The Dominican Republic:
A Secret Tax Haven?
When investors think about tax havens, normally places like Switzerland, The Channel Islands, Panama, Belize and The Cayman Islands all come to mind. In reality, many other countries are in fact tax havens if you are a foreigner. The Dominican Republic and many other places become a secret tax haven for you if you simply understand the tax code and why governments offer incentives for investors.
Let us take an example with the United States and other high tax countries in Europe. If you are a local citizen or resident, certainly you will pay income tax on interest or gains from your bank account and brokerage account. However, when a US brokerage account is titled in the name of a foreigner or foreign entity, such as a Foundation or Corporation, capital gains on your appreciated stocks are tax-free. Is this Unfair? Maybe it is, but investors certainly can use this to their advantage. Interest or dividends earned on your US based bank or brokerage accounts are subject to immediate tax deduction (up to 30%) at the time the interest or dividend is credited, so the US is really only a good place to do your stock trading. For your fixed income investments, such as bank accounts and time deposits, a bank account with many banks in Europe in the local currency are not reported to the local government and are tax free for foreigners (or for your offshore trust, foundation or corporation).
Many countries, such as the Dominican Republic & Panama, allow bank accounts to be tax-free for residents and foreigners alike because it helps the economy. This is just common economic sense. When people have a reason and incentive to save, more money goes into the banking system and can be put to work for mortgages, construction and general long-term investment. Smart governments do not try to tax their citizens on money that is put to work for the benefit of the economy.
Auction your money to the highest bidder!
One problem many investors have is that they want to keep their money in US Dollars or another currency they are comfortable with. The tax-free appeal of a bank account in Danish Krona or another currency is of course less appealing when currency conversion issues get factored in. So .What is the answer for investors that want the highest tax-free return possible in US Dollars? The simple answer is to auction your money to the highest bidder. To put it another way, go where dollars are in short supply and where the highest interest rates are offered.
To understand this idea, you must first change your thinking about money. Money is a commodity, just like coffee, bananas, silver, oil or anything else. When any of these items are in short supply, the price goes up. When the market is flooded, the price comes down. We all can understand the price changes in some of the other commodities mentioned, but what is the price of money? The answer is Interest Rates.
For many countries or foreign businesses that need or want to trade with the United States, one problem is having enough dollars on hand. The way they can attract those US Dollars is to offer a higher interest rate than what may be found elsewhere. This is one basic reason why interest rates for US dollar deposits are higher outside the US borders. Along that line of thinking, interest rates for US dollar deposits will always be higher in countries that do not use the US dollar as their currency. Since Panama uses the US Dollar as its legal currency, but is a separate and independent country, interest rates in Panama will always be higher than the US, but US dollar interest rates in the Dominican Republic will always be higher than Panama.
The Dominican Republic A Back Door to a Tax Free US Bank Account
Many investors are excited about the appeal of a high yielding tax-free US Dollar account, bond investment or other type of time deposit in another country, but are concerned about safety of their money. Certainly this is a valid concern.
When discussing US Dollar accounts with a non-US bank, most investors do not realize that the foreign banks US Dollar assets are actually in the United States. This is true for any foreign bank, anywhere in the world. How is this possible? Well, quite simply, all foreign banks dealing in US Dollars have an account with a US Domiciled Bank. It could be Chase Manhattan, Citibank, First Boston, Wells Fargo or any number of major commercial banks in the United States. The foreign bank has what is known as a correspondent account with the US bank. The foreign bank uses this US account to facilitate payments, transfers and any other business requiring US Dollars. The money never really leaves the United States; it just gets "re-titled" in the name of a foreign entity. In reality, your tax-free US dollar bank account with your Dominican Bank is actually an internal sub-set account of the banks correspondent account with First Chicago Bank or whomever. To take this example further, First Chicago does not know that you have a tax-free bank account in the Dominican Republic, they only know that they have a correspondent bank account with "ABC Bank" in Santo Domingo that happens to have US $ 10 Million in it. So, while the rate of return on your Dominican US Dollar savings bank account is currently only about 4%, which is about what you would get with a US account at the present time, it is tax-free.
What about the higher yields we spoke about in the past? The answer is very simple. Longer-term time deposits, certificates of deposit, or "Plaza Fijos" in dollars do pay up to 12% tax-free. The Dominican Bank is using your US Dollars for some longer-term investment. It could be for investment in commercial paper, a short-term loan or any worthwhile short-term investment. What is happening here is the same thing when you take out a certificate of deposit with a US bank. The bank is taking your money and investing it or loaning it at X percent. They take a little "off the top" any pay you Y percent. Most people never ask what the US bank is doing with the money, because they assume the banks management knows what they are doing and have experience with loans or investments. The same is true with your Dominican Bank. The money in your tax-free 90-day certificate of deposit for 11% may in fact be loaned to a major Dominican Company, such as the national beer conglomerate, for contract payments on goods purchased from a US company. The bank makes money, you make money (tax-free), the local beer distributor has access to a short-term loan in dollars, and the money never left the US.
Another alternative is of course to directly take out a US Dollar denominated tax-free bond or commercial paper investment with a company. The interest rate will usually be a little higher, because the bank is not involved. Naturally, all investors wants to make sure that they get their money back when the time deposit matures. Well, one simple rule is to look for foreign companies that are paid in US dollars for their product or services. It stands to reason that a Dominican Company that only receives Pesos may have a difficult time converting pesos to dollars for interest rate payments or the return of principal. That is not to say that the company does not have plenty of money to make the payment. It is to explain that if the conversion rate changes, it may become very expensive for the company to make the currency conversion and may place a heavy financial burden on the company. The safest idea is to look for companies that get paid in dollars. Obviously any company that sells products to the US market or deals with tourists will fit this profile. Hotels and Casinos are the first example that comes to mind.