For individuals living in the United States, an offshore bank account would be defined as those held outside of North America. In this article, we'll talk about the advantages offshore accounts offer the investor in terms of personal finance, privacy, and taxes.
History of Offshore Banking
For individuals living in the United States, an offshore bank account would be defined as those held outside North America. In this article, we'll talk about the advantages offshore accounts offer the investor in terms of personal finance, privacy, and taxes.
History of Offshore Banking
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The offshore banking industry has its roots in the 1934 Swiss Banking Act. One of the important components of this act had to do with bank secrecy, which was meant to protect the privacy of bank account holders. Part of that secrecy promise was to not divulge interest earned on these accounts directly to tax collection agencies such as the Internal Revenue Service.
While it is a requirement of all U.S. citizens to report to the IRS all interest earned on banking accounts; the IRS must rely on offshore bank accountholders to report, or declare, this information to them directly. The IRS does not receive a report from the offshore banking institution.
It was this secrecy, or protection, of the accountholder's privacy that led to certain abuses by individuals seeking to shelter income from taxes. The mere fact that a banking institution has a policy to not report interest income to authorities does not make that policy illegal. It is an individual taxpayer's purposeful refusal to report such income to tax authorities that opens these accounts up for potential abuse.
Offshore banks can also be used to protect assets from other parties. For example, a bank account could be used to protect assets from a monetary award in conjunction with a lawsuit.
Political and Economic Environments
One of the big advantages of offshore banks is they provide investors with more options such as access to politically and economically stable countries. An investor that lives in a country that is experiencing political disorder might believe their assets are at risk of being frozen or even seized. By moving their money to an offshore account with a more stable political environment, the investor can protect their assets from this risk.
Expenses and Fees
A second advantage of an offshore bank has to do with operating expenses. Since offshore banks are allowed to operate with less government intervention, they may be able to operate at a lower cost. This cost savings can then be passed back to the accountholder in the form of higher interest rates or lower transaction fees.
Interest Payments
Quite often, the interest paid to accountholders is provided without any tax deduction. For investors that reside in countries that do not require paying tax on foreign income, this is a big advantage that offshore banks can offer.
Financing
There are many island nations that are not as rich in natural resources as their larger neighbors. These countries often rely heavily on tourism to support their economies. The offering of bank accounts by these island nations can provide their economies with a second significant source of financing to fuel their island's growth.
Anonymous Accounts
Finally, and at the extreme, some offshore banks offer their clients the ability to create anonymous bank accounts. This certainly might be one avenue to pursue if the investor was trying to shelter income from tax. It is also a banking feature that is not found here in the United States. That being said, there are some legitimate reasons for creating an anonymous bank account.
Disadvantages
Following the events of 9/11, offshore banks, tax havens, and clearing houses were frequently accused of providing the necessary funding for such acts. This post 9/11 association has resulted in many countries taking a closer look at potential banking activities and abuses by investors.
Tax Evasion
While some might view the secrecy agreement as the protection of privacy, others might view this practice as an open door for abuses such as tax evasion and hiding income. The European Savings Tax Directive, which will be discussed later on, is a recent development aimed at lowering this potential for abuse.
Access to Information
At one time, access to offshore banks was limited to individuals that might be considered rich or wealthy. This was due to the fact these accounts were difficult and / or expensive to conduct business with, since their location was either distant or remote. This cost to upper income taxpayers is offset by the advantages offshore banks provide to them.
Due to advances in telecommunications and the Internet, nearly all income classes have access to offshore banks. It's possible to create an account by phone, mail, and it's even feasible to set up an account online.
Transfer of Money
The final disadvantage of offshore banks is access to money. Some countries simply do not allow their banks to transfer money as quickly as the accountholder would like. This is often referred to as "hot money" by these countries.
Savings Tax Directive Impact
In an effort to reduce the likelihood of offshore accounts being used to evade taxes, European governments participating in the European Union have agreed to the Savings Tax Directive. This directive makes EU residents, with offshore bank accounts, choose between one of two options:
Allowing their offshore bank(s) to report savings income directly to local tax authorities.
Pay tax immediately at such time income is provided to the accountholder by their bank.
Over time, it is expected that an increasing number of offshore banks will be affected by this decision. In addition, if the accountholder chooses the second option mentioned above, then the tax rate used to collect monies due was scheduled to increase in the years 2008 and 2011.
These subsequent increases in the tax rate were viewed as a way of eventually forcing all accountholders to choose the first option listed above. That is, allowing those banks to report directly to their country's tax collecting agencies.
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