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Immigration to Canada from Countries other than the United States
I. EXECUTIVE SUMMARY:
Taxation of Worldwide Income
The Canadian income tax system is designed to tax residents of Canada on their worldwide income (citizenship is irrelevant). Passive income that has not actually been received by the taxpayer from offshore entities (for example offshore trusts and corporations) is included in computing income annually. Unless a properly structured immigrant trust is used, these rules can be particularly onerous on recent immigrants who continue to have investments or income sources based outside of Canada.
When is an Immigrant "Resident" for tax purposes?
Revenue Canada takes the view that "where an individual enters Canada, otherwise than as a sojourner, and establishes resident ties within Canada . . . he will generally be considered to have become a resident of Canada for tax purposes on the day he entered Canada."(1) Where the individual is attempting to obtain Canadian citizenship this view may be reasonable since the immigrant will have established residential ties for citizenship purposes.
Special Rules for Immigrants -
The Immigrant Trust
The Income Tax Act contains provisions that facilitate an immigrant's transition to the Canadian tax system, and provides them with an opportunity to reorganize their affairs. Specifically, a correctly structured immigrant trust can prevent Canadian taxation of foreign income for a period of up to 60 months. [For a simplified discussion of trusts.].
EXAMPLE - If the Immigrant, at the time s/he becomes resident, personally holds/owns offshore investments that generate passive income of $1 million per year, then there could be tax of approximately $500,000 a year, even though the income may not actually be received by the immigrant. If these investments were held in a qualifying Immigrant Trust, there could be tax savings of up to $2.5 million over the 5 years following immigration.
What happens after 60 months?
Within four to five years after establishing residence, the income of the discretionary offshore immigrant trust will generally be taxable as income of one or more of the settlor or the beneficiaries who are resident in Canada. As a result, the trust is typically wound up, unless a mechanism exists for extending the tax-free status.
II. STEPS IN THE CREATION OF AN IMMIGRATION TRUST:
In simple terms, the steps in the creation of an immigration trust are:
Settle a non-resident trust in a tax haven by a gift of the income producing assets from nonresident of Canada;
Select non-resident trustees and, if necessary, a non-resident protector;
Ensure that the Trust is irrevocable and discretionary;
All investment decisions and trustee meetings should occur outside of Canada; and
Trust deed should provide that annual income of the trust be accumulated and that the trustees would have the discretionary power to make capital distributions to the beneficiaries
Issues to Consider When Forming an Immigrant Trust:
Possible use of corporations
Source of funds for settlement
Selection of a tax haven
Appointment of trustees
Selection of a protector
III. TAXATION OF NON-RESIDENT TRUSTS:
Subject to comments below regarding income attribution, a non-resident(2) discretionary trust can be structured so as not to attract any immediate Canadian tax if:
it is created and settled with property outside of Canada;
all of its property is acquired from a non-resident settlor who does not become a resident Canadian;
it does not receive any financial assistance from any person resident in Canada at any time;
its non-resident trustees constitute a majority of the trustees; and
the non-resident trustees actively exercise their responsibilities as trustees.
Any income distributed to or for the benefit of a Canadian resident beneficiary (including capital gains) will be taxable in the hands of the beneficiary. Income splitting may reduce total tax payable by having the income taxed in the hands of a beneficiary who is at a lower marginal tax rate. Care must be taken to avoid the new rules regarding taxation of dividends and business income received by minors.
Distributions of capital are not subject to Canadian tax. Prior to the February 16, 1999 budget, income that was not distributed could be accumulated, added to capital and eventually distributed to the Canadian beneficiaries as a tax-free capital distribution. The February budget will result in the taxation in the hands of the beneficiary when there is a distribution of any of the trust's previously untaxed accumulated income, whether or not it has been reclassified as capital.
The February 16, 1999 budget also proposes that where a "Canadian resident transfers or loans property to a non-resident trust, the trust be treated as being resident in Canada and be taxed [at the highest marginal rate] on all of its undistributed income". (3) An immigration trust is excluded from these budget provisions during the four to five year period following immigration, and therefore the trust will not be deemed to be a resident of Canada merely because the immigrant gave or lent the trust income producing assets.
IV. INCOME ATTRIBUTION:
Notwithstanding the special treatment for immigration trusts, it is still possible that the immigrant will be subject to taxation in Canada on trust income that has not been distributed to beneficiaries in Canada. In particular, subsections 74.4(2), 75(2) and 56(4.1) of the Income Tax Act may cause taxation in the hands of the immigrant in certain instances where the immigrant has gifted or lent property to the immigrant trust or a corporation owned by the immigrant trust. The rules are extremely complex and beyond the scope of this paper. Needless to say, extreme care must be taken in the creation of the immigrant trust structure to avoid taxation. It is not uncommon for the structure to involve loans, redeemable shares and several trusts and corporations.
V. A COMMON IMMIGRATION TRUST STRUCTURE:
A commonly used structure is the following:
a non-resident (other than the immigrant) establishes an immigrant trust with the immigrant as capital beneficiary. Other beneficiaries may include adult children, and, provided there are prescribed restrictions on when funds can be distributed, minor children and the spouse. To ensure that the trust is a discretionary trust, someone other than the resident (perhaps a favorite charity) is also a beneficiary.
the trust purchases common shares of a corporation resident in a tax haven jurisdiction (using funds provided by someone who is not and will never be a resident of Canada). Care is taken to ensure that the corporation never becomes a resident of Canada.
the immigrant transfers the income producing assets to the corporation for redeemable retractable non-cumulative preferred shares
the immigrant gives the shares to the immigrant trust
no dividends are paid on the preferred shares
if the immigrant requires funds the trust will retract the preferred shares and transfer the funds to the immigrant as a capital distribution
the corporation never declares dividends on the common shares and therefore the trust has no income. Income accumulated in the corporation is only transferred to the trust after it has migrated to Canada and other steps have been taken to ensure that this can be done on a tax-free basis.
This article deals with complex issues in a brief manner, it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained herein. Although every reasonable effort has been made to insure the accuracy of the information contained in this publication, no individual or organization involved in either the preparation or distribution of this publication accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.