How to Work with Tax Haven Jurisdictions

The phrase “tax haven” often conjures images of secrecy and illicit activity, but in practice it refers to jurisdictions with either very low or no income tax, favorable regulatory regimes, and robust privacy protections. Common examples include the Cayman Islands, British Virgin Islands (BVI), Bermuda, and, in Europe, jurisdictions such as Luxembourg or Liechtenstein in certain contexts. For multinational families and investors, these jurisdictions can play a legitimate role in structuring holdings, provided they are approached with care and full compliance with U.S. law.

From a U.S. tax perspective, the most relevant rules are those governing Controlled Foreign Corporations (CFCs) and the Passive Foreign Investment Company (PFIC) regime. Under Subpart F of the Internal Revenue Code (IRC §§ 951–965), U.S. shareholders who own more than 50% (by vote or value) of a foreign corporation may be required to include certain categories of income—“Subpart F income”—on a current basis, even if the earnings are not distributed. After the Tax Cuts and Jobs Act of 2017, the rules expanded to include Global Intangible Low-Taxed Income (GILTI), codified at IRC § 951A, which requires annual inclusion of certain CFC income regardless of repatriation.

Meanwhile, if a U.S. investor owns shares in a foreign corporation that meets the PFIC thresholds (essentially, 75% or more of income is passive, or 50% or more of assets produce passive income, under IRC § 1297), highly punitive tax treatment can result unless the investor makes a Qualified Electing Fund (QEF) or Mark-to-Market election. The PFIC regime was designed specifically to discourage the use of offshore “blocker” companies as tax shelters for passive investment income.

In addition to federal income tax rules, U.S. persons with ownership in or transactions with foreign entities must comply with reporting requirements, including Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations), Form 8865 (for foreign partnerships), and Form 8938 (Statement of Specified Foreign Financial Assets), among others. Civil penalties for failure to file these forms can be severe, often exceeding $10,000 per form per year.

The legitimate uses of tax haven jurisdictions often fall into categories such as:

• Pooling capital for cross-border investments: Offshore SPVs allow investors from multiple jurisdictions to co-invest in a neutral vehicle, avoiding exposure to one another’s domestic tax regimes.
• Asset protection and estate planning: Trust structures in Cayman or BVI can shield assets from creditor claims, though U.S. estate and gift tax rules (IRC §§ 2031–2046; § 2501) still apply.
• Investment funds: Many private equity and hedge funds are domiciled offshore to accommodate tax-exempt or foreign investors who prefer a non-U.S. vehicle.

That said, misuse of such jurisdictions can create exposure under U.S. anti-avoidance regimes. For example, the IRS can disregard sham entities under the “economic substance doctrine” (IRC § 7701(o)) if the structure lacks a substantial business purpose beyond tax reduction. Likewise, failure to comply with FATCA (Foreign Account Tax Compliance Act, IRC §§ 1471–1474) reporting can result in significant withholding and reputational risk.

In sum, working with tax haven jurisdictions is not about avoiding tax—it is about careful structuring, documentation, and compliance. The correct approach typically involves pairing an offshore entity with a U.S. blocker or partnership, filing the necessary forms, and ensuring that the foreign vehicle serves a genuine business or investment purpose. Done properly, these structures can provide tax efficiency, investor neutrality, and asset protection while staying squarely within the boundaries of U.S. law.