CROSS BORDER TAXATION

Transcription

1 WHITE PAPER ON CROSS BORDER TAXATION Knowledge Bureau, Inc. 187 St. Mary s Rd., Winnipeg, MB, R2H 1J2 registrar@knowledgebureau.com Toll-Free: , Fax:

2 WHITE PAPER ON CROSS BORDER TAXATION Brought to You by KNOWLEDGE BUREAU ISBN No.: Published by Knowledge Bureau 187 St. Mary s Road, Winnipeg, Manitoba Canada Phone: (204) Toll Free: Fax: (204) C O P Y R I G H T N O T I C E 2017 Knowledge Bureau, Inc. The contents of this work are copyright protected; all rights are reserved. No part of this work including anything in print, audio or online including charts, data, logos, art, videos, design, architecture, articles, quotes or PowerPoint presentations may be reproduced or transmitted in any form or by any means, or stored in a data base and retrieval system, without prior written consent from Knowledge Bureau, Inc. Users of the intellectual properties published by Knowledge Bureau (including books, website, news services, educational works and any other aspects of the products and services of Knowledge Bureau, Inc.) are responsible for their own actions and outcomes and are advised to seek legal counsel or other professional advice before acting on any information or recommendations received. For full disclosure of polices visit knowledgebureau.com. For further information or to request permission for reproduction call us at or by at admin@knowledgebureau.com 2017 Knowledge Bureau, Inc. All Rights Reserved.

3 D I S C L A I M E R Users of the intellectual properties published by Knowledge Bureau (including books, website, news services, educational works and any other aspects of the products and services of Knowledge Bureau, Inc.) are responsible for their own actions and outcomes and are advised to seek legal counsel or other professional advice before acting on any information or recommendations received. The owners, publishers, authors, instructors, editors, coaches and contributors therefore expressly disclaim all and any liability to any person in respect of anything and any consequence as a result of the use of the works which may be taken through Knowledge Bureau, Inc., including any news releases or commentary, courseware, workshops, conferences, webcasts, online materials, calculators, libraries or other information resource herein referred. Knowledge Bureau Inc. makes no representations or warranties with respect to third party software used in its programs and accepts no responsibility with respect to its use by the student. Only those warranties available from software developers are applicable. Users of the intellectual properties of Knowledge Bureau including its websites, courses or other services of Knowledge Bureau, Inc. are also herewith notified that the company, its principals, shareholders, employees, writers, instructors or subcontractors are not involved in any aspect of any business conducted by any persons or companies for which it supplies or offers courseware, information or intellectual property management services, including resellers of its courseware, and does not endorse any such person or companies or its products or services. Knowledge Bureau, Inc., therefore expressly disclaims any responsibility for any consequence any person or entity has in relation to dealings with any such person or company. The examples used in the intellectual property published by Knowledge Bureau are fictitious unless otherwise stated and any resemblance to real life people, facts or circumstances is purely coincidental. Much care has been taken to trace ownership of copyrighted material contained in this material; however, the publisher will welcome any information that enables it to rectify any reference or credit for subsequent editions and or any errors or omissions that require correction. Please contact the manager of Content Development at Knowledge Bureau, Inc. All Rights Reserved.

4 A message from Evelyn Jacks, President, Knowledge Bureau We are very pleased to present to you this Knowledge Bureau White Paper on Cross Border Taxation, written by Faculty Member, Dean Smith of Cadesky Tax. We have three specific goals for you in delving into this material: Goal 1: Deeper, Richer Conversation Tools for Great Year End Tax Planning Discussions We have included talking points and strategies to guide you towards deeper and richer conversations about planning for your clients who want to engage in tax efficient wealth management in the area of cross border taxation. Goal 2: Deeper, Richer Online Resources to Boost Your Knowledge and Confidence We also invite you to visit and explore Knowledge Bureau s Website for deeper, richer content that embellishes planning opportunities with your clients. Here you will find the opportunity to learn more about our certificate courses on Cross Border Taxation, Personal and Canadian Corporate Taxation. Call us to inquire about how we can help you develop your specialized professional development. Goal 3: Deeper, Richer Peer-to-Peer Learning and Networking in November Please consider consolidating your knowledge and your knowledge network at two peer-to-peer learning events powered by Knowledge Bureau. You will be able to learn from and ask your most detailed questions as we present Canada s most experienced and prolific experts on the latest changes to personal and private corporation taxes and how the proposals will impact the after-tax dollars your clients will use to meet their goals. Mark your calendar now: Earn up to 15 CE Credits at the Distinguished Advisor Conference in Kelowna, BC. November 5 8. Visit for details. Earn 10 CE Credits at Knowledge Bureau s New CE Summits being held in Winnipeg, November 21, Calgary on the 22 nd, Vancouver on the 23 rd and Toronto on the 28 th To register at preferred student rates (50% off when you mention this White Paper), call See all the details on the back cover of this White Paper. Sincerely, EVELYN JACKS, PRESIDENT KNOWLEDGE BUREAU 2017 Knowledge Bureau, Inc. All Rights Reserved.

