There is only one way to learn; from our mistakes. Some mistakes are more painful than others; i.e. like realizing that you have said things in private that are crude or rude, and then having them put in public. Which is what happened to me the other day, but I will hopefully come out of it a better lawyer and advisor.

Long story; and there is no short version, so deal with it. An accounting firm, for which I have never done any work, referred a potential client to me about 8 months ago. I did not know the accounting firm, nor the potential client. But out of professional courtesy to the accountants, as I would for any other potential or current referral sources, I took the meeting. I repeat, I only took the meeting out of PROFESSIONAL COURTESY to the accounting firm. As usual in such cases, I do not charge a fee or issue an engagement letter for such preliminary meetings because: 1) the point is to provide a PROFESSIONAL COURTESY to potential referral sources; and 2) I do not know enough about the client to be providing advice in any event, so I don’t.

My standard practice is that I tell the potential client in writing and at the outset of the meeting that this initial meeting is just a “get to know you” session. I am not going to give them advice. The potential client can tell me the story of what is going on. Then I will ask some questions, and I may throw out some ideas. We can then kick the ideas around and see if they are appropriate options on the facts. If they are going to work (and/or the client is prepared to make certain business/life changes to in order to make them work) then I draft up an engagement letter setting out what I think is the best course of action, and what it will cost to accomplish the objectives. That way they can understand what the “do-able options” are, and can make a rational cost-benefit analysis going forward. But, and I reiterate, they are not my client until such time as they get the letter, they sign it, put up the retainer and provide all the due diligence documentation I am required to get by the law society.

So the potential client (lets just call him “Basil Mangano”, because that was the name he gave me), in this case, was a businessman who had a few local restaurants with a brand name I did not recognize. My articling student, who was with me for the meeting, did recognize the brand, had been there, and liked it. Basil had some investors lined up who were going to help him take his budding restaurant chain to the Big Box level. You know, like Olive Garden, or Outback or whatever; the ones that are out in the parking lots of malls. Great food, good prices, fun for the whole family; you get the picture. So he tells me that he has some buddies that are “offshore” and he is looking for similar advice. OK … I explain in no uncertain terms that you can’t use offshore structuring for a restaurant chain in Canada. I then do my best to explain that generally speaking, you can’t do much offshore with a restaurant chain unless you are expanding outside of Canada. However there are ways that he and/or his investors could potentially “go offshore” personally in a compliant manner. We kicked the ideas around a bit, but “going offshore” would only work if: 1) he was retiring and leaving the country; 2) he wanted to settle an asset protection trust offshore with tax-paid assets; 3) he does some pretty complicated planning involving Canadian-Compliant International Private Placement Life Insurance. Which is complicated, and which would work for the investors into the new business (not the old business. Generally, I gave him only the highlight reel; the 10,000 foot level /1000 miles an hour version of how it could all work.

I also explained to him that a lot of the offshore planning is really about inter-generational wealth transfer, and protecting those assets for future generations. There are some tax benefits, but the big gains are to be made over his lifetime and during the transfer to his kids. I told him in no uncertain terms, several times, that the issue is that as a tax lawyer, I can’t give advice until I am hired, and even then I will only advise structures that actually work. If it works, I will opine on it, if it doesn’t I will not recommend it. He kept on trying to throw in things like using nominees offshore, or just getting a bank account, and he also at one point told me that the accountants said “it was easy” and that it did not need to be that hard. But I kept telling him, “No, that crap does not work”, and I will not do it.

Then we discussed a number of domestic “no-brainer” structures that he could do to reduce tax. I spent probably 2 hours with Basil, which is a lot, but he seemed like a good guy who needed some help, so I was willing to try to work with him. I sent him an engagement letter focused entirely on the domestic issues he needs to address, because, frankly, in my opinion he was not ready to do any complicated planning, offshore or otherwise.

It turns out Basil was really a reporter from CBC. They are doing this investigative thing on offshore unreported accounts, etc. He recorded the entire conversation. Yeah, OH SH…..

