Category Archives: Tax and Trusts

FBAR – Implication for Canadian Permanent Residents and Citizens

The Internal Revenue Service (IRS) is increasing its focus on reporting of foreign financial accounts by U.S. persons. Despite recent protests by Finance Minister Jim Flaherty on the matter, the changes seem like they are going to go ahead. There are potentially significant implications that representatives should advise their US clients about. Put simply, just because your US clients are becoming Canadian permanent residents or citizens does not mean that they are absolved from reporting their taxes to the United States.

The Report of Foreign Bank and Financial Accounts (FBAR) is an IRS form. Any United States person who has a financial interest in any financial account in a foreign country where the aggregate value of the accounts exceeds $10,000 is required to file the form. Accounts that require reporting include Canadian bank accounts, investments, mutual funds, life insurance, RRSPs, RESPs, TFSA’s, etc. With such a low threshold, the FBAR reporting requirements likely apply to many of your American clients.

The IRS website states that failure to file an FBAR when required to do so may result in civil penalties, criminal penalties or both. If your clients have not been filing an FBAR when they were required to do so, then they can file the delinquent FBAR reports and attach a statement explaining why the reports were filed late. The IRS website states that no penalty will be asserted if the IRS determines that the late filings were due to reasonable cause.

Clients who knowingly fail to file the FBAR report could be subject to civil penalties equal to the greater of USD $100,000 or 50% of the total value of the foreign assets per year, assuming the client is non-compliant for multiple years. In addition, clients could be subject to criminal charges as well.

Margaret Wente in the Globe and Mail recently wrote a piece about this that is worth reading. One particular paragraph of note stated that:

As many as a million U.S.-born residents of Canada are caught in this Kafkaesque nightmare. Finance Minister Jim Flaherty has written an indignant letter to leading U.S. newspapers. All of us are getting wildly conflicting professional advice. At first, Brian and his wife, who are by no means wealthy, decided to come clean. But when they were told they’d be on the hook for $250,000, they changed their minds.

The issue has received the attention of Finance Minister Jim Flaherty.  In a letter published in several US publications, he wrote that:

Another issue, this one affecting more directly the large numbers of dual U.S.- Canadian citizens and their relatives living in Canada, is the IRS’s Foreign Bank Account Report (FBAR) filing requirements.
Most of these Canadian citizens, many with only distant links to the United States, have a very limited knowledge of their tax reporting obligations to the United States. These are honest and law-abiding people, including many senior citizens now caught in a nerve-wracking situation. Moreover, because they work and pay taxes in Canada, they generally do not owe any taxes in the United States in any event. Their only transgression is failing to file the IRS paperwork they were never aware they were required to file.
These people are not the targets of a crackdown on tax evasion. These are not high rollers with offshore bank accounts. These are people who have made innocent errors of omission that deserve to be looked upon with leniency
Rather, these people are typically hard-working citizens of our two great countries.
Faced with the knowledge that they do have an obligation to file U.S. tax returns (even if they most often do not actually owe any taxes) they want to do the right thing.
But the threat of prohibitive fines for simply failing to file a return they were unaware they had to file, is a frightening prospect that is causing unnecessary stress and fear among law abiding hardworking dual citizens.
We support efforts to crack down on legitimate tax evasion. These measures, however, do not achieve that goal.

I will post updates on this issue as they arise.  However, as it currently stands, you will be doing your American clients an immense favor if you explain this issue to them, and refer them to an experience tax lawyer or accountant.

Certainty of Intention and Immigration Trusts

 

It is becoming increasingly common for wealthy people immigrating to Canada to inquire about establishing non-resident trusts prior to coming to Canada in order to take advantage of the five-year tax holiday available under section 94(1) of the Income Tax Act.  Professionals are of course all to eager to assist, happily describing the tax savings available in setting up such entities.

The Federal Court and Federal Court of Appeal decisions in Antle v. Canada (2010 FCA 280 and 2009 TCC 465) (“Antle“), however, suggest that such professionals should also make sure that their clients understand the nature of what a trust is.

Both the Federal Court and the Court of Appeal found that an off-shore trust did not exist because a lack of certainty of intention, a requirement for setting up a trust.