5 AUTHOR BIOGRAPHY Dean T. Smith BRIEF INTRODUCTION: Dean is a partner with Cadesky and Associates LLP and the President of Cadesky U.S. Tax Ltd. Cadesky is a boutique accounting firm which provides only taxation services. Dean has been involved with expatriate tax work for over 23 years assisting companies moving employees around the world. Clients also include private individuals who have multiple jurisdictional filings. Dean is also an instructor and writer with Knowledge Bureau. CAREER HIGHLIGHTS: Graduate Certificate in Estate Planning (U.S.) Golden Gate University, San Francisco (2005) Ph.D. (in Financial Accounting), University of Waterloo, Waterloo, ON Canada (1999) Honours, B Comm. McMaster University, Hamilton, ON Canada (1987) NOTEWORTHY ENGAGEMENTS President British Canadian Chamber of Trade and Commerce (BCCTC) Past Chair Tax Committee - American Chamber of Commerce in Canada (Amcham) Member - Society and Trust and Estate Practitioners, Toronto Chartered Professional Accountant CPA Ontario Chartered Professional Accountant CPA Manitoba Certified Public Accountant Illinois Certified Financial Planner Financial Planners Standards Council AREAS OF PRACTICE: Practice Leader - US-Cross Border Tax Services High net worth individuals with cross border needs Acceptance agent for IRS, can assist clients with obtaining U.S. Individual Taxpayer Identification Numbers (ITINs) Assistance with the implementation of Retirement Compensation Arrangements (RCA) and Immigrant Trusts Use of trusts in tax and estate planning. Cross-border personal tax Canada, U.S. and U.K. Cross-border estate tax planning and compliance - U.S. estates and trusts 2017 Knowledge Bureau, Inc. All Rights Reserved.

6 FORMS, FORMS, AND MORE US TAX FORMS! By Dean T. Smith, CPA, CA, Ph.D., CFP, TEP Tax compliance is complex and time consuming, no doubt. But in the United States, clearly the IRS loves its forms, especially for U.S. Citizens living abroad! Unfortunately, many taxpayers, are not aware of what forms need to be filed, how long this process will take, and the enormous penalties they may be exposed to for not filing them on a timely basis. To prepare for the challenge, readers can actually find out the amount of time the IRS expects taxpayers to spend in regards to this annual ritual as it relates to (i) (ii) (iii) Recordkeeping (for the form); Learning about the law of the form; and Preparing and sending the form to the IRS. To give you an idea of the depth of information for U.S. taxpayers who are living abroad, Nina Olson (IRS National Taxpayer Advocate) stated in her 2011Taxpayer Advocate s Report to Congress: IRS publication 4732, Federal Tax Information for U.S. Taxpayers Living Abroad, illustrates the complexity of the filing requirements. It refers to at least eight other relevant IRS publications, totaling 563 pages, and the additional documents referred to by these other publications include 4,727 pages of instructions, 667 pages of forms, and another 1,928 pages of form instructions, or 7,322 total pages. Therefore, tax form immersion is a good idea, sooner rather than later. Taxpayers and their advisors would be wise to take note of the summary of some of the more relevant forms which may need to be filed below, all in addition to their regular tax return Form 1040, U.S. Individual Income Tax Return. This is especially so for U.S. taxpayers living abroad. FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR) The filing of an FBAR is governed under the U.S. Bank Secrecy Act of 1970 ( BSA ). It is not part of the Internal Revenue Code ( IRC ). FBARs must be filed electronically on the Financial Crimes Enforcement Network ( FinCEN ) website Generally FBAR reporting applies to each United States person who has a financial interest in (directly or indirectly), signing authority or any authority over, foreign (non-u.s.) financial accounts that have an aggregate value exceeding US $10,000 at any time in the calendar year. Note that the US $10,000 threshold is in aggregate, it is not US $10,000 per account. The FBAR does not report taxable income. The form reports those individuals who can control the flow of funds in non-u.s. bank accounts and is used, in conjunction with other law enforcement tools, to track down money laundering, organized crime, terrorisms, etc.

7 Since it is not a tax form, its scope goes beyond just the personal accounts of the filer. As such U.S. persons who may be corporate officers or trustees would be required to report the corporate or trust accounts, in addition to their personal accounts, on their FBAR filings. If an individual fails to file the FBAR, the IRS can impose one of two civil penalties: - A non-willfulness penalty, not to exceed US $10,000, may be imposed on any person who violates or causes any violation of the FBAR filings and recordkeeping requirements; or - A willfulness penalty may be imposed on any person who wilfully fails to file the FBAR, with the penalty being the greater of $100,000 or 50% of the balance in the account at the time of the violation. Criminal penalties may also be applied. Questions, ascertaining the need to file an FBAR, are asked on Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends, Part III Foreign Accounts and Trusts. Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation Generally, a U.S. citizen or resident, a U.S. domestic corporation, or a U.S. domestic estate or trust must complete and file Form 926 to report transfers of certain property to foreign corporations. For example, where a U.S. citizen resident in Canada has undergone a corporate reorganization and, as part of that reorganization, has transferred property (i.e., shares) to a new Canadian entity, form 926 may be required to report the transfer. If the taxpayer fails to comply, the penalty will be equal 10% of the fair market value of the property at the time of the transfer (note that it is the FMV not an elected transfer price). The penalty is limited to US $100,000 unless the failure to comply was due to intentional disregard. Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts This form is filed when a U.S. person has a transaction with (i.e., a contribution to or distribution from) a non-u.s. trust or receives a gift or bequest from a non-u.s. person. The initial penalty for not timely filing Form 3520 is the greater of US $10,000 or 35% of the gross value of property transferred to the foreign trust or 35% of the gross value of distributions received from a foreign trust. For U.S. tax purposes, a TFSA, RESP, and RDSP may be considered foreign trusts (a question of fact). RRSPs, however, are specifically excluded. Legitimate Canadian resident family trusts would be caught under these rules if distributions are made to a U.S. resident beneficiary. For example, if a Canadian resident family trust makes a distribution of $50,000 to a beneficiary who had moved to the U.S. and the U.S. beneficiary failed to file Form 3520, a penalty of $17,500 may be assessed. Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner

