Tag: Canada

CBP Announces Optimized Processing for First-Time Canadian TN and L Applicants

Greenberg Traurig Law firm

U.S. Customs and Border Protection (CBP) has announced optimized processing procedures at fourteen ports-of-entry, including four pre-clearance locations, for Canadian citizens seeking TN or L status for the first time. This initiative is designed to increase customer satisfaction, decrease wait times and allow CBP to effectively deal with increased volume of Canadian TN and L applicants. Although first-time Canadian TN and L applicants may go to other ports for processing, CBP is encouraging applicants to go through one of the designated ports below for optimized processing:

Pre-Flight Inspection Locations

  • Pearson International Airport, Toronto, Ontario

  • Trudeau International Airport, Dorval, Quebec

  • Vancouver International Airport, Richmond, British Columbia

  • Calgary International Airport, Calgary, Alberta

Land Port Locations

  • Highgate Springs Port of Entry, Highgate Springs, Vermont

  • Derby Line Port of Entry, Derby Line, Vermont

  • Alexandria Bay Port of Entry, Alexandria, New York

  • Peace Bridge Port of Entry, Buffalo, New York

  • Rainbow Bridge Port of Entry, Niagara Falls, New York

  • Champlain Port of Entry, Champlain, New York

  • Detroit Canada Tunnel Port of Entry, Detroit, Michigan

  • Detroit Ambassador Bridge Port of Entry, Detroit, Michigan

  • Blaine Peace Arch Port of Entry, Blaine, Washington

  • Sweetgrass Port of Entry,  Sweetgrass Montana

ARTICLE BY

Ian R. Macdonald
OF
Greenberg Traurig, LLP

The Real Tax Benefits of Inverting to Canada

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On August 26, Burger King announced that it entered into an agreement to acquire Tim Hortons, Inc., the Canadian coffee-and-doughnut chain, in a transaction that will be structured as an “inversion” (i.e., Burger King will become a subsidiary of a Canadian parent corporation).  The deal is expected to close in 2014 or 2015. The agreement values Tim Hortons at approximately $11 billion, which represents a 30 percent premium over Tim Hortons’ August 22 closing stock price.

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Under the terms of the deal, Tim Hortons shareholders will receive a combination of cash and common shares in the new company. Each common share of Burger King will be converted into 0.99 of a share of the new parent company and 0.01 of a unit of a newly formed, Ontario-based limited partnership controlled by the new parent company. Holders of shares of Burger King common stock, however, will be given the right to elect to receive only partnership units in lieu of common shares of the new parent company, subject to a limit on the maximum number of partnership units issued.  Burger King shareholders who make this election will be able to defer paying tax on the built-in gain in their Burger King shares until the partnership units are sold. 3G Capital, Burger King’s principal shareholder, has elected to receive only partnership units. 3G will own approximately 51 percent of the new Burger King-Tim Hortons company, with current public shareholders of Burger King and Tim Hortons receiving 27 percent and 22 percent, respectively.

Inversions have gotten plenty of negative publicity during the past few years.  Most of the reported deals involve U.S. companies that have acquired smaller foreign companies in low tax jurisdictions such as Ireland, Switzerland, and the U.K.  As with any inversion transaction, the U.S. company will continue to be subject to U.S. federal income tax on its worldwide income.  The U.S. company will benefit, however, from the ability to: (i) reorganize its controlled foreign subsidiaries under a new foreign parent corporation (thereby removing those subsidiaries from the U.S. “controlled foreign corporation” regime and also allowing for the future repatriation of non-U.S. source profits to the foreign parent corporation and avoid U.S. corporate income tax); and (ii) “base erode” the U.S. company with intercompany debt and/or license arrangements with the new foreign parent or its non-U.S. subsidiaries.

