Offshore investing is often demonized in the media, which paints a picture of tax-evading investors illegally stashing their money with some shady company located on an obscure Caribbean island. While it's true that there will always be instances of shady deals, the vast majority of offshore investing is perfectly legal.
Offshore investing, despite its sketchy reputation, is a legal, effective way to invest in entities that are only available outside your home country.
Offshore Investing: An Overview
Offshore investing refers to a wide range of investment strategies that capitalize on advantages offered outside of an investor's home country. There is no shortage of investment opportunities offered by reputable offshore companies that are fiscally sound, time-tested, and, most importantly, legal.
Depending on your situation, offshore investing may offer you many advantages including tax benefits, asset protection, and privacy. Disadvantages include increasing regulatory scrutiny on a global scale and high costs associated with offshore accounts.
Pros of Offshore Investing
There are several reasons why people invest offshore:
Many countries (known as tax havens) offer tax incentives to foreign investors. The favorable tax rates in an offshore country are designed to promote a healthy investment environment that attracts outside wealth. For a tiny country with very few resources and a small population, attracting investors can dramatically increase economic activity.
- Offshore investing is beyond the means of many but the wealthiest of investors.
- Advantages include tax benefits, asset protection, privacy, and a broader range of investments.
- Downsides include high costs and increased regulatory scrutiny that offshore jurisdictions and accounts face.
Simply put, offshore investment occurs when offshore investors form a corporation in a foreign country. The corporation acts as a shell for the investors' accounts, shielding them from the higher tax burden that would be incurred in their home country. Because the corporation does not engage in local operations, little or no tax is imposed on it. Many foreign companies also enjoy tax-exempt status when they invest in U.S. markets. As such, making investments through foreign corporations can hold a distinct advantage over making investments as an individual.
Offshore centers are popular locations for restructuring ownership of assets. Through trusts, foundations, or an existing corporation, individual wealth ownership can be transferred. Many individuals who are concerned about lawsuits, foreclosing lenders, or creditors collecting on outstanding debts elect to transfer a portion of their assets from their personal estates to an entity that holds it outside of their home country.
By making these on-paper ownership transfers, individuals are no longer susceptible to seizure or other domestic troubles. If the trustor is a U.S. resident, their trustor status allows them to make contributions to their offshore trust free of income tax. However, the trustor of an offshore asset-protection fund will still be taxed on the trust's income (the revenue made from investments under the trust entity), even if that income has not been distributed.
Many offshore jurisdictions offer the complementary benefit of secrecy legislation. These countries have enacted laws establishing strict corporate and banking confidentiality. If this confidentiality is breached, there are serious consequences for the offending party. An example of a breach of banking confidentiality is divulging customer identities. Disclosing shareholders is a breach of corporate confidentiality in some jurisdictions.
However, this secrecy doesn't mean that offshore investors are criminals with something to hide. It's also important to note that offshore laws will allow identity disclosure in clear instances of drug trafficking, money laundering, or other illegal activities. From the point of view of a high-profile investor, however, keeping the information, such as the investor's identity, secret while accumulating shares of a public company can offer that investor a significant financial (and legal) advantage. High-profile investors don't like the public at large knowing what stocks they're investing in. Multimillionaire investors don't want a bunch of little fish buying the same stocks that they have targeted for large-volume share purchases. The small fry runs up the prices.
Because nations are not required to accept the laws of a foreign government, offshore jurisdictions are, in most cases, immune to the laws that may apply where the investor resides. U.S. courts can assert jurisdiction over any assets that are located within U.S. borders. Therefore, it is prudent to be sure that the assets an investor is attempting to protect not be held physically in the United States. On the other hand (see below), assets kept in foreign bank accounts are still regulated under United States law.
Diversification of Investments
In some countries, regulations restrict the international investment opportunities of citizens. Many investors feel that such restriction hinders the establishment of a truly diversified investment portfolio. Offshore accounts are much more flexible, giving investors unlimited access to international markets and to all major exchanges.
On top of that, there are many opportunities in developing nations, especially in those that are beginning to privatize sectors formerly under government control. China's willingness to privatize some industries, in particular, has investors drooling over the world's largest consumer market.
Offshore jurisdictions, such as the Bahamas, Bermuda, the Cayman Islands, and the Isle of Man, are popular locations that are known to offer fairly secure investment opportunities.
Cons of Offshore Investing
While domiciling investments and assets in an offshore jurisdiction has benefits, there are also drawbacks to consider.
Increasing Regulatory Scrutiny
In recent years, the U.S. government has become increasingly aware of the tax revenue lost to offshore investing and has created more defined and restrictive laws that close tax loopholes. Investment revenue earned offshore is now a focus of both regulators and tax laws.
The U.S. Foreign Account Tax Compliance Act (FATCA) is an example. FATCA requires U.S. citizens at home and overseas to file annual reports on any foreign account holdings.
According to the U.S. Internal Revenue Service (IRS), U.S. citizens and residents are taxed on their worldwide income. As a result, investors who use offshore entities to evade U.S. federal income tax on capital gains can be prosecuted for tax evasion. Therefore, although the lower corporate expenses of offshore companies can translate into better gains for investors, the IRS maintains that U.S. taxpayers are not to be allowed to evade taxes by shifting their individual tax liability to some foreign entity.
The Organization for Economic Cooperation and Development (OECD) and the World Trade Organization (WTO) also have rules that require banks to report information about their foreign customers, but each country complies with these laws in different ways and to different degrees.
There are still tax loopholes, but most are shrinking more and more every year.
Offshore accounts are not cheap to set up. Depending on the individual's investment goals and the jurisdiction they choose, an offshore corporation may need to be started, and that may mean steep legal fees and corporate or account registration fees. In some cases, investors are required to own property (a residence) in the country in which they have an offshore account or operate a holding company.
Furthermore, many offshore accounts require minimum investments of between $100,000 and $1 million. Businesses that make money facilitating offshore investment know that their offerings are in high demand by the very wealthy and they charge accordingly.
More than half the world's assets and investments are held in offshore jurisdictions. Many well-recognized companies have investment opportunities in offshore locales.
Still, like every investment move you make, use common sense and choose a reputable investment firm. It is also a good idea to consult with an experienced and reputable investment advisor, accountant, and lawyer who specialize in international investment.
If you are looking to offshore investments to help protect your assets—or are concerned with estate planning—it would be prudent to find an attorney (or a team of attorneys) specializing in asset protection, wills, or business succession. You need to look at the investments themselves and their legal and tax implications. Of course, these professionals come at a cost. In most cases, the benefits of offshore investing are outweighed by the tremendous costs of professional fees, commissions, and travel expenses.