Approximately 2,700 Canadian individuals and 560 Canadian corporations have been named in the Paradise Papers, a massive leak of documents from a tax law firm setting up tax structures in low and no-tax nations.

Canadians named include three former prime ministers and a top Liberal fundraiser closely aligned with Prime Minister Justin Trudeau. More than 13.4 million records were uncovered and analyzed in a year-long project by 400 journalists in 67 countries.

The Canada Revenue Agency says it has identified approximately $25 billion in unpaid taxes, interest and penalties related to offshore accounts. It says 990 audits involving both participants and facilitators are underway and there are more than 42 ongoing criminal investigations related to offshore tax havens.

Paul DioGuardi, a Toronto-area tax lawyer, thinks the CRA will go after “the little guy and the little gal” to bump up prosecution statistics.

“They’re going to want to be able to show, ‘Oh, we’re very rough, we’re very rough’ but they’ll go after the easy pickings, the low-hanging fruit because they can really prosecute people. They’ll be very nasty, but unfortunately, or fortunately depending on your outlook, they may not be going after the high rollers,” he told CTV News Channel Monday. put a series of questions to Jonathan Farrar, an expert in tax evasion and fairness who teaches at Ryerson University’s Ted Rogers School of Management, to help explain how offshore tax accounts work and why rich Canadians and companies use them.

How do offshore tax accounts work?

A taxpayer in Canada (individual or corporation) transfers assets (cash, or investments such as shares, mutual funds, real estate) to a country with much lower tax rates than Canada. Popular lower-tax countries are Caribbean islands, such as the Cayman Islands, which are “offshore” from Canada. A transfer could be done by loaning the assets.

The goal is to have the income from the assets taxed at a lower tax rate in the offshore country.  Had the income from the assets been taxed in Canada, the taxpayer would have paid taxes at much higher rates, and would therefore have paid more in taxes.

A new legal entity, such as a trust, is created in the offshore country. A trust is a legal arrangement involving a settlor (a taxpayer who transfers assets to a trust), a trustee (someone to manage the assets), and a beneficiary (an individual who will receive the income from the trust’s assets).

From a Canadian tax perspective, an offshore trust is taxable in Canada if the management and control is exercised within Canada. That is, if the trustees make their decisions about the trust’s assets in Canada, all the income from the trust is considered to be taxable in Canada. (However, if a trust’s decisions are not made within Canada, income from the trust’s assets is not taxable in Canada (unless the assets are Canadian – Canada always gets to tax income that is generated from Canadian assets).  Therefore, a Canadian taxpayer with foreign assets (such as shares in non-Canadian companies) can avoid paying Canadian income tax on income generated from the foreign assets by creating an offshore trust with a non-Canadian trustee.

How rich do you have to be to take advantage?

An offshore arrangement is typically done for taxpayers earning within the top 0.1 per cent of income in Canada, who would have a net worth of several million dollars at a minimum.  Annual fees paid to lawyers and accountants each year would have to be more than offset from the reduction in income taxes paid to the offshore country’s government.

How much can offshore structures save an individual or corporation in taxes?

The amount of tax savings depends on the differences in tax rates and amount of income. For example, a Canadian individual living in Ontario in 2017, could pay tax at a rate as high as 53.53 per cent on interest income. Supposing that same individual were taxed in the Cayman Islands, she or he would pay a tax rate of zero per cent. The tax savings could be very significant, depending on the amount of interest income.

If the Canadians named in the Paradise Papers haven’t done anything illegal, should tax laws change?

Generally, tax avoidance is the legal use of tax laws to reduce the taxes that someone owes (an RRSP deduction is a tax avoidance mechanism that is perfectly legal). In an offshore context, there is confusion over tax planning to legally reduce one’s taxes (tax avoidance) versus engaging in transactions that were not intended by the Canadian tax system, or an intentional defiance of the Canadian tax system (tax evasion). 

I think the distinction between legitimate and illegitimate tax planning should be clarified further by the Canadian government and all national governments. To this end, the OECD (Organisation for Economic Cooperation and Development), which is an informal world tax authority, is trying to engage all countries to agree on a series of principles to guide international tax transactions, which would be applied consistently across all countries by all tax administrations. To assist in this process, there are TIEAs (Tax Information Sharing Agreements) that countries can make with each other, which will improve transparency.

What do you expect the fallout of this to be in Canada?

I think there will be more cynicism among Canadians: the Panama Papers, now the Paradise Papers … what next?  Particularly problematic is a perception that political leaders are associated with wrongdoing, as that may decrease trust in the government and undermine the legitimacy of the government, which may lead to resistance and uncooperative attitudes from citizens. 

What kinds of penalties do individuals and corporations face if the CRA finds offshore tax structures to be illegal?

All taxpayers can be assessed penalties and interest on unpaid amounts (amounts that should have been paid by April 30 each year), as well as interest on these penalties. In addition, a taxpayer engaged in an illegal transaction couldface an administrative penalty of at least 50 per cent of the income tax avoided.  Taxpayers could also face criminal penalties, if there was a criminal intent to deceive the government, which could bring another penalty (of up to $25,000) and a possible prison term. Tax advisers who intentionally engage in tax evasion can also be given an administrative penalty and a fine and jail term.