Introduction to Tax Havens

The term tax haven has come to be associated with unsavory, immoral, and perhaps even illegal activities in the minds of many people. Novels like The Firm as well as constant negative media coverage and government propaganda have all caused the public to associate tax havens with shady business deals and characters of questionable nature. As a result, many people wonder why anyone would want to take their money offshore. The reality of tax havens and those who use them could not be further from the truth. Since the French Revolution, the wealthy have moved money offshore to protect their assets and to avoid paying taxes on gains. There are currently over 200 jurisdictions that offer these and other special incentives to foreign investors across the globe. They vary from sun-drenched Caribbean islands with palm-lined beaches to mountainous, European principalities filled with castles and picturesque villages.

First, it is important to define what a tax haven is. A tax haven is a foreign country or dependency that has a series of unique characteristics, the primary one being relatively lower tax rates in comparison with other countries. In fact, many tax havens impose no taxes at all on income earned by foreign individuals. Bank secrecy and strict privacy laws are other important characteristics of tax havens. In fact, in some tax havens there are prison sentences for anyone revealing private financial information. In the US, the IRS agents’ handbook defines tax haven as “a term that generally connotes any foreign country that has either a very low tax or no tax at all on certain categories of income.” The IRS itself defines at least 30 jurisdictions around the world as tax havens, including Austria, the Cayman Islands, Hong Kong, Liechtenstein, Panama, Singapore and Switzerland and lesser known places such as Bahrain, Nauru, and Turks & Caicos Islands.

Governments of most industrialized nations, and especially their tax collecting agencies, would have everyone believe that the use of a tax haven is the same thing as tax evasion. These governments frown on you relocating your money offshore. If everyone could invest abroad and in secrecy and never pay taxes these governments would go broke. The Governments do everything in their power to discourage citizens from moving funds offshore because when you move your money offshore, the government loses control. It is in no way illegal to take your money offshore, even though the government has done its part to try to persuade you to not do so. To this end, the taxman would have the public believe that tax havens are used exclusively for tax evasion, but that is just not the reality of the matter. For example, in the US the IRS agents’ handbook carefully notes that taxpayers use havens to avoid taxes, not evade them. Tax avoidance is the legal reduction of taxes, while evasion is any illegal means of reducing or eliminating taxes. Furthermore, the IRS guide concedes that US taxpayers may also use tax havens for tax planning reasons. This same guide also admits that some transactions conducted through tax havens have a beneficial tax result that is completely within the letter of US tax law. In fact, the US Supreme Court stated in Gregory vs. Helvering (1935), 293 US 465 that taxpayers can arrange their affairs so that they can make their taxes as low as possible. Given that admission, it becomes highly probable that many Americans are overlooking tax havens, private international banking and offshore investing as a fully legal means of restructuring their income and reducing their tax liability.

Given the information above, there are multiple reasons for using tax havens. One of the most important tax related reasons is the formation of an offshore corporation to engage in international business activities. Since the corporation is based in the haven, the income it generates is not subject to foreign taxes and through expert planning, US taxes may be minimized or deferred. The same rule applies to investments made through an offshore corporation and any resulting profits. The most prominent of non-tax reasons for using a haven is the privacy and confidentiality they offer for business transactions. It is very difficult for the US government to obtain information about business activities that take place in offshore tax havens or to locate income from investments made through an offshore corporation. Freedom from overly restrictive banking regulations is yet another attractive characteristic of many tax havens. Banks in many offshore jurisdictions may not have reserve requirements and so they are able to loan funds at higher rates and pay higher rates on deposits. Many offshore havens also give banks greater discretion in investing funds on deposit. Although not a concern for US residents, tax havens can provide economic and political stability for individuals who live in countries where such stability is sadly lacking.

An excellent example of a well-known public figure who is publicly known to utilize tax havens to his advantage is Rupert Murdoch. In 1985, media magnate Rupert Murdoch renounced his Australian citizenship and became a US citizen and so was able to comply with the US law that prohibits foreign ownership of television stations. This very wise business move helped Mr. Murdoch build a global entertainment empire that includes among its many subsidiaries the 20th Century Fox studios. Mr. Murdoch’s company, News Corp., earns most of its revenue from US subsidiaries, but through the use of international tax havens, Mr. Murdoch has paid corporate income taxes of one-fifth the rate of his US competitors during the 1990s. US authorities do in no way suggest that there is any impropriety in his business strategies. News Corp. has remained incorporated in Australia in spite of Mr. Murdoch’s taking on US citizenship. News Corp. has mastered the use of the offshore tax haven in its many international transactions. The company reduces its annual tax bill by moving profits through multiple subsidiaries in offshore tax havens like the Cayman Islands. For example, the overseas profits from movies made by 20th Century Fox, go into a News Corp. subsidiary in the Caymans, where they are not taxed, according to one insider familiar with the transactions. Mr. Murdoch has taken advantage of the differing tax regimes around the globe and so has been able to make sure his companies keep more of what they earn. Mr. Murdoch provides an excellent example of the proper use of tax havens in business strategy for all to follow.

Since most of high industrialized nations enforce extremely high rates of income and estate taxes on the worldwide income and assets on resident citizens, expatriation has become the ultimate tax-planning tool for their citizens. For instance, a former American citizen who adopts Bahamian nationality pays zero estate tax. There are generally significant income tax savings in renouncing U.S. citizenship. As an example, St. Kitts-Nevis and the Cayman Island levy no income taxes while some other countries do not tax the foreign income of retirees. Although some may have second thoughts about expatriation for patriotic and practical reasons, the costs of American citizenship may eventually outweigh renunciation. Ultimately, the loss of American citizenship is not terribly burdensome. Telecommunications and convenient international airline schedules facilitate the expat life. Now with the Internet and satellite television, an expatriate can be as well informed living in San Jose as in Manhattan. Frederick Krieble, a director and former treasurer of Loctite Corp., moved to the Turks and Caicos Islands, where he runs an investment company. Expatriation is not limited to the super rich. Jane Siebels-Kilnes, a vice president of Templeton, Galbraith & Hansberger, in Nassau, followed in the footsteps of Sir John Templeton. Templeton gave up his U.S. citizenship in 1962 and moved to Nassau. As a result, Templeton saved over US$100 million on the sale of his investment management company in October 1992. Obtaining a second nationality is not quite as expensive as one may think. For example, St. Kitts-Nevis requires the purchase of US$150,000 worth of local real estate and paying US$50,000 in fees for instant citizenship. For those with time on their hands, Costa Rica offers permanent residency with a US$50,000 investment in reforestation and a passport a few years later. Many mid level executives and small business people nearing retirement consider expatriation as a method to ensure a high standard of living in a comfortable environment. As you can see, there are a handful of viable options for an American looking for expatriation.

Tax havens offer numerous opportunities and if you have not yet researched the use of one or more in both your personal and business tax planning, it is now time to seriously consider the matter. Every student of American taxation is required to memorize Judge Learned Hand’s declaration, “Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.” It is foolish to not take advantage of the tax code regulations and provisions that give one legal right to use tax havens. Only the government loses because it will be taking less of your money in taxes. Keeping more of what you earn is not such a bad outcome after all, is it?