As we get ready to celebrate Heritage Day here in Alberta, and Edmonton prepares for my favourite annual festival – the Heritage Festival – thoughts of coming to Canada and leaving Canada are fresh on my mind. I had a conversation last week about leaving Canada.
Last week, I had lunch with a financial advisor who is also a good friend. He has a client who is preparing to leave Canada, likely for about a year, and to spend that time working in Europe, in the country that he originally immigrated from. This client of his, apparently quite self-motivated, took the time to call CRA and ask about a change in residency. He was told, quite correctly, that departure from Canada results in a deemed disposition of most non-registered assets. Basically, the Income Tax Act treats a departure from Canada much the same way that it treats death. Both are viewed as the last chance to tax any appreciation on assets that one might own. There are some notable exceptions, mostly pertaining to property that CRA still has a way to tax in the future:
Real estate. You don’t have to declare a capital gain associated with a disposition of these properties on departure. This is because CRA will apply a 25% withholding tax on the buyer of a property where the seller is not a resident of Canada. This withholding tax is refundable when the seller files their taxes and pays any capital gains tax associated with the disposition of the property.
If the property was a principal residence prior to the seller’s departure, the seller could still access the principal residence exemption, even if the property was rented for as long as four years. This 25% withholding tax is a good reason to make sure that you have a good team of professionals in your corner when buying real property. Occasionally, CRA finds a buyer who did not deal with the withholding tax correctly, and these cases result in messy disputes.
- Registered and similar assets. Property held in RRSPs, RRIFs, PRPPs, TFSAs, Pensions, LIRAs, LIFs, RESPs, EPSPs, DPSPs, RCAs, and RDSPs is not deemed disposed upon departure. Because the underlying assets are registered with CRA and held by a Canadian financial institution, CRA will apply a withholding tax on withdrawal. These withholding taxes are refundable if the non-resident subsequently files a Canadian tax return and pays tax on the withdrawal. Non-residents making withdrawals from registered plans must decide whether it is better to only pay withholding tax, or to file a tax return. There are many other issues associated with non-resident owners of these various plans.
- Shares and other property of the taxpayer’s own business. If an emigrant owns shares of, for example, Power Corporation, in a non-registered account, those shares would be deemed disposed upon departure. On the other hand, if I were to emigrate from Canada, and still own shares of Business Career College Corp, those shares would not be deemed disposed. The rules concerning ownership of shares by non-residents are very complex and will always require competent professional tax advice.
Insurance contracts. Insurance contracts, other than seg funds, are exempted from this disposition. On departure from Canada, a life insurance policy with a cash value greater than its adjusted cost basis is not deemed disposed. However, the emigrant will become resident in another jurisdiction, and that jurisdiction may apply its own tax rules to the policy.
For example, a resident of the United States will likely have to report any Canadian policy owned against the US equivalent of the exempt test. (This is the test in Canada that limits how much value can accrue in a life insurance policy before it becomes taxable. In Canada, we use the Maximum Tax Actuarial Reserve, or MTAR. The US equivalent is the Modified Endowment Contract test, or MEC.) The problem here is that Canadian insurers typically don’t report in a manner that is useful for US tax reporting. While there may not be a disposition, other consequences can be just as damaging. As with a business, qualified advice is necessary for somebody leaving Canada with a life insurance policy.
With respect to real estate and shares, an election is available on departure. The emigrant can elect to pay the tax on a gain, rather than defer that gain. This can make sense for somebody who is leaving early in the year and hasn’t yet earned a lot of income. Departure results in a shortened tax-year. For example, Alice is leaving Canada in February, and has earned $20,000 to this point. She owns a rental property with a $50,000 capital gain on it. Rather than defer the gain, she elects to have the rental property deemed disposed, bringing her taxable income for the year up to $45,000, keeping her in a low tax bracket. She has increased the ACB for her property at a very low tax cost.
Now, I know those of you who are familiar with these issues are champing at the bit, saying, “but this client will only be gone for a year.” This raises an important question. For any of what I have written so far to be true, the taxpayer must be emigrating, or changing residency. If you’re only leaving the country for a year, with the intention to return, are you really leaving. This is a very complex question without a clear answer. Based on my conversation with my friend, I would suggest that the client in question is not actually severing residential ties with Canada.
Generally, to be considered an emigrant, you must take several steps. CRA will consider a set of ‘primary tests’, which include dwelling place(s), location of the spouse or partner, and the locations of dependants. That doesn’t tell the whole story, though. A range of secondary tests also consider the locations of personal effects, social ties, economic ties, health care coverage, driver’s license, passport, and memberships in professional organizations. Further, the intention to return is an important factor. CRA’s Folio S5-F1-C1 actually does a pretty good job of explaining this.
The whole conversation emphasizes the importance of professional advice. If this client had just called CRA and not discussed this with an advisor (who also talked to a professional accountant about this issue), they might have done a lot of unnecessary work. The agents at CRA, as helpful as they might be, are not trained to ask the full set of client discovery questions that a good advisor will ask.
With an increasingly mobile workforce, and more Canadians who have ties to another country, advisors should be prepared to discuss these issues with clients. It’s not necessarily a matter of becoming an expert, but knowing when to seek expert advice is a must.