For a number of years, Canadians with substantial assets have been transferring their assets offshore in order to avoid the impact of Canadian taxation. Recently, with high punitive and other damages being awarded by the courts against directors and officers of corporations and other professionals, more and more individuals are transferring their assets offshore, in order to achieve a degree of asset protection.
Offshore trusts and offshore corporations are viewed as a means to avoid the high level of Canadian Taxation and protect assets against catastrophic judgments.
1. Canadian Taxation
Residents of Canada are subject to income tax on their worldwide income. Assets which are transferred by residents to foreign trusts and foreign corporations as passive investments, may be deemed to be income of Canadian residents, to the extent that Canadian residents control such foreign trusts or foreign corporations or to the extent that Canadian residents are beneficiaries of such foreign trusts or foreign corporations.
2. The Elements of a Foreign Trust
In every trust, there is a settlor, which is a person who sets up the trust and transfers assets to the trust. The settlor must not be able to control the assets which he has transferred to the trust, because that would make those assets available to his creditors and may also subject those assets to taxation in Canada.
Every trust also has beneficiaries, being the persons who are entitled to receive either the capital or the income (or both) of the trust. If these beneficiaries are or can be residents of Canada, or if the settlor (who is a resident of Canada) retains an interest in either the capital or the income, then the trust will be subject to Canadian taxation, and creditors of the beneficiaries may be able to attach such income or capital when it becomes payable.
The trustee of the trust is the person (or company) which holds and invests the trust funds. By selecting a trustee who resides in an offshore jurisdiction, the trust funds may not be subject to Canadian taxation and if the foreign jurisdiction has debtor protection laws, such assets are also protected from seizure by creditors of the settlor and beneficiaries.
The normal offshore asset protection trust will provide that the income from the trust may be paid to an international charity not resident in Canada during the lifetime of the settlor, and that at the death of the settlor or some time thereafter, both the income and the capital will be paid to persons who are within a class of beneficiaries, such persons to be determined by the protector.
The protector is a trusted friend of the settlor who preferably is not resident of Canada and not subject to the laws of Canada. The protector makes the ultimate decisions as to the choice of trustee and the fees payable to the trustee. He also has the power to allocate the income and capital within the class of beneficiaries.
In a typical offshore trust, the trustee would be directed to invest all of the assets of the trust in an offshore corporation.
3. The Offshore Corporation
The offshore corporation holds and invests all of the trust’s assets. In the typical situation, all of the shares of the offshore trust are held in bearer form by the trustee, and the directors and officers of the offshore corporation are employees of the trustee. Accordingly, the trustee controls the offshore corporation. The settlor, the beneficiaries, and the protector have absolutely no interest in the offshore corporation. As such, the offshore corporation is only liable to taxation in Canada on its income earned in Canada (through non-resident withholding tax), and neither its outstanding shares nor its assets are available for seizure by creditors of the settlor.
4. Investments of the Offshore Corporation
“Possession is nine-tenths of the law.” The assets of the offshore corporation are maintained in bank accounts or accounts with investment dealers, or in some other form, with full power of attorney given to a consultant or manager of such assets. In a typical scenario, the manager of those assets is the settlor of the trust. In fact, the directors and officers of the offshore corporation have no actual knowledge of the location or form of those assets; only the manager has that knowledge. The manager has the full power (on behalf of the offshore corporation) to deal with those assets as he pleases, and to transfer those assets to whoever he pleases, including himself.
It must be remembered however that the offshore corporation owns the assets and the income. The offshore corporation must pay tax on the income where the income is earned (non-resident withholding tax in the case of investment income earned in Canada). Assets of the offshore corporation that are transferred or paid to residents of Canada may be subject to taxation in the hands of the recipient.
In its simplest of terms, a person who transfers assets to an offshore trust and an offshore corporation can protect the assets so transferred from his creditors because he no longer has ownership or legal control of those assets. The person with legal ownership and control is the offshore corporation and the person with deemed control is the offshore trust. If properly set-up, neither the offshore corporation nor the offshore trust will be subject to Canadian taxation, except to the extent of non-resident withholding tax on investments in Canada. Actual control over the transferred assets is achieved by possession and power of attorney.