MORE AGGRESSIVE?? Paul R. LeBreux, LL.B, LL.M. TEP Chair, STEP Canada Global Tax Law Professional Corporation

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1 INTERNATIONAL TAX PLANNING A CANADIAN PERSPECTIVE CANADA REVENUE OR DO THEY?? AGENCY GETS MORE AGGRESSIVE?? Paul R. LeBreux, LL.B, LL.M. TEP Chair, STEP Canada Global Tax Law Professional Corporation

2 IS THERE TAX PLANNING LEFT FOR CANADIANS? Non-Resident Discretionary Trusts are still the most common and effective international tax planning tool for high net-worth individuals desirous of increasing their after tax accumulations International tax structures involving non-resident trusts seek to bring the non-resident trust outside the Canadian tax system in order to avoid Canadian taxation. To the extent that the nonresident jurisdiction does not tax the Trust s income, income taxes are avoided completely (Canada does not tax distributions of capital from a Trust [resident or non-resident]).

3 DISTRIBUTION OF CAPITAL (TAX-FREE) SETTLOR DISCRETIONARY TRUST CANADIAN BENEFICIARIES Canadian resident beneficiaries will receive capital taxfree from the Trust (104(13)(a). INCOME $100,000 CAPITAL $1,000,000 Income earned by the Trust will not be distributed at year end but will be added to the capital account of the Trust.

4 DISTRIBUTION OF CAPITAL (TAX-FREE) SETTLOR DISCRETIONARY TRUST CANADIAN BENEFICIARIES Canadian resident beneficiaries will receive capital taxfree from the Trust (104(13)(a). CAPITAL $1,100,000 The Trust will distribute proceeds to the Canadian resident beneficiaries from the capital account. Canadian resident beneficiaries will receive distributions tax free.

5 TRUST RESIDENCY Ensuring that a Trust is non-resident for Common Law purposes is generally quite simple! Ensuring that a Trust is non-resident for statutory purposes is/was not that difficult either (at least this is what many clients and advisors believed)!

6 Canada will deem an otherwise non-resident trust to be resident in Canada for tax purposes if the following conditions are satisfied (two tests) (par. 94(1)(c)): TEST ONE (Beneficiary Test) if in any taxation year a person BENEFICIALLY INTERESTED in the trust was resident in Canada, TEST TWO (Contribution Test) the trust has acquired property directly or indirectly from a person who was resident in Canada

7 DEEMED IN CANADA (ss. 94(1)) CANADIAN SETTLOR DISCRETIONARY TRUST CANADIAN BENEFICIARIES Canadian resident beneficiaries related to Settlor (or terms of Trust Indenture permit Canadians to be appointed i.e. beneficially interested (ss. 248(25)). INVESTMENTS Even though trustees of the Trust may reside in an offshore jurisdiction and the management of the Trust conducted offshore, the Trust will be deemed resident in Canada for Canadian tax purposes.

8 BROADENING THE SCOPE Despite a number of amendments to the Act (aimed at reducing the effective utilization of non-resident Trusts), the use of non-resident trusts continues (?) to be prevalent in international tax planning. Numerous amendments main one: expanding definition of beneficially interested (ss. 248(25)) (basically if a Canadian resident can be appointed as a beneficiary [by Deed, Letter of Wishes, etc.] a Canadian resident will be deemed beneficially interested).

9 INTERESTINGLY, THE REWORDING OF SS 248(25) SEEMED TO HAVE LITTLE OR NO EFFECT ON THE USE OF TRUSTS WHY?? 1. PRACTITIONERS EITHER QUICKLY FOUND WAYS AROUND THIS BROAD DEFINITION; OR 2. THERE SIMPLY WERE NOT AS MANY OFFSHORE ARRANGEMENTS AS PEOPLE MAY HAVE BEEN LED TO BELIEVE; OR 3. CLIENTS/ADVISORS ACCEPTED THE RISK/REWARD

10 BROADENING THE SCOPE Amendments Continued: introduction of the Foreign Reporting Rules (specifically section (Foreign Trust Reporting - Information return related to a Canadian that contributes property to a non-resident trust) and section (Information return related to distribution from and indebtedness to a non-resident trust). The Foreign Reporting Rules seemed to have very little deterrent effect (largely seemed to be ignored or workarounds).

11 DESPITE ALL OF THE ATTEMPTS TO ERRADICATE THE USE OF TRUSTS AND AGGRESSIVE TAX PLANNING, THE DEPARTMENT OF FINANCE STILL FELT THAT IT WAS NECESSARY TO DRASTICALLY AMEND THE RULES???

12 TAXATION OF TRUSTS - PROPOSED RULE Under the proposed rules (proposed section 94), a nonresident trust that acquires property or receives loans from a Canadian resident would be deemed to be resident in Canada and would be taxed on all of its undistributed income (regardless of having a Canadian resident beneficiary). Transferor, the Trust (and Trustee if distributions made) and certain beneficiaries (subject to certain recovery limits [94 (7) (9)]) would be jointly liable for the tax (would be entitled to credit for foreign taxes paid on undistributed income).

