Tax havens' taxing problems

National Post

2006-04-08


The temptation to escape the Canada Revenue Agency is certainly strong this
time of year. But before transferring your entire investment portfolio offshore,
you should at least acquaint yourself with Canadian tax rules that govern
offshore income.

The general principle is that as a Canadian resident, you are required to
report your income from all sources, inside and outside Canada. Foreign income
must be reported on your Canadian return in Canadian dollars by converting the
amount according to the exchange rate in effect on the day you received the
income or, if income was received throughout the year, by using the average
annual exchange rate for the year.

(If the foreign jurisdiction withheld foreign taxes on the income you
received, you must still report the entire gross amount of foreign income on
your Canadian tax return. However, you may be entitled to claim a foreign tax
credit for any foreign taxes paid.)

Tax havens, therefore, are of little use as a tax-avoidance shelter to the
average Canadian because any income earned in such havens has to be reported on
your Canadian return.

But how will the taxman ever find out about your stash of offshore cash?

On page 2 of your 2005 tax return, there is a question about whether you
owned any foreign property at any time in 2005. If the total cost of all your
foreign investments was over $100,000, you must complete a special form, the
T1135 or the Foreign Income Verification Statement.

Note that foreign property does not include any foreign property held in your
RRSP, RRIF or registered pension plan. Nor does it include Canadian mutual funds
with foreign holdings. The term also excludes any business property or
personal-use property such as vacation properties.

On the T1135 form, you are asked to specifically state the types of foreign
investments you own and the cost of those investments, along with geographical
locations. You are then asked to identify the total income you reported on your
tax return from the identified foreign investments.

The penalties for failing to file this form are severe: $25 per day, to a
maximum of $2,500. If you knowingly or under circumstances amounting to "gross
negligence" fail to file the form, the penalty jumps to $500 for each month the
form is not filed, to a maximum of 24 months.

What if your offshore tax-haven investment doesn't produce any income, but
simply increases in value each year?

In this case, you may be caught by the relatively new "foreign investment
entity" rules. The FIE rules are complex and may require you to include in your
income the CRA's prescribed interest rate to the cost of your FIE investment.
Essentially, this is "phantom income" -- clearly, not an ideal result.

Investors with offshore investments should consult a tax professional to
determine whether they are subject to this new regime.

GRAPHIC: Black & White
Photo: Peter J. Thompson/National Post; Alex Doulis's 1994 book Take Your Money
and Run! revealed his techniques for severing taxation ties with Canada. It sold
140,000 copies. Now he's returned with a new book on beating taxes.