Part 5
THE SCHMIDT OFFSHORE REPORT
Vol 1, no 5 - Oct/Nov 2004
Contents
EDITORIAL
NEWS
- Switzerland To Return Briton Facing Tax- Evasion Charges
- Brussels Delays New Savings Tax
- New Money-Laundering Laws “To Close Off Nauru To Terrorists”
- Arab Officials Agree On New Middle East Money-Laundering Watchdog
- EU To Introduce Tougher Rules On Money Laundering To Combat Terrorism
- Irish Tax Dodgers Fork Out €1.5 Billion
- Sun Setting On Region’s Tax Havens
TIPS
- The best income-tax loophole in the world
- Alternative offshore tax havens
- America’s QI System
- The US Echelon system
- Banking secrecy where you’d least expect it
- EU tax developments
ASK THE EXPERTS
EDITORIAL
First of all, I must apologise for the late publication of this issue. Last month, just as we were about to post the newsletter out, our solicitors informed us that one particular article on the subject of offshore trusts could lead us to face criminal prosecution. Naturally, none of us liked the idea of being prosecuted and – as a result – we had to shred the issue and start all over again.
This new, less controversial, issue is divided into four separate elements: my editorial, a news section, tips and warnings, and answers to readers’ questions. I would like to emphasise, as usual, that all correspondence is treated in the strictest confidence and that if you wish to write to me anonymously I will publish a response in the next available issue of the newsletter.
Although the rest of the newsletter covers more than 20 different subjects relating to international tax planning, my editorial is going to concentrate on a single topic: asset protection. If you are a professional (such as a doctor or architect), an entrepreneur, or a high-net-worth individual, in this day and age there is the ever-present worry that one’s assets might be lost as a result of litigation or unavoidable bankruptcy. If one lives or works in an unstable region of the world, there is the additional worry that one’s assets might be lost owing to political upheaval. Finally, in an era when governments have started to adopt a draconian approach to taxation and the collection of taxes, there is the concern that assets might be seized by a revenue-collecting authority.
Most of the available information on asset protection is either highly technical or of questionable value. In particular, there are any number of so-called asset protection planners promoting so-called bulletproof schemes and strategies that are, frankly, seriously flawed. However, I have found one book that I can strongly recommend to anybody interested in this topic. It is written in plain English by two of the world’s leading experts and contains a plethora of advice to anyone interested in this topic. It is entitled, simply, Asset Protection: Concepts and Strategies for Protecting Your Wealth. Its authors are J. Adkisson (one of today’s foremost authorities on contemporary asset protection and founder of the internationally popular asset protection website of Quatloos www.quatloos.com) and C. M. Riser (a US tax attorney specialising in asset protection and Vice Chair of the American Bar Associations Asset Protection Planning Committee). Indeed, this editorial piece is really a review of their excellent book, which was published by McGraw-Hill earlier this year.
I can’t recommend Asset Protection highly enough as a level-headed and technique-based look at how asset protection planning should be approached. It presents tools that have worked, while warning against means that are inappropriate or even perilous, and provides guidelines for developing effective strategies that will work in any situation.
Not surprisingly, the book starts by explaining what asset protection actually is. The authors suggest that what we are really talking about is risk-management planning that is designed to discourage a potential lawsuit before it begins or to promote a settlement most favourable to the owner of those assets. The risk being managed is the legal risk that the client may lose wealth in a lawsuit. “Asset protection planning”, they say near the beginning of the book, “is about creating a plausible story to tell a judge or jury, which has as its end result that assets are protected. Yes, there are statutes, codes, regulations, and notices, but all of these are applied in the context of specific facts. The whole of English common law is a collection of stories embodied in the factual recitations of the opinions recorded in the law reporters. When a lawyer makes his or her opening statement, lays out the evidence, and makes his or her closing argument, he or she is telling the story of that case. When the judge summarises the case in the opinion, he is retelling that story. Litigation is competitive story telling based on provable facts.”
The importance of a good story is emphasised throughout the book as being a crucial component of asset protection. Having a good story is the basis of pre-litigation planning. Asset protection planning is like writing a script for a grand play. Paradoxically, the storyline will never be about asset protection. Although there are a few significant exceptions, the law generally frowns upon asset protection. No one has an inherent right to protect his assets from creditors, and courts are deeply reluctant to allow debtors to shield themselves against the judgment that those courts have produced.
Put another way, much of asset protection takes advantage of legal loopholes in the same way that many tax shelters attempt to take advantage of the tax code: by exploiting the unintended effects of statues and court rulings intended to do something else.
Let me give you a very practical example of this. Imagine that your major asset is not the shares in the company but the rights to any distribution of profits that the company may make. Your creditors may succeed in court in obtaining a control of your assets. However, if the company concerned never makes a distribution of profits, your creditors will receive nothing. No court in the world can force a company to distribute its profits.
It is worth bearing in mind that, although planners place a great emphasis on the structures which are used in asset protection planning, the method of transferring wealth to a structure is probably more important than the structure itself. If the transfer cannot be challenged as a fraudulent transfer or a preferential transfer, it may be very difficult for the creditors to attack the structure. By contrast, if a court deems a transfer to be fraudulent or preferential, the assets may be backed out of the structure even if the structure itself is otherwise impenetrable. Worse still, if the transfer is fraudulent or preferential, the debtor, along with his planner, risks charges of contempt, bankruptcy fraud and civil conspiracy. Thus, the effect of a bad transfer can be to put the debtor in a much worse situation than if he had done nothing at all. It is probably worth pointing out here, by the way, that almost all asset protection involves transferring assets. It is also worth pointing out that the earlier you arrange to protect your assets, the safer they are likely to be. If you wait until your assets are under threat, your chances of protection are substantially reduced. The chances are that if you can identify a specific risk you may have left it too late.
