The Taxation of Non-Resident Trusts in Canada

Transcription

1 Presented by: Richter Tax Services Updated for 2014 Federal Budget Proposals The Taxation of Non-Resident Trusts in Canada

2 Part I Background to NRT Rules

3 Introduction What is a trust? - An agreement between two parties, being the trustees and the settlor, in respect of the beneficiaries of the trust. Why trusts are created? - Inter-vivos trust - Testamentary trust What is a non-resident trust? - Typically, a trust that is not created under Canadian tax law - Administered by non-resident trustees Distinction between in-trust vs. trust 3

4 What is a Trust? A three party arrangement among the Settlor who contributes property to a trust; property is administered by a Trustee for the benefit of Beneficiaries Settlor Beneficiary Contribution Trust Benefits Administers Trustee 4

5 What s the problem with Non-Resident Trusts? Vehicle to move assets out of Canada or transfer wealth without paying tax in Canada Shareholder X Beneficiaries Preferred Shares Trust Barbados Common Shares Canco 5

6 Government s Response? Rules to address taxation of certain non-resident trusts (NRTs) in Canada Introduced in the 70s Perception that rules were ineffective 6

7 Proposed Amendments to NRT Rules Revisions to rules began on June 22, 2000 Revised again in August 2001 Revised yet again in October 2002 and again in October 2003 and again in July and again in November 2006 Guess what? Yup, again in August 2010 Revision #7 in October 2012 and FINALLY Adopted on June 26, 2013 (October 2012 version) 7

8 NRT 8

9 Part II Summary of the NRT Rules

10 Summary of the NRT Rules 1. Deems a NRT to be a Canadian resident trust in certain situations Canadian resident contributor Canadian resident beneficiary 2. Proposed elimination of 60 month holiday for an Immigration Trust 3. As a deemed Canadian resident trust, subject to Canadian tax on worldwide income 4. Application of Canadian tax rules to NRTs Complexities of determining what income is taxable and what provisions of Canadian tax law are applicable Applicability of treaties Election Disclosures 5. Key elements of new rules: Contribution Election 10

11 Provisions applicable to deemed Canadian resident trust For purposes of computing income of the trust Part I tax liability Distributions by a trust CFA rules T3 Return Transfers of property to a non-resident trust (form T1141) Foreign reporting (T1134, T1135) Part XIII tax and withholding liability Emigration rules (when no longer deemed Canadian trust) Residence of trust for treaty purposes, Income Tax Conventions Interpretation Act (deemed resident of Canada and NOT of the other state, so no tie breaker applicable) 11

12 Part III Key Concepts Resident Contributors and Resident Beneficiaries

13 Resident Contributor and Resident Beneficiary Resident Contributor any person resident in Canada; and a contributor to the particular trust. Resident Beneficiary at least one beneficiary that is resident in Canada; and a connected contributor to the trust. Essential criteria is whether contributor is resident in Canada at any particular time (i.e. year end of trust) and not necessarily when contribution is made Upon emigration from Canada, 60 month moratorium on contributions to a NRT; 10 year window after emigration and before re-immigration required if contribution is made to a NRT Exception to resident contributor and connected contributor to allow for immigration trust provides grace period of 60 months from the time contributor becomes Canadian resident Canadian Federal Budget proposes to eliminate this 60-month tax holiday. 13

14 Immigration Trusts 2014 Federal Budget Proposal 2014 Canadian Federal Budget proposes to eliminate the 60-month tax holiday for trusts established by a non-resident. This measure will apply for taxation years ending on or after Budget Day (February 11, 2014) or, subject to certain transitional rules, in The transitional rules apply if these conditions are met: An immigration trust existed after 2013 and prior to Budget Day; and No contributions were made to the trust on or after Budget Day and before Important to review all existing immigration trusts to determine whether the proposed rules apply in 2014 or

15 Part III Key Concepts Contribution

16 Contribution What constitutes a contribution? Contribution includes any transfer or loan of property to a trust, other than an arm s length transfer Arm s length transfer Transfer or loan of property must meet arm s length standard Reasonable to conclude none of the reasons for the transfer was to acquire an interest in the trust; Excludes restricted property Includes transfer that is payment of interest, rent, royalty, dividend or any other return on investment Types of contributions Direct contributions Indirect contributions 16

17 Arm s Length Transfer Example 1 Beneficiaries (NR kids) Dad (Cdn Res) Loan at arm s length terms and conditions Dad normally does not make loans to others; Does it meet definition of arm s length transfer? Reasonable to conclude that none of the reasons for the loan was for the acquisition at any time of an interest as a beneficiary? NRT 17

18 Arm s Length Transfer Example 2 Beneficiaries Other Cdn S/H NRT 25% 75% NR acquired Canco common shares 20 years ago; NR settled NRT with Canco shares Are dividends arm s length transfer or contribution by Canadian resident? Purpose test OK, history of dividend payments to all s/h s Arm s length amount? Dividend Payment Canco Dividend Payment 18

