Emigration from Canada: Tax Implications

Emigration from Canada: Tax Implications Introduction Liability for tax under the Canadian income tax system is based on residency. Neither the concept of residency, nor the notion of termination of Canadian residency is expressly defined in the Income Tax Act (the Act ). A determination of when an individual s Canadian residency has ceased to exist is based on a consideration of all the factual circumstances and on common law principles that analyze the severing of residential ties that the individual had within Canada. Departure Tax Canada is one of the few countries in the world that imposes a tax on emigration or departure tax. Under subsection 128.1(4)(b) of the Act, where a taxpayer emigrates from Canada, the taxpayer is generally deemed to dispose of most properties owned by the taxpayer immediately before departing and to receive deemed proceeds of disposition equal to the fair market value ( FMV ) of each such property. The deemed proceeds of disposition then become the new cost of the property to the taxpayer on the deemed reacquisition under subsection 128.1(4)(c) of the Act. The deemed disposition and reacquisition have the effect of determining the emigrant s tax liability in respect of any accrued capital gains. The emigrant can either pay the tax immediately or provide the Canada Revenue Agency ( CRA ) with security for paying it later (without interest charges), when the property is actually sold. In addition, all individual emigrants who own, immediately after the time of emigration, reportable properties (as defined in subsection 128.1(10) of the Act), with a total value of more than $25,000, are required to report their property holdings to the CRA. The definition of reportable properties excludes any personal use property with a value of less than $10,000. This reporting requirement applies to all individuals who have left Canada after 1995. Form T1161, List of Properties by an Emigrant of Canada, is used to report all required property holdings and should be included with the income tax return for the year the emigrant leaves Canada. A life insurance policy is a reportable property. In CRA s view, for the purpose of determining whether reporting under subsection 128.1(10) of the Act is required, an interest in a life insurance policy owned by an individual must be valued at its fair market value taking into account the factors listed in paragraphs 40 and 41 of Information Circular 89-3 Policy Statement on Business Equity Valuations (Technical Interpretation 2008-0270401C6). Similar rules apply to deem a FMV disposition and reacquisition of such property at FMV on immigration to Canada. The general rationale for these reciprocal rules is that a person should only be subject to tax in respect of gains that accrue while such person is resident in Canada. The acts of immigration and emigration essentially crystallize the taxpayer s tax position at those times. 1

For taxpayers ceasing residency in Canada, the deemed disposition rule in paragraph 128.1(4)(b) of the Act applies to all property other than the following property owned by an individual: - immovable or real property situated in Canada, Canadian resource properties and timber resource properties; - capital property used by a business carried on by the taxpayer, at emigration time, through a permanent establishment in Canada, eligible capital property and property held as inventory of such a business; - property that is an excluded right or interest of the taxpayer (see definition further on); - certain property of short-term residents, where the individual (other than a trust) who has been resident in Canada for 60 months or less during the 10 year period preceding the cessation of residency is not deemed to have disposed of any property that the individual owned on becoming a resident of Canada or that the individual inherited after becoming a resident of Canada; and - certain property of a returning former resident who last emigrated after October 1, 1996, will no longer be treated as having realized accrued gains on departure, if the taxpayer so elects. Excluded right or interest is defined in subsection 128.1(10) of the Act and includes a long list of items that are considered excluded rights or interests. In general terms, an excluded right or interest is a right of an individual to future benefits or other payments under certain plans or arrangements, many of which are employer sponsored or legislative in nature. Excluded rights or interests also include an interest of an individual in a trust governed by certain plans. Though the list is extensive, the more common types of trusts include: pension plans (RPP s, RRSP s and RRIF s), retirement compensation arrangements, registered education savings plans, registered disability plans, tax-free savings accounts, deferred profit sharing plans and employee profit sharing plans. In addition, an interest of an individual in a life insurance policy (other than an interest in a segregated fund) issued