It has been reported that Burger King’s effective tax rate was 27.5 percent in 2013 and Tim Hortons was 26.8 percent (15 percent federal rate plus 11.8 percent provincial rate), so “base eroding” Burger King with deductible interest and/or royalty payments to Canada will not provide a significant tax benefit to Burger King.  Where the use of a Canadian parent corporation, however, will benefit Burger King (and other U.S. companies that have inverted into Canada) from a tax perspective is the ability to take advantage of Canada’s (i) “exempt surplus” regime, which allows for the repatriation of dividends from foreign subsidiaries into Canada on a tax-free basis; and (ii) income tax treaties that contain tax sparing provisions, granting foreign tax credits at rates higher than the actual foreign taxes paid.  The United States does not provide either of these tax benefits under its corporate income tax system or treaty network. 

Canadian Exempt Surplus Regime

In general, under Canadian law, dividends received by a Canadian corporation out of the “exempt surplus” of a foreign subsidiary are not subject to corporate income tax in Canada.  Exempt surplus includes earnings of a foreign subsidiary that is resident in, and carrying on an active business in, a country with which Canada has concluded an income tax treaty or, more recently, a tax information exchange agreement (TIEA).  A TIEA is an agreement between two jurisdictions pursuant to which the jurisdictions may request and share certain information that is relevant to the determination, assessment and collection of taxes, the recovery and enforcement of tax claims, and the investigation or prosecution of tax matters.  The extension of the exempt surplus regime to jurisdictions that have signed TIEAs (but not income tax treaties) with Canada is significant because Canada has signed such agreements with low-tax jurisdictions, such as the Cayman Islands, Bermuda, and the Bahamas. Historically, the use of a Barbados IBC, which has a maximum corporate income tax rate of 2.5 percent, was the preferred jurisdiction for a Canadian parent company operating in a low-tax jurisdiction because of the long standing Canada-Barbados income tax treaty.

On the other hand, dividends received by a Canadian corporation out of the “taxable surplus” of a foreign subsidiary will be taxable in Canada (subject to a grossed-up deduction for foreign taxes) at regular corporate income tax rates. Taxable surplus includes most types of passive income, such as royalties, interest, etc., and active business income of a foreign subsidiary that is resident in, or carrying on business in, a country with which Canada has neither an income tax treaty nor a TIEA.  Special rules may deem certain passive income (such as interest or royalties) to be included in exempt surplus if received by a foreign subsidiary resident in a tax treaty or TIEA jurisdiction, if those amounts are deductible in computing the exempt earnings of another foreign subsidiary.  For example, interest and royalties paid from an active business of a U.K. subsidiary of a Canadian parent corporation to a Cayman Islands subsidiary of such Canadian parent will be eligible to be repatriated to Canada from the Cayman Islands under the exempt surplus regime on a tax-free basis.

It is interesting to note, however, that Burger King will not be able to repatriate most of its foreign-source income to Canada on a tax-free basis under the exempt surplus rules.  The majority of Burger King’s foreign-source income consists of royalties and franchise fees, which will be considered passive income for Canadian income tax purposes.  (Burger King, which operates in about 14,000 locations in nearly 100 countries, has become a franchiser that collects royalty fees from its franchisees, not an operator of restaurants).

Canada’s Tax Sparing Provisions

Another tax benefit offered by a Canadian parent corporation is the ability to utilize the “tax sparing” provisions contained in many Canadian income tax treaties. Canada currently has income tax treaties that contain tax sparing provisions with more than 30 countries, including Argentina, Brazil, China, Israel, Singapore, and Spain. In general, the purpose of a tax spari
ng provision is to preserve certain tax incentives granted by a developing jurisdiction by requiring the other jurisdiction to give a foreign tax credit for the taxes that would have been paid to the developing country had the tax incentive not been granted.  For example, under Article 22 of the Canada-Brazil income tax treaty, dividends paid by a Brazilian company to a Canadian parent corporation are deemed to have been subject to a 25 percent withholding tax in Brazil and therefore, eligible for a 25 percent foreign tax credit in Canada, even though the treaty limits the withholding tax to 15 percent (and in actuality, Brazil does not even impose withholding taxes on dividends under its local law).  A similar benefit is available for interest and royalties paid from Brazil to Canada (e.g., a deemed withholding tax, and therefore foreign tax credit, of 20 percent, even though the treaty caps the withholding tax at 15 percent).  As noted above, the United States does not currently have any income tax treaties that contain tax sparing provisions.

