5 Questions About Offshore Entities Answered

Following the headline-grabbing release of the so-called Panama Papers, here's what you need to know about tax havens and many of the companies headquartered in them

Written by Aleksandra Sagan, The Canadian Press

The so-called Panama Papers data leak shows how major banks helped clients create companies in offshore tax havens, raising questions about the legality of offshore operations. Here’s what you need to know about offshore dealings and tax evasion:

What is an offshore company?

The term offshore is quite literal. It refers to a company that is largely owned by residents of one country, but is located and operates outside that nation’s borders. For example, a Canadian-owned company that is incorporated in the Cayman Islands would qualify as an offshore entity.

What is a tax haven?

These offshore companies are often located in what’s known as tax havens. These nations allow people and businesses from abroad to pay lower taxes than they might be required to fork over at home.

The British Virgin Islands and Panama are both named in the leaked documents and are considered traditional tax havens. Barbados, the Cayman Islands, Luxembourg, Bermuda, Ireland, Switzerland, Hong Kong, Cyprus, Singapore and the British Virgin Islands were the top 10 tax havens in 2014, according to Canadians for Tax Fairness.

Is it illegal to create an offshore company?

Not necessarily. It is entirely legal for Canadians to have offshore companies, said David Duff, a professor at the University of British Columbia’s Peter A. Allard law school.

Investing outside Canada is not illegal, according to the Canada Revenue Agency (CRA). Offshore companies can be used for business finance, mergers and acquisitions, and estate or tax planning, says the Financial Action Task Force, a global watchdog.

So why the controversy?

Because it’s possible to conduct illegal dealings through the offshore entity. “The question is whether you have to report tax and on what kind of income,” Duff said.

The leak claims thousands of the companies registered with the Panamanian law firm are shell companies, which lack active business ventures and don’t tend to have many assets.

Offshore companies generally must pay Canadian taxes on any passive income earned, said Duff. Passive income could come from interest on investments or rent, he said. Active income, on the other hand, comes from manufacturing goods or providing services.

Canada could be missing out on a large sum of money owed in taxes if these companies are not declaring their passive income in Canada. In 2014, Canadian corporations kept nearly $200 billion in the Top 10 tax havens, according to Canadians for Tax Fairness.

It’s also possible some of these offshore companies participate in money laundering—using the business as a front to funnel money to and from illegal activities. “There’s a lot of criminal activity and money laundering that flourishes in the shadows of the international financial system and tax systems,” said Duff.

What’s Canada doing about tax evasion?

Canada has entered into various information-sharing agreements with other countries to try to obtain information about offshore companies, said Duff, but such deals can be ineffective.

The Liberal government’s budget allotted nearly $450 million over five years to the CRA to help it ramp up efforts to crack down on tax evasion and avoidance. Over that time, the government anticipates the agency will be able to retrieve $2.6 billion in otherwise undeclared taxes.

The CRA also operates an offshore tax informant program. People can tip off the agency to offshore tax evasion and, in return, the agency promises to award the whistleblower between five and 15 per cent of federal tax collected if it amounts to more than $100,000 (before interest and penalties).

The agency also offers a second chance through the voluntary disclosures program to anyone wanting to own up to leaving out information, including foreign-sourced income, on past tax returns.

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