or effected on the life of a person resident in Canada at the time the policy was issued is considered to be an excluded right or interest. Thus, insurance policies in Canada, other than segregated funds, are not subject to the deemed disposition on emigration. (Note also that the deemed disposition rule on immigration does not apply to a life insurance policy in Canada owned by an individual as this rule does not apply to taxable Canadian property (subparagraph 128.1(1)(b)(i)).) Note that other insurance policies are not excluded under this rule as confirmed in CRA s Technical Interpretation 2010-0359411C6, in respect of a disability policy. CRA indicated that there would be a disposition of a disability policy owned at the time of emigration; however, paragraph 128.1(4)(b) of the Act only requires an amount to be included in income to the extent that there would have been an income inclusion had the policy actually been disposed of. Since there are no provisions in the Act that include income from a disability policy on disposition, presumably the income inclusion, as a result of the deemed disposition of a disability policy on emigration, would be nil. Where the life insurance policy is owned by a corporation, and an immigrating or emigrating individual is deemed to have disposed of the shares of the corporation immediately prior to immigration or emigration, as the case may be, subsection 70(5.3) of the Act will apply. This subsection provides that where the particular individual (or an individual not dealing at arm s length with the particular individual) is insured under the policy, the policy will be deemed to have a value equal to its cash surrender value immediately prior to immigration or emigration for the purpose of valuing the corporation s shares. Non-resident owners of a life insurance policy in Canada A life insurance policy will only be a life insurance policy in Canada if the life insured is resident in Canada at the time the policy was issued or effected. Consider the following example. Mr. A, Mrs. B and Mr. C have equal ownership of all of the shares of ABC Co, a corporation resident in Canada. Mr. A and Mrs. B are residents of Canada; Mr. C is a non-resident. ABC Co acquires life insurance policies on the lives of each of Mr. A, Mrs. B and Mr. C for buysell purposes. The insurance policies on the lives of Mr. A and Mrs. B are life insurance policies in Canada but the policy on Mr. C is not a life insurance policy in Canada since Mr. C was not resident in Canada at the time the policy was issued. There are certain circumstances whereby a non-resident of Canada may own a life insurance policy in Canada. The most common situation involves a former resident of Canada who owned a life insurance policy in Canada at the time of emigration. As described below, special rules apply where a non-resident of Canada disposes of a life insurance policy in Canada. In the case of a former Canadian resident returning to Canada, the rules are included in subsection 128.1(6) of the Act. This provision has the effect of reversing the accrued gains realized on departure but only for individuals who last emigrated after October 1, 1996 and file and election. 2

In the case of persons who are not former residents, immigrating to Canada owning foreign insurance policies, the deemed disposition and reacquisition rules apply since the foreign insurance policy is not a life insurance policy in Canada and therefore does not meet the definition of excluded right or interest. Dual-resident individuals There may be circumstances where an individual is a resident of both Canada and another jurisdiction. Canada s tax treaties provide that that the country in which the properties are situated have the right (but not the exclusive right) to tax gains from the alienation of property situated in that country. A deemed disposition would be characterized as an alienation of property for the purposes of Canada s tax treaties. Since most countries tax residents on their income from all sources, this raises the possibility of double taxation. Canada s bilateral tax treaties are designed to provide relief from this potential double taxation and contain tiebreaker rules to determine in which country the individual is resident for purposes of the Treaty. Prior to the February 1998 federal budget, Canada s income tax legislation did not take these treaty tie-breaker rules into account. Thus, for example, an individual could claim that she was a resident of both Canada and the United States but under the tiebreaker rules, was considered a resident of the United States. This individual could argue that she was resident in Canada for the purposes of the Act (and therefore not subject to rules governing non-residents) but, at the same time, resident in a treaty country (the United States) and therefore not liable for tax in Canada as a resident. As a resident of Canada, for the purposes of the Act, this individual could have acquired a Canadian life insurance policy on her life that would