- Copthorne Decision: Supreme Court of Canada unanimously applies GAAR
- Canada Revenue Agency Eliminates Tax Deferral for Joint Ventures
- Transalta Case: FCA Adopts Residual Approach to Valuation of Goodwill
- Cross-Border Employee Transfers: Planning and Compliance are Critical
- U.S. Tax and Filing Obligations for Canadians*
- What's Happening at Miller Thomson
In its most recent decision involving the application of the general anti-avoidance rule (the “GAAR”), under section 245 of the Income Tax Act (Canada) (the “Act”) a unanimous Supreme Court of Canada (the “SCC”) applied the GAAR to a complex series of transactions that culminated in what would otherwise have been a tax-free share redemption. The share redemption at issue involved the redemption of shares of a Canadian resident corporation owned by a non-resident shareholder.
Copthorne Holdings Ltd. v. Canada (2011 SCC 63) (“Copthorne”) serves as a warning for taxpayers and tax planners that, even in circumstances where the taxpayer’s transactions are in strict compliance with the text of the relevant provision of the Act, Canadian courts may apply the GAAR to disallow abusive income tax avoidance. The unanimous Copthorne decision, both at the SCC and in the lower Courts, should strengthen Canada Revenue Agency’s (“CRA”) resolve to apply the GAAR as it deems appropriate.
The Transactions at Issue
The series of transactions at issue in Copthorne was complex and involved a multitude of corporations, transactions and investments. These transactions can be distilled into three essential features: (i) they occurred over a number of years; (ii) they involved a sale of shares and subsequent horizontal amalgamation that were structured to preserve the paid-up capital (“PUC”) of the shares of the amalgamating corporations; and (iii) they culminated in a tax-free redemption of shares of a Canadian resident corporation owned by a non-resident shareholder. The tax-free nature of the redemption was a result of the sale of shares and subsequent horizontal amalgamation that preserved PUC in the manner described below.
In a nutshell, the PUC of shares generally represents funds that have been invested by shareholders in a corporation, subject to certain adjustments under the Act. The PUC of shares of a Canadian resident corporation (other than a public corporation in certain circumstances) can be returned to the corporation’s shareholders tax-free. The general principle governing the PUC of shares is that capital investments that are made by shareholders in shares of Canadian resident corporations using after-tax dollars should not be taxed again when such capital is withdrawn.
For example, if a shareholder subscribes for shares in a Canadian resident corporation for $100 and the value of those shares increases to $105, the redemption of those shares by the corporation should result in a tax-free return of the PUC of $100 and a taxable distribution to the shareholder of $5. If that same shareholder subscribes for shares in two Canadian resident corporations for $100 each and those sister corporations are then amalgamated horizontally, the PUC of the shares of the amalgamated corporation that could be returned to the shareholder on a tax-free basis should generally be $200.
The potential for abuse arises in the context of multiple tiers of corporations. If a shareholder subscribes for shares of a Canadian resident corporation (referred to herein as “parent corporation”) for $100, and the parent corporation then uses these funds to subscribe for shares of a wholly-owned Canadian resident subsidiary (referred to herein as “subsidiary corporation”), the PUC of the shares of the parent corporation and the subsidiary corporation will be $100 each notwithstanding that only $100 was initially invested by the shareholder in the corporate structure. There is generally no limit to the amount of PUC that could be created in this manner by an initial investment through a number of tiered subsidiary corporations.
Subsection 87(3) of the Act effectively provides that on a horizontal amalgamation involving sister corporations the PUC of the shares of the amalgamated corporation is equal to the sum of the PUC of shares of the predecessor sister corporations. However, subsection 87(3) of the Act also prevents taxpayers from taking advantage of the potential duplication of PUC by effectively providing that, on a vertical amalgamation involving a parent corporation and its subsidiary corporation, the PUC of the shares of the subsidiary corporation is eliminated.
Put simply, the series of transactions in Copthorne involved the type of PUC duplication described above. The PUC duplication was achieved by arranging to have the parent corporation sell shares in its subsidiary corporation to the non-resident shareholder of the parent corporation, such that the parent corporation and the subsidiary corporation became sister corporations immediately prior to the amalgamation. In this manner, the PUC of the shares of the subsidiary corporation was preserved and could be returned to the non-resident shareholder of the amalgamated corporation without any Canadian withholding taxes. The shares of the amalgamated corporation were redeemed approximately one year after the horizontal amalgamation under review.
