Offshore Havens and Asset Protection
The topic of offshore havens conjures alluring images of secret bank accounts in exotic locations-far from the prying eyes of the IRS. In this section, we will discuss the real world of the offshore havens. We’ll show you what can and can’t be accomplished to save you taxes and the legitimate strategies available for asset protection and privacy planning.
The offshore havens exist because of a powerful demand by individuals in many countries to shelter their accumulated wealth from a variety of perceived threats. In the United States, these dangers are often the product of a lawsuit system, which unfairly targets those with property or savings. In all other countries-with fewer lawyers and lawsuits-the threat of litigation is not the primary concern. Instead, asset protection and privacy issues are related to the political and economic climate which pose risks with varying degrees of severity.
In many countries the greatest dangers to wealth may arise in the political arena. A friendly government can be voted out or overthrown, or the existing government may radically alter its political course. Recently, the opposition candidates were elected president of South Korea and mayor of Mexico City. Whenever the party in power changes, there is a massive redistribution of wealth as business ties with supporters of the old regime are cut and new relationships with new supporters are forged.
In every country, to greater or lesser degrees, the success of a business depends upon the relationship with the proper government officials. Contracts, licenses, permits, and privileges are granted to those who are able to cultivate influence at the right levels of government. When power in the government shifts from one faction to another, there can be a dramatic reshuffling of the wealth in society. Money and influence shift to the friends of the newly empowered, and those previously excluded enjoy their day in the sun.
The political and business forces removed from power face varying degrees of retribution. Cuba’s Fidel Castro confiscated the property of the Battista supporters and thousands were jailed. Business associates of the Shah of Iran were forced to flee the country, leaving behind their homes and savings. In the U.S., political ideology is secondary to an uninterrupted flow of campaign contributions. A change of administration only impacts those business owners who foolishly bet everything on the losing candidate and are unable to make amends with the winner.
Wealth also can be attacked by ill-conceived political and fiscal policies, which weaken the local currency and devalue the accumulated wealth of the population. Cyprus, Greece, Italy, Spain, Iceland, Ireland and the recent fiscal crisis in the rest of southern Europe continues to cause great concern about the extent to which the Euro will be able to survive as a single currency. Besides Europe, at various times in the recent past, Russia, Indonesia, Thailand, and South Korea, have seen the value of their currencies collapse as a result of entrenched corruption and badly mismanaged fiscal policies.The cumulative savings of much of the citizenry have been obliterated. Cyprus is only the most recent example of strict exchange controls, prohibiting the movement of bank deposits out of the country. A devalued currency disproportionately penalizes that portion of the population without sufficient resources or ingenuity to successfully avoid capital control laws.
To protect against the financial consequences of a shift of political power and to avoid controls on the flow of funds, those who have accumulated wealth rely on financial privacy to ensure their livelihood and their physical safety. The universal strategy for those who can afford to do so is to keep what they own well-protected and hidden-outside the country-in a jurisdiction that specializes in providing these services.
Understanding Offshore Havens
Many countries outside the United States recognize and appreciate financial privacy as a traditional and important right of their citizens. The European nations impose a variety of safeguards to limit unauthorized disclosure of personal information. The members of the European Union have imposed strict controls over the dissemination of personal data. Companies are not permitted to gather personal information or use it for marketing purposes without an individual’s consent. This law effectively bars the type of cross-selling and information peddling engaged in by U.S. companies.
Germany has particularly stringent laws governing the use of personal data. For example, in return for the right to market its credit cards in Germany, Citigroup agreed to allow German inspectors to regularly monitor its giant computer databases-located in South Dakota-to ensure that Germany’s privacy laws are not violated. The European countries are acutely sensitive to the issue-having witnessed firsthand the consequences of privacy abuses from the Nazi and communist regimes.
Elsewhere in the world, out of purely practical concerns, countries have recognized that meeting the demand for financial privacy can be a lucrative source of business. These countries are generally referred to as financial privacy havens or tax havens or offshore havens.
Often, offshore havens have limited domestic resources. Sometimes they are geographically isolated with limited opportunity for economic expansion. Especially for the Caribbean nations, the clean, well-paying jobs and steady revenue source provided by a financial services industry can be an attractive complement or alternative to a complete reliance on tourist dollars.
