If you are a emigrating from Canada and own shares of a private company , beware of a new tax trap that awaits you.
Generally, when a Canadian become a non-resident, he is deemed to have disposed of all capital property (with certain exceptions) at fair market value. Shares of private companies are therefore subject to capital gains tax.
There are a number of rules in place to ease the transition, and avoid double-taxation when, for example, these shares are finally sold or liquidated after emigration.
One such rule is contained in section 119 of the Income Tax Act. In essence, where shares of a private company have been taxed on emigration, a credit against that tax is allowed for any further withholding taxes paid on dividends coming from that company. The credit applies when the shares are finally disposed of.
Let’s look at a simple example. In year 1, a Canadian owning shares of his holding company moves to the U.S. The only asset in the company is $100,000 cash, and his shares have a nominal cost base. Upon emigration, therefore, the shares will be subject to capital gains tax at a rate of 25%. The taxpayer pays $25,000 to the CRA.
In year 2, the company pays a $100,000 dividend to its shareholder and is then dissolved. The dividend is subject to a 15% non-resident withholding tax in Canada. The taxpayer pays $15,000 to the CRA.
As you can see, the taxpayer has now paid the CRA twice on the same $100,000, first in capital gains tax on emigration and again upon paying himself the cash.
In order to alleviate this problem, section 119 was put in place when the emigration rules were first introduced. It essentially allows a credit for the $15,000 withholding tax so all that is ultimately paid is the $25,000 capital gains tax.
Since the March 2010 federal budget, things have changed. Section 119 is available only for shares that are “taxable Canadian property”, which no longer includes private company shares in most cases.
While the elimination of most private company shares as taxable Canadian property will be a relief for many non-resident shareholders, it creates a trap for emigrating Canadian shareholders.
Now that private company shares are not taxable Canadian property, there is no credit available under section 119 and the value of a private company’s assets, as in the above example, could be subject to two incidences of tax.
A taxpayer who has already left Canada, paid capital gains tax and may have already paid dividends subject to 15% withholding tax with the intention of availing themselves of section 119 in the future is protected by grandfathering rules which provide that if you emigrated prior to March 5, 2010, any taxable Canadian property you owned at that time will remain as such after the change.
Clearly, this places an unfair burden on Canadians leaving Canada; however, the Department of Finance does not agree. They are aware of the issue and they stand by the change as a matter of policy (for now). I am just not quite sure what the policy is that intentionally creates a double-tax trap for unwary Canadian taxpayers.