TIM CESTNICK
Special to The Globe and Mail
Saturday, August 21, 1999
Hands up if you believe offshore investing is only for the wealthy and wily. Or that the only people who would ever consider investing offshore are the unscrupulous who are out to beat the taxman illegally. Okay Paul Martin, you can put your hand down now.
It's no secret that the Minister of Finance and his department are on a mission, along with Revenue Canada, to change the way Canadians think about and utilize offshore investments. It would take two hands and a foot for me to count the legislative changes dealing with offshore issues introduced by the Department of Finance in the past three years, about four days for me to explain to you these changes in detail, and all of three minutes for you to fall asleep in the process.
While it's important to understand some of the recent changes that will affect any decision to invest offshore, there are really three critical questions the average Canadian should ask when it comes to the exotic world of offshore investing:
1. What in the world is meant by offshore investing?
2. Who can benefit from it and how?
3. What are the risks involved?
Good questions. Let me walk through some of these issues with you.
What is it?
Offshore investing can take on any number of forms. It can be as simple as opening a bank account in the United States, or, for that matter, in any locale outside Canada.
Taking it a step further, offshore investing can include owning real estate or other investments located outside Canada. At the extreme, offshore investing can include giving up Canadian residency and moving yourself, your family and your investments to another country. In a nutshell, offshore investing can be thought of as the process of purchasing or placing some of your investable assets in a location outside Canada. If you've already done this, then I'll refer to you as an offshore global investor.
Being an offshore global investor is a whole lot different than being an onshore global investor. While an onshore global investor has an international perspective, he or she simply uses onshore institutions, like Canadian mutual fund companies, to invest money abroad.
In this case, it's the mutual fund company that goes offshore on behalf of the investor. Make no mistake, Canadian mutual fund companies offer a terrific means to diversify internationally.
The fact is however, the truly offshore global investor is often looking for more than just diversification. In fact, there are five common reasons why Canadians who have gone offshore with their investments have taken this leap:
Tax avoidance
Let's not beat around the bush. Thousands of Canadians have moved some of their hard-earned dollars to offshore accounts in one manner or another, all in the name of avoiding the long arm of Revenue Canada. It's the mystique behind this endeavour that has attracted so many Canadians to at least wonder about offshore investing, and whether it might be possible for them. Patience. I'll talk about who is a candidate in a minute.
Asset protection
Many Canadians are concerned with protecting accumulated wealth from future, unknown creditors. After all, malpractice actions, claims against corporate officers and directors, environmental liability and divorce settlements are all too common today.
Asset protection trusts (APTs), when properly structured offshore, can offer protection by making it more difficult for a creditor to reach the assets while providing the settlor with a greater degree of control over the assets than otherwise available with a domestic trust.
Privacy and confidentiality
I was taken aback recently when I received a glimpse of just how much the government knows about me. I was renewing my driver's licence at a computerized terminal, not unlike a banking machine, and after I hit a few buttons, the machine spit out a new licence complete, to my surprise, with my picture and signature.
It was all on file. So much for privacy in Canada. Offshore investors understand that some jurisdictions have very strict secrecy laws that will prevent institutions that you deal with from divulging information about you. Who wouldn't appreciate this privacy?
Access to global markets
No doubt, you've heard it before: Canada represents about 3 per cent of markets world wide. That's all. So, this leaves 97 per cent of all investment choices world wide available only to those who look outside Canada's borders. The fact is, many of the best investment funds and other securities cannot even be purchased through accounts in this country. An offshore investment account could open a whole new world of investment opportunities.
Estate planning
One of the problems with dying, besides the obvious, is the appearance of the tax collector and the undertaker at your door at the same time. You will be deemed to have disposed of, at fair market value, immediately before death, all property that you own at the time of death.
This could trigger a tax hit. In addition, you may have probate fees to pay where your province levies this tax. And don't be surprised if, one day in the future, the Department of Finance decides to reintroduce an estate tax in Canada. An offshore trust could reduce taxes and probate fees on death by taking those assets out of your hands during your lifetime.
Who can benefit?
Is offshore investing for everyone? Definitely not. In my view, there are two tests you have to pass before you can consider yourself a candidate for offshore investing.
The objective test
Your objectives for going offshore should be broader than to avoid income tax. The reason? It's tougher than ever (and some would say next to impossible) to avoid tax altogether as an offshore global investor today.
Given the many proposed changes to Canadian tax legislation recently, tax deferral is a more realistic objective than tax avoidance, says Paul Lebreux, a partner with the law firm Harris and Harris in Toronto and a specialist in offshore planning.