Competition to Attract Business
Like all businesses with attractive profit opportunities, offshore havens must compete with each other to attract a volume of banking and financial services clients. This was not always the case. Only twenty years ago a few well-known centers such as the Bahamas, Bermuda, the Cayman Islands, and Switzerland were the predominant service providers in this area.
Within the last ten years, many new countries have developed the necessary package of banking services and asset protection products. There are now a significant number of countries seeking this business, and competition is fierce. Successful countries attract this business with some or all of the traditional techniques: better service, innovative products, favorable laws and regulations, and competitive prices. When a particular country develops a financial product that satisfies a wide demand, it may leapfrog over its competitors to the top ranks of the financial centers.
Offshore Money Magnets
We are all familiar or have at least heard about financial centers such as the Bahamas, Hong Kong, Singapore, Liechtenstein, the Cayman Islands, and Monaco. Fewer know that Tonga, Nauru, Maldives, Guam, and Nevis have joined the ranks of the offshore service providers.
The common characteristics in the offshore havens are:
- A system of low or no taxes.
- Maximum flexibility and secrecy in the ownership of business entities.
- Strict bank secrecy rules.
This powerful package of services is in high demand from individuals throughout the world seeking privacy for their wealth and protection of assets from government or economic instability. And let’s not forget about taxes. There is a massive flow of funds from the high tax countries-the United States, Canada, and Europe-into the offshore havens.
For example, studies show that when tax rates in a country move above 30 percent, to the 40 percent and higher range, tax avoidance becomes a preoccupation of many individuals and businesses. Much of Europe, the United States, and Canada have progressive tax rates which approach or exceed 50 percent-providing an endless source of demand for the attractive services offered by the tax havens.
A recent study showed that 50 percent of all international transactions are directed through the offshore jurisdictions. Hundreds of billions of dollars in international trade and commerce are routed through these countries each day. These nations allow the greatest degree of freedom in the ownership and operation of a business, and there is little government interference with business activities. It is only natural that international buying and selling of products and services, whenever feasible, are routed to a jurisdiction that protects the privacy of the parties and provides little or no taxation.
Common Tax Strategies
Goods which are imported into the U.S. are often routed or invoiced through a company established in one of the tax havens. Products exported from the U.S. may be “sold” first to a tax haven company to drop most of the profit in the no tax jurisdiction. This technique is known as offsite pricing, and the goal is to move profits from a high tax country to a low or no tax country.
Let’s say that you are in the business of importing cheese from Holland. Each year you buy $100,000 worth of cheese which you sell for $200,000 to local supermarkets. That’s a gross profit of $100,000 before other expenses, and that income is subject to tax in the U.S. at the normal rates.
What if you could work it differently? Instead of buying from Holland directly, you set up a company in the Bahamas to buy the cheese. That company then sells the cheese to you in America for $150,000. Now, when you sell to grocery stores, your gross profit is only $50,000 not $100,000. The other $50,000 in profit was earned by the Bahamas company where there is no income tax.
Companies that export goods often use the same basic strategy. A U.S. company sells T-shirts to France for $3 per shirt. It sells 100,000 shirts per year for a gross of $300,000. Instead of shipping directly, the orders come from a company in Hong Kong at a price of $1.50 per shirt. The Hong Kong company now sells the shirts to France for the full $3. As a result of this arrangement, the U.S. company now has gross income of only $150,000. The balance was earned in Hong Kong, where there is no tax on this income.
Despite provisions in the tax law and regulations which prohibit or restrict the use of these strategies, the demand from citizens of high tax countries for these techniques is powerful. Those who receive royalty income from patents or copyrights such as book authors, software developers, and inventors often transfer these rights to offshore companies and have the funds collected in a tax haven jurisdiction. Owners of appreciating stock, which includes almost every man, woman, and child in the Silicon Valley, seek to move and sell the asset in a country that does not tax this income. Founders and employees of successful companies may receive stock options representing a substantial portion of their wealth. Avoiding the tax on the gain is always an important consideration. Individuals with large investment portfolios or those who want to avoid a large tax bite on their investment earnings are eager to shift to non-tax jurisdictions. Most of these strategies for U.S. citizens and residents cannot be accomplished legally. But the demand is powerful and unscrupulous operators, “consultants” and even lawyers promote a variety of tax evasion plans to unwitting or highly motivated individuals.
For more information see Article “Are Secret Accounts and Offshore Havens Gone for Good?” by Robert J. Mintz