On October 24, 2012, Canada's Department of Finance (Finance) released a Notice of Ways and Means Motion (NWMM)1 that included the long-awaited "final" version of the proposed legislation for non-resident trusts (NRTs).
This Tax memo summarizes the main provisions of the proposed NRT legislation, referring to current relevant provisions of the Income Tax Act (Canada) as "old NRT rules" and those in the October 24, 2012 NWMM as "new NRT rules."
New NRT rules
An NRT generally will be deemed to be resident in Canada for a taxation year if, at the end of that taxation year, there is either:
- a "resident contributor" to the NRT; or
- a "resident beneficiary" under the NRT.
A resident contributor is a person who:
- has made a contribution to the NRT at any time;
- is a resident of Canada at the end of the NRT's taxation year (excluding an individual who has been resident in Canada for less than 60 months2 (a "new Canadian"); and
- at the time of applying the test is in existence and a resident of Canada.
Residency at the time of the contribution is not relevant.
A resident beneficiary must be:
- a beneficiary of the NRT;
- not a "successor beneficiary"; and
- a resident of Canada at the end of the NRT's tax year, but only if there is a "connected contributor" to the NRT.
A successor beneficiary generally is a person:
- whose rights under the trust are contingent on the death of another person who is a contributor to the trust; and
- is related to a contributor to the trust (including aunts, uncles, nieces and nephews).
A connected contributor generally is a person (including a person that has ceased to exist) who contributed property to the NRT at a time that was not a "non-resident time," but excludes a person while he or she is a new Canadian.
A contribution generally will be considered to have been made at a non-resident time if it was made when the person was not resident in Canada:
- at the time of the contribution; and
- throughout the 60 months before and after the contribution.
Once an NRT has a connected contributor, it will always have a connected contributor.
Generally, a contribution to an NRT means a transfer or loan of property to the NRT. It also includes transfers or loans to other entities when there is a series of transactions that includes that transfer or loan and a separate transfer or loan to the NRT.
The new NRT rules also include many broadly worded provisions that can deem various direct and indirect transfers and loans to an NRT, or to another entity in which the NRT has an interest, to be contributions to the NRT.
A provision of services, guarantee or other financial assistance or the issuances of shares or debt to an NRT, or to another entity in which the NRT has an interest, can also be deemed to be a transfer of property and result in a contribution to the NRT.
An exception is made for transfers or loans, and deemed transfers or loans, that generally are on arm's length terms ("arm's length transfers").
However, this exception does not apply:
- if the transferred property is a "restricted property" (generally common shares issued in an estate freeze or similar transaction); or
- if any reason for the transfer or loan was the acquisition of an interest in the NRT at any time by a beneficiary of the NRT.
Because of this latter requirement, even transfers or loans that have arm's length terms may not be arm's length transfers.
In assessing the contributions to an NRT, including those that result from deemed transfers or loans to the NRT, all previous transactions involving the NRT or an entity in which the NRT has an interest must be considered - even those that occurred before the effective date of the new NRT rules. Consequently, any NRT that has had transactions with Canadian residents, or holds an interest in an entity that has had transactions with Canadian residents, should review those transactions to determine whether a resident of Canada made any contributions to the NRT.
Exceptions from new NRT rules
NRTs that are not subject to the new NRT rules include:
- charitable trusts;
- trusts established for non-resident beneficiaries with mental or physical disabilities;
- trusts that provide retirement or pension benefits for employees; and
- commercial mutual funds in which the beneficiaries' interests are not discretionary. In addition, contributors to an NRT and resident beneficiaries of an NRT, do not include:
- persons who are exempt from tax (such as charities, non-profit entities and pension funds); and
- mutual fund trusts and corporations.
The exception for mutual funds is subject to an anti-avoidance measure. A fund will be a contributor to, or a resident beneficiary of, an NRT if representations or statements have been made in respect of the fund that the taxes under the new NRT rules in respect of property of the fund that is an NRT (or a property deriving its value from a NRT) will be less than, or are expected to be less than, the tax that would otherwise arise if the property of the fund was held directly by an investor of the fund.