Mr. Lebreux is referring to a large handful of tax changes either recently proposed or now in force. Most of the changes make it more difficult to avoid tax offshore. Consider these key changes:
March 5, 1996: Draft legislation was released that requires Canadians to report a number of offshore activities. This gives the taxman a greater ability to scrutinize offshore investments to ensure taxpayers are properly reporting income.
Dec. 23, 1998: Draft legislation was released that will significantly affect the use of offshore trusts by, among other things, deeming certain trusts to have received foreign accrual property income (FAPI). The FAPI rules require a Canadian resident to pay the tax on income earned offshore through a trust or corporation.
Feb. 16, 1999: The 1999 federal budget proposes to change the taxation of offshore trusts in two significant ways.
First, any untaxed, accumulated income in the trust will now be taxed in the hands of the Canadian-resident beneficiary when payments are made to him or her, and where an offshore trust receives a loan or transfer of property from a Canadian resident, the trust will be deemed to be a resident in Canada and taxable on its undistributed income (with some exceptions).
Further, proposed rules relating to offshore investment funds will virtually eliminate any tax deferral opportunities that used to exist.
The bottom line here is that avoiding tax by investing offshore is no easy task. We are encouraging investors to look offshore for reasons other than tax avoidance, Mr. Lebreux says. Asset protection, confidentiality anddiversification are all valid reasons to go offshore, he continues. If your objective is not exclusively tax avoidance, then you've passed this test.
The means test
Some offshore structures will require more money than others to make it worth your while. And it all comes down to the fees you're going to face with the structure.
For example, setting up a simple bank account offshore may cost you very little in the way of initial and continuing fees. In this case, setting up an account with very little money may work.
At the other extreme, setting up an offshore trust and/or corporation to hold your investments or operate an active business offshore could cost you between $5,000 and $10,000 (U.S.). The annual fees for maintaining the structure could run $2,000 to $7,000.
With fees this steep, it only makes sense to set up a structure if you've got investable assets of at least $500,000 that you're willing to place offshore. As a rule of thumb, the initial fees shouldn't be more than 2 per cent of the capital you're placing offshore, and the annual fees shouldn't run more than 1 per cent. If the fees are higher than this, it's a sign you probably need more capital to invest offshore to bring these percentages down and make it worth your while.
Want my best advice? Make sure you visit a tax pro who understands the world of offshore investing before making any moves. With Canadian tax laws changing like the wind in this area, you shouldn't go this route alone.
Tim Cestnick, CA, CFP, is author of Winning The Tax Game, and president of The WaterStreet Group Inc. (http://www.waterstreet.ca) based in Toronto. He can be reached by E-mail at tim@waterstreet.ca
1.
Investing offshore is for the super-rich only. Not so. Offshore investing can be as simple as a bank account in another country.
2.
Money invested in a tax haven always grows tax-free. Not true. You may not pay tax in the foreign jurisdiction, but Revenue Canada wants a share of your worldwide income.
3.
Canadians place investments offshore primarily to avoid tax. While this may have been true in the past, the rules are much tighter now. Tax avoidance is extremely difficult without bordering on tax evasion. If you've got a strong stomach and an aggressive streak, you'll no doubt find structures to suit your goals.
4.
What Revenue Canada doesn't know won't hurt me. Bad philosophy. Stick to the premise that Revenue Canada knows what you're up to. With recent changes to offshore investing rules and 75 auditors on the offshore trail, it's becoming more difficult to side-step the taxman, and the penalties for evading tax are very steep.
5.
Giving up Canadian residency is an easy thing to do. If you give up residency properly, you'll manage to avoid tax in Canada, but there's more to it than you may think. Simply moving to another country is not enough. Visit a tax pro to talk over the residency issue if you're thinking of leaving.
Investment risk:
Investing offshore carries the same risk as investing onshore -- you may lose some or all of your capital. Unlike onshore investing, you may find it harder to evaluate investment choices because of your lack of familiarity with international investment opportunities. It's critical to find an investment adviser or fund company offshore that you can trust.
Currency risk:
Sorry, but you want Canadian dollars as the currency of choice when investing offshore. The U.S. dollar is most common. As a result, you'll be exposed to additional risk to the extent the Canadian dollar appreciates in value relative to the currency in which you've invested.
Tax risk:
As a Canadian resident, don't forget that you're required to report your worldwide income from all sources. If you fail to do this, or where you choose a structure that violates the intention or spirit of our tax law, you could face a battle with Revenue Canada.
Operate under the assumption that they know what you're up to.