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After well over a decade of debate, consultation and consideration, on June 26, 2013, Bill C-48 received royal assent. Bill C-48 is an omnibus tax bill that includes, among other measures, revised rules for the taxation of non-resident trusts in Canada (collectively, the “NRT Rules”). Bill C-48 almost entirely reflects the draft legislation or Notice of Ways and Means Motion that was released on October 24, 2012. Retroactive to January 1, 2007, the NRT Rules amend section 94 of the Income Tax Act (Canada) (the “Act”) and establish measures aimed at restricting the use of offshore or non-resident trusts as a means of limiting or deferring the payment of income taxes in Canada.
In general, the NRT Rules deem an otherwise non-resident trust to be resident in Canada if property is loaned or transferred to the trust, directly or indirectly, by a resident of Canada. In some circumstances, in order to be applicable the trust must have a beneficiary who is resident in Canada. The NRT Rules provide numerous and often complicated deeming provisions for offshore trusts. For example, the NRT Rules may deem a transfer to have been made to a non-resident trust in the event that a contribution is made to a Canadian-resident corporation in which a non-resident trust has a direct or indirect interest, provided that the contribution has the effect of increasing the value of the non-resident trust’s interest in the corporation.
Since versions of the NRT Rules have been long proposed and available in draft format for some time, many advisors have already had the opportunity to determine if the NRT Rules may affect their clients’ planning. If not already done, advisors should consult the NRT Rules to determine if any trusts that may have fallen outside of the scope of former section 94 of the Act may be subject to the NRT Rules. If so, there are important transitional measures to consider, which are discussed below. Income tax advice should be obtained as soon as possible by any persons unsure of the impact the NRT Rules may have on their planning, if any.
Important Transitional Provisions
The NRT Rules apply to taxation years of a trust ending after 2006, which is consistent with earlier drafts of similar legislation. In general, otherwise non-resident trusts to which the NRT Rules apply will be subject to taxation in Canada on their worldwide income and capital gains, regardless of the proportion of overall property that was contributed to the trust by a resident of Canada. As a simple example, assume that a trust otherwise resident in the Bahamas has one or more beneficiaries resident in Canada and that the trust received contributions from residents of three separate international jurisdictions in the following proportions:
Nation of Contributor’s Tax Residency
Percentage of Overall Contributions to Trust
Despite the fact the Canadian resident contributed only 5% of the trust’s overall property (which contribution may have been inadvertently made), the trust runs the risk of having the NRT Rules apply to its worldwide income. Accordingly, if the trust had total income of $10,000 in 2013 (of which only $500 related in any way to the Canadian property contribution) this entire amount would be taxable in Canada unless the trust filed an election within the applicable time frame to be treated as an “electing trust.”
As a result of provisions first proposed in the October 24, 2012 Notice of Ways and Means Motion, non-resident trusts that are subject to the NRT Rules can elect to be treated as “electing trusts” if they have received contributions of property from non-residents of Canada. If such an election is filed, the “electing trust” would only be taxable in Canada on the portion of its annual income or capital gains that relate to its “resident portion” (i.e. the portion of the trust’s overall property that was contributed by resident Canadians). As such, returning to the above example, the trust’s “resident portion” would be limited to the $5,000 contributed to it by the resident Canadian.
An “electing trust” would be responsible for filing an annual Canadian tax return. It will therefore need to keep track of the Canadian contribution to the trust and the annual income or capital gains that specifically relate to that contribution. The trust’s property that cannot be traced to a contribution by a resident Canadian constitutes its “non-resident portion,” which is to be treated as a separate trust and not subject to taxation in Canada (unless, for instance, there is Canadian-source income or a disposition of taxable Canadian property).
Non-resident trusts in existence on June 26, 2014 must elect to be treated as “electing trusts” by filing an election by no later than that day. Late elections will not be accepted and trusts that fail to file the election in a timely manner will not be able to be treated as “electing trusts” for any future taxation years. Non-resident trusts that previously fell outside the purview of former section 94 of the Act, but to which the NRT Rules now apply:
- may also elect to have the NRT Rules apply retroactively to their 2000 to 2007 taxation years (assuming this would provide a beneficial result emanating from those years and must be filed no later than March 31, 2014); and
- are required to file income tax returns by no later than June 26, 2014 (an extended deadline).
There are no changes to the filing deadlines for income tax returns for non-resident trusts that were subject to the former section 94 of the Act.
Amendments to the Foreign Investment Entity (“FIE”) Rules
Practitioners dealing with non-resident trusts should still consider the potential application of section 94.1 of the Act to any planning. Section 94.1 provides rules for the Canadian tax treatment of investments in offshore investment fund property (the “FIE Rules”). The FIE Rules are, in general, engaged when a taxpayer holds or has an interest in or a right to acquire an interest in property that is a share in the capital stock of, an interest in or a debt of a “non-resident entity.”
With respect to non-resident trusts, together with the NRT Rules, the definition of “non-resident entity” in subsection 94.1(2) of the Act has been amended such that a “non-resident entity” includes an “exempt foreign trust,” other than a trust falling within paragraphs (a) to (g) of the definition of an “exempt foreign trust” in subsection 94(1) of the Act. This addresses matters regarding the potential application of the FIE rules to beneficiaries of discretionary or certain non-resident family trusts to which the NRT Rules did not apply. Paragraphs (a) to (g) of the definition of an “exempt foreign trust” include, inter alia, trusts established for charitable purposes, trusts settled solely for the maintenance of infirm dependants, trusts settled as the result of a marriage breakdown and/or trusts established for pension or employee benefits. As such, legitimate non-resident trust arrangements that are not subject to the NRT Rules are likely to also fall outside the purview of the FIE Rules.
Bill C-48 has also added section 94.2 to the Act, which is a new provision that deems certain non-resident trust funds to be controlled foreign affiliates for the purposes of the Act, and accordingly subject to the Act’s rules regarding foreign accrual property income (“FAPI”). Section 94.2 will generally apply to taxpayers and persons not dealing at arm’s length with the taxpayer with fixed interests of 10% or more in commercial offshore trust funds. Section 94.2 may also apply to taxpayers who transfer “restricted property” to a non-resident trust fund. “Restricted property” is defined in subsection 94(1) of the Act to include, inter alia, shares in a closely held corporation that are issued as a result of an estate freeze or similar reorganization-like transaction.