An offshore bank is a financial institution located in a country in which typically accepts depositor funds from non-residents. Offshore banks are typically located in a low tax jurisdiction, also known as a 'tax haven', that often provides legal or fiscal advantages.
One of the primary advantages offered by offshore banks (especially private offshore banks) is the promise of increased privacy for a client's financial matters.
While tax matters provided the genesis for the modern day offshore financial centres, people have come to think of them as offering a greater degree of privacy over their financial matters. This association probably began with the 1934 Swiss Banking Act. With the advent of the "information age", and aggressive tax collection tactics, customers' demands for privacy have grown stronger.
Virtually every offshore financial institution is chartered in a jurisdiction that at least purports to provide a higher level of financial privacy and a lower level of financial transparency into the affairs of their clientele. For this reason you are more likely to find a swiss offshore bank or cayman offshore bank than one in high-tax jurisdiction.
Low Tax or Tax Free
The most obvious reason for banking in a tax haven, is the potential to reduce one's taxes. All manner of complex offshore structures, involving offshore trusts, private interest foundations, and offshore companies create transactions involving a bewildering variety of financial instruments. Most often, however, the transactions involve moving the jurisdiction of a transaction to location that will produce the most favorable net tax outcome for the entity in question.
More Relaxed Regulatory Environment
While many frustrated business owners welcome less red tape, potential offshore banking customers should exercise a bit of due diligence here. Most offshore banks do NOT come within the purview of their respective Central Banks. In addition, those that are public, are generally small divisions within much larger offshore financial institutions or banking conglomerates. As a result, there is often very little insight potential clients can get into whether these offshore banks are staying within responsible capital ratios relative to the risk in their portfolios.
Financial, Legal, and Political Diversification
Another advantage that depositors in offshore bank accounts perceive is financial, legal, and political diversification. Off shore bank customers, due to the bank secrecy laws can use an offshore account as a first level of a greater offshore asset protection strategy.
Their offshore accounts are protected from overreaching lawyers and liberal judges in heavily litigious societies, criminal elements targeting them in their own home countries, and the whims of the current administration's tax changes going against them.
Disadvantages of Offshore Banks
Offshore banking has often been associated with the gray market, "underground" economy and organized crime for purposes of evading taxes (tax evasion), and/or money laundering.
Tax collecting authorities have often attempted to characterize offshore bank accounts as being associated with tax evasion, money laundering, criminal enterprises or more recently terrorism. US persons, for example, are required to declare any offshore bank account, including a numbered bank account, they have each year when they declare taxes. The United States' tax collection authorities, Internal Revenue Service, estimate that last year they missed $40B in tax receipts due to the existence of offshore bank accounts and offshore financial centers.
Attempts to Regulate Offshore Banking
Most offshore banks do not to report income to their respective clients' tax authorities. In countries with strong bank secrecy laws they are under a duty not to do so.
The problem is, since September 11, 2001 many tax authorities have used the opportunity created in the crisis to levy addition scrutiny on offshore bank accounts, offshore banks and offshore financial centers. Those jurisdictions and institutions that were the most susceptible to political and economic pressures from the United States have in essence ceased observing their own bank secrecy laws and have in effect ceased to be effective offshore financial centers.
Laws Regarding Depositors in Offshore Bank Accounts
Personal income tax laws in many high-tax regimes (including the US and EU) does not differentiate between offshore banks interest, domestic banks interest and interest earned from onshore banks abroad in international banking accounts.
In the case of US persons, citizens are required to declare any offshore bank accounts - which may or may not be numbered bank accounts - they may have. Although offshore banks may decide not to report income to other tax authorities, and have no legal obligation to do so as they are protected by bank secrecy, this does not make the non-declaration of the income by the tax-payer or the evasion of the tax on that income legal. Following September 11, 2001, there have been many calls for more regulation on international finance, in particular concerning offshore banks, tax havens, and financial clearing houses.
Defenders of offshore banking have criticised these attempts at regulation. They claim the process is prompted, not by security and financial concerns, but by the desire of domestic banks and tax agencies to access the money held in offshore accounts. They cite the fact that offshore banking offers a competitive threat to the banking and taxation systems in developed countries, suggesting that Organisation for Economic Co-operation and Development (OECD) countries are trying to stamp out competition.
Origins of Term 'Offshore Bank'?
The term offshore bank may have originated from the United Kingdom's Channel Islands, which are "offshore" from Great Britain. While it's true that to this day many offshore banks are located in small island nations, the phrase more generally refers to the service offerings, bank secrecy and tax structure of the jurisdiction, or offshore centre, in which the institution is located. By way of example, some of the most famous "offshore financial centres" are the tax havens of Liechtenstein, Luxembourg, Andorra, Austria, and Switzerland, all of which are land locked.