19 Restricted Property What is Restricted Property? Common shares of a closely held corporation that are acquired on a classic estate freeze; BUT Can also include indebtedness and other property that is acquired in the course of an estate freeze; and In the case of indebtedness, the payment is derived from value of the closely held corporation; In the case of property, FMV is derived directly or indirectly from the common shares 19

20 Example Direct Contribution NRT Mr. X Canadian Resident Cash as Settlement of Trust Direct transfer of any property or loan (whether or not consideration is received by Mr. X from the NRT) Excludes an arm s length transfer Mr. X is a contributor to a NRT 20

21 Example NRT in an Estate US Children NRT Estate Estate Assets Will of deceased Canadian individual bequeaths Estate s assets to a NRT (that has already been in existence outside of the will) over a period of time Canadian resident Estate is a Canadian contributor NRT deemed to be Canadian resident trust as long as Estate exists Once Estate ceases to exist, there is no Canadian contributor and therefore NRT ceases to be deemed Canadian resident Emigration rules apply 21

22 Direct Contribution Estate Freeze 22

23 Indirect Contribution Beneficiaries (NR Kids) Canadian Resident (Dad) NRT Non-Resident Transfers $$ (Grandmother) Transfers $$ 23

24 Indirect Contribution (94(2)(c)) Canadian s/h owns shares of Canco (assume restricted property) Transfers to non-resident corporation in exchange for p/s Non-resident corporation issues common shares to NRT for FMV consideration Assume purpose of transfer is to reduce Canadian tax on eventual sale of Canco Contribution under definition in 94(1)(b) as well? Canadian Shareholder p/s Non-Resident Corporation Canco c/s Restricted Property NRT 24

25 Example Indirect Contributions (Transfer Pricing) NRT Forco Beneficiary: Canadian shareholder Transfer of Property Canadian Shareholder Canco Assume Forco and Canco do not deal at arm s length Forco and Canco are subject to transfer pricing rules Assume that CRA reassesses a transaction between Forco and Canco as non-arm s length (Forco purchased goods or services at an amount less than FMV) It is considered a transfer of property to Forco and indirect transfer to the NRT 25

26 Part III Key Concepts: Election

27 Election Election to treat the resident portion of the trust as a separate deemed Canadian trust Treatment of the non-resident portion as a separate trust not subject to taxation as a Canadian resident Otherwise, entire trust will be subject to Canadian tax Election must be made by filing due date of year in which resident contribution is made Retroactive application of rules from 2007, election is due June 26,

28 Election Election to treat the resident portion of the trust as a separate deemed Canadian trust Deemed NRT Cdn. Trust Result is hypothetical two trusts; one that is subject to Canadian tax and another that is non-resident Otherwise, entire trust is subject to Canadian tax 28

29 Part IV Determination of Canadian Tax Consequences

30 Where Election has been filed Step 1: Determine the Resident Portion Resident NR Portion Portion NRT $600 $1,000 $400 Determining the Resident Portion of Property owned by the NRT Where there was a direct contribution, identify the property that tainted the trust If contribution was a decrease in liability of the trust, select a property with FMV at least equal to amount in question 30

31 Where Election has been filed Step 1: Determine the Resident Portion NR Resident NRT Portion Portion FMV $10 million Canadian Resident Forco Indirect Contribution to Trust FMV $100 Determining the Resident Portion of Property owned by NRT Where there was an indirect contribution, the whole property that gave rise to the indirect contribution is attributed to resident portion Eg. Canadian indirect contribution with value of $1000 to Forco, all of the shares of Forco are attributed to resident portion 31

32 Step 2: Track the Income Resident Portion is Cash Fungible? Resident Portion $32 $40 NRT Income Earned $100 NR Portion $68 $60 Track the income from the resident portion The income from the property of the resident portion Property that is substituted (resident portion earns 8% return; non-resident portion earns 11% return) Cash fungible or direct tracking? Proration vs. direct tracking if possible 32

33 Example Dividend Income Dividend Resident Beneficiary Resident Portion Treaty Country Beneficiary Canco has obligation to withhold, say 15% because NRT is non-resident 94(4)(c) Dividend income is taxed as income to NRT 94(3)(a)(viii) W/H tax remitted by Canco is applied as tax installment of NRT 94(3)(g) If NRT distributes dividend to beneficiary deduction allowed under 104(7.01) is limited to 65% of dividend, resulting in tax of 15% to trust Canco 33

34 Part V Outstanding Issues

35 Example Emigration (or Death) of Resident Contributor Canada Foreign Country NRT Trust Assets Contributor Emigration Deemed Disposal of Assets Canadian resident contributor, NRT deemed to be Canadian resident Subsequently, Contributor emigrates from Canada Pursuant to 128.1, deemed emigration of the Trust for Canadian purposes Pursuant to 128.1(4), deemed disposal of all assets, but only for Canadian purposes. Therefore possible mismatch in relation to the Foreign Tax Credit (consideration should be given to possible treaty relief) 35

