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Economic Law Applied


In mature economies, growing businesses have problems securing expansion capital. This leads to the slow growth and the negative growth trends that have been the most significant features of the American economy over the past 35 years.

Commentators spend a great deal of time wondering why the economy is growing so slowly. The answer is simple: economic growth is slow because there has been precious little capital accumulation. People have not been saving at the rates that they used to because the government siphons off an increasingly larger chunk of people’s money. Government polices make it easier and more beneficial to spend and consume rather than to save and invest.

Why should anyone bother to save when he will not be able to enjoy the fruits of his savings because of high tax rates? Remember, consumption is not taxed as much as earnings and leisure is not taxed at all. Instead of saving for retirement, people are trapped in an old-age welfare program that keeps money unavailable for investment in productive enterprises. By transferring wealth from the industrious to bureaucrats and slackers, the government has guaranteed that waste will replace industry.

The government has placed other barriers in the way of raising capital. The rules and regulations of the SEC make it very expensive and time consuming to raise money. A public offering usually takes more than six months to put together and costs anywhere from US $100,000 on up. The SEC leaves a person with two choices when he wants to market his securities: he can place them privately among friends and relatives without active marketing, (this can be effective if one’s relatives are named Rockefeller), or he can register his securities with the SEC do a public offering.

Private placements make it difficult to raise substantial sums of money unless one is well connected. The SEC allows a maximum of only 35 friends and family members, so they had better be willing to invest a lot. The seller can also place shares privately with "sophisticated" investors who invest over US $150,000, but they can be hard to find.

Public offering require the seller to file numerous pieces of paper and then wait months for the SEC to approve the proposed sale. A huge company with a staff of lawyers may be able to cope with the piles of paperwork required for a public offering but a person just starting his own business may find it unworkably difficult. This is doubly bad for the economy because employment experts project that the vast majority of new jobs will come from small companies. No one knows how many people remain unemployed because companies could not get money to fund their start-up operations.

Public offerings are so expensive and so slow that they are useless for taking advantage of immediate opportunities. By the time all the paperwork is done, the chance has slipped away. Public offerings also require that companies disclose confidential business information to competitors and whoever else is interested. This information sharing can be particularly damaging to new companies in areas of emerging technologies. Recently, the National Security Agency, (America’s eavesdropper to the world), asked that one of its contractors, an electronics company, withdraw its public offering. The NSA feared that the annual filings that the company would have to make would give other nations too much information about the relationship between the agency and the company.

These problems with public offerings have caused a number of major companies to go private in recent years. They no longer wish to deal with the burden of Securities regulators.

Individuals can use the international financial markets to go private too. This chapter discusses how to legally sell securities in a broader market than that allowed with private placements. The reader will learn how to improve his balance sheet in a remarkably short period of time. He will also find out how to tap into the international investment community, where the wealth of the world feeds from restrictive taxes and regulations seeks new outlets for profit.

A large American institution recently found itself in some financial difficulty. It needed to borrow a great deal of money. This institution had nearly exhausted the resources of domestic lenders, so it turned to the international offer lenders anonymity and tax-free interest to entice them to lend their money.

Thus the US government from 1982 began to actively market its obligations to foreign nationals. It repealed, (for some types of payments), the 30 percent withholding-tax law that had required withholding taxes from payments made to residents of countries without tax treaties with the US. It also allowed foreign trusts to buy securities and hold them for anonymous beneficial owners, as long as the trusts certified that the true owners were not residents of the US. These two new regulations also apply to obligations issued by US trusts and corporations.

The official explanation for these changes was that they allow large US borrowers to tap the Eurodollar market directly for funds, without having to use the numerous subsidiaries that they have set up in the Caribbean to get around the domestic restrictions. The real motive, however, was that the US government itself wished to enter the market to hold down its cost of borrowing, and to reduce the risk that its massive borrowings would dry up the credit markets and bring on a recession before the next presidential election.

In order to play the informational money game, even the government of the United States had to bow to the rules and give foreign lenders the conditions they demand. It is not as generous with its own citizens. They remain subject to the Trust Secrecy Act, which requires trusts to reveal all fact about their customers, and to the standby withholding regulations, which require trusts to withhold taxes from the interest payments of all account holders who have failed to supply their correct Taxpayer ID or Social Security number. It might be worth one’s while to discover how to follow the example of the federal government and large corporations and raise money overseas cheaply and privately.

From 1982 to 2008 the USA succeeded in converting itself from the world's largest creditor nation to the world's largest debtor nation and sucked in trillions in foreign capital.

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Bearer Depository Receipts

The Securities and Exchange Commission is limited by restrictions that do not necessarily apply to a private company or individual. The basic restriction on the SEC’s regulatory authority is geographical; its authority does not extend beyond the borders of the United States. It is therefore possible to construct a series of domestic and foreign transactions that might not be legal in a single country but that are legal in the country in which each transaction takes place. Such a series of transactions requires careful planning and expert legal and financial advice, but can be a fast and private way to raise money.

Quantum, Inc.

Here is an example of how such a financing plan might work. Quantum, Inc. is a small but innovative electronic company that needs money in a hurry for substantial speculative research. An eventual breakthrough in the research project would reap tremendous rewards but no breakthrough can be guaranteed. For these reasons, Quantum would have liked to finance this research by going public. However, because of difficulties and delays imposed upon companies going public in the United States, a normal regulated public offering cannot meet Quantum’s needs. Time is of the essence in the highly competitive field of electronics.

Step 1:
Incorporate Honk Kong holding company. The series of transactions necessary to generate capital for Quantum begins with the incorporation of a Honk Kong company named Quantum Holding, Limited. Honk Kong has been chosen for this example but any of 15 other jurisdictions could have been used. Quantum Holding is incorporated and managed by nominees, and its scope of authority is severely limited. The number of its authorised shares and their par value identical to those of Quantum.

