International Offshore Banking

by the Lowtax Network Editorial Team, February, 2007

A Very Potted History of Offshore Banking

If the words 'offshore banking' conjure up for you a shadowy figure wearing a Panama hat and crumpled white suit, smoking a cigar, and probably sipping cocktails from a hollowed out coconut, then you've clearly been reading too much John Grisham. Stop it. It isn't good for you. In an increasingly globalised world, in which more and more of the population are becoming internationally mobile, and need financial services which reflect their circumstances, offshore and international banking has moved on. The growing need for international banking on both a personal and corporate level has led to an increase in the number and quality of financial centres, both offshore and on, and the diversity of financial services offered.

As a result, there is a huge spectrum of different offshore banking services available to expats, international investors, globetrotters, international consultants and corporations, offering varying degrees of return, protection, and privacy. Before we look into the different sorts of offshore bank account available, however, a brief rundown of the background of this ever-growing industry is necessary, in order to understand the present situation.

As more and more financial institutions became keen to establish themselves on an international level, regulators perceived a need for greater banking regulation, and introduced a set of minimum standards and safeguards, known as the Basle Accord (introduced 1988). The Accord outlined the requirements necessary for banks to obtain licenses, which included two minimum types of bank capitalisation- core capital and supplementary capital. Core (Tier 1) capital is basically a mixture of shareholder equity and disclosed reserves, and supplementary capital is a mixture of debt and equity instruments. (Wake up there, you at the back! There is a reason why we're telling you this…).

The Basle Accord set the minimum capital adequacy level for each type of bank capital at 4%, meaning that many banks operating in countries under this accord were forced to increase their capital reserves and to invest in 'safer' investments. Recently introduced modifications to the original Basle Accord (originally enough, called Basle 2, and running to 541 pages) seek to align capital requirements with the underlying risks of loans made, and will further affect the amount of capital which each bank is required to hold. This may mean that banks in countries which are operating under the Basle Accord are forced to be more cautious about the instruments in which they invest, resulting in potentially less attractive returns. However, in non-Accord countries (which includes many offshore jurisdictions), regulation of this kind is usually down to the regulatory authorities of the jurisdiction, and the required capital adequacy levels can vary.

Other legislative issues have also had an effect on the offshore banking world. Initiatives by the OECD/FATF/G7 countries to combat money laundering have, in the process, severely damaged the banking secrecy laws of many offshore jurisdictions. 'Know your Customer' legislation has meant that privacy in high tax and certain low tax jurisdictions has been jettisoned in return for international acceptance. In addition, US rules have introduced 'Qualified Intermediary' status which also imposes more stringent controls on any institution wanting to avoid having to tax US-source income regardless of the nationality or tax status of the recipient. For all these reasons, opening an offshore account can now often require a small rainforest's worth of paperwork.

The OECD's first shot across the bows of banking secrecy was fired in earnest with the release of a report in 2000 into improving access to bank information for tax purposes, endorsed by all 29 members of the organisation. Although the report was more a statement of intent rather than a detailed plan, it set the template upon which national tax authorities could obtain information about specific individuals or companies whom they have reason to suppose are engaged in tax evasion or criminal activity.

Although many offshore jurisdictions have responded to the pressure brought about as a result of their blacklisting by the OECD and the FATF by strengthening legislation against money-laundering and introducing better controls over financial institutions, the high tax countries have failed to really galvanise a move towards any comprehensive dilution of banking secrecy, and the international framework of mutual assistance treaties remains largely as it was.

Indeed, the high-tax countries themselves are gradually being forced by peer pressure and international regulations to tighten up their own regimes.

In January, 2007, for instance the UK took the latest in a series of EU-inspired measures when Economic Secretary to the UK Treasury, Ed Balls, published draft money laundering regulations for consultation.

The regulations are designed to implement the EU's Third Money Laundering Directive, and have already caused controversy.

The proposed regulations include:

The Directive includes criminal penalties for advisers ranging from stockbrokers to lawyers and estate agents to bankers if they do not carry out multiple checks.

However, the UK's Law Society warned that the new money laundering regulations could put solicitors at risk of inadvertently committing criminal offences because they are "impossible to interpret" in practice. It also warned that the new rules will increase the cost to clients of solicitor’s work in dealing with trusts.

According to the Law Society, a number of the terms in the new EU Directive are unclear, and unless the Government clarifies them, solicitors will have to make extensive enquiries – at clients’ expense – in order to avoid inadvertently committing a criminal offence.