Conclusion

With Burger King’s effective corporate tax rate of 27.5 percent in the United States in 2013 and Tim Hortons 26.8 percent in Canada, the tax benefits of Burger King inverting to Canada are not readily apparent.  Notwithstanding the lack of a significant disparity in these tax rates, Canada does offer the ability to exclude from its corporate income tax dividends received from the earnings of a foreign subsidiary that is resident in, and carrying on an active business in, a jurisdiction that has concluded an income tax treaty or TIEA with Canada.  This key benefit, along with the Canadian income tax treaties that contain tax sparing provisions, provides one more example of why U.S. multinationals are operating at a competitive disadvantage when compared to other OECD countries around the world. 

ARTICLE BY

Jeffrey L. Rubinger
 
OF 
Bilzin Sumberg Baena Price & Axelrod LLP

U.S. Consular Posts in Canada Temporarily Suspend Nonimmigrant Visa Processing for TCNs (Third Country Nationals)

Morgan Lewis

Third Country Nationals may be unable to schedule nonimmigrant visa appointments at U.S. consulates and embassies throughout Canada this summer.

U.S. consular posts in Canada have temporarily suspended nonimmigrant visa processing for Third Country Nationals (TCNs) during June, July, and August because of staffing issues. In this context, “TCN” refers to any non-Canadian national applying for a U.S. nonimmigrant visa in Canada. The status of TCN visa application processing in Canada is as follows:

  • The only posts with remaining availability during the month of September are Calgary and Vancouver.
  • The Toronto and Ottawa posts are currently scheduling visa appointments in October and do not plan to release any earlier appointments during the summer months.
  • Applicants whose appointments have already been scheduled during the summer months will not be affected.
  • Applicants who reside in Canada with Canadian immigration status will also not be affected.

The Ottawa post may assist in scheduling appointments for applicants who hold senior or executive positions with their U.S. employers.

Article By:

Eric S. Bord
Lisa Stephanian Burton
Tracy Evlogidis
Malcolm K. Goeschl
Eleanor Pelta
A. James Vázquez-Azpiri
Of:
Morgan, Lewis & Bockius LLP

The Complicated Landscape of US Estate Tax

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Canadians who own assets in the U.S. may be subject to U.S. estate tax.

This tax is based on the fair market value of all U.S. assets owned at the time of death. It can reach 40%, depending on the value of U.S. assets and the world-wide estate.

But not all Canadians who own U.S. assets will be subject to U.S. estate tax. A close look at the new U.S. estate tax rules will help you determine whether your Canadian clients are exposed to U.S. estate tax.

New U.S. estate tax rules

On January 2, 2013, President Obama signed the American Taxpayer Relief Act of 2013 (the Act) into law. The Act resolves many of the issues raised by the fiscal cliff.

Pursuant to the Act, U.S. estate tax liability of non-U.S. residents depends on the answers to the following two questions:

  1. Is the value of the U.S. estate more than $60,000?
  2. Is the value of the worldwide estate greater than $5,250,000?

If the fair market value (FMV) of U.S. assets is less than $60,000 on the date of death, then there is no U.S. estate tax. If the value of U.S. assets on death exceeds $60,000, a Canadian’s estate may still be exempt from U.S. estate tax if the value of his or her worldwide estate upon death is less than what is known as the “exemption.”

Worldwide exemption for 2013 and beyond

The Act provides an exemption from U.S. estate tax if a non-resident dies with a worldwide estate with a FMV of less than $5,250,000. This exemption amount is inflation-adjusted. Everything counts when calculating a Canadian client’s worldwide estate—including RRSPs and life insurance.

Additionally, when advising a married couple about U.S. estate tax exposure, it’s important to calculate the value of both spouses’ estates combined.

Clients often ask whether the U.S. estate tax is on the worldwide estate. The answer is no; the IRS does not tax a Canadian resident (who is not a U.S. citizen) on his or her worldwide estate.

The only assets that are subject to U.S. estate tax for Canadians are U.S. assets.

What are U.S. assets?

Common U.S. assets include real estate in the U.S. and personally held stocks of U.S. corporations, both public and private.

