If you invest in shares of US and other foreign corporations, you could be subjected to harsh tax treatment in Canada where certain corporate reorganizations have taken place. The problem lies with so called “spin-off” transactions, where, for example, shares of a subsidiary corporation are distributed to the shareholders of the parent public company. Although tax-free in the foreign jurisdiction, for Canadian taxpayers these distributions could be considered fully taxable as foreign dividends, unless you make a special election in your Canadian income tax return for the year.
If you make the election, there will be no foreign dividend to report. Instead, you will apportion a part of the cost base of your original shares to the shares received on the spin-off. This allocation of the cost base will be based on the fair market value of the shares of the parent and of the distributed shares at the date of the distribution.
If you do not make the election, the value of the shares received is fully taxable as a foreign dividend and this amount is considered as the adjusted cost base of the shares.
To be eligible for the election, a foreign spin-off must meet certain criteria. Essentially, both the parent and the subsidiary companies must be in the same jurisdiction, must be publicly traded, shares received must be common stock, and the transaction must qualify for tax-free treatment in the country of origin.
If a foreign corporation meets the criteria, they will report to the CRA, who will place them on their list of foreign spin-offs that qualify. This list is updated regularly and may be found on the CRA’s website.
Once you have confirmed the above, you may make an election on your Canadian tax return by filing a letter with the return, containing the following information:
- Notification that you are electing under section 86.1 of the Income Tax Act to defer the tax relating to the distribution of spin-off shares from a foreign corporation, including a description of both the original shares and the spin-off shares
- The number, cost, and fair market value of the original shares, both immediately before and immediately after the distribution;
- The number and fair market value of the spin-off shares immediately after the distribution.
If you have received a T5 or other information slip that shows foreign dividend income in respect of a distribution for which you wish to make the election, you should include the slip in your return, along with the election, but do not report the income on the slip. Finally, if you make this election, you will not be eligible to E-file your tax return.