How to Invest in Offshore Funds

With reference to the previous week’s article on our tax laws pertaining to offshore investment fund property (OIFP) rules and the recent court decision on Gerbro Holdings Co. v. The Queen, avoiding the OIFP rules, as Gerbro did, can actually benefit investing outside of Canada. In the case of Gerbro, the investor had valid reasons for offshore investment which aimed neither to reduce nor to defer tax – winning the case in the process. How will this affect you as an investor?

The rules

Under applicable rules, you will be taxed by adding to your income a certain amount per year in the amount of your offshore investment times the present 3 per cent interest rate. (The 3% rate is two percentage points more than the stipulated present interest of 1%).

You are entitled to deduct from this assumed income figure any other income (except for capital gains) included on your annual tax statement from the offshore investment. Moreover, any deemed income will be augmented to the adjusted cost base of your offshore investment. Ultimately, these requirements accomplish two things: First, you are paying tax before receiving the income, and second, they allow you to consider as regular income that which should be taxable as capital gain.

As an illustration: If you have invested $300,000 in offshore funds. Using OIFP rules, you pay tax, since a major goal of the investment is to reduce or defer tax, on the deemed income of $9,000 (3 per cent multiplied by $300,000). A payable tax of $4,500 based on a 50% marginal rate.

Under cases of tax deferral or avoidance as a primary objective for the investment – which means OIFP rules do not apply – taxes may still be applicable using the same rules, leaving you the choice to file a case in court. However, majority of investors will accede and pay the tax and will then decide to alter their investments in this case considering that accounting and legal fees to sue the Canada Revenue Agency will certainly be higher that the tax due under the rules in question.

CRA is well aware of this. It will not hesitate to harass taxpayers for as low as an imputed income below $10,000, showing how unfair and abusive CRA can become. Why should CRA take steps to unduly increase tax due and lead Canadians to choose investment options not designed to attain their long-term objectives.

Remember, CRA can pinpoint these investors using Form T1135, filed annually by investors outside of Canada in amounts above $100,000. CRA believes these investors are out to avoid tax. Heads up, CRA: Why would taxpayers report such investments on their Form T1135 if they mean to avoid tax? Look for evaders somewhere else!

Tips for Investing

Accomplish an Investment Policy Statement (IPS)

Ask an investment manager to accomplish an IPS for you, which is a vital document you need. An IPS must include specific investment information, such as your investment goals and risk capacity. Make it very clear that you have valid reasons for your offshore investment and that they do not include reduction or deferral of tax.

Discuss Your Documents

Sit down with your investment counselor to explain your investments goals and make it very plain that tax reduction is not among your primary reasons for your investment and include such discussions in your prepared meeting minutes. Those minutes should be kept on file as proof of your reasons for choosing the offshore investment.

Monitor your investment cost

For investments in offshore property below the total value of $100,000, you need not reflect such assets on CRA’s Form T1135, keeping you out of its screen. Keep dreaming of that time when CRA hikes up the golden standard below which the agency will not make any fuss about your intentions for investing in offshore funds.