Offshore Planning: What is it & Why You Need a Plan

Offshore planning is a generalised term used to describe the process of using offshore financial structures and entities. To put it simply, these vehicles are set up outside of one’s home country for tax optimisation, asset protection, and increased financial privacy among other reasons. 

By placing assets and financial activities outside of your jurisdiction of residence, they are significantly more difficult for creditors to make claims against, as well as being protected from other domestic threats such as local judgements, divorce, and bankruptcy. 

In this article, we examine various aspects of offshore planning, such as the difference between legal offshore planning and illegal tax evasion, how offshore planning works, and some of the major types of offshore planning vehicles that are widely used. 

Legal VS Illegal

There has been a great deal of debate surrounding the legality and legitimacy of the use of offshore planning to avoid taxes and protect assets. There have been many major scandals over the years (e.g., Panama Papers) and examples of the unlawful and immoral use of offshore structures by wealthy individuals and businesses to evade taxes and escape their financial obligations.

Much of this involves a misrepresentation of what offshore planning, and the offshore financial services industry is actually about, and is confined to a few isolated incidents. 

Legal Information

In fact, there are many completely legal and legitimate ways to use offshore planning to improve your overall financial and tax structure, without wrongfully evading taxes or unscrupulously hiding assets.

Legal offshore planning is simply about making intelligent uses of financial vehicles in foreign countries to take advantage of asymmetries in regulations, tax rates, and various other factors. In doing so, you would fulfil all required tax and financial reporting obligations in your country of tax residence as well as the country in which your asset structures are based.

With the help of an offshore tax expert, you would simply make the best use of these structures to minimise your taxes and protect your assets in a transparent and legal manner. 

Tax Evasion

On the other hand, there are instances where individuals and businesses have attempted to use offshore tax havens to illegally hide assets from both the IRS and/or creditors, misrepresent their taxable income, conduct illegal business activities in secrecy, and so on.

These strategies may work for some time, but always come with a high risk of being caught and having to pay heavy penalties or even face criminal charges. They are not at all recommended, and are not what is being referred to when the term “offshore planning” is used. 

For more: Differences between tax evasion and tax planning

How Does it Work?

Offshore planning involves using legal entities and financial structures in favourable offshore jurisdictions which aid to provide additional layers of asset protection, privacy, and tax efficiency. The offshore entities are generally placed in the control of foreign trustees and managers who are not residents of your home country and do not have any business operations in your home country. This effectively helps to put your assets out of harm’s way and beyond the reach of local creditors and court rulings. This is an effective strategy because these favourable jurisdictions do not recognise the judgments passed by your home country and have their own regulations which favour strong asset protection and confidentiality. 

Key to offshore planning is the existence of favourable offshore jurisdictions, known as International Financial Centres (IFCs). The offshore financial services industry has become a major driver of the economy in many of these countries, which means they are incentivised to continue providing a favourable environment for effective offshore planning. They usually offer one or more of the following key benefits:

• Low or zero taxation, or at least special tax breaks for offshore entities.
• Strong asset protection laws with specialised asset protection vehicles available to take advantage of them (e.g., the well-known Cook Islands Trust, or Nevis LLC). Many IFCs have a shorter statute of limitation making it difficult for creditors to retrospectively make claims against your assets once the specified period has passed. 
• Privacy preserving structures such as private bank accounts, low corporate reporting requirements, etc. 

An example of where effective offshore planning can help to reduce taxes is in the case of US citizens, who are taxed on their worldwide income. However, the IRS allows US citizens to exclude or defer their US tax on income earned abroad if:

1. They are residing and working in a foreign country for more than 330 days of the year and therefore qualify for the Foreign Earned Income Exclusion (FEIE) act.
2. A division of their business is based in a foreign jurisdiction. What this means is that there is an entire division of the business (including employees) operating independently from another country and adding their own value to the product or service. In this instance, whatever value they add and therefore profits are generated, can be held in the foreign country, and deferred for tax purposes. Note that as soon as those profits are repatriated to the United States, the company will have to pay US tax, so this is only a tax deferral strategy. However, these profits can therefore be reinvested without paying tax and directly add value and profitability to the business. 

The above are simply two examples of how careful offshore planning can lead to overall greater tax efficiency and other benefits. 

Different Types

When it comes to offshore planning, there are no one-size-fits-all solutions. Every individual must tailor their offshore financial strategy so as to best suit their own circumstances, needs and objectives. In doing so, there are a number of different offshore planning vehicles that can be used.

Some examples include:

1. Offshore Company

Offshore companies are the most widely used and popular offshore entities. They can be divided between public and private companies. Both types provide limited liability protection, but the most commonly used are private Limited Liability Companies (LLCs) for their simplicity and cost-effectiveness. 