Offshore Versus Onshore in 2007

It is unlikely that the relative advantages of offshore will be undermined in the short term at least. The OECD's rather uneventful Global Forum on Taxation in Berlin in June 2004 encouraged participants to continue to strive towards effective exchange of information and transparency by 2006, although it was also recognised that flexibility is required since many participants have not yet initiated negotiations towards the required signing of bilateral agreements.

The OECD claims however that substantial progress has been made. A report from the Global Forum secretariat in 2006 stated that countries continue to improve their international cooperation to combat tax abuse by putting in place mechanisms which enhance transparency and exchange of information for tax purposes. Many of the economies reviewed have enhanced transparency by introducing rules on customer due diligence, information gathering powers and the immobilisation of bearer shares. Most have entered into double taxation conventions and/or tax information exchange agreements, and many are engaged in negotiations for such agreements.

The OECD also noted that none of its member countries, and very few non-members, now make domestic tax interests a condition for responding to a treaty partner’s request for information on a specific taxpayer. However, the Organisation argues that more progress can be made to improve global tax transparency, and stated that some countries still place constraints on international co-operation to counter criminal tax matters and a number continue to impose strict limits on access to bank information in civil tax matters.

"The direction of change is clear," Paolo Ciocca, Chair of the OECD’s Committee of Fiscal Affairs and Co-Chair of the Global Forum stated. "Onshore and offshore financial centres are prepared to work towards the implementation of mutually agreed standards. I look forward to the day when the centres that have met these standards are joined by other jurisdictions that have not yet achieved them," he added.

Leasi P. T. Scanlan, Governor of the Central Bank of Samoa and also a Co-Chair of the Global Forum, said the report demonstrated the ability of OECD and non-OECD countries to co-operate in order to prevent their financial centres being misused for illegal tax avoidance and evasion. "This has been a huge undertaking but we now have a clear idea of where we stand. It is an important step in helping countries to work towards a level playing field so that these abuses do not simply shift from one financial centre to another," he observed.

It must be made clear that although in most countries, having an offshore account is not illegal in itself, the illegality comes when the client doesn't declare the account, or the income from it. Banks in jurisdictions with strong banking secrecy legislation tend to place the onus for this reporting on the client themselves (which is not to suggest for a moment that they recommend not reporting the income, merely that they do not volunteer the information to other countries, and will usually reject requests for the client's personal details unless there is evidence of criminal activity).

Despite the efforts of the OECD countries to restrain the offshore banking sector, the reality is that in most offshore centres, deposit totals have shot up in recent years, and seemed to be having a particularly good year in 2006, with double digit percentage increases in many cases.

Why Do I Need An Offshore Bank Account?

Whether you are a professional expatriate, globetrotter, international investor, or consultant, an offshore bank account could prove invaluable. Relocation, whether on a regular or one-off basis can have serious taxation implications for your assets, but if they are safely anchored in an offshore jurisdiction, barring unforeseen events they can remain there for the duration of your expatriation (and beyond), usually attracting favourable taxation and higher returns. However, it is probably advisable to open an account in your country of secondment for day to day transactions as well.

If you are employed in a profession which has a greater than average chance of attracting litigation (for example the medical profession), or are concerned about future attacks on your assets from family members, offshore bank accounts can also prove effective as asset protection vehicles. If you have waited until your assets are under threat, and would now like to transfer them offshore and out of danger, however, we have four words for you - Stable Door. Horse. Bolted.

As previously mentioned, initiatives by the OECD and EU have dealt the concept of offshore privacy a bit of a blow, and in several jurisdictions it has been severely compromised. Some individuals choose to address this by interposing an International Business Company (or IBC) or trust between themselves and the offshore account, as it can be the case that the beneficial owner of an IBC or a trust does not have to be disclosed. Some providers also come to arrangements with banks in jurisdictions with strong secrecy laws, whereby reporting requirements (to the bank at least) are minimised. However, this is a complicated area, and professional advice needs to be taken in order to ensure that you are in compliance with the rules of both countries.

The Bush administration's actions regarding the ongoing OECD crackdown campaign may be a silver lining in the tax havens' cloud; the administration appears to have backed away from the organisation's campaign, and has withdrawn US support for essential elements of the project. This climb-down appears to only be partial at the moment, and ex-Treasury Secretary Paul O'Neill stated that although America no longer wants to participate in efforts towards world tax harmonisation, there is still room for international co-operation on issues such as tax avoidance. However, the issue looks set to run and run, so watch this space…

What Services do Offshore Banks Offer?

