What tax matters are important when emigrating?

What tax matters are important when emigrating?

What tax matters are important when emigrating?

When you take up residence in another country, have you obtained advice on tax matters both on departure and on any risks of having continuing connections with your former residence?

While it is possible with proper planning to minimize tax on expatriation to another country, it is equally important to reduce exposure to the risk of continued residence-based taxation in the former country.

When my client Michael told me he was planning to leave Canada and needed tax advice, I prepared to give him some advice he was not expecting. He had heard from some friends that they had emigrated to The Bahamas because there is no income or estate tax there.  But Michael’s wife was pushing him to go to England where their teenage children might get a superior education.

He was surprised to find out that on leaving Canada he will be deemed to have disposed of all of his assets, subject to certain exceptions, for proceeds of disposition equal to the then fair market value of each such asset, resulting in capital gains tax (at a rate of 25%, effectively).  Some have called this Canadian rule, “Golden handcuffs”. Several other countries have adopted similar departure taxes, including Spain and South Africa.

When Michael explained that he wanted to support the arts from his new home, I suggested a plan that could accomplish his goal and save tax on departure. I suggested we register a private charitable foundation with the Canada Revenue Agency, which he could run from his new home.  The object of this charity to support the arts was one that the CRA has found acceptable in the past. He could then make a tax-free gift of his publicly-listed securities to this foundation, which would reduce the value of his assets on departure. He would also be entitled to a donation tax credit based on the value of the donated securities, which in turn could be used to shelter taxable income for his year of departure.

While he liked the idea of going to The Bahamas and not to have to worry about paying local income tax or estate tax, I explained that he should not forget about his connections with Canada and the special risks associated with those continuing connections. When Michael said that he liked the summers in Canada and so would retain his cottage here, I cautioned him about his Canadian tax exposure.

The Income Tax Act (Canada) (the “ITA”) would deem Michael to be a resident of Canada if he sojourned in Canada for more than 183 days in any year, even though he may have acquired a residence for tax purposes elsewhere. Under Canada’s tax treaties with ninety-four other jurisdictions, including the U.K. but not with The Bahamas, 1 there is a set of “tie-breaker rules” to determine if a person is a dual-resident, and which jurisdiction has the right to tax him/her on worldwide income on the basis of his/her having the closer connection with that jurisdiction.

In addition, I explained that the courts have broadly interpreted the rule in the ITA that a reference to a person resident in Canada includes a person who was at the relevant time ordinarily resident in Canada.  In other words, the question is where the person in his/her settled routine of life regularly, normally or customarily lives. One must consider the degree to which the person in mind and fact settles into, maintains, or centralizes his/her ordinary mode of living, with its accessories in social relations, interests and conveniences, at or in the place in question.

I told Michael that if he keeps the cottage in Canada and habitually returns to it from a non-treaty jurisdiction like The Bahamas, he is likely to be found to be a resident of Canada. In contrast, if he lives in England and maintains his “centre of vital interests” there and not in Canada, he is likely not to be found to be a resident of Canada under the Canada-U.K. Income Tax Convention.

In the end, Michael moved to England; we set up the foundation; and he uses the liquid funds in the charity to support the arts in Canada and elsewhere.

  1. As Canada considers The Bahamas to be a tax haven, it does not have a double tax treaty with that country, but it does have a Tax Information Agreement that provides for tax information to be exchanged between The Bahamas and Canada. In addition, the Agreement provides that a Canadian multinational with a subsidiary that carries on an active business, such as a hotel, in The Bahamas, is able to repatriate profits by way of tax-free dividends. However, the Agreement does not provide Bahamian individuals with relief in the area of exposure to Canadian tax residence. []
Investing in U.S. Real Estate – A Canadian Perspective

Investing in U.S. Real Estate – A Canadian Perspective

Structure your real estate investments to preserve your assets on a tax-effective basis

If you are making investments in U.S. real estate, you can avoid common pitfalls and take full advantage of opportunities by using appropriate structures to preserve your assets and do so on a tax-effective basis.

Holding Investments in U.S. Real Estate

I recently advised my client, David, about an opportunity he was offered to invest in a U.S. real estate project.  We started by identifying the structuring objectives:

  • minimize U.S. taxation on income and exit gains
  • avoid exposure to U.S. estate or gift tax
  • avoid U.S. tax reporting obligations
  • ensure Canadian tax credit for U.S. taxes paid

Cross-border tax concerns arise on a current basis if the investment in U.S. real estate produces income or capital gain, and there is the possibility of having both U.S. and Canadian tax apply to the same realization.

