Many wealthy (as well as not so wealthy) immigrants to Canada will establish very successful Canadian corporations (“Cancos”) that will ultimately become extremely valuable.
In many cases, those immigrants to Canada will still have family abroad, and might be happy to have equity interests in Canco owned by those family members.
In such cases, there can be significant Canadian tax benefits, which are often overlooked, resulting from such foreign ownership of Canco.
If shares in Canco are owned by a Canadian resident, capital gains on those Canco shares (including deemed capital gains on death or emigration) will be subject to tax in Canada except to the extent that they might be eligible for a limited amount of exemption[1].
On the other hand, if shares in Canco are owned by non-residents, capital gains will generally be exempt from Canadian tax, regardless of the amount, unless the shares in Canco are “taxable Canadian property” (“TCP”). As a result of changes to the Act that came into effect in 2010, the shares of Canco will generally not be TCP unless the value of those shares is primarily derived from Canadian real estate or resource properties. Shares of normal operating companies would generally not be TCP.
As such, if Canco grows in value, the equity accruing to non-resident family members would not be subject to Canadian tax. Furthermore, such shares could be inherited by Canadian family members on the death of the holder at a stepped-up cost basis that would reflect any gains accruing at the date of death, without any Canadian tax applying.
In addition, dividends paid by Canco would be subject to Canadian tax at a maximum rate of 25%; on the other hand, dividends received by a Canadian resident could be subject to Canadian tax at a substantially higher tax rate.
Even if foreign family members hold a majority of the equity shares of Canco, it could be possible for it to still qualify as a “Canadian controlled private corporation” (“CCPC”), if desired, by ensuring that at least 50% of the voting power is in the hands of Canadian residents.
Obviously, tax considerations in the country of residence of the foreign family members have to be considered.
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In theory, similar benefits could be achieved if shares in Canco were owned by a trust established by a foreign settlor that is resident outside of Canada.
However, from a tax perspective, direct ownership by foreign family members would always be safer because of the high degree of risk that a non-resident trust owning shares of Canco can inadvertently become a deemed resident trust[2].
In situations where Canco has already been established with only Canadians as shareholders, it should be possible to introduce foreign family members as shareholders, for whom further increases in value would accrue, without triggering any gain in the hands of the current shareholders[3].
[1] Under subsection 110.6(2.1) of the Income Tax Act (“the Act”), capital gains of up to $800,000 (indexed for inflation-about $825,000 in 2016) arising on the disposition of “qualified small business corporation shares” may be effectively tax exempt.
[2] For example, the acquisition of shares of a Canadian corporation from treasury by a trust is deemed to be a “transfer” of property to the trust by the corporations (see subparagraph 94(2)(g)(i) of the Act). In addition, the payment of a dividend by the corporation would also be a “transfer”. This could result in the trust being deemed resident in Canada, for many purposes of the Act, under subsection 94(3) of the Act.
[3] By exchanging the common shares owned by the Canadian resident(s) for fixed value “freeze type” shares. This would normally be a tax-free exchange under section 86 of the Act. New common shares could then be issued for nominal consideration to the non-resident(s). Voting control could remain in the hands of the Canadian residents via voting rights attached to the “freeze type” shares.
ABOUT THE AUTHOR OF THIS ARTICLE
Michael I. Atlas, CPA,CA,CPA(ILL),TEP
Michael Atlas is one of the most prominent international tax experts in Canada. He advises accounting and law firms all across Canada, as well as select private clients (corporate and personal) worldwide. He can be reached by phone (416.860.9175) or email (matlas@TaxCA.com).