A recent lunch with a tax lawyer friend of mine gave me some valuable insights regarding how tough and aggressive the Canada Revenue Agency is getting with Canadians who report substantial distributions from offshore trusts.
It also suggests that there are certain precautions that Canadians who are beneficiaries of offshore trusts should take in the event of an audit.
First, let’s understand what is apparently precipitating audits. The CRA is focusing on Canadians who file form T1142. This form is generally used by Canadians to report distributions that they receive from non-resident trusts[1]. On the form, the taxpayer would generally report whether the distribution is income or capital. If the latter, normally, this would be tax-free[2], but still would be reportable.
The CRA seems particularly interested in Canadians who receive substantial capital distributions which are (presumably) tax-free. Strange that government auditors who work five days a week for a modest taxable salary might be targeting Canadians who don’t have to do anything to get six-figure (tax-free) distributions, but, go figure!
My tax lawyer friend told me that they are asking his clients to supply all sorts of information about the trust and its distributions that could go back many, many years. This includes financial statements and records of payments. They want proof that distributions are capital. They are even asking for proof that the trust was properly settled.
In many cases, getting the kind of information they are seeking is extremely difficult. Try getting information going back 25 years! Often, people who worked for the offshore trustee at various relevant time are either dead or retired; the people there today do not necessarily have all the background. Over the years, the financial institution acting as trustee may have changed, or merged with another institution.
The CRA is also obviously focusing on issues that relate to the “mind and management” of the trust. There is nothing that they would like better than to determine that the trust was really resident in Canada. This would make the trust taxable, and guess who would be on the hook if the trust does not fork-up any back taxes that it might assess[3]?
The message here is that Canadian residents who get substantial capital distributions that are reported on form T1142, particularly on a regular basis, should make sure that they are in a position to supply information and documents to the CRA if they come knocking.
Hopefully, the items supplied should provide evidence to establish the following:
- That the trust was properly settled,
- That “mind and management” was not in Canada-that is, the offshore trustees (or someone else outside of Canada) made all strategic decisions
- That capital distribution were not actually made from current year’s trust income.
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[1] Assuming that they never were a “contributor” to the trust, thereby making it a “deemed resident trust”. In such cases, form T1141, instead, should be used to report such distributions.
[2]Capital distributions would normally be tax-free, but not always. For example, a distribution of capital gains would normally be capital under trust law; however, it could be taxable to the extent that it represents the taxable portion (50%) of gains realized in the same year as the distribution. On the T1142, it asks the “nature of receipt for Canadian tax purposes”. Presumably, the intention would be to show the distribution of the taxable portion of the gain as income on the form, even if capital under trust law.
[3] Under subsection 160(1) of the ITA, the beneficiary could be liable, especially since, under paragraph 250(1)(b) of the ITA, he or she would be deemed to be not dealing at arm’s length with the trust.
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).