Here’s a complete list of U.S. assets subject to U.S. tax:

  • real estate property located in the U.S;
  • certain tangible personal property located in the U.S., such as furniture, vehicles, boats and airplanes;
  • golf club equity memberships;
  • shares of U.S. corporations, regardless of the location of the share certificates (even inside RRSPs or RRIFs);
  • interests in partnerships owning U.S. real estate or carrying on business in the U.S.;
  • U.S. pension plans and annuity amounts (IRAs and 401K plans);
  • stock options of a U.S. company;
  • U.S. mutual funds;
  • money owed to Canadians by American persons; and
  • money market accounts with U.S. brokerage firms.

The following is a list of U.S. assets not subject to U.S. estate tax:

  • U.S. bank deposits;
  • certain debt obligations, such as U.S. government bonds;
  • American depository receipts;
  • term deposits/guaranteed investment certificates;
  • real estate situated outside the U.S.;
  • Canadian mutual funds denominated in U.S. dollars that invest in U.S. stocks;
  • life insurance proceeds payable on the death of a Canadian citizen and resident who is not an American citizen; and
  • non-U.S. stocks, bonds and mutual funds.

Many Canadians own assets subject to U.S. estate tax with vacation homes and shares of U.S. corporations topping the list. How can you help clients who own these assets?

The following scenario provides some answers.

Strategies for Canadians who own U.S. assets

Richard is a Canadian citizen and resident, single, with a worldwide estate of $10 million. He owns an $800,000 property in Ft. Lauderdale, Fla.

Richard’s inherited 25% of the shares of four Florida corporations from his deceased father, which he estimates have a value of $200,000. Each corporation owns an apartment building in South Florida.

The chart “Example estimates” (this page) approximates Richard’s 2013 exposure to U.S. estate tax.

Tax planning for U.S. real estate

The goal of any tax-planning for a Canadian owner of U.S. real estate is to ensure the estate of the Canadian decedent is not subject to U.S. estate tax. Consequently, title should not be in his or her name. Alternative ownership structures include:

  • corporation;
  • cross-border trust (irrevocable or revocable); and
  • limited partnership.

These ownership structures avoid probate and guardianship proceedings in the case of incapacity and can defer or avoid U.S. estate tax.

Tax planning for stocks

Although Richard’s shares of U.S. stock are considered U.S. assets, there are tax-planning techniques for avoiding U.S. estate tax.

01 Sell

This may trigger capital gains tax in Canada, though Richard may have some capital losses to apply against it.

02 Create a Canadian holding corporation

Transfer the shares of U.S. stocks on a tax-free basis into a Canadian corporation, of which Richard is the shareholder.

Should Richard pass away with U.S. stock in his Canadian holding company, there will be no U.S. estate tax because Richard no longer owns shares of a U.S. company; he only owns shares of a Canadian holding corporation that owns shares of the Florida companies that Richard’s father passed on to him.

The U.S. Foreign Investment in Real Property Tax Act (FIRPTA) may apply to Richard’s transfer of U.S. stocks into a Canadian company. FIRPTA requires that 10% of the sale price or transfer value of U.S. real estate by a non-resident of the U.S. be withheld and remitted to the IRS. Richard can avoid this with proper structuring and reporting, which we’ll explain next time. No withholding will be required and no disposition will have occurred.

Example estimates of U.S. Estate Tax Payable for 2013

Article by:

David A. Altro

Of:

Altro Levy LLP

Digital Currency Identified as an “Emerging Risk” in the Canadian Federal Government’s 2014 Budget

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On February 11, 2014, the Canadian Federal Government released its 2014 Budget. In the 2014 Budget, the Federal Government pledged to introduce legislative amendments to strengthen Canada’s anti-money laundering and terrorist financing regime in the area of virtual (digital) currency.

2013: Year of Bitcoin?

At the beginning of 2013, one bitcoin could be purchased for $12. For a brief period in November 2013, one bitcoin was worth more than one ounce of gold ($1242 to $1240, respectively). Forbes and MarketWatch wrote articles proclaiming 2013 as the year of bitcoin, and “bitcoin” was chosen as the word of the year by the Australian National Dictionary Centre (beating out worthy candidates, including “selfie” and “twerk”).

