January 2000 volume 4, issue 1 

Stroll down the aisles of your favourite giant bookstore, and you'll quickly discover that there are dozens of books and magazines advising Canadians how to take or transfer their money to the nearest tax haven -- preferably some place with a lot of sun and a stable currency.

But recent proposed amendments to the Income Tax Act are calling into question the tax advantages of offshore trusts for Canadian residents. As the Auditor General points out, the steady growth in the popularity of tax havens among Canadians has led to hundreds of millions of dollars in lost revenues in past years. The question of whether offshore trust planning is fair to the Canadian tax system has led to these proposed legislative changes that will significantly impact Canadians with foreign trust investments.

At the heart of the matter is the fact that Canadians (like Americans and many other nationalities) have always been, and continue to be, required to report and pay tax on their world income.

what has changed
Previously, the Canadian tax rules only applied to non-resident trusts with a Canadian resident beneficiary. It was possible for Canadian residents to establish an offshore trust that did not provide for a "stated" beneficiary, thereby providing opportunities to circumvent the Canadian tax system. The proposed rules will now apply to any offshore arrangement where a Canadian resident has transferred or loaned property to it, whether or not the trust or affiliate has a Canadian resident beneficiary.

Also, under the old rules, it was possible to convert "trust income" into "trust capital" which was not taxable when distributed. Under the new rules, such distributions will generally be taxable.

In reality, many offshore arrangements created previously were established under the mistaken impression that they were exempt from Canadian tax. The new rules will leave little room for doubt, and will bring the majority of existing offshore trusts established by Canadian residents, under the Canadian tax umbrella. By putting these rules in place, Canada will be following the trend set by many other countries, including the USA.

new reporting requirements
The offshore reporting rules require Canadians to file information returns where they have (a) transferred or loaned property to a non-resident entity; (b) received a distribution from a non-resident entity, or (c) own an interest in a foreign entity. The proposed changes also provide for very prohibitive penalties for non-compliance which can be levied against third parties such as advisors and promoters. Settlors, trustees, and beneficiaries can be held jointly liable for tax and penalties. For most offshore arrangements, the new rules will take effect for the 2001 tax year.

what will be taxed
Income from property invested offshore will effectively be taxed as though it was received directly by the Canadian resident beneficiary, and may also be subject to attribution rules. In circumstances where offshore income is not distributed and is not readily measurable, the Canadian resident beneficiary may be required to include their pro-rata share of the change in fair market value of the offshore assets, in taxable income.

the future of offshore trusts
It will still be possible for immigrants to establish offshore trusts that will be exempt from Canadian taxation during their first five years of Canadian residency. If they continue to reside in Canada after the grace period, their offshore trust becomes subject to Canadian taxation. Potential immigrants should note that such a trust must be established before they arrive in Canada.

Although not a tax-exempt arrangement, Canadian residents may want to establish offshore "Asset Protection Trusts" (APTs). There are many reasons why someone might want to establish an APT, for instance creditor protection.

Also, if a Canadian resident operates a business in a foreign jurisdiction, there may be good business reasons for the ownership of that business to be vested in an offshore trust. Although the new rules will restrict offshore planning for purposes of minimizing Canadian tax, there may still be opportunities

for tax deferral; particularly, where an offshore operating company accumulates business income that is not taxable in Canada until repatriated.

Offshore investing will continue to be very attractive to taxpayers who believe you should not put all of your eggs in one basket. There may also be opportunities to use offshore arrangements to convert foreign income distributions into capital gains, thereby achieving a better after-tax result.

Offshore planning is still very much alive. To learn more about the implications of legislative changes to offshore trusts, or to seek help when filling out foreign reporting forms, contact your tax partner at Wilkinson & Company LLP.