qualify as a life insurance policy in Canada within the meaning of subsection 138(12) of the Act. However, under subsection 250(5) of the Act, a person is deemed not to be resident in Canada where he or she would otherwise be resident in Canada, but has become entitled under a tax treaty, as a resident of another country, to an exemption from or reduction in Canadian income tax. This provision generally applies to individuals who become entitled to treaty benefits after February 24, 1998. Taxable Dispositions by a non-resident Certain types of income of a non-resident of Canada are taxable in Canada in the same way as the income is taxable for Canadian residents. A complete review of all such income is beyond the scope of this article, but includes, among other things, income from employment or a business in Canada, certain types of passive income and dispositions of taxable Canadian property with certain exceptions. Where a non-resident person disposes of an interest in a life insurance policy in Canada, any policy gain on the disposition is taxed under subparagraph 115(1)(a)(vi) of the Act as taxable income earned in Canada by a nonresident. Dispositions may include, among other things, full or partial surrenders, policy dividends, policy loans and policy transfers. The income from a disposition is determined in accordance with subsection 148(1) of the Act. The taxable amount is the amount which would have been taxable and included in the non-resident s income had the nonresident been a resident of Canada at the time of disposition of the policy. The income is taxable under Part I of the Act at marginal rates rather than the flat withholding tax rate for non-resident property income taxed under Part XIII of the Act. Withholding Tax and Section 116 Clearance Requirements As noted above, when a non-resident disposes of an interest in a life insurance policy in Canada, the disposition is taxed under subsection 115(1)(a)(vi) of the Act. If the purchaser is a Canadian resident, there are two possible scenarios. The first scenario is that the non-resident person reports the disposition (or proposed disposition) and pays the Canadian tax arising in accordance with subsection 116(5.2) of the Act (or alternatively provides the Minister with acceptable security). The Minister then issues a certificate (often referred to as a Clearance Certificate ) in respect of the disposition or proposed disposition. In this case, there is no withholding tax requirement for the Canadian purchaser. The second scenario is that the policyholder does not remit the tax and does not obtain a clearance certificate. In this case, the Canadian resident purchaser will be liable for tax equal to 50% of the amount payable for the property. The purchaser is entitled to withhold this tax from the payment and must remit the amount withheld to the Minister (under subsection 116(5.3) of the Act). 1 1 Under subsection 116(5.3) of the Act, the purchaser acquiring the life insurance policy from the non-resident is liable to pay as tax, on behalf of the non-resident, 50% of the amount by which the amount payable exceeds the amount of proceeds stated in the certificate, if any, issued under subsection 116(5.2). 3

Under subsection 116(5.4) of the Act, where a non-resident of Canada disposes of, or is deemed to dispose of a life insurance policy in Canada, by virtue of subsection 148(2) of the Act or any of paragraphs (a) to (c) or (e) of the definition of disposition in subsection 148(9) of the Act, the insurer, in respect of the policy, is deemed to be the purchaser for purposes of subsections 116(5.2) and (5.3) of the Act. What this means is that the insurance company is deemed to be the purchaser in respect of the following events: 1. policy dividends (paragraph 148(2)(a)); 2. the deemed disposition of a non-exempt life insurance contract or certain annuity contracts as a result of the death of the policyholder, the annuitant or the life insured (paragraph 148(2)(b)); 3. policy changes which cause an exempt policy to become non-exempt (paragraph 148(2)(d)); 4. the surrender (or partial surrender/withdrawal) of an interest in a life insurance policy (paragraph (a) of the definition of disposition in subsection 148(9)); 5. policy loans (paragraph (b) of the definition of disposition in subsection 148(9)); 6. dissolution of the interest by virtue of the maturity of the policy (paragraph (c) of the definition of disposition in subsection 148(9)); and 7. a payment on death under a life annuity issued after November 16, 1978 and before November 13, 1981 (paragraph (e) of the definition of disposition at subsection 148(9)). The effect of these rules is that if a clearance certificate is not obtained, then the insurer is liable to withhold tax equal to 50% of the proceeds of disposition in respect of the life insurance policy (i.e. the dividend, withdrawal amount etc.) on behalf of the non-resident. Note that the 50% tax is calculated on the entire payment, not just the policy gain. To avoid this high rate of