In the last article in this series, I reviewed the basics of the dreaded Canadian “departure tax”.
The purpose of this article is to discuss some special considerations applicable to expats with investment or real estate holding companies.
I will outline these special considerations in point form below.
1) As I indicated in the last article, 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. However, this requires posting security with the CRA that is acceptable to them. This may be challenging in situations where the bulk of the expat’s assets is in the form of private corporation shares (“Canco”).
The best security from the CRA’s perspective would be a letter of credit (“LOC”) from a Canadian bank. It is unlikely that a bank will issue that based on the security of the expat’s shares in Canco. However, it is possible that Canco could provide a guarantee to the bank that would allow the bank to issue the LOC to the CRA.
Until recently, I would have said that the only tax risk associated with such corporate guarantee would be a potential taxable benefit equal to a notional guarantee fee. However, one would also have to consider the possible application of recent amendments to the Income Tax Act (“the ITA”) (see subsection 15(2.17)) under which debts guaranteed by a corporation for a shareholder could be treated as shareholder loans.
What about providing the shares of Canco to the CRA as security? In a letter dated July 15, 2016 which was issued by the CRA to a colleague, the CRA stated:
“Private company shares can be pledged for security on departure tax, however, these shares (and the shares of all privately held corporations) must be the only property that gives rise to the departure tax. Should other property be involved, that portion must be secured by another form of security. The Canada Revenue Agency must hold 100% of all the privately held shares owned by the taxpayer, and we require at least a 2:1 ratio of share value to tax liability.”
2) In some respects, proper planning in this area is similar to post-mortem tax planning in relation to taxpayers who die owning shares of private corporations. There is a gain taxed on the shares, but possibly also an additional tax when Canco disposes of appreciated assets, and, also when assets are distributed to shareholders. Accordingly, the challenge is how best to mitigate the effects of these multiple layers of tax.
3) In situations where the expat controls Canco, and it owns appreciated assets, consideration should be given to liquidating those assets and distributing to the expat prior to departure. Or, the appreciated assets themselves could be distributed to the expat prior to departure at a “bumped-up” cost base. In that way, the potential capital gain on the Canco shares is reduced, and, through the usual mechanism of “capital dividend account” and “refundable dividend tax on hand”, the capital gain applicable to the appreciated assets is only taxed once.
4) Where shares of Canco are “qualified small business corporation shares”, the expat may be able to use the “capital gains exemption” to shelter up to about $835,000 in capital gains on departure (in the case of farming or fishing corporations, up to $1,000,000). The balance sheet of Canco prior to the departure date should be reviewed to make sure that the shares qualify. In certain cases, “purification” prior to departure may be desirable to ensure that the shares qualify.
5) Consideration should be given to steps that can be taken to remove surplus from Canco at a reduced tax rate after departure.
In the absence of a lower rate applying under a treaty, 25% tax under Part XIII of the ITA will apply to all dividend distributions.
In a recent article, I outlined a technique, that might be used by expats moving to the US, to reduce that rate to just 5% by using a US S Corporation (see https://taxca.com/blog-2017-5/)
There are many other potential jurisdictions that might be consider in other cases. For example, the UK is appealing too because it also offers a 5% rate, and does not levy tax on dividends coming into a UK company, nor does it levy any outbound withholding tax on dividends paid.
In this regard, one would have to consider the possible application of the “General Anti-Avoidance Rule” (“GAAR”) in section 245 of the ITA, to such planning, as well as any statutory provisions that Canada could enact in the future to curtail “treaty shopping”.
6) If the shares of Canco are redeemed or cancelled (including on the wind-up of Canco), a deemed dividend will arise, and tax under Part XIII of the ITA will apply. However, in certain cases, section 119 of the ITA will allow all or a portion of that Part XIII tax to be used to retroactively reduce the “departure tax” that was payable at in the year of departure. This would only apply where the Canco shares are TCP throughout the period between the departure date and the disposition date.
7) If the Canco shares are “taxable Canadian property” (“TCP”) that are not “treaty protected property”, gains accruing on such shares, even after departure, can be subject to Canadian tax. This would most commonly be applicable in situations where Canco’s assets consist mainly of Canadian real estate. This could result in a liability for Canadian taxes, on the death of the expat, on any gain that accrued after departure. In light of that, consideration should be given to taking steps to eliminate such potential for Canadian taxes on the death of the expat. Such steps could include:
- “Freezing” the expats interest in Canco at the time of departure by exchanging it for fixed value special shares, such that all future growth would accrue on newly issued common shares that would be held by younger family members or a trust,
- Transferring the Canco shares to a Holding corporation resident in a foreign jurisdiction. If the expat is resident in certain jurisdictions, such as the US, this will provide protection under the relevant tax treaty from Canadian taxation. This is because those treaties only allow Canada to tax gains on shares of real estate Holding corporations that are resident in Canada.
- Transferring the Canco shares to a Holding corporation resident in a foreign jurisdiction with the idea that other types of assets would also be held in that corporation, such that the shares would not derive most of their value from Canadian real estate. That would mean that the shares of the Holding corporation would not be TCP, and there would not be exposure to Canadian taxes on death. A similar result could be achieved if a partnership, rather than a corporation, were used.
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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).