Offshore finance

Offshore finance

Offshore finance is the topic of the moment. Interviewers may test you with it, but hold onto your (Panama) hats, because we've done some homework for you.

Being marooned on a desert island is no longer the great excuse for ignorance – at least where the Panama Papers are concerned. In a pre-Panama world we were getting hot under the collar about headlines like Facebook's meagre £4,327 UK corporation tax bill, but the leaks have reinvigorated the debate surrounding offshore tax havens and tax avoidance schemes. This affects so many areas of law – businesses, governments and high net-worth individuals are all implicated – so it's likely to be a hot topic in this year's interview round. Contrary to what you'll read in the press, offshore finance isn't entirely dodgy  they serve practical purposes too  and law firms will be more impressed if you can argue one side then the other. If you need a quick recap: German newspaper Süddeutsche Zeitung got hold of 11.5 million data files from Panamanian law firm Mossack Fonseca which have since been published around the world. The documents revealed who was secretly using offshore structures in Panama and also brought to light numerous instances of fraud and tax evasion.

Here we're not concerned with tax evasion – deceitful behaviour to conceal taxable incomes and assets  which is illegal, but with tax avoidance schemes: using cunning, loopholes and lots of lawyers and accountants to save large sums on your tax bill. Using offshore jurisdictions for financial transactions or to set up companies or other commercial entities is completely legal. Many of the institutions and individuals named in the Panama Papers weren't operating illegal structures. And yet opinion is strongly divided on the ethics of what was done: stashing assets in low-tax jurisdictions. Stephenson Harwood lawyer James Quarmby got quite worked up on the BBC's Today programme defending the use of offshore jurisdictions for legitimate commercial reasons that have nothing to do with tax.

Regardless of your opinions on the morality or justifiability of offshore structures, as a lawyer you are likely to come across them during your career. Here's a Dentons trainee describing their banking seat: “You could be dealing with a Chinese bank funding an Indian airline with a special purpose vehicle in the Cayman Islands.” Or what about this Withers trainee talking about private client wealth planning work related to that same island group: “There are a lot of trust laws in place there that are 'good for tax'.” Withers wealth planning partner Christopher Groves tells us: “A huge range of areas touch upon offshore matters: funds, commercial and tax lawyers can deal with the same jurisdictions for very different clients. What I may do for an individual, someone else could be doing for a huge corporation like Apple or for any type of company or individual in between.” But what exactly are lawyers dealing with when they handle offshore matters, and why these deals happen in the first place?

Where is 'offshore'?

The first hurdle to understanding what's happening is to get your head around the use of the word 'offshore'. An offshore finance centre (OFC), as defined by the International Monetary Fund, is a jurisdiction where most financial sector transactions 'are with individuals or companies that are not residents of OFCs, where the transactions are initiated elsewhere, and where the majority of the institutions involved are controlled by non-residents.' So far, so straightforward and the IMF's website even has a list of jurisdictions considered to be offshore finance centres.

But when law firms use the term offshore they're not always using it to mean the same set of jurisdictions which the IMF lists. Over at Travers Smith, Chambers-ranked partner and head of investment funds Aaron Stocks tells us: “When we refer to offshore, we mean offshore finance centres such as Jersey, Guernsey, the Isle of Man, Bermuda, the Cayman Islands and the British Virgin Islands. Then there are the hybrid offshore centres like Luxembourg and Ireland,” – both of which you can find on that IMF list – “which we call onshore offshore. These are jurisdictions which have a low tax rate but aren't actually offshore.” Others use 'offshore' in a much broader sense. At Withers, for example, “we characterise 'offshore' as meaning any jurisdiction outside the UK,” Christopher Groves says. Colloquially the term 'offshore' is used to describe tax havens, though these jurisdictions themselves prefer the term the IMF uses, offshore financial centre. For the sake of convenience we're going to follow Stocks' definition throughout this article but bear in mind the different connotations when researching or discussing offshore matters.

“People who often move between countries or have investments in different countries may choose to establish trusts in offshore jurisdictions because they are a central, stable, neutral place to hold assets as you move around the world.”

The term offshore finance can also be used in two ways. Caroline Barton, a partner at offshore firm Appleby who's based in the Cayman Islands, explains: “At its simplest offshore finance is the provision of financial services by banks or agents to non-residents of a jurisdiction. But offshore finance is usually meant to indicate onshore financial institutions organising an onshore financial transaction, for example a loan, through offshore corporate vehicles.” To avoid confusion, we'll refer to the latter practice as offshore finance. In fact, to be more exact it's better to think about offshore trusts, companies and funds separately. We'll handle each in turn.