8 This form is filed when a U.S. person is considered to be the owner of a foreign trust under the U.S. grantor trust rules. This would apply when a U.S. person (citizen, green card holder, or resident alien) transfers property to a Canadian trust in such a manner that they are considered to still own the trust assets. A Canadian alter-ego trust may be one such example since the settler maintains control of the property and the property can revert back to the settler at any time. The initial penalty is the greater of US $10,000 or 5% of the gross value of the foreign trust s assets treated as owned by the U.S. person under the grantor trust rules. Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations This form is filed when a United States shareholder (defined as a United States person with at least 10% of the combined voting stock of the foreign corporation) has a reportable interest in a controlled foreign corporation (a CFC being a non-united States corporation where more than 50% of the votes or more than 50% of the value is held by United States shareholders ). This form would be required, for example, where a U.S. citizen Canadian resident has established their own incorporated family business. The initial penalty for not timely filing Form 5471 is US$10,000 but may be increased to US$50,000 if the form is not filed within 90 days of an IRS request to file. If the United States person is an entity, the IRS automatically imposes the penalty. If the United States person is an individual the IRS does not automatically (yet) impose the penalty but there is a risk that the penalty could be applied. Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business Form 5472 is similar to Canadian form T106, Information Return of Non-Arm s Length Transactions with Non-Residents, in that it reports transactions with foreign related parties. Unlike Form T106, which has a Cdn $1,000,000 filing threshold, there is no de minimis threshold. A $10 loan from a Canadian shareholder to a U.S. subsidiary may require that Form 5472 be filed. This form allows to IRS to examine possible transfer pricing issues. A penalty of US $10,000 will be assessed on any reporting corporation that fails to file the form when due and in the manner prescribed. An addition penalty of US $10,000 can be assessed if the form is not timely filed after notification by the IRS. Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships This form is the partnership equivalent of Form Depending on the category of the filer the penalties can range from US $10,000 (up to a maximum of US $50,000 after an IRS request to file has been received) to a penalty equal to 10% of the fair market value of property contributed to the partnership (subject to a potential US $100,000 limit unless the failure is due to intentional disregard).

9 Form 8938, Statement of Specified Foreign Financial Assets Form 8938 is essentially the income tax equivalent of an FBAR. Since an FBAR is not filed with the IRS, a taxpayer can be fully FBAR compliant but still not report the associated foreign income on their tax return. Form 8938 is meant to prevent that. There are two main differences between Form 8938 and the FBAR. While the FBAR reports other s accounts (i.e. signing authority or other authority) Form 8938 will only reports the taxpayer s accounts. In addition, the FBAR only reports financial accounts while Form 8938 reports financial assets, which is broader. Private company shares are one example of a foreign financial asset which is not a foreign financial account. Other possible foreign assets may include an interest in a foreign trust, a foreign estate, a foreign pension plan or a foreign deferred compensation plan. Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund A U.S. person that is a direct or indirect shareholder of a passive foreign investment company ( PFIC ) may be required to file Form 8621 for each individual PFIC that they have an interest in (there are actually five conditions under which filing is required). There is no minimum ownership requirement. Having 1 share of a PFIC would result in a potential filing obligation. A foreign corporation is a PFIC if either (i) 75% of more of the corporation s gross revenue for its taxable year is passive investment income or (ii) at least 50% of the average percentage of assets held by the foreign corporation during the taxable year are assets that produce passive income or are held for the production of passive income. Many Canadian mutual funds trusts, mutual fund corporations, exchange traded funds, and corporate class investments may be considered to be associations/corporations for U.S. tax purposes and, as such, would be classified as PFICs. Penalties associated with Form 8621 can vary depending on the exact PFIC regime which applies. In general, a minimum penalty of US $10,000 may apply. Dean Smith is one of Canada s foremost experts on Canada-U.S. tax matters, a partner with Cadesky and Associates LLP, President of Cadesky U.S. Tax Ltd., and a faculty member of Knowledge Bureau. Knowledge Bureau is Canada s leading educational institution for the continuing professional development of financial advisors and their clients, and a strategic educational partner with Dynamic Funds.

10 REPORTING FOREIGN INCOME AND ASSETS As Canadians look to maximize their investment returns and diversify their portfolio risk, it is not unusual to look for investment opportunities outside of Canada. However, this opportunity comes with some important tax consequences, which if ignored, can quickly erode away returns. There are several steps to getting it right and enjoying the most after-tax returns on these investments. Income Reporting on the T1 Return. First, Canadian residents must know they are required to report world wide income earned, annually, on their personal income tax returns. That foreign source income, including pensions and investment income and any capital gains, must be reported in Canadian dollars using the appropriate foreign exchange rate. In addition, aside from the income reporting requirements, it s important that the existence of foreign investment assets to be reported to the Canada Revenue Agency ( CRA ) on a separate tax form, as explained below. Form T1135, Foreign Income Verification Statement. Although many Canadian investors may think this is a new requirement, there is some interesting history to it. Codified in the Income Tax Act (the Act ) as section as part of the February 27, 1995 budget, the filing rules were to apply to returns for taxation years and fiscal periods that began after 1995 (though there were subsequent changes to delay certain filing deadlines to April 1999). As such, the requirement to file Form T1135 has been around for over 20 years. What has changed in recent years, however, is the focus of tax authorities to collect the information. There has been a concerted effort, globally, to combat international tax evasion and aggressive tax avoidance. This can be seen in the United States with their Offshore Voluntary Disclosure Program ( OVDP ) going back to 2009 and their Streamlined Compliance Filing Procedures program which goes back to Canada, too, has jumped on the off-shore compliance bandwagon. The CRA launched the Offshore Tax Informant Program (OTIP) in 2014 as part of this crackdown. In addition, CRA has, over the last few years, made changes to Form T1135 and increased their compliance focus on the filing of this form to combat international tax noncompliance. Who must report? Canadian resident individuals, Canadian resident corporations, Canadian resident trusts (with some exceptions) and certain partnerships are potentially caught under these rules. These reporting entities will be non-compliant if they have failed to declare (, for example, - Canadian taxable income that has been transferred outside of Canada; - foreign taxable income; - ownership of specified foreign property ; defined below; - participation in tax avoidance schemes that involve offshore transactions; and - trusts held offshore in respect of which federal income has not been declared. Form T1135 must be filed when the aggregate cost of all specified foreign property owned exceeds $100,000 at any time during the tax year. Note that it is the cost that is relevant here, not the fair market value. Form T1135 reports the cost at two different points in time: the maximum cost at any time during the year and the cost at the end of the year. Differences between the two costs would reflect additions and/or dispositions during the year. A lower cost at the end of the year would reflect a disposition and the CRA would be able to reconcile the disposition against reported capital gains. Knowledge Bureau, Inc. All Rights Reserved.