withholding tax, Canadian insurers typically facilitate the process of obtaining a clearance certificate by filing Form T2062B, Notice of dispositions of a life insurance policy in Canada by a Non-Resident of Canada. The life insurer completes Form T2062B to inform the CRA when there is a disposition of a life insurance policy under one of the events described in points 1 to 7 above, by a non-resident policyholder who was resident in Canada at the time the policy was issued or affected. A letter of authorization from the non-resident policyholder must accompany Form T2062B to authorize the insurer to withhold the tax arising from the disposition under section 115 of the Act. As a result, when a Canadian life insurer receives a request for a policy loan or withdrawal by a non-resident, or if the insurer intends to make a payment to a non-resident due to any of the events referred to earlier in points 1 to 7, the life insurer will request the authorization letter from the non-resident policyholder in order to proceed with filing Form T2062B. A cheque for the tax payable based on the federal non-resident tax rates must also accompany Form T2062B. For this purpose, the applicable rates are the graduated federal tax rates multiplied by 1.48 (as per subsection 120(1) of the Act) and applied as if the policy gain is the only income of the non-resident. Note that the tax payable is calculated based on the cumulative amount for all dispositions of the person for the year and not on each individual disposition. After reviewing the form and receiving the payment from the insurer, the CRA issues a clearance certificate (Form T2064 or Form T2068 for proposed or actual dispositions respectively) to the insurer and the non-resident person. The insurer can then proceed with the payment and withhold the corresponding amount from the policyholder (i.e., the amount the insurer paid to CRA when it filed the form). Essentially this process permits the insurer to withhold tax at graduated tax rates rather than at 50% of the proceeds. The final settlement of the tax liability is made when the non-resident person files a Canadian tax return reporting the disposition of the policy. A refund is issued where the tax withheld by the insurer exceeds the non-resident s ultimate tax liability, or alternatively, provision is made for the release of security once the established debt has been satisfied. In archived Interpretation Bulletin IT-150R2 Acquisition from a non-resident of certain property on death or mortgage foreclosure or by virtue of a deemed disposition dated January 9, 1985, and repealed on September 30, 2012, the Department notes that section 116 of the Act does not apply to a deemed disposition on death or, generally, by mortgage foreclosure. Section 116 also does not apply to property that is transferred or distributed on or after death and as a consequence thereof. However, an executor acting on behalf of a non-resident person must file an income tax return for the year of death and pay any tax that may be necessary on the deemed disposition. CRA considered a disposition of a life insurance policy in Canada by a non-resident policyholder to a non-arm s length party, at the CLHIA CRA Roundtable on May 17, 2013 (#2013-0481411C6). The example in this question involved a 4

person who purchased a policy while they were a resident of Canada that had no cash surrender value but who later moved to the U.S. The policyholder then wanted to transfer the policy to an irrevocable life insurance trust (ILIT). The CRA confirmed that the ILIT would be required to withhold and remit an amount (50%) pursuant to subsection 116(5.3) of the Act based on the fair market value of the policy. There are many instances in which the fair market value may be significant, even for a term insurance policy with no cash values. Withholding can be minimized if the purchaser applies to the CRA for a clearance certificate under subsection 116(5.2) of the Act. The request must be made and clearance certificate issued by CRA prior to 30 days after the month in which the purchaser acquires the property. In order to get the clearance certificate, the purchaser will have to remit 25% of the FMV of the policy or provide adequate security. From the insurer s point of view, there will be no withholding obligation since the transfer does not involve a disposition covered under subsection 116(5.4) of the Act. Generally, dispositions like surrenders, receipt of dividends or policy loans, are ones under which the insurer would have to withhold and remit on behalf of the policyholder. As there is no obligation for withholdings from the insurer s point of view, the purchaser will need to identify the issue and report and submit the appropriate filings and payment to the CRA. Other examples of non-arm s length non-resident to non-resident transfers that would be caught in this situation could be simple transfers between spouses when both spouses are now non-residents. Impact of Tax Treaties If the life insurance policy in Canada