This is probably a good point at which to mention the role of offshore vehicles in relation to asset protection. Asset protection is commonly associated with offshore planning, for instance forming an asset protection trust in the Cook Islands. Indeed, a number of small countries make a business out of catering to the needs of judgment debtors and those who worry that they may be judgment debtors some day. Not coincidentally, these debtor havens are also tax havens. A few small, wealthy countries, such as Switzerland and Luxembourg, compete for asset protection business with the smaller, poorer countries of the Caribbean. Likewise, they also compete with various self-governing British protectorates and colonies scattered throughout the world. As a practical matter, all of these jurisdictions offer essentially the same thing: court judgments made in countries such as the UK and US are not easily enforced, if at all, in their courts. This means that actions to recover assets in these jurisdictions usually must be started anew in those jurisdictions, despite the fact that the creditor already has a judgment elsewhere. These jurisdictions have also padded their laws with debtor-friendly provisions, such as shortened statutes of limitations and very restricted fraudulent transfer laws. Additionally, these jurisdictions usually have strict confidentiality laws that prohibit, as a crime, a bank, trust company or other financial institution from divulging information about its clients without an order from a court in that jurisdiction.
However, just as offshore courts do not respect the laws of other countries, so the courts of other countries do not respect the laws of these debtor havens or the judgments of their courts. So long as a court in, say, the US has jurisdiction over the physical person of a debtor and can throw him in jail for contempt, it can order the debtor to bring back or repatriate assets. This means that for offshore planning to work, by the mere fact that the debtor’s assets are offshore, the debtor must physically remove himself from the reach of the relevant courts as onshore courts as well. Put another way, asset protection planning that takes advantage of asset protection trusts without there being any other sort of structure involved are likely to fail – unless you are willing to move abroad when the going gets tough. Furthermore, if the physical asset you are trying to protect is located onshore, no matter who potentially owns it offshore, you may find that the courts simply seize it anyway.
One of the best features of Adkisson’s and Riser’s book is that it devotes several chapters to methodology. They discuss more than 30 different structures that one might use depending on one’s circumstances. They also make the point that novel strategies are less likely to be identified by creditors or courts as having an asset protection agenda. Strategies and structures that are heavily marketed for asset protection purposes will alert creditors and courts to the fact that a debtor’s motivation in planning was asset protection. The creditor may be comfortable attacking known asset protection strategies or might even desire to make an example out of a debtor who is engaged in them. Novel strategies, on the other hand, can unnerve a creditor, because the creditor and his lawyers are unlikely to have seen the strategy before and may not be familiar with the particular area of business or finance upon which it is based.
Let me give you just one example. It involves recapitalising a company by having the owners contribute illiquid long-term debt instruments (such as a promissory note from another entity they control) to the company to increase the company’s value temporarily. This strategy, known as recapitalisation, allows the shareholders then to extract valuable, vulnerable assets from the company by liquidating or redeeming shares. What has happened is simply that the extracted, vulnerable, attractive and liquid assets of the corporation have been replaced by less-vulnerable, unattractive and illiquid assets. The benefit of recapitalisation is that the balance sheet of the corporation is relatively unchanged, even though the liquid assets have been stripped out. A creditor must wait for these long-term obligations to come due, instead of immediately collecting against the assets. Few creditors will wait decades to be paid. More importantly, few creditors’ lawyers will wait even a few months, much less a few years, to be paid. So such a recapitalisation can help achieve a more-favourable settlement for the debtor.
Another interesting strategy is the dilution strategy. This involves the subsequent issue of additional shares from the corporation to another entity. This has the effect of reducing the value of the stock for the original holder, with a corresponding accretion of wealth to the holder of the newly issued stock. Thus, if the stock of the original holder is later attached by creditor, the creditor will receive less value than before the dilution. So long as there is a reasonable economic justification for the dilution, and it is not close in time to the appearance of a creditor of the shareholder being diluted, a creditor will have difficultly asserting that a fraudulent transfer has occurred.
Finally, I must just mention some of the migration strategies that the authors outline. The process of creating multiple layers of entities, and transferring assets through these layers until their distance from the entities carrying the potential liability, is termed migration. Migration strategies are sometimes employed in the sale of an asset from a vulnerable entity, for example in the transfer of patent rights away from a company that has product liability concerns. They work because creditors can really only chase assets to the extent that they can trace title from entity to entity. The interposition of an offshore entity may severely impair a creditor’s ability to trace title.
At the very end of their book, the authors suggest different strategies for people in different positions – professionals, company directors, business owners, doctors and so forth. As I say, I really can’t recommend it highly enough.
SWITZERLAND TO RETURN BRITON FACING TAX-EVASION CHARGES
The Financial Times recently reported that Switzerland had agreed to the extradition of Ian Leaf, a millionaire businessman, who has been living openly in the ski resort of Verbier, to face tax-evasion charges in the UK. Mr Leaf, a chartered accountant, faces multiple charges of tax evasion, which followed raids in 1997 by the Inland Revenue of a group of companies with which he was allegedly connected. The Swiss Federal Office of Justice said it agreed to the UK’s request for extradition on 7th September. Mr Leaf is being held in custody and plans to lodge an appeal with the Swill Federal Court. Mr Leaf has made no attempt to hide his presence in Switzerland. He was elected president of the Rotary Club of Verbier, where he was one of the two people in charge of its accounts.
Mr Leaf was arrested in Italy in 2000 when he travelled there on an out-of-date passport. The UK then made an extradition request to the Italian authorities on the tax charges. Newspaper reports in 2001 said that Mr Leaf, alleged to have evaded up to £70 million in taxes, crossed the border to Switzerland while under house arrest and is now awaiting extradition proceedings.
BRUSSELS DELAYS NEW SAVINGS TAX
Europe’s new Savings Tax system will be delayed until 1st July 2005 because of a six-month extension agreed by European diplomats during September to allow equivalent measures in Switzerland to come into force. Countries such as Germany and the UK hope the new system will crack down on tax dodgers, who move their money abroad, and save millions of euros for their exchequers. The system, under which some countries exchange banking information and others increase tax on interest on foreigners’ accounts, depends on equivalent measures in third countries taking effect simultaneously. In recent discussions, the Swiss Government have made it clear they could not give assurances that their own Savings Tax regime would be ready by the original 1st January 2005 target date. Meanwhile, Luxembourg, Switzerland’s banking rival, had indicated it would be unhappy with a deal that automatically put the EU’s new regime in place before it was certain that Switzerland was following suit. But the savings-tax directive already makes clear that the legislation will take effect only if arrangements in third countries are satisfactory.
