DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Posts Tagged ‘Tax Treaty’

Offshore Trusts – Is The Sun Setting?

In Canadian Income Tax, Tax Avoidance on November 3, 2009 at 1:27 pm

So often, I see tax strategies fall short, not due to faulty planning, but faulty execution. It is so easy to fall into complacency with regard to documentation. But I’m not going to ask you to take my word for it. I’ll let you read a great excerpt from the Tax Court of Canada in the case of Antle (2009 TCC 465). This case, by the way is one of the two recent “Barbados trust” cases involving the use of offshore trusts to escape tax on large capital gains.

Parenthetically, the other case, Garron Family Trust, (2009 TCC 465) calls into question the long-standing notion that a trust is resident in the jurisdiction where the majority of the trustees reside. This absolute certainty, like the shape of our globe, once considered to be flat, has given way to the reality that the residence of a trust should be determined based on the set of circumstances in question, and that the place where management and control takes place is now the overriding factor.

But I digress. I want to get to this great quotation, because the lawyers involved in this case must be pulling out their hair. When Mr. Antle was about to sell his shares, he decided he could avoid the capital gains tax by following a few simple tax planning steps, as follows:

Step 1: Set up a spouse trust with a trustee resident in Barbados.

Step 2: Transfer shares to a spouse trust (tax free under Canadian law)

Step 3: Trust sells shares to Mrs. Antle (tax-free under Barbados law and Canadian-Barbados tax treaty)

Step 4: Mrs. Antle sells shares with stepped-up cost base

Forget the fact that GAAR also applies to this transaction. The court, in fact made another fun statement in this regard, calling the strategy “a classic law school model of what GAAR was intended to capture”.

But again, I digress. The point is, don’t lose your case for a client before it gets out of the starting block through sloppy paperwork and poor execution. In Antle, the court stated:

“With certainty of intention and certainty of subject matter in question and, more significantly, no actual transfer of shares, there is no properly constituted trust: the Trust never came into existence. This conclusion emphasizes how important it is, in implementing strategies with no purpose other than avoidance of tax, that meticulous and scrupulous regard be had to timing and execution. Backdating of documents, fuzzy intentions, lack of transfer documents, lack of discretion, lack of commercial purpose, delivery of signed documents distributing capital from the trust prior to its purported settlement, all frankly miss the mark — by a long shot. They leave an impression of elaborate window dressing. In short, if you are going to play the avoidance game, it is not enough to have brilliant strategy, you must have brilliant execution.”

So true. Both the Garron and Antle cases are being appealed.

Non-Resident Investors In Canadian Real Estate

In Canadian Income Tax, Non-residents on September 29, 2009 at 5:20 pm

Maybe it’s the global warming thing, but Canada has suddenly become a very popular destination for non-residents (“NR”) investing in real estate. What are the tax rules for non-resident investors, and what investment vehicle should be used?

Non-Resident Investors

A NR investor is subject to withholding taxes under Part XIII of the Act. Generally, 25% of gross rents must be remitted to the CRA each month. An election under section 216 may be made. Under this election, the NR files a tax return and is eligible for the same deductions as Canadian residents including capital cost allowance. However, it does not entitle the NR to loss carryovers from prior years.

A survey of the tax rules would be advised prior to investing in Canadian real estate

A survey of the tax rules would be advised prior to investing in Canadian real estate

If form NR6 is filed, the NR undertakes to file a return within 6 months from the end of the year, and the tax withheld is reduced to 25% of the estimated income after deductions. Where no undertaking is filed, the tax withheld is 25% of the gross rent, but the deadline for filing a return is extended to 2 years.

Under certain circumstances a NR paying interest to another NR may also be subject to withholding taxes on the interest payments.

A NR corporation would be subject to further withholding requirements known as branch tax. This tax is intended to equal dividend withholding tax on profits repatriated out of Canada by the NR corporation. The branch tax rates are similar to withholding rates for dividends, subject to treaty reductions. NR corporations are also subject to tax on capital in certain provinces. Finally, an NR corporation may be subject to “thin capitalization” rules that restrict interest deductions.

A NR trust pays no branch tax or tax on capital. Losses of a trust , however, cannot be flowed out to beneficiaries.

Using a  Canadian Investment Vehicle

The two major choices for a Canadian investment vehicle is the Canadian resident trust or the Canadian corporation.

A Canadian corporation is subject to the full rates of tax on investment income. Unless it qualifies as a Canadian controlled private corporation, no part of the taxes payable will be refundable upon the payment of dividends. Dividend payments will be subject to withholding taxes of 25%, unless reduced by treaty. Further, in certain provinces, a Corporation is subject to tax on capital. Thin capitalization rules apply as well. These factors make this vehicle an unpopular choice for most NR investors.