 

Offshore trusts

Trusts are established when a person, the settlor, legally transfers their assets to a trustee, who then manages and safeguards the assets for the benefit of beneficiaries, who may include the original settlor. Chambers-ranked barrister Eason Rajah QC of Ten Old Square explains what such structures are good for: “Wealthy individuals might consider using an offshore trust as part of their succession and tax planning. Trusts can hold a vast amount of wealth and are usually set up in tax-neutral jurisdictions like Guernsey, Jersey, the Isle of Man or certain islands in the Caribbean. They're run by professional trustees and are quite often private and for the benefit of a family.”

Perhaps the most commonly understood desire to establish offshore trusts centres around what lawyers openly called tax efficiency but which critics would call tax avoidance. “Trusts are quite often set up with the intention of lasting a very long time,” Eason Rajah explains. “Establishing a trust in a tax-neutral jurisdiction will mean no extra layer of tax is payable for beneficiaries who in the future could be living anywhere in the world.” This is more than just convenient – it means someone with their assets in an offshore trust will not be liable to pay tax over those assets in the jurisdiction they live in, say the UK. It's also convenient if the individual or family who owns the trust ever ends up living in a high-tax jurisdiction or the country where they live decides to hike tax rates. Christopher Groves of Withers comments: “It stands to reason that if there is an offshore jurisdiction where assets can be held without being taxable, irrespective of the tax that would be payable if they were invested onshore, that tax-neutral offshore jurisdiction will be the preferred place for the assets to be kept.” Depending on factors such as where the settlor is domiciled (which country they treat as their permanent home for legal purposes), where the settlor is resident (where they live – you can have more than one residence), and the type of trust established, offshore trusts can mitigate both capital gains and inheritance tax. So long as you declare to the taxman what assets you hold abroad, offshore trusts aren't illegal and (in theory) higher tax countries address the shortfall in tax from these assets by taxing people on the distribution of their offshore trusts. Needless to say arranging all this is hella complicated and that's where the lawyers come in.

Tax efficiency may be the first thing which springs to mind when discussing motivations for offshore trusts, but, Christopher Groves reminds us, other things also matter: “People who often move between countries or have investments in different countries may choose to establish trusts in offshore jurisdictions because they are a central, stable, neutral place to hold assets as you move around the world.” Other motivations include asset protection “trusts can protect assets by sheltering them from creditors or sometimes even in the event of divorce,” says Eason Rajah – and privacy. Unlike wills, the contents of trusts are not made public once someone has died, so settlors seeking privacy in the distribution of their assets may find this option suits them.

"If you end up going to court in one of these jurisdictions you'll be in front of English-trained judges and barristers.”

Using trusts to ensure control over the distribution of assets is also common. “Succession planning using offshore trusts can be a means of avoiding forced heirship in places like South America and in Islamic countries,” Eason Rajah points out. (Residents in countries which recognise forced heirship – Germany, Italy, Spain, Japan and Russia are just some of them – can't choose who their estate passes too. All assets must instead pass to a spouse or offspring, though some countries allow citizens to choose where a portion of their estate can go.) Christopher Groves says: “Those who live in a forced heirship country like France and object to how the state determines they divide their assets on death may seek to establish a structure in a country which does not have, or respect, forced heirship. Many offshore centres expressly state forced heirship does not apply to assets in their country so people establish trusts there to retain the freedom to dispose assets as they wish.” Conversely you can also find people establishing offshore structures to abide by forced heirship rules. “We particularly see Muslims who feel bound by Sharia law looking to use structures which encourage Sharia succession rules,” Groves says. But, whatever your exact reason for setting up an offshore structure, Groves believes the motivation essentially boils down to “the concept of protecting what is yours.”

 

Offshore funds and companies

Offshore companies are companies registered in jurisdictions they don't actually do business in while an offshore fund is an investment scheme established in an offshore jurisdiction. Aaron Stocks of Travers Smith informs us that using offshore companies and funds “is very normal when you're investing in certain jurisdictions. They're triggered by the fact that the jurisdiction you're investing in might not have a very good tax treaty with the UK.” Tax treaties are agreed between countries in order that individuals, businesses and investors can avoid double taxation – ie so that they don't have to pay taxes twice on the same goods, assets, income, transaction etc. They work by reducing the taxes of one country for residents of the other. “By placing an offshore company in the middle you can get better access to tax exemptions,” Stocks explains. “For example, India has a very good tax treaty with Mauritius and Mauritius has a good relationship with other offshore jurisdictions. If you're investing in India you might set up an offshore holding company in Jersey with a subsidiary in Mauritius and the underlying investment in India.”