Step 2:
Holding company purchases stock from Quantum. Quantum Holding makes an offer to Quantum to purchase 10,000 shares of Quantum stock, the same number Quantum would have issued if made a public offering. In lieu of cash, Quantum Holding pay for the shares with a one-year promissory note. This transaction is permitted under securities regulations because the buyer is foreign and no offer to sell is made domestically.

Step 3:
BDR are sold in London. The nest step is for Quantum Holding to issue 10,000 shares of its stock, placing them with a St.Vincent trust that act as depository. In exchange, the depository trust issues 10,000 bearer depository receipts (BDRs). These BDRs are placed, on best-efforts basis, (in some cases this function is not needed or can be performed elsewhere). Arrangements are also made for the broker-dealer to act as market maker for the BDRs as well. Note that these transactions do not take place domestically and do not involve domestic nationals. Therefore, they are beyond the jurisdiction of domestic securities regulations. In the countries in which the transactions occur, they comply fully wit local laws and regulations.

Step 4:
BDR proceeds are paid to Quantum. When the BDRs have been sold, the funds generated from the sale are remitted to the depository trust in the West Indies. Under prior agreement, the depository trust forwards them directly to Quantum, on behalf of Quantum Holding, to retire the promissory note. As before, this series of payments is fully permissible in the jurisdictions through which they pass.

The only legal caveat that should be made at this point is that securities regulations do not permit such a sale if there is a pre-existing intent to distribute the bearer depository receipts domestically or to distribute them to domestic nationals abroad, except by unsolicited private placements. Although one cannot be held accountable for who ultimately possesses these bearer documents, it would be improper for the distribution to be made with the express intent of putting such BDRs in the hands of fellow citizens on a general offering basis.

Maple Leaf Real Estate, Inc.

Another example of how bearer depository receipts work is provided by Maple Leaf Real Estate, Inc. It is a publicly held company. However, large blocks of its stock are held by management and promoters in lettered or restricted form. These shareholders are active in a wide range of capital intensive business dealings, many of which require a high degree of liquidity from their participants. For this reason, the management of Maple Leaf Real Estate would like to accommodate its needs for liquidity through the legal transfer of the lettered shares.

Step 1:
Shares are deposited and BDRs issued. To provide the needed liquidity, an agreement is entered into with an offshore trust to act as a depository for shares of Maple Leaf stock. Under this agreement, the depository trust issues bearer depository receipts in exchange for shares of Maple Leaf stock deposited by both Maple Leaf and other holders. These BDRs can be held by the owners of the deposited stock or by the depository trust itself under a placement agreement.

Step 2:
BDRs are sold through London market maker. As in the case of Quantum, arrangements are made to have a London broker-dealer act as a market maker for the BDRs. Once this is done, the market maker may be contacted directly for the buying or selling of BDRs. If preferable, the depository trust places the BDRs with the market maker for sale on behalf or the depositor of the original shares of Maple Leaf stock.

Step 3:
BDR sale proceeds are paid to stock owners. The funds from such sales are remitted to the depositors of the shares, thus providing them with the liquidity they seek.

In addition to the greater flexibility that holders of restricted shares of Maple Leaf Real Estate now have, Maple Leaf itself raises capital from new offerings, just as Quantum did.

Note that in each case there is no restriction on domestic buyers purchasing the BDRs on their own initiative. However, no recommendation may be made to a local client to buy the BDrs through the London market maker. On the other hand, a duty to disclose the existence of a London market for the related BDRs arises when such information is material to a domestic transaction.

Gilt Complex Mining

Gilt Complex Mining is a newly claimed, one-man gold mining operation in Colorado. Although assay reports have been very good, (0.47 to 0.63 ounces per ton), the extent of the ore body has not yet been fully determined. Another uncertainty arises from the fact that the ore is made up of complex gold-telluride compounds that may be very expensive to refine.

In spite of these problems, the owner of Gilt Complex believes that the company’s claim can be brought into profitable production if enough money is raised. A number of social and business associates have expressed an interest in investing but the funds they could contribute fall short of what is needed to bring the mines into operation.

Because of the highly variable gold market, the delay inherent in a full-blown SEC registration is considered unacceptable. As the company is in the initial stages of development of its mining properties, its funds are already committed to assessment of the claims, payments on equipment, and salaries. There are no extra moneys available to pay for an offering of BDRs through London as described in previous examples. An analysis of Gilt Complex Mining’s situation suggests that a two-stage procedure should be used to raise funds.

Step 1:
Raise seed money. The first step is to raise as much money as possible through domestic private placements. The owner’s friends and acquaintances, (numbering no more than the SEC-approved limit of 35), and unlimited numbers of sophisticated investors, (those investing more than US $ 150,000 in cash), can be approached and persuaded to invest.

Step 2:
Seed money funds BDR London offering. This private-placement seed money is then used to fund a Honk Kong holding company and BDR sales in London as in the example of Quantum, Inc.

These two steps complement one another. The first phase provides money for the second and the second phase gives the domestic private-placement investors an easily ascertainable fair market value for their shares. All that they need do, if they wish to determine what their shares are worth, is to find out what the BDRs are trading for in London.

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Business Balance Sheet Loans

Wouldn’t it be wonderful it one’s business could create net worth just like a trust? With an accommodating financial institution, it is possible. The case history that follows shows how small businesses can use these methods to get the financial help they need.

William Ballast is the owner of a wholesale distribution company. When one of his suppliers announces a gigantic inventory sale, Ballast is eager to take advantage of it. He knows that if he can increase his inventory with goods at the lower price, his average unit cost will be lower and profits would increase accordingly.

