I just tried using the offset and the capsule seems to remain above the ground, I thought maybe it could be the auto-stepping size you know so it makes the object sit off the ground that amount so it can step over objects of that height but no.
Anyway here is my code for setting up the character.
array insert at bottom g_arrCharacters()
g_arrCharacters(0).CharID = GetFreeObjectNumber( )
make object sphere g_arrCharacters(0).CharID, 128.0
hide object g_arrCharacters(0).CharID
phy make capsule character controller g_arrCharacters(0).CharID, 0.0, 256.0, 0.0, 32.0, 128.0, 1, 16.0, 40.0
I know the voices aren't real, but they have good ideas!