Canada: New Treaty Guidance For Canadians Who Emigrate To The U.S.

The Internal Revenue Service has issued guidance for Canadian individuals who emigrate to the United States and desire to make a gain recognition election under Article XIII(7) of the Canada-United States Treaty ("Treaty"), as amended by the Fifth Protocol to the Treaty.¹

Canada's Deemed Disposition Rule

Canadian individual residents who emigrate from Canada are generally deemed to have disposed of their capital property for proceeds of disposition equal to fair market value on the date of emigration, with any resulting gain or loss subject to Canadian tax ("Departure Tax").² For Canadians emigrating to the United States, the Departure Tax creates a potential double tax issue since the individual is ordinarily subject to U.S. tax on the same gain only upon an actual disposition of the property, when foreign tax credits for the Canadian tax paid on the earlier deemed disposition may not be available.

Election under Article XIII of the Treaty

To resolve this timing difference, a Canadian who emigrates to the United States can make an election under Article XIII(7) of the Treaty to be treated also for U.S. federal income tax purposes as having disposed of his or her property and reacquired it at its fair market value immediately before the deemed Canadian disposition. Prior to the Fifth Protocol, this election was available in cases where the gain resulting from the deemed disposition would be taxable in the United States (either because the individual is a U.S. citizen or because the property in question is a U.S. real property interest or is attributable to a permanent establishment in the U.S.). The Fifth Protocol amended Article XIII(7) to make the election available even in the case of a Canadian resident who is not a U.S. citizen and is not subject to U.S. taxation on the deemed disposition. In such cases, the election is particularly attractive, as it will give the individual an adjusted basis in the property equal to the fair market value of the property on the date of the deemed disposition, which means that the individual will only be taxed in the United States on post-emigration gain.

Relief from Double Taxation

In the case of a Canadian resident who is subject to U.S. taxation on gain realized from the deemed disposition, the individual will be permitted to utilize foreign tax credits to eliminate double taxation. Where the property deemed disposed of consists of U.S. real property or property attributable to a U.S. permanent establishment, Article XXIV(2) of the Treaty allows individuals to credit the U.S. tax against the Canadian taxes on the deemed disposition. Where the deemed disposition is by a Canadian resident who is also a U.S. citizen, Article XXIV(4) of the Treaty limits the credit against Canadian taxes to the amount of U.S. income tax that would have been imposed on a Canadian resident who is not a U.S. citizen. Any Canadian tax imposed on the remainder of such individual's income is credited against his or her U.S. tax liability.


The individual makes the Article XIII(7) election by (i) reporting the deemed disposition on the individual's timely filed U.S. federal income tax return for the first taxable year ending after emigration, (ii) attaching IRS Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b) ("Form 8833"), and (iii) attaching documentation establishing the fair market value of the property and confirming that gain or loss was recognized and reported in Canada in the year of the deemed disposition.

Multiple Properties

If an individual is deemed to have disposed of multiple properties under Canadian law, any election that is made under Article XIII(7) must be made with respect to all such properties.³ No election is permitted to be made if the deemed disposition of all of the properties resulted in a net loss for Canadian tax purposes.

Relief for Individuals Who Emigrated after September 17, 2000 and before March 29, 2010

The expansion of the Article XIII(7) election to deemed dispositions that are not subject to U.S. tax was publicly announced in simultaneous press releases issued on September 18, 2000, by the Department of Finance Canada and the U.S. Treasury Department. The press releases stated that the new rule, if approved, would apply to changes in residence that took place on and after September 28, 2000. Consistent with the press releases, the Fifth Protocol provided that the amendment to Article XIII(7) is effective for individuals who emigrated from Canada after September 17, 2000. Revenue Procedure. 2010-19 permits such elections to be made by filing an amended return for the year in which the individual emigrated and including the attachments and documentation described above. The new procedures, however, include limitations and adjustments for elections by such individuals in cases where relevant years are closed under the statute of limitations. While the Fifth Protocol does not refer to such limitations, they appear to be a reasonable attempt to implement the new rules in a fair manner.

With respect to deemed dispositions of property that is subject to U.S. tax, an individual can make the election only if the year of the deemed disposition is still open under the statute of limitations. If the year of emigration is a closed year, then no election is available.⁴ In general, an election is not time barred if it is made within three years from the date the return was filed or two years from the date that the tax was paid, whichever period expires later. In the case of a deemed disposition of property that would not have been subject to U.S. tax, the election is permitted to be made for an emigration that occurred after September 17, 2000, even if the year of emigration is a closed year.⁵

If any property that was subject to the deemed disposition was actually disposed of by the taxpayer in an intervening year for which the taxpayer has filed a return, then the taxpayer is required to file an amended return to correct the amount of gain or loss reported on the disposition. If the year in which the property was disposed of is one which the statute of limitations has closed, then the taxpayer is barred from making the election for such property but is permitted to make the election for any remaining property. If the property that was disposed of in the closed year was disposed of at a loss, then the taxpayer is required to make appropriate adjustments to prevent a duplicate benefit, e.g., by reducing the basis of the remaining properties by the amount of such loss.

The foregoing limitations on elections relating to closed years do not apply if the individual has made an election under Article XIII(7) before the statute of limitations for the year closed by attaching a Form 8833 or similar statement to a timely filed tax return. In that case, the IRS will not challenge such election, and the individual is not required to make a new election pursuant to Revenue Procedure 2010-19, provided the election was not inconsistent with the principles of the Revenue Procedure, and all tax returns and information returns are consistent with such election. Thus, taxpayers who had the foresight to rely on the press releases issued in 2000 are rewarded for their initiative.

Footnotes

1. Revenue Procedure 2010-19, 2010-13 IRB.
2. Certain exceptions to this rule apply. For example, the "deemed disposition" rule does not apply to direct interests in Canadian real property, property used in a business carried on in Canada through a Canadian permanent establishment, employee stock options, or interests in certain Canadian resident trusts.
3. This election is unrelated to the one provided for by Code section 877A(h)(2) which is permitted to be made by individuals who emigrate to the United States and later expatriate.
4. But see the point below regarding elections that were made in a timely filed return.
5. In the case of an individual that has both property that is subject to U.S. tax and property that is not subject to U.S. tax, the individual should list both types of property on the same election statement.

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.