In addition, if a Canadian resident dies owning property with a U.S. situs in law, such as real estate located in the United States, he/she may be subject to U.S. estate tax at an escalating scale up to a maximum rate of 40%.

Under the Internal Revenue Code, a gift of U.S. situs property may also give rise to gift tax on a similar scale to the estate tax.

While a Canadian resident faces tax on death as well under the ITA, this is a tax on capital gains deemed to have been realized on the assets of the deceased at the time of death, not a tax on the gross value of an estate’s assets at the time of death. In addition, the maximum tax rate in Ontario on such capital gains is, effectively, about 26.5%.

Under the Canada/U.S. Tax Convention for the Avoidance of Double Taxation (the “U.S. Treaty”), there is some relief from double taxation at death resulting from the foregoing taxes, but the relief is inadequate.  Moreover, there is no relief under the U.S. Treaty for any U.S. gift tax that may become payable by a Canadian resident transferring U.S. situs property.

Accordingly, we started with considering U.S. taxation of income from U.S. real estate: investment income subject to withholding tax, and business income subject to ordinary tax rates.  Capital gains are taxed in the U.S. when a Canadian investor realizes a capital gain on the disposition of U.S. real estate, including equity ownership in a U.S. real property holding company or partnership.

Typically instead of using an LP, a U.S. investor in real estate will use an LLC, or limited liability company.  It is treated as a flow-through entity (like a partnership) for tax purposes to a U.S. taxpayer, but at the same time provides limited liability protection without restrictions on participating in the management and control found with an LP.

For Canadian investors, a direct investment in an American LLC can be problematic.  First, it can give rise to double taxation, because the CRA does not treat the LLC as a flow-through entity but as a separate foreign corporation, which in certain circumstances of earning passive investment income can result in current Canadian tax on so-called foreign accrual property income, or “FAPI”, imposed on the Canadian investor.

In addition, the Canadian member of an LLC will be exposed to U.S. estate and gift tax in relation to the value of the membership interest.

By structuring the investment in the LLC through a regular U.S. taxable corporation, those exposures are minimized.  Moreover, if the LLC (or U.S. corporation) is considered to be carrying on an active real estate business (e.g. having more than 5 employees engaged full-time in the conduct of the U.S. business), the Canadian investor could invest in the U.S. corporation through a Canadian holding company to minimize both Canadian and U.S. tax on repatriated profits.

Lorne Saltman

Lorne Saltman

Gardiner Roberts LLP
+1-41-6625-1832
www.grllp.com
lsaltman@grllp.com

Protecting real estate after death – Canadian NPO

Protecting real estate after death – Canadian NPO

Protecting real estate after death – Canadian NPO

If you are considering acquiring a domestic vacation property, you can avoid common pitfalls and take full advantage of opportunities by using appropriate structures to preserve your assets and do so on a tax-effective basis.

Non-Profit Corporation

My client, David, was concerned that with the growth in the future value of summer vacation properties near Toronto, Canada, there will also come increased tax liability associated with such a vacation property. David asked how to structure the ownership of this property, so that the transfer ultimately to his heirs could be done with minimal cost in terms of tax and administration.

I explained that on the death of each Canadian resident, he or she is deemed for income tax purposes to have disposed of all property, including ones such as this Canadian vacation property, and to have realized proceeds of disposition equal to the then fair market value of such property.  Similar rules apply in respect of a gift of the property during his lifetime.  In other words, capital gains tax may become payable on such transfers.

Furthermore, when his Will would be probated, the value of this Canadian vacation property will be taken into account in calculation of the applicable probate fee (1.5% of the value of the assets covered by the Will).  Moreover, the filed Will would become a public document.

If he were to use a trust to hold this Canadian vacation property, the trust would be deemed to have disposed of this property every 21 years for proceeds of disposition equal to the then fair market value.

Instead, I recommended that David establish a non-share capital, not-for-profit corporation (“NPO”).  David and his spouse would run the NPO like a recreational club.  To be cautious the NPO would lease the vacation property to David and his spouse, and they would pay a minimum rental at least equal to the operating expenses.

As the NPO will continue after they die, there will be no capital gains tax on either death (the life interests merely expire).  In addition, there would be no probating of Wills necessary.  Their children as the successor directors and members would continue to run the NPO.

If the NPO were to sell the property, there would be no capital gains tax payable.  The proceeds could be invested in another property to be used as a club and the tax deferral could continue.

If the proceeds were distributed, say, on a winding-up of the NPO, the member(s) would be considered to have realized capital gains on any increase in value above the initial cost when the property was purchased.

