There is a little-known method by which wealthy immigrants to Canada can use a holding company (“Holdco”), either in Canada or offshore, to receive, otherwise taxable, money tax-free in Canada.
This will be applicable in situations where that immigrant holds a significant interest in foreign a corporation (“Forco”), either alone, or with family members.
This technique will be even more attractive now that “immigrant trusts” will no longer be available as a tax planning tool for wealthy immigrants.
The key to using this method is to understand the fact that the cost base of an immigrant to Canada of property owned at the time of becoming resident is generally the fair market value of such property at that time[1].
This means that the immigrant can sell his or her shares to Holdco in return for a note having a face amount equal to that fair market value. Because of the stepped-up cost base of the Forco shares, no capital gain would be realized for Canadian tax purposes.
In situations where the immigrant has been in Canada for a period of time, and there has been appreciation in value of the Forco shares, this technique can still be used without triggering any capital gain. Recognition of that gain can be avoided on the transfer by properly by using the provisions of subsection 85(1) of the Act, in cases where the transferee is a Canadian corporation, or subsection 85.1(3), if it is a foreign corporation.
Once this structure is in place, when dividends are paid by Forco, which would otherwise go to the immigrant, they will go, instead, to Holdco.
In the hands of Holdco, the dividends will generally not create any liability for Canadian tax, regardless of whether Holdco is a Canadian[2] or a foreign corporation[3].
Once the dividends are paid to Holdco, they can be paid tax-free to the immigrant as repayments of debt as long as the note has not been fully repaid.
[1] Paragraph 128.1(1)(c) of the Income Tax Act (“the Act”)
[2] Assuming that Forco is a “foreign affiliate” of the Canadian company, which generally requires ownership of at least 10% of any class of shares, the dividend will generally be tax-exempt under one of the paragraphs of subsection 113(1) of the Act.
[3] Assuming that Forco is a “foreign affiliate” of the immigrant, dividends received from Holdco will not be considered “foreign accrual property income” (“FAPI”).
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