The SCC’s Analysis and Decision
CRA assessed the taxpayer in Copthorne on the basis that the series of transactions undertaken by the taxpayer was subject to the GAAR and resulted in a deemed dividend to the non-resident shareholder which was subject to Canadian withholding taxes. The Tax Court of Canada and the Federal Court of Appeal each upheld CRA’s assessment, save for a penalty (equal to 10% of the tax owing as a result of the deemed dividend) that had also been assessed by CRA.
The SCC upheld the decisions of the lower Courts and applied the analytical framework it had previously applied in another case involving the GAAR: Canada Trustco Mortgage Co. v. Canada (2005 SCC 54). The three questions to be decided in applying the GAAR were described as follows, with an affirmative answer to each being a prerequisite to the application of the GAAR: (i) Was there a tax benefit? (ii) Was the transaction giving rise to the tax benefit an avoidance transaction? and (iii) Was the avoidance transaction giving rise to the tax benefit abusive?
The first question – the existence of a tax benefit – was answered affirmatively on the facts of the case. The sale of the shares and the horizontal amalgamation that preserved the PUC of the shares of the amalgamating corporations and subsequent tax-free share redemption resulted in a tax benefit.
With respect to the second question, the SCC noted that the sale of the shares of the subsidiary corporation to the non-resident shareholder and the subsequent horizontal amalgamation that preserved the PUC of the shares of the amalgamating corporations did not, in and of themselves, result in a tax benefit. The tax benefit was only realized on the tax-free share redemption. Therefore, the SCC had to consider whether the share redemption transaction was part of the series of transaction that included the share sale to the non-resident shareholder and the subsequent horizontal amalgamation.
The SCC noted that subsection 248(10) of the Act provides that a series of transactions is deemed to include “any related transactions or events completed in contemplation of the series”. In what is perhaps the most significant conclusion in the judgment, the SCC found that the phrase “in contemplation of” could apply both prospectively and retrospectively. The SCC rejected the taxpayer’s argument that a subsequent transaction must be “contemplated by the parties” at the time of a prior transaction in order for the subsequent transaction to form part of the same series. Instead, the SCC confirmed its prior holding in the Canada Trustco case that it is sufficient for a later transaction to have been completed “because of” or “in relation to” an earlier transaction in order to be considered part of the same series, regardless of whether the later transaction was contemplated at the time of the earlier transaction. The SCC also rejected the findings of the Tax Court that a “strong nexus” is required to meet the series test but indicated that it does require more than a “mere possibility” or a connection with “an extreme degree of remoteness”.
On the relevance of the passage of time to the determination of the existence of a series of transactions, the SCC stated that “the length of time between the series and the related transaction may be a relevant consideration in some cases; as would intervening events taking place between the series and the completion of the related transaction.” However, the Court did indicate that, in the end, it will be the “because of” or “in relation to” test whether applied retrospectively or prospectively, on a balance of probabilities, which will ultimately determine whether a related transaction was completed in contemplation of a particular series.
The SCC agreed with the findings of the lower Courts that on a retrospective application of this test the redemption transaction was part of the same series of transactions as the prior sale of the shares of the subsidiary corporation to the non-resident shareholder and the subsequent horizontal amalgamation. The SCC also agreed with the conclusion of the lower Courts that the sale of the shares of the subsidiary corporation to the non-resident shareholder was an avoidance transaction because it had the effect of preserving the PUC of the shares of the sister corporations on the subsequent horizontal amalgamation and was not primarily undertaken for a bona fide non-tax purpose.
Finally, on the issue of whether the avoidance transaction had been abusive, the SCC held that the double counting of the PUC was abusive in this particular case because the taxpayer structured the transactions in order to artificially preserve the PUC in a way that frustrated the purpose of subsection 87(3) which provides that on a vertical amalgamation the PUC of shares of a subsidiary corporation is not preserved. Thus, the third question in the GAAR analysis was answered in the affirmative and the SCC upheld the decisions of the lower Courts and CRA’s assessment of Canadian withholding taxes on the deemed dividend resulting from the share redemption.
Takeaways from Copthorne Decision
The decision in Copthorne does not constitute a fundamental change to the analytical framework for the application of the GAAR. However, significant takeaways from the judgment include the SCC’s affirmation of the retrospective application of the phrase “in contemplation of”; the SCC’s willingness to consider a series of transactions extending over several years; and the clarification of the object, purpose and spirit of subsection 87(3) of the Act.
