From our Canadian Bureau: Tax Proposal in Canada Raises Questions

By Dan Hallett, Contributing Writer

A controversial Canadian tax proposal has been opened for comment until Sept. 1, and the impact on your portfolio could be hugely negative. Here's the gist of the proposal:

All non-resident trusts and foreign investment entities will lose their
capital-gains treatment, and be taxed on 100% of the "increase in value" each year.

Suppose you, as a Canadian citizen, invest $10,000 in a foreign investment entity (defined below) and it rises to $12,000 by year's end. Even though you haven't sold it, you'll have to include the full $2,000 in your taxable income under the proposed law.

Current tax laws wouldn't tax that $2,000 gain until the investment was sold. Even when it is sold, only $1,333, or two-thirds, of the $2,000 would be taxable under current rules. Other income such as dividends, interest and capital-gains distributions that flow through to investors - either in cash or in the form of additional units - each year is also taxed accordingly.

What is affected?

This law is being proposed to stop wealthy Canadians from moving funds offshore to avoid taxes. A few years ago, a very wealthy Canadian family moved a $2 billion family trust fund out of the country. Canada's tax authorities failed to collect a dime of taxes, thanks to a loophole in the tax laws.

So, the intent of the law seems genuine. However, in attempting to stop a recurrence of this type of wealth transfer, the Canadian Department of Finance is sticking a knife in the back of honest taxpayers that neither exploit loopholes nor fall into the higher echelon of Canada's net worth.

The proposal defines a foreign investment entity as any corporation or trust, or any business structure not governed by Canada, with at least 50% of the carrying value of its assets in investment properties.
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