Helping clients avoid tax haven heartache

(March 21, 2005) Irrationality has long been the bane and the driver of financial markets, but just as financial advisors need to be vigilant about their advice and client investment decisions, a lesser recognized risk — a potentially powerful Achilles heel for many people — is the urge to avoid taxes.

Paying taxes is inevitable for the most part, but this has never stopped people from trying to avoid them. The urge to save taxes seems almost ingrained in the collective unconscious, fostering an environment where the business of tax sheltering has thrived.

RRSPs and mutual fund vehicles are the obvious example, but offshore investing is also becoming more widely known to investors. Globalization has made far-flung countries seem much closer to the average client. People travel more, fewer places are seen as exotic and the Internet has made it very easy for would be swindlers to make their wares appear authentic.

In this atmosphere of virtual familiarity, coupled with the sometimes mad desire to pay less money to the government, people might be unable to recognize the risks associated with certain offshore investments — even if presented with an opportunity that would normally fall far outside the realm of credibility, such as the chance to invest in a bogus country.

“It just shows you the huge motivation people have to eliminate tax,” says Heather Clarke, director of tax and estate planning at Investors Group. “It’s something that really seems to get under their skin. It sometimes causes them to not use their best judgment because they’re so motivated by saving tax they forget that they also need to be considering the value of the investment.”

Unlike getting an e-mail from Uganda asking for money to unlock fictitious abandoned bank accounts (although some people fell for that one, too), the validity of an offshore investment might be difficult to determine. Several years ago Clarke herself got a call from the Grand Cayman police after a website in Texas lifted content, including her name, from her company’s website to produce a very legitimate looking business front online.

Although there are also many legitimate offshore investment opportunities, more often than not, people lose their entire investment. Even if they find a good offering, the reality of the situation is that Canada expects its citizens to pay taxes on their income, regardless of where it comes from.

Generally speaking, there are only two situations where Canadian-based clients could receive income from an offshore trust without paying tax. One is if they receive an inheritance from a non-resident. And if the client is an immigrant, they can receive income from an offshore trust without paying tax for the first 60 months they are in Canada.

In both cases, the costs associated with establishing the trust can be prohibitive for most people. “You need the trust to be resident offshore in order for it to be effective for one of these immigration trusts or inheritance trusts,” Clarke says. “So you need a trust company or someone to be a trustee. That’s where the costs come in — the setup, the maintenance and filing. The other point of it is you need a trustee in a foreign country. You are placing a lot of faith in that individual.”

If clients still think an offshore investment trust is a good solution, Clarke strongly recommends doing research, following up with regulators if the investment is being sold by someone in Canada and consulting a tax advisor first. “There are all kinds of countries around the world that have attractive tax attributes. Some of them have attractive legal attributes and people use them because of their legal structure.”

The list also includes a number of countries with some questionable practices. She says balancing the risks associated with the different countries is not an exercise that most average investors are capable of. There is also the question of who will be the client’s trustee.

Clarke points to large financial institutions that offer trustee services as “probably one of the better bets.” Trustees can also be found in the classified ads of national and international publications, but some of these may be questionable.

After all is said and done, investors and their advisors need to ask if all the costs associated with going the offshore investing route are worth the amount they would otherwise pay in taxes.

“People are blinded by that notion of saving tax, but if you’re spending a dollar to save 50 cents in tax, you’re not going to be ahead in the game,” notes Clarke, adding that “whether it’s an offshore tax shelter or an onshore tax shelter, it needs to have legitimate investment values.”

Filed by Kate McCaffery Advisor.ca, kate.mccaffery@advisor.rogers.com