On this last point, it remains to be seen whether the SCC’s unanimous support of the integrity of the PUC regime will extend to transactions involving arm’s length share sales and reorganizations. The transactions in Copthorne involved non-arm’s length parties, but there could also be situations where PUC is preserved in a transaction involving arm’s length parties, where, for example, a third party unknowingly purchases a corporation with artificially-inflated PUC. The application of the GAAR requires a fact-specific analysis, and tax practitioners and taxpayers alike must always evaluate the potential application of the GAAR in light of their particular facts and circumstances.
Richard Barbacki, Montréal
CRA has announced that it is withdrawing its administrative position allowing participants in a joint venture (“JV”) to establish a fiscal period for the JV that differs from the fiscal periods of the JV participants. This change was made inevitable by the proposed changes announced in the 2011 Federal Budget to limit the tax deferral opportunities for a corporation with a significant interest in a partnership that has a fiscal period that is different from a corporate partner’s taxation year (the “corporate partnership anti-deferral rules”).
There is no definitive distinction between a JV and a partnership. Neither a JV nor a “partnership” is defined in the Act and the case law is of limited assistance in this regard. On its website, CRA describes a JV as “… an arrangement where two or more persons (participants) work together in a limited and defined business undertaking. Ordinarily all participants of the joint venture contribute assets, share risks and have mutual liability”. It should be observed that this definition could just as easily describe a partnership.
CRA, however, goes on to identify what, rightly or wrongly, has become the factor that is usually used to distinguish a JV from a partnership: “A joint venture agreement is not a continuing relationship between participants. For example the venture may be for one specific business project. Once the project is completed, the joint venture ceases to exist.”
GST/HST Policy Statement P-171R lists 12 criteria that can be used to attempt to distinguish a JV from a partnership. In practice, however, CRA has not frequently taken the position that a JV is, in fact, a partnership.
Contrary to a partnership, a JV does not have a separate fiscal period for taxation purposes. Accordingly, each participant in a JV should be required to include in income for a taxation year its income from the JV up to the end of its taxation year. If the various participants in a JV have different taxation year ends, the profits of the JV should be computed at each participant’s taxation year end.
Nevertheless, at the 1989 Canadian Tax Foundation Conference, Revenue Canada (as it was then called) announced that it would, on an administrative basis, allow a JV to establish a fiscal period different from the fiscal periods of the JV participants, where the participants have different fiscal periods and there is a valid business reason for a separate fiscal period. This administrative position allowed the income earned by a participant in a fiscal period of a JV to be included in the participant’s income for its taxation year in which the fiscal period of the JV ended.
Significant deferral of tax was possible based on CRA’s administrative policy. For example, a taxpayer with a December 31st taxation year end that was a participant in a JV with a January 31st fiscal year end could defer 11 months of JV income.
For its first taxation year ending after March 22nd, 2011, a participant in a JV that has relied on CRA’s administrative position will no longer be able to compute its income as if the JV had a separate fiscal period. Such a JV participant will be required to include in computing its income its share of income from the JV for the fiscal period of the JV ending in its taxation year (“non-stub period”), as well as its share of income from the JV venture for the period beginning on the first day after the end of the non-stub period and ending on the last day of the taxation year of the JV participant (“stub period”).
However, the CRA has announced that administratively it will allow the stub period income to be spread over five taxation years. The following table shows how the stub period income inclusion for the period from July 1, 2011 to December 31st, 2011 for a JV with a June 30th fiscal year end will be included in the income of a JV participant that has a December 31st taxation year end.
2011 Stub Period Income Inclusion
Net Stub Period Income Inclusion
December 31st, 2011
December 31st, 2012
December 31st, 2013
December 31st, 2014
December 31st, 2015
December 31st, 2016
In order to avail itself of this transitional relief, a JV participant is required to file an election in writing on or before its filing due date for its first taxation year ending after March 22nd, 2011. The election is filed by attaching a letter to the tax return or, in the event that the tax return has already been filed, by sending a letter to the appropriate tax centre. CRA has extended the filing due date for this election to September 22, 2012.
Transitional relief is not available to:
- a JV participant that fails to include all the stub period income in its first taxation year that ends after March 22nd, 2011;
- a JV participant that had not relied on the former administrative policy to calculate its income based on the fiscal period of the JV;
- income that would otherwise have been included in income for the taxation year of the JV participant; and
- income for which a deduction is available under section 112 or 113 of the Act.
Finally, a number of the technical corporate partnership anti-deferral rules will be applied in a similar manner to JV participants.
