Once the shadowy tax havens of mafia bosses and global jetsetters, offshore banking operations are going mainstream - thanks in large part to the Internet. With the click of a few computer keys, anyone can set up a corporation in the Caymans, a trust in the Cook Islands, or a bank account in Barbados.
Much of it's perfectly legal, although law-enforcement authorities still consider it highly suspicious. Nonetheless, more and more Americans are doing it: from a doctor protecting his savings from an onerous malpractice suit, to an estranged husband hiding assets in a potentially messy divorce, to an investor gambling on high-risk offshore mutual funds. Then there are the traditional tax dodgers.
No one knows exactly how many Americans have gone offshore because the jurisdictions' strict secrecy laws make it easy for individuals to duck US authorities.
But experts say the growth has been "dramatic," particularly in the past five years. And more and more of it is legitimate. The number of people actually reporting offshore accounts to the IRS - something rarely done in the past - has jumped almost 25 percent in the past three years alone. They now number close to 200,000.
"It used to just be for the millionaires, but now ... it's not," says a senior staff member of the House Banking Committee, which has just asked the General Accounting Office to investigate the growth in offshore banking.
Reasons for the jump are varied. Some experts point to the ease with which Americans can now buy and bank on the Internet. Others blame the litigious nature of American society. "People don't think they'll get a fair shake when they do get their day in court," says Denver lawyer Barry Engel, one of the pioneers in creating offshore-protection trusts. "In the words of one of my clients who's a litigator: 'I don't want somebody to do to me what I do to people all day long.' "
And then there is the simple desire for the kind of privacy and confidentiality an offshore banking center provides. "I think people are getting fed up with Big Brother peering into every aspect of their lives," says Anthony Ginsberg, publisher of Offshore Outlook, a trade magazine based in Los Angeles.
But law-enforcement officials warn offshore banking still carries a dark underside. Because there are few regulations and strict secrecy laws, the system is ripe for fraud, abuse, and money laundering. Americans who use it can easily be duped. And unless they get expert legal advice, they can also run afoul of US tax laws that impose strict penalties for not reporting offshore financial activity.
"If there's no punishment for going offshore, why should anyone stay onshore where they have to pay taxes and live by the rules?" asks Jonathan Winer, an assistant secretary of State for narcotics and law-enforcement affairs. "That's the problem policymakers all over the world are facing."
A conservative estimate puts $5 trillion in banks, mutual funds, and trusts in the world's 35 international offshore banking centers. These range from European states like Ireland and Luxembourg to exotic Caribbean islands like the Caymens and Antigua. All have no or low taxes, flexible regulations, and, quite often, strict secrecy laws designed to attract capital.
Initially, it was the very rich, international spies, drug dealers, and thieves who took advantage of the tax havens and their secrecy. But as the economy's gone global, corporations have increasingly used them to stay competitive. In fact, most offshore money now comes from international companies setting up subsidiaries in low-tax, low-regulation countries to increase their profits and flexibility in the fast-moving global market.
As a result, the international community is pressuring the banking centers to tighten up their regulations and do more to discourage illegal activity. The pressure is beginning to have an effect.
Some jurisdictions, including the Caymen Islands, have even agreed to breach their secrecy laws if drug trafficking or other illicit activity is suspected by a foreign government. That has increased the islands' respectability.
"We don't know how good the implementation is, but at least on paper things have improved," says Jeff Ross, a senior law-enforcement official at the Justice Department.
Those changes have fueled confidence, particularly in Europe and Asia. Their tax laws generally exempt overseas profits, and, as a result, Europeans and Asians have fueled a boom in offshore mutual funds. Valued at $2.4 trillion, the offshore funds now account for almost half the mutual funds sold worldwide. Their chief selling point is their higher-than-average yields.
Dodging the SEC
But those offshore funds generally aren't sold in the US. That's because most of the fund managers refuse to comply with the tough restrictions and paper work imposed by the Securities and Exchange Commission (SEC). The requirements are designed to shield American investors from unnecessary risk, but offshore managers see them more as impediments to the split-second, high-risk decisions that can produce huge returns in the global market. Most would rather exclude Americans and their investments then bow to the SEC.
But like any barrier, there's a way to get over it. Several islands have passed laws that allow anyone to set up an "international business company." If it's done right, American investors with legitimate overseas commercial interests can bypass the SEC. They trade risk for the potential of higher profits. But the IRS' regulations are like a "minefield," says one expert, and an investor has to be careful in doing it.
"You can also open an account with a foreign broker, or you can set up a foreign trust and have the trustees buy the funds," says Denis Kleinfield, a Miami lawyer and expert in offshore international planning.
Avoid those lawsuits
Americans are also opening offshore "asset protection trusts" at unprecedented rates. While they offer no direct tax benefits, they do provide protection from liability suits. "Before anyone sets up an asset protection trust, he has to sign a solvency affidavit that says there are no outstanding judgments or lawsuits against him," says Mario Novello, a New York attorney who specializes in such accounts.
But these, too, are open to abuse and can be used to undermine the American legal system. Ms. Smith, not her real name, has first-hand experience with them. Shortly before asking for a divorce, her husband set up a series of offshore trusts in the Cook Islands, where he deposited most of their assets. Because the Islands generally don't recognize US legal rulings against such trusts, Ms. Smith may not be able to collect any judgment awarded in the case.
"Now, the only way to go after that is to get an American judge to rule that this is fraudulent activity designed to avoid paying support, and, in effect, threaten to put him in jail until he repatriates the money," says Ms. Smith's lawyer, Jack Blum, a money-laundering expert based in Washington. "What this does is put whole categories of people beyond the legal system of their country."
But what Blum considers an unethical skirting of the law, Denis Kleinfield considers thoughtful financial planning. "This is not about rightness or fairness; this is about money," says Mr. Kleinfield, a lawyer. "That's why people sue each other. They want the money."