At paragraph 49 of its decision, the Federal Court noted that (emphasis added):

I reach the inevitable conclusion that [the appellant] did not truly intend to settle shares in trust with [the trustee]. He simply signed documents on the advice of his professional advisers with the expectation the result would avoid tax in Canada. I find that on December 14th, he never intended to lose control of the shares or the money resulting from the sale. He knew when he purported to settle the Trust that nothing could or would derail the steps in the strategy. This is not indicative of an intention to settle a discretionary trust. Frankly, I have not been convinced [the appellant] even fully appreciated the significance of settling a discretionary trust, beyond an appreciation for the result it might provide. I conclude that his actions and the surrounding circumstances cannot support a conclusion that signing the Trust Deed, as worded, reflects any true intention to settle shares in a discretionary trust. I do not find that [the appellant] is saved by the language of the Trust Deed itself, no matter how clear it might be. It does not reflect his intentions.

Although Antle did not apply to an immigration trust, it is easy to see such a scenario developing in the immigration trust context. Simply signing documents on the advice of “professional advisers ? Not appreciating what one is entering into and signing?  People who are moving to a new country with a new legal system and relying on experts to best position themselves in that system understandably sign documents without fully understanding them all the time.

What Antle reminds these individuals, as well as their advisers, is that it is important that immigrants setting up an immigration trust not only understand why they are doing something (the tax benefit), it is important that they understand what they are doing (transferring legal title of property to trustee for the benefit of a beneficiary).

The reason that it is important that an immigrant understand the nature of a trust when establishing an immigration trust is because no matter how flawless the trust document is, the trust document alone does not determine whether the certainty of intentions is met. Rather, as the Federal Court of Appeal noted in Antle, a contextual approach that considers all the factors is necessary.

In short, make sure that you understand the nature of a trust before putting your assets into one, because failure to do so may result in all those professional fees to set up the “perfect trust deed” may be wasted.

Residence Under the Canada-Russia Tax Treaty

We often have clients approach us asking how they can immigrate to Canada without become tax residents.  There are a variety of ways to do this, and the recent Tax Court of Canada decision in Denisov v. The Queen highlights one issue that those interested in not being tax-resident need to be prepared to address.

In Denisov, the appellant was a citizen of both Russia and Canada.  During the years that the appellant was alleged to have under-reported income, he had a dwelling place available to him in Montreal, as well as an investment condo. In addition, he had personal property and belongings in Canada. He had a Quebec drivers license and health card, a Canadian passport, a Canadian social insurance card, a Canadian cell phone, and numerous Canadian bank accounts. He was also the sole shareholder of a Canadian corporation. In numerous forms that he filled out he indicated that he was a resident of Canada.

Given this, the Court found that he was a tax resident of Canada.

However, the decision rested not on whether the appellant was a tax resident of Canada, but also on whether he was a tax resident of Russia. Pursuant to the Canada-Russia Tax Treaty, if the appellant was factually resident in both Russia and Canada, then the tie-breaker rule found in Article 4 of the Treaty would kick in and provide that he could legally be tax resident in only one country.  Thus, as with Canada-China Tax Treaty, an individual cannot be tax resident in both countries.

Article 4 of the Canada-Russia Tax Treaty is very similar to that contained in Article 4 of the Canada-China Tax Treaty. It states:

ARTICLE 4

Resident

1.       For the purposes of this Agreement, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.

2.      Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:

(a)      he shall be deemed to be a resident of the State in which he has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident of the State with which his personal and economic relations are closer (centre of vital interests);

(b)      if the State in which he has his centre of vital interests cannot be determined, or if he has not a permanent home available to him in either State, he shall be deemed to be a resident of the State in which he has an habitual abode;

(c)      if he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident of the State of which he is a citizen;

(d)      if each State considers him as its citizen or if neither State considers him as its citizen, the competent authorities of the Contracting States shall settle the question by mutual agreement.

3.      Where by reason of the provisions of paragraph 1 a company is a resident of both Contracting States, then its status shall be determined as follows:

(a)      it shall be deemed to be a resident of the State under the laws of which it was created;

(b)      if it was created under the laws of neither of the States, it shall be deemed to be a resident of the State in which its place of effective management is situated.

