Litigation Involving Offshore Banking, Offshore Bank Accounts, Offshore Finance, Trade Finance, and Tax Havens

Court-recognized banking, anti-money laundering, and taxation expert witness and former banking regulator Don Coker explains from a banker’s and financial professional’s point of view factors that must be taken into account by attorneys handling litigation involving offshore banks, offshore bank accounts, offshore finance, offshore transactions, transfer pricing, international business entities and finance, multinational business entities, tax havens, wire transfers, and many related subjects.

Offshore bank accounts have been in the spotlight in the 2009 – 2010 timeframe owing to the limited privacy policy changes that have been agreed to by the Swiss government; but there are many more offshore banking centers than Switzerland. For example: Andorra, Anguilla, Antigua and Barbuda, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Cyprus, Dominica, English Channel Islands of Jersey and Guernsey, Ghana, Hong Kong, Ireland, Isle of Man, Labuan (in Malaysia), Liechtenstein, Luxembourg, Madeira, Malta, Macau, Mauritius, Monaco, Montserrat, Nauru, Panama, Saint Kitts and Nevis, Seychelles, Singapore, and the Turks and Caicos Islands.
Gibraltar used to be considered an offshore banking center but ceased issuing new company certificates in 2006.

The Aland Islands in Finland offer some sales tax advantages on some purchases.

The United States of America state of Delaware sometimes is considered somewhat of a tax haven since it offers some of the advantages that could be found in an offshore tax haven. Likewise, states that do not have a corporate income tax – such as Nevada, Washington, and Wyoming as of 2010 – are sometimes considered a tax haven.

Reasons for Using an Offshore Bank Account

Let’s define an offshore bank and why anyone would want to use one:

First, an offshore bank simply is a bank located outside the depositor’s primary country of residence. An offshore bank does not have to be truly “offshore” as is evidenced by the fact that the Grandfather of all offshore banking countries is landlocked Switzerland. The term actually originated in the United Kingdom with the innovative banking and financial services offered by the banks in the Channel Islands of Jersey and Guernsey.

Typical reasons why a depositor might want to have an account at an offshore bank include:

● The offshore bank may be located in a country with a lower taxation rate than the depositor’s home country.

● Offshore banks often offer higher interest rates on deposits than are available at banks in a depositor’s home country.

● Interest paid by offshore banks usually is not taxed at the source, as it is in most countries throughout the world.

● Loans made by offshore banks are sometimes at interest rates that are lower than those available in the borrower’s home country.

● Loans originated by offshore banks often are not limited by the structuring restrictions that may apply to loans originated in a borrower’s home country. This is why a United States domiciled bank originating a uniquely-structured loan in the United States, or elsewhere, may choose to run a particular loan through its captive offshore bank or branch.

● United States banks, as well as banks in other countries, sometimes choose to originate loans to foreign borrowers through their captive offshore banks or branches.

● Greater financial privacy, sometimes including anonymous or numbered accounts, compared to the depositor’s home country.

● Protection against possible political instability in the depositor’s home country.

● Protection against possible economic and financial instability in the depositor’s home country.

● Improved bank account structure flexibility relative to what is available at banks and other financial institutions in the depositor’s home country.

● Availability of account funds in a time zone different from that of the depositor’s home country.

● Offshore bank accounts are sometimes attached to other entities such as offshore companies, offshore trusts, or offshore foundations which may provide the account holder with some tax advantages.

● Offshore accounts are often used by international workers, expatriates, frequent travelers, and employees of worldwide organizations such as international aid agencies and non-governmental organizations (NGOs).

● Corporate financial structuring purposes, such as transfer pricing situations where different parts of a company’s overall process are attached to separate entities owned by the company and tagged with either a profit or a loss for various parts of the process.

● Corporate financial requirements such as worldwide cash management.

An important and widely held misconception is that interest, profits, dividends, capital gains, and other forms of income that are received by an offshore bank account are exempt from income taxes in the account owner’s home country. However, this is generally untrue. United States tax laws require that income earned outside the United States be reported on a United States’ taxpayer’s tax return, as clearly spelled out in the instructions for Form 1040:

“Foreign-Source Income
“You must report unearned income, such as interest, dividends, and pensions, from sources outside the United States unless exempt by law or a tax treaty. You must also report earned income, such as wages and tips, from sources outside the United States.”

Also, on Schedule B, where you report Interest and Ordinary Dividends, you will notice at the bottom of the page:

“Part III Foreign Accounts and Trusts
“7 a. At any time during 2009, did you have an interest in or a signature or other authority over a
financial account in a foreign country, such as a bank account, securities account, or other
financial account? See instructions on back for exceptions and filing requirements for Form TDF 90-22.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
b. If “Yes,” enter the name of the foreign country ____________________________
8. During 2009, did you receive a distribution from, or were you the grantor of, or transferor to, a foreign trust? If “Yes,” you may have to file Form 3520. See instructions on back . . .”

