which their potential losses were restricted to the amount of the share capital that they had either paid for or undertaken to pay for. Because the company was a distinct legal entity, creditors were only able to attach to assets of the company for payment and the personal assets of the shareholders remained safe.
But companies can also be used to mitigate tax. Profits received by a company are also taxed at the company rate rather than the rate applicable to its shareholders. So a resident of a high tax country may set up a company in a low or zero tax jurisdiction and arrange for profits to be booked into the name of that company. This generates a saving equal to the difference between the corporate rate of tax and the shareholders' personal tax rate. Anti-avoidance legislation in the shareholder's country of residence may reduce or nullify the effectiveness of such arrangements, but skilful structuring may also render such anti-avoidance legislation inapplicable.
If the company makes a distribution of profit, usually in the form of dividends or royalties, then those distributions are generally taxable in the hands of the recipient. Accordingly, the greatest advantage is achieved by letting the profits roll up within the company account so that tax is deferred or avoided. If profits can remain untaxed offshore, then tax is saved both on the original profit and the investment income generated by reinvesting those profits, so the benefit is cumulative and substantive. Distribution of the profits can be delayed until the recipient has moved to a jurisdiction with a lower, even zero, tax rate so that tax is avoided completely.