In the last article in this series, I explained what I call my “Guaranteed No-Fail Recipe for Becoming a Non-Resident”.
Assuming that the expat is successful in becoming a non-resident, there is often a significant cost and hurdle in the form of the so-called “departure tax”. If ridding oneself from the ongoing burden of Canadian taxation is the rose, the departure tax is the thorn!
However, unlike the kind of “departure tax” that is levied at some airports, there is no tax official in Canada waiting to collect it when the Canadian expat leaves. Rather, it is calculated and payable as part of the normal income tax filing for the year of departure.
The purpose of this article is to explain the basics of this tax.
This tax arises because of the fact that, when an individual, who was resident in Canada for tax purposes, ceases to be resident in Canada, there is generally a deemed disposition of assets owned by that individual at their fair market value. Any resulting deemed gain must be reported on the final tax return filed as a resident. This additional tax is what is meant by the term “departure tax”. The rationale is that this may me the last time that the resulting gains may be subject to Canadian tax.
The deemed disposition at fair market value immediately prior to emigration generally applies to all property owned by the individual at that time. However, there are many important exceptions, including:
- Direct interests in Canadian real property
- Interests in Canadian “Registered Retirement Savings Plans” and “Tax Free Savings Accounts”
- Rights under various types of employee benefit or pension plans, as well as rights under stock option plans
- In the case of an individual who was resident in Canada for not more than 60 months in the 120 months prior to departure, property that was owned by that individual at the time when he or she last became a Canadian resident, or that was acquired by gift or bequest after that time,
- Interests in a personal trust resident in Canada that was not acquired for consideration, and
- Interests in a non-resident testamentary trust that was not acquired for consideration
With regard to the first exception, it is important to note it only applies to direct interests in Canadian real estate. If the expat holds an interest in Canadian real estate as a shareholder of a corporation owning such property, or a member of a partnership owning such property, the shares or the partnership interest will be subject to the deemed disposition.
Why the distinction? In the case of direct interests in Canadian real estate, the tax authorities can be confident that they will collect Canadian tax when the property is ultimately sold, so they don’t need a “departure tax”. This is because none of Canada’s tax treaties would prevent Canada from collecting such tax; in the case of indirect interests, it is not as certain because of the ability to change the nature of indirect interests after departure.
I was involved with a situation a couple of years ago where an individual was a member of a partnership that owned Canadian real estate. We were able to avoid the departure tax by dissolving the partnership, prior to departure, on a tax-free basis, by using subsection 98(3) of the Income Tax Act. However, it is usually not that simple!
Surprising, there are still some accountants around that think that all “taxable Canadian property” (“TCP”) is exempt. In fact, when the system was first put in place after 1971, such was the case. However, over the years, it became apparent that taxpayers could depart and ultimately avoid paying tax on TCP gains by the skillful use of tax treaties. Because of that fact, and the publicity surrounding the infamous “Bronfman Trust Rollout”, the rules were tightened in the mid-1990s. Now, direct interests in Canadian real estate (and similar properties) are generally the only form of TCP exempt.
This is particularly important for affluent Canadians whose wealth is concentrated in the shares of private corporations that they hold.
It is possible to elect to defer the payment of any tax resulting from the deemed disposition until the time that there is an actual disposition of the relevant property.
The election is made by filing form T1244 with final tax return as a resident and subsequently providing adequate security to the Canada Revenue Agency. No interest is charged on the deferred tax.
In the next article in this series, I will discuss some special considerations for expats with private investment or real estate holding companies