It is interesting to compare some aspects of the JV anti-deferral change in administrative policy to the corporate partnership anti-deferral rules.
- The proposed corporate partnership anti-deferral rules are contained in proposed sections 34.2 and 34.3 and section 249.1 while the JV anti-deferral changes are merely an administrative position.
- The proposed corporate partnership anti-deferral rules
apply only to corporations that have a significant interest (10%) in a
partnership. Partnerships involving
individuals and professional corporations were the object of anti-deferral
legislation back in 1995.
The JV anti-deferral administrative policy applies to all participants in a JV. Whether or not a participant’s interest in a JV is “significant”, it will be affected by the new CRA administrative policy.
- Partnerships will continue to have a separate fiscal
period from that of its partners.
Partnerships will be permitted to elect to change their fiscal year end
to align to the taxation year of one or more of the corporate partners.
JVs will not be considered to have a separate fiscal period and each JV participant will have to compute its income from the JV based on its own taxation year end. This may be a significant hardship for some JV participants.
It remains to be seen how well the new administrative policy with respect to JV will work. Perhaps some JV participant may take the position that a JV was really a partnership all along if doing so would give rise to better tax results under the proposed corporate partnership anti-deferral rules.
A different approach might have been to define a partnership for tax purposes in a manner that included JVs. This would have allowed joint ventures to continue to have a separate fiscal period while eliminating undue deferral in the same manner as the proposed corporate partnership anti-deferral rules.
Laura R. Shylko, Edmonton
In Transalta v. The Queen, 212 FCA 20 (“Transalta”), the Federal Court of Appeal (“FCA”) confirmed that a residual approach should be applied in the valuation of goodwill in the context of an asset purchase transaction. The two-step residual approach adopted by the FCA consists of allocating in the first step a fair market value to the tangible assets and in the second step allocating any excess of the consideration over such fair market value to the goodwill.
Transalta involves the sale by Transalta Corporation of its regulated electricity transmission business to AltaLink LP (“AltaLink”) for an aggregate purchase price of approximately $818 million, approximately $190 million of which was allocated to goodwill. At issue was the Minister’s reliance on section 68 of the Act to reallocate the portion of the purchase price allocated by Transalta Corporation and AltaLink to goodwill to tangible assets, on the basis that there can be no goodwill in a regulated industry.
On appeal to the Tax Court of Canada (“Tax Court”), Justice Campbell Miller concluded that goodwill can exist in a regulated industry but that approximately $50 million of the amount allocated to goodwill, being the value of the potential for leverage and a potential tax allowance benefit, was in fact attached to the tangible assets sold and therefore should be reallocated to such assets. Refer to Current Cases: Sale of Business – Defining Goodwill and Defending the Purchase Price Allocation for a detailed commentary on the decision rendered by the Tax Court of Canada in Transalta. Transalta Corporation appealed this decision and the Crown filed a cross-appeal.
In a unanimous decision authored by Justice Mainville, the FCA agreed with the Tax Court that goodwill can exist in a regulated industry but concluded that the Tax Court erred in reducing the portion of the purchase price allocated to goodwill by Transalta Corporation and AltaLink. Accordingly, the FCA allowed Transalta’s appeal and dismissed the cross-appeal, reinstating the $190 million purchase price allocation to goodwill.
Existence of Goodwill
The FCA confirmed that goodwill can exist in regulated industries on the basis that regulated industries have the potential to achieve returns on equity which are higher than those approved by a regulator for rate making purposes. However, the FCA did not agree with the findings of the Tax Court that the potential for leverage and a potential tax allowance benefit were not part of the goodwill.
The FCA rejected any attempt to define goodwill which, in its view, would be doomed to failure due to the difficulties in defining such a concept. Rather, the FCA opted for a modern concept of goodwill focused on the identification of the various characteristics inherent to the notion of goodwill in order to ascertain the existence of goodwill on a case by case basis. The FCA identified the following three characteristics that must be present for goodwill to exist: (i) goodwill must be an unidentified intangible as opposed to a tangible asset or an identified intangible such as a brand name, a patent or a franchise; (ii) goodwill must arise from the expectation of future earnings, returns or other benefits in excess of what would be expected in a comparable business; and (iii) goodwill must be inseparable from the business to which it belongs and cannot normally be sold apart from the sale of the business as a going concern.
Applying these three characteristics of goodwill, the FCA was of the view that while Transalta did not leverage its investment in its electricity transmission business, this did not mean that the potential for excess returns resulting therefrom was not one of the intangible assets that Transalta held in its business. The FCA concluded that the potential for leverage was part of the goodwill sold to AltaLink.