An offshore LLC in a favourable IFC can provide a host of advantages to its beneficial owners, such as greater tax efficiency, enhanced asset protection, anonymous ownership, access to many new business opportunities, and greater operating and cost efficiency. These entities are usually the simplest and most affordable to setup, and are known for their versatility. 

2. Offshore Trust

The offshore trust is the most popular asset protection tool. Trusts involve an agreement between three parties, in which the settlor transfers his/her assets to the trust (which is managed and overseen by the trustee) for the benefit of the beneficiaries.

It is an incredibly powerful financial vehicle because it effectively removes ownership of the assets that are transferred and thus puts them out of reach of local court rulings and other dangers.

Trusts have also been used effectively for estate planning and tax optimisation. There are several different types of trusts, each with their own use and function. The ultimate example of a successful offshore trust for asset protection is that of a Cook Islands Asset Protection Trust. 

3. Offshore Foundation

Foundations are a unique financial entity, which can be seen almost as a hybrid between a company and a trust. 

A foundation is a type of non-profit organisation that is established to fulfil a specific purpose, which is in accordance with the wishes of the original founder. A foundation may be a charitable organisation or non-profit organisation with its own purpose. That purpose may be to simply benefit its designated beneficiaries. 

Due to this versatility in purpose of a foundation, they have been successfully used in offshore jurisdictions for asset protection, estate planning, managing family assets, holding shares or other investments in a more tax efficient way, and various other uses. A major advantage of foundations is that they are usually not liable for taxation and can exist as a separate legal entity without the need for financial reporting or auditing. 

A Nevis Foundation is an example of a widely used vehicle for offshore planning.  

Other Offshore Structures

Other types of legal entities which have been successfully used for offshore planning include (but are not limited to):

• Offshore Partnerships
• Foreign Investment Funds
• Offshore Bank Accounts

Does it Always Work?

It is important to realise that offshore planning is not a sure fix in all circumstances, and certainly has its limitations. Proper offshore planning takes very careful and expert structuring of a variety of offshore vehicles, so as to create an integral plan that can be used to optimise the user’s situation. 

Offshore planning cannot always be used to:

Avoid bankruptcy

Offshore planning can be less effective in protecting against bankruptcy compared to ordinary state creditor collection cases. This is because bankruptcy courts are federal courts which means they have jurisdiction over assets worldwide. Even with such powerful jurisdiction though, it will be difficult for these courts to successfully lay claim to foreign assets in a protective offshore jurisdiction like Cook Islands, Nevis, etc. 

Avoid domestic taxes

It is not always easy to use offshore planning to avoid or reduce domestic taxes, especially for US taxpayers. This is because US citizens are taxed on their worldwide income, which means they must declare all assets and income held in foreign jurisdictions or face severe penalties and/or criminal charges. It is still possible, with clever structuring, to legitimately optimise taxes through offshore business entities. However, these strategies are complex and require expert guidance. They do not apply to simple individual passive income from investments held in foreign countries. 

Guarantee secrecy

While there are many offshore jurisdictions which offer their customers higher levels of financial privacy, the days of complete secrecy are long gone. In recent decades, there has been a strong push towards transparency and information sharing worldwide. US citizens are lawfully required to report all of their foreign income and foreign assets on their tax returns. Reporting standards such as FATCA in the US and the CRS and AEOI (Automatic Exchange of Information) across most of the rest of the world, makes it incredibly difficult to legitimately conceal assets. 

In addition to the abovementioned points, the IRS has taken a strong stand against offshore business planning for tax avoidance in recent years. It has become difficult for the average person to know the difference between legal offshore financial planning and illegal tax evasion. Offshore activities always come with the risk of unintentionally stepping over that line and getting penalised for doing so. 

The introduction of economic substance requirements by the council of the EU and OECD means that offshore businesses are now required to prove real economic substance for their existence, other than only being legal vehicles for tax reduction. It is clear that the offshore landscape is rapidly evolving, and generally tending towards being more difficult for the average individual to use to their advantage. That said, new strategies and opportunities are emerging all the time, and there are always methods to optimise your financial situation and wellbeing through careful offshore planning. 

Ask the Experts

Due to the incredibly complex nature of offshore financial structures and offshore planning, it is advised that you consult with an expert before setting up your own offshore plan.

An asset protection attorney or offshore planning expert will have the knowledge and skills to guide you through setting up the best structure to suit your particular circumstances, in the most cost-effective way.

There are so many different offshore vehicles in various jurisdictions to choose from, it is important that these decisions are well thought out and take into consideration all factors related to your current needs and objectives. An asset protection attorney will be able to help with exactly this, and the small fee could save you much more in the long run.