Offshore banking

Offshore banking (역외금융/域外金融) is characterized as an out-out (외-외/外-外) transaction. Offshore banking may be simply defined as borrowing from and lending to non-residents. So the offshore financial center (OFC) is a jurisdiction where such out-out transactions far outweigh transactions related to the domestic economy. The most famous OFCs are London, Singapore, Dublin, Cayman Islands and Labuan, among others, typically in a low tax jurisdiction, and lending to a bank or a company located outside the country.

The Korean government wishes to see Incheon Songdo, Seoul Yeoido or Jeju Island established as an OFC in the Far East. As for Korean businessmen, Labuan of Malaysia and Carribean Islands are preferred among others.

Key words
offshore bank, offshore financial center (OFC), tax haven, harmful tax practices, surveillance

Advantages of Offshore Banking
The advantages out of offshore banking typically include: - Greater privacy with respect to bank secrecy - Low or no taxation (i.e. tax havens, 조세피난처/租稅避難處) - Easy access to deposits (at least in terms of regulation) - Protection against local political or financial instability.

Emulating the unique services of Swiss banks operating in a permanently neutral state, offshore banks may sometimes provide their clients with reliable offshore banking access to politically and economically stable jurisdictions. This will be an advantage for residents in areas where there is risk of political turmoil, who fear their assets may be frozen, seized or disappear. However it is often argued that developed countries with regulated banking systems offer the same advantages in terms of stability.

Some offshore banks may operate with a lower cost base and can provide higher interest rates than the legal rate in the home country due to lower overheads and a lack of government intervention. Advocates of offshore banking often characterise government regulation as a form of tax on domestic banks, reducing interest rates on deposits. Offshore finance is one of the few industries, along with tourism, in which geographically remote island nations can competitively engage. It can help developing countries source investment and create growth in their economies, and can help redistribute world finance from the developed to the developing world. Interest is generally paid by offshore banks without tax being deducted. This is an advantage to individuals who do not pay tax on worldwide income, or who do not pay tax until the tax return is agreed, or who feel that they can illegally evade tax by hiding the interest income.

Some offshore banks offer banking services that may not be available from domestic banks such as anonymous bank accounts, higher or lower rate loans based on risk and investment opportunities not available elsewhere. Offshore banking is often linked to other structures, such as offshore companies, trusts or foundations, which may have specific tax advantages for some individuals.

Many advocates of offshore banking also assert that the creation of tax and banking competition is an advantage of the industry, arguing with Charles Tiebout that tax competition allows people to choose an appropriate balance of services and taxes. Critics of the industry, however, claim this competition as a disadvantage, arguing that it encourages a "race to the bottom" in which governments in developed countries are pressured to deregulate their own banking systems in an attempt to prevent the offshoring of capital.

Legal Issues on Offshore Financial Centers
Korea's admission to the Organization for Economic Cooperation and Development (OECD) in 1996 ignited the inbound and outbound flows of capital. Several Korean corporations embarked on investment in the so-called tax havens like Cayman Islands, Labuan and Dublin. Until the 1970s, the (OFCs) around the globe had been tapped only for the purpose of borrowing foreign capital necessary for the development of the nation. Since the 1980s, OFCs have been used as a gateway to foreign investments in line with the improved Korea's balance of payment conditions.

As the international funds flow to the OFCs making use of looser regulation than any other financial markets, OFCs attract more and more capital around the world. International banks, insurance companies, fund managers, representatives of the special purpose vehicles (SPVs) related with securitization are mushrooming in those financial centers. More often than not OFCs are criticized for money laundering, tax competition and other unfair transactions. The Korean government, however, has a master plan to establish a regional financial hub in East Asia by making Incheon and Jeju Island an attractive offshore market.

Harmful tax practices
On the other hand, harmful tax practices staged in those tax havens are increasingly put under the surveillance of nations concerned. OECD is leading the project to eliminate such practices to preserve the integrity and fairness of the tax systems of Member States. In particular, the United States is alert to the movement of unidentified funds through many OFCs. In this context, the Korean government is reinforcing the regulation and supervision of the offshore banking activities of Korean financial institutions and companies. Authorities' attention have been paid to the attempted tax evasion and unfair trading of securities in violation of the Korean tax law and the foreign exchange-related laws.

Mechanism of offshore banking
The mechanism of the OFCs around the world can be explained as below in brief.

Take an example of Hankuk Tyre. There are regulations concerning Korean financial institutions and enterprises operating in OFCs, which usually raise and manage "out-out" funds. The taxation of profits from the offshore funds invested by the tire manufacturer would make an interesting issue in this regard.

In general, the preoccupation of offshore fund managers is to give more dividends to the investors than expected. So every OFC levies no or nominal tax on revenues arising out of such funds, and makes convenient or streamlined the chores of establishment of a company, calling of shareholders' meeting, distribution of dividends and so on. It is allegedly offshore funds stationed to OFCs that commit such illegal activities as foreign exchange speculation and manipulation of stock prices. However, such activities must be subject to strict regulation of each government.

Illegality at issue
In terms of illegality, the effect of activities at issue depends on the nature of provisions. If a fund manager violates provisions of the Foreign Exchange Transactions Act, which aims at law enforcement with little legal impact to the violating activity, his activities are not always null and void keeping the legal status of funds intact, though he could be subject to administrative fines.

Therefore, it is not advisable to determine the activities of offshore funds in accordance with local laws and regulations. It will thwart the international banking activities related with OFCs because international competitiveness depends to some extent on how to exploit OFCs. In this regard, it is contrary to the national agenda to make a regional financial hub that the revenue from the offshore funds is directly acknowledged as that of a local investor, although the fund is invested and directed by its beneficial owner.

Conclusion
In conclusion, the government had better to change its OFC-related tax policy looking at the reality. If an offshore fund turns out to be profitable, its sponsor should pay relevant tax on the capital gains and other income derived from the fund, and its whole profit should not be construed as, and integrated into, its sponsor's domestic income for the tax purpose. It's because the offshore fund is recognized legally and economically as an independent and separable entity from its beneficial owner.