The CBC asked me to come in to address my comments to him in an interview. First of all, I refrain from saying anything because of privilege, confidentially etc. . So I looked into whether privilege attached to the discussion. It does, but it was the potential client’s privilege, not mine (I knew that much) but the second he shared the content of the discussion with a third party, there was no more privilege. Also, since the potential client never intended to legitimately obtain advice, and always intended to share the content of the conversation with third parties for a purpose other than receiving legal advice, the conversation was actually never privileged or confidential to begin with as a matter of law. Basil also waived his privilege and confidentiality in writing.

Secondly, I was ticked off that anyone would do that to me, and I wanted to say that to the CBC. All they had to do was ask and I would have discussed everything on the tape with them directly. I am not shy about my views. (see link among other cases where I have shared my views with the press) Along the way, I looked into whether it was legal to record people like that (it is), then I looked into whether or not I could sue (I could, but I would have to prove no public policy reason for the taping, and also that my office was an area of privacy). I think I could win, but I do not think it would do any good.

Also, I talked to my articling student, who was in the room during the meeting with Basil, and asked him “What did I say to that guy the other day with the restaurants?” My articling student said “You talked about the typical offshore structuring for Canadian individuals & businesses, nothing unusual … it was mostly about all the domestic issues he has to deal with ASAP…. ” So I figured, you know what, with this type of thing, you can’t hide from it. You have to engage and move forward. SHOW NO FEAR and maybe they will go away. Just be yourself and everything will be OK.

OK, but I looked bad. So I have deal with it. And this is the only way I know how.

Context is everything. The CRA article clearly quotes me out of context on their website today (see link), and on TV tonight, but everyone says that. The context was that Basil was a man of my own age (45+), who was clearly a man of the world and no fainting violet. He was also pushing me very hard to tell him that the illegal offshore stuff was OK, saying “my buddy is offshore and he gets away with this … my accountant says I can do that… “ and I was trying to do my best to save him from doing something stupid. But he just kept pushing me. So I told him that I am smarter than anyone he has talked to, and if say it is wrong, doesn’t work and you will get caught, you should believe me, not them.

Just to top things off, I used some of my favourite expressions to drive the point home. I said, look, “I am the most devious underhanded son of a bitch in the room and that’s what you’re paying me for.”, so if I say it a structure is illegal and does not work, that’s because I say so; end of discussion. But the problem is not what I said but how I said it. I am a sneaky underhanded scheming … lawyer, and that is why I am good my job. In every transaction or structure, I am always thinking about new ways the people on the other side of the table could screw over my client, and then figure out ways to stop it. That is what I do. And I am good at it. But I sound like a scumbag for saying it.

Moreover I say the same thing in public, all the time. If anyone ever says to me that they want to be a lawyer, I tell them if you do not have a “sneaky weasel brain”, and are not constantly thinking about how to rip your client off, you are not going to be a good lawyer. Because if you do not think of how your clients could be ripped off (or get their structure unwound by the CRA), and get out front and stop it, someone else out there will. And then your client will sue you, quite rightly, for not being the most devious underhanded SOB in the room. Which generally discourages them from wanting to be a lawyer, and is exactly why people hate lawyers. They need us to keep them safe from people who do not use their sneaky weasel brains for good, but rather for evil… so I am kind of a superhero (with great brains, knowledge and imagination comes great responsibilities…)

And the thing about the International Canadian-Compliant International Private Placement Life Insurance (CCI PPLI) product, is that it works, and the professor the CBC quoted in the article who said it does not work simply does not understand the facts and law. He also has a particularly interesting world view.

What I said, in a nutshell, was as follows: Canadian residents want invest in big box restaurant. They need to invest say $8 M for four to six big box restaurants. They own equal shares of the individual special purpose entities that will own each store. The investors, individually in their own names, buy bonds (formal proper bond, as qualified investors in a manner compliant the Securities Act, effectively “long term commercial paper”) issued by each company with an arm’s length interest rate based on proper economics for the entire $8 M investment in tranches as the money becomes needed. This will likely take a couple of years to roll out (as you would want to ease into this structure for valid business and tax law reasons), one store at a time until you get the hang of it. They settle a trust outside of Canada with the bonds as the assets of the trust. The interest payable on the bonds will attract withholding tax, as the owner, the trust, is outside of Canada. The interest on the bonds will be attributed back to the Canadian settlor of the trust. This is bad, as it is double taxed.

