By Peter Megoudis, LLM, BCL, LLB
Individuals who relocate to Canada have a whole series of tax issues they typically worry about: “will Canada tax my trailing bonuses from my former employer?”; “if I sell my foreign house the day after I arrive in Canada, will Canada tax the whole gain realized on it?”. (The answers, by the way, are “yes” and “no”.) What is often overlooked, however, is that offshore family trust that was settled years ago by either that individual, or a member of his or her family: “certainly, Canada cannot concern itself with a trust that was created a long long time ago in a country far far away?!” Unfortunately, subject to a few exceptions, it is likely that Canada will indeed concern itself with such trust, and seek to tax its income and gains.
There are basically three ways that the income and gains of such offshore trust can be subject to Canadian tax.
First, the trust can become “factually resident” of Canada by virtue of having its mind and management exercised in Canada. For example, if that incoming individual is the sole trustee of the trust, and he or she is, in fact, making all the decisions for the trust, then the trust will likely become itself resident of Canada on the very day the individual becomes resident. Of course, the trust will be deemed to have acquired all of its assets (except for Canadian real estate) at their fair market value (FMV) on the date it became resident, so that only gains accruing after such date will be subject to Canadian tax. Still, it will be subject to the same rules as trusts created in Canada.
This does not necessarily mean however that the trust itself will be taxable. For example, one of those rules is the attribution rule in subsection 75(2) of the Act, whereby contributors to a trust that retain control over, or an interest in, a factually resident trust will be deemed to have earned (and thus be taxable themselves on) any income or gains earned by that trust, instead of the trust. In addition, even where this attribution rule does not apply, there are other attribution rules that impose tax on contributors when the income or gains are distributed to their spouse, or when income is distributed to their minor children or grandchildren. Further, even if none of the attribution apply, the trust can avoid Canadian tax by allocating or distributing its income or gains to a beneficiary by its year end (in which case, it is the beneficiary that will be subject to Canadian tax, even if a non-resident (who will be subject to a non-resident tax of 25% on income, 12.5% on gains, or lower rate under a treaty)).
Second, the trust that is managed outside Canada can still become “deemed resident” of Canada by, for example, having one of its contributors become resident of Canada. In this way, even if an individual set up a trust in, for example, China 70 years ago, and comes to Canada 70 years later, the trust will become a Canadian resident trust on January 1 of the year he or she becomes a resident, even if he is not a beneficiary and even if none of the beneficiaries are resident of Canada. Further, even if there were multiple contributors to the trust, and the new Canadian’s contributions only represented, say, 1% of the total contributions, the whole trust will become subject to Canadian tax unless a special election is filed by the trust’s filing due date for the first year in which it becomes deemed resident (in which case, only 1% of the income or gains is subject to Canadian tax). This often comes as a huge surprise to incoming Canadians with some family wealth, as it does appear to violate the “long long time ago in a country far far away” principle. Further, it should be recalled that the old “immigrant trust” exception, whereby such deemed resident trusts escaped Canadian residency for the first 5 years of the contributor’s Canadian residency, was repealed in 2015; as a result, if a contributor first becomes resident on, say, April 1, 2017, the trust will be deemed resident as of January 1, 2017.
Third, even if a trust does not itself become factually or deemed resident of Canada (for example, it is managed outside Canada and none of the contributors to the trust have ever been Canadian residents), a Canadian beneficiary who receives a distribution or allocation of income or gains from such trust will be subject to Canadian tax, at ordinary graduated rates (i.e., as “foreign investment income”) on such income or gains. This actually creates a planning opportunity whereby such trusts only allocate and distribute their current year income or gains after December 31. Such subsequent year allocations will be treated as tax free capital in Canada. Such trusts are typically referred to as “granny trusts”, in honor of all the non-Canadian grandmothers who set up trusts for their Canadian grandchildren.
Finally, one must also consider any potential foreign taxes that may be imposed on the income or gains realized by all three types of trust, and whether there will be double taxation, or whether foreign tax credits can be claimed to reduce the incidence of double taxation. That will be the subject of a forthcoming article.
To be continued…