As readers will be aware, the deal among EU nations involves either collecting taxes on savings held outside the depositor’s home country on the home country’s behalf or providing information on interest earned to tax collectors in the home country so that they can impose the tax themselves.
In tough negotiations over recent months, the EU has pushed Switzerland to make it easier to get information about EU residents who stash their money in Swiss banks and dug higher taxes at home. The Swiss, whose banking secrecy legislation dates back to the 1930s, agreed to levy a 35% withholding tax on interest income and to pay the money to the EU without revealing the depositor’s identity.
In fact, the good news for those with Swiss bank accounts is that the Swiss authorities are actually refusing to commit to an implementation date. Indeed, it is possible that there will be a referendum in which Swiss voters will have the right to overturn this particular decision.
NEW MONEY-LAUNDERING LAWS “TO CLOSE OFF NAURU TO TERRORISTS”
Nauru’s parliament has passed new laws on money laundering and offshore banking in an attempt to convince the international Financial Action Task Force (FATF) that it should be removed from a blacklist of non-cooperative states and territories. This is about the fourth attempt Nauru has made to satisfy the FATF that it has closed down its offshore banking sector and is serious about preventing money laundering. However, this attempt is likely to be more successful as the new anti-money-laundering Bill was drafted with the assistance of the INF.
ARAB OFFICIALS AGREE ON NEW MIDDLE EAST MONEY-LAUNDERING WATCHDOG
Middle Eastern and North African states have agreed to set up a regional body to combat money laundering and terror financing, a senior Bahraini official announced during September. The new body will be based in Bahrain and launched there at an inaugural meeting in November. The new organisation has received political backing from Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. Tunisia, Algeria and Morocco have signalled their support without making a final commitment.
EU TO INTRODUCE TOUGHER RULES ON MONEY LAUNDERING TO COMBAT TERRORISM
The European Union’s head office are planning to tighten their rules on money laundering as part of their ongoing efforts to fight terrorism. As part of the proposals drafted by the EU’s Internal Market Commissioner, the definition of money laundering will be extended to include the financing of terrorism. Currently, EU governments are obliged to seize funds used for terrorist activities only if they are obtained through illegal means.
Much of the burden of the new rules rests on banks, insurance companies and law firms, which would have to report any transactions they deem suspicious. Banks and others would have to monitor large transactions made without face-to-face contact with the customer. Banks and lawyers would be required to know the identity of their customers. Another part of the proposal demands that any cash transaction, by anybody, over €15,000 (US $18,000) be reported to authorities.
Banking industry representatives welcomed the plans insofar as they provided leeway for banks to use their own judgement in what constitutes a risky transaction. They warned, however, that the EU may be casting so wide a net in its efforts to fight terrorism and fraud that the system would be too overwhelmed to identify real suspects.
IRISH TAX DODGERS FORK OUT €1.5 BILLION
A total of €1.5 billion has been collected by the Irish Revenue Commissioners in their investigations into offshore investments, Ansbacher accounts, the Moriarty and Mahon-Flood tribunals, and as a result of the NIB/CIM investigation. Now, they are gearing up to go after holders of offshore accounts who did not avail themselves of the voluntary disclosure scheme, which alone netted €677 million from 14,000 tax dodgers. The Revenue gave offshore account holders up until 29th March of this year to make voluntary disclosures about their tax affairs, with an extended deadline for payment up until 10th June.
At a meeting of the public accounts committee in September, the chairman of the Revenue Commissioners, Frank Daly, said work is now progressing to secure High Court orders to get full lists of account holders from financial institutions so that those who did not avail themselves of the scheme could be brought to book.
“Individuals identified during this phase will face additional penalties, and will also face publication and possible prosecution,” said Mr Daly. “Nobody should be in any doubt about our intention to follow through on this investigation.”
He said that, although 14,000 people had made voluntary disclosures on their offshore accounts, it was know that the ten major financial institutions had sent a total of 100,000 letters to potential account holders. The revenue chairman explained that cooperation from the banks had been good but that it may be necessary to seek High Court orders for lists of offshore account holders, as some banks might argue that there are issues regarding client confidentiality.
Meanwhile, the Revenue Commissioners are beginning to consider the results of a High Court report on National Irish Bank (NIB) to see whether they will seek to initiate criminal proceedings against any executives for assisting NIB customers to engage in tax evasion.
SUN SETTING ON REGION’S TAX HAVENS
There are more than 20 offshore financial centres (or tax havens) in the Caribbean and Central America and, according to a report by Tax-News, some commentators are arguing that their day in the sun is nearly done.
The list of adverse factors is certainly daunting: first of all, the gradual reduction in tariff barriers worldwide has undermined the Caribbean islands’ reliance on subsidised exports of sugar and bananas. Second, the attacks by the United States, the FATF and other bodies on money laundering and terrorist financing have forced the offshore financial centres to eschew many of their traditional clientele.
The OECD ( Organization for Economic Cooperation and Development) are pressing for harmonised onshore and offshore regimes, and, to cap it all, a majority of the offshore financial centres are dependent territories of Britain, and have been forced to adopt the EU’s Savings Tax Directive.
It’s this last problem that may turn out to be the most disastrous, at least in the short term, as investors shy away from the EU’s spotlight. Perhaps not coincidentally, the British Virgin Islands saw a drop in revenue from IBC registrations of 20% last year. With such a wide choice of offshore financial centres available worldwide, the uncomfortable demonstration that Britain’s dependencies had no choice but to knuckle under to the FCO can hardly have helped them.