This increased popularity of digital currency has brought increased scrutiny from regulators and law enforcement. Last year in the United States, the Financial Crimes Enforcement Network issued guidance with respect to whether activities by individuals and companies related to virtual currencies are subject to registration, reporting, and recordkeeping requirements, and the FBI arrested the “mastermind” of Silk Road (a marketplace selling illegal items and accepting payment in virtual currency). In early 2014, a prominent member of the bitcoin community was indicted on money laundering charges.

Canada Revenue Agency (“CRA”) Release Its Position on Bitcoin

Prior to the release of the 2014 Budget, the main Canadian government references to digital currency were from the CRA. The first notable CRA acknowledgment of bitcoin was in April 2013 in the form of a CRA communication to the Canadian Broadcasting Corporation (“CBC”). The communication stated that transactions involving bitcoin are barter transactions and that gains resulting from bitcoin transactions could be income or capital depending on the specific facts.

On November 5, 2013, the CRA issued its first release on the taxation of digital currency. This release reinforced the CRA’s earlier position on bitcoin that was set out in its April 2013 e-mail to the CBC. On December 23, 2013, in CRA Document No. 2013-0514701|7, subject “Bitcoins,” the CRA further clarified its position with respect to bitcoin “in response to a summary of comments that were provided in response to a recent media enquiry describing the income tax consequences of various transactions involving digital currency.”

Accordingly, the CRA considers bitcoin to be a commodity, not a currency. Therefore, using bitcoins to purchase goods or services is considered a barter transaction. The sale of bitcoins at a profit is treated as either income or capital depending on a particular taxpayer’s circumstances.

Virtual Currency in the 2014 Budget

Virtual currency is identified in the 2014 Budget as an “emerging risk” that threatens Canada’s international leadership in the fight against money laundering and terrorist financing. Bitcoin is cited in the 2014 Budget as an example of such virtual currency.

In the 2014 Budget, the Federal Government proposed to introduce anti-money laundering and anti-terrorist financing regulations for virtual currencies, such as bitcoin.

The Federal Government noted in the 2014 Budget that this proposal was based on a report by the Standing Senate Committee on Banking, Trade and Commerce entitled Follow the Money: Is Canada Making Progress in Combatting Money Laundering and Terrorist Financing? Not Really (the “Report”). The Report is a five-year review of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the “Act”) and was issued in March 2013. However, the only reference in the Report to digital currency is a brief note that the development of electronic methods to launder money must be addressed through timely amendments to the Act and its regulations.

2014: Year of Bitcoin Regulation

The Federal Government has identified digital currency as an “emerging risk” in the fight against money laundering and terrorist financing. Accordingly, the regulation of digital currency in Canada is imminent, and individuals and businesses dealing in bitcoin will soon be subject to certain registration, reporting, and recordkeeping requirements.

Article by:

Dickinson Wright PLLC

 

Planning for Disabled Beneficiaries in Ontario

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Whether you own Cross-Border assets or not, when dealing with the transfer of assets to a disabled beneficiary who is resident in Ontario, special planning may be needed to preserve your disabled beneficiary’s entitlement to certain benefits he or she may be receiving, or may be entitled to receive in future.

The Ontario Disability Support Program (“ODSP”) is a provincial program offering income and employment support to adults with physical and/or mental disabilities.

An eligible applicant must show financial need, which is determined by calculating the assets held by such applicant. A single adult is entitled to hold up to $5,000 worth of assets. If he or she has a spouse (whether married or common-law), the limit rises to $7,500. The limit increases by $500 for each dependent child living with the disabled beneficiary.

Certain assets are exempt from counting toward the asset limit, including, but not limited to, an interest in a principal residence, a car and a prepaid funeral. Other assets may be exempt up to certain limits or as determined by specified rules.