11 Also, many taxpayers make the error of believing the Cdn $100,000 threshold is by asset. That is not the case; it is the aggregate of all specified foreign properties (defined below) that must be reported. What is Specified Foreign Property? Investors who own Specified foreign property must file this form if they meet the $100,000 threshold. The Act defines specified foreign property to include (among other items) - Funds, including funds in foreign bank accounts situated, deposited or held outside Canada - an interest in a non-resident trust (i.e., foreign mutual funds) - indebtedness owed by a non-resident person (i.e., foreign bonds, debentures, mortgages and notes receivable) - An interest in a foreign insurance policy - Precious metals, gold certificates and futures contracts held outside Canada - Intangible property, or for civil law, incorporeal property, such as patents or copyrights, situated, deposited or held outside Canada - tangible property, or for civil law, corporeal property, situated outside Canada; (specifically including real estate) - shares of non-resident corporations (other than foreign affiliates) - an interest in a partnership that owns of holds specified foreign property - an interest in, or right with respect to, an entity that is non-resident In general, only those assets which generate or are used to generate investment income are reportable. Personal use foreign assets, i.e. a Florida vacation home, are therefore not reportable if they are used primarily for personal use. Some of these properties, therefore, could be included in the reportable category. The CRA defines primary to mean more than 50%. The test is based on the use of the property throughout the entire year. Therefore, it is entirely possible, for example, that a vacation property may be required to be reported in one year (because it was rented out more than 50% of the time) and not reportable in another year (because it was NOT rented out more than 50% of the time). The determination of whether a personal-use property is reportable or not is based on the facts as determined on a case-by-case basis. In addition, depending on the assets owned and the level of ownership, other tax reporting forms may be required to be filed, in addition to or instead of Form T1135: Form T1134, Information Return Relating To Controlled and No-Controlled Foreign Affiliates ; Form T1141, Information Return in Respect of Contributions to Non-Resident Trusts, Arrangements or Entities and Form T1142, Information Return in Respect of Distributions from and Indebtedness to a Non-Resident Trust. Filing due date. Form T1135 is required to be filed by the regular tax filing due date of the taxpayer (defined below), typically April 30, along with the T1 tax return. What happens if I don t file these forms or file late? A late filed T1135 is subject to a late filing penalty of $25 per day up to a maximum of 100 days ($2,500) with a minimum penalty of $100. In addition, where a person knowingly fails to file or files under circumstances amounting to gross negligence, additional penalties equal to $500 per month may be assessed (up to a maximum of $12,000). Where the Minister has issued a demand to file, those penalties may be doubled. Knowledge Bureau, Inc. All Rights Reserved.

12 Where a late filing penalty has been assessed and the return is filed more than 24 months late, a penalty equal to 5% of the greatest total costs can be imposed. In addition, the tax assessment period can be extended to 6 years, from the normal 3 year period, if the T1135 has not been filed or filed late and income from a specified foreign property has not been reported on the tax return. Options Voluntary disclosure. All, however, is not lost. Taxpayers who have not yet filed (and who have not yet received a demand to file from the CRA) may file under the CRA Voluntary Disclosure Program to being their delinquent filings up to date. Acceptance, under the program, means that the CRA will not assess any late filing penalties on Form T1135 requirements. However, to be clear, all foreign income and gains must still also be disclosed on the T1 tax returns, which will attract an alternate set of penalties for non-compliance. Voluntary disclosure here too can provide important financial relief in the case or errors or omissions. Conclusion. Taxpayers, in conjunction with their investment advisors and tax advisors, must annually review their investment portfolios (and other investment assets) to determine if they have exceeded the Cdn $100,000 threshold on their foreign-based investments. Filing Form T1135, if required, should become an annual part of their routine tax filings. Failure to do may result in unanticipated penalties, interest and head-aches in today s global tax environment. Dean Smith is one of Canada s foremost experts on Canada-U.S. tax matters, a partner with Cadesky and Associates LLP, President of Cadesky U.S. Tax Ltd., and a faculty member of Knowledge Bureau. Knowledge Bureau is Canada s leading educational institution for the continuing professional development of financial advisors and their clients, and a strategic educational partner with Dynamic Funds. Knowledge Bureau, Inc. All Rights Reserved.