An Economist report pointed out that all 14 of the independent countries in the Caribbean Community (CARICOM) are among the 30 most heavily indebted emerging-economy governments, and seven of them are in the top ten. Ratna Sahay, of the IMF’s Western Hemisphere Department, suggested in a recent report that a continuation of current policies would endanger the Caribbean’s macroeconomic stability. The IMF say that the Caribbean economies have managed an average growth rate of barely 2.5% in the last 25 years.
Still, the gloom and doom may be overdone, at least in many cases. The BVI still managed to grow last year, helped on by tourism, increased business in financial services and substantial asset flows from booming China. Many other jurisdictions in the region have been reporting increased business, and most of them are well aware that they have to change their fiscal models, if for no other reason than that regional integration is undermining tariff revenues, which underpin budgets in most cases.
Ratings agencies have had hard words for Belize and Barbados (disputed in the case of Barbados) but have complimented the Cayman Islands, and the IMF have been mostly favourable in their regional assessments. The dark cloud of the Savings Tax Directive may not persist; in reality, it is easy to escape the Savings Tax in a number of perfectly legal ways, and the convenience of the Caribbean for United States and European investors may outweigh their concerns once the dust has settled. (LowTax.com)
The best income-tax loophole in the world
As you may be aware, income earned by artists, writers, composers and sculptors from the sale of their works is exempt from tax in Ireland. Under section 195, of the Taxes Consolidation Act 1997 the Revenue Commissioners can make a determination that certain artistic works are original and creative works generally recognised as having cultural or artistic merit and, therefore, earnings derived from such works are exempt from income tax from the year in which the claim is made.
This is one of those tax loopholes that is simply crying out to be taken advantage of. Obviously, in order to use it, you must fulfil two basic criteria:
1. You must be able to sign a declaration that the work you submitted to the Revenue Commissioners is your own.
2. You must be resident in Ireland for tax purposes.
Naturally, the Revenue Commissioners are not going to accept any old thing as being of artistic or cultural merit. Guidelines have been drawn up by the Arts Council and the Minister of Arts for the purposes of this particular rule as to whether a work is original and creative and whether it has, or is generally recognised as having, cultural or artistic merit. Furthermore, the Revenue Commissioners may consult with a person or body of persons to help them reach a decision in relation to what is referred to as “artists’ exemption”.
If you wish to take advantage of artists’ exemption you may do so in any one of the following categories:
• a book or other writing
• a play
• a musical composition
• a painting or other like picture
• a sculpture.
Clearly, it would be fraudulent to simply commission someone else to produce an artistic work for you and then claim it as your own. But, it wouldn’t surprise me if some people didn’t do just that. Furthermore, I suspect one or two people have joined together with professional writers so that they can claim the exemption. Here is a scenario that I imagine may have happened more than once:
• Someone who wishes to take advantage of the artists’ exemption signs a professional screenwriter willing to cowrite a film script with him.
• Although the person wishing to take advantage of the artists’ exemption may do little more than sketch a few ideas he would be perfectly entitled to have their name on the title page.
• On the strength of this (providing it was a decent enough script), they apply – and get – artists’ exemption.
• The film script is then sold to a production company, who make a large payment to the, now Irish, resident individual… all, of course, tax-free.
In this way, money located offshore could readily be brought onshore with no tax liability and only the cost of commissioning a professional writer for their services.
The Revenue Commissioner’s website carries full details of the artists’ exemption – go to www.revenue.ie. It is interesting to notice that the exemption has been extended to include quite a lot of non-fiction work, including art criticism, art history, autobiography and literary diaries.
Alternative offshore tax havens
With the EU, OECD, INF, US Government, British Government and various other bodies making life decidedly difficult for some of the world’s most popular tax havens, the search is on for new offshore jurisdictions that offer:
• confidentiality
• stability
• security
• independence.
Of these, perhaps independence is the hardest feature to find. This is because many tax havens are either located in the EU, former colonies belonging to the UK or under the influence of the US Government.
If you are looking for a new offshore jurisdiction that is slightly out of the ordinary – and won’t, necessarily, set alarm bells ringing with the tax authorities of your home country, you may like to consider one or more of the following:
Labuan
The Malaysian Federal Territory of Labuan is a highly publicised late arrival among the world’s offshore business locations. Labuan is an island 360 km off the coast of Sabah, which has had free-port status for some time. It has a population of 70,400 and a land area of 92 sq. km. The 1990 Labuan Offshore Business Activity Tax Act provides a tax-haven-like environment for offshore operations in the International Offshore Financial Centre (IOFC). The Tax Act forms part of a comprehensive regulatory framework, which deals separately with offshore companies, trusts, banking and insurance. Strict confidentiality is guaranteed by secrecy provisions in all the laws covering business and financial activities in the IOFC. However, trust companies are expected to know the true identities of offshore companies’ beneficial owners.
The taxation of offshore operations in Labuan is based on a distinction between trading activities, including banking, insurance, management and licensing, and non-trading activities, such as holding companies for investments in securities and property. An offshore trading company can choose to pay M$20,000 a year or be taxed at the rate of 3% of audited net profits up to a maximum of M$20,000. Non-trading companies are tax-exempt.
Most dividend, interest, royalty and fee payments by IOFC companies are not subject to a withholding tax. There is no wealth tax, no estate or gift taxes and no capital gains tax, other than a tax on real property gains. Offshore companies may not buy local real estate except for use as business premises or to house personnel. Offshore business instruments are not liable for stamp duty.
To broaden the range of offshore activities that might be attracted, the Government produced a stream of new legislation providing incentives for reinsurance, captive insurance, money-brokering and fund-management activities. Entry criteria for offshore banks and captive insurance were eased in 2000. Minimum Tier 1 capital for offshore banks was lowered from US$l billion to US$500 million, and capital requirements for captives were reduced from US$300,000 to US$79,000. Captives no longer have to maintain a physical presence in the Labuan IOFC. Companies may also make use of a rent-a-captive scheme. The Labuan International Financial Exchange (LFX) was launched in November 2000, the first offshore exchange in Asia, listing investment funds, equities and structured debt instruments. Initially, it will trade only in US dollars, but it will eventually include euro- and yen-denominated instruments. Labuan also has high hopes for the success of its International Islamic Money Market, a joint development between the Labuan Offshore Financial Services Authority, the Islamic Development Bank, the Bahrain Monetary Agency, Bank Indonesia and finance ministries in Brunei, Saudi Arabia, Iran and the Sudan.