For instance, an interest in a second property, such as a cottage or vacation property in Florida, may be exempt if it can be shown that the property is an asset necessary for the health and well-being of the ODSP applicant. If the second property is not exempt, the owner may not be eligible for ODSP benefits. Where this is so, the property will be exempt for only 6-months, during which time the property would be expected to be sold. If reasonable efforts to sell the property fail to produce a bona fide purchaser, the property may remain exempt until such time as the property is sold, provided that reasonable efforts to sell are maintained. Following the sale, attention must be paid to structuring the holding of the proceeds of sale in order to ensure such proceeds do not put the ODSP recipient offside of the asset limitations.

The ODSP regulations are complex, with many restrictions, of which the consequence of breaking may be ineligibility or permanent loss of ODSP income benefits. Some of the notable restrictions include limitations on ownership of assets above the thresholds outlined above as well as asset class. For instance, an ODSP recipient is restricted from owning more than $100,000, in aggregate, of life insurance (cash value), segregated funds (similar to a mutual fund but offered only by insurance companies) and any inheritance, whether received outright or held in trust for the recipient’s benefit.

You might ask why go through the trouble of trying to protect such income benefits when you plan to leave your disabled beneficiary much more than what he or she would receive from ODSP? Although ODSP provides financial benefit to your disabled beneficiary, there are also social programs, such as employment assistance, that may be lost. Such programs can be valuable to disabled persons of all financial backgrounds.

A special type of trust, referred to as a “Henson Trust” (named after the precedent-setting Ontario Court of Appeal case: The Director of the Income Maintenance Branch of the Ministry of Community and Social Services v. Henson, 36 Estates and Trusts Reporter 192, and also referred to as an absolute discretionary trust), may alleviate many of the foregoing issues.

Where drafted appropriately, a Henson Trust provides a means to leave unlimited assets to a disabled beneficiary without jeopardizing the benefits he or she may receive from ODSP or other government sources, both financial and otherwise. In other words, your disabled beneficiary can benefit from the substantial inheritance you may leave in such Henson Trust for his or her benefit, while continuing to collect the financial (and other) benefits available pursuant to the ODSP.

Whether a Henson Trust is an appropriate structure requires some fact gathering and analysis, coupled with a consideration of whether the beneficiary is disabled but has capacity, versus disabled but does not have capacity. In the case of the former, a trust structure may not be ideal where the beneficiary manages or is involved in managing his or her own finances. Further, where a Henson Trust is implemented, selection of one or more trustees to administer the trust is critical as there is a greater potential for abuse than in non-Henson Trusts.

Consideration should also be given to whether to utilize the federal government’s Registered Disability Savings Plan (“RDSP”), a registered matched savings plan for people with disabilities. An RDSP may be used in conjunction with a Henson Trust or on its own.

Article by:

Heela Donsky

Of:

Altro Levy LLP

Is a U.S. Revocable Trust Okay for Canadians?

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Revocable trusts are a common estate planning tool in the U.S. Also referred to as living trusts and grantor trusts, they provide a method of avoiding costly probate and incapacity proceedings. A well written revocable trust will also include tax and creditor protection planning for future generations. In addition to all of these benefits, the individual setting up the trust remains in control of the trust and trust property during his or her lifetime.

A revocable trust does not provide creditor protection to the grantor, nor does it shield the grantor from U.S. estate tax liability. Rather, it is a powerful and popular tool for U.S. citizens and residents who are below the U.S. estate tax exemption amount to hold their personal residences. The revocable trust is popular among Americans, and rightly so.

Unfortunately, the benefits a Canadian may receive by using a U.S. revocable trust to avoid the issues of probate and incapacity proceedings will likely be negated by the numerous tax disadvantages a U.S. revocable trust faces in Canada.

How a U.S. Revocable Trust Works

As with any trust, a revocable trust must have a grantor (also known as a settlor), a trustee, and a beneficiary. The grantor creates and settles the trust, meaning he or she chooses the parameters of the trust agreement and donates the initial capital to the trust. The trustee is the individual or company named to manage the trust property for the benefit the beneficiary. Finally, the beneficiary is the individual who enjoys the beneficial use of the trust property, which may include income or other payments from the trust.