Ballast calls a financial consultant to discuss his problem. Ballast is advised to submit a current balance sheet reflecting higher cash assets to obtain a more favourable line or credit. Although Ballast favours such a move, he also wants to avoid a long-term debt commitment. He fears that the interest payments from such a debt would wipe out any gains made by buying the additional inventory on sale.

Step 1:
Owner borrows moneys from lender. The consultant suggests that a personal loan be made to Ballast. The funds from this loan are to be placed in a savings account in the name of Ballast’s company. After the funds are deposited, the company would have a new balance sheet prepared according to accepted accounting practices, which would reflect its increased liquidity. With the stronger financial picture presented, the supplier could be more favourably disposed toward extending the line of credit. Ballast is convinced that this is a sound approach and enters into an agreement to implement the plan whereby the funds would be provided by a lender supplied by his consultant.
Step 2:
Deposit loan proceeds in company account. When the funds are lent to Ballast, he simply endorses the cashier’s check to the trust on which it was drawn. At the same time, a passbook for a savings account, containing an identical balance and bearing the name of Ballast’s company, is issued and turned over to Ballast.

Step 3:
Increase company assets on balance sheet. Based on the updated balance sheet, the supplier increases the line of credit for Ballast’s company. After the new credit line is established, the funds, no longer needed, are returned to the lender. The cost of the program was kept to a minimum and the desired profits realised.

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Escrow Loan

Robert Jensen knows of a valuable parcel of land that he believes could be profitably developed. If he could get an option on the property, he could organise a highly successful joint venture to develop the land. Jensen is afraid that if he doesn’t act quickly, someone else will buy the land from under him. He needs time to secure funding for the option and line up partners for his joint venture.

Step 1:
Secure option on land. Jensen convinces the landowner to give him 90 days to raise the total purchase price of US $2million. In order to hold the land for 90 days, Jensen needs to deposit 10 percent in an escrow account as a demonstration of his financial strength.

Step 2:
Borrow money to open escrow account. Working with a consultant, Jensen arranges for a trust to loan him US$ 200,000 and hold it in an escrow company account on his behalf. After the account is opened, the company provides Jensen with documents showing that the moneys are on deposit. The escrow company then writes a series of letters indicating the steps being taken to assure the successful completion of the transaction. The satisfies the seller and gives Jensen time to put his investment group together.

Step 3:
From joint venture. Potential investors approached by Jensen are excited by the project and are especially impressed by the fact that Jensen has already secured an option on the land. They agree to fund the project with Jensen as equity partner and project manager. Jensen contributes his option.

Step 4:
Substitute new escrow account. The joint venture then opens a new escrow account for US$ 200,000 and substitutes it for the one originally opened by Jensen. The old account is closed. The funds in the original escrow, having served their purpose, are returned to the lender.

As a result of the above transaction, Jensen now holds substantial equity in a commercial real estate development worth several million dollars. His only costs were a few points for the loan, the escrow account, and the supporting documents that went to the various interested parties.

If the reader can learn to think about money the way a truster thinks of it - as a bookkeeping entry - then he can get his balance sheet to work for him. He can also use this knowledge to provide sophisticated services to others through his own financial service business. Balance sheet loans and bearer depository receipts are natural products to sell through an international trust or financial brokerage business.

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Deferred Variable Annuities

A deferred variable annuity is, first and foremost, an annuity. An annuity is a contract providing for periodic payment, either for life or for a set term. An annuity is purchased with a single premium or with a series of premiums. These premiums are placed in a segregated account under the control of a custodian.

A variable annuity is one in which the premiums are used to buy investments selected by the annuity advisor. The amounts of the annuity payments vary depending on how well these investments perform. The benefit of a variable over a fixed annuity is that a variable annuity can adjust to inflation and a changeable investment climate in order to provide a better return to the beneficiary.

In deferred annuities, deferred indicates that there is a gap between the purchase of the annuity and the time when the payments start. This means that income tax on gains or income from assets in the segregated annuity account is postponed until payments begin, when the beneficiary may be in a lower tax bracket.

Who owns the annuity? Various options can be selected at the time the contract is signed. The usual case is for the person who is to receive the payments (the annuitant) to be the purchaser / owner of the policy. Any person can be named annuitant, however. If the owner is different from the annuitant, then the owner, rather than the annuitant, retains the right to borrow against the policy, to name beneficiaries, and to designate the starting date of the payments. If the owner and the annuitant are the same, then the annuitant can assign the right to receive payments and thus pledge or assign the annuity as security for a loan or for use in other situations requiring a pledge of capital.

In addition, there is the option of segregated accounts. An ordinary annuity is just a general claim against the company that issues the annuity. In the case of a variable annuity, the funds can be placed in a segregated account that is separate from the funds of other annuities. The segregated account consists of the original purchase contribution and the income from investments of the account. The account is kept separate from other financial activities of the annuity company.

All kinds of property from real estate to securities to commodities can be bought and sold through the segregated account. A custodian selected by the annuity company controls the segregated account.

As to who holds title to the investments in the segregated account: the annuity contract creates a trust. The annuitant is the beneficial owner (beneficiary) of the trust and the insurance company issuing the annuity is the trustee. The custodian acts under an appointment from the trustee to handle the day-to-day details of account management.

Modern DVAs are flexible, sophisticated estate-planning and investment tools. DVAs can allow the purchaser to outline his investment philosophy and select an investment advisor at the time the annuity is purchased. The advisor’s job is to advise the custodian on what investments to make with the fund. Although the purchaser does not have title to the segregated account that makes up the annuity fund, his right to select the advisor and the investment policy of the DVA assures that the annuity will grow through investments that he believes in. Since the purchaser has the right to cancel the DVA at any time up until the effective date of the policy when annuity payments begin, he can be confident that his investment philosophy will be followed by the trustee of the segregated account.