Lorne Saltman

Lorne Saltman

Gardiner Roberts

Common pitfalls with a USA Family Trust

Common pitfalls with a USA Family Trust

Structure your real estate investments to preserve your assets on a tax-effective basis.

If you are acquiring a vacation home in the USA, you can avoid common pitfalls and take full advantage of opportunities by using appropriate structures to preserve your assets and do so on a tax-effective basis.

USA Family Trust

My client, David, recently told me that as a so-called “snowbird” going to Florida each winter, he wanted to acquire a vacation property there.  I advised him that a Canadian resident who dies owning property with a U.S. situs in law, such as the Florida Property which is real estate located in the United States, may be subject to U.S. estate tax at an escalating scale up to a maximum rate of 40%.

Accordingly, unless proper tax planning is undertaken by a Canadian resident investing in U.S. situs property, there can be an onerous tax burden on death or from making a gift.

Instead, I suggested he consider establishing a Canadian discretionary family Trust to hold the American vacation property.  Thus, on the death of either David or his spouse, there will be no exposure to U.S. estate tax.  In addition, if the Trust sells the property for a capital gain, the Trust is viewed as a flow-through vehicle for U.S. tax purposes, and so the long-term capital gains rate of about 23% would apply to the individual Canadian beneficiaries.  Because the top rate in Ontario for capital gains is about 26.5% and a foreign tax credit will be available to offset Canadian tax, only 3.5% tax would be payable in Canada.

Lorne Saltman

Lorne Saltman

Gardiner Roberts LLP
+1-41-6625-1832
www.grllp.com
lsaltman@grllp.com

Common Tax Pitfalls with Real Estate Investments

Common Tax Pitfalls with Real Estate Investments

Structure your real estate investments to preserve your assets on a tax-effective basis

In a variety of real estate investments, you can avoid common pitfalls and take full advantage of opportunities by using appropriate structures to preserve your assets and do so on a tax-effective basis.

Investing Through Limited Partnerships

I recently advised David, a successful real estate investor and , to use a limited partnership (“LP”) for a new project instead of his usual practice- a corporation alongside other corporate investments.

I cautioned against using a separate corporation for each venture, because in Canada we do not have consolidated reporting of affiliated groups for tax purposes.

By arranging to have each new venture structured as an LP, those with profits can be offset by those with losses at the end of each taxation year.  Accordingly, there is no need to have one entity, generally a corporation with a loss, charge a management fee to another affiliated corporation with a profit, in order to have one offset the other, as is a common, but risky, practise.  This arrangement has been successfully attacked by the Canada Revenue Agency (“CRA”), as being artificial and motivated strictly by tax savings.

A partnership is not viewed as a separate legal entity distinct from its members but an aggregation of those parties.  An LP is a form of partnership that can be registered under a local statute, e.g. Limited Partnership’s Act (Ontario), to give the firm separate status for certain commercial purposes.  A limited partner’s liability exposure is the amount of capital invested, not the partner’s personal assets.

For income tax purposes, the income or loss at the end of the limited partnership’s fiscal period will be allocated to the partners in accordance with the partnership agreement.  Typically in an LP, the general partner will get a nominal allocation, say, 1%, and the limited partners will get the balance of, say, 99%.

The LP structure thus provides asset protection and tax efficiencies.

Holding Investments in U.S. Real Estate

David also asked me about an opportunity he was offered to invest in a U.S. real estate project.  We started by identifying the structuring objectives:

  • minimize U.S. taxation on income and exit gains
  • avoid exposure to U.S. estate or gift tax
  • avoid U.S. tax reporting obligations
  • ensure Canadian tax credit for U.S. taxes paid

Cross-border tax concerns arise on a current basis if the investment in U.S. real estate produces income or capital gain, and there is the possibility of having both U.S. and Canadian tax apply to the same realization.

In addition, if a Canadian resident dies owning property with a U.S. situs in law, such as real estate located in the United States, he/she may be subject to U.S. estate tax at an escalating scale up to a maximum rate of 40%.

Under the Internal Revenue Code, a gift of U.S. situs property may also give rise to gift tax on a similar scale to the estate tax.

While a Canadian resident faces tax on death as well under the ITA, this is a tax on capital gains deemed to have been realized on the assets of the deceased at the time of death, not a tax on the gross value of an estate’s assets at the time of death. In addition, the maximum tax rate in Ontario on such capital gains is, effectively, about 26.5%.

