Offshore Banking Centers and Offshore Finance

The rise of the global economy has increased international transactions and enabled money to be moved very quickly. Offshore financial centers are thought to be safe havens for financial assets acquired illegally, but they may also offer some legal financial advantages for multinational companies and wealthy individuals. Most of these financial centers are located in small jurisdictions or microstates particularly in small island countries. This article addresses some specific questions regarding offshore banking; for instance, Do I have to declare income I generate from interest in my offshore bank account?, Are there any government regulations to keep a check on offshore financial transactions?, What is the meaning of the term "the Laffer curve" and what relation does it have with offshore banking?, What does the automatic exchange of information option mean?, and Which countries are affected by The EU Savings Tax Directive 2005?
An offshore bank is a bank located outside the country of residence of a depositor, typically in a low tax jurisdiction or a tax haven that provides financial and legal advantages. These advantages usually include strong privacy laws, less restrictive regulation, easy access to deposits and protection against local political or financial instability. Some offshore banks may operate with a lower cost base. Lower overhead and lack of government intervention enable them to provide higher interest rates than those available in the taxpayer’s home country.

Offshore banking is often associated with the underground economy, organized crime, tax evasion and money laundering. However, offshore banking does not always involve illegal activity and most of the time, banking offshore does not remove assets from the coverage of holder’s domestic income tax laws. For tax purposes, many countries now make no distinction between interest earned in local banks and those earned abroad. Additionally, while most offshore jurisdictions offer high levels of confidentiality, they cannot guarantee absolute secrecy, as financial institutions worldwide are obliged to report suspicions of serious criminal conduct, including, terrorism. In the 21st century, regulation of offshore banking is allegedly improving, although critics maintain it remains largely insufficient. The quality of the regulation is monitored by supra-national bodies such as the International Monetary Fund (IMF). Banks are generally required to maintain capital adequacy in accordance with international standards, and must report at least quarterly to the regulator on the current state of their businesses.

Persons subject to U.S. income tax, for example, are required to declare any offshore bank accounts, including numbered bank accounts. Offshore banks may not be required to report bank account’s income to other tax authorities and may have no legal obligation to do so, as they are protected by their jurisdiction’s bank secrecy laws. Nevertheless, the taxpayer is required to report such income.

In addition to voluntary report of offshore bank accounts, international financial co-operation is increasing. Recently, there have been many calls for more regulation of international finance, in particular, of offshore banks, tax havens, and clearing houses. For example, ClearStream, based in Luxembourg, has been accused of being a crossroads for major illegal money flows.

In an effort to clamp down on tax evasion, in July, 2005, members of the European Union governments agreed to the introduction of a withholding tax, the Savings Tax Directive. A complex measure, it forced EU resident savers depositing money in offshore banks to choose between paying taxes before depositing in offshore banks or allowing notification by the offshore banks to tax authorities in their country of residence. The EU intends to reach offshore banks in an increasing number of jurisdictions. The rate of tax deducted at the source will rise in 2008 and again in 2011, making disclosure increasingly attractive. Savers' choice of action is complex; tax authorities are not prevented from enquiring into accounts previously held by savers which were not then disclosed.



Do I have to declare income I generate from interest in my offshore bank account?
Certain countries in the world require their residents to declare their worldwide income. Tax is then payable on that offshore income as well. The U.K. and the U.S. are two such countries. Most countries have no restrictions on where your business interests, investments or bank accounts are located; it is simply your responsibility to report any income you earn to the appropriate tax authority.

Are there any government regulations to keep a check on offshore financial transactions?
The U.S. introduced the USA PATRIOT Act, which authorizes the U.S. authorities to seize the assets of bank accounts deemed to hold assets from a suspected criminal. Similar measures have been introduced in some other countries. The European Union has introduced sharing of tax information between certain jurisdictions, and enforcement measures regarding certain controlled-centers, such as the UK Offshore Islands.

What is the meaning of the term "the Laffer curve" and what relation does it have with offshore banking?
The Laffer curve is used to illustrate the concept of taxable income elasticity, the idea that government can maximize tax revenue by setting tax rates at an optimum point. The curve, popularized by Arthur Laffer though widely known among economists, is primarily used by advocates who want government to reduce tax rates. For example, consider that offshore banking is usually more accessible to those with higher incomes, because of the costs of establishing and maintaining offshore accounts. The tax burden in developed countries thus falls disproportionately on middle-income groups. Historically, tax cuts have tended to result in a higher proportion of the tax taken being paid by high-income groups, as previously sheltered income is brought back into the mainstream economy.

What does the automatic exchange of information option mean?
The EU Savings Tax Directive 2005 is an agreement between the EU Member States to automatically exchange information about any customers who earn savings income in one EU State but who reside in another EU State. This is known as the ‘automatic exchange of information option’ and it is the ultimate objective of the Directive.

Which countries are affected by The EU Savings Tax Directive 2005?
The countries affected by The EU Savings Tax Directive 2005 are; Andorra, Anguilla, Aruba, Austria, Belgium, British Virgin Islands, Cayman Islands, Channel Islands, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Isle of Man, Italy, Latvia, Lichtenstein, Lithuania, Luxembourg, Malta, Monaco, Montserrat, Netherlands, Netherlands Antilles, Poland, Portugal, San Marino, Slovakia, Slovenia, Spain, Sweden, Switzerland, Turks & Caicos and U.K.