13 TIPS FOR SNOWBIRDS: AVOIDING TAX AND BORDER ISSUES IN THE UNITED STATES With the increased scrutiny of both the U.S. Internal Revenue Service ( IRS ) and the U.S. Customs and Border Protection ( CBP ), many snowbirds are unsure of what U.S. tax filing obligations, if any, they may have. It also needs to be emphasised that there are two distinct branches of the U.S. government involved, and that their rules are very different. What works for one branch (say, the IRS) may not work for the other branch (say, CBP). Individuals should also be advised that, with respect to immigration issues, they should consult a qualified U.S. immigration attorney. The objective of this brief is to address some of these issues. Am I a U.S. tax resident? The determination of one s U.S. residence status is factual. You become a U.S. tax resident, under U.S. domestic tax law, if you obtain lawful permanent resident status (obtain a green card ) or you spend a significant amount of time in the U.S., such that you meet the substantial presence test. In other words, for most snowbirds, the issue is strictly a days counting test. Under the substantial presence test, an individual will become a U.S. (tax) resident if the number of days, under the test, exceeds 183. First, however, the individual must have at least 31 days of physical presence in the current year. If that condition is met, the number of days can then be computed as follows: The number of days in the current year + (the number of days in the first prior year x 1/3) + (the number of days in the second prior year x 1/6) In general, for the purpose of any U.S. days counting test, any part of a day counts as a day. So, for example, if an individual crosses into the U.S., say Buffalo via the Peace Bridge, at 11:50 PM they will have one day of physical presence. The average number of days to be under the threshold is approximately 120. We can see as follows (120/3) + (120/6) = 180 < 183 Certain days and individuals are excluded from the test. Such individuals would include foreign governmentrelated individuals (i.e., those in the U.S. on a diplomatic status or visa), teachers or trainees, students and some professional athletes (competing in a charitable event). Excluded days would be for commuters, days in transit between two foreign points, crew members temporarily present in the U.S., and certain medical conditions that arose while in the U.S. For snowbirds, however, these exceptions should not apply, meaning that all days of presence are counted. To check back at your travels across the border, consider checking the I-94 website ( which provides a (somewhat incomplete) record of an individual s entry and departure dates in the U.S. Not a US. Resident for tax purposes. If you do not meet the substantial presence test, you are not a U.S. resident for tax purposes. If you have no U.S. source income, you would not be required to file anything. You would only have to file a Form 1040NR, U.S. Nonresident Alien Income Tax Return, or Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents if you had U.S. source income and the appropriate withholdings had not been made. If you exceed the 183 days you are a U.S. tax resident, under U.S. domestic taw law, from the first day of physical presence in the current year.

14 The Closer Connection Argument. If you exceed 183 days but remain a bona fide resident of another country (say Canada), another form may help you avoid tax filing in the U.S. As long as you do not exceed 183 days in the current year alone, you may rely on the closer connection argument to state that you are not a tax resident of the United States. This declaration is made by filing Form 8840, Closer Connection Exception Statement for Aliens. If Form 1040NR or Form 1040NR-EZ, is being filed (because you have U.S. source income), Form 8804 should be attached to the return and filed by the regular due date (usually June 15 th ) including extensions (December 15 th ). If neither Form 1040NR nor Form 1040NR-EZ is being filed, the due date is the same as if you had filed Forms 1040NR or Form 1040NR-EZ. Form 8804 reports the number of days of physical presence (over the current and prior two years) and what your ties are between the country of residence and the United States. Such ties would include the location of your permanent residence and vacation homes, location and type of investments, location of personal belongings (such as cars, furniture and clothing), current social, political and cultural or religious affiliations, business activities, driver s licenses, health coverage and the jurisdiction where they vote. If you factually have a closer connection to the other country then, under the Internal Revenue Code, you are not a U.S. tax resident. Beyond 183 days in current year. If you exceed 183 days in the current year alone, you can not rely on the closer connection argument. Instead you must rely on the residency tie-breaker rules contained in the appropriate income tax treaty, such as Article IV of the Canada-United States Tax Convention (1980). You would be required to file either Form 1040NR or Form 1040NR-EZ and attach Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b). Failure to file a treaty based position on a timely basis can result in a U.S. $1,000 penalty. A treaty is used to reduce or eliminate any potential U.S. tax liability. Reliance on a treaty does not, however, eliminate the requirement to file any information returns that may be required based on the individual s facts. Such forms may include Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations and Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. There are severe penalties for not filing these information returns on a timely basis. As such it is extremely important that snowbirds do not exceed 183 days of actual physical presence in any calendar year. Immigration issues. Snowbirds usually enter the U.S. under a B-2 Tourist Visa. Though no paper document may actually be issued, that is the status that a non-immigrant visitor would enter under. Under a B-2 visa, the maximum length of stay is 6 months less a day at a time. The immigration officer at the point of entry, however, determines how long each visitor is allowed to stay in the U.S. It is a question of fact as to how long you must be outside the United States before you can re-enter on a new B-2 visa. Individuals who over-stay their welcome may be banned from returning to the U.S. on subsequent trips. The ban may be anywhere from three to ten years. Those wishing to re-enter the U.S. would then need to apply for some form of waiver resulting in extra costs and delays with no guarantee of success. Dean Smith is one of Canada s foremost experts on Canada-U.S. tax matters, a partner with Cadesky and Associates LLP, President of Cadesky U.S. Tax Ltd., and a faculty member of Knowledge Bureau.

15 Knowledge Bureau is Canada s leading educational institution for the continuing professional development of financial advisors and their clients, and a strategic educational partner with Dynamic Funds.

