The federal government continues to draw the net ever tighter around Canadians who have undeclared offshore accounts, recently signing a number of tax information exchange agreements with certain tax havens.

“A key to tackling the use and abuse of tax havens is the exchange of information between countries,” said Robin Maley, an official with the income tax rulings directorate of the Canada Revenue Agency, at the national conference of the Canadian chapter of the Society of Trust and Estate Practitioners (known as STEP Canada) in Toronto in June. “To that end, Canada is working to increase this flow of information through tax information exchange agreements, by renegotiating existing tax treaties and enhancing the administrative arrangements it has with other countries.”

Canada now has TIEAs signed with nine jurisdictions regarded as “tax havens,” loosely defined as jurisdictions in which there may be either low or no taxes, a high degree of financial secrecy, or both.

Eight of the nine signings were announced in June, including the TIEAs with the Bahamas, Bermuda and the Cayman Islands. The Canadian government is in the process of negotiating similar agreements with 10 other such tax jurisdictions. All of the signed TIEAs still need to be ratified by both Canada and the other signatory jurisdictions and, therefore, are not yet in force.

Canada, along with other nations, is signing TIEAs with tax havens as part of a co-ordinated global push against international tax evasion. According to the
Organization for Economic Co-operation and Development, more than 500 TIEAs have been signed worldwide as of July 2010 — up from fewer than 50 in November 2008.

TIEAs are signed between two countries or jurisdictions when a formal, more all-encompassing, tax treaty doesn’t already exist. A TIEA allows for the exchange of information “that is foreseeably relevant to the administration and enforcement of the domestic laws of the parties concerning taxes covered by [the TIEA].”

However, the scope of TIEAs is limited in such as a way as to prevent one party from engaging in a “fishing expedition” — that is, the requesting party must already be in possession of some basic information, including the name of the person being investigated and the specific nature of the information being sought, before a request for information can be made.

Despite the limits on the scope of TIEAs, these agreements are expected to contribute to what many experts say is a general global decline in the availability of offshore secrecy. “Once TIEAs are in effect and they become much more prevalent around the world,” says Sandra Slaats, a partner in Toronto with Deloitte & Touche LLP’s international tax practice, “I think it’ll be much more difficult for people who are trying to hide income and assets in foreign jurisdictions to be able to that successfully.”

In order to encourage tax havens to sign TIEAs with Canada, the federal government has been employing a “carrot and stick” approach. On the “carrot” side, Canada enacted legislative changes after its 2007 federal budget that allow Canadian foreign affiliates operating in countries with which Canada has a TIEA to include business income in “exempt surplus,” thereby allowing the foreign affiliate to repatriate income to Canada without it being taxed in Canada. Previously, only foreign affiliates that operated in jurisdictions with which Canada had a tax treaty could include repatriated income in exempt surplus.
@page_break@On the “stick” side, Canada has made legislative changes so that if a country does not sign a TIEA within five years of having been approached by Canada to do so, any Canadian foreign affiliate operating in that country would have its business income treated as “foreign accrual property income” — which would be taxable at the relatively high rate of 35% in the hands of the Canadian parent firm.

This FAPI rule will also apply to individuals who earn income in a non-treaty tax haven that has not entered into a TIEA with Canada within five years.

“A lot of these [tax haven] countries base their economies on providing services to non-residents,” says Robin MacKnight, a lawyer and tax partner with Markham, Ont.-based Wilson Vukelich LLP. Tax havens, he says, therefore have an incentive to sign TIEAs with Canada if they wish to prevent Canadian foreign affiliates from leaving the jurisdiction or to attract new ones.

Most observers believe that the TIEAs are being established in order to target individuals who may be hiding income or accounts offshore rather than Canadian multinationals, which experts argue, usually stay within the confines of applicable laws even as they seek out favourable investment and tax opportunities offshore. In fact, some experts believe, the TIEAs could possibly result in more Canadian corporations moving affiliates to tax havens now that they offer the same “exempt surplus” opportunity as tax-treaty countries.

“It definitely does give Canadian corporations looking to invest offshore and to use relatively sophisticated techniques to earn income offshore more jurisdictions through which to do that,” says Bill Holms, incorporated partner of international tax services with PricewaterhouseCoopers LLP in Vancouver. “It provides them with more flexibility, more opportunity.”

Over the past few years, there has been increasing global focus on targeting offshore tax evasion. Interest in the issue spiked in 2008, when an employee of a bank in Liechtenstein, a tax haven, sold an allegedly stolen electronic file containing the names of some of the bank’s depositors to the German government for millions of euros. Also in 2008, the U.S. government began investigating Switzerland-based bank UBS AG concerning U.S. citizens who were suspected of tax evasion.

In step with the global trend, the Canadian government has also become increasingly vigilant in targeting Canadians who fail to disclose income and accounts held offshore.

However, there does appear to be a limit to what the CRA will do to identify non-compliant individuals with offshore accounts. When asked at the STEP Canada conference if the Canadian government would ever use tax information that had been obtained in an arguably illegal fashion — if it had to pay for it, as the German government did in Liechtenstein affair, for example — Maley was unequivocal in her answer: “The CRA does not pay for information.”

But in answering the second part of the question — whether the CRA would use information that had been obtained in an arguably illegal manner if it did not have to pay — Maley was somewhat more vague, while still reaffirming one of the CRA’s main priorities: “As it is the CRA’s mandate to address non-compliance in the tax system, it should probably be assumed that if we are in possession of information that shows that somebody has failed to report their world income, and should have, we will act on it.”

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