In the U.S., a revocable trust allows the same individual to act as grantor, trustee, and beneficiary, as long as future beneficiaries (also known as remainder beneficiaries) are named. This allows the individual to maintain complete control of the trust and trust property, and streamline the management of the trust property during his or her lifetime. Often, married couples will go a step further and create a joint revocable trust for jointly owned properties.

The U.S. Internal Revenue Service (“IRS”) disregards the existence of the U.S. revocable trust for tax purposes due to the control and reversionary rights retained by the grantor of the revocable trust. This means any income or capital gains earned on trust property is taxable in the hands of the grantor during his or her lifetime. This is normally not an issue, since the grantor of a revocable trust is almost always the initial beneficiary. It also means that property with accrued gains can be transferred to a U.S. revocable trust without triggering a tax on this capital gain.

U.S. revocable trusts do not provide protection from U.S. estate tax to the grantor, but certain planning can be included to reduce or defer this tax where a surviving spouse is inheriting the trust property.

There is no creditor protection for a property held in a U.S. revocable trust. Similar to the above-described tax treatment, the trust will be disregarded should creditors pursue the grantor.

Canadians and U.S. Revocable Trusts

Canadians who seek tax and estate planning advice from U.S. attorneys are often counseled to take title to their U.S. vacation residences through a U.S. revocable trust. These attorneys are trying to help their clients avoid the expensive and time-consuming issues of probate and incapacity, and take advantage of other tax and estate planning opportunities within the trust document. Unfortunately, a U.S. revocable trust is often not the ideal structure for a Canadian resident.

In Canada, trusts are considered separate taxpayers, meaning trusts are not normally disregarded like the U.S. revocable trust is in the U.S. There are limited exceptions to this rule, such as the Alter Ego trust available to Canadian residents over age 65.

Tax on income or capital gains earned by trust property could result in a double taxation scenario where tax is paid personally by the grantor in the U.S., but the income or gains are not attributed or distributed to the same individual as a beneficiary in Canada, therefore triggering income or capital gains tax at the trust level in Canada.

Such double taxation may be avoided by function of section 75(2) of the Canadian Income Tax Act (“ITA”). This section says that where an individual contributes property to a Canadian resident trust in which he or she is a controlling trustee and potential capital beneficiary, and he or she has the power to decide who will receive the property, then all income, capital gains, and capital losses associated with the donated property will be attributed back to that person during his or her lifetime.

Example 1:

Let’s say Mr. Smith, a Canadian citizen and resident, agrees with his U.S. attorney’s advice on how to avoid U.S. probate and incapacity proceedings, and has a U.S. revocable trust drawn up in which he is the grantor, trustee, and sole beneficiary during his lifetime. Section 75(2) of the ITA will cause all income, capital gains, and capital losses related to any property contributed by Mr. Smith to the trust to be attributed back to him individually. The trust will therefore essentially be disregarded for income and capital gains tax purposes on both sides of the border.

Result: During Mr. Smith’s lifetime, there should be no double taxation on income and capital gains earned on property he contributed to the trust.

The application of section 75(2) of the ITA does not protect against tax on the rollover of a property with accrued gain by a Canadian resident into a U.S. revocable trust. While not recognized for tax purposes in the U.S., such a rollover would cause an immediate disposition on the gain in Canada.

Example 2:

Let’s take Mr. Smith as an example again, but look at a slightly different situation. He has a condominium in Naples, Florida that he purchased 15 years ago for $150,000. His US attorney has informed him that he needs proper planning to avoid probate and incapacity issues for his family. If he continues to own the property in his name personally they could face lengthy court proceedings and high fees should he ever become incapacitated, and certainly upon his eventual death.

Mr. Smith would therefore like to put his condominium, which now has a fair market value of $250,000 into the U.S. revocable trust prepared by his U.S. attorney, since the trust would allow him to avoid these two issues. There is no tax on this rollover in the U.S. Such a rollover would trigger tax in Canada though, on the existing $100,000 in capital gain. To make matters worse, since no corresponding gain would be triggered in the U.S., if Mr. Smith then sells the same property five years later he would potentially be faced with taxation in the U.S. on the same $100,000 in gain for which he has already paid tax in Canada.

