By Dean Blachford, Tax Litigation Lawyer and Robert Barnes, Law Student

Thousands of Canadians invest in Offshore Investment Fund Property (OIFP) every year. There are many legitimate reasons why Canadian individuals and corporations may want to invest offshore. Higher ROI, added security, and diversification are just some of the most common reasons. There is nothing wrong with such investments.

Where the potential trouble lurks, however, is when the Canada Revenue Agency (“CRA” or “Agency”) suspects that the taxpayers are investing offshore to avoid paying taxes. In such cases, the CRA will try to apply the stringent OIFP rules to severally penalize taxpayers for their offshore investment.

Fortunately, there are ways for taxpayers to fight back and defend themselves against CRA’s false accusations of tax avoidance.

What are the OIFP rules?

The OIFP rules are found in section 94.1 of the Income Tax Act ( “ITA”). They are anti-avoidance rules designed to deter Canadian investors from investing in low tax or no tax jurisdictions in order to reduce or defer their Canadian tax liabilities.

The CRA will apply the OIFP rules if it believes that 3 criteria have been met:

    1. The taxpayer acquired an interest in offshore property, specifically in an independent foreign entity.
    2. The investment in question can be reasonably considered to principally derive its value, directly or indirectly, from certain “portfolio investment” (i.e. passive investments for financial gain only, such as investments in securities, with no effective control of the invested entity).
    3. That one of the taxpayer’s main reasons for investing in the offshore property is tax avoidance or deferral of tax, such that the taxpayer pays significantly less tax than would have been paid if the investment was in Canada.

If the rules apply, the offshore investment is subject to a “deemed income accrual,” and the taxpayer must pay tax on the product of the cost of the offshore investment multiplied by a prescribed interest rate, currently around 3%. For example, an offshore investment property that costs $500,000 has a “deemed income accrual” of $15,000 ($500,000 x 3%). So if the OFIP rules apply, the taxpayer at the highest marginal rate will have to pay approximately $7,500 in tax on that offshore investment property.

What does the dispute with CRA come down to?

The dispute over whether the OIFP rules apply ultimately comes down to motive: Is one of the main reasons for a taxpayer investing in an offshore property to realize a tax benefit?

What can you do if CRA is questioning your motives?

The test for applying the OIFP rules is weighted in favor of the CRA. All the Agency has to do in order to apply the rules is assert that one out of potentially many of your “main reasons” for investing in the offshore property is to reduce your tax liability. The burden then falls on you to demonstrate that this wasn’t one of the main reasons for your offshore investment. In other words, you have to prove you are innocent.

Despite this high burden, taxpayers can nevertheless successfully rebut CRA’s presumption of tax avoidance.

In R v Gerbro Holdings Company,[1] for example, the corporate taxpayer was able to demonstrate that tax avoidance was not one of its main reasons for investing in an offshore property. The corporation was able to support this position by providing years’ worth of evidence, which included board meeting minutes and investment guidelines. In the end, the taxpayer was able to successfully argue that it did not owe CRA any additional taxes in relation to its Offshore Investment Fund Property.

Conclusion

Gerbro Holdings is a testament to taxpayers being able to successfully rebut CRA’s unfair assumptions about their investment motives. While the OIFP regime is complex, it is often applied in an overly broad manner by CRA, and results in innocent investors being caught up in a net which is designed to capture tax avoidance and evasion.

If you have Offshore Investment Fund Properties and have been adversely assessed or re-assessed by CRA, please contact Dean Blachford at Hazlo Law – Business Lawyers to discuss your options.

[1] 2018 FCA 197.

This article is for informational purposes only and does not constitute legal advice. If you wish to discuss your issue with a lawyer, contact Dean Blachford today.  613-747-2459 ext.310, dblachford@hazlolaw.com