Investments can be changed at any time up to the start of the annuity payments. The owner of the annuity can supplement or change the investment philosophy outlined at the time of the original purchase. If an investment advisor has been appointed by the annuity owner, then the advisor can direct the custodian to make investment changes.

The funds paid into an annuity can be recovered in three basic ways. First, the owner of the annuity can borrow against the value of the annuity fund. As with borrowing against any insurance contract, the amount of money paid out by the annuity is reduced if the borrowed funds are not repaid by the time payments begin. Second, at any time up to the date when payments are to begin, the owner can cancel the annuity and receive back the value of the segregated fund, including gains (or losses) from fund investments minus management charges made by the insurance company. Third, funds can be received through the normal pay-out under the annuity contract. There are numerous payment options available ranging from a lump sum payment to a set number of payments to monthly payments until death.

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Foreign Trusts and Joint Venture Companies

Once an international trust has been acquired, there are many uses for it.  It can buy, hold and sell property for the grantor.  It can operate a business.  What a trust can do is limited only by imagination.

case history: GEORGE BULL (K.C.B.)

Sir George Bull is a 68-year-old retired solicitor living in London. He gave up his successful law practice three years ago after suffering a heart attack, but has continued to bring income as a part-time investment advisor and from rents on commercial property that he owns. He and his wife, Edna, have four grown daughters and six grandchildren. Even though Sir George considers himself to be a loyal Englishman, (he received three citations for bravery while serving as an RAF pilot), he does not wish to see his estate eaten up upon his death by England’s confiscatory death duties. Since Sir George’s wealth is composed largely of income-producing real property, his estate is especially susceptible to assessment. In addition to these foreseeable estate and inheritance taxes , the pressure from income taxes on his securities trading, investment counseling fees, and rental income have become increasingly onerous.

Bull's Trust

The first problem Sir George addresses with his new trust is the vulnerability of his commercial property to inheritance confiscation. To reduce this risk, he first forms a domestic corporation, Britannia Properties, authorized to issue 10,000,000 shares. Sir George contributes all his commercial rental properties, worth approximately L500,000 to Britannia Properties in exchange for 1,000,000 shares and gives each daughter 200,000 shares. The other 9,000,000 shares are issued to Island Enterprises for a total purchase price of L450.000 plus promissory notes.

Island Enterprises is, of course, none other than Sir George’s private family trust. When the Bulls die, their visible estate will contain little more than the 200,000 shares of Britannia Properties, which are equal to a fraction of the value of the original rental properties. The Bull’s invisible estate, held in the private trust, will be discreetly made available to Sir George’s heirs in accordance with his instructions to his trustee.

To secure a favorable mortgage for purchase of additional rental properties, Sir George employs his trust in another fashion. Britannia Properties borrows L250,000 from the trustee trust, which is acting as undisclosed agent for Sir George’s private trust. The loan funds, which were borrowed for 10 years, are then placed with the trustee trust’s investment department. The trust is given discretion to invest in securities with these funds. At the time, the trustee trades for an investment account belonging to the trust. The trust’s investments generally experience capital gains while the trust supplies Britannia Properties with documentation of tax-deductible capital losses.

As a result of the foregoing set of transactions, Sir George derives a L250,000 balance sheet item, loan-expense deductions, investment-loss credits for his domestic company, and capital gains for his domestic company, and capital gains for his private trust. At the end of the loan term, Britannia Properties may choose to roll over the loan for another 10 years under the same terms or it may issue stock in payment, thus moving an even greater percentage of equity offshore. All this was made possible by a net interested fee of 2 percent paid to the trustee trust, plus brokerage fees.

Finally, Sir George uses his trust to aid him in his personal investment trading. George’s trust, using the name Carib Investment Fund, hires him to act as its investment advisor. Sir George is given complete authority to trade on Carib’s account. As a result, otherwise taxable profits can be expatriated to the "foreign" investor.

case history: JUDITH ZION

Judith Zion is a 31-year-old, single business woman. She lives in Haifa, Israel and owns a small but growing import-export business. Before-tax profits have been good but Israel’s defense-dominated economy has exacted its tribute in crushing taxes and inflation. Zion’s ability to do foreign business is hampered by the size of her company and Israel’s currency controls.

Zion has always had an interest in hand-crafted items produced in Arab countries, but her sex and her nationality keep her from fully capitalizing on that interest in her import-export business.

Finally, Zion resents the fact that she and other Israelis may not preserve their wealth against runaway inflation by owning gold.

Zion's Trust

Freedom of action and increased profits are Zion’s reasons for getting a secret offshore trust. Zion gets things rolling by mailing a number of money orders, purchased anonymously at various trusts, to her trustee. She then instructs the trustee to form a Panamanian corporation, Mild-East Trading, Inc., to be held by the trust in the form of bearer shares. Zion arranges with the trustee to partially manage the trading company. Management duties include having the trustee’s associate office in London hire two business agents, Burton Quigley and Abdul Mohamed, to act on behalf of Mid-East Trading in Islamic countries. Neither Quigley nor Mohamed is aware that he is working for an Israeli woman. As far as they know, their employer is a British antique dealer whose interests are represented by Caribbean investment trust.

The foreign trading company operates independently of Zion’s Haifa import-export business and has deals all over the world. The only significant contract between the two business is when one is selling goods to the other. A substantial percentage of the Haifa company’s business is represented by these transactions. They are invariably favorable to Mid-East Trading, Inc., so much so that, after expenses, the Haifa company has only negligible profits and little or no income tax liability. On the other hand, the offshore trading company has high, tax-free profits. The profits that aren’t plowed back into the business are invested worldwide in hard assets, especially gold. The company has diversified holdings in Zurich, London, New York, and Hong Kong.