36 Example 21 Year Rule Canada Foreign Country NRT Trust Assets Contributor 21-Year Anniversary Deemed Disposal of Assets Canadian deemed disposition at FMV on 21st anniversary + successive anniversaries Certain exclusions Applies to non-canadian trusts if assets are taxable in Canada NRT rules can create Canadian deemed disposition of assets not otherwise taxable for nonresident trusts (with a step up in FMV of assets subsequently) Existing trusts might be subject to deemed disposition soon (i.e. trust established in 1993 or 1994) 36

37 Example Quebec Rules Quebec Resident Contributor US Trust Beneficiaries 1999 Quebec budget stated that Québec would harmonize with the federal law Discussions with Revenu Quebec legislation division suggest that legislation is being prepared and will be tabled in Spring 2014 Legislation will be retroactive to effective date of federal rules RQ website describes the Quebec rule as being a twostep rule: (1) trust subject to 94(3); and (2) one of its contributors or beneficiaries resident in Quebec at end of year Many unanswered questions 37

38 Example Tax Bite in Quebec Quebec Resident Contributor Beneficiaries Federal views income as not earned in a province No abatements Federal surtax Federal tax 29% Federal surtax 13.92% Québec tax 25.75% 68.67% US Trust Non-Canadian Income Ontario On the other hand, compare the NRT rate of 42.92% to combined federal and Ontario personal tax rate of % if trust were resident in Canada. 38

39 Treaty Residence Section 4.3 Income Tax Convention Interpretation Act Canadian Resident Contributor US Trust Canadian Dividend Income Beneficiaries Deems 94(3) trusts to be a resident of Canada, and not a resident of the other contracting state, for the purposes of applying the convention Purports to override Treaties, implementing legislation, case law FTCs expressly provided for Other interpretive issues Can US trust benefit from Article X of treaty to reduce section 215 withholding? 39

40 Part VI Compliance

41 Compliance Requirements 1. T3 Return (due March 31 st for Inter Vivos Trusts) 2. T1141 Information Return in Respect of Transfers or Loans to a Non-Resident Trust (due at the time of filing of contributor s tax return) 3. T1134 Information Return Relating to Controlled and Not-Controlled Foreign Affiliates (due 18 months following tax return filing date) 4. T1135 Foreign Income Verification (due with filing of tax return) 41

42 Form T Who is required to file? Resident Contributor Connected Contributor 2. What situation? Where a transfer, other than an arm s length transfer, has been made Arm s length transfer for purposes of reporting excludes any transfer under 94(2)(g) Difference between this exclusion and exclusion of restricted property Disclosure requirement is broader than NRT legislation 3. When is it due? Tax return due date of contributor Must file for every year it has status, not only for year of contribution 4. What are consequences of not filing? Penalty $2,500 basic Up to $24,000 for gross negligence Up to 5% of contribution for gross negligence > 24 months 42

43 Part VII Summary

44 but the (only) good news is Non-Resident (always non-resident) Canadian Beneficiaries Settles Trust NRT the Granny Trust still works (for now) 44

45 as long as you don t trip up under these rules Granny Trust Watch out for subsequent inadvertent contributions to trust by a Canadian resident: Examples: Contributions of services provided by Canadian resident beneficiaries to trust not at FMV; Trust loans money to Canadian resident beneficiary who pays interest on loan Canadian resident beneficiary transfers funds to trust to cover overdraft Trust subscribes for shares of a Canco in certain situations Trust holds shares of a Canco and Canco pays excessive dividends 45

46 Possible solutions to over reaching resident contributor? Non-Resident contributor Non-resident beneficiaries Settles Trust NRT Canadian Resident Dad Common shares Forco Preferred shares 46

47 Filing Requirements - Deadlines Form Date Election June 26, 2014 Trust s Tax Return for Taxation Years June 26, 2014 Trust s Tax Return for 2013 Taxation Year March 31, 2014 T Information Return in Respect of Transfers or Loans to a Non-Resident Trust T Information Return Relating to Controlled and Not- Controlled Foreign Affiliates - for Taxation Years Due with tax return of contributor (including all prior year forms) June 26, 2014 T1134 Form for 2012 Taxation Years March 31, 2014 T Foreign Income Verification Statement Due with tax return 47

48 Recommendations Plan with two separate trusts FILE YOUR ELECTION ON TIME! Develop tracking mechanism with respect to resident and non-resident portion. Separate bank accounts Pro-ration 48

49 Richter s Non-Resident Trust Task Force: David Hogan Tasso Lagios Giovanni Molinaro Lorne Richter Diane Tsonos Phil Nadler Irina Oks Jennifer Rhee Bradley Thompson Joy Wang