Offshore tax shelters explained

Offshore Tax Shelters Around the World 

 Image attribution: Arkyan, GFDL, CC BY-SA 3.0

An offshore tax shelter is a legal mechanism or entity by which income that would normally be earned and taxable in one tax district is only taxable within the domicile of that tax shelter's registration. In other words, when capital is transferred to another legal jurisdiction and is subject only to that jurisdiction's taxation system, then income earned from use of that capital is no longer considered taxable in a higher taxed jurisdiction.

Several criteria must apply for offshore tax shelters to be legitimate. For example, if income is earned for purposes other than tax avoidance, it is more likely to be considered legal. This is more the case when the income earned through that tax shelter comes from the country that holds tax sheltered assets. Moreover, this is because income earned in a higher tax zone can still be taxable even if earned from a foreign registered entity.

Some entities attempt to avoid taxable income earned from offshore entities by taking advantage of rules that don't require taxes from foreign registered entities. For example, a Senate committee report chaired by Senator Carl Levin found that certain hedge funds were avoiding taxes on dividends earned within the U.S. This abusive practice was accomplished by restructuring the transaction so the money would not be taxable under the rules of the new transaction. The transactions were still considered tax evasion because they were believed to not serve the purpose of the transaction, but rather the intent of tax evasion.

In some cases, tax treaties are signed into law between two countries. The Internal Revenue Service (IRS) states these treaties often do not protect residents or citizens from U.S. Taxes due to a 'savings clause'. However, also according to the IRS, there are exemptions to the savings clauses of tax treaties. In such case, the saving clause exemptions of a tax treaty can serve an offshore tax shelter by allowing income to be earned within the United States through the tax shelter in so far as tax exemptions apply. Filing of specific tax forms may still be required by the IRS in order to claim the tax exemption.

With our without tax information sharing treaties between countries, tax that is illegally sheltered is still illegally retained income. In other words, tax shelter fraud and misuse of offshore portfolio investment strategy are considered tax evasion and not tax shelters as distinguished by the IRS. For this reason it is necessary to understand the basic tax laws that classify income as either taxable or non-taxable, and the difference between tax shelter fraud and tax shelters.

For most individuals that earn income in an offshore account, that income must still be reported to the IRS. However, if that income is not earned by an individual, but rather an entity that is legally separate from the individual, new rules apply. Even this can be considered tax evasion if that entity is established solely to avoid taxes. In other words, the motive of an offshore tax shelter should not be tax avoidance, but rather tax sheltered income according to  US Legal. When considering offshore tax shelters, consulting with the IRS or contacting a skilled tax professional that is also accurately knowledgeable in the area of offshore tax shelters may be advisable.

The Importance of the LIBOR

LIBOR is the acronym for London Interbank Offered Rate and this rate can vary from basis points in the tens to the multiple hundreds. The LIBOR is widely used as a financial benchmark for both consumer and business finances worldwide and is linked to the lending of over a hundred trillion dollars. (economistsviewtypepad.com) To put that in perspective, the U.S. economy produces around $14 trillion in value every year, making the LIBOR's influence very large.

LIBOR rates are set daily for 1 month, 3 month, 6 month and 1 year lending between United Kingdom banks. The reason LIBOR is important in regard to a credit crisis is because lending rates can affect the availability of capital in a financial system. The higher the LIBOR rate is, the greater the cost of borrowing funds for individual, real estate, equipment, individual or other loans becomes.

What happened to LIBOR during the credit crisis

When the most recent credit crisis began and the U.S. Federal Reserve Bank was lowering interest rates and making funds generally more accessible, the LIBOR continued to rise until October 2008, well into the credit crisis. (wsjprimerate.com) Essentially, this meant the British Bankers Association responsible for setting LIBOR rates were either unable to convince banks to lower rates or not fully cognizant of the implications high LIBOR has on financial markets. Unfortunately, the credit crisis was a big problem for the U.K. and the LIBOR did end up being lowered. In fact, the 1 month LIBOR rates dropped from over 3.8096% in October, 2008 to .3834 percent in January, 2009. (wsjprimerate.com)

The fourth quarter 2008 and 1st quarter 2009 drops in the LIBOR were due primarily to a recognition the credit crisis required liquidity to be alleviated. Dropping the 1, 3, 6 and 12 month LIBOR rates implied lower costs of financing new lending for banks. The reason LIBOR rates took so long to decline so long after the credit crisis started has to do with credit worthiness of banks. Since banks lend to each other with the risk of default, the risk of default rises during a credit crisis despite being a bank with good credit. Consequently, the default risk was built into the LIBOR rate until the credit crisis risk became higher resulting in a lower LIBOR.