However, the trustees have options to deal with the taxable income. For example, the trust could buy a Canadian-Compliant International Private Placement Life Insurance (CCI PPLI) policy on the settlor with the bonds contributed to the policies as premiums over a number of years.

Lets unpack the parts of the concept first. A “Canadian-compliant life insurance policy” is an “Exempt Policy” under the Income Tax Act. That means that the growth of the assets underneath the policy are tax-free, and the death benefit is also tax-free. Specifically, Canadian actuaries certify it is an exempt policy in compliance with all of the MTAR rules and the exempt policy tests. “Compliant” also means that the Canadian resident beneficiary of the trust declares the existence of the trust on their T1135 and the trust files a T3 return. The T3 will show no taxable income, because the assets of a Canadian compliant life insurance policy do not throw off taxable income.

“Private Placement” just means that the premium going to the life insurance company consists of whatever assets the life insurance company is willing to accept as going into the policy. In Canada you pay cash, and then get back a promise, or you can sometimes make some choices about investments within the policy. Private Placement has been around for 30 years in the US. The insurance company just makes a contract with the existing asset manager, and so there are no fees on top of fees on top of commissions and expenses etc. Private Placement policies are generally sold on a “full disclosure” basis, in that all costs and fees (including all compensation and profits) are revealed to the purchaser, and those fees/costs are a fraction of the costs you typically see in Canada.

“International”, in this case just means that the purchaser of the policy is the trust, which is a non-resident of Canada as a practical matter, but taxable in Canada under the Act. The vendor of the policy is also not a resident of Canada.

The policies are issued by major non-Canadian insurers, using Canadian actuaries who will opine that the policies are Canadian-complaint (with a proper shift of risk). The trustees are all major trust companies, they will come to their own conclusions whether or not the life insurance policy is proper for them and the beneficiaries so there is no sham or non-discretionary trustee problem. The life insurance companies, and their re-insurance partners, will have to accept the assets and become comfortable with the risks and the assets involved. The structure has been vetted by a major Canadian bank, who were the ones who asked us to set these policies up, so they could offer it to their clients. We spent years talking to the bank about it and getting them to OK it. So it has been reviewed by a lot of people, not just me. The thing with the bonds, that was all me, but that still works.

Put it all together, and you get a structure that allows you to put bonds of a related party into a trust, and the trust uses the bonds as premium for an exempt policy that throws off no income tax. The interest paid on the bonds would be deductible in Canada at the corporate level, and subject to withholding tax on the way out (depending on your view of the concept of “arm’s length”), but not personal Canadian tax in the hands of the settlors/beneficiaries of the trust because the trust has no taxable income to attribute back to the settlors/beneficiaries. Generally speaking, we would do this structure mostly with other after-tax bankable assets, to get them out from under Canadian tax, and to get them behind two layers of asset protection.

There are no rules or regulations in Canadian life insurance policies that say a life insurance policy can’t hold related-party assets like the bonds as set out above. NONE. There are lots of rules about how life insurance companies resident in Canada are taxed, and rules about their reserves and investments. But there are none about the nature of the assets contributed to the policy. Not because the CRA could not put them in, but because the product does not exist in Canada.

FYI, no Canadian life insurance company would ever issue a private placement product in Canada. The fees are not high enough and they do not make enough money on them. I know because we asked them if they would create such policies for the Canadian market, and they refused…

Also, if and when the CRA does get around to regulating the content of private placement policies, they will most likely place the same kinds of restrictions you see in the US. Why? Because Canadian regulations often wind up looking like US rules, and the major players in the private placement market are likely to be US entities, who will squeal loudly if the rules are too different. The US rules require that the assets be effectively marketable securities, that the assets not be overly concentrated, and that the owner of the policy does not “control” the assets in the policy. By using corporate paper, we avoid pretty much all of these issues, and if we can diversify the policy away from the bonds over time, we are not only compliant with the law now, but what the law is going to be sooner or later.