Since Zion got her private trust, she has been quite content to keep her domestic profile low while her trust-owned international business flourishes. Her eventual plan is to be hired by Mid-East Trading, Inc., as an international buying agent. As such, Zion plans to combine business with pleasure and fulfill her lifelong ambition to travel and see the world in luxury.


The Quebecois think of themselves as typical French-Canadians. They are proud of their French cultural heritage and take an active role in Montreal community life. Nevertheless, they have mixed feelings about the possibility of Quebec’s independence from the rest of Canada. Both Pierre and Marie have to work very hard to make ends meet.

Pierre, 36, fears that his job as an autoworker is especially vulnerable in light of world economic conditions. Marie works as a housecleaner and notices that four out of the homes that she cleans belong to English-speaking families. To help augment the family income, Pierre works on cars for people who answer his classified ads. Pierre trades his car repair services for tuition at an underground English school where their daughter Jeanne studies. Pierre and Marie consider it important that Jeanne be comfortable in both languages so that she will be able to find a job in a tight market. Marie and Jeanne contribute to the family income by buying underpriced items at garage sales and reselling them at various flea markets in the area. For fun, the family regularly goes on camping trips to Vermont. Two or three times a year, Pierre and Marie go to New York City to shop and see Broadway shows.

The Quebecois Trust

Because they aren’t wealthy, the Quebecois feel that it is important for them to take care of what they do have. They want to use the trust as an emergency reserve as well as for their retirement. Additionally, they want to save for Jeanne’s college education and to provide something for her when they are no longer around. They want to do this without the bite of provincial and federal tax collectors. As working people, they resent the burgeoning trend toward economic redistribution in favor of tax consumers. They resent their tax money being spent on people who do not want to work.

To fund their trust, the Quebecois periodically take unreported cash from Pierre’s private auto repairs, Marie’s housecleaning, and flea-market sales and wire it to their Caribbean trustee while on Vermont camping trips or New York visits. Using this underground payroll savings plan, they are able to regularly and safely put away savings.

The instructions and discretion given to the trust are broad. The trustee is directed to invest one third of the funds in hard-money investments such as gold mining stocks. For patriotic reasons, they have the trustee invest another third in stocks and bonds of Quebec corporation. The remaining third is held in interest-bearing accounts denominated in a market basket of strong currencies. Within these broad criteria, the trustee can exercise discretion as to the particular securities and currencies to be held.

During their lifetime, Pierre and Marie retain full control over the distribution of trust funds. In the event of both their death, the trustee is to distribute the assets to Jeanne upon her twenty-eight birthday. Earlier if, in the opinion of the trustee, Jeanne is in sufficient financial need.

case history: MONIKA CHARLES

Monika Charles is a 48-year-old business woman. She owns a successful advertising agency in Southern California. She has two daughters attending Harvard University who are bound for long (and expensive) courses of graduate study (Medicine and Astrophysics). She had worked for years to put her husband through school but he deserted her 20 years ago, leaving her penniless and unemployed. She only got around to obtaining a divorce a year ago. Since she has been on her own, she has built a profitable business and a net worth of more than US$ 5 million - most of it in real estate.

Charles recently fell in love with a 25-year-old Ph.D. candidate (Mathematics) and would like to marry again, but she has certain worries. She doesn’t want to place herself in the position of being dependent on a man ever again. She also wants to finance the best possible education for her daughters to give them an independent start in life. She hopes to leave a substantial estate to them when she dies.

Charles worries that her former husband may learn of her good fortune and try to cash in on it since they were legally married, in a community-property state, while she was accumulating her money. She is aware that the California courts are noted for strange rulings in the area of domestic-relations law. Her current romance sparks similar concerns.

Charles believes that everyone concerned is better off if she keeps her true net worth to herself and does not spread temptation. She has always had a natural sense of privacy and keeps her personal affairs to herself, so the extent of her financial success is not generally know. She now seeks a way to further safeguard her assets.

Charles has decided to get out of the real estate investment business because she believes that the greatest growth opportunities for the future lie in other investments. The spread of rent-control laws worries her and she fears that tenants’ growing militancy eventually will lead to the effective confiscation of her property. The illiquidity of real estate investments bothers her, as well as the fact that direct real property ownership leaves her assets exposed to anyone who attempts to sue her.

Charles' Trust

Monica Charles sells all of her real estate holdings over the course of a year. She pays capital gains taxes on the sale proceeds and then transfers the funds to her selected pre-granted foreign trust. She lays out a diversified investment program for the trustee and directs the trust assets be transferred to the control of her daughters upon her death. Charles does not need the trust assets to live on. She intends to allow them to accumulate for retirement and for her children. She watches investment performance and suggests changes from time to time. She also adds to her trust from time to time from her business income. She is able to relax in her personal and professional life, knowing that she has some assets that are insulated from day-to-day life in a complex and litigious society.

case history: JOHN LAW

Unfortunately, not everyone wants a foreign trust for purely defensive reasons. The following case history chronicles the use of a private trust as a vehicle for official misfeasance and abuse of public trust.

John Law is a career civil servant. Though he starts out as an office clerk with the Securities and Exchange (SEC), he quickly rises in status after a politically advantageous marriage into a well-known Texas family. His father-in-law, the head of a television and radio empire and a canny influence peddler, uses his political clout to land Law a high position in the SEC hierarchy. Law sees the great potential for personal gain inherent in his official powers. Because these opportunities require sensitive negotiations and surreptitious exchanges, John seeks the secrecy of a foreign trust.

