The reason for the escalating attention? Money. Governments are feeling the squeeze from mounting debts, are unwilling or unable to raise taxes, and no doubt expect to find billions or trillions secretly stashed away by their citizens in tropical — and not so tropical — tax havens. Add in some well-earned public anger over bonus-taking bank managers and high-profile financial frauds and you have the recipe for the G20’s “name and shame” campaign against opaque tax havens launched last spring.
What is held in offshore havens has been estimated to be US$11.5 trillion by independent advocacy group Tax Justice Network.
The pressure on OFCs and those individuals who have used them to hide income in their home jurisdictions continues to grow as European governments have taken to rewarding employees at secretive offshore banks to act as whistleblowers and provide client lists in exchange for cash. The power of the cash-for-client-lists strategy, combined with a new spirit of information sharing among the Organisation for Economic Co-operation and Development nations, was illustrated last year after the U.S. government’s probe of Switzerland’s UBS bank and more than 14,000 American taxpayers disclosed the existence of offshore bank accounts to the Internal Revenue Service.
The trend could ultimately prove to be a boon to Ottawa and its tax collectors at the Canada Revenue Agency, which has traditionally lacked the budget or international muscle to go after the billions supposedly stashed with OFCs. While it co-operated with American tax authorities, UBS has so far rebuffed the CRA’s efforts to obtain secret client data. The CRA’s major victory so far came when it obtained a list of approximately 100 Canadian account holders with Liechtenstein’s LGT bank and went to court to force the Royal Bank of Canada to divulge information regarding bank customers suspected of having undeclared accounts at LGT.
Undisclosed offshore accounts are a “continuing problem” for affected Canadian taxpayers who have likely been worrying about undisclosed foreign accounts for years, notes Ottawa tax lawyer Paul DioGuardi, co-author of The Taxman is Watching. “I have been sort of preaching for years that they were going to be attacking them with more vigour,” he says. “Even I didn’t realize that they would start paying people to steal [banking information].”
CRA statistics show the taxman is making progress. Since last May, 2,562 Canadians have stepped forward under its voluntary disclosure program to reveal nearly $600 million in offshore income, a big jump from the prior 12 months when 1,858 people disclosed $100 million in previously unreported offshore money. That success has got Ottawa talking tough. “It is not a question of if we will find you,” former revenue minister Jean-Pierre Blackburn said last December. “It is a question of when.”
But international information sharing and tough rhetoric aside, the biggest obstacle to the CRA finding as much as $100 billion in offshore accounts may be its own policies, argues Adrienne Woodyard, who recently joined Davis LLP. The CRA’s voluntary disclosure program is essentially a 10-year amnesty against criminal prosecution, fines, and civil penalties regardless of the amount of tax evaded or the type of evasion involved. In theory, a taxpayer who qualifies for the VDP would only have to pay back taxes and arrears interest. That is a major concession as fines and penalties can total 50 to 250 per cent of the amount of tax evaded.
Woodyard compares the CRA program to that of the IRS and finds the Canadian version lacking. While the U.S. amnesty requires the payment of penalties as well as back taxes and interest, it only looks at unreported income over a six-year period. That short time frame established by the IRS was key to its success, she says. The CRA program, by contrast, has no time limit, meaning back taxes and interest could have accumulated to “staggering” amounts. To make the Canadian program even less attractive to taxpayers looking to come in from the cold, the CRA has taken the position that it has no discretion to waive penalties — which are equal to 50 per cent of the tax and interest on those penalties — past the first 10 years. For those with disclosures going back 20 or 30 years, that’s not much of an amnesty.
“This is a real disincentive to people [who] otherwise might want to come forward to clean up their tax affairs to actually coming forward,” says Woodyard. “By failing to give any tax relief past the 10-year mark, the CRA is basically thumbing its nose at people who might want to come forward because they are making it completely unattractive for them to do that.”
To make matters worse, the revenue agency is also inconsistent in how it administers the amnesty, she says. Some agency officials will ignore income past the 10-year period or offer a reduction on the arrears interest rate, while other officials will take a more strict approach. That inconsistency, which was recognized but not ultimately fixed with a number of CRA reforms, makes it impossible for tax lawyers and accountants to predict what the implications of a voluntary disclosure might be and what the client will have to pay in the end. “That’s a real problem because you don’t know what you are going to get, depending on who you deal with,” says Woodyard.
Woodyard and other tax practitioners would like to see the CRA change its 10-year amnesty limit and consistently apply the program across the country. “It should put a finite limit on how far back it will go,” she says. “It behooves the CRA to provide a measure of certainty to these people because it is found money from the CRA’s perspective.”
While international organizations such as the International Monetary Fund, the OECD, and the G8 group of nations are paying increasing attention to the subject of offshore financial centres, especially in the wake of the financial crisis, there is a recognition that not all OFCs are created equal and that these centres often engage in legitimate practices.
