Offshore banking is one of the most misunderstood aspects of modern finance and the Panama Papers leak has reinforced its reputation as a way for rich people to cheat on their taxes. But how offshore banking works is more complicated than simply avoiding taxes. There are legitimate reasons why one might invest in a bank in another country, as well as real risks.
Even the phrase "offshore banking" isn't understood well. It doesn't mean small islands or shadowy kingdoms; instead it refers to a financial investment made in a country other than the one you live in. Many of these are done to lower taxes or avoid double taxation, but they can also be done to get money out of an unstable country or ensure privacy from hostile governments. And the risks can be considerable, anywhere from tax penalties to money being lost in downturns.Here are some things you might not know about offshore banking.
Offshore Banking is Legal in Most Countries
While some countries with tightly regulated banking systems have strict controls on offshore banking, the idea of moving assets to a remote financial institution is legal in almost the entire world. What makes offshore banking popular in places like Switzerland, the Bahamas, the Cayman Islands, Jersey, and the like is a combination of extremely low taxes on interest and investment income, privacy, and access to financial instruments specifically designed to maximize wealth.
An Offshore Bank Is Any Bank Not in Your Home Country
While the phrase "offshore banking" conjures up shadowy tax havens and tiny island kingdoms, technically, having investments in any country other than the one you live in is offshore banking. Some countries don't allow it, and others wouldn't be advisable places to park money. But there are dozens of nations recognized by at least one financial body as offshore financial centers.
Offshore Finance Began as a Way for a Tiny Island to Grow Its Economy
It was in the Channel Islands - an archipelago of small protectorates in the English Channel - that the idea of using low taxes to attract foreign investment was born.During World War II, the Channel Islands were the only part of the British Commonwealth occupied by Germany. After the war, they needed a way to attract both revenue and workers. Laws were passed ensuring easy access and low tax rates for investors from abroad, and modern offshore banking was born. The two largest islands are now offshore banking havens on the scale of countries like Bermuda and the Cayman Islands.
Swiss Banking Secrecy Was Started to Hide Money from the Nazis
The famed Swiss banking industry is based on the small country's obsessive devotion to secrecy. This, in turn, began with the Federal Act on Banks and Savings Banks, passed in 1934 by the Swiss legislature. It was designed to shield money invested in the country by individuals and companies fleeing the Nazis - meaning it was legally impossible for the neutral country to answer questions about who had invested there.Sadly, the Bank Secrecy Act didn't work as planned for Jews who hid money in Switzerland. Swiss accounts were still transferred to Germany under duress, and after the war, the country wasn't forthcoming about what happened to the money, destroying millions of bank records.