16 U.S. CITIZENS, RESIDENT ALIENS AND NON-RESIDENT ALIENS Despite the fact that many U.S. citizens living in Canada might prefer to take the ostrich approach to their U.S. tax filing obligations and ignore them entirely, that s a really bad idea, especially in the current cross-border environment. The consequences and penalties can be truly enormous. A much better approach is to understand and determine your filing obligations and then deal with them as quickly as possible in an effort to preserve family wealth. Readers are cautioned that if they are unsure of their United States filing status (in the U.S. there are four different filing statuses depending on your personal situation being (i) married filing joint,(ii) married filing separate, (iii) head of household or (iv) single) they should consult a United States immigration lawyer (with respect to citizenship) or their U.S. tax advisor (with respect to tax residence). Who must file U.S. returns? The requirement to file U.S. tax and information returns is based on two factors: (i) whether you are a United States citizen and (ii) if you are not a United States citizen, whether you are a resident alien or not. In general, individuals those who are either U.S. citizens or resident aliens are required to file Form 1040, U.S. Individual Income Tax Return and report their world wide income (as determined under U.S. tax law). This does not mean, however, that they will necessarily be subject to U.S. taxation; only that they have a filing obligation. Income is sourced to a jurisdiction, meaning the country of source has the first right to tax that income. The other country has a residual right. For example, let s assume a Canadian resident has received U.S. source dividends. The dividend would be considered U.S. source income, meaning that the U.S. would have the first right to tax the income. If the recipient is not a U.S. person, the U.S. tax would be limited to the 15% nonresident withholding tax under the Treaty. Canada would then also have a right to tax the income, since the recipient is a Canadian resident. The Canada Revenue Agency would then allow a foreign tax credit for the U.S. tax already paid in order to eliminate any double taxation. The claiming of the Foreign Earned Income Exclusion and foreign tax credits however, may reduce or eliminate the ultimate U.S. tax liability. The foreign earned income exclusion is a deduction, of up to US $102,100 (2017), in computing taxable income. In general, it applies to non-u.s. source employment income and self employed income. A nonresident alien ( NRA ), on the other hand, would be required to file Form 1040NR, U.S. Nonresident Alien Income Tax Return only if they had U.S. source income. If the NRA had U.S. source income for which the proper amount of U.S. nonresident tax has been withheld, they may not required to file anything more in the U.S. These filing requirements may apply to certain Canadian residents, commonly, snowbirds, or those with business or rental assets in the U.S. Who is a United States citizen? Section 301 of the U.S. Immigration and Nationality Act ( INA ) outlines the conditions by which an individual is a United States citizen at birth. Under these provisions, an

17 individual does not elect to become a United States citizen; they are United States citizens automatically, together with their inherent tax filing requirements. For Canadian residents, who are U.S. citizens, three conditions may be relevant: (i) (ii) (iii) A person was born in the United States...; A person born was outside of the United States...of parents BOTH of whom are citizens of the United States and one of whom has had a residence in the United States or one of its outlying possessions, prior to the birth of such person; or A person was born outside the geographical limits of the United States and its outlying possessions of parents one of whom is an alien, and the other a citizen of the United States who, prior to the birth of such person, was physically present in the United States...for a period or periods totaling not less than five years, at least two of which were after attaining the age of fourteen years. Conditions (ii) and (iii) above catch those individuals who were born in Canada to one or two U.S. citizen parents. Note that the residency requirement provides an end to inherited citizenship such that grandchildren may not be U.S. citizens at birth if their Canadian-born U.S. citizen parent(s) never resided in the United States. Who is a U.S. resident? When a non-u.s. citizen is defined as a U.S. (tax) resident is determined under Internal Revenue Code ( IRC ) 7701(b). An alien individual shall be treated as a resident of the United States with respect to any calendar year (if and only if): (i) (ii) (iii) Such individual is a lawful permanent resident of the United States at any time during such calendar year; that is, they have obtained a green card and have commenced residency. Such individual has meet the conditions of the substantial presence test; or Such individual makes the first year election. Substantial presence test. The substantial presence test is a three year rolling average test which counts the number of days of actual physical presence in the United States (regardless of the reason). In general, for the purpose of any U.S. days counting test, any part of a day counts as a day. So, for example, if an individual crosses into the U.S., say Buffalo via the Peace Bridge, at 11:50 PM they will have one day of physical presence. Certain days and individuals are excluded from the test. Such individuals would include foreign government-related individuals (i.e., those in the U.S. on a diplomatic status or visa), teachers or trainees, students and some professional athletes (competing in a charitable event). Excluded days would be for commuters, days in transit between two foreign points, crew members temporarily present in the U.S., and certain medical conditions that arose while in the U.S. To fall within this test, the taxpayer must first have at least 31 days of physical presence in the current year. The formula is then =