At the end of 2000, the Labuan IOFC had 2,310 operating offshore and foreign offshore entities and supporting companies. They included 60 offshore banks, with total assets of US$19 billion, 68 offshore insurance and insurance-related companies, 19 leasing companies, 8 fund managers and 20 trust companies, enough of a critical mass to build on in the next decade.
Lebanon
Lebanon gives special tax treatment to holding and to offshore companies. Holding companies are exempt from business income tax, normally levied at rates ranging from 4% to 21% (on taxable profits over L£104 million), and from the 10% withholding tax on dividends, interest and royalties. Offshore companies are also exempt from business income tax but must pay an annual lump-sum tax of L£l million (US$660). Offshore companies’ capital gains on transfers of fixed assets in Lebanon are subject to a tax of 6% (normally 10%) and no stamp duty is levied on contracts related to foreign transactions. Foreign employees of offshore companies are granted a tax exemption on 30% of their salaries as “representation allowances”. Standard personal income-tax rates range from 2% to 20%. The top rate applies to taxable incomes over L£120 million. Lebanon was considered to be a Group III offshore finance centre in the Financial Stability Forum (FSF) report published in June 2000. This means that supervision and regulation practices are not up to international standards.
Several readers of TSR are using Lebanon for offshore financial transactions and have found it surprisingly useful.
The Cook Islands
The Cook Islands (one island, with potential for confusion, is called Nassau) are hoping to secure a small place among the world’s professional tax havens. The islands achieved self-government in 1965. They maintain a free association with New Zealand by virtue of which New Zealand citizenship is extended to all Cook Islanders, and the currency is the New Zealand dollar. So far, being a tax haven has not made the islanders rich: GDP per head in 1997/98 was only US$5,600.
Administrative and commercial activities are concentrated in Avarua on the main island, Rarotonga, which is home to 11,200 of the islands’ 19,100 inhabitants (1996 census). Communications with the rest of the world, via New Zealand, Fiji or Tahiti, are good, as are international telecommunications services. Rarotonga is in the right time zone for business with Sydney, Hong Kong, Singapore, Tokyo and San Francisco. There is a five-hour time differential with New York, Bermuda and the Caribbean, which bankers can live with, but the 11- and 12-hour gaps that separate Rarotonga from London or Luxembourg make a European rush for Cook Islands offshore banking units unlikely.
A framework for the creation of an offshore business centre was provided by a quintet of laws introduced in 1981 and 1982 – the Cook Islands Monetary Board, Offshore Banking, International Companies, Offshore Insurance and Trustee Companies Acts – and by two further laws dealing with international trusts and international partnerships, introduced in 1984. In 1998, a law on offshore financial services was enacted to streamline the licensing of trust companies, offshore banks and offshore insurance companies.
The Offshore (Criminal Provisions) Act was introduced in 1996 to ensure that Cook Islands offshore entities could not be used for money laundering, with the Cook Islands Monetary Board designated as the reporting authority. Furthermore, a Money Laundering Prevention Act was hurried through Parliament in August 2000 to placate the Financial Action Task Force (FATF) , the Financial Stability Forum (FSF) and the OECD (see page 152). None of these organisations like the Cook Islands: the FATF named and shamed them for being uncooperative in their international campaign against money laundering; the FSF put the islands among Group III, considered to be the least-well-regulated offshore finance centres, and the OECD just blacklisted them. What is remarkable is that small and remote from markets as they are, they should have been able to arouse so much fury. In a progress report published in March 2001, the FATF gave their seal of approval to the new anti-money-laundering law and the appointment of a Money Laundering Prevention Authority. The law establishes a mechanism for exchanges of information with other jurisdictions relating to money laundering and provides for customer-identification procedures.
Offshore international companies and exempt trusts and partnerships pay no income taxes or any other “fee, impost, tax, levy, dues, duty or excise”. There are no reporting requirements. Offshore banking and insurance companies are similarly tax exempt, but they are subject to annual report and audit requirements. An Australian court has ruled that the Cook Islands’ 5% withholding tax on interest payments to residents of Australia was enough to prevent the application of Australia’s anti-avoidance provisions.* All offshore business is free of exchange controls (except on New Zealand dollar operations). Bearer shares are permitted, as are bearer warrants and bearer debentures. Incorporation requires only one shareholder. Secrecy provisions apply to all offshore business. Registration and licence fees payable by offshore enterprises are modest: US$l,000 initially plus US$500 annually for international companies, US$2,000 initially plus US$500 annually for offshore insurance companies, US$10,000 a year for an A-class banking licence and up to US$6,000 for a B-class banking licence. Trustee company fees range from US$l,000 to US$l,500 a year for international companies and trust-management companies.
Through their international-trusts law, the Cook Islands established a niche in asset protection trusts and, daringly for 1981, abolished the rule against perpetuities. The law provides that a Cook Islands trust is considered to be valid even if it is invalid under the laws of the settlor’s domicile.
In mid-1996, the country as a whole faced bankruptcy after defaulting on loans from Nauru, Italy, the New Zealand Superannuation Fund and the Asian Development Bank. The Government had managed to run up a national debt of over US$100 million. The creditors agreed to a respite during which economic and financial reforms are being implemented.
