InvestmentsApr 21 2016

Why go offshore?

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Why go offshore?

With the recent revelations about the ‘Panama Papers’, there has been a lot of media coverage regarding tax havens and offshore investments.

Based on the evidence presented so far, there does appear to be widespread instances of aggressive avoidance of tax through Panama, but does that mean that all so-called tax havens and all offshore investments are wilful acts of flagrant tax fraud?

Surely there are perfectly legitimate and tax-compliant reasons why some individuals and businesses choose to invest in this way?

To begin to answer these questions, it is important to get behind some of the commonly used terminology used in this context:

‘Offshore’

The term conjures up visions of some faraway exotic island with palm trees and sandy beaches, where lower standards of regulation permit shady dealings for the rich and famous.

While the Panama Papers seem to suggest there is some truth in this view, the term ‘offshore’ can apply to any investment conducted outside the country that an individual or company is resident in. In this respect, a transaction involving a UK resident buying a Luxembourg-based mutual fund is no less ‘offshore’ than if they bought a fund from Panama. However, unlike Panama, Luxembourg is in the EU, and there are various EU directives to ensure that common standards of disclosure apply, within the EU at least.

So regulatory standards are a key issue in this debate, but if we are going to get serious about offshore investment in its strictest sense, then the pension funds that of most of us are invested in would need to change radically, let alone the ‘offshore’ investments of the rich and famous. The term ‘offshore’ is therefore unhelpful, as it is rooted in a basic misconception – perhaps ‘foreign investment’ is a better description. Short of bringing back exchange controls, it is difficult to see how or why foreign investment should be restricted.

‘Tax haven’

Again, the label is often applied in broad-brush terms, which is not helpful in understanding what is really going on.

The term ‘tax haven’ should really be reserved for those financial centres that promote secrecy both in terms of the ownership of assets and the identity of the beneficial owners. ‘Tax haven’ therefore is not an adequate description for many of the reputable financial centres that comply with international standards of disclosure such as the Foreign Account Tax Compliance Act and Common Reporting Standards, conclude multiple tax information exchange agreements with other countries, and provide details on the beneficial ownership of companies. Unfortunately, when incidents such as the Panama Papers arise, the good, the bad and the ugly centres tend to be branded the same.

So, now we are a bit clearer on the terminology around this, why would anybody want to make a legitimate offshore investment?

The truth is, for the majority of us, offshore investment is an irrelevance, as the wide range of domestic investments is generally more than adequate to meet the needs of most investors. However, there are a range of scenarios where being able to invest outside a home country has some advantages over the options available domestically, although the proceeds of such are generally treated exactly the same way for tax purposes.

It should not be surprising that the sort of clients attracted to these options are the asset-rich with high levels of liquid disposable income and have, in all probability, exhausted all domestic ‘onshore’ tax breaks. In the UK, we are talking about possibly no more than 0.5 per cent of the population. This group is generally looking to control and manage its tax affairs rather than to avoid or evade tax, as well as meeting any specialist investment needs they may have. It is still a highly relevant – if niche – sector of the financial services market in most countries.

So, who and why would one of these investors wish to invest legitimately in an ‘offshore’ or foreign investment?

There are three basic scenarios:

1. UK tax residents looking to manage an income tax liability

In the same way that PAYE for most of us ensures we pay broadly the right amount of tax ‘painlessly’ out of our salary each month, most UK onshore investments perform the same function. For the wealthy, their tax position can be less homogenous. They can be higher-rate payers now, but confidently expect to be standard rate payers in, say, retirement. Offshore investments can give some investors the non-PAYE tax option which involves them paying the tax at a time of exit rather than having it deducted regardless. Get the calculations wrong and individuals can end up paying more tax by going the offshore route, but that is their choice and the taxman generally gets his money one way or another.

2. Persons looking to achieve tax-efficient and compliant intergenerational wealth transfer

Offshore investments are routinely used in relation to fiduciary structures such as trusts in Common Law jurisdictions and Foundations in Civil Law markets to ensure that post-death assets are directed to the chosen recipients. The use of fiduciary structures in wealth transfer planning for individuals and companies is not unique to the offshore world, but much of the historic expertise in this specialist area still resides there, and in the context of the UK market, the combination of such structures with the tax control in scenario one, above, is also a powerful tool. Provided there is no fraudulent intention to disguise the identity of beneficiaries, wealth transfer planning is a perfectly legitimate activity in which offshore solutions can play a key part.

3. Persons who are currently resident outside their home country

As an example, this might be a German national that is currently resident in the UK or a UK national living and working in Germany. However, whether you are resident there, permanently or otherwise, depending on where you are and where you are from, there can be quite legitimate tax-based reasons for placing some of your investments in a tax-neutral third-party jurisdiction, particularly if you are ‘globally mobile’ and/or enjoy income from multiple locations.

There are of course many variations on these basic scenarios, but they form the basis of most of the perfectly respectable offshore investment planning that is carried out on a daily basis in contrast to what the Panama Papers have highlighted. The key is to ensure that only reputable, transparent and well-regulated jurisdictions are utilised, and that individuals choosing to ‘go offshore’ fully declare their investments and pay the appropriate level of tax to the right tax authority.

Simon Willoughby is head of proposition, Axa Wealth International and chairman of the AILO Distribution Committee

Key points

The term ‘offshore’ can apply to any investment conducted outside the country that an individual or company is resident in.

Offshore investments can give some investors the non-PAYE tax option which involves them paying the tax at a time of exit.

Offshore investments are routinely used in relation to fiduciary structures such as trusts in Common Law jurisdictions.