"...the jurisdiction you're investing in might not have a very good tax treaty with the UK.”

Subsidiaries, holding companies... this is all starting to sound rather complicated. “The structures are relatively simple,” Stocks corrects us. “The companies and funds established there look very similar to English companies and the legal system is based on English law. If you end up going to court in one of these jurisdictions you'll be in front of English-trained judges and barristers.” For risk-averse companies operating on a global level this familiar legal framework provides a sense of security. It also explains the involvement of English lawyers based in London in offshore transactions.

Another reason for establishing an offshore fund is that its founders may wish to take advantage of the regulatory regime in an offshore jurisdiction, Christopher Groves points out: “If you want to sell funds to a number of different countries you would look to structure the investment vehicle in a neutral place.” Under the EU's Alternative Investment Fund Managers Directive passport scheme, a single collective investment scheme fund can be created in one EU member state for the entire EU. Without this, the fund would have to be structured differently for each individual jurisdiction. So in Europe, a fund might be established in a low tax, onshore offshore jurisdiction like Ireland or Luxembourg before being sold to investors in onshore European countries. Beyond Europe a master-feeder structure is often established. Groves again: “This single fund has different vehicles which feed into it and the vehicles are designed to be appropriate for people in different jurisdictions. One thing you can guarantee about the rules relating to investments in different countries is that they'll be sufficiently different to prevent a one-size-fits-all approach. The role of the offshore financial centre is that it's a neutral holding place that sits between the actual investment and the people making the investment.” In other words the offshore jurisdiction acts a bit like one of those multi-country plug adaptors you take on holiday – parties from all kinds of jurisdictions can plug in, no matter their local regulations, and make use of the fund. This desire for a neutral base can also see offshore jurisdictions becoming home to joint ventures formed by companies from different jurisdictions.

“We don't find people using these structures for reasons much other than tax.

So what's most driving the desire to set up offshore companies? Aaron Stocks reckons it's tax. “We don't find people using these structures for reasons much other than tax. In theory people may say they want to use an offshore entity for secrecy reasons and there are certain ultra high net worth individuals who do that, but it's rare.” Stocks again: Most of the matters we handle are driven not by a desire to reduce overall tax to zero but rather have the aim of making sure investors aren't paying an additional layer of tax.” For example: an overseas asset – be it a company, property or say a mine – pays tax in the local jurisdiction where it resides. The shareholders pay tax to the country in which they're resident on the dividends they receive from the asset. So they decide to put an offshore company in a tax neutral jurisdiction because “the offshore company or fund means there is no third layer of tax in the middle.”

 

How are trainees involved?

At almost any commercial firm there's the possibility you'll come across financial arrangements involving offshore jurisdictions. It's most likely to be something you'll encounter at firms which are big in areas like investment funds (eg Travers Smith) or private wealth (eg Withers). If you're interested in offshore-related work, here are some tips from our expert sources on how to get ahead.

“You do read a lot about offshore structures which isn't couched in particularly complimentary terms. So understanding the reality of how offshore structures work and the proper motivations for setting them up is important.”

There are no official prerequisites for UK-bound lawyers wishing to work in the offshore field. But it pays to start honing your knowledge early on. “Get a good grounding in trusts,” advises barrister Eason Rajah. “And it's helpful to have done a tax-related module in university or at law school.” Aaron Stocks also points to the importance of understanding tax: “You need a basic understanding of the type of taxation which is relevant to corporate transactions. Understanding the basics of structuring a transaction, concepts like equity and debt funding, and how money can flow from one entity to another is also key.”

But it's not all about getting your head round the logistics of it. “Understanding how the world works is important,” says Christopher Groves. “You do read a lot about offshore structures which isn't couched in particularly complimentary terms. So understanding the reality of how offshore structures work and the proper motivations for setting them up is important.”

 

Whatever your opinion on the rights and wrongs of offshore structures, they are nevertheless legal. So long as client demand for these types of entities persists, lawyers will be in demand to service them.

 

This feature was first published in May 2016.