An offshore tax shelter is any single or series of business transactions that aid an individual in the avoidance of paying some or all of his income tax. Offshore tax shelters are located in countries that do not require income to be reported or do not tax income that is reported. These countries are referred to as tax havens. Depending on the country of residence, offshore tax shelters may be illegal, but in most cases they are considered at least questionable. There are several business transactions that may qualify as tax shelters within a tax haven.
A foreign trust is one of the most common offshore tax shelters. Individuals set up a trust fund, which are subject to the laws of the offshore tax haven where the trust is located. Assets, most often money, are granted to the trustee or beneficiary of the account, who may spend the money in accordance with local laws.
Creating a business is another common type of offshore tax shelter. Foreign businesses may be corporations, partnerships or international business companies (IBC) governed by the country where they are formed. Businesses located in tax havens offer asset protection and financial privacy for investors seeking a tax shelter. Some of the most common locations to create businesses for the purpose of tax avoidance are the Bahamas, Samoa, Belize, Panama, Nevis and Dominica.
Private annuities, private banks and credit cards are additional offshore tax shelters used by individuals trying to avoid paying taxes on their income. Private annuities work in the same way as a foreign trust, whereas private banks and credit cards allow individuals to conduct business and serve as a flow-through entity for income. Once again, these shelters are governed by the rules of the country where they are located.
Offshore captive insurance companies also provide offshore tax shelters for those who wish to avoid taxes. A business owner creates a subsidiary insurance company to finance his risk in an offshore tax haven. The payment of these premiums is tax deductible in some countries and the insurance company finances the risk of the parent business.
Another offshore tax shelter frequently used is a related party loan. A domestic business or individual from one country lends money to a business or individual in a tax haven. The money flows through the loan so the person or business in the other country may receive a tax-free loan. Even if the income is reported, it will not be taxable in most countries.