Introduction - Non-Resident Trusts Canadian Tax Reporting Requirements
The Canada Revenue Agency continues to bolster reporting requirements for foreign assets or offshore income and the penalties associated with failure to file tax returns or information returns can be onerous. Trusts are an extremely effective way to distribute income among several beneficiaries in the most tax optimal way, and setting the trust up to be non-resident for Canadian tax purposes can serve to further limit their Canadian tax liability. However, although non-resident trusts are prima facie not subject to domestic Canadian income tax, the Canadian Tax Act deems otherwise non-resident trusts to be Canadian resident in a broad set of circumstances, thus making them subject to full Canadian taxation. In order to gather information about non-resident trusts, the Income Tax Act requires resident Canadian taxpayers to file Form T1141 with Revenue Canada if they are sufficiently connected to a non-resident trust and the Tax Act heavily penalizes Canadian taxpayers who do not live up to this reporting obligation. The purpose of this tax analysis article is to provide a general summary of the tax reporting rules relating to non-resident trusts. For a more in-depth examination of your specific circumstances, contact our experienced Canadian tax lawyers to discuss your particular situation, determine your tax reporting obligations and ensure that you are compliant with Revenue Canada.
Common Law Residence Test for Trusts
The common law test for trust residency was reformulated by the Supreme Court of Canada in Fundy Settlement v Canada, 2012 SCC 14. The Supreme Court held that the test for trust residency is the same as the test for corporate residency, namely, that a trust is a resident of the country where its "central management and control" is exercised. Prior to Fundy, the residence of a trust was generally accepted to be the country in which the trustee or trustees who manage the trust reside. Under the "central management and control" analysis, the residence of the trustee is still an important factor, but is no longer determinative: for example if a trust is managed by a trustee in the Cayman Islands, but the trustee just follows the orders of a beneficiary located in Vancouver, the trust is likely resident in Canada.
Canadian Deemed Residence for Trusts
The common law residence test for trusts, however, is rendered fairly irrelevant by several changes to the Canadian Income Tax Act. Parliament has recently amended section 94 of the Tax Act to greatly expand the situations in which a non-resident trust will be considered a resident of Canada. Under paragraph 94(3)(a) of the Tax Act, a non-resident trust is deemed to be resident in Canada if at the trust's year end, the trust has a resident contributor or a resident beneficiary.
A resident contributor is defined in subsection 94(1) to be a resident Canadian taxpayer who has made a "contribution" to the trust. "Contribution" is broadly defined by subsection 94(1) of the Tax Act to include a wide variety of scenarios, including a transfer or loan made directly from the resident contributor, in addition to transfers or loans made to the non-resident trust by a non-resident third party if the transfer or loan is part of a "series of transactions", part of which involved a transfer or loan from the resident contributor as part of the series of transactions. Contribution is also defined to include a situation where the resident contributor transfers or loans funds to a non-resident third-party in satisfaction of an obligation that was created due to a series of transactions which included a transfer to the non-resident trust. The rules are very complex, but suffice to say that the definition of "contribution" will catch most, if not all, indirect transfers to a non-resident trust, which will result in the trust being deemed resident in Canada. If you are planning any transaction through which funds will end up in a trust be sure to check the tax consequences with our experienced Toronto tax lawyers.
A "resident beneficiary" is defined in subsection 94(1) of the Tax Act to be a resident of Canada who is a beneficiary under the non-resident trust, and there is a "connected contributor" to the trust. A "connected contributor" is defined as any contributor to the trust, other than a person all of whose contributions made to the trust occurred at a "non-resident time of the person". Also defined in subsection 94(1), contributions during a "non-resident time" of a particular person refer to contributions made during the period of time that is more than 60 months prior to the person becoming resident in Canada, and the period of time that is more than 60 months after the person ceased to be resident in Canada. The breadth of the provision cannot be overstated. If a particular trust has 10,000 beneficiaries, only one of whom is a resident Canadian, and a former-resident of Canada makes a contribution within 5 years of ceasing to be resident of Canada, subsection 94(3) of the Canadian Tax Act will deem such a trust to be resident of Canada and fully liable to Canadian income tax.