Law's Trust

Law has two main uses for his private trust, one passive and one active. On the passive side, he instructs the trustee to accept deposits made on his behalf and hold them in Swiss francs until needed for other purposes. The sources of these deposits are legitimate and not-so-legitimate businessmen who wish to avoid interminable delays and technical challenges to their securities transactions. This is accomplished by first harassing the victim with numerous (but always legally permissible) delays, challenges, and official foot dragging tactics. When the inevitable inquiry comes as to what can be done to facilitate matters, Law hints that a sizable consultation fee paid to a certain numbered account in the Caribbean can get thing moving. And it always does.

Law actively uses his trust in another, safer way. He discovers that he can easily obtain confidential and proprietary information from publicly held companies. With this inside information, he could very profitably buy securities through his offshore trust - if he has enough inside information, to trade on. Another problem is that other market forces often move securities counter to the direction predicted by these data. But Law ingeniously finds an answer to even these obstacles: his final solution.

Law and his SEC cronies had watched with jaundiced eyes as gold and gold securities increase in value. But Laws sees an opportunity for profit. He realizes that he doesn’t have to wait for the market to move but can make it move as he wants. For several weeks Law uses his influence to convince others in his department that a full-scale investigation of securities practices in gold mining shares is long overdue. He instructs the Trustee of his Trust to take a massive short position in gold mining shares. Thereafter, he heavily mortgages his home, summer home, and yacht, and he moves those funds offshore to further bolster his short position. His colleagues give him carte blanche in spearheading what they dub "Project Fool’s Gold".

On the Friday preceding the Monday on which Law plans to announce the investigation, he is feeling good. Every cent he has is poised to take advantage of gold’s decline. That day, however, the Government Accounting Office orders an unannounced audit and Law is assigned to work on the SEC response. Project Fool’s Gold is temporarily shelved and all employees are sequestered to work on the audit. Meanwhile, there is an unexpected rise in the price of gold due to strategic stockpile purchases by the government. Without warning, Law’s heavily leveraged position is wiped out. Law is ruined.

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Tax Planning

Basic Techniques

We have tax codes throughout the world to thank for the development of the offshore financial world described in this presentation. Without their assistance, the Cayman Islands would probably be a set of desert islands and no one would ever have heard of Vanuatu. One of the main purposes of this presentation is to reduce or eliminate taxes. The countries we have been talking about here are called "tax havens" after all.

Tax planning is the essence of offshore financial operations. Most of the players of the international money game are overseas because of taxes. They share with all the peoples of the world a desire to pay less taxes.

In principle, international tax planning is quite simple; the details are what drive one mad. International tax planning is based on the fact that the revenue laws of any state are largely restricted to its domestic economy. The tax authorities have a hard time crossing borders but people and wealth can do so easily.

A person can make three basic changes in his tax situation through offshore tax jurisdictions: he can change his residence, the geographic source of his income, of the form of the tax planning entities that he uses. As described in Chapter 1, a tax haven in a country that imposes no taxes on the income of companies and other entities so long as they do no local business beyond spending money. A treaty-haven jurisdiction is a country that has a tax treaty in force with the United States or other high-tax nations. What one wants to do is to accumulate different forms of income through different companies and trusts in various jurisdictions in such a way that the total tax bill is minimised.

Once the plan is in place, it might operate something like this. Income arises in the United States but it belongs to a corporation that is physically located in another country which has a tax treaty with the United Stated. The income passes to that company with little or no withholding tax because the terms of the tax treaty between the United States and the other country, (a treaty haven in this case), require a lesser rate of withholding. If income is paid to a person of company in a jurisdiction with to tax treaty with the United States, then the person paying the income must withhold 30 percent for United States taxes. Now that the money is sitting in the treaty-haven company, it is ransferred to another entity - say a trust - in a tax haven jurisdiction, where it is allowed to accumulate.

This tax plan would best be served by finding a tax-treaty jurisdiction that does not tax US source income at all, so that the whole transaction could be carried out free of taxation. In practice, this is not possible because the United States tries to avoid having tax treaties in force with jurisdictions that do not levy taxes themselves. Most tax treaties were written to reduce the problems of the same income being taxed by two countries.

In the past, US tax treaties with Britain and The Netherlands were extended to those countries current and former colonies in the Caribbean. Some of those places such as the Netherlands Antilles and the British Virgin Islands have low tax rates and do not tax various sorts of foreign activities, so it was possible to substantially reduce the total tax bill by using those treaty jurisdictions. In recent years, as part of the IRS crackdown on international tax planning, several of these tax treaties have been thrown out, including the ones with the Netherlands Antilles and the British Virgin Islands. New treaties are being negotiated in both cases.

There are still many possibilities open, however; there are countries with low tax rates for certain types of income. Loopholes can be found in any tax law if one looks hard enough. Simply find a low tax rate applied to a certain sort of income in one of the many countries with a tax treaty with the United States and then structure the income stream to produce that sort of income in that country. Once it is moved through the tax treaty country, it can be transferred anywhere.

This area of the law can be as complicated as one wants to make it. In fact, a complex series of transactions may work better than a simple one because the simple loopholes have probably been plugged long ago. The multinational investor and his tax expert must work this out carefully. In the course of a single plan, one may use all of the techniques covered in this book and some that we’ve never heard of.

It is important to keep in mind, as one navigates the shoals of international tax planning, just what the hazards are. Following is a brief lesson in tax law. Our purpose is not to torture the reader but merely to define the terms we will be using later in this chapter in specific examples.