Unless the NRT is an "electing trust," an NRT that is deemed resident in Canada is subject to tax on its worldwide income and capital gains in respect of all of its property, whether contributed by a Canadian resident or not.
If the NRT received contributions from both residents and non-residents, it can elect that Canada tax only the portions of its income and capital gains that arise with respect to property contributed by Canadian residents and certain former Canadian residents (an "electing trust").
To be valid, the election to be an electing trust must be made for the first taxation year in which:
- the NRT has non-resident portion property; and
- throughout which it is deemed resident in Canada (subject to transitional measures discussed below).
The election applies to the year in which it is made and to all subsequent taxation years.
An electing trust will be required to track those properties that make up its "resident portion" (generally, properties contributed by Canadians).
Property not part of the resident portion is included in the "non-resident portion." For income tax purposes, these are deemed to be held by a separate trust (a "non-resident portion trust"), which will not be subject to Canadian tax.
The Explanatory Notes accompanying the October 24, 2012 NWMM confirm that both the electing trust and the non-resident portion trust will be required to file a Canadian tax return, and each will be assigned a separate trust account number.
Jointly and severally, or solidarily, liable
If an NRT is deemed resident in Canada, beneficiaries and resident contributors can be held liable (jointly and severally, or solidarily) for the tax of the NRT (unless the contributor is an "electing contributor").
A beneficiary generally is liable to the extent of the distributions, proceeds of disposition, or loans received from the NRT.
Limit on liability
A resident contributor's liability can be limited to the extent of his/her/its contributions, but only if:
- the total of all those contributions is not more than the greater of: $10,000; and
- 10% of the total of all contributions made to the NRT by all contributors; and
- form T1141 has been filed on time with respect to that resident contributor's contributions for all years (except when the contributions were $10,000 or less).
If a resident contributor elects to be an electing contributor, a proportionate share of the NRT's income is attributed to the electing contributor. The proportion is based on the ratio of the contributor's total contributions to all contributions by resident and connected contributors.
In addition, an electing contributor is not jointly and severally, or solidarily, liable for the taxes of the deemed resident NRT, instead being liable for only the tax on income attributed.
NRTs and non-resident portion trusts are required to file a Trust Income Tax and Information Return, similar to that required for any Canadian resident trust.
Contributors to an NRT are also required to file an information return reporting their contributions (Form T1141) and may be required to file an information return reporting their interest in the NRT (Form T1135) if the contributor is a beneficiary and contributed more than $100,000 to the NRT.
Beneficiaries of an NRT that receive distributions are required to file Form T1142 to report the distribution received, unless they have filed Form T1141.
The new NRT rules generally apply for taxation years of a trust that begin after 2006. It is possible for an NRT to elect to have the new NRT rules apply to any taxation year ending after 2000.
Tax returns and any elections required to be filed under the new NRT rules will be considered to be on time if they are filed on or before the day that is 365 days after the day the new NRT rules receive royal assent. However, an NRT that was deemed resident in Canada under the old NRT rules must still file its tax return within 90 days after its year end.
Information returns and forms, however, will be considered to be on time only if they are filed by the taxpayer's return due date for the year in which the new NRT rules receive royal assent.
Who should do what
Any NRT that has had any:
- direct or indirect transfers or loans from Canadian residents (or former Canadian residents); or
- transactions with a Canadian resident, directly or indirectly, should review its past transactions and determine whether the new NRT rules will apply.
NRTs may be required to file tax returns, forms and elections, resulting from transactions that occurred many years ago.
In addition, any Canadian resident who has made a contribution to an NRT should seek Canadian tax advice on:
- whether any of the NRT's income will be taxable in his/her/its hands;
- whether he/she/it should be making the electing contributor election; and
- the foreign reporting requirements in Canada. Canadians who have received distributions from an NRT should seek Canadian tax advice on:
- whether all or part of the distribution must be included in their income; and
- their foreign reporting requirements.
1. Implemented by Bill C-48, Technical Tax Amendments Act, 2012, which received first reading in the House of Commons on November 21, 2012.
2. The months do not have to be consecutive for purposes of this threshold.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.