Monthly Archives: March 2016

HOW CANADIAN “STARTUP” ENTREPRENEURS CAN USE A CROSS-BORDER STRATEGY TO ELIMINATE TAX ON CAPITAL GAINS  

31397108-sign-caution-tax-freeIt is hard these days to pick-up the pages of a business magazine or the financial pages of a newspaper without reading something about “startups”. Either there will be advice for people involved with startups, or stories about some nerd, still in his 20’s, who became a gazillionaire (at least on paper) when his startup was either acquired, or completed an IPO.

One things is for sure: lots of people are finding innovative ways to make a fortune these days via startups in relatively short periods of time. Canada has no shortage of talent when it comes to creating great ideas that are turned into start-up companies that ultimately take-off.

There is a Canada-US cross-border strategy that many Canadian entrepreneurs can use to completely avoid taxes on capital gains applicable to the wealth that will be created as a result of their efforts.

Envision the following scenario:

Mr. A is an unmarried Canadian and citizen living in Toronto who, together with his buddy from university, owns 50% of the shares of X Ltd, an Ontario corporation developing a new system relating to airport security. The shares of X Ltd. are not worth that much now, but there is a good chance that, because of some ideas they have that are just at the formative stages, within a few years, their shares could be worth over $100 million for each of them.

Is there a way that Mr. A could avoid a potential Canadian tax hit (currently at 26.75%) on all the wealth he may be creating?

Sure, in theory, he could move to some tax haven like the Bahamas and not have to worry about income taxes at all, but that would not really fit his lifestyle. In addition, he has lots of family ties in Toronto and would like to visit frequently. He might well have an issue as to whether he is still “factually resident” in Canada.

But, what about just moving across the border to the US? Even though the US is generally not thought of as a “tax haven”, it could turn into one in this case, with the right planning.

For one thing, Mr. A likes the lifestyle in NYC, and would really like to live there for a few years, although he would ultimately want to move back to Toronto.

Coming back for visits to Toronto would be a breeze-same time zone and just an hour flight!

He could easily work on the business of X Ltd. remotely via his PC, from his apartment in NYC, or a small office he would rent, and occasionally fly up to Toronto for meetings.

More significantly from a tax perspective, he would have protection from being considered a Canadian resident, even if he maintained ties here, and visited frequently, because of the “tie breaker rule” in Article IV(2) of the Canada-US Tax Convention. Namely, as long as he:

  • Became a “resident alien” for US tax purposes,
  • Maintained a “permanent home available” in the US, and
  • Did not have any “permanent home available” in Canada

he would automatically be deemed a non-resident of Canada under subsection 250(5) of the Income Tax Act (“the Act”)[1].

In addition, since the shares of XLtd. are not really worth anything yet, there would be no “departure tax” issue for Mr. A when he ceases to be a Canadian resident.

Let’s jump ahead now. Mr. A got an appropriate visa to live and work in the US and has lived in his NYC apartment for 4 years as a resident alien. The business of X Ltd. has skyrocketed, and there has just been an IPO-Mr. A’s shares of XLtd. Are now worth $110 million!

He thinks it may be time to move back home to Toronto. If so, this is what happens from a tax perspective:

  • When he ceases to be a US resident alien, there would be no “departure tax”. Although section 877A of the IRC does have such a regime, it will not apply to Mr. A because he will not be a “long term resident” of the US when he becomes a non-resident alien[2].
  • When he becomes a Canadian resident again, he will have a deemed cost base of his XLtd. shares for Canadian tax purposes equal to their fair market value at that time ($110 Million)[3].

 

The end result is that Mr. A will ultimately get the benefit of a $110 Million capital gain completely free of any tax. Plus, he got to live in NYC for a few years! Not too bad at all!

[1] See my blog posting at http://taxca.com/blog-2016-2/

[2] Either because he was living in NYC on some type of work visa, and not as a “lawful permanent resident” (i.e. “Green Card” holder) or, if he was, it was for less than the requisite 8 out of 15 years.

[3] Paragraph 128.1(1)(c) of the Income Tax Act.

CANADA’S “BRANCH” TAX ON FOREIGN CORPORATIONS-AN OVERVIEW

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FOREIGN CORPORATIONS THAT ARE RESIDENT IN CANADA-HOW ARE THEY TAXED?

As a general rule, any corporation formed in Canada is deemed to be resident in Canada for the purposes of the Income Tax Act (“the Act”)[1]. This is true even if the “central management and control” (“CMC”) of that corporation is located outside of Canada. But is the converse true? Certainly not! Unlike our neighbors… Continue Reading

EIGHT (8) MYTHS REGARDING BEING NON-RESIDENT FOR CANADIAN TAX PURPOSES

Over the years, I have advised hundreds of people, including many accountants and lawyers, regarding Canadian tax residency issues for individuals. I am frequently amazed at how little they know about this critically important area, and the misconceptions that many of them have. Below are what I have found to be the eight (8) most… Continue Reading

CANADIAN TAX ISSUES WITH RRSP AND RRIF PAYMENTS TO NON-RESIDENTS

As a general rule, any amounts paid from a Registered Retirement Savings Plan (“RRSP”) or Registered Retirement Income Fund (“RRIF”) to a non-resident of Canada are subject to a 25% tax under Part XIII of the Income Tax Act (“the Act”) However, amounts paid to residents of certain countries with which Canada has a tax… Continue Reading

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BE WARY OF PITFALL WHEN DOING POST-MORTEM “PIPELINE” PLANNING FOR ESTATES WITH NON-RESIDENT BENEFICIARIES

The use of post-mortem “pipeline” planning is a popular technique aimed at avoiding double taxation in situations where there is a capital gain recognized on the death of a taxpayer who held a significant interest in the shares of a Canadian private corporation at the time of death. It can also apply in situations where… Continue Reading

FOREIGN ASSETS THAT DON’T REQUIRE T1135 REPORTING

In recent years, Canadian taxpayers and their accountants have been increasingly aware of issues relating to CRA form T1135, which is generally required where taxpayers hold “specified foreign property” (“SFP”) with a total cost base of more than $100,000 at any time in a year. This form and the related requirements have been the subject… Continue Reading