Clients leaving Canada must put departure tax planning at the top of their travel checklist.
While there are easy fixes to the negative effects from last-minute packing, the same can’t be said of a rushed approach to the departure tax — a colloquial term to describe the deemed disposition under the Income Tax Act that generally requires emigrants to pay capital gains tax as if they had sold all their assets at fair market value immediately before becoming a non-resident.
Debra Moses, expatriate tax practice leader for BDO Canada in Montreal, finds nothing more frustrating than a client who asks for help with their travel already booked and a tight timeline for departure — except for one who has already left the country.
“Once you’re gone, you can’t do any planning, because you’ve already triggered the tax,” Moses said.
Emigrants whose total property exceeds $25,000 in value have until April 30 in the year following their move to file forms T1243 and T1161 detailing their assets’ fair market value and adjusted cost base, as well as to arrange with the Canada Revenue Agency to post collateral to cover any deferred tax owing without incurring late filing penalties, which accrue at $25 per day up to a maximum of $2,500.
Half of any capital gains are taxed at the emigrant’s marginal tax rate for their year of departure.
Moses likes to build in plenty of lead time to talk clients through their options and then execute on strategies to minimize their tax liability. Doing so could take months or even years, depending on the complexity of their finances and the need to post collateral, known as security.
“Depending on the country you’re going to, you want to make sure that your holdings are structured properly so that your departure tax can be done in an efficient manner and you’re not double-taxing yourself,” Moses added.
Kim Moody, founder of Moodys Tax Law in Calgary, has noticed a spike in interest in departure tax matters in recent years, which he traces back to the feds enacting a new top personal income tax rate of 33% in 2016.
“That spooked a lot of high-income earners,” said Moody, who estimates his firm has helped 600 clients prepare to expatriate while Prime Minister Justin Trudeau has been in power. That’s many times greater than the number of departure files he’d handled in the two-plus decades he’d practised pre-Trudeau.
“Not all of them have actually pulled the trigger and left,” he added.
Once a client considers giving up their Canadian tax residency, much of Moody’s focus turns to which of their assets could fall into one of the five major categories of exceptions to the deemed disposition rule:
- Canadian real estate
- Property of a business carried on through a permanent establishment located in Canada
- An “excluded right or interest” as defined under the Income Tax Act, which includes RRSPs, RRIFs, TFSAs, life insurance policies, pension plans and interests in certain Canadian-resident trusts
- Unexercised employee stock options
- For short-term Canadian tax residents, certain assets owned before or inherited during a stay in the country of five years or less
Typically, the major assets left subject to the deemed disposition include investments held in non-registered accounts, shares in private corporations and real estate outside Canada — including vacation properties for personal use.
Kris Rossignoli, a cross-border tax and private wealth manager partner with Cardinal Point Wealth Management in Toronto, frequently handles departure tax issues for U.S.-bound clients.
“Every family and every person is unique,” he said, explaining that the firm creates a personal net-worth statement for anyone looking to depart Canada that allows them to study the implications of the tax.
Rossignoli said clients with business interests may wish to pay out from their corporations’ capital dividend accounts before ending their Canadian tax residency, in order to avoid withholding taxes that become due when the company makes distributions to non-residents under the Canada/U.S. Tax Treaty.
Eligible individuals approaching their Canadian departure date may also wish to fund retirement compensation arrangements, individual pension plans or other vehicles that meet the definition of an “excluded right or interest” exempt from the deemed disposition under the Income Tax Act, Rossignoli added.
Moody said the deferred payment election available in Form T1244 is an important tool for emigrants faced with particularly large departure-tax bills, since the election allows them to pay the owed amount, without interest, when the asset is actually disposed of. (If the emigrant owes $16,500 or less in federal tax due to their deemed disposition of property, they don’t have to post security. The threshold is slightly lower for Quebec residents.)
“What we’re trying to do in many cases is to time the tax with the actual monetization of the assets, as opposed to having a fictional disposition, because that’s where you can get into cash flow issues,” Moody said. “Putting up security with the CRA used to be worse than pulling teeth, but it’s gotten better.”
Moses said clients posting security using a letter of credit from a financial institution can expect the smoothest ride from the CRA, but added that borrowing can be expensive if clients run into higher-than-expected interest rates.
Otherwise, clients may have to arrange a lien or mortgage in favour of the government on assets subject to the departure tax or put up investment instruments like publicly traded securities. In either case, Moses said the security may be held at a discount from its full value against the deferred tax owing.
“They want to have a buffer in there in case anything drops in value,” she explained.