Direct consequences of LIBOR and LIBOR Metrics

As a market indicator, a lower LIBOR indicates 1) acknowledgement of the magnitude of problem the credit crisis imposed on financial institutions and 2) the cost of borrowing money for financial institutions utilizing the LIBOR 3) measurement of perceived risk in the credit market and 4) assessment of progression and development within credit crisis. The causes of changes in LIBOR have been measured statistically by comparing the rate to other market lending rates. 

For example the TED spread is used to determine the difference between LIBOR and government securities yields of the same maturity. Other spreads used include the overnight interest swap rate for 30 day LIBOR, credit default swap rate to LIBOR spreads, and bank solvency risk to LIBOR spreads for measurement of credit and lending risk as a cause for LIBOR rates. (economistsviewtypepad.com) The course credit crises take is dependent on a wide range of factors both economic and financial.

A lower LIBOR has the effect of alleviating and spurring on economic and/or financial growth but is still only one of the variables in the equation of market and economic growth. Since LIBOR is not as connected to the government as the U.S. Reserve's Federal Funds Rate, the LIBOR is a more direct measurement of market conditions rather than Government linked response to financial market conditions. 

When LIBOR rates decline it may also be an indicator of where the financial markets are within a credit crisis. For example, since LIBOR reflects lending and default risk, a lowered LIBOR may indicate more creditworthiness between banks and a beginning to progressed resolution of the credit problems within the crisis. Moreover, a continually lowering LIBOR or bottoming of the LIBOR over time may also indicate the desire for financial growth combined with lower credit risk between banks.

Summary 

In summary, the LIBOR is an important banking-lending rate tied to a large amount of money worldwide. When credit and lending risk for banks rise, generally, so does LIBOR. However, when these risks become resolved, or are less important than the need for commercial growth, the LIBOR would decline. During the unresolved concerns of the credit crisis, LIBOR rose dramatically as commercial lending tied to the previous financial crisis devaluated. This happened even as the U.S. Federal Reserve has consistently lowered its lending rates. 

Evidently, the risks were still present throughout this period. It wasn't until the 4th quarter of 2008 and 1st quarter of 2009 that the LIBOR began to decline reflecting a possible resolution or bottoming of the credit problems and risks associated with the credit crisis. Nevertheless, in late January 2009, the three month LIBOR did experience an uptick indicating a possible continuation of credit risk.

Sources:

1. http://www.investopedia.com/terms/l/libor.asp
2. http://www.telegraph.co.uk/finance/economics/2815187/Liquidity-crisis-grows-as-Libor-rates-gap-hits-20-year-high.html
3. http://www.wsjprimerate.us/libor/libor_rates_history.htm
3.  http://tinyurl.com/6339trl (London Evening Standard)

How to Open an Offshore Euro Bank Account

An offshore Euro Bank Account is simply an offshore account in Euro denominations rather than dollars. Essentially, the same rules and laws apply whether the account is Euros or Dollars and is subject to taxation in one's country of residence regardless of the privacy protections, and banking regulations of the offshore locality or jurisdiction in which the account is held.

The first step in opening an offshore Euro bank account is to determine if one's home country considers offshore banking legal. Many countries allow offshore banking however some require taxes on income earned through offshore accounts.

Offshore Euro bank account requirements

Offshore Euro bank accounts can be held in European, Caribbean, Central American or any banking service provider outside of one's country of residence. The rules and regulations governing banking in each Jurisdiction vary widely and may include the following requirements for opening an Euro account.

