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Investing offshore? Even mainstream strategies can draw CRA scrutiny

Emergence of ‘borderless’ technologies has led to greater interest in diversifying risk overseas

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The world can seem borderless for Canada’s wealthy families, with many boasting business interests and homes in multiple countries, children who study abroad and vacations that take them to far-off places.

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Given their global lifestyles and outlook, it’s not unusual for high-net-worth Canadians to also adopt a borderless mindset to managing their wealth. For many, offshore investments present ways to address their often-complex financial needs.

Lorn Kutner, a tax consultant with Toronto-based Northwood Family Office, cites three main reasons why wealthy Canadians might want to invest their money overseas: a permanent or long-term move to another country, a desire to expand their portfolio to include more diverse investments outside North America, and tax planning.

“Many who are actively looking at leaving Canada already have residences and vacation properties in other jurisdictions, and maybe their kids have all grown up, or they’re just tired of Canadian winters,” says Kutner.

“There are obviously a lot of investment opportunities in other jurisdictions that can help them achieve their goal to diversify, and which could perhaps also produce tax efficiencies and even provide additional benefits like creditor protection.”

Investing offshore isn’t illegal

Whatever the reason, it’s important to consider all the implications associated with offshore investing. First off, says Kutner, “there’s nothing illegal about offshore investing – you’re not breaking any Canadian tax law by investing some or all of your assets in another jurisdiction.”

He also debunks the prevalent notion that people who invest offshore are just doing so to evade taxes. That tends to be the exception rather than the rule, he says.
“Most do it primarily for risk diversification,” says Kutner.

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The emergence of technology that makes it easier to track investments any place in the world has also contributed to the greater interest in – and comfort with – investing offshore, he adds.

Try not to create an overly complex and restrictive strategy that may perhaps work for you but won’t work for the second, third or even fourth generation.

Lorn Kutner, Northwood Family Office

The asset classes available are no different than what Canadians would have access to in North American markets, says Kutner. Some clients choose the location of these investments based partly on that jurisdiction’s rules around asset protection from potential creditor claims, he adds.

“There are real estate opportunities – for example, we have one client invested in a number of eastern European retail plazas – but most of the time you’d be looking at offshore commodities, mutual fund-type of investments, maybe some hedging, derivatives and venture capital opportunities,” says Kutner. “There’s also currencies, but being so volatile it’s typically for play money.”

Watch for overly sophisticated schemes

While risk diversification may be the main focus, knowing and following Canadian rules on offshore investments is key, says Kutner. These rules, which focus largely on reporting, are often different than the tax rules in the foreign country where money has been invested.

“If you’re a Canadian resident, whatever you make is taxed each year,” says Kutner. “So you have to understand how that divergence in reporting impacts your tax position.”

Kutner cautions against focusing too much on tax avoidance when investing offshore or jumping in with too-sophisticated strategies that are likely to be challenged by the Canada Revenue Agency.

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“You may be doing something completely legitimate and well within the letter of the law, but the CRA has a record of spending significant dollars and time fighting these cases,” he says.

“So when your friend tells you at a cocktail party about a tax agreement that he got, just remember: It may sound sexy and exotic, but would you have the tolerance to deal with CRA and having that cloud hanging over your head?”

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Even mainstream, tax-driven offshore structures that have been acceptable for years to the CRA can draw unwanted scrutiny as more people adopt them, says Douglas Byblow, president of the Toronto-based family office Forthlane Partners. This is why it’s important to ask a lot of questions before transferring money abroad into a tax-driven structure.

One particularly important question to ask is how easy – or difficult – it would be to take money out of the offshore vehicle.

“Will you be able to access that money as and when you want to?” asks Byblow.

“For some clients, the goal of reducing taxes may be driven by a desire to achieve the highest net worth number possible. But if their money is structured into an offshore vehicle that makes it difficult to bring the money back into the country, then it’s a false victory because they may have achieved that high score but they can’t actually access their wealth.”

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Rules can change

His advice: Veer away from strategies that rely too much on technicalities or artificial structures and that lack a valid business purpose.

“These are particularly prone to being eliminated at the stroke of a pen from Canada’s finance minister and can be very difficult and costly to unwind,” says Byblow. “Not to mention the potential damage to the wealthy individual or family’s reputation.”

Kutner at Northwood points to another important consideration when setting up an offshore investment or tax-driven structure, or when relocating overseas: the political climate and stability of the offshore location.

“Ideally, you would be looking at countries where the rule of law is based on the English common laws that we’re used to, perhaps where English is the native language, and the standard of currency is the U.S. dollar, which is the most recognized worldwide,” says Kutner.

Ongoing vigilance and oversight are essential, he says, because “rules and governments change all the time.”

Kutner also calls for planning with legacy in mind. “Try not to create an overly complex and restrictive strategy that may perhaps work for you but won’t work for the second, third or even fourth generation,” he says.

“This isn’t just about you or the flavour of the month for you, but also about how it will impact your children and grandchildren, and where they might want to live and invest.”