13 BACKGROUND The Draft Legislation originated in the federal budget (February 16, 1999). The Draft Legislation has been released five times, each time with substantial amendments, (a first draft of amendments introduced on June 22, 2000, a second draft on August 2, 2001, a third draft on October 11, 2002, a fourth draft on October 30, 2003 and a fifth draft on July 18, 2005).

14 WHAT TO EXPECT? Draft Legislation has yet to be proclaimed as law, despite the fact that it is to be effective and enforceable as of January 1, 2003 (STEP response) No grandfathering (i.e. trusts that were set up years ago where there may be no ability to amend the Deed could be caught) (STEP response); Extremely complex Shift away from aggressive planning? (Form vs. Substance) Is there a move away from offshore tax planning? Significant opportunity for remedial planning

15 NEW SECTION 94 Extended Meaning of Transfer Proposed ss. 94(2) sets out a number of rules that effectively broaden the definition contribution. Two main purposes of ss. 94(2): extend the circumstances under which a transfer will be considered to have taken place; and quantify the value of property that is transferred (for joint and several liability purposes)

16 WHY WERE THESE AMENDMENTS NEEDED??? CURRENT SECTION 94 STRATEGIES

17 CURRENT STRATEGIES There are essentially 3 (possibly 4) ways to avoid Canadian taxation utilizing non-resident trusts: AVOID HAVING A CANADIAN SETTLOR (CONTRIBUTOR) (usually involved indirect transfer techniques); AVOID HAVING A CANADIAN BENEFICIALLY INTERESTED IN THE TRUST; AVOID HAVING INCOME IN THE TRUST (i.e. distribute all income) TREATY OVERRIDE???

18 TAX DEFERRAL UNDER EXISTING LEGISLATION SETTLOR DISCRETIONARY TRUST CDN. BENEFICIARIES * Difficulty with this strategy is how to introduce real money into the offshore structure. (Note: obviously CRA felt there were enough indirect contributions to non-resident trusts to warrant the introduction of proposed subsection 94(2)) Based on existing rules, Trust will not be deemed resident in Canada pursuant to ss. 94(1). Income will grow on a tax-free basis.

19 FREEZE STRUCTURE CDN. (MR. X) 100% common shares Canadian resident owns the shares in Opco and anticipates that Opco will increase in value significantly over the next 3-5 years. Mr. X is looking for options to reduce the potential capital gains tax if Opco is sold. CANADIAN OPERATING COMPANY (OPCO) Canadian resident owns the shares in Opco and anticipates that Opco will increase in value significantly over the next 3-5 years. Mr. X is looking for options to reduce the potential capital gains tax if Opco is sold.

20 FREEZE STRUCTURE Non-Resident Settlor (nominal capital) Class A Freeze Shares (voting and entitled to dividends) CDN. (MR. X) Mr. X exchanges his common shares for Class A Freeze Shares (this is done pursuant to section 86 of ITA - tax-free exchange). This freezes the value of Opco. CANADIAN OPERATING COMPANY (OPCO) New Common Shares (growth shares) TRUST OFFSHORE CORPORATION (OFFSHORECO) OffshoreCo will subscribe for new common shares - for nominal consideration. Any future gain in Opco will accrue to OffshoreCo. Canadian resident owns the shares in Opco and anticipates that Opco will increase in value significantly over the next 3-5 years. Mr. X is looking for options to reduce the potential capital gains tax if Opco is sold.

21 CURRENT STRATEGIES There are essentially 3 (possibly 4) ways to avoid Canadian taxation utilizing non-resident trusts: AVOID HAVING A CANADIAN SETTLOR (CONTRIBUTOR) (usually involved indirect transfer techniques); AVOID HAVING A CANADIAN BENEFICIALLY INTERESTED IN THE TRUST; AVOID HAVING INCOME IN THE TRUST (i.e. distribute all income) TREATY OVERRIDE???

22 TAX DEFERRAL UNDER EXISTING LEGISLATION CANADIAN SETTLOR DISCRETIONARY TRUST * Difficulty with this strategy is how to get the money back into the hands of the Canadian resident that ultimately wants to benefit. (Interestingly, the foreign disclosure rules do not catch this transfer since the Non-resident Trust would be exempt given that it is not caught under section 94 of the Act.) BENEFICIARIES Trust Indenture will often provide specific exclusion prohibiting Canadian residents from being named as beneficiaries (some jurisdictions also allow purpose trusts [Cayman Islands, {The Special Trusts Alternative Regime Law 1997}]) Based on existing rules, Trust will not be deemed resident in Canada pursuant to ss. 94(1). Income will grow on a tax-free basis.

