THE BASICS OF OFFSHORE INVESTING

While there is nothing inherently illegal or hazardous about investing outside your home country, offshore investing should be approached with caution. The benefits can be tricky for a small investor to realize, the risks hard to calculate, and the potential for fraud high.

The main reason people used to invest offshore was to avoid high taxes in their home countries. For residents and citizens of the United States, there's no longer the tax advantage there once was. Since 2004, the U.S Internal Revenue Service (IRS) has been collecting taxes from U.S. corporations that are based in other countries and from U.S citizens and residents who make money from offshore investments.

And in July 2005, the European Union Savings Tax Directive took effect. Under it, banks in EU nations are required to give information about investments and their earnings to the tax agency in the investor's home country. If you want to keep your investment details secret under the directive, you can agree to a withholding tax. But the tax is nothing to sneeze at: 15 percent for the first three years, 20 percent for the next three, and 35 percent starting in 2011.

Many notorious "tax havens" that are not members of the EU have also agreed to abide by the directive, including the islands of Jersey and Guernsey, the Isle of Man, the British Virgin Islands, the Cayman Islands, Switzerland, Liechtenstein, Monaco, and San Marino.

But there are still some situations for which offshore investment may be a good strategy. One is confidentiality. Some countries' banking and financial laws make it a crime to disclose customers' identities or the names of shareholders. If you need to conceal your ownership of some assets, placing them offshore is one way to do so. Major corporations sometimes use offshore entities to make acquisitions when knowing the identity of the purchaser might drive the price up.

Just remember that if you are found to be using an offshore corporation to avoid paying U.S. taxes, you can be prosecuted for tax evasion, and the confidentiality laws in most countries can be waived to investigate suspected illegal activity.

The other advantages to offshore investing typically result from forming a shell corporation in a foreign locale. Some countries don't tax foreign-owned corporations; or your shell corporation may avoid local taxes because it doesn't conduct operations there. In addition, some foreign corporations aren't taxed when investing in the U.S.

Setting up an offshore corporation can be expensive, however. There are legal fees, registration fees, and sometimes a requirement that you own property in the country. Some offshore accounts require minimum investments of $100,000 or more.

Offshore investing is a strategy where it's especially important to work with known, trustworthy entities and get professional advice tailored to your specific needs and goals. This is a situation where you need an investment advisor, an attorney, and an accountant who are all well-versed in offshore banking.

Otherwise, you're at serious risk. The freedom from U.S. regulations that may make offshore attractive also means those regulations aren't there to protect you from scams, questionable claims, and outright theft. That makes offshore investing attractive to con artists, too.

Investigate all claims and offers, and have them reviewed by professionals, before you sign anything or commit any funds. It can be much harder to recover your money if it has left the U.S., and those confidentiality laws may make it impossible to track down once it's been stolen.

Make sure an offshore strategy is really the best way to meet your investment goals. If you're more interested in diversification or taking advantage of the growth in emerging markets, consider a U.S.-based mutual fund that invests overseas.