Samoa
The independent state of Samoa (formerly Western Samoa), in the eastern Pacific, was briefly a German then a New Zealand protectorate. Its 174,000 people speak Samoan and English and have a common-law system. Comprehensive offshore finance legislation was first introduced in 1987–1988, in the hope of attracting crumbs falling off the Asian tax-planning table. The 1987 International Companies Act created an attractive tax-exempt alternative to Caribbean international business companies. The Samoan model has a special feature to attract Hong Kong-, Taiwan- and China-based clients: it provides for the filing of memoranda and articles of association written in Chinese (Labuan, Vanuatu and the British Virgin Islands do this as well). Only one shareholder is required, and bearer shares are allowed. The application fee is US$300, and annual renewal fees are the same.
The International Insurance Companies Act 1988 covers the setting up of profits-tax-exempt captive insurance companies (annual licence fee US$1,250). They must have a minimum paid-up capital and reserves of US$100,000. Protected-cell facilities were introduced in 2000 with the Segregated Funds International Companies Act, based on Guernsey (Channel Islands) legislation. The International Trusts Act 1987 covers the registration of non-charitable purpose trusts, which are useful international tax-planning vehicles. Fashionable limited-liability company legislation was passed in 1996, modelled on a tried-and-tested law of the US state of Wyoming. With this, Samoa is clearly targeting the US market and keeping up with the competition (Nevis had just passed its own law in this area). The International Partnerships and Limited Partnerships Act further broadened the choice of tax-exempt statutory investment vehicles.
The Offshore Banking Act 1987 was amended in 1998 when a new post of Inspector of Offshore Banks was created. New II gateway” provisions were enacted to allow regulator-to-regulator disclosure for international supervision purposes. Licensing procedures have been tightened by imposing strict ‘know your customer’ requirements. The Prevention of Money Laundering Act 2000 overrides secrecy provisions in other laws.
Resident companies and individuals in Samoa pay an income tax of 29% (individual incomes over US$20,000). Non-residents are subject to a 15% withholding-tax interest, royalties and fees. There are no estate, inheritance or gift taxes. Capital gains are taxed as income. Offshore entities are tax-exempt but subject to initial and annual fees, which are usually the same. They range from the US$150 initial and annual fees payable by international and limited partnerships to US$17,500 payable for an A-class banking licence. Samoa has no tax treaties. Exchange-control regulations require Central Bank approval for the repatriation of overseas capital and profits. Commercial banks and licensed foreign-exchange dealers handle day-to-day foreign-currency operations. The Offshore Finance Centre is based in the capital, Apia, on the island of Upolo. There are good financial-sector support services. Scheduled air services link Samoa with Australia, New Zealand and the US. Samoa has its own currency, the tala (US$0.29:Tala1 at end-June 2001), issued and managed by the Central Bank of Samoa.
Niue
Niue is a Pacific island 500 km east of Tonga and 1,000 km west of the southern Cook Islands. The population was 1,745 in 1999. Another 20,000 Niueans live in New Zealand. The island is self-governing in free association with New Zealand, which remains responsible for defence and foreign affairs. Niue found itself on the FATF name-and-shame list because of its weak anti-money-laundering regulations. By the end of November 2000, expecting to placate the FATF, it had a Financial Transactions Reporting Act on the statute book and was committed to the establishment of a Financial Intelligence Unit. Meanwhile, international business companies (IBCs) in Niue are wholly exempt from tax and offshore banks pay a maximum tax of 2.5% on the first US$10 million of taxable profits.
In 1994, the Legislative Assembly approved 15 international business-related laws and regulations to provide a legal infrastructure for the Niuean offshore finance centre. The International Business Companies, Offshore Banking, Offshore Insurance, Trustee Companies and Trusts Acts are all improved versions of the best available elsewhere at the time. The IBCs and trusts laws in particular offer state-of-the-art flexibility. Supervisory powers have been entrusted to the Central Bank. All offshore business activities and foreign-source income are tax-exempt. Registration and statutory fees for IBCs are modest (up to US$150 initially, and annually); there are no exchange controls. Niue has created an ideal offshore operating environment – only its remoteness militates against it. Access is limited to infrequent flights to and from Auckland, New Zealand, and Tonga. Niue, like the Cook Islands and Tokelau, uses the New Zealand dollar.
Tonga
Tonga, although listed among the world’s objectionable tax havens by the OECD, levies profits tax at a rate of 15%–30% on local corporations and at a punishing 42.5% on non-resident companies. Profits made by export-oriented companies are taxed at a moderately concessionary rate of 17%. Dividend payments to non-residents are subject to a 15% withholding tax. To attract companies’ headquarters, a special 10% rate of corporate income tax was introduced in 1990 for income earned by such entities. Individuals are subject to tax on worldwide income (if resident), or Tongan-sourced income (if non--resident), at a rate of only 10%. As well as low income tax, the possibility of buying an internationally respectable Tongan passport for less than US$50,000 attracted quite a few bolt-hole seekers from Hong Kong.
Tonga levies no tax on property, wealth, inheritances or gifts. It has its own currency, the Tonga dollar (T$2.14:US$1 at end June 2001), and its own central bank, the National Reserve Bank of Tonga. Almost half of its population lives in the capital, Nuku’alofa, on the island of Tongatapu. The kingdom is the only one to survive from the pre-European period in Polynesia. It regained its independence in 1970, having been a British protectorate for 70 years. The population of 110,000 speak Tongan and English. GDP per head in 2000 was estimated at US$2,100. Relatively poor and relatively highly taxed, it is a mystery why the OECD should think that Tonga had been unfairly competitive. It was removed from the OECD blacklist in August 2001.
America’s QI System
With so much emphasis being place on the EU Tax Savings Directive, many people fail to remember the US Qualified Intermediary (QI) system, which came into effect two years ago. Basically, anyone in any part of the world who invests in US securities must provide full beneficial ownership disclosure, unless one exception applies. When the United States gets this beneficial ownership disclosure, it exchanges the information with other countries. So, if someone in the UK has an investment in IBM stock, his name is given to the IRS and the IRS exchange that information with the Inland Revenue – which, of course, if the money is undeclared, is a huge problem. The one exception is that made by the QI system: it arises where a bank or other intermediary is located in the country that has adequate exchange of information with the United States, and that country has adequate ‘know your client’ rules, so that the bank can say, “You can trust us, we know who our clients are, we have adequate controls, and we shall document our clients the way you want us to.” In these instances, the IRS will sign what is called a Qualified Intermediary agreement with that bank. This effectively allows the bank to shield the names of most of their clients, but not all, providing those clients are properly documented.
