Barron's International Tax Service

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Abusive Offshore Tax Havens

Some $5 trillion in assets worldwide are presently held in offshore tax havens. The annual revenue loss to the United States has been estimated at $70 billion. For this reason has Congress legislated provisions in the Internal Revenue Code designed to prevent the use of offshore entities for tax evasion or deferral.

Some forty countries currently promote themselves as tax havens, permitting the formation of foreign financial entities without requiring proof of actual identity. These entities include foreign trusts, corporations and partnerships; international business companies; offshore private annuities; offshore private banks; personal investment companies; captive insurance companies; offshore bank accounts and credit cards; and related party loans. Such structures create the appearance of third party ownership. However, according to Internal Revenue Service, true ownership is the U.S. taxpayer who controls the offshore assets and conceals repatriation of proceeds.

Methods by which funds may be repatriated include:

• Credit cards by which the U.S. taxpayer simply draws on his offshore account
• Use of property titled to offshore entities at below-market rental
• Loans in amounts beyond the taxpayer's borrowing power
• Bogus transactions designed to transfer funds
• Loans from mystery offshore lenders
• Scholarships for taxpayer's children
• Flow-through accounts
• Gifts

IRS has summarized what it considers abusive offshore tax avoidance schemes as involving:

• Offshore Wagering
• Offshore Internet Business
• Limited Liability Companies
• Abusive Insurance Arrangements
• Fictitious or Overstated Invoicing
• Factoring of Accounts Receivable
• Offshore Deferred Compensation Arrangements
• Repatriation of Offshore Funds Using Credit Cards
• Shifting of Income Using Offshore Private Annuities

The U.S. Congress has adopted rules designed to prevent U.S. persons from using foreign entities to avoid U.S. taxes, imposing stiff penalties against taxpayers who fail to report transactions with these entities. These rules mandate tax consequences for U.S. persons who transfer property to or own the following:

• Foreign personal holding companies
• Controlled foreign corporations
• Foreign investment companies
• Passive foreign investment companies
• Controlled foreign partnerships
• Foreign grantor trusts

While the IRS cracks down on offshore tax sheltering schemes, there are legitimate reasons for offshore entities and accounts. Foreign corporations may be the only way to conduct business in a foreign country. Foreign partnerships may be the only way in which participants can invest in the foreign country. Foreign trusts may offer advantages to operate in a different legal environment.

Otherwise IRS cautions taxpayers that:

'promoters of (Abusive Offshore Tax Avoidance) schemes may offer comprehensive management services that include bookkeeping and (tax) return preparation. (They) unscrupulously sell their clients on the idea that the arrangement legally permits avoidance of tax liability, (and then) simply create a "paper shield" behind which the taxpayer/client can control everything. (However), once a taxpayer has entered into an abusive scheme, it may be difficult to get out of it. Consequently, the taxpayer may rely heavily on the promoter for advice, and even representation, when confronted with an IRS examination.' www.irs.gov