23 TAX DEFERRAL UNDER EXISTING STRUCTURE CANADIAN SETTLOR In order to give the Settlor some control and access to the Trust funds, if needed, the Trust Indenture provides that the Trust is revocable at the option of the Settlor. To prevent adverse operation of ss. 75(2), Trust invests money in Holdco below. DISCRETIONARY TRUST HOLDCO PORTFOLIO BENEFICIARIES Trust Indenture will often provide specific exclusion prohibiting Canadian residents from being named as beneficiaries (some jurisdictions also allow purpose trusts [i.e..cayman Islands {The Special Trusts Alternative Regime Law 1997}]) Trust proceeds will be invested in Holdco and will grow tax-free until paid to Trust. If income paid to Trust, Settlor would be required to include income in his return (ss. 75(2)).

24 CURRENT STRATEGIES There are essentially 3 (possibly 4) ways to avoid Canadian taxation utilizing non-resident trusts: AVOID HAVING A CANADIAN SETTLOR (CONTRIBUTOR) (usually involved indirect transfer techniques); AVOID HAVING A CANADIAN BENEFICIALLY INTERESTED IN THE TRUST; AVOID HAVING INCOME IN THE TRUST (i.e. distribute all income) TREATY OVERRIDE???

25 TAX AVOIDANCE UNDER EXISTING STRUCTURE (DISTRIBUTION OF INCOME) CANADIAN SETTLOR Settlor transfers capital to the Trust. Trust uses the capital to purchase a portfolio of investment assets (assume shares of publicly traded companies i.e.. Non- TCP). DISCRETIONARY TRUST PORTFOLIO CDN- BENEFICIARIES Trust Indenture appoints the Cdn. Settlor and/or family members as discretionary beneficiaries of the Trust. Trust will be deemed resident in Canada for purposes of section 94 of the Act.

26 TAX AVOIDANCE UNDER EXISTING STRUCTURE (DISTRIBUTION OF INCOME) CANADIAN SETTLOR Settlor transfers capital to the Trust. Trust uses the capital to purchase a portfolio of investment assets (assume shares of publicly traded companies i.e.. Non- TCP). DISCRETIONARY TRUST PORTFOLIO Trust distributes all of its income to a non-resident beneficiary in the current year. BENEFICIARIES At a future point, Trust will dispose of portfolio assets. At this point Trust can either pay tax in Canada on the capital gains OR beneficiary could become a non-resident of Canada and the Trust could distribute all of the gain to the non-resident Beneficiary (Note: Trust would have been entitled to deduct the distribution and would therefore have no Canadian tax exposure however October 2003 draft added new 94(3)(a)(viii) [now (ix)]) which blocks this (creates a withholding tax obligation).

27 WHAT S LEFT?

28 IMMIGRANT TRUST CDN. SETTLOR Cdn. Resident settlor will not be a Resident Contributor until he/she has resided in Canada for a period totaling 60 months) Old Rules: New Rules: Not Taxed Not Taxed DISCRETIONARY TRUST PORTFOLIO The portfolio will grow taxfree as long as the Trust is not subject to tax in the jurisdiction where it is resident. Distributions of capital may be made taxfree to Canadian resident beneficiaries. CDN. BENEFICIARIES Beneficiaries will generally be the Immigrant and/or his/her family (Note: such Trusts are now excepted for the provisions of ss. 75(2)).

29 INBOUND TRUST ( Granny Trust )/INHERITANCE TRUST SETTLOR Non-Resident settlor transfers assets to Non- Resident Trust (Note: must be a transfer outside of the 60 month window). DISCRETIONARY TRUST CDN. BENEFICIARIES PORTFOLIO The portfolio will grow taxfree indefinitely. Distributions of capital may be made tax-free to Canadian resident beneficiaries. Old Rules: New Rules: Not Taxed Not Taxed

30 OUTBOUND TRUST CDN. SETTLOR DISCRETIONARY TRUST BENEFICIARIES PORTFOLIO Trust will be deemed resident in Canada pursuant to the provisions of ss. 94(3) and taxed on its world-wide income. Beneficiaries will not be residents of Canada (and no chance of having Canadian resident beneficiaries [i.e. no Canadian resident beneficially interested ] (Charities possibly) Old Rules: New Rules: Not Taxed Taxed

31 OPERATING COMPANY SETTLOR Non-Resident settlor transfers assets to Non- Resident Trust (Note: must be a transfer outside of the 60 month window). DISCRETIONARY TRUST CDN. BENEFICIARIES OPERATING COMPANY (OPCO) Proceeds of sale of the shares of Opco may not be taxable. Old Rules: New Rules: Not Taxed Not Taxed (?) (watch out for par. 94(2)(g) if Canadian company)

32 PRACTITIONERS HAVE ARGUED THAT NEW LEGISLATION IS NOT NEEDED, RATHER CRA SHOULD SIMPLY ENFORCE THE LEGISLATION THAT CURRENTLY EXISTS??