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 If you live in the United States, then an offshore bank account would be defined as any account held outside of the United States. Opening an offshore account has some immediate advantages to the investor in terms of finance, privacy, and taxes.
History of Offshore Banking
Much of the history of offshore banking has its roots in connection with 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.
So while it is a requirement of all US citizens to report to the IRS all interest earned on banking accounts, the IRS must rely on offshore bank account holders to report or declare this information to them directly. The IRS does not receive any report directly from the offshore bank.
It was this secrecy or protection of the account holder's privacy that lead to certain abuses by those seeking to shelter income from taxes. The mere fact that an offshore bank has a policy to not report interest income to authorities does not make that policy illegal. It is individual taxpayers and their purposeful refusal to report such offshore income to tax authorities that opens things up for potential abuse.
In addition, these offshore banks could be used to protect assets from other parties. For example, an offshore bank account could be used to protect assets from monetary award stemming from lawsuits.
Advantages of Offshore Bank Accounts
One of the big advantages of offshore banks is that they provide investors with more options - they provide access to politically and economically stable countries. For example, an investor that lives in a country that is experiencing political disorder might believe that 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.
Bank Expenses
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 many be able to operate at a lower cost. This cost savings can then be passed back to the account holder in the form of higher interest rates.
Interest Paid by Offshore Banks
Quite often the interest paid to account holders in offshore banks is paid without any tax deducted. For investors that reside in countries that do not require paying tax on foreign income this is a big advantage that offshore banks offer.
Offshore 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 offshore bank accounts by these island nations can provide their economies with a second significant source of financing to fuel their island's growth.
Anonymous Bank 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 tax from income. 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 of Offshore Bank Accounts
Following the events of 9/11, offshore banks, offshore 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 offshore banking activities and abuses by investors.
Offshore Banks and 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 Account Information
At one time, access to offshore banks was limited to those that might be considered rich or wealthy. This was due to the fact that accessing offshore bank accounts was difficult and / or expensive since their location was either distant or remote. This cost to upper income taxpayers is offset by the advantages offshore banks provide to them.
Today, due to advances in telecommunications and the Internet nearly all classes of income have access to offshore banks. It's possible to create an offshore bank account by phone, mail, and it's even possible to set up an account online.
Transfer of Money from Offshore Banks
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 on Offshore Banks
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 to 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 account holder by their offshore 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 is scheduled to rise in the years 2008 and 2011.
These subsequent increases in the tax rate is viewed as a way of eventually forcing all account holders in offshore banks to choose the first option mentioned above - namely allowing those banks to report directly to their countries tax collecting agencies.
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