The FCA agreed with the Tax Court that the potential tax allowance benefit in respect of one of the partners of AltaLink, a non-taxable pension fund, could not be viewed as an asset of Transalta. According to the FCA, this potential tax allowance benefit was neither part of the goodwill nor attached to Transalta’s tangible assets but rather was an intangible asset of AltaLink and the pension fund.
Allocation of Purchase Price to Goodwill
The negotiated purchase price was equal to 1.31 times the net regulated book value of Transalta’s tangible assets. The parties allocated the premium over net regulated book value to goodwill. In the FCA’s view, the net regulated book value of regulated tangible assets of a transmission business may reasonably be understood as reflecting the fair market value of those assets as this is one of the basis upon which regulatory authorities determine the regulatory rate of return. The FCA found that any premium paid above the net regulated book value of those assets represents the value of special advantages which allow it to potentially achieve returns in excess of what is determined by regulators to be a normal market return and can properly be allocated to goodwill.
The FCA noted that goodwill is inherently difficult to value and that it would be improper to break down goodwill on an asset by asset basis in order to assign a specific separate value to each of its constituent elements. Instead, the FCA opted for a more practical approach by valuing goodwill as a residual whole with the more easily valued tangible assets being given an assigned fair market value and any consideration in excess of such value being allocated to goodwill. The FCA concluded that, based on this residual approach, the tax allowance benefit should not be deducted from the goodwill allocation notwithstanding that it may not squarely fall under the legal concept of goodwill.
The FCA found the two-tier reasonableness test adopted by the Tax Court in applying section 68 in situations where there is an agreed upon allocation of the purchase price but no evidence of real bargaining to be unduly complex and devoid of any guiding principles. The FCA was also critical of the Tax Court’s willingness to substitute its own subjective allocation for the purchase price allocation agreed to by the parties. The FCA confirmed that the proper reasonableness test in applying section 68 is whether a reasonable business person, with business considerations in mind, would have made the allocation.
Transalta provides a welcome clarification of the applicable reasonableness test under section 68 and the proper approach to goodwill valuation. The FCA’s findings in Transalta could effectively limit the Minister’s reliance on section 68 to dispute goodwill allocations.
James A. Fraser, Toronto
Transferring employees between members of a corporate group can be an effective way to leverage expertise, promote existing corporate culture, transition business units and develop new markets. To ensure that the benefits are realized, it is important that an employee transfer comply with employer payroll obligations and employee entitlements and obligations under applicable legislation, as well as take into account the tax and other implications for all of the parties involved.
In the domestic context, employee transfers between employers in a corporate group (hereinafter referred to as the “sending employer” and the “receiving employer”) are generally straightforward provided the transfers are properly documented, necessary adjustments to payroll and human resource services of the sending and receiving employers are made and continuity of employment between the sending and receiving employers is preserved with respect to Canada Pension Plan contributions and Employment Insurance premiums. However, the planning and implications can be more complicated when an employee is transferred to a foreign jurisdiction.
It is not uncommon for businesses operating in Canada and looking to expand in another country to send one or a group of existing employees to a foreign jurisdiction to assist in establishing the new business. Similarly, businesses looking to expand into Canada will often send employees to Canada to assist in starting up the new Canadian business. While a review of all of the relevant issues is beyond the scope of this article, there are three important tax considerations to be kept in mind whenever an employer transfers an employee to a related employer in another jurisdiction:
- Will the exercise of employment services in the jurisdiction where the receiving employer is located result in the sending employer being considered to have a permanent establishment in that jurisdiction?
- What are the payroll tax implications for the employer and employee?
- Do any of Canada’s bilateral treaties dealing with social security or unemployment insurance apply?
Secondment Agreements to Mitigate Permanent Establishment Risks for Sending Employer
Generally, a non-resident corporation carrying on business in Canada or a Canadian resident corporation carrying on business in a foreign jurisdiction will not be subject to tax in that jurisdiction provided their activities and presence are not considered to constitute a permanent establishment in the other country and the non-resident corporation or Canadian resident corporation, as applicable, is entitled to the benefits of a tax treaty between Canada and that other country. This is an important advantage of dealing with treaty jurisdictions.