The Denisov decision is unique in that Justice Angers never even had to go through the tie-breaker factors.  Instead, he found that the appellant was not a resident of Russia under the treaty. He held that section  1 requires an analysis beyond simply looking at whether an individual is factually a resident Russia.  Rather, the person has to be “liable to tax therein”. This decision was based on the Supreme Court of Canada’s decision in The Queen v. Crown Forest Industries Limited, where Justice Iacobucci stated:

[T]he criteria for determining residence in Article IV, paragraph 1 involve more than simply being liable to taxation on some portion of income (source liability); they entail being subject to as comprehensive a tax liability as is imposed by a state.

Here, the appellant could not demonstrate that he was subject to a comprehensive tax liability in Russia. The only tax he appeared to pay was a very small amount that was withheld by a Russian employer.  As well, although the appellant had tried to obtain a letter from the Russian authorities confirming his status as a resident of the Russian Federation, he was unable to do so.

Given this, Justice Angers found that the appellant was not a tax resident of Russia, and that he was liable to Canadian taxation on his worldwide income.

The implications of this decision are clear. If an individual is going to rely on a tax treaty to show that he/she is not legally a tax-resident in Canada, then that person should expect that he/she will be asked to prove that he/she was actually subject to tax under the other jurisdiction. It is not difficult to see the policy reasons behind this principle. After all, what would have stopped the appellant in this case from then going to Russia and arguing that he was only a Canadian tax resident, and avoid paying taxes in both jurisdictions?

Of course, if a person immigrates to Canada in a way such that it is clear that he/she is not a tax resident, then it may never even reach the audit stage.

Am I a Tax Resident in Canada or China?

A person who is a Canadian tax resident must pay income tax on his/her worldwide income.

It is important to note that an individual can be tax resident in more than one country.  When this occurs, credits are generally available for any income taxes paid in another jurisdiction.  Nonetheless, because Canada’s taxes are higher than in many other nations, Canadian tax residents are often required to pay taxes on income earned outside of Canada.

However, Canada has entered into numerous tax agreements which provide that an individual cannot be tax resident in both countries which are a party to the treaty. Article 4 of the Canada-China Income Tax Agreement provides that an individual can only be tax resident in either China or Canada.

From an immigration perspective, this has huge implications. It means that an individual can immigrate to Canada and obtain permanent resident status, maintain that permanent resident status, yet not be a Canadian tax resident.

Article 4 contains a series of tie-breaker rules to determine tax residency when an individual has ties to both China and Canada. It states that:

1. For the purposes of this Agreement, the term “resident of a Contracting State” means any person who, under the laws of that Contracting State, is liable to tax therein by reason of his domicile, residence, place of head office, place of management or any other criterion of a similar nature.

2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:

a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him in both Contracting States, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);

b) if the Contracting State in which he has his centre of vital interests cannot be determined, or if he has not a permanent home available to him in either Contracting State, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;

c) if he has an habitual abode in both Contracting States or in neither of them, he shall be deemed to be a resident of the Contracting State of which he is a national;

d) if he is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

3. Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, the competent authorities of the Contracting States shall by mutual agreement endeavour to settle the question and to determine the mode of application of this Agreement to such person.

Any potential immigrant from China should read Article 4 extremely carefully.  The potential exists for huge tax savings without compromising your immigration status, or violating Canadian law.

Immigrant Investor Fined For Tax Evasion

On July 15, 2010, the Tax Court of Canada declared that S Korki, an Immigrant Investor from Iran, would have to pay gross negligence penalties for failure to fully disclose income.

In the 2002 and 2003 taxation years, Mr. Korki declared a net income of $19,100 and $22,312 respectively. After carrying out a Net Worth Analysis during an audit, the CRA reassessed this amount to $287,340 and $177,380.

Over the court of the whole affair, the Canada Revenue Agency pounced on inconsistencies in testimony, statements from officers and friends, obtained evidence of wire transfers, discovered undeclared offshore accounts, and real property sales.

They found that the applicant had not met the burden of showing that the reassessment was wrong. They further found that gross negligence penalties were appropriate. These penalties add 50% to the amount of tax owing.

The case stresses how important it is for immigrant investors to obtain proper tax advice prior to immigrating.