18 The number of days in the current year + (the number of days in the first prior year x 1/3) + (the number of days in the second prior year x 1/6) If the total exceeds 183 then the individual is a U.S. tax resident from the first day of physical presence in the current year. 120 days is used as a guideline as the average amount of time a NRA can spend in the U.S. without becoming a U.S. resident (120/3) + (120/6) = 180 < 183 If the taxpayer exceeds 183 days, under the formula, but has not spent more than 183 days in the current year alone, they can then rely on the closer connection argument that they are not a U.S. tax resident in the current year. Form 8840, Closer Connection Exception Statement for Aliens would be required to be filed. If the taxpayer spent more than 183 days in the current year alone then the closer connection argument can not be made. Instead the taxpayer would be required to rely on the residency tie-breaker rules contained in a U.S. tax treaty (for example Article IV of the Canada-United States Tax Convention (1980)). In these situations the taxpayer would be required to file Form 1040NR along with Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b) to disclose their reliance on a tax treaty. There is significant risk in that, as a U.S. tax resident, a number of information returns may be required to be filed in addition to their personal income tax return. While the treaty may reduce or eliminate any potential U.S. tax, the treaty does NOT eliminate the filing of additional information returns. First-year election. Since the determination of residence is a question of fact (physical presence) an individual who moves to the U.S. late in the year may not qualify as a tax resident. Certain itemized deductions and filing statuses are only available to residents. For example, if a Canadian took a transfer to the U.S., effective November 1, 2017 and purchased a home in the U.S. he would not be able to deduct the associated mortgage interest nor property taxes as he is not a U.S. resident for tax purpose as he would only have 61 days of physical presence under the substantial presence test. In these situations, the taxpayer may elect to be treated as a resident, as of November 1. This election can be made if (i) the taxpayer was also not a U.S. resident for the immediate preceding tax year (2016) and (ii) would be a resident, under the substantial presence test, in the following year (2018). A brief note on penalties. Failure to file penalties can be big and add up quickly. If you owe any U.S. tax the penalties can easily be up to 50% of the balance owing PLUS interest. The penalty for not filing various information returns can be US $10,000 for each failure. While the IRS has the statutory authority to abate penalties they can not abate interest charges. For any abatement request to be effective, the taxpayer must have a reasonable cause which gave rise to the failure to file. Be sure to talk to your financial advisors for a strategy that will stave off family wealth erosion from filing failures.

19 Dean Smith is one of Canada s foremost experts on Canada-U.S. tax matters, a partner with Cadesky and Associates LLP, President of Cadesky U.S. Tax Ltd., and a faculty member of Knowledge Bureau. Knowledge Bureau is Canada s leading educational institution for the continuing professional development of financial advisors and their clients, and a strategic educational partner with Dynamic Funds.

20 U.S. ESTATE TAX A PRIMER Will I have to pay estate taxes on my property in the U.S.? It s a common question Canadian snowbirds may have for their advisors, and the primer below can be helpful in both easing anxiety and guiding important wealth management conversations. In addition to an income tax, the U.S. imposes a wealth transfer tax system which is comprised of three parts: the estate tax, the gift tax and the generation skipping transfer tax (GSTT). The gift tax and the GSTT were not imposed to raise revenue so much as to provide a back stop for the estate tax. For example, if someone on their death bed were to give everything they own away, they would have no estate subject to estate tax! It was precisely because of this potential problem for the American tax department that the gift tax was introduced as a permanent feature of the transfer tax system in The Estate Tax Some history. The U.S. has had a long history with respect to inheritance and estate taxes. A temporary stamp tax was enacted on July 6, 1797 to help pay for naval rearmament (to fund a potential war with France). It was repealed four years later when the need for the revenue had passed. The Revenue Act of 1862 (during the U.S. Civil War) imposed a direct tax on inheritances. This tax was abolished on July 14, The War Revenue Act of 1898 (to fund the Spanish-American War) imposed an estate tax at a top rate of 15% on estates over US $1 million. A US $10,000 exemption was provided to exclude small estates. In addition, bequests to surviving spouses were also excluded. This tax was subsequent repealed on April 12, The current version of the estate tax was originally enacted as part of The Revenue Act of The tax set a top rate of 10% on estates over US $5 million with an exemption level of US $50,000. The rate was raised to 25% for estates over US $10 million. The Republicans have tried, since the election of President George W. Bush, to eliminate the estate tax. The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 provided for the phase out of the estate tax as of January 1, Under President Obama, however, the estate tax returned (retroactively in some cases) with the enactment of The Tax Relief, Unemployment Reauthorization, and Job Creation Act of 2010 on December 17, Why is this relevant, you may ask? President Trump (and other Republican members of Congress) has proposed repealing the estate tax. The next mid-term elections are in 2019 and it possible that the

21 Democrats may regain the majority in both the House of Representatives and the Senate. Even if the estate tax is repealed, there is a risk that it could be re-instated in subsequent years. As such, advisors should still consider potential U.S. estate tax exposure when advising clients on various investments. Current law. Over the years, the estate tax rates and exemption amounts have fluctuated greatly. The current top rate is 40%. The exemption amount is US $5,490,000 (2017 the threshold is indexed for inflation and is adjusted annually) and the applicable credit is US $2,141,800 (which represents the estate tax on an estate valued at US $5,490,000). The estate tax is actually imposed on a decedent s taxable assets. First, it is necessary to determine the fair market value of the decedent s gross estate. The Internal Revenue Code and Regulations provide guidance on what to include and how to value certain assets. Deductions are then allowed in computing the decedent s taxable estate. Such deductions include funeral expenses, expenses incurred in administering property, claims against the estate, debts of the decedent, charitable bequests, and property transferred to a (U.S. citizen) surviving spouse. A gross estate tax is then computed based on the (graduated) transfer tax rate schedule. Once the tax has been computed, applicable credits will be applied. For a U.S. person (U.S. citizen or someone who is domiciled in the U.S.) the applicable credit is equal to U.S. $2,141,800. Because of the math, someone who s net worth at the time of death, is less than the current year exemption amount, will not be subject to any U.S. federal estate tax. Canadian residents who are not U.S. citizens. A non-domiciliary of the United States would only be subject to U.S. estate tax on U.S. situs assets (known as property within the United States ). Such assets include, but are not limited to, real property located in the U.S. (i.e., that Florida vacation home), tangible property located in the U.S. (i.e. a luxury yacht moored in Florida, furniture and fixtures), and stock of U.S. domestic corporations (i.e., IBM, McDonald s). Certain assets, though located in the U.S., are considered to be property without the United States and would not be subject to U.S. estate tax. Such property would include, but not limited to, proceeds of a U.S. life insurance policy, bank deposits in a U.S. financial institution, certain U.S. debt obligations, works of art on loan for exhibition and stock in a U.S. regulated investment company ( RIC ). Canadian mutual fund trusts, Canadian mutual fund corporations, Canadian exchange traded funds, and Canadian corporate class investments are not U.S. situs assets for U.S. estate tax purposes even if they hold U.S. investments. In IRS Chief Counsel Advice (CCA) document , the IRS was asked whether shares of Canadian mutual funds that, in turn, owned shares of U.S. corporations, would be included in the gross estate of a non-citizen nonresident decedent. The document stated: If the Canadian mutual funds held by the Decedent s RRSP are classified as corporations for U.S. tax purposes, the shares of the mutual funds would not constitute U.S. situs property under 2014(a) and would not be includible in Decedent s U.S. gross estate. (The