This depends upon the organisation you choose to bank with, and the jurisdiction in which it is located. Nearly all international and offshore banks offer checking, savings and current accounts, many offer credit and debit cards, and some offer foreign currency services and investment accounts. Larger organisations, usually in the more regulated jurisdictions, also sometimes provide mortgages and other financial products. Other institutions offer IBC registration and maintenance. Increasingly, banks and financial service providers are recognising the need for online facilities (especially if they are hoping to attract an expatriate audience), and many now offer 24 hour online account access, and allow you to conduct much of your banking by e-mail or telephone.

However, bear in mind that in a lot of cases, these services (with the exception of online banking) are not offered for free, and the charges can vary significantly between jurisdictions and institutions. Therefore it is probably best to decide what you need from your offshore bank account before you start looking, and if you decide that you do need extra facilities, use them wisely, otherwise the charges can start to mount up.

Which Offshore Jurisdiction Should I Choose?

Choosing a jurisdiction in which to locate your international bank account is tricky at the best of times, and made more so by the constant uncertainty foisted on the offshore community by the OECD, FATF et al. However, if circumstances dictate that you need an offshore bank account, then choose you must, so what should you look out for?

There are several key criteria which any offshore jurisdiction should fulfil before you consider banking there. These include (although are not limited to) the following:

So, how do I go about opening an offshore bank account then?

Due diligence is not just a one way process, and the amount that banks are required to conduct on potential customers increased greatly with the advent of 'Know your Customer' legislation in the last few years. If you are applying to open a bank account through an intermediary, or with an institution that has agreed to implement KYC, you will need to provide at least the following:

It is difficult to discern whether 'Know Your Customer' legislation came about as a result of the efforts of the FATF (Financial Action Task Force), as a result of the efforts of the IRS, or as a combination of the two. In some people's minds, however, it is inextricably linked with the latter, and with the introduction of 'Qualified Intermediaries' and 'Qualified Jurisdictions' in 2001. Qualified intermediaries are primarily concerned with US citizens, and those with US source income, and are required by the IRS to implement KYC in return for simplified reporting, and withholding tax procedures.

However, it all gets a bit complicated from here on in, because it is possible to find a qualified institution in a qualified jurisdiction, a non-qualified institution in a qualified jurisdiction, and sometimes a qualified institution in a non-qualified jurisdiction (although this is only permitted if the institution is a branch of a company resident in a qualified country). Got all that? All that this really means is that unfortunately US citizens have got the short end of the stick again, in that some banks may choose not to take them on as a result of the extra reporting requirements. However, once again this is a complicated matter, and best discussed with a qualified professional.

The EU's Savings Tax Directive

Meanwhile in Europe, the EU introduced the Savings Tax Directive, which means that as from July, 2005, all EU member states and a number of their offshore dependent territories are either placing a 15% withholding tax on the returns on savings paid to citizens of EU member states, or are passing information about the payment to the citizens' home countries. The EU put pressure on Switzerland, where tax avoidance is not a criminal activity (and which is not actually an EU member), to agree to exchange of information on the identities of depositors and savers, but the Swiss, who have always been fiercely protective of their banking secrecy laws, put forward a compromise whereby their existing withholding tax system would be extended and strengthened, which was reluctantly accepted by the EU.

After the first year of operation of the Savings Tax Directive, however, it became clear that most savers and investors have easily escaped the Directive, when statistics showed far lower levels of reported or taxed interest had been expected.

In Switzerland, for instance, in the first six months of the operation of the legislation, Swiss institutions withheld and passed on to the tax authority about EUR100 million (US$128 million) from the savings of individuals resident in EU member states.

On the surface it seems implausible that Switzerland, the world's largest private banking centre with more than 500 major banking institutions and home to an estimated 35% of the world's private wealth, could collect such a relatively small amount; but given the relative ease with which the directive can be circumvented, the figures are not really surprising.

The most obvious route is for investors to place their assets in jurisdictions not covered by the directive; anecdotal evidence suggests that Dubai, Hong Kong and Singapore have been major beneficiaries. However, there are a number of investment instruments that have, for whatever reason, not been included within the scope of the directive.

Other major banking centres have also reported lowly withholding tax revenues: Luxembourg EUR48 million, Jersey EUR13 million, Belgium EUR9.7 million, Guernsey EUR4.5 million and Liechtenstein EUR2.5 million.

In Conclusion…

Although no-one would deny that there is uncertainty in the world of offshore banking and investing at the moment, with the proper planning, international banking can still offer the chance to achieve enhanced returns and greater privacy to both international investors and expatriates. Achieving tax efficiency may be becoming more complicated, but this does not mean that it is impossible, and there are an increasing number of qualified individuals.