It is clear that anyone that is required to file an income tax return in the United States is also required to include in their reported income any income coming from foreign sources, such as offshore bank accounts, offshore investment companies, offshore trusts, and other offshore entities.

It is generally true that other countries also require the reporting of foreign source income.

Reasons for Not Using an Offshore Bank Account

● It is often difficult to gauge the financial health and stability of an offshore bank. This is not really as much of a problem if you are dealing with an offshore bank that is affiliated with an American bank or another bank with which you are familiar.

● Likewise, it is often difficult to gauge the political and economic stability of the country in which an offshore bank is located, especially since they are usually smaller countries.

● Deposit insurance – like that provided in the US by the FDIC – is generally not available in offshore accounts. However, in some instances, FDIC insurance may be extended to cover deposits in captive offshore banks or branches of US banks.

● Simply having and using an offshore bank account automatically raises suspicions and may create barriers due to the negative connotations of offshore financial activities.

● Depending on your location and the location of the offshore bank, access to an offshore bank account could be very cumbersome when compared to a regular bank account in your home country.

Banking Services Offered by Offshore Banks

Just about all banking services offered by non-offshore banks are offered by offshore banks, such as:

● Checking accounts.

● Savings accounts and Certificates of Deposit.

● Trust accounts.

● Retirement accounts.

● Securities custody accounts.

● Securities clearing services.

● Investment management accounts.

● Trustee services.

● Foreign exchange and multi-currency transactions.

● International trade financing.

● Letters-of-credit.

● Wire Transfer services, inbound and outbound.

● Loans.

Opening an offshore bank account can usually be accomplished online or over the telephone.

The Extent of Offshore Banking

It has been reported that as much as half the capital in the world flows through offshore banking and financial centers. While offshore banking centers are the home to only approximately 1% of the world’s population, it is estimated that they hold approximately 26% of the world’s wealth, including over 30% of the net profits of all of the multinational corporations headquartered in the United States. Other estimates say that offshore banking centers hold approximately one third of the wealth of the world’s wealthiest people, amounting to some $6 trillion U.S. dollars, and made up of funds on deposit as well as securities held by international business companies, trusts, and other offshore entities.

Litigation Considerations

The most common offshore banking issues that give rise to litigation center around two areas:

1. Taxation of the income that is paid into or sent to the offshore bank account or generated by the funds in the offshore bank account.

Taxation litigation has to examine the source of the funds in order to determine if the income has already been taxed or is more appropriately taxable elsewhere.

Taxation litigation also requires examining which country’s tax laws apply in the specific case at hand.

An economic substance analysis is often a significant part of taxation litigation cases.

2. Allegations of money-laundering involving the funds passing through the offshore banking accounts.

There are three basic aspects to most money laundering allegations:

First, the source of the funds has to be considered. Banks where the cash funds (read “currency”) are first deposited serve an important gatekeeper role for the entire financial system making sure that only funds from a legitimate business enter the world’s financial system. This currency aspect is obviously aimed at the illegal drug business, and there are very stringent banking regulations in place in the United States – at least eight major laws that stretch back to the Bank Secrecy Act in 1970 – to help detect large inflows of currency into the financial system. Accordingly, an offshore bank or other foreign bank receiving funds by wire transfer or cashier’s check from a United States bank is justified in feeling somewhat comfortable that the funds were thoroughly screened before they were accepted for deposit at the United States bank.

Second, money laundering involves more than just detecting large amounts of currency entering and flowing around the world’s financial system. If funds that are the result of an illegal activity do manage to avoid detection and enter the world’s financial system at any point in the world, then those funds can be wired around the world to anywhere the owner of the funds specifies. This is where the “Know Your Customer” rule comes into play. Financial institutions are required to know what business their customer is in, and basically how they operate in respect to their normal patterns of receiving funds into and sending funds out from their accounts. Know Your Customer requirements had their roots in the Bank Secrecy Act in 1970 and were strengthened in the PATRIOT Act in 2001.

Third, and this clearly overlaps with the Know Your Customer requirements, banks in the United States are required to essentially conduct a basic Economic Substance Analysis for their customers that have large volumes of funds flowing into and out of their accounts in order to determine their typical funds flow patterns, and that these patterns are logical and in line with the business operations of the customer. If the funds flows are found not to comply with what the bank thinks is normal for the particular type of business, then the bank is required to report the activities to the appropriate federal governmental authorities.

Summary

Clearly, offshore banking is a huge field and a significant part of the international financial system. Offshore banking activities have always been viewed as possibly having some illegal component, but more often than not are simply valid and legal activities that have been reviewed by knowledgeable attorneys and accountants.

If you are considering opening an offshore account, be sure to seek advice from qualified professionals.

Likewise, if you already have an offshore account and are facing litigation, be sure to consult with an attorney that is experienced in offshore financial matters for assistance.

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