5 Things to Know About Offshore Centers

The alleged data leak of millions of documents from Panama law firm Mossack Fonseca has propelled offshore finance into the public consciousness.

The term covers a huge number of countries and a wide range of vehicles used for a variety of purposes, from the legitimate to the illegal.

Here are five things to know about them.

1. Which are most popular?

Despite the focus on Panama since the alleged leak of data, there are many other so-called offshore centers. They are also frequently referred to as tax havens. All have their own specialties and variable reputations.

The Cayman Islands is well known for being home to hedge funds, lawyers and service providers. Bermuda is a world center for reinsurance. Gibraltar is home to e-gaming and motor insurance.

The International Consortium of Investigative Journalists’ data focuses on some of the more secretive or lesser-known offshore centers. The British Virgin Islands is the most popular jurisdiction for Mossack Fonseca, followed by Panama, the Seychelles, British Anguilla and Samoa.

2. What is happening in these places?

Offshore activity can be a catch-all term that encompasses structures such as companies, funds, trusts and foundations. According to the ICIJ, the data included information on more than 210,000 companies, although Mossack Fonseca also set up foundations and trusts.

Offshore companies can be used for myriad purposes, from minimizing tax or taking advantage of a different legal regime to hiding the owner’s identity. They are often used as a means of owning another company.

Offshore investment funds, meanwhile, are often vehicles that pool together money from many investors, such as pension funds, university endowments and rich individuals before investing it, usually in mainstream financial markets.

3. Hedge funds are based offshore, right?

Not quite. While most hedge fund managers are based in the U.S. or the U.K., the U.K. overseas territory the  Cayman Islands is by far the most popular jurisdiction to base the fund structures themselves.

There are two main reasons for this. The first is to stop investors paying double tax on their profits or income–instead they only have to pay tax in their home jurisdictions.

And while some fund structures in the U.S. or U.K. have similar tax arrangements, hedge funds point to a second advantage of Cayman funds, the freedom to invest in more assets and use a wide array of trading tools, a key attraction for investors.

Funds say Cayman is not as supersecret as many assume. The islands were moved to the Organization for Economic Cooperation and Development’s white list in 2009, meaning individuals and companies’ tax information must be shared on request. But shady hedge-fund activity has occurred.

For instance, last year Swedish financier Magnus Peterson was convicted of fraud and sentenced to 13 years in prison after the collapse of Cayman-based Weavering Macro fund, in which investors lost around $536 million. The fund’s entire value was found to consist of swaps where the counterparty was a company based in the British Virgin Islands controlled by Mr. Peterson.

4. Onshore versus offshore isn’t as simple as good versus evil

The assumption is often that offshore jurisdictions are somehow shadier than “onshore” territories and more likely to be sheltering money from tax or hiding ill-gotten gains.

However, some onshore jurisdictions have been found to have lax rules.

U.S. states including Nevada, Wyoming and Delaware have in recent years come under pressure over the corporate anonymity they have offered. The ultimate owner of a company registered in the U.K. can also be hidden, although a register of beneficial owners is scheduled to be implemented this year.

Onshore centers can also feature in financial scandals. For instance, the Cayman-based hedge fund of investment firm Dynamic Decisions was found to have bought bonds ostensibly backed by oil before its credit-crisis collapse. Behind the bonds was a global trail of shell companies, including entities in Arizona, Australia and Spain. The fund’s manager, Alberto Micalizzi, was eventually banned from finance in the U.K. and fined £2.7 million ($3.8 million).

5. Have there been problems with offshore centers before?

Yes. While the data leak is unprecedented in its scale, the notion that offshore centers or tax havens can be used for shady purposes is hardly new.

The U.S. has for years been conducting a campaign against secret offshore accounts used by U.S. citizens and companies that have helped them hide from domestic tax.

Financier R. Allen Stanford, who was found guilty in 2012 of masterminding a $7.1 billion Ponzi scheme, had built an offshore empire centered on an Antigua-based bank. More recently, a British Virgin Islands company is alleged by investigators to be the conduit for money that passed from 1Malaysia Development Bhd., a fund designed to spur development, to the bank account of the prime minister. - wsj