In general, the mere fact that a corporation resident in one jurisdiction controls or is controlled by a corporation resident in another jurisdiction does not amount to either corporation being a permanent establishment of the other for tax treaty purposes. With that said, it is important that dealings between such related corporations be clearly established and their respective activities formally delineated so that treaty benefits are preserved and neither corporation inadvertently comes within the tax net of the other country’s jurisdiction – this is particularly highlighted in the case of employee transfers.
The threshold for having a permanent establishment in another country will generally be met under most of Canada’s bilateral tax treaties if the employee has, and habitually exercises in the other country, an authority to conclude contracts and bind their employer in that foreign jurisdiction. To address this issue and mitigate the related tax risks, it is critical for both the sending and receiving employers to set out the parameters of the employee transfer.
For these purposes, the sending and receiving employers can enter into a secondment agreement providing, among other things, for:
- What position and responsibilities will the transferred employee have?
- For whom will the employee be exercising employment services?
- Where will employment services be rendered?
- During which periods will the employee be considered to be providing employment services in one jurisdiction as opposed to the other?
A secondment agreement also provides the opportunity for the respective employers to determine their responsibilities including administering payroll, providing office space and equipment, ensuring compliance with applicable laws and insuring against liability.
Tax implications for the Employer and Employee
From the sending and receiving employers’ perspective, the tax implications may involve, among other things, withholding and remitting payroll taxes and other amounts to the relevant taxing authority in the other country, filing tax and information returns and other compliance obligations in the other country, as well as determining whether the sending employer has a permanent establishment in the other country for tax treaty purposes as discussed above. From the employee’s perspective, the tax implications may include, among other things, filing a tax return and paying taxes in the other country, claiming foreign tax credits, and determining the employee’s residency for tax purposes. It is important that tax and legal advice in both Canada and the relevant foreign jurisdiction be obtained.
Canada’s Bilateral Social Security and Unemployment Insurance Treaties
In addition to tax treaties, Canada has a network of bilateral treaties that deal with the interactions, obligations and entitlements with respect to contributions and payments to social security and unemployment insurance programs that may apply to a transferred employee’s employment in Canada or in another country. Applicable treaties should be reviewed to ensure that payments are not needlessly being made to programs in both jurisdictions and that existing program entitlements will not be adversely affected as a result of the transfer.
Sending and receiving employers and transferred employees should consult with their tax and legal advisors in Canada and the relevant foreign jurisdiction in order to become apprised of the various tax, employment, emigration, immigration and other implications of the transfer before sending an employee to another jurisdiction.
Canadian individuals are well aware of the April 30 tax filing deadline for Canadian income tax returns. However, many Canadians may not be aware of the earlier April tax filing deadline of April 15 for United States tax purposes. A fundamental dichotomy exists between the basis for taxation in Canada and the U.S. While Canada’s taxation system is based on residency, meaning that residents of Canada are required to file and pay taxes in Canada on their worldwide income, the U.S. system for taxation is based on citizenship. This dichotomy translates into a dual filing obligation for certain Canadians with ties to the U.S (“U.S. persons”).
Generally, U.S. tax issues for U.S. persons resident in Canada arise in the following areas:
1. U.S. Citizens/ Green Card Holders
U.S. citizens or green card holders living abroad must file U.S. tax returns on an annual basis regardless of residency in respect of his or her worldwide income. Therefore, a Canadian resident who holds a U.S. citizenship must file both a Canadian T1 Income Tax Return and a U.S.1040 Income Tax Return. The U.S.1040 Income Tax Return is due April 15. However, U.S. citizens or U.S. green card holders living outside of the U.S. are granted an automatic extension to June 15 to file.
This dual filing obligation may not result in additional taxes owing for Canadians who file a U.S. tax return. The Canada-U.S. Tax treaty often shields a dual filer from double taxation as each respective country permits a foreign tax credit in respect of taxes paid in the other country. However, there are instances where the foreign tax credit is insufficient or unavailable to avoid additional tax in the other country. Examples of the most common transactions include the payment of a capital dividend by a Canadian corporation to a Canadian resident who is a U.S. person, or the disposition of shares by a Canadian resident (who is also a U.S. person) in a qualified small business corporation that may result in little or no Canadian taxes owing.
Even if a Canadian does not hold U.S. citizenship or a green card, he or she may still be subject to U.S. tax or filing obligations if the “substantial presence test” contained in the U.S. Internal Revenue Code is satisfied. Under the substantial presence test, U.S. residency is deemed to occur where the weighted total of the number of days spent in the U.S. over the last three years equals or exceeds 183 days, and the individual has been in the U.S. for more than 30 days in the current year. Generally, if an individual spends 183 days in the U.S. in any given year, he or she will meet the substantial presence test. However, if the Canadian instead regularly spends over four months a year in the U.S. (122 days), under the formula, he or she may still be considered to be a U.S. resident.
