OFFSHORE INVESTMENTS:   STRUCTURING TAX FREE OFFSHORE INVESTMENTS

Offshore Investment Strategies Using The IBC

Proper IBC Structuring is Essential

At one time, offshore simply referred to a collection of safe havens where money could be placed for greater security. Now, for many Americans, offshore has expanded into a much broader concept. Offshore is a term for a collage of philosophies regarding investing, wealth management, lifestyle and living. It describes a self-directed mentality and independent approach to living, in which a person is neither stifled by government, nor reliant upon it. In the extreme, it describes a state of living in anonymity and drifting the globe without ties or allegiance to any particular nation on earth.

It is important not to become seduced by abstract offshore theory and ideology at the expense of overlooking the hard practice. After all, everything about offshore begins and ends with the dollar. The basis of offshore freedom is economics. Collections of passports, intellectual exercises about offshore possibilities and multitudes of trusts will not serve your interests if you have no assets. Accumulation and investment of wealth offshore, where it is more secure and better able to work for the individual, should always remain the focus. ¹Investing outside the United States is not easy for Americans because of restrictions imposed by the Securities Exchange Commission and the Internal Revenue Service. These two U.S. agencies create challenges for individuals, who seek offshore alternatives, by regulating investment and by imposing broad tax liability on all citizens.

The Securities Exchange Commission ("SEC') has severely limited the ability of Americans to purchase securities outside of the United States. This was accomplished in the Securities Act of 1933 ("1933 Act') and the Securities Exchange Act of 1934 ("1934 Act'). The 1933 Act is meant to compel full disclosure in public offerings and prevent fraud in connection with the original issuance of securities, while the 1934 Act is intended to ensure a fair and honest market for the trading of securities once in the marketplace. Section 5 of the 1933 Act requires that, unless there is an exemption, all offers or sales of securities in the United States must be registered with the SEC. The 1934 Act makes corollary requirements in Section 12, which requires registration and periodic reporting of foreign issues that have securities listed on a United States exchange. While there are certain exceptions² to the registration requirements, from a practical standpoint what this means for United States investors is that all foreign investment opportunities are prohibited unless they have been properly registered with the SEC. This means United States investors are confined to the U.S. domestic market and foreign issues that have been registered, and further, that they do not enjoy the right to invest freely in the world market. If an American can discover a way to invest offshore in non-SEC registered securities; there is the second challenge of tax liability facing the offshore aspirant. Most people who go offshore seek not only flexibility of investment, but also desire to minimize the tax consequences of the returns that are earned. However, United States citizens are taxed on gross income, which is broadly defined as "all income from whatever source derived," hence meant to include income generated worldwide. ³Therefore, whether a United States citizen has domestic gains or gains from offshore sources, there will be a tax liability. Many Americans do not understand from a philosophical standpoint why gains earned offshore are taxable when the ventures have not enjoyed United States protections. In fact, they find this repugnant.

These are the two central challenges facing Americans interested in offshore. Solutions are not complicated, and begin with a simple understanding that foreign corporations are for sale in practically every jurisdiction in the world. A corporation formed in a jurisdiction outside of the United States is obviously beyond the jurisdictional reach of the SEC. By virtue of its domicile outside the United States, a foreign corporation enjoys access to all the markets in the world and all of the securities issues that exist - not just the ones which have been registered with the SEC. This is true economic freedom and a limitless opportunity for growth and diversity.

With respect to the tax challenge, the first important point is that many tax haven jurisdictions do not impose taxes on their corporations so long as they do not actively conduct business locally. From a United States tax perspective, foreign corporations are not liable for taxes under certain conditions. The tax liability for foreign corporations is articulated in IRC Section 882 which states, "A foreign corporation engaged in trade or business within the United States during the taxable year shall be taxable as provided in section USC on its taxable income which is effectively connected with the conduct of a trade or business within the United States." Therefore, taxes only accrue when business is actually conducted in the United States. Capital gains from securities trading by foreign corporations falls outside of this definition. This is further clarified in IRC Section 865(a)(2) which states the general rule, "Except as otherwise provided in this section, income from the sale of personal property by a nonresident shall be sourced outside the United States." Hence, foreign corporations do not incur capital gain tax liability.

The foregoing information should lead to some obvious conclusions about how SEC and IRS rules may be legally circumvented. What should have been communicated is that, what cannot be accomplished from within the United States, may be accomplished internationally, using corporate vehicles. Both investing and tax mitigation may be accomplished through a corporation established in any of a number of tax-lenient jurisdictions around the world.

If terminated at this point, the discussion would indeed be incomplete. The challenges posed by the SEC and the IRS have been presented. Several legal strategies to meet these challenges followed. What has not been addressed is how these techniques may be put to use for a United States citizen. How exactly may a United States citizen avail himself of these benefits? At this point, the person who seeks a safe haven offshore needs to begin working with a professional in the industry, for it is not as simple as buying a personal international business corporation. There are a host of additional concerns, outlined below, which must be addressed. If a United States citizen owns the foreign corporation, then the tax avoidance effort has been for naught, because of IRS provisions concerning Controlled Foreign Corporations ("CFC'). Where CFC rules do not apply, other circumstances trigger tax consequences, such as when the foreign corporation makes a distribution. Further, in the course of these activities, if a United States citizen has had "an interest in, or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account or other financial account" this must be reported. Finally, any funds that are repatriated to the United States must be classed as income and taxed accordingly.

What is clear from this examination is that in order to invest directly offshore, it is necessary to have a foreign vehicle through which transactions are performed. This is the only way in which goals may be achieved, while remaining in compliance with SEC and IRS rules. While it is clear that a foreign entity is an absolute requirement, the nature of the relationship between such an entity and a United States citizen is a particularly delicate matter which should only be undertaken with the advice of a qualified provider.

 

 

¹The methods by which funds are accumulated offshore are beyond the scope of this piece. It is important to note that if such the funds are accumulated through transfers from within the United States there could be withholding or gift tax consequences. Therefore, we strongly recommend that anyone seeking to secure wealth offshore consult a professional.
² The exemption for offshore issues is Regulation S, which is comprised of rules 901-904 of the 1933 Act. It clarifies that the registration requirements of the Securities Act do not apply to offers and sales outside the United States. To qualify for the Reg. S exemption there can be no direct solicitation of U.S. investors, no buy orders placed within the United States nor share delivery within the United States. Hence, while this is an exception to the registration requirement, it effectively minimizes chances that an offering outside the United States will reach United States citizens.
³ This is clarified in Internal Revenue Code section 61(a).
⁴The other exemption for offshore investments is the American Depository Receipt. This technique interposes an American bank which makes the securities purchase which are held in trust for the beneficial ownership of the investor. This does not afford the flexibility which American investors seek.