Offshore Loopholes Can Be Legitimate

THERE is nothing more galling than listening to expatriates boast about the way they are using offshore bank accounts to evade tax. They delight in telling dinner-party guests how their money is running up tax-free interest or how it is piling up huge tax-free gains on the stock market.As you sit and listen, you can't help asking yourself if you really shouldn't open an offshore account for yourself. The answer may well be "yes, " but not for the reasons you might think. Rather than missing an opportunity to cheat the taxman, it is more likely that you are missing an opportunity to exploit, legally, certain loopholes in the law. The most obvious legitimate reason for opening an offshore bank account is the cash-flow advantage of getting interest on deposits paid gross, without the withholding tax usually imposed on non-resident bank accounts.But there are other tricks to the trade, depending on where you live. For instance, countries with a "remittance" loophole will tax expatriates on income brought into the country, but not on capital — and not on income or capital gains that are not brought into the country. Japan, Britain, Singapore and India are examples.An expatriate moving from, say, Germany to Japan could put savings into two offshore bank accounts — one for capital, one for interest. Any transfers of funds into Japan could be made, tax-free, from the capital account, while any income could be held, tax-free, in the interest account. Gillian Copperwheat, senior manager for personal taxation at Coopers & Lybrand in London, says this plan has obvious advantages, but that having the two accounts is critical to its success — because once capital and interest are comingled, the loophole is closed. "Many expatriates make the mistake of having their interest paid into the same account as their capital," she says. "Once they have set their accounts up this way, it is very difficult to untangle."Another legitimate plan, which is popular among high-earning expatriates in Britain, is the so-called dual contract. It works like this: An employee sets up two different employment contracts with his or her employer. One contract covers one set of functions — say, marketing and sales — which are carried out, compensated and taxed in Britain. The other contract covers a separate set of functions — say, international recruitment — which are carried out abroad and compensated, tax-free, by payments to an offshore bank account. Not surprisingly, tax authorities look carefully at dual contracts, so expatriates planning to use this loophole must be able to prove that they have two completely separate functions and that the contracts are with different parts of their organization. For those who are unfortunate enough to live in a country without any obvious tax loopholes, the temptation may be strong to use an offshore account to evade tax in illegitimate ways, such as to store undeclared income. Tax authorities acknowledge that it can be difficult to catch expatriate tax cheats with savings in offshore accounts, particularly if they have moved repeatedly over the years or are self-employed. Tracing these expats often involves too much effort and cost to make it worthwhile, authorities say.But while there undoubtedly are plenty of people who have avoided tax for years by using offshore bank accounts and have lived to tell the tale, there are plenty of others who didn't get away with it. Earlier this year the German tax authorities raided branches of banks in Germany to find out if people with bank accounts in Luxembourg were declaring their interest income. A third of the people weren't, and they were stunned to get a tax demand through the mail. These people must now be wondering if it was worth it.