• Certified Identification
• Minimum Deposit
• Proof of Residency
• Chamber of Commerce reference (for business accounts)
• Legal and/or Accounting referral
• Incorporation of a company within the Jurisdiction

Opening non-Euro Zone offshore bank accounts

To open an offshore account, one may have to form a corporation depending on one's nationality and the jurisdiction in which the account is to be opened. In the case of corporate formation, services of a corporate registry or law firm may be required. An example of a jurisdiction requiring corporate formation is Panama if one is a resident of either Canada or the United States.

If one is a European opening an offshore Euro account, corporate formation and corporate bank accounts may not be necessary in lieu of personal bank accounts. Additionally, in Caribbean jurisdiction, Euro bank account's minimum deposits may range from 500-1250 Euros.

Additional offshore jurisdictions

There are many offshore jurisdictions to choose from each with varying levels of privacy, local taxation, convenience and banking products and services. The rules for opening an account in each jurisdiction may vary and thus it is important to research and consider each one carefully before making a decision.

A few of the offshore jurisdictions offering offshore bank accounts include but are not limited to Panama, the Cayman Islands, Aruba, the Bahamas and Saint Kitts and Nevis. Local laws, banking procedures and international treaties may also be a factor in the opening and management of an offshore euro bank account. For example, in Panama a recommendation is required more often than not to qualify for an offshore account.

European and Euro-Zone offshore bank accounts

Euro-Zone offshore accounts are accounts in countries other than that of one's residence that are also located in a European country participating in the European Union. Swiss banks accounts are European but not Euro-zone accounts due to Switzerland's political neutrality.

Swiss bank accounts however, are typically considered an offshore account of choice for individuals seeking high quality professional service, protection from dissemination of information to third parties and a more diversified range of banking services. Euro requirements for opening some Swiss bank accounts may be very high or relatively low depending on the bank and type of services. To open a Swiss bank account the following steps may be taken:

• Research bank and account type i.e. postal, numbered, investment
• Contact an international branch of a Swiss bank or a Swiss consulate
• Determine what identification and paperwork requirements are needed
• Gather minimum deposit
• Notarize and/or verify documents and send

Additional countries within the Europe and/or the Euro zone also offer off shore accounts including Austria, Luxembourg, Gibraltar, Cyprus and the Isle of Man. Account requirements such as minimum deposits, points of contact, and paperwork vary from location to location but generally, the steps required for Swiss bank accounts can serve as a blueprint for opening offshore euro accounts in other jurisdictions with the Euro zone.

Opening on offshore Euro bank account on the Internet

Opening an offshore euro bank account over the internet ideally uses a little more due diligence as the internet is not as regulated as more in person, bureaucratic and brick and mortar banking services. For this reason it is appropriate to use precautionary steps before proceeding to open an offshore euro bank account over the internet. Some of those precautions are as follows:

• Verify the online banking services are connected to a physical financial institution
• Confirm legality, registration and reputation of the financial institution
• Choosing a jurisdiction with a sound reputation may be advisable
• Encrypt web transmitted information if possible • Investigate website security features
• Consult the references provided with this article

Offshore Euro bank accounts can be opened via the internet and also have certain requirements such as those listed for Caribbean and European offshore accounts. The added measure of security and extra research is prudent when utilizing this option. Depending on where one lives, possession of offshore or certain offshore accounts may not be legal and thus it is wise to verify this as well.

To recap the process, essentially opening an offshore accounts involves first an foremost verifying legality with local tax and banking regulatory bodies and then, if the account is allowable using the following steps 1) Identifying one's banking needs 2) researching the benefits and disadvantages of each offshore jurisdiction 3) Identifying the various banks and their services 4) contacting the appropriate legal or banking entity to determine exact paperwork, deposit and any other requirements 5) submitting the appropriate information and funds for opening. Off shore banks exist all over the world and are used by a wide variety of individuals, and/or corporations for a number of reasons including diversity of banking services, privacy protection, and financial security in the case of residents who live in politically unstable countries.

