Offshore banking evokes images of shady businessmen stashing millions of dollars away in secret bank accounts, in exotic locations, to avoid paying hefty taxes.

The image is unlikely to ever fade away completely, but today offshore banking has become a legitimate way for thousands of Europeans to manage their finances. Mega-rich sports stars, such as Formula One World Champion Michael Schumacher, and A-list celebrities, such as Tom Jones, have become tax-exiles to save money, while hundreds of ordinary rich people have shifted their assets to offshore centres to take advantage of tax-saving schemes.

There are plenty of offshore centres from which to choose, from the Channel Islands to the Cayman Islands to Luxembourg, but when it comes to offshore banking one country always springs to mind – Switzerland. With four financial centres of its own – Basel, Geneva, Lugano and Zurich – no other country comes close to matching Switzerland, which manages around 30 per cent of all cross-border private assets.

One of the main reasons for Switzerland’s dominance is its strict confidentiality over customers’ financial affairs. Wealthy individuals have long been able to lock away their riches in secret bank accounts known only by numbers. It has appealed to dozens of super-rich people from the Middle East or South America who have taken advantage to safeguard their fortunes.

Its reputation for secrecy can be traced back to 1934, when the Swiss authorities made it illegal for banks to provide information about customers’ affairs after the Nazis started snooping around for money that German Jews had deposited abroad. Even today, an employee found disobeying the rules still faces substantial fines, or even imprisonment.

Switzerland also has another temptation to entice the very the rich. It operates what is known as a “forfait” system, and tax-exiles worth millions of dollars can agree with a local canton (political district) a set amount of tax to pay each year without completing annual tax returns. People qualify providing they are over the age of 55and do not work in the country.

“It is well-known that the further you live away from an airport in Switzerland, the better rate a canton will give you,” says Jamie Appold, wealth adviser at JPMorgan Private Bank in Geneva. “The cantons in the countryside are trying to attract wealthy people.”

But in recent years Switzerland has started to lose some of its dominance in the offshore world, and many of its bankers admit that the rate of new money coming is slowing down. One of the reasons is that offshore banking has changed. It is no longer simply about tax avoidance scams; instead, it is about legitimate tax planning and wealth management. Today, the majority of people who bank offshore declare their offshore interests to domestic tax authorities. JPMorgan Private Bank, whose clients are expected to have at least $10m of liquid wealth, reckons that 80 per cent of its business is now “declared wealth” – go back ten years and more than 90 per cent of its customer base would have been “undeclared wealth”. People come to private banks today for the expertise in preserving personal fortunes, rather than tax evasion, says the bank.

What’s more, several countries, such as Italy and Belgium, where a lot of money was traditionally stashed away offshore in the past by older generations, are beginning to offer tax amnesties in a bid to get their people to repatriate their wealth to their homeland. The younger generations who have inherited money from relatives are being encouraged to bring it back onshore – safe in the knowledge that they will not get penalised by hefty tax bills. Although they are repatriating their money, they are continuing to use the offshore banks for wealth management services.

Switzerland manages around
30 per cent of all cross-border private assets

“A new generation of investors is bringing it home, paying their tax and then spending it. It is becoming increasingly difficult to avoid taxes.
Nowadays, offshore is about legitimate tax structures, rather than outright tax avoidance,” says
Alessandro Lasagna, executive director, Schroders Private Bank.

“Wealthy individuals are turning to off-shore centres to get access to investment specialists and specialist products that they may not be able to access in their own country. London, for example, is becoming a major offshore centre for French, German and Italian nationals. They are tapping into London’s financial intellectual capital, its culture, its financial management expertise and high service levels.”

Citizens from countries troubled by political problems and economic instability also seek refuge in offshore banking centres. “I have a Turkish client who banks offshore in Switzerland because he gets economic and political stability and stable currencies,” says Appold. “Switzerland is very discreet – knowledge of his worth will not get leaked over here. He also gets a very high level of personal service. At the moment he wants us to execute a derivative to 'hedge’ a value of a stock. I will devote my time to ensure that happens.”

The phrase “hedge” is synonymous with investing offshore – and, typically, the exotic centres such as those in the Cayman Islands or the Bahamas. Some experts reckon that investing offshore enables people to access investment products, such as hedge funds, which they would find difficult to buy in their own country because of restrictive regulations. Hedge funds are highly sophisticated funds that use complex investment strategies and financial instruments, such as derivatives. They are proving a popular diversification tool for wealthy investors because not only do they aim to deliver absolute returns, they can also make money even when markets fall. The hedge fund market has doubled in size over the past five years; today, there are more than 6,000 funds worldwide, worth an estimated $800bn.

Chris Burton, Chief Executive Officer of Coutts (Jersey) says: “For sophisticated individuals who understand hedge funds, there is a reason to bank offshore. The smaller exotic funds do not have the critical mass to go through the regulatory channels, going via offshore jurisdictions get around that problem.”

People who decide to bank offshore can take better control of their tax liabilities

Wealth management also encompasses tax planning and there are tax advantages to be had by using offshore centres. People who decide to bank offshore can take better control of their tax liabilities, be it income tax, capital gains tax or inheritance tax. Banking offshore is not so much about evading tax as about being able to choose when and how much to pay through careful tax planning. Indeed, most European countries require you to declare your offshore assets on your domestic tax returns. If you bank offshore you can avoid paying capital gains tax and income tax on investments, while it is held offshore and so you can roll-up any gains gross, which over time will lead to bigger returns.

There is little doubt that some people use offshore havens to evade tax bills – it would be naïve to think otherwise – but regulations are getting tighter. Last year, for example, the British Inland Revenue formed a team of investigators to target Britons who failed to declare their offshore banking interests on their tax returns.

Even the Swiss authorities are becoming stricter on where the money has come from – if a bank suspects it is dirty money, today it must co-operate with law enforcement authorities at home and abroad.

Offshore banking will always be associated with millionaire playboys and drug barons, but in reality the face of offshore banking, particularly in Europe, is changing. A tougher stand on money laundering has been embraced and tighter tax evasion regulations are being introduced. Next year sees a new European Directive that is set to introduce new withholding tax rules that will mean that some offshore countries will have to start deducting tax at source instead of paying interest or dividends gross. The loss of tax advantages will only serve to push the wealth management service further into the limelight. The super-rich will always want a personal, highly specialist expert to help them preserve their fortune, and private banks in offshore jurisdictions will continue to be the first port of call.