One of the fascinating effects of the QI system is that both Swiss and Liechtensteinian banks have signed up to it. Why? Because the banks were terrified that if they didn’t sign up they would have to disclose the names of their clients to the IRS on every US share deal. Of course, what they probably didn’t think about was the fact that in order to get the QI system into place both Switzerland and Liechtenstein entered into exchange-of-information agreements, which, believe it or not, technically allow the IRS to audit each bank’s own systems and accounts.
If banking secrecy is important to you, you may like to consider whether the bank and/or country in which you have your bank account has signed up to the US QI system. If they have, your account details may not be as confidential as you had hoped.
The US Echelon system
While on the subject of US-sponsored tax-collecting initiatives, it is perhaps worth mentioning Echelon. Echelon is a US information-gathering system that is based around the world. It is sponsored not only by the United States but also the UK, Canada, Australia and New Zealand. It is a global network of computers and does an automatic search on all messages intercepted from satellite-based communications. Any communications that go by telephone, fax, email or telex can be picked up, and the system will look for pre-programmed words. Readers should remember to exercise the utmost caution when conducting any confidential business by any other method other than face-to-face discussion or secure delivery.
Banking secrecy where you’d least expect it
There are, literally, billions and billions and billions of dollars of money invested in the United States’ banking system by people who are not US taxpayers and the US Government will not do what the UK Government have now done for some years – require banks to disclose to the IRS details of interest payments made to non-US taxpayers. As Senator Charlie Norwood commented when it was proposed by the OECD that the United States should pass non-resident bank-account information to the IRS:
“This regulation is particularly misguided since there is no need for the IRS to collect this information. For more than 80 years Congress deliberately has chosen not to tax non-resident bank accounts and not to require reporting of this information. The proposed regulation is therefore not only unnecessary it is actually a clear violation of Congressional intent. The IRS has also chosen to flout the law requiring a cost benefit analysis of regulations that could have a significant impact on the economy.”
And a significant impact, of course, it would have, if the world at large began to realise that any money held within the US banking system was likely to be reported back to the country of origin. The fact is that the United States at the moment, with record trade and budget deficits, simply cannot afford not to run on other people’s potentially dishonest money.
Therefore, if you are looking for a non-resident bank account that is likely to remain confidential, you might do worse than choose the United States.
EU tax developments
The news is not all bad in relation to the EU and taxation. One interesting development, for instance, is the fact that the EU now includes jurisdictions that are effectively zero-tax jurisdictions. That means that businesses can operate in and through the European Union, using its entire web of tax treaties and directives, to bring money into the EU on a tax-favoured basis, take it out to an EU jurisdiction where there is no tax and then finally pass it along to an international offshore financial services centre at no tax cost. As one tax expert recently commented: “the door to the European Union is wide open”.
One way in which this might be used is in relation to the new directive on interest and royalties. Basically, under the new directive on interest and royalties: “interest on royalty arising in a member state should be exempt from any taxes imposed on those payments in that state whether by deduction at source or by assessment provided as the beneficial owner of the interest or royalties is a member of another member state or a permanent establishment situated in another member state of a company of a member state.” Or, to put it in plain English, interest and royalties can be paid tax-free to companies located in a different country. Best of all, there are planning opportunities to be derived from the definitions of what is interest and what are royalties. These are not the most precise terms in the world. The directive does provide a very limited definition; nonetheless, taxpayers have enormous latitude in converting something into an interest or royalty payment to bring it within the scope of the directive.
Estonia is one country within the EU that is likely to find itself a popular place for the establishment of new companies. This is because an Estonian company, when it receives income, is not subject to income tax. There is no corporate tax due until the Estonian company makes what is known as a distribution to its shareholders. With respect to money which sits inside the Estonian company, there is no local income taxation. Interest paid out of an Estonian company is not considered a distribution to a shareholder. So a parent lender can strip all the money out of its Estonian subsidiary simply by way of a loan. Estonia has neither asked for nor been granted any transitional relief from the directive on interest and royalties, to which it is already subscribed. Estonia has no withholding tax on interest paid to a non-resident, no withholding tax on dividends paid to a non-resident and no withholding tax on royalties paid to an EU recipient. Estonia also has no FIN capitalisation rules, no net-worth rules, and no general anti-abuse rules.
Estonia can, in fact, be used by a wide variety of taxpayers as an alternative to Cyprus or Malta. It would be a great place for a multinational to put its treasury function establishing in Estonia the lending company for the group. All the group members throughout the European Union will get a tax deduction for the interest which they pay to this company, as long as it meets an arm’s-length standard, and the interest flows to Estonia tax-free, and may be reinvested tax-free.
ASK THE EXPERTS
Q. – My family and I have money in several bank accounts in the Isle of Man. I never paid tax on it. We are resident in the British Isles (Belfast) and are worried the account details will be disclosed to the Inland Revenue under the new EU Savings Tax Directive rules. What should we do?
A. It is now a criminal offence to evade tax, and any professional – including an accountant – who has reason to believe that someone has committed this crime must report the person without telling them. You should bear this in mind.
The first point I need to make is that if you want to sleep easy your best course of action would be to confess all to the Inland Revenue. Three things will happen. First of all, the Revenue will work out what tax was evaded originally. Secondly, they will charge you interest on the unpaid tax and penalties. Thirdly, they will almost certainly dig into your other tax affairs. It will not be pleasant, but you will escape really harsh treatment. If you say (and it may be true for all I know) that you didn’t understand that you were evading tax and it has only really just dawned on you that what you have done was wrong and if you make a full disclosure and cooperate the penalties could be 20% of the tax due or even less if you get lucky. In other words, your bill will be unpaid tax, plus (say) 20%, plus interest. If you want to go this route, you should discuss it with your solicitor – not your accountant – as the former will be obliged to observe your confidentiality whereas the latter will be obliged to report you immediately whatever you decide to do. This is the course of action we recommend – because it is what, by law, you should do – because it is only money – and because it will mean an end to your worrying.
