Tax and Estate Planning Blog : Moodys LLP and SNC Law

Following-up on our previous post, Part 1: Tax Evasion - The United States and the UBS Affair, regarding the U.S.'s efforts to gather information from UBS about American account holders who may have been hiding assets and evading US taxes, the Internal Revenue Service (IRS) last week indicated that it is setting up an elite division to handle audits of wealthy Americans suspected of offshore tax evasion.

The newly created office will be within its Large and Mid-Size Business division, indicating the IRS wishes to have the audits handled by those with experience in dealing with tax treaties and cross-border business structures. As Jack Townsend of "Federal Tax Crime" notes in his post, Get in Line Brother #25 - IRS Plans for Life After Voluntary Disclosure, this should encourage those who may have US information reporting requirements to seek advice and consider a voluntary disclosure to the IRS. The IRS's voluntary disclosure program for reporting previously unreported offshore accounts ends September 23, 2009.

And in news closer to home, a spokeswoman for the CRA announced last week that Canadian government officials are pressing UBS for details of Canadian account holders. As we mentioned in the part one post, reportedly there is evidence that UBS ran a "Canada Desk" that may have been conducting similarly fraudulent activities for Canadians, and at one point may have managed approximately $5.6 billion in assets.

Although it appears that Canada's efforts at this point are limited to meeting with UBS, Canada may follow the US's footsteps and seek a court order requiring disclosure of account information.

As previously mentioned, Canadian taxpayers who may be affected by a crack-down would be wise to consider a voluntary disclosure to the CRA and seek legal advice.

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The recent U.S. Internal Revenue Service suit against and settlement with Swiss bank UBS over the identity of potential tax evaders appears to be just the start of a more concerted global effort by the US to crack down on unpaid tax on offshore accounts.

In the settlement, announced on August 19, 2009, UBS agreed to provide the IRS with details related to an estimated 4,450 American clients that the IRS suspects were evading taxes. The IRS estimates that the related accounts held over $18 billion USD at one point, a potentially significant source of taxes. The agreement comes on the heels of the February 2009 settlement of criminal fraud charges against UBS, wherein UBS agreed to pay a $750 million USD fine and to identify certain US clients whom it allegedly assisted to hide assets and evade taxes.

Will Canada be next?

Although to date the CRA has been silent on the issue, it would not be surprising. With respect to UBS, the ongoing US investigation recently revealed that UBS may have been conducting similarly fraudulent activities for Canadians. Known internally as "the Canada Desk," it appears UBS ran a Canadian operation similar to the one it ran in the US, whereby it would recruit wealthy clients and encourage them to move their assets to Switzerland. According to US investigators, as of October 2005, the Canada Desk managed $5.6 billion.

More generally, similar to the US, Canadian taxpayers' unreported offshore accounts could be a significant source of tax revenue. Canadian taxpayers generally must report and pay tax on their worldwide income, including income from foreign sources. Thus, CRA may be owed tax on unreported income held in offshore accounts, and may also be able to collect civil penalties if such income was not reported.

In addition to the US, other countries recently have made efforts to go after unreported offshore assets. For example, Her Majesty's Revenue & Customs (HRMC), the tax authority of the United Kingdom, recently won a court order to force more than 300 banks to provide details of their customers with offshore accounts. HRMC estimates that it will be able to recoup £500 million in unpaid taxes by British offshore investors over the next four years.

These efforts by individual countries coincide with a stronger recent focus on international tax information sharing. The Organization for Economic Cooperation and Development (OECD) recently issued a report on its work on countering international tax evasion, highlighting the fact that all OECD countries now accept the Exchange of Information Article of the OECD Model Tax Convention, including Austria, Belgium, Luxembourg and Switzerland - See OECD Progress Report (PDF).

In a further show of its commitment to the issue, the OECD is currently proposing a new, formal body to replace the current informal tax-information sharing group, the Global Forum on Transparency and Exchange of Information. Members discussed this new body during the recent OECD meeting on September 1, 2009. The proposed institution will provide a formal peer review mechanism "designed to ensure full implementation of international standards developed at the OECD," and will likely have a permanent staff of examiners.

Although Canada may rely solely on these efforts to improve future access to information about offshore accounts, the success of countries like the US and UK in obtaining information about historical offshore accounts suggests Canada will not ignore this potential source of revenue.

Indeed, Canada Revenue Minister Jean-Pierre Blackburn has asked U.S. justice officials to notify Ottawa if any data that they get from UBS has pertinent information on Canadians.

Canadian taxpayers who may be affected by a crack-down would be wise to consider a voluntary disclosure to the CRA and seek legal advice.

Follow-up post: Part 2: Tax Evasion - The United States and the UBS Affair

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In the recent past, US taxpayers who wanted to invest in Canada would often do so with structures that would avoid inefficient tax results on both sides of the border. One of the common structures that was employed in the corporate context was to utilize certain Canadian Unlimited Liability Corporations ("ULCs") that were fiscally transparent for US purposes.

In Canada, such corporations only existed in Nova Scotia (as a Nova Scotia Unlimited Liability Corporation) or in Alberta (as an Alberta Unlimited Liability Corporation). To the extent that a US taxpayer owned, say 100% of the shares of the ULC, all of the profits of the ULC would generally be fiscally transparent for US tax purposes (meaning that the US would not respect the ULC as being a separate legal entity and would require the profits of the ULC to be included in the US taxpayer's income directly).

For Canadian purposes, the ULC was treated as a "normal" corporation for taxation purposes and thus the profits were subject to Canadian tax with such tax generally being creditable against the US tax on the ULC's profits. The result was the avoidance of potential inefficient tax results on an overall basis.

To the extent that the profits of the ULC were repatriated to the US parent by way of a dividend, such dividends would often be subject to "treaty benefits" which would result in a reduced withholding tax rate.

Conversely, a Canadian taxpayer who wished to invest in the US would often utilize a US Limited Liability Corporation ("LLC") for reasons that are similar to the above but are beyond the scope of this blog entry.

On December 15, 2008, the Fifth Protocol to the Canada-United States Income Tax Convention came into force. A large surprise with the new Protocol was how ULCs and other fiscally transparent entities such as US LLCs (or sometimes partnerships) were to be treated.

New paragraph 7 of Article 4 of the revised treaty contains provisions that essentially deny treaty benefits to such fiscally transparent entities in many cases. However, the impact and implementation of the new provisions was delayed until January 1, 2010.

Accordingly, taxpayers and their advisors now have roughly four months to deal with the pending impact of the new provisions. Taxpayers who are impacted by such a change should consider alternative structures that would avoid the negative consequences of the new rules.

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