To build upon the previous article (on myths about investing offshore), I wanted to briefly explain the difference between tax evasion and tax avoidance, in particular because there is so much confusion around this topic.
Institutions such as banks, investment firms, and insurance companies might not be required to report their clients’ assets or income to foreign governments or foreign tax authorities. However, depending on where you are resident and what passport you hold, not reporting your foreign assets or income may be considered a crime in your home country or country of residence.
For example, for Americans, purchasing foreign funds and not reporting the capital gains to the Internal Revenue Service (IRS) would be considered tax evasion. Additionally, opening an offshore bank account and not reporting it to the Department of the Treasury (either through the IRS and/or the Financial Crimes Enforcement Network), might constitute tax evasion, depending on whether the balances of the accounts exceed the threshold for filing.
However, deciding to hold on to a foreign investment for longer than one year before selling it in order to pay the lower long-term capital gains tax is an example of tax avoidance and is perfectly legal. Also, taking advantage of various tax credits that are available in order to directly reduce your tax liability is an example of tax avoidance.
Therefore, tax avoidance is the act of minimizing your tax burden through legal means, and tax evasion is the illegal act of not claiming your assets, under-reporting income, or overstating deductions in order to reduce your tax burden.
It goes without saying that one should never resort to tax evasion, as the penalties are harsh and include heavy fines and possibly even a prison sentence.
Before investing offshore, it is wise to enlist the services of a tax advisor experienced with foreign taxation, just to ensure that you are fully compliant with the tax laws in your country of citizenship/residence.