The most recent federal government moves to tighten the net around offshore tax evaders are drawing criticism from tax experts.

Last month, Ottawa released the sixth draft of offshore trust rules since they were unveiled in the 1999 federal budget. In releasing the most recent draft, federal Finance Minister Jim Flaherty commented that the government will be scrutinizing offshore tax avoidance.

The new rules are aimed at capturing revenue from the $88 billion that, Statistics Canada says, Canadians have stashed in offshore trusts. Tax experts argue that figure is too large.

“Where does it get that number?” asks Robin MacKnight, tax lawyer and partner at Wilson Vukelich LLP in Markham, Ont. “Canada doesn’t have that many wealthy individuals to stash that amount offshore.” He says the number must include “a lot of corporations.

“It also doesn’t distinguish what is legally offshore and properly not subject to Canadian taxes, and what is illegally offshore,” he says. “These statistics are prepared by people without a connection to the real world. They can’t distinguish the difference.”

Further, he adds, Flaherty is making derisive comments about offshore trusts to deflect the heat he is getting for cracking down on income trusts.

Paul LeBreux, chairman of the Canadian chapter of the Society of Trust and Estate Practitioners and partner at Bayshore Wealth Management in Toronto, says offshore tax planning is regularly confused with illegality; it shouldn’t be.

“There is a place for offshore planning in today’s global marketplace,” he says. “And any government that decides to insulate itself from such globalization will be proven ill-advised.”

LeBreaux says STEP Canada has worked closely with the federal Finance Department to try to refine the offshore rules, which most practitioners find “hopelessly complex.” He adds that the proposed rules “will be difficult to administer.”

A problem with increasingly complex legislation, he notes, is that it actually leads to leakage: “The more you tighten the net, the more holes you create.” He says taxpayers inadvertently find themselves offside or purposely look for loopholes to avoid the complexity.

“Obviously, you can’t have companies pretending to be offshore when they aren’t. But you can’t have double taxation of corporate profits, either,” says LeBreux.

If Canadian companies have foreign affiliates operating offshore and paying taxes in the respective jurisdiction: “It’s not fair to say that is lost tax revenue.”

MacKnight points out that one of the possible sources of the $88 billion is money that is held in “immigrant trusts.”

Under the federal Income Tax Act, immigrants who have been resident in Canada for less than five years and who have significant income-producing investments in their country of origin can set up an immigrant trust. The income within the trust will be exempt from Canadian taxation until the individual has been a resident of Canada for 60 months.

But, after becoming permanent residents, MacKnight notes, immigrants have three years to qualify for citizenship and a passport. Then they can leave, having paid no taxes, while being entitled to all the benefits of citizenship. “I have never understood why this is allowed. How much of that $88 billion is tied up in these trusts?” he asks.

He says advisors need to educate the federal government about what their clients’ money is doing offshore: “What it is. Why it got there. Why it is staying there. And why it is not tax leakage.”

“The goal is to provide a transparent structure that is legally compliant,” says LeBreux. “The days of hiding assets offshore are gone.”

Ottawa should be clear about which offshore structures are acceptable, he adds: “The Canada Revenue Agency should work with industry instead of against it.”

MacKnight says the issue can be resolved “without a ridiculous amount” of complex tax compliance legislation: “Once we identify what is not a problem, we can focus on what is a problem.”

He presents two examples of offshore planning — one that should be considered offensive and another that should, in his view, be considered valid.

First the abusive example: a Canadian company borrows a substantial sum of money in Canada and subscribes for shares in the capital of a company in an offshore island country, such as Barbados, which has a tax treaty preventing corporate profits being taxed in both jurisdictions. The company invests in U.S. government bonds, which do not provide a huge amount of income. And no dividends are paid on the shares, which would be taxable in Canada upon receipt. Consequently, the value of the shares in the offshore company increases because of retained interest income.

@page_break@“When the shares are sold, a capital gain would be realized that could be exempt from taxes under the applicable tax treaty or subject to Canada’s low capital gains rate. There would be little or no corporate taxes to be paid in the offshore jurisdiction,” says MacKnight.

“That’s offensive,” he adds. “The taxpayer gets a tax deduction for the interest expense based on borrowing in Canada, tax-free accumulation of offshore income and, ultimately, a tax-free or low-tax capital gain. Why should people with lots of money and high-priced advisors be able to do that?”

In contrast, he points out a tax plan that should be considered valid: a Canadian multinational corporation sees an offshore opportunity. It can operate its business in the foreign jurisdiction and pay taxes there.

He questions why the multina-tional should be subject to Canadian taxes. “Why should those foreign profits be taxable in Canada if they are not paid back to the Canadian parent company?” he asks. “If the Canadian firm had not expanded operations, there’d be no profit for Ottawa to tax.” IE