Result: Capital gains tax on the rollover of property in the U.S. revocable trust by a Canadian resident. Potential double taxation on an eventual sale of the U.S. property.

The situation gets even more complicated. Under section 104 of the ITA all Canadian trusts are subject to a 21 year deemed disposition rule. This means that the trust is treated as having sold and reacquired its property on the 21 year anniversary of the trust. Any accrued gains are taxed, even if the property is not actually sold. It does not matter if the property has not been in the trust for the full 21 years. A trust is generally considered resident in Canada when central management and control of the trust is carried out in Canada.

Example 3:

To continue with Mr. Smith as an example, say he purchased a condominium in Fort Lauderdale, Florida, in his U.S. revocable trust ten years after the trust was created. The property is still in the trust on the 21st anniversary of the trust. This condominium was purchased by the trust for $200,000, but is currently worth $325,000. Mr. Smith has no intention of selling the property anytime soon. Unfortunately, on the 21st anniversary of his trust he must pay tax on the gain of $125,000 in Canada. Like the last example, if Mr. Smith later sells this property he will potentially face a double taxation on the gain in the U.S., because no corresponding gain was recognized in the U.S. on the 21 year anniversary.

Result: U.S. revocable trusts are subject to Canada’s 21 year deemed disposition rule, which may also result in double taxation upon an eventual sale of the U.S. property.

Finally, Canadians who own property through a U.S. revocable trust face potential double taxation on the assets when they die owning property in the trust. Since the assets in the U.S. revocable trust are included in an individual’s estate upon death in the U.S., they may be subject to U.S. estate tax upon death. Estate tax is on the fair market value of the property at the time of death, not on the accrued gain. No credit for taxes paid by the estate in the U.S. will be available to the trust in Canada. Even if no U.S. estate tax is due, the IRS considers the value, also known as the adjusted cost basis, of the asset to have increased to its fair market value when inherited by the grantor’s heirs.

No such increase in adjusted cost basis will take place on this asset in Canada, which means that there may be tax on the total accrued gain either on the 21 year anniversary of the trust or when the deceased’s heirs eventually dispose of the trust assets. This could turn into a double taxation scenario where the deceased’s estate had to pay U.S. estate tax on the property at the time of death, since no credit is available for the tax already paid in the U.S.

Example 4:

As a final example, let’s say Mr. Smith dies leaving a Miami condominium in his U.S. revocable trust worth $500,000 that he originally purchased for $400,000, and a worldwide estate of $10 Million. As a Canadian citizen and resident, US estate tax only applies to his US situs assets, which include, but are not limited to real property held in a revocable trust. Should Mr. Smith pass away in 2013, his U.S. estate tax would be about $53,510.

If Mr. Smith had owned the property in his name personally at time of death, Canada would have also assessed a deemed disposition on the $100,000 in capital gain. Mr. Smith’s estate should have been able to use the U.S. estate tax paid as a foreign tax credit against the capital gains tax owed on the property in Canada, eliminating the double taxation.

Since the property is held in a U.S. revocable trust though, tax is not due in Canada until the 21 year anniversary of the trust, the sale of the property, or, in certain situations the distribution of the property to the trust beneficiaries. No foreign tax credit will be given for the U.S. estate tax paid by Mr. Smith’s estate.

Result: Potential for double taxation where U.S. estate tax is due on property held in a U.S. revocable trust.

Conclusion

On the rare occasion a U.S. revocable trust may be used effectively by a Canadian resident. Due to the potential for double taxation scenarios though, U.S. revocable trusts are best avoided by Canadian residents, especially when not used under the watchful eye of an informed cross border tax and estate planning attorney.

Alternatives to the U.S. revocable trust that still allow you to avoid issues of U.S. probate and incapacity proceedings do exist. Due to the revocable nature of such a trust, steps may be taken even with an existing U.S. revocable trust to implement an appropriate alternative and bring the structure into line with Canadian tax rules. You can contact Altro Levy LLP to learn more about the various alternatives available to you as a Canadian resident owning property in the U.S.

Article by:

Melissa V. La Venia

Of:

Altro Levy LLP