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Forecast Partly Sunny – Offshore Trusts for Canadians

Afridi & Angell inBrief (Canada edition)

By James Bowden

As most tax-minded Canadians will know, the opportunities to realise tax efficiencies by moving money offshore have become very few indeed.  If you invest in overseas investments using a foreign investment vehicle (offshore investment/holding company) in the hopes of deferring tax on income or capital gains until you eventually repatriate the funds, the foreign accrual property income (FAPI) rules set out in the Income Tax Act (ITA) will operate to attribute any such income and capital gains to you every year on an accrual basis, even if not (or never) actually paid to you.  If you establish an offshore trust with similar hopes, the trust will be deemed Canadian resident for tax purposes because you, as a Canadian resident, contributed assets to it.  The idea of an offshore tax utopia is usually a mirage, much sought after but rarely ever real.  Nevertheless, for those whose circumstances support it, offshore vehicles still retain their usefulness for both tax and non-tax reasons.

 

One such tax-focused opportunity is colloquially known as a “granny trust”.  This is where a non-resident of Canada (such as a relative or friend, or a benevolent “granny” who lives abroad) establishes a trust in a no-tax jurisdiction, which includes Canadian beneficiaries.  In that case, the trust is not deemed Canadian resident because the settlor (or any other contributor of assets to the trust) is not a Canadian resident, and the fact that Canadian residents are beneficiaries is not on its own sufficient to cause the foreign trust to be deemed Canadian resident.  It is critical that no Canadian resident (or anyone who was a Canadian resident within the last 5 years or who becomes a Canadian resident within the next 5 years) contributes any funds or assets to the trust, or it will be deemed Canadian resident.[1]  The trust can make payments to the Canadian beneficiary(ies) on a tax-free basis, provided the payments are out of trust capital (not trust income), which is not a difficult rule for the trustees to follow. Had the same funds been gifted to a Canadian resident directly, the gift would be tax-free, but any capital growth and income earned on the gift would be taxed.

 

Making the gift by way of the offshore trust allows both the gift and all growth to be realized and paid to a Canadian resident tax-free, indefinitely.  If the quantum of the gift is sufficient that it will generate income and gains that exceed the cost of maintaining the trust then it is an attractive solution.

 

It may occur to some Canadian residents to try to manufacture a granny trust by funding it themselves, perhaps indirectly by gifting or loaning their own funds to a would-be settlor overseas.  There are several attribution and anti-avoidance rules in the Income Tax Act that would operate in that case to deem the “real” settlor to be a settlor/contributor to the trust, and the trust would thus be deemed Canadian resident for tax purposes, and all granny trust advantages would be lost.  For example, one such rule appears at section 74.5(6) of the Act, which attributes back-to-back loans or transfers back to you, so if you transfer funds to your cousin abroad who then settles a trust with those funds, the Canada Revenue Agency (CRA) could apply the rule to attribute the trust settlement to you.  The definition of “contribution” (to a trust) at section 94(1) of the Act also has anti-avoidance language built into it directly, so that it captures transfers made indirectly through a third party or through a “series of transactions”, whereby your money ends up in a trust.  While some grey areas may arguably remain, the attribution and anti-avoidance rules together operate to form a fairly tight net. In the background, there is also always the Act’s general anti-avoidance rule (GAAR), which the CRA can apply to challenge virtually any transaction or structure that it believes to be abusive or disingenuous planning.  Aggressive planning will therefore always carry risk.

 

Does the analysis change if you become a non-resident of Canada yourself?  Can you establish a granny trust for beneficiaries in Canada then?  Perhaps surprisingly given that very many of your Canadian tax and filing obligations fall away when you cease to be Canadian resident, the answer is that the analysis does not change at all until you have been continuously non-resident for 5 years.[2]  If you are non-resident and not filing Canadian tax returns, and you make a gift to another third party non-resident who settles an offshore trust using those funds, the CRA will want to know if there are any Canadian beneficiaries of the trust (and if there are, they will tax the trust as though it was Canadian resident). However, the moment you become non-resident, you can establish offshore trusts that do not include any Canadian resident beneficiaries and those trusts will not be deemed resident in Canada.  Alternatively, you can explore structures other than trusts, to which Canada’s anti-avoidance and attribution rules do not apply in the same manner (at least for the first 5 years of your non-residency).  There are many safe and tax-efficient structures available to you once you are no longer a Canadian resident.[3]  

 

It must be noted that there are other good reasons, tax considerations aside, to consider establishing a trust in other jurisdictions.  The laws of the well-developed offshore jurisdictions like Jersey, Guernsey, Cayman Islands, British Virgin Islands, Bermuda, Barbados, Bahamas, the Cook Islands, and several up-and-coming jurisdictions like the Seychelles, Mauritius, and the United Arab Emirates, offer various features that can be attractive depending on what you wish to achieve with the trust.  These features include, for instance:

 

Privacy: strong privacy rules whereby beneficiaries need not be informed of their interest, for example.

 

Legacy trusts: where the rule against perpetuities which imposes a deemed disposition on all trust assets (and tax duly imposed on the deemed gains) to have occurred every 21 years does not apply (increasing the period to 80 years, 150 years, or indefinite).

 

Asset protection: many offshore jurisdictions maintain strong firewall legislation which prevents certain foreign judgments from being enforced against the trust, and some have relatively short limitations periods during which creditors must bring their claims, which can be useful for forced heirship situations and for asset protection generally.

 

No probate: the probate process (and taxes) is avoided if property is transferred to a trust during one’s lifetime rather than passing on death under a will.  This is currently true of domestic Canadian trusts too, but Canada regularly adopts new tax policies to expand its tax base and it is a realistic possibility that assets held by an inter vivos trust will be made subject to probate tax at some point.

 

Stability: the leading offshore jurisdictions have long histories of well-established trust service providers that have the expertise and professionalism necessary to give you confidence and peace of mind, and strong, reliable judicial systems that will uphold their domestic laws.

 

The offshore planning landscape may not be for everyone, but for Canadians (including prospective immigrants and emigrants) who fit the mold the benefits are still very attractive and are well worth considering whether for tax reasons, asset protection, or greater freedom in your wealth and estate planning.  If you wish to explore these or other offshore planning opportunities, please do not hesitate to contact us. ■

 

[1] If the trust is created in the settlor’s will as a testamentary trust, they need only have been non-resident for 18 months, not 5 years.

 

[2] Section 94(1) of the Act provides that if a “contribution” was made during a “non-resident time of the person”, it still counts as a “connected contributor” for purposes of deeming the trust resident in Canada.  A “non-resident time” means 60 months before, and after, a person’s Canadian residency commences or ceases, respectively.

 

[3] These comments are made from the Canadian perspective.  You may also need to consider the rules applicable in your new place of residence, if it is not a low-or-no-tax jurisdiction.

 

 

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