What is the difference between passive and active companies?

Suppose you have opened a foreign account for a company or are in the process of opening one. In that case, you have probably encountered questions in the questionnaire about its international classification: financial/non-financial, passive/active. It is no coincidence that these criteria are included in the questionnaire, as they significantly affect your tax bill. 

As experts in opening and maintaining foreign corporate accounts, we assist entrepreneurs worldwide by helping them navigate the many and sometimes complex legal aspects of business. In this article, we will be happy to tell you how to navigate the "language" of banking classification and see your company through the eyes of the bank through key international characteristics. 

So, let's find out whether your company is financial or non-financial. Everything is quite simple here: financial companies are enterprises engaged in financial transactions, such as banks, insurance and investment companies, stock exchanges, pension funds, and others. Therefore, if your activities are unrelated to financial services, you are a non-financial organization. 

Then, we move on to the more important classification of the company - active or passive. Your business will be considered inactive if more than 50 percent of its gross income was generated passively in the previous calendar/fiscal year. At the same time, the weighted average share of your company's assets that create or are held to generate passive income is more than 50 percent. The value of assets is determined by the fair market value or book value of the assets recorded on the firm's balance sheet prepared by the U.S. or international system. 

Thus, you are classified as a passive company if, by the criteria above, you generate your income passively, for example, through investments, dividends from shares, granting your rights to patents, trademarks, intellectual property to other companies, renting out real estate, and other sources.

Consequently, all other organizations whose specified characteristics do not exceed 50% can be classified as active companies. For example, it is active if your company is engaged in I.T. development or trading. In general, most companies in the world earn income that directly depends on their work's quantity, quality, and effort. 

It is also important for you to know CRS (Common Reporting Standard) and FATCA (Foreign Account Tax Compliance Act) - these are two key standards aimed at increasing transparency in the global financial system. Although they sound complicated, let's understand what they mean. 

CRS is a globally accepted standard for exchanging financial account information between countries. In simple terms, CRS helps countries share information about people's bank accounts. Submitting to it, banks automatically report to the tax authorities about the accounts and income of foreign clients. As you might have guessed, the CRS was adopted to prevent tax evasion. 

FATCA is an American law against tax evasion through foreign financial accounts. Foreign banking and financial institutions must share information about U.S. customers' accounts with U.S. tax authorities. In this way, the United States monitors the income of its citizens abroad and ensures compliance with tax obligations. 

So, we have looked at important aspects related to banking classifications and global tax standards. If your company has foreign accounts, knowing whether your company is financial or non-financial, as well as determining its activity, becomes important for the successful development of your business. 

Antwort Law is committed to providing you with the information and assistance you need to understand the complex aspects of doing business abroad. We hope that this article has helped you see your company more clearly in the context of banking and tax standards. Stay informed, and your business will thrive in the global economic environment.

Lidia Ivanova,

International Lawyer
Antwort Law