What will happen if you don’t?
If you leave the money where it is – as you rightly surmise – sooner rather than later it will be reported to the Inland Revenue. All the account holders will be reported, and sooner (but probably later) you will all be asked about it. If you can’t show that the money was taxed prior to depositing it or if you can’t explain it in some other way, you will probably be offered Hansard – a procedure whereby you confess to all your tax sins and thus escape criminal proceedings. It won’t be nice! But, on the bright side, if you hold nothing back, you will almost certainly escape prison. You may also be able to convince the taxman (and the courts) that the other members of your family knew nothing about the origin of the cash and thus keep them out of it. I don’t believe you can count on this not happening. It is really just a matter of time.
What will happen if you close the accounts? This will dramatically reduce the chances of your being reported to the Inland Revenue in the short term. They will probably deal with active accounts first before looking into past accounts. Also, they will look at larger sums before they look at smaller sums. Sooner or later, I think, they will get to you – it may take years – even decades – but I feel it is pretty inevitable. If you had closed the accounts, say, five or ten years ago, I think the chances of your being caught would have been miniscule. But now I think your chances are much higher, another reason why a confession to the Revenue makes sense.
If you close the accounts, you will also have the problem of how to take the money. You might want to talk to your bank about this:
• If you transfer the money or take a banker’s draft you will definitely leave a money trail. This means that at some point in the future the taxman will be able to find out what happened to the money.
• Your bank may, however, be willing to give you cash or to sell you, say, a precious metal such as gold. You may have to withdraw the cash over a period to avoid suspicion. Gold or similar can probably be bought in bar form.
If you can turn your capital into cash or bullion, I would not recommend taking it off the island in one swoop. People are often searched coming off flights and even the ferry by Customs (or by the Irish equivalent in the Republic), and, if you were found with a large sum of money or bullion about your person, you would be for it! I have heard of people who own boats smuggling it off that way. Ditto people with light aircraft. I have heard of other people who drive over to the IoM in the summer with their families and golf clubs and hope to pass as tourists. Frankly, you would have to be pretty James Bond-like to take any pleasure in doing this, but, if you have a cool head and are willing to make a trial run, you might get away with it.
Another option might be to take a safety-deposit box in another bank in the IoM. Remember, under ‘know your customer’ rules, they will want a bank reference, to see your passport etc. In the short term, you should be relatively safe – but longer term this option is fraught with danger.
You could turn the accounts into current accounts and go on a spending spree in, say, London – paying by cheque. For instance, you could spend the money on art or furniture – tangible assets – bought through reputable dealers or auction houses. This would give you physical assets, would close the accounts but would leave you with the same problem of a trail.
You might buy property on the IoM. This would get the accounts closed, but wouldn’t look that suspicious – if you see what I mean. Use all the cash and tell anyone who asks that you want a holiday home there to retire to later. After buying the property, close all the accounts. Leave it a long time before you sell the property. You will still have left a trail, however; so, if the Revenue ever receive a list of former account holders based in the UK, your name will still come up.
Are there any other options?
Moving it to another account in another offshore jurisdiction is asking for trouble. First of all, you will leave a paper trail when the money is transferred. Secondly, it will be really, really obvious you know that you have evaded tax. Even if you get a bank draft from your IoM bank, it can be traced to wherever you put it.
Possibly you might come up with a plausible story about how you got the cash in the first place – but make it plausible because if it involves gambling or something similar you will be laughed at. You might claim it isn’t your money but you are holding it in trust for someone who lives abroad or is dead, but you will have to show trust documents and/or come up with a real person and some plausible story as to how they came by it.
You might become an ex-pat, I suppose. The Inland Revenue aren’t terribly interested in ex-pats, and, once you have left the UK, they probably won’t care. But it seems a bit dramatic. You might try changing the addresses on the accounts to local addresses – that is in the Isle of Man – so they are no longer non-resident. You can get an accommodation address easily enough. This may, at least, remove the accounts from the high-priority lists.
Exchange of information is on the way. The one benefit of doing nothing is that it doesn’t make you look guilty later.
If you deposited the money in one sum I suppose you might claim to have inherited it. In Ireland, I know it used to be the way people used to keep a lot of their money in cash hidden away somewhere. If you had a convenient relative who died all those years ago, you might try this as a story. But, if you were making lots of small deposits over a period, you won’t get away with that. You didn’t tell me the origins of the money or whether it was cash or cheque; so I can’t help more with this.
I am sorry not to be the bearer of more joyous news. If you go to the Revenue before they come to you, you will save the greatest amount of money and you can stop worrying. If you do nothing or spend the money on something tangible like a property you can claim you didn’t realise what you were doing was against the law but thought everyone could do it (remember the climate 30 years ago was different and lots of people used to use the IoM as a place to keep cash in) and just take the consequences – if you ever have to face them – on the chin. If you start transferring the money or trying to hide it, it will be clear that you knew you were breaking the law and evading tax and you can expect a fairly hard time of it.
Best of luck whatever decision you decide upon. Remember, if you write to the newsletter again, don’t mention your name. The reply will be published in the next edition.
It is our intention to be as accurate in fact, detail, analysis and comment as possible. However, publishers and their representatives cannot be held responsible for any error in detail, accuracy or judgement whatsoever. The Schmidt Offshore Report is sold on this understanding. The Schmidt Offshore Report is commissioned and published by Wentworth Publishing Ltd, 17 Fleet Street, London EC4Y 1AA. Email: wentworth@online.rednet.co.uk Tel: 020 7353 6606. © Wentworth Publishing Ltd 2004. All rights strictly reserved. This publication may not be lent, hired, reproduced (in any way whatsoever) or re-sold. This information is authorised for personal consumption only.
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