The substantial presence test is especially significant for employees working in the U.S. and for “snowbirds” who prefer the warmer climate provided in the U.S than Canada’s more taxing winter. If a Canadian satisfies the substantial presence test in any given year, the individual is automatically considered to be a U.S. resident for tax purposes and therefore subject to U.S. tax on U.S. source income. Notwithstanding that the substantial presence test is met, a Canadian may be entitled to an exemption from U.S. residency if he or she can claim the “closer connection exception” or a “treaty exemption”. Under either exception, the general principle is that the particular individual must have greater ties to Canada than the U.S. In cases where a Canadian has residential ties in both countries, the treaty provides tie-breaker rules to determine in which country the particular individual is resident for purposes of the Canada-US Tax Treaty. Note that the closer connection exception is not available if the particular individual spends more than 183 days in the U.S. in the current year, or the individual has applied for a green card. In order to claim either the closer connection exception or the treaty based exemption, a filing obligation exists in order to make the claim.
3. U.S. Real Property
Another U.S. tax concern exists for Canadians who hold U.S. real property. In recent years, the number of Canadians buying real property into the depressed U.S. real estate market has increased exponentially. For those Canadians who hold U.S. real property and rent out the property, the income received is subject to U.S. tax. Furthermore, a disposition of the real property in the U.S. may also result in U.S. tax and could also result in Canadian taxes owing even though the Canadian taxpayer would be entitled to a foreign tax credit on the U.S. tax paid due to insufficient foreign tax credits or differing gains due to foreign currency fluctuations. Professional tax advice should be sought by a Canadian looking to acquire U.S. real property as it may be possible to mitigate tax exposure.4. U.S. Estate Tax and Gift Tax
Separate and apart from any Canadian tax issues on the death of a taxpayer, U.S. estate tax is also applicable in respect of U.S. citizens or green card holders. In order to prevent U.S. taxpayers from gifting his or her assets while living to avoid or reduce the impact of the U.S. estate tax, a U.S. gift tax also exists. While the particulars of the US estate and gift tax are beyond the scope of this article, these are other areas of note as the amount of tax can be significant.5. Report of Foreign Bank and Financial Accounts (“FBAR”)
Canadians holding U.S. citizenship or a green card are also subject to certain disclosure obligations. Foremost, is the requirement to submit a FBAR by June 30 each year if the individual has at any point in time in the year signing authority over a bank account with an aggregate value of USD $10,000.00 or more. The requirements for disclosure include popular accounts such as registered education savings plans (“RESP”) and tax-free savings accounts (“TFSA”). Note that while an RESP and TFSA can be a tax efficient vehicle from a Canadian tax perspective, from a U.S. tax perspective, the income derived may be subject to U.S. tax.
Considering the plethora of tax and filing obligations for Canadians with U.S. citizenship or a green card, Canadians should consider the benefit of U.S. citizenship against the increased compliance costs. For those Canadians, especially those who do not intend on living in the U.S., one option to consider is a renunciation of their U.S. citizenship. While a discussion of the renunciation process is beyond the scope of this article, the reader should be aware that such renunciation can result in a taxable event from a U.S. tax perspective if the individual’s net assets are significant enough. Anyone looking to renounce should also consider what impact, if any, such renunciation will have on the individual’s ability to travel to and from the U.S.
During the U.S. economic struggles, the U.S. debt load is increasing to historic levels and the U.S. government is looking for additional ways to increase its tax revenue. To do so, the U.S. is becoming more vigilant in collecting tax from foreigners and requiring foreigners to disclose more financial information. Given the close proximity of Canada to the U.S., it should come as no surprise that a majority of U.S. foreigners subject to tax under U.S. law reside in Canada. Canadians with U.S. ties must be cognizant of the issues discussed herein and seek professional advice to assist them with the various compliance obligations and planning to mitigate potential tax costs.
* The writers are not qualified to practice U.S. law and therefore the commentary herein should not be relied upon as tax or legal advice.
What's Happening at Miller Thomson
Dalton Albrecht of our Toronto office presented on “The Challenges for Imports/Exports: Canadian Customs, GST, Trade Remedy Laws, and IP” at the Canadian Chinese Professional Accountants Association Conference, International Trade with China in Toronto on March 18, 2012. He also presented (with Eric Trudel of the Canada Border Services Agency) on “What's New with Trade Program Policies” at the Canadian Association of Importers and Exporters 2nd Annual Ontario Regional Conference, Optimizing Trade & Compliance Programs in Toronto on May 15, 2012.