Sources:

1. http://www.offshorecompany.com/banking/institutes.asp
2. http://tinyurl.com/4nmxdec
3. http://www.myoffshoreaccounts.com/english/faq.php#05
4. http://tinyurl.com/4lbdrwc
5. http://www.mn.essortment.com/howtoopenswis_rjiw.htm

The functioning of offshore banks

Offshore banks provide financial opportunities and services not necessarily possible or available in one's place of residence. Many people associate offshore Banking with gangsters and criminals trying to hide their money. To some extent these stereotypes are true but it is not the complete picture. Criminals may take advantage of the greater confidentiality to launder money and evade taxes, but law abiding banking clients may also benefit.

• Regulatory environment of offshore banking

Not reporting income earned in offshore banks is illegal in the United States as per U.S. tax code. However, several additional beneficial services and legal protections are facilitated by offshore banks. Fees and account maintenance expenses vary from offshore bank to offshore bank, but this information is generally available upon inquiry by the potential bank holder.

The reasons contributing to an offshore banks profitable operations include the unique advantages they have as 'offshore' Institutions. Often the countries they are located in do not heavily regulate them enabling them much freedom of service and lower operating costs associated with taxation.

In other words, the unregulated banking atmosphere in which these banks operate can increase their profit margin because they themselves may not have to pay high taxes and can charge rates and fees that are above typical. This can also make the banks more liquid, have great financial leveraging and offer potentially more profitable investment opportunities to international investors. In this sense the banking must comply with the national banking regulations in which the offshore bank is regulated and in terms of any applicable international laws.

• Offshore banking services

Services provided from offshore banks can include greater privacy, financial security and investment vehicles which may not be available to clients in their home countries. An example of some favorable investment vehicles not necessarily available at local banks include access to international markets according to Bahamasb2b.com Offshore banks have a lower operating cost environment due to less regulatory constraints.

The offshore banking environment allows its banks to operate in greater ease and with less fear of failure. In other words because these banks are not as heavily regulated as banks in developed countries such as the United States or Member of the European Union, they are not subject to the same constraints on fees, rates, legal reporting requirements, scope of services and associated operating costs. This freedom from regulatory constraint may allow them to offer better rates on loans and offer services not traditionally offered by local banks.

Offshore banks may not pay competitive interest rates on deposited money. Nevertheless, these banks can also offer asset protection from legal proceedings according to Shelter Offshore. Such protection enables individuals under litigation to protect themselves from total financial loss.

Individuals who are residents of countries with political instability can also benefit from offshore banks because they offer a safer environment to do banking. Offshore banking allows businesses that are registered in foreign countries to operate in a favorable tax environment. So a company that trades on an American Exchange does not necessarily have to operate solely out of the country in which the exchange listing is offered. The cost implications and benefits of such a business operation can make the difference between provability and loss.

• Where to find an offshore bank

Several countries offer offshore banking services and include panama, Bahamas, Bermuda and many others. Theoretically, money held in these banks can be frozen under international law that protect country's citizens from potential harm, and/or extreme criminal activity.

Some countries such as Anguilla have their banking law posted on the Internet. The link at the bottom of the page demonstrates this 'transparency' of operational activity but not necessarily transparency of the activities that occur under such law.

Due to the fact offshore banking has the potential to be vague in its reporting requirements this may also conceal the details of its financial success. For in investor placing money in such a bank, it is worth considering the stability of the bank in addition to the stability of the country in which the bank is located. Swiss offshore banks are recognized for their quality of service and relative stability in terms of the banking system within which they exist.

When considering whether to open an offshore bank, several factors may come into play with the decision. Items such as 1. quality of service 2. products and services, and 3. cost and ease of banking may all be pertinent concerns that offshore banks may or may not be able to meet.

Offshore banks exist to provide additional commercial revenue to the nation-states that allow for this type of banking via their national regulation. The services provided by offshore banks may not be available in one's home country or the offshore bank may offer security that one cannot easily obtain in one's own country.

Sources:
1. http://bit.ly/cHE3Vy (Yahoo Finance)
2. http://bit.ly/dtLqJP (ShelterOffshore.com)
3. http://bit.ly/a9c9Un (Bahamas Business to Business)
4. http://bit.ly/dbrxvh (Offshore Legal)
5. http://bit.ly/b9rLX8 (Targetwomen.com)