22 underlying assets also would be excluded from Decedent s gross estate.) You indicated that the RRSP held shares in several mutual funds that are organized as trusts. However, a mutual fund may have been formed as a trust under Canadian law, but be properly classified as a corporation under U.S. law. Based on the information provided, it appears that all the Canadian mutual funds held by the Decedent s RRSP would be classified as corporation for U.S. tax purposes. While CCA is fact-specific and can not be used or cited as a precedent, it does provide some guidance as to how the IRS would treat Canadian mutual funds, et al. The Tax Treaty Helps. Under the Internal Revenue Code, itself, the estate tax exemption amount for a non-u.s. person is U.S. $60,000 which translates into an applicable credit of $13,000. Canadian residents, however, can look to Article XXIX-B of the Canada-United States Tax Convention (1980) for relief. Under the treaty, a Canadian resident has access to the applicable credit amount (exemption) available to a U.S. person. The allowable credit is based on a pro-ration of the decedent s U.S. situs assets divided by their world wide assets. Similar to a U.S. person, the first step is to determine their (U.S.) gross estate. Deductions are then allowed in computing their U.S. taxable estate. Deductions that are not directly allocable to a particular U.S. asset (i.e., a non-recourse loan on the Florida vacation home) are allowed pro-rata based on the ration of U.S. assets to world wide assets. For example, assume that a Canadian resident has a net worth of $25 million on death. He is single and has no debts. Within his world wide estate he has a Florida vacation home worth $3,500,000 and he has $275,000 of U.S. stock in his RRSP (RRSPs are look through vehicles for U.S. estate tax purposes as they are considered to be a foreign grantor trust). His U.S. gross estate would be $3,755,000 The preliminary (gross) U.S. estate tax would be $1,447,800 The applicable credit (for 2017) would be computed as follows $3,755,000 (U.S. situs assets) / $25,000,000 (world wide assets) x $2,141,800 (applicable credit) = $321,698 Deducting the credit against the gross estate tax results in a final U.S. estate tax liability of $1,126,102. Though this may be claimed as a foreign tax credit against the Canadian capital gains tax on death (with certain potential provincial limitations), the estate tax is based on the fair market value of the estate, not the inherent gain. If there is no associated capital gain on the decedent s Canadian return, there is no basis to claim a foreign tax credit.

23 Where the property is left to a surviving Canadian resident spouse, an additional credit may be claimed equal to the lesser of (i) the applicable credit claimed under the treaty (the $321,698 per above) or (ii) the remaining estate tax balance. In the above example, if the taxpayer were married and all of the property was transferred to a Canadian resident non-u.s. surviving spouse the ultimate estate tax would be $804,404 ($1,126,102 the lesser of (i) $321,698 or (ii) $1,126,102). Tax Form Filing is Important. Whenever a person relies on a treaty provision to reduce or eliminate U.S. tax (income or estate), a treaty-based filing must be done. As such, a Canadian resident (not a U.S. person) would be required to file Form 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return. The due date is 9 months after death, though an extension for an additional 6 months may be filed by the original due date. The extension, however, does not extend the payment of any tax only the filing date of the return. If the full tax balance is not paid by the original due date, late payment penalties and interest will accrue. Gifts For a non-u.s. person, there is no gift tax exemption under either the Internal Revenue Code or the tax treaty. The provisions, under Article XXI-B, only apply to U.S. estate tax not to U.S. gift tax. Care must be exercised when Canadians gift U.S. certain U.S. property. For example, if a parent gifted a piece of U.S. real estate to one of their children, the U.S. gift tax would apply to the full value of the gift. The take away When advising client on their investment choices, advisors and clients need to understand the potential U.S. estate tax implications, particularly if the direct holding of U.S. assets is recommended for client s portfolios. Advisors, instead, may wish to consider Canadian investment vehicles, such as mutual fund trusts or exchange traded funds that mirror the U.S. market. Dean Smith is one of Canada s foremost experts on Canada-U.S. tax matters, a partner with Cadesky and Associates LLP, President of Cadesky U.S. Tax Ltd., and a faculty member of Knowledge Bureau. Knowledge Bureau is Canada s leading educational institution for the continuing professional development of financial advisors and their clients, and a strategic educational partner with Dynamic Funds.

24 For Business Builders Learning Solutions for Growing Businesses Our Mission is to Raise Standards in Continuing Professional Development in the Tax and Financial Services Registrar

25 The Business School for Professional Tax and Financial Advisors management Train new or returning staff: individually or as a group, anytime 24/7. Earn valuable CE/CPD credits online for your own professional development. Build your business and meet the demand for specialized wealth & tax services. VISIT YOUR VIRTUAL CAMPUS OFTEN!