is a whole life policy entitling the non-resident to policy dividends, such dividends constitute a partial disposition of the policy and will trigger the reporting and withholding obligations under section 116. The proceeds of disposition are deemed under paragraph 148(2)(a) of the Act, to be equal to the amount of the dividend in excess of that part of the dividend used to pay an eligible premium under the policy or repay a policy loan under the policy. Policy dividends are taxable under Part I of the Act and included in the non-resident s income under subsection 115(1)(a)(vi) of the Act. Policy dividends do not constitute dividends for purposes of Canada s bilateral income tax conventions and therefore do not qualify for a reduced rate of withholding tax. Under Canada s bilateral tax treaties with foreign jurisdictions, certain gains in respect of dispositions of taxable Canadian property may be exempt from tax in Canada. However, the CRA takes the position that the term gains in Canada s bilateral tax treaties is actually a reference to capital gains. In Technical Interpretation letter 9518087, dated September 13, 1995, the CRA indicated that the term gains in paragraph 9 of Article XIII of the Canada- United States Income Tax Convention (1980) was limited to capital gains. Since a policy gain in respect of a disposition of a life insurance policy is not a capital gain, a disposition of a life insurance policy in Canada does not qualify for relief under the Canada-United States Income Tax Convention. In the same Technical Interpretation, the CRA also noted that the Canada-United States Income Tax Convention is patterned on the OECD Model Convention; Article XIII of the Model Convention indicates that the provision is only intended to apply to capital gains. A contrary position was expressed in Technical Interpretation letter 2002-0152647, dated July 8, 2002. The CRA considered the tax treatment of a life insurance policy owned by a Canadian resident but issued in France. In discussing the tax treatment arising from a disposition of the French life insurance policy, the CRA indicated that the gain would be subject to the provisions of Article XIII of the Canada-France Tax Treaty. Taxation of Canadian life insurance policies in foreign jurisdictions A non-resident owner of a Canadian life insurance policy should also consider how the life insurance policy will be treated for tax purposes in their new country of residence. Depending on the life insurance policy and the tax rules in the foreign jurisdiction, the accumulation of cash value inside the policy may be subject to income or other taxes and the death benefit may be subject to estate taxes. Non-resident owner leveraging a policy issued by a Canadian insurance company It can be difficult to enforce repayment of a loan by a non-resident. Consequently, a Canadian lender, depending on its lending practices, may not loan to non-residents or may do so only at a lower margin. As a result, if a Canadian resident uses their policy as collateral security for a loan from a Canadian lender and subsequently emigrates from Canada, he/she may be required to provide additional collateral or repay all or a portion of the loan. If a Canadian resident emigrates from Canada and later decides to assign their policy as collateral for a loan, he/she may have to obtain the loan from a lender in their new country of residence. 5

The tax treatment of a collateral loan secured by a life insurance policy in the foreign jurisdiction should also be considered. In some countries, such a loan may be taxable in a manner similar to a policy loan in Canada. Conclusion The emigration process can be onerous from a reporting and compliance perspective. Professional income tax advice should be sought by any individual who is contemplating the move to a foreign jurisdiction for retirement, business or other reason. In addition, resources such as Global Affairs Canada at http://www.international.gc.ca/international/index.aspx?lang=eng/ and the CRA at http://www.cra-arc.gc.ca/menueng.html are excellent sources of information. Last updated: March 2016 Tax, Retirement & Estate Planning Services at Manulife writes various publications on an ongoing basis. This team of accountants, lawyers and insurance professionals provides specialized information about legal issues, accounting and life insurance and their link to complex tax and estate planning solutions. These publications are distributed on the understanding that Manulife is not engaged in rendering legal, accounting or other professional advice. If legal or other expert assistance is required, the service of a competent professional should be sought. This information is for Advisor use only. It is not intended for clients. This document is protected by copyright. Reproduction is prohibited without Manulife's written permission. Manulife, the Block Design, the Four Cubes Design, and strong reliable trustworthy forward-thinking are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license. 6