In a report in 2000, the IMF defined OFCs as a place where “the bulk of financial sector activity is offshore on both sides of the balance sheet . . . where the transactions are initiated elsewhere, and where the majority of the financial institutions involved are controlled by non-residents.” A more simple definition might be any small, sparsely populated, low-tax jurisdiction which specializes in providing the corporate and commercial services to non-residents in the form of offshore companies and the investment of offshore funds.
The United Nations agency’s report identified a number of uses for OFCs: for offshore banking licences (whereby a multinational company sets up an offshore bank to handle foreign-exchange operations or international financing); to set up offshore corporations or limited-liability international business corporations; to create captive insurance companies to manage risk and minimize taxes; to create special-purpose vehicles to engage in financial activities in a more favourable tax environment; for tax planning and asset management and protection for a wealthy individual; and tax evasion and money laundering. At the time of the report, the IMF estimated that offshore finance assets totalled US$4.6 trillion with about $900 billion in the Caribbean, $1 trillion in Asia, and the remainder in international financial centres such as London, England, and New York.
Depending on the definition utilized, the numbers of OFCs around the world range between 14 and 69, the IMF found. It settles upon the Financial Stability Forum’s list of 42 jurisdictions, which groups OFCs into three categories depending on their standards and international co-operation. The top-ranked group, viewed as co-operative with a high quality of supervision and international standards, is made up of eight countries including Switzerland, Isle of Man, Guernsey, and Jersey. The second group, with procedures for supervision and co-operation but performance below international standards, is made up of nine countries including Barbados, Bermuda, and Bahrain. The third group, characterized by a low quality of supervision, unco-operative, and operated with little regard to international standards, comprises a group of 25 countries ranging from Liechtenstein to the Bahamas and the Cayman Islands.
Representatives of OFCs do not typically make business development forays into target countries such as Canada. “The exception is Barbados who from time to time do send delegations or their business investment chamber of commerce to Canada,” says Michael Cadesky, principal of Cadesky and Associates LLP of Toronto and chairman of STEP Canada, the Society of Trust and Estate Practitioners. That does exclude private individuals or people representing trust companies and service providers from “many, many countries because Canada is considered a significant marketplace,” he says.
Cadesky describes the establishment of offshore trusts and corporations as “a series of unique situations.” Giving the example of a new Canadian who needs to create an offshore trust eligible for a five-year statutory tax exemption, he says the process would start with introducing the individual to a trustee in an offshore (usually zero-tax) jurisdiction. “Very often we would arrange for the client to meet with the trustee. Sometimes we would go to the offshore jurisdiction with the client but often the client would go on their own.”
Although governments remain hostile to the idea of their citizens putting money into OFCs, the jurisdictions are doing a better job in reporting their activities. According to the OECD in its 2010 report, the so-called “gray list” of tax havens that have not fully implemented internationally agreed-upon tax standards has dropped to 17 from more than 40. That is either a victory in the effort to curtail untaxed and illicit money or, as critics say, proof the OECD set its compliance standards too low.
The increased scrutiny of OFCs help-ed spur the creation of the International Financial Centres Forum last December by a number of law firms operating in small international financial centres led by Appleby, Conyers Dill & Pearman, Mourant du Feu & Jeune, Ogier LLP, and Walkers, advised by Stikeman Elliott LLP. “The offshore world is tired of being the world’s whipping boy,” John Collis, chairman of Conyers Dill & Pearman in Bermuda, says about the group’s launch.
Canada and other G8 countries have a bit of an attitude problem when it comes to their citizens using offshore tax centres, says Paul LeBreux, principal of Global Tax Law Professional Corp. and past chairman of the 2,000-member STEP. “The challenge — and it is not as big a challenge as it used to be — is that they just don’t have the information about these centres, what is going on there, or where the assets are,” he explains. “The concern is that people are going to cheat and if we as a government can’t find out about it, then these centres are bad.”
A 2009 STEP report contends that contrary to popular belief, OFCs “are not the locations of choice for anonymous accounts and other vehicles for international tax evasion, recent evidence instead indicating that large countries such as the United States and United Kingdom instead serve this function.”
OFCs proliferated during the 1960s and 1970s, which can be credited to “historic and distortionary” regulations such as the imposition of reserve requirements, interest rate ceilings, restrictions on the range of financial products that supervised financial institutions could offer, capital controls, and high effective taxation in many OECD countries. The appeal of OFCs for conventional banking lessened in the 1990s as financial regulatory changes were made in developed countries and countries such as the U.S. and Japan began to add incentives to win away OFC clients. While tax advantages for commercial banking waned, the tax advantages for asset management appear to have grown in importance, reports the IMF. “[T]he ability to reduce inheritance and other capital taxes seems to have been a prime incentive and has led to a large expansion in offshore fund management activity, in particular by the use of investment vehicles such as trusts and private companies. . . .”
Andrew Rogerson, a Toronto-based lawyer specializing in onshore and offshore estate and tax planning who has practised in the Turks and Caicos Islands and the Jersey (Channel Islands), notes that OFCs have long been the target of western governments. “The CRA, the Canadian government, have always been trying to put the frighteners on people not to use these places. There are a lot of different things done in these places that actually assist the world economy, it is just that domestic politicians, when times are bad at home, like to villainize these places.”