The critque of this structure by Professor Andre Lareau is laughable. By the way. Prof. Lareau is my definition of an out-of-touch professor; during the height of the student protests in Quebec last year, he wrote an article (in French, link available here) suggesting that rather than ask the students to pay more for university (more than the mere CAD$750 per year they paid in Quebec….) the government of Quebec should shut down the capital gains exemption to get more money to spend on the already overly pampered students.. Yeah, really. OK, as far as real tax policy goes, the capital gains exemption on the sale of a small business is one of the few lines in the Income Tax Act that actually encourages entrepreneurship, but Prof. Lareau apparently thinks it is a bad thing. So if the only person the CBC can find that thinks my structure violates the “spirit of the Act” is this guy, well, I am not worried.

The so-called experts who critiqued me on The National were also problematic.  First of all, when I did the interview, the CBC reporter said that they had at least six different reviewers who said the CCI PPLI structure was offside.  After the interview, and after I explained the structure in detail to the reporter’s flunky/researcher, all but two of the critics appear to have backed off. As I said, I only gave Basil the highlight reel in our original meeting, and  that might have not been enough to inspire confidence among my colleagues. But once they saw the whole thing, then well, anyone credible backed off.  The two people willing to be quoted on-air consisted of a guy who did not want to reveal his name or face? Really? Whatever Dude. The only people involved in this world are bankers, not bikers… So why hide your face, unless you do not stand behind what you say?  And the other person was a US tax “expert”, who was so out of touch his critique consisted of “wrappers do not work”.  Ummm, in the US they do, and in Canada they do not. Which is why the product is called Canadian Compliant…. because we have a proper exempt policy.  An exempt policy can’t be a wrapper, by definition.  Which I explained ad nauseum.  But apparently no one at the CBC could understand …

And FYI, the General Anti-Avoidance Rule (GAAR) does not apply on the facts and law. In order to be offside on the GAAR, you have to fail all three parts of a three-part test. First of all there has to be a tax benefit. What benefit is there to an exempt policy outside of Canada vs. one inside of Canada? Neither generates taxable income. So no tax benefit because there is no tax in either case. There also has to be an avoidance transaction. An avoidance transaction is any transaction, within a series of pre-ordained events, with no valid business/non-tax purpose. The creation of the bonds has a purpose, to finance the businesses, and to allow for the investors to more easily claim ABILs if the businesses fail. The investors create valid asset protection trusts, for the purpose of protecting their assets, and contribute the bonds for the same purpose. The trustees, who are independent third parties, decide to invest the bonds in the most tax effective manner possible, and to provide the families with long-term protection and adequate life insurance coverage for estate and legacy planning purposes. The insurance company, also an arm’s length third party, decides whether it wishes to insure the beneficiary, and also whether or not it wishes to accept any assets provided as premium. So there is no pre-ordained series of events, because a series of third parties have to make a series of independent decisions, and there is no transaction taken only, or even predominantly, for tax purposes. So there is no avoidance transaction. And lastly, the policy of the Act is that exempt policies do not throw off taxable income. Period. So how can an exempt policy be a misuse or abuse of the Act? I admit that the structure is pretty cute, but on the GAAR (which is not a “sniff test”, but a proper legal rule) it is solid.

So what can I learn from this experience? First of all, do not say things in a blunt, direct-as-possible way to make people pay attention to a key point and/or try to state your message in language that you think they may understand, and never ever try to prevent someone from doing something stupid. In other words, I need to be more like a traditional, stick-in-the-mud, boring, unhelpful, incomprehensible lawyer. And do not take referrals from fellow professionals for free as a courtesy. Generally, just not be me.

OK screw that. I am me, and I will have to live with it. And I am still right, I just really wish I had said it a lot better.

Jonathan Neil Garbutt