Effective January 1, 2005, the Canada Revenue Agency (the "CRA") has reversed its long-standing administrative policy on single-purpose corporations typically used by Canadian residents who own residential real estate or vacation properties in the United States. Consequently, many issues arise from an estate planning perspective for Canadian residents who already own or who plan to purchase personal-use residential property in the US.
U.S. Estate Taxes
The Internal Revenue Code (US) imposes an estate tax on the US situs assets of non-US residents. Although the US estate tax is only imposed on assets situated in the US, this tax can impose a heavy burden on the estate of a Canadian resident.
A Canadian resident (other than a US citizen), who does not own real property, is exempt from US estate tax if his or her entire gross estate does not exceed $1,200,000. A Canadian resident who owns real property in the US is not entitled to this exemption and is subject to estate tax on all US situs assets. The estate is entitled to a tax credit in calculating its US estate tax liability under the Canada-United States Tax Convention (the "Convention"). The minimum tax credit is $13,000, but can be as high as $192,800 depending on the proportion of the individual’s US situs assets to his or her worldwide gross estate. In calculating an individual’s worldwide gross estate, many assets that are otherwise excluded from the calculation of an individual’s estate under Canadian law (e.g., retirement funds, life insurance proceeds, and jointly held property) are included for the purpose of calculating the tax credit which has the effect of inflating the worldwide estate and lowering the amount of the tax credit.
Prior to 1995, the Convention did not provide any relief from US estate tax by way of tax credits or a similar mechanism. As a result, the combination of US estate tax levied on a Canadian resident’s property situated in the US and Canadian tax levied on capital gains realized at death often resulted in double taxation of real property in the US As a measure to reduce the double taxation that otherwise resulted on the death of a Canadian resident, the CRA introduced an administrative policy in the early 1980s with respect to the use of single-purpose corporations to hold real property in the US Since the introduction of this policy, single-purpose corporations have been a widely used planning strategy employed by Canadian residents to avoid US estate tax. Unlike real estate, shares in a Canadian corporation holding a US residence or vacation property are not situated in the US for purposes of the US estate tax, and are therefore exempt from such tax.
From a Canadian tax perspective, the use of a Canadian corporation to hold personal use real estate in the US is an effective tax planning strategy only to the extent it is sanctioned by the CRA. This is so because the Income Tax Act (Canada) (the "Tax Act") generally taxes a shareholder on the value of any benefits conferred by a corporation on him or her. The benefits received by a shareholder, and taxable as income, are broadly defined under the Tax Act. Virtually all benefits conferred by a corporation are captured by the shareholder benefit rules, including the personal use by a shareholder of a corporation’s property. The income inclusion for a shareholder benefit is generally measured in terms of the rent the shareholder would otherwise have been required to pay for the use of the property.
The CRA’s administrative policy exempted single-purpose corporations from the application of the shareholder benefit rules that normally apply. To qualify as a single purpose corporation, the corporation had to be established with the sole objective of holding property for the personal use and enjoyment of the shareholder. The corporation’s shares could only be held by the individual for whose use the property was purchased and related persons. In addition, the property could not be rented when not in use, and all operating expenses associated with the property had to be borne by the shareholder.
In June 2004, the CRA revoked this administrative policy, stating that this planning technique will no longer be available for any new property acquired by a single-purpose corporation or for an individual who acquires the shares of a single-purpose corporation unless the share acquisition results from the death of his or her spouse or common-law partner.
Single-purpose corporations established before December 31, 2004 are grandfathered under the old administrative policy subject to two important limitations. The policy will continue to apply to, and no shareholder benefits will be assessed on, pre-existing single-purpose corporations until the earlier of the disposition of the underlying property or the disposition of the shares to someone other than the individual’s spouse or common law partner. The disposition of shares to a spouse or common law partner will only qualify under the grandfathering rule if they are transferred as a result of the death of the shareholder.
The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.
© Copyright 2005 McMillan Binch LLP