Elena Balkos of our Toronto office presented at the Canadian Property Tax Association Ontario Chapter on “Correcting Palpable Errors in the Assessment Roll - A Review and Case Law Update of Section 40.1 of the Assessment Act” in Toronto on May 10, 2012.
Rachel Blumenfeld of our Toronto office spoke on "Cross-Border Estate Planning: Tips and Traps" at the national conference of the National Assembly of Elder Law Attorneys in Seattle on April 26, 2012. She moderated the session on Cross-Border Estate Planning at the STEP Toronto seminar on May 9, 2012. She is co-chairing the National STEP Conference in Toronto on June 11 and 12, 2012, as well as moderating a panel discussion on charities matters at the conference.
Rachel Blumenfeld, Patricia Fourcand, Sandra Enticknap, and Susan Metzler of our Toronto, Montreal and Vancouver offices presented a webinar on "How Family Law Impacts Your Estate Plan" with TD Financial on Tuesday June 5, 2012.
John Campbell, Maurice Fleming and Antonio Fratianni of our Toronto and Montreal offices presented on "Insolvency Meets Tax: Debt Forgiveness and Restructuring” at The Commons Institute in Toronto on March 2, 2012.
David Chodikoff of our Toronto office is leading a workshop on “Practical Approach to Common Practice Management Issues - An Interdisciplinary Approach” at the National STEP Conference in Toronto on June 12, 2012.
Sandra Enticknap of our Vancouver office is speaking about litigation, compensation and financial obligation on a panel at the National STEP Conference in Toronto on June 11, 2012.
William Fowlis of our Calgary office presented on "Case Law Update" to the Calgary Branch of the Society of Trust and Estate Practitioners on April 25, 2012.
Robert Hayhoe of our Toronto office is speaking on a charities update panel at the National STEP Conference in Toronto on June 11, 2012.
James Hutchinson of our Toronto office presented on "Simultaneous U.S. and Canadian Non-recognition Rollovers - Current Developments in Section 1031 and 1033 Transactions" at the American Bar Association, Tax Section, Midyear Meeting in San Diego on February 18, 2012. He also presented on US and Other Non-Resident Beneficiaries of Canadian Estates and Trusts/Canadian Beneficiaries of US Estates and Trusts at STEP Canada in Toronto on May 9, 2012.
Daniel Kiselbach of our Vancouver office presented on customs and trade issues at the American Bar Association International Section Spring Meeting in New York City on April 18, 2012. He also participated in breakfast round table discussions on customs and trade with representatives for KPMG, KPMG Enterprise and the Canada Border Services Agency in Calgary on May 23 and 24, 2012.
Yens Pedersen, Crystal Taylor, Greg Murphy and Reg Watson of our Saskatchewan offices presented on tax planning, trusts, advance health care directives (living wills), life insurance and jointly owned property at the Law Society of Saskatchewan's Wills and Estates Seminar in Regina on April 17 and 18, 2012.
Rahul Sharma of our Toronto office presented at the Toronto Public Library Foundation on "Wills and Estate Planning and Charitable Gift Giving" on May 24, 2012.
Crystal Taylor of our Saskatoon office presented "Legal Considerations with Respect to the Ownership of US Real Property by Canadians" at St. Paul's Hospital Foundation in Saskatoon on March 14, 2012. She also presented "Trusts: Tax Aspects" for the Wills & Estates Seminar for the Law Society of Saskatchewan in Regina on April 17, 2012 and in Saskatoon on April 18, 2012.
Donald Carr, O.Ont., Q.C., J.D., L.H.D. of our Toronto office has been awarded The Queen Elizabeth II Diamond Jubilee Medal in recognition of his contributions to Canada and the Province of Ontario.
Rachel Blumenfeld of our Toronto office has been awarded the 2012 Hoffstein Prize (Private Client Young Lawyers Award) by the Ontario Bar Association Trusts and Estates Section in recognition of her demonstrated leadership in the trusts and estates bar.
Joseph W. Yurkovich, Q.C. of our Edmonton office was featured in an article in the Alberta Venture, "When it comes to doing business abroad, it pays to plan ahead.”
Miller Thomson is a Gold Sponsor of the National STEP Conference being held in Toronto on June 11 and 12, 2012.
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