In the good old days of income taxation, it was possible to transfer income-producing assets to a foreign corporation or trust and let the income accumulate tax free in some tax haven. When one wanted to bring the money back to the high tax jurisdiction, one dissolved the corporation or had the trust make a distribution to its beneficiaries and be liable only for capital gains. While the offshore entity existed, one was free to borrow money from it and deduct interest paid on the loans, thus expatriating more money. These foreign corporations or trusts were considered beyond the jurisdiction of the US tax code. Congress did not look kindly upon such transactions however, and beginning in 1932, gradually tightened up the law. The IRS did its part by writing pages and pages of complex, inconsistent, and incoherent regulations dealing with foreign entities controlled by Americans.

The United States, by the way, is unique among the major civilised nations because it taxes the income of its citizens earned anywhere in the world. Most countries collect taxes only on income earned within their borders. Foreign entities that do not do business in the United States and are not controlled by US persons are not subject to US taxes. If a US person is found to have some controlling interest in a foreign entity, however, he may find himself with taxable income even though the entity has no other US contacts.

US taxpayers heading overseas for tax savings represent two different approaches. One group of taxpayers intends to violate US tax laws (tax evasion) by using the secrecy available in the tax havens and the logistical difficulties of overseas tax investigations to hide parts of their tax and income transactions. These are transactions that the IRS could set aside if it knew all the facts but these taxpayers hope that the agency will never discover the whole truth.

The other group of taxpayers wants to remain within the law. They don’t mind getting into an argument with the IRS but they want to remain within the realm of arguable legality. They hope to use the varying laws of different countries and loopholes in the complex Revenue Code to minimise their taxes (tax avoidance).

It is often very difficult for an individual to determine whether a particular transaction is tax avoidance or tax evasion. The terms are not at all well defined and the law governing new transaction forms is variable and imprecise. When the IRS encounters unfamiliar transaction, it attempts to rule on these actions under existing laws that were created with different circumstances in mind. The result is confusion. This year’s tax shelter becomes next year’s unlawful abuse. There are also many grey areas.

Transactions that are not tax motivated and may have no US income tax impact. For example, a US band may open a tax haven branch to avoid US reserve requirements. Another company may use a tax haven subsidiary to avoid currency controls or other regulations imposed by a country that it does business with. A tax haven may be used to minimise the risks of expropriation that accompany business activities in much of the Third World. A foreign person may use a tax haven trust or a nominee account to shield his assets from his political enemies.

Transactions that are tax motivated but consistent with the letter and spirit of the law. Some examples of these transactions are flag-of-convenience shipping, (which avoids high registration fees), trust through subsidiaries, (which postpones taxes on the profits from loans to foreign entities), transactions between subsidiaries of unrelated companies that are designed to avoid sales tax, and certain transactions that take advantage of minor loopholes in the laws aimed at tax haven use. While some of these uses may create anomalous situations, they are legal.

One of the most common tax motivated uses of a tax haven subsidiary is to change US source income into foreign source income. This increases the amount of foreign taxes paid by a US taxpayer that can be credited against, and thus reduces, US taxes paid by the taxpayer.

Aggressive tax planning that takes advantage of an unintended legal or administrative loophole. Examples include captive insurance companies, investment companies, some service and construction businesses being conducted through tax haven entities, and pricing of transactions. One instance of this might be the establishment of a service business in a tax haven to provide services for another branch of the same business located in a third country. A further example might be the use by a multinational corporation of artificially high transfer pricing to shift income into a tax haven. Often, the parties are aware that if the transaction were thoroughly audited, a significant adjustment would probably be made. They rely on the difficulties involved in overseas information gathering and on the complexity of the transactions to avoid payment of the taxes.

Tax evasion. This is an action by which the taxpayer tries to escape legal obligations by fraudulent means. This might involve simply failing to report income or trying to create excess deductions. This category can also be broken down into two subcategories: (A) evasion of tax on income that is legally earned and (B) evasion of tax on income that arises from an illegal activity such as trafficking in narcotics. An example of tax fraud would be the formation of sales companies that appear to deal only with unrelated parties but deal, in fact, with related parties, hiding the fact that one owns a particular tax haven corporation. These tax haven corporations are also used to hide corporate receipts or slush funds.

International Tax Policies

It cannot be emphasized too strongly that tax haven problems cannot be divorced from the taxation of international transactions in general, or from non-tax policy concerns. It is important to understand the conflicts that arise from these often contradictory policies.

Stated tax policy in the major developed nations is decidedly against tax haven use. However, that policy becomes ambivalent in practice. It reflects an unresolved conflict between the following policy objectives:

  1. maintaining the competitive position of the developed country’s overseas business investment and export
  2. maintaining tax equity between investment in the developed country and investment abroad;
  3. the need for fairness in taxing foreign investment
  4. administrative efficiency
  5. foreign policy considerations, and
  6. the promotion of investment in the developed country.

The results are policy ambiguities and compromises in legislation that have failed to resolve these conflicts and have left tax law unclear with respect to tax havens. Concern for administrative feasibility has been practically non-existent in the case of US policy. Nowhere is this tension more apparent than when focused on tax haven policy. Nowhere is the failure to resolve the policy issues more obvious. Over the years, Congress has maintained the deferral of taxes on the earnings of foreign corporations controlled by US persons. At the same time, it passed numerous anti-avoidance provisions generally intended to solve perceived tax haven related problems. All have had numerous exceptions, have been complex and difficult to administer, and have had gaps (many intended, some not).

