Moving to the United States may raise all sorts of concerns for individuals resident in Canada, not the least of which are the potential tax consequences to such a move. There are, however, significant planning opportunities available to potentially mitigate such tax consequences and even provide further tax relief in the future.
Tax Consequences of Migration
When an individual taxpayer ceases to be resident in Canada, paragraphs 128.1(4)(b) and (c) of the Income Tax Act (Canada) (the "Act") deem the taxpayer to have disposed of and then reacquired certain of his or her property immediately before the cessation of residence. The purpose of this provision is to create a "departure tax" for the taxpayer. This departure tax ensures that Canada has the ability to tax taxpayers on property gains that have accrued while they were resident in Canada.
Property excluded from this departure tax includes Canadian real property, Canadian resource property, timber resource property, certain property used in a Canadian business, certain property owned by short-term Canadian residents, and other miscellaneous properties. Individual taxpayers may, however, elect to have the departure tax apply to certain of his or her Canadian real property, Canadian resource property, timber resource property and Canadian business property. One of the reasons migrating taxpayers may elect to trigger these additional capital gains on cessation of residency is where the taxpayer has unused capital losses or an available capital gains deduction to shelter such gains.
Pursuant to the Canada-United States Tax Convention (the "Treaty"), taxpayers, in certain circumstances and in respect of certain property that was subject to the departure tax, may be able to get a step up in tax basis for US purposes. The purpose of this tax basis step up is to ensure that the United States would not tax the pre-immigration gains of migrating Canadian residents. These provisions1 in the current Treaty are limited and will not provide complete relief in all cases. The new Treaty Protocol, agreed to between Canada and the United States on September 21, 2007, expands considerably the scope of these provisions2. Unfortunately, to date the Treaty Protocol has not been ratified by the U.S. Congress, and as such is not yet enforceable.
Tax Planning Opportunities
Taxpayers may defer the departure tax by posting adequate security with the Canada Revenue Agency ("CRA") pursuant to subsection 220(4.5) of the Act. Consider the example of a taxpayer subject to a departure tax of $100,000 on ceasing to reside in Canada. By the taxpayer's filing deadline for the year in which he or she ceased to reside in Canada, the taxpayer would ordinarily be required to pay a $100,000 departure tax. If, however, the taxpayer posted with CRA acceptable security in the amount of $100,000 before this time, the taxpayer's departure tax would be deferred until the earlier of the date of the sale of the property that was subject to the departure tax, or until security was no longer posted. While the absolute tax savings in posting security are nil, the real tax savings, when the time value of money is considered, can be significant.
Another planning opportunity for taxpayers are certain types of property, defined as an "excluded right or interest" in subsection 128.1(10) of the Act, that are excluded from the departure tax. Excluded rights or interest include interests in personal trusts, registered retirement savings plans ("RRSPs"), registered retirement income funds ("RRIFs") and retirement compensation arrangements ("RCAs").
Where a taxpayer's property is held through a personal trust the taxpayer will not be subject to the departure tax on such property. The reason for this is twofold. First, because the taxpayer does not actually own the trust property, on migration there is no deemed disposition and reacquisition of the property attributable to the taxpayer. Second, the taxpayer's interest in the trust is specifically excluded from the types of property subject to the departure tax. Whether the fair market value of a beneficial interest in a fully discretionary trust can be determined is another limitation as well.
Care must be taken however, to avoid the application of paragraph 104(4)(a.3) of the Act, which may result in a deemed disposition to a personal trust of all of its property where the property was contributed to the trust on a tax-deferred rollover basis in anticipation of the migration of the taxpayer beneficiary. To avoid the application of this provision the personal trust should be set up well in advance of a taxpayer's migration, perhaps as much as two years. Furthermore, the main purpose for the setting up of the personal trust should not be to save or reduce taxes, but rather estate planning, asset protection or some other business, investment or family planning purpose.
RCAs may also provide significant tax savings when organized properly. While Canadian residents can expect to pay as much as 40-50% tax on their employment income, payments from RCAs to non-resident beneficiaries are only subject to a 25% withholding tax. Care must be taken when setting up these arrangements, as CRA has stated publicly that they will look at RCAs set up for non-residents to ensure they were not designed merely to reduce taxes.
The same reduced tax rates available to RCAs are also available to RRSPs and RRIFs. Furthermore, the applicable withholding tax rate may be reduced even further, from 25% to 15%, where funds in the RRSP or RRIF are taken out over a 10 year period, rather than as a lump sum, while the beneficiary is resident in the US. Consequently, a taxpayer, with contribution room in his or her RRSP, planning on moving to the US, should consider whether to make such contributions before emigrating to the US.
Other more sophisticated tax planning techniques may be available to taxpayers under certain circumstances. Through the use of personal trusts and corporations, taxpayers may be able to arrange their affairs to not only reduce their departure tax significantly, but also to access the taxes they paid in Canada as foreign tax credits once living in the US.
While this article is not the place to outline such tax planning opportunities, taxpayers should always involve tax professionals in their estate, investment, business and, of course, migration planning.
Footnotes1.See Article XIII, sections 6 and 7 of the Treaty.
2.In particular, See Article XIII, section 7 of the Treaty, which provides for an election to achieve this step up in tax basis.
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.