Offshore investing may seem like an attractive option to lower your taxes, but you need to be aware of the risks.

There are various ways of structuring your business affairs using offshore investing companies or trusts that can cut or defer your taxes. You may also be able to protect your assets from legal judgments rendered in Canada if you move them to accounts in certain foreign jurisdictions.

Earnings in an “offshore account” are generally lightly taxed, or not taxed at all, by the country where the bank or brokerage account is located. This includes jurisdictions like Switzerland or the Cayman Islands.

However, Canadian residents are obliged to report any income they earn through foreign investing on their Canadian tax returns. (You can only claim tax-exempt “non-resident” status without giving up your citizenship by staying outside of Canada for more than half of a tax year.)

The high cost of obeying the complex rules of offshore investing

Offshore investing banks generally do not provide reports on your investment income to the Canada Revenue Agency. So it’s up to you to comply with these reporting requirements.

However, the reporting rules for foreign investment property are complex, the information required is extensive, and the penalties for non-compliance are steep in offshore investing.

You’ll need to consult a tax advisor or lawyer in order to correctly structure the shelter. Note, however, that some law firms and tax advisors sell tax shelters to their clients as part of their businesses. It’s a major profit centre for them, so they are operating under a conflict of interest. Impartial lawyers or tax advisors may, and often do, disagree about the legality and/or practicality of those shelters.

What’s more, the fees involved in setting up and maintaining offshore investing accounts may offset a lot of your tax savings. That’s true even if the funds are already in a taxable account, and you don’t face a major tax cost of moving them into offshore accounts, as you do with an RRSP withdrawal. It’s also harder to evaluate and obtain adequate information on an offshore investment.

How offshore investing can create bigger losses than tax savings

An offshore account may help you defer or avoid taxes on investment profits, legally or otherwise. However, when you invest money with any offshore investing company, you need to carefully investigate and make sure you have adequate safeguards. Otherwise, you may have losses rather than profits.

Let’s put it this way: we strongly advise against doing anything illegal to cut taxes. Moreover, when you engage in offshore investing with the intention of evading taxes, you may be risking losses that exceed the taxes you would have paid.

Something else to consider: If you discover that you’ve been cheated while offshore investing, you may not be able to complain to authorities without admitting your own involvement in tax evasion.

Is offshore investing right for your family?

There are many ways to leave money to your heirs, offshore investing is not one of them. If you want to build up an investment portfolio for a child, then an informal in-trust account is a low-cost and flexible option. (Investments or investment accounts in the name of a child must be set up in trust because minors are not allowed to enter into binding financial contracts.) An adult must be responsible for providing the investment instructions and signing the contract on the child’s behalf.

An informal in-trust account has a donor (or “settlor”) who contributes funds to the trust. The trustee is the person in charge of the account, and is responsible for managing the funds for the child (the “beneficiary”). The settlor should not act as the trustee. The settlor’s spouse can be a trustee, however.

The money belongs to the child, but only the trustee can make withdrawals if the child is under the age of 18. Once the child reaches 18, the money is theirs to do with as they wish. Consult a reputable tax and trust attorney to create and manage your trusts.

Paying capital gains tax instead of using risky offshore accounts

If you’re trying to use offshore investing to reduce your tax burden, think about this: Canadian capital gains tax is fairly low.

With stocks, you only pay capital gains tax when you sell or “realize” the increase in the value of the stock over and above what you paid for it. (Although mutual funds generally pass on their realized capital gains each year.)

A properly structured investment portfolio can let you take advantage of the low tax rate on capital gains and dividend income while sheltering your higher-taxed interest income in your Registered Retirement Savings Plan.

Do you have experience with offshore investing? Has it been successful? Share your experience with us in the comments.