Offshore financial centers are often used to run tax shelters. They have little or no taxes, and little or no financial regulations. For example, in the British Virgin Islands, corporations can be formed without the public disclosure of the names of the directors or officers of the corporation. Favorite offshore tax havens include colonial relics such as the Cayman Islands (British), the Dutch Antilles and Curacao (Netherlands). Other places are feudal relics like Monaco, Liechentenstein and Andorra in Europe, or other nominally independent small nations from the old British, Dutch and French Empires. Other places historically in the U.S. zone of influence are Panama and the U.S. Virgin Islands.
The leading offshore center is the Cayman Islands, which is now the fifth largest banking center in the world, after New York, London, Tokyo and Hong Kong.
This is the backdrop on looking over legal papers from a court opinion on July 20th 2006. The judge in Texas District court ruled that certain technicalities of the case against the BLIPS tax shelter were wrong. This will have some effects in the case against 8 KPMG Accounting Firm former executives. KPMG itself has already pled guilty and paid a $456 million fine. One gets a feeling how these illegal tax shelter were carried out from these papers. BLIPS stands for Bond Linked Issue Premium Structure. It created a financial structure to make the capital gains tax deductions, through a capital loss. However, this “loss” had been paid at the beginning of the deal as the “premium”, hence the “BLIPS”.
The mechanism was as follows: Two companies in the Isle of Man (UK), St. Croix and another investment firm “Rogue” each borrowed $41.7 million from National Westminster Bank. The loans were for 7 years at fixed interest rates. The loans paid Interest Only, until a balloon payment at the end of the 7 years. St. Croix and Rogue agreed to pay high interest rates of 17.97%, in exchange for a $25 million payment to them from Nat West at the time the loans originated. So St. Croix and Rogue, received at the beginning of the loans a total of $66.7 million. Then the $66.7 million plus $1.5 million from each was put in an interest bearing loan at Nat West.
In addition, St. Croix and Rogue agreed to pay $25 million to NatWest, if they paid off the loan early, which is exactly what they did a couple of weeks later, May 25th, 2000. To make it a little juicier, the two onshore companies behind the offshore companies had an interest swap deal with NatWest, where they received a floating interest rate, in exchange for the high fixed interest rate. Those under indictment argued that the $25 million that they received upfront was a liability or not. It was money they received, but it was not actually “loaned” to them. Plaintiffs argued that it was not a liability under IRS section 762, because this money was never lent to them. The tax shelters aim to create an illusion of capital losses, and also interest payments, both of which are tax deductible.