Obligation to File T1141 and Penalties for Non-Compliance
Canadian resident taxpayers who, at the non-resident trust's year-end, were a resident contributor or a connected contributor to a non-resident trust must file Form T1141 with Revenue Canada with respect to that particular year. The form is essentially a tool designed to allow CRA to identify non-resident trusts which might be subject to the deeming provisions in subsection 94(3) of the Income Tax Act. The form asks for a wide variety of information, including the names of the trustee(s), names of individuals whom the trustee(s) must consult with, settlors of the trust, beneficiaries of the trust, all contributions and disbursements to and from the trust during the year, non-arms length persons who are indebted to the trust during the year and persons to whom the trust is indebted during the year. Speak to one of leading Canadian tax lawyer experts to get advice on how to fill out Form T1141 accurately and without incurring any more liabilities than absolutely necessary.
There are significant penalties for failing to file form T1141 as and when required. The simple failure to file form T1141 carries a penalty of $2,500 per year under subsection 162(7) of the Tax Act, regardless of intent. Under subsection 162(10), if an individual required to file form T1141 "knowingly or under circumstances amounting to gross negligence" fails to do so as and when required is liable to a penalty of $500 per month up to a maximum of 24 months, or $12,000, for each failure to file form T1141. Further, if more than 24 months have passed since form T1141 was required to be filed with CRA, and the conditions of subsection 162(10) are met, under subsection 162(10.1) of the Income Tax Act the penalty is equal to 5% of the fair-market value of amounts transferred or loaned to the non-resident trust by the taxpayer and which form the basis of the obligation to file the T1141. So you can see that the penalties for failing to file form T1141 are significant and have the potential to cripple a taxpayer's finances, especially if several years worth of failure to file penalties are levied following a CRA audit.
Voluntary Disclosure by Canadian tax lawyers for Failure to File Form T1141
The reporting obligation of taxpayers to file form T1141 is complicated, often requiring a detailed analysis of the provisions of the Canadian Tax Act by one of our top Canadian tax lawyers. Taxpayers who have not filed T1141 as required may be eligible for Revenue Canada's Voluntary Disclosures Program if:
- CRA has not contacted them about the failure to file form T1141;
- At least one year has passed since they were required to file the form T1141;
- The failure to file form T1141 is subject to a penalty; and
- The voluntary disclosure identifies all areas of the taxpayer's non-compliance with the Income Tax Act.
If the above pre-requisites are met, a taxpayer has a strong chance of making a successful voluntary disclosure to CRA for the failure to file form T1141 as and when required by the Tax Act. A successful tax amnesty disclosure completely eliminates penalties, removes the possibility of criminal prosecution and typically offers partial interest relief on any taxes that may be owing. Failed reporting obligations under the Tax Act are ideally suited for the voluntary disclosures program: the penalties are severe and taxes owing are often minimal or nil.
Conclusion – Non-Resident Trusts and T1141 Reporting Requirements
The Canadian government has a clear mandate to gather information on all foreign assets with a connection to resident Canadian taxpayers. While the majority of media coverage focuses on bank accounts located in traditional tax havens such as Switzerland and the Cayman Islands, the massive data leaks of the Panama Papers and the recent amendments made to section 94 of the Income Tax Act are evidence that Parliament is also seeking to collect tax on income that is flown through non-resident trusts, even if the income is only tenuously tied to Canada.
The rules relating to non-resident trusts are complicated, and have the potential to impose reporting obligations that can be overwhelming for individuals to handle on their own. Our top Toronto tax lawyers are experts on CRA's Voluntary Disclosures Program and can accurately determine whether you have to file a T1141 with respect to non-resident trusts. If we determine you are not current with your obligation to file form T1141 with CRA, our Toronto tax law firm can help you become compliant with the Income Tax Act by filing a Voluntary Disclosure with CRA to eliminate any possible penalties or prosecution, and to reduce interest on any unreported income owing on account of your relationship with the non-resident trust.
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.