The most famous Canadian example of the use of an OFC to minimize tax liabilities was that of former prime minister Paul Martin, whose shipping business was based in Barbados where it was subject to a 2.5-per-cent tax rate. “What [Martin] did was perfectly legal. The double-tax treaty with Barbados . . . the bottom line is you pay 2.5-per-cent tax on your profits in Barbados and under the double-tax treaty what is left is remitted free of charge to Canada. The Canadian government entered that tax treaty because they wanted it and Barbados is a great encouragement to Canadian trade. It is not a question of people cheating, they are just using what the government wanted them to have,” says Rogerson.
Although Martin’s Barbados tax scheme made him a target for criticism, corporate use of OFCs has benefited the Canadian economy, argues Walid Hejazi, an associate professor of international business at the University of Toronto’s Rotman School of Management. He found that Canadian corporations’ use of OFCs for direct investment abroad more than doubled from 1990 to 2004, when it reached $97 billion. Barbados is the most popular conduit, accounting for about a quarter of all Canadian investment capital sent to OFCs.
Studying the OFC impact by examining the links between Canada’s trade and investment abroad for 40 countries over the period of 1980 to 2005, Hejazi’s 2007 study discovered that when a Canadian multinational accesses a foreign market by using an OFC as a conduit, the increase in Canada’s trade is larger than if that multinational had not used the conduit. Canadian firms using a low-tax jurisdiction such as Barbados offsets higher global risks, he found, a benefit even more relevant for riskier markets beyond the U.S. and Europe.
Rogerson’s main offshore activity for clients involves the creation of offshore trusts and company structures as a means of asset protection. The main advantage of establishing a trust in an OFC is its “debtor-friendly regimes” which shorten the period of time in which a creditor may bring proceedings to attack the establishment of the trust/settlement of specific assets into trust, he notes. Having OFC legal regimes balanced in favour of trusts over creditors serves to discourage “frivolous lawsuits and to encourage reasonable settlement offers,” he says. Other pros associated with offshore trusts include freedom from probate, east of administration, and a perpetuity period from 80 years up to an unlimited period in Jersey.
“The main benefit of using the offshore tax havens [like] these is not for tax reasons but for asset-protection reasons,” says Rogerson. A typical case is a professional such as a dentist or doctor who wants to ensure “that a big law claim doesn’t wipe him out. It’s a hell of a lot more difficult to get somebody’s money if it is in an offshore trust than if it is sitting in a bank in Hamilton or Toronto.” The downside to establishing an offshore trust is the time and cost involved as well as the scale — “it’s probably not cost-effective for less than a half a million, probably a million.” He advises his clients to have an amount of money necessary to cover at least six months’ worth of expenses.
Secrecy is not a prime motivator for such clients, while asset protection from creditors, business partners, or even spouses is. While owning offshore trusts could subject individuals to heightened scrutiny by the CRA, there is nothing illegal about setting up and holding an offshore trust, provided that any income is reported to the tax authorities.
The three-sided international efforts to rip away the veil of secrecy of OFCs, through government-to-government pressure, government-to-institution pressure, and with the rise of whistleblowers will be an ongoing concern for the unknown numbers of Canadians that have long-standing and undeclared offshore accounts, says David Lesperance, whose boutique law firm Lesperance & Associates specializes in citizenship, residence, and domicile strategies for the wealthy. “Illegal options [are] no longer available to them,” he says.
A combination of rising government debts and an increasingly mobile, wealthy international cohort of “golden geese” in Lesperance’s parlance should translate into heightened competition for wealthy citizens willing to relocate for tax relief. “When we look at offshore financial centres . . . their business model, if it was based on secrecy, is kind of blown out of the water. There are already governments gearing up” to attract this well-heeled international group “on a legal, full-disclosure basis.”
Lesperance notes that the term “offshore financial centre” can be expanded to include any country other than the one an individual is currently residing in, even Canada. To that end, in June he is presenting a white paper in London, England, organized by the Canadian High Commission and the Canada-U.K. Chamber of Commerce to U.K.-based hedge-fund managers looking for low-tax jurisdictions.
While thought of as a high-tax jurisdiction, Canada qualifies as a tax haven internationally. Ottawa allows newcomers to set up a five-year immigrant trust which is tax-free for that span. “I have been giving effectively this presentation my entire legal career,” he says. “But now the drivers are there and now in particular people are leaving the U.K. and the next round will be in the United States.”
After 20 years in his golden geese “micro niche,” Lesperance finds himself with just a few, mainly Europe-based, competitors. It’s a situation that is unlikely to last, although he believes there is going to be plenty of business to go around as the world’s well-to-do geese seek new nests to safeguard their eggs. “The Canadian firms can do very well by realizing, ‘Hey, here is something that is our area of expertise and we are going to sell it to the world,’” he says.