A Canadian trust is not subject to tax on capital. Nor would the payments to beneficiaries of after-tax income be subject to any withholding taxes. Thus, the trust would be subject to tax only once, at the highest marginal tax rates for individuals. This rate could vary, depending on the province of residence of the trust.

Dispositions of Real Estate by Non-Residents

As taxable Canadian property, a gain on the disposition of real estate by a non-resident is generally subject to Canadian tax at Canadian rates for capital gains and recaptured capital cost allowance.

Withholding taxes must be remitted, and may be based on the gain on sale only where a withholding tax certificate is obtained under section 116 of the Act. If no certificate is requested by the due date (either before the sale, or within 10 days following the sale), then the purchaser is required to withhold based on the gross purchase price. The withholding rate is 25%. An additional 12% applies for the province of Quebec, which has its own certificate request procedure under Article 1097.

One common problem that arises when a NR disposes of Canadian real estate is that a 116 certificate will only be issued if all the withholding requirements have been met in the past. That is, if no returns were filed under section 216, then the CRA will require remittance of 25% of gross rents for the previous years plus interest. If the 2 year deadline has passed, the CRA will normally not accept late-filed 216 returns.

Canadian Tax on the Entertainer

In Canadian Income Tax, Non-residents on September 16, 2009 at 12:16 pm

Like most people, while enjoying a live concert or watching a movie, my mind inevitably begins to wander away from the performers on stage towards the Canadian income tax rules that apply to them. They are truly talented and unique, these non-residents of Canada, and as such, special tax rules apply to them.

General Rule for Services Rendered in Canada

In my August 31 post you will recall that we dealt then with Regulation 105 withholding requirements. When a non-resident enters Canada to perform services, he is subject to a 15% levy (plus an additional 9% in Quebec) on account of income tax payable in Canada. This charge applies similarly to musicians, and other performing artists. According to the CRA, these performers are carrying on business in Canada and are subject to tax on their income earned in this country.

In many cases, however, services rendered by a resident of a treaty country, such as the US would be exempt from Canadian taxes. Business income is exempt under most treaties unless the taxpayer has a “fixed base regularly available to him” in this country.

Artistes and Athletes

A special section found in most of Canada’s treaties deals specifically with “Artistes and Athletes”. This provision essentially provides that the above treaty exemption for business income does not apply to income of more that $15,000 in a year, derived as an entertainer such as a movie, theatre, radio or television artiste, a musician or an athlete. Accordingly, these talented people have to “pay to play”, so to speak.

Requirement to File a Tax Return

Whether or not a person is exempt from Canadian tax under a treaty provision, he must file a Canadian income tax return. The 15% tax withheld does not relieve a non-resident of this duty. If the income is exempt under a treaty, then the full amount withheld would be claimed as a refund. If the taxpayer is not exempt, he must report his net income earned in Canada, and the 15% tax withheld is applied as a credit against taxes owing. Failure to file a Canadian return would result in penalties.

Like Me, Some People Are Not Artistic Enough

Billy Joel in Montreal - Must file a Canadian tax return

Billy Joel in Montreal - Must file a Canadian tax return

The question of whether a taxpayer is an “artiste or athlete” can be difficult to answer at times. In the case of Thomas F. Cheek v. The Queen, Toronto Blue Jays announcer Tom Cheek was held not to be a “radio artiste”, because he was simply reporting on the games and was not attracting his own audience by virtue of his talents as a radio personality. The court found he was exempt under the Canada –US Treaty.

More Issues for Athletes

For athletes, questions can become even more complex. US athletes playing for Canadian sports teams might be considered resident in Canada depending on their circumstances, and vise versa. Non-resident employees of sports teams might benefit from treaty protection if they are not present in Canada for more than 183 days in a year. However, self-employed athletes, such as tennis players would likely have no treaty protection.

Special Rules for Film Actors

Finally, a completely separate set of overriding rules applies to actors who provide acting services in a film or video production. These taxpayers, whether they provide services directly or through a corporation, are subject to a flat 23% withholding tax under Part XIII of the Act. This rate applies to income from acting services, including residuals and contingent compensation. Further, these taxpayers are not required to file Canadian income tax returns.

However, a special election is available to actors who choose to file a tax return. Under this election the 23% withholding tax does not apply, and they will be taxed under Part I on their net income earned in Canada. To be valid, this election must accompany a Canadian income tax return filed by the person’s filing due date.

Note that these special rules do not apply, for example, to stage actors or radio artistes. They do not apply to other income earned by the actor, such as from services as a producer or director. Nor do they apply to other personnel working behind the scenes in the film industry. All these other services are subject to the normal 15% Reg. 105 withholding and the requirement to file a return.