When you say offshore banking, the image of a billionaire (or James Bond) spiriting away millions of dollars into some arcane foreign bank comes to mind. The media is partly to blame for the negativity. The recent government crackdown on tax evasion, issues like money laundering and Mitt Romney’s overseas bank accounts do not help the case. It’s a common misconception to think that offshore banking is part of underground economy when in fact, it is perfectly legal. Not only legal, offshore banking may interest average people who want to protect their money. The term “offshore” originally referred to the Channel Islands off the United Kingdom, but it is now used to refer to any bank in a location where a foreign national chooses to make deposits. An offshore bank is simply a financial institution in a location that is not the depositor’s country of residence. The bank is chosen due to its legal and financial advantages (subject to much less strict taxation laws for example).
But this is not the only reason why some people opt to invest and do business with a foreign bank. There are many advantages, like protection from the weak dollar or protection from financial instability, low or zero taxes (tax havens), security, privacy and easy access to deposits. Legally, all assets deposited in an offshore bank are still subject to personal income tax on interest (except under specific circumstances), regardless of whether the interest was earned locally or abroad. Americans, for example, have to declare under penalty of perjury the existence of any offshore bank accounts. Some people find a way to get around this problem, and that’s when the whole thing turns into a shady operation.
Offshore Banking Jurisdictions
Majority of offshore banks are located in island nations, and only a few are landlocked. According to the investigators from the U.S. Congress, there are about 50 tax havens worldwide. The biggest jurisdictions are Switzerland and the Cayman Islands. Switzerland’s so-called “numbered accounts” aren’t as airtight as they are portrayed in the movies, but the banks do ensure that only a few people know the client’s name. They also focus more on wealthy rather than ordinary clients. Hong Kong’s symbol-marked chop accounts are similar to the Swiss version. The Cayman Islands have an attractive menu of tax advantages, and are a magnet for hedge funds and private equity funds. Mitt Romney has revealed several accounts in Bermuda and the Cayman Islands—the funds in the Cayman Islands alone are said to be worth between $7 and $32 million. Romney also had (closed in 2010) a UBS account in Switzerland.
Advantages of Offshore Banking
Besides the advantages mentioned above, offshore banks are not only tax havens but safe havens for residents of countries in political turmoil or economically unstable countries. Dictators often have offshore accounts to protect their assets in case of revolution. Another pro is the higher than normal interest rates (in some banks) without tax due to lower operation costs. Offshore banking can also redistribute global wealth to developing nations, much like tourism does. Advocates also argue that offshore banking creates healthy competition that is beneficial to the industry.
Disadvantages of Offshore Banking
Perhaps the biggest downside to offshore banking is that the amount of money beyond what the bank’s depositor compensation scheme (in case of crisis or collapse) covers is always at risk. For example, the Isle of Man compensation scheme only covers £50,000 per depositor. Some offshore banks were unable to repay their depositors during the 2008 crisis. Offshore banking is associated (and may long be associated) with underground activities such as organized crime, swindlers and drug traffickers. While anyone can open a basic savings account with offshore banks, people with higher incomes have greater access and as well as access to high-cost private banking.
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