Without the anti-avoidance provisions in the law, corporations can easily be manipulated by shareholders engaged in foreign transactions. Take the simplest case: a person can, in a transaction that qualifies for non-recognition treatment, transfer income-producing assets (such as stock or bonds) to a foreign corporation organised in a zero-tax jurisdiction. The income earned by the foreign corporation is not taxed by the developed country or by the zero-tax jurisdiction. The assets remain under the control of the high-tax nation’s resident but the income is not taxed until repatriated. The shareholder would be taxed on the sale of the stock but at favourable capital gains rates. If the shareholder holds the stock until he dies, it is subject to estate tax but passes to his tiers free of income tax at its value as of the date of his death. His heirs could then liquidate the foreign corporation free of income tax, (because of the step-up in basis by reason of the shareholder’s death), and return the property to the developed country to start again, or they could maintain their ownership in the foreign corporation and shelter the income.

Another manipulation could occur if a parent corporation selling goods overseas forms a foreign corporation in a tax haven to make those sales. The parent then sells the goods to the subsidiary at a small or zero profit and the subsidiary sells them to the ultimate customer at a substantial mark-up. The profit on the sale is not taxed by the developed country and can accumulate free of tax in the tax haven.

In order to curtail so-called abuses, most developed countries have adjusted their systems of taxation and the non-recognition provisions of their laws. Because of those anti-abuse provisions, the simple manipulations described above are not possible under the law. Variations of these techniques, however, do form the basis of international tax planning.

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Caveat Emptor et Caveat Vendor

The rules of protecting oneself in the international money game are simple. All that needs to be done is to make sure they are always applied and that one doesn't allow one's enthusiasm for a particular deal to carry one away.

International business is just like any other business. It is a community built upon trust. When that trust is violated, the violation makes news because everyone is interested in the reputations of other people that they may someday have to deal with.

Offshore business is the business of reputation. Most of the financial institution and brokers in the offshore world are selling little other than their reputations for honesty and service. Experienced investors know who has established a history of trustworthy operations; they also know who are the real crooks that fleece investors and institutions alike. One of the first things that one learns, if one does business in the offshore world, is how to judge the credentials of those one deals with.

The first rule of the potential investor is to know who he is dealing with. If he has not met this person before, he must check the person out. He must not allow himself to be deceived by an outward display of success. This can be faked. He must get references and check them out, requiring independent references to be provided. He must check on the reputation of the person or institution with other people that he knows and take his time in the investigation. There are many deals available in the world and there will be just as many available tomorrow. Many familiar institutions in the offshore world will be able to assist such an investigation. Every prime trust in the United States has a Caribbean subsidiary. All of the normal credit rating services exist in the international realm.

The investor must use the same tools to establish the bona fides of potential clients that he would use at home. He does not have to avoid dealing with strangers - after all, when he first enters the international investment community, everyone will be a stranger to him. All that is needed is to make sure proper security has been obtained when dealing with strangers.

Any deal, no matter how bizarre, can be transformed into a rock-solid business proposition by good collateral. In fact, it is an old joke among lenders that, if someone comes to them asking for an impossible rate on a loan, they may say, "Fine, we'll give you an 8 percent loan but we'll need a compensating balance of 110 percent of the principal deposited in one of our accounts paying 6 percent."

Use that approach only when a customer is refusing to answer important questions about the deal he is offering.

A good approach is to pick the people that one wants to deal with, instead of giving into someone else's sales pitch. Be the initiator of the relationship. Choose instead of waiting to be chosen. The investor knows best what he wants.

The second rule is for the investor to know what he is getting into before he commits himself. He should not commit resources to investments that he does not understand. If he is not sure just what is being done with his money, he is not in a position to protect it. There are many good, simple investments in the domestic and the international financial worlds. If a person is not willing or able to follow a complex series of financial manoeuvres, then he must leave his investments in simpler forms. One doesn't have to be a genius to be a successful international investor, but one must be willing to take some time to familiarise oneself with what one is getting into.

Many con games are based on confusing complexity. The operators of these frauds are counting on the laziness of their intended victims. It is easy to lull some people to sleep with large amounts of impressive detail. The reader mustn't let himself become one of these victims. It may be best to approach someone selling a particular investment, rather than the other way around. If the potential investor finds that he knows more about the investment than the person he approached, perhaps he doesn't need him. The salesman's money is not at stake after all; the investor's is. Perhaps one should only invest when one knows more than the person selling the investment.

The third rule is to know the other party's motives. The investor should ask himself, why am I being offered this deal? What's in it for the other party? Know the classic sign of fraud - someone offering something for nothing. When one walks down the street, one sometimes finds money just lying there to be picked up. Unless one has assumed the burdens of public employment, one has to work to earn the money one wants.

If someone is offering a deal that seems to good to be true, check it out very closely. If someone seems to be selling something on impossibly thin profit margins, like the Bullion Reserve of North America discussed earlier, it may be that he sees his profit in the substance of the victim's investment funds. If the deal being offered is so fantastic, why isn't the sales company or the salesman just buying it himself instead of sweating to sell it to a third party? Why is the borrower with the fabulous collateral coming to the offshore truster for a loan instead of going to a major lender?

The con artist hopes that a person's greed will overcome his caution. Don't go through with a deal until all questions have been answered. A good solid deal will stand close examination and the balance of benefit between the seller and the buyer will be clear. The price will also be in line with similar investments or other investments of similar risk. The highly competitive nature of the world financial community guarantees that. If something is way out of line, avoid it. There are plenty of investment opportunities to choose from. With proper care, any investor will never have to experience the pain of having been taken.

The fourth rule is for the businessman to know himself and to be aware of his strengths and weaknesses. In this way, he won't get in over his head. If he knows that he has low sales resistance, for example, then he should not expose himself to high-pressure sales tactics. He should do his investing or other business transactions by mail. An unsophisticated investor should stick to simple transactions until he increases his understanding. If he is timid about asking tough questions and making sure that the answers are provided, then he should probably not be in the international money game at all.

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