Under the Canada/U.S. Tax Convention for the Avoidance of Double Taxation (the “U.S. Treaty”), there is some relief from double taxation at death resulting from the foregoing taxes, but the relief is inadequate.  Moreover, there is no relief under the U.S. Treaty for any U.S. gift tax that may become payable by a Canadian resident transferring U.S. situs property.

Accordingly, we started with considering U.S. taxation of income from U.S. real estate: investment income subject to withholding tax, and business income subject to ordinary tax rates.  Capital gains are taxed in the U.S. when a Canadian investor realizes a capital gain on the disposition of U.S. real estate, including equity ownership in a U.S. real property holding company or partnership.

Typically instead of using an LP, a U.S. investor in real estate will use an LLC, or limited liability company.  It is treated as a flow-through entity (like a partnership) for tax purposes to a U.S. taxpayer, but at the same time provides limited liability protection without restrictions on participating in the management and control found with an LP.

For Canadian investors, a direct investment in an American LLC can be problematic.  First, it can give rise to double taxation, because the CRA does not treat the LLC as a flow-through entity but as a separate foreign corporation, which in certain circumstances of earning passive investment income can result in current Canadian tax on so-called foreign accrual property income, or “FAPI”, imposed on the Canadian investor.

In addition, the Canadian member of an LLC will be exposed to U.S. estate and gift tax in relation to the value of the membership interest.

By structuring the investment in the LLC through a regular U.S. taxable corporation, those exposures are minimized.  Moreover, if the LLC (or U.S. corporation) is considered to be carrying on an active real estate business (e.g. having more than 5 employees engaged full-time in the conduct of the U.S. business), the Canadian investor could invest in the U.S. corporation through a Canadian holding company to minimize both Canadian and U.S. tax on repatriated profits.

USA Family Trust

David told me that as a so-called “snowbird” going to Florida each winter, he wanted to acquire a vacation property there.  I advised him that, as noted earlier, a Canadian resident who dies owning property with a U.S. situs in law, such as the Florida Property which is real estate located in the United States, may be subject to U.S. estate tax at an escalating scale up to a maximum rate of 40%.

Accordingly, unless proper tax planning is undertaken by a Canadian resident investing in U.S. situs property, there can be an onerous tax burden on death or from making a gift.

Instead, I suggested he consider establishing a Canadian discretionary family Trust to hold the American vacation property.  Thus, on the death of either David or his spouse, there will be no exposure to U.S. estate tax.  In addition, if the Trust sells the property for a capital gain, the Trust is viewed as a flow-through vehicle for U.S. tax purposes, and so the long-term capital gains rate of about 23% would apply to the individual Canadian beneficiaries.  Because the top rate in Ontario for capital gains is about 26.5% and a foreign tax credit will be available to offset Canadian tax, only 3.5% tax would be payable in Canada.

Non-Profit Corporation

Finally, David was concerned that with the growth in the future value of summer vacation properties near Toronto, there will also come increased tax liability associated with such a vacation property. David asked how to structure the ownership of this property, so that the transfer ultimately to his heirs could be done with minimal cost in terms of tax and administration.

I explained that, as noted above, on the death of each Canadian resident, he or she is deemed under the ITA to have disposed of all property, including ones such as this Canadian vacation property, and to have realized proceeds of disposition equal to the then fair market value of such property.  Similar rules apply in respect of a gift of the property during his lifetime.  In other words, capital gains tax may become payable on such transfers.

Furthermore, when his Will would be probated, the value of this Canadian vacation property will be taken into account in calculation of the applicable probate fee.  Moreover, the filed Will would become a public document.

If he were to use a trust to hold this Canadian vacation property, the trust would be deemed to have disposed of this property every 21 years for proceeds of disposition equal to the then fair market value.

Instead, I recommended that David establish a non-share capital, not-for-profit corporation (“NPO”).  David and his spouse would run the NPO like a recreational club.  To be cautious the NPO would lease the vacation property to David and his spouse, and they would pay a minimum rental at least equal to the operating expenses.

As the NPO will continue after they die, there will be no capital gains tax on either death (the life interests merely expire).  In addition, there would be no probate necessary.  Their children as the successor directors and members would continue to run the NPO.

If the NPO were to sell the property, there would be no capital gains tax payable.  The proceeds could be invested in another property to be used as a club and the tax deferral could continue.

If the proceeds were distributed, say, on a winding-up of the NPO, the member(s) would be considered to have realized capital gains on any increase in value above the initial cost when the property was purchased.

Lorne Saltman

Lorne Saltman

Gardiner Roberts