The Canadian federal budget, released on 4 March 2010 (Budget 2010), proposed important international tax measures, including changes to the proposed non-resident trust rules and revised proposals on "foreign investment entities."
Draft legislation relating to these budget measures was tabled on 27 August, 2010 (the "Draft Legislation"), with some departures from the original budget proposals. The Draft Legislation is generally scheduled to become effective from 1 January 2007.
Non-Resident Trust (NRT) Rules
The Draft Legislation, if adopted, will substantially revise the Canadian taxation of offshore trusts. These revisions were first announced in the 1999 Canadian federal Budget but have not been passed into law; the August 2010 release marks the seventh iteration of proposed changes to the non-resident trust rules.
Generally, the proposed legislation makes the tax regime for foreign trusts more attractive for immigrants who have been resident in Canada for less than five years, but more onerous for long-term Canadian residents. With regard to the latter, under the Draft Legislation, a trust may be deemed to be resident in Canada where a person resident in Canada for more than five years transfers or loans property, or provides services, to the trust. The additional requirement in the existing rules for a Canadian-resident beneficiary of the trust is dropped for most purposes.
The Draft Legislation includes the following proposals:
Trustee Liable for Tax - The deemed resident trust (i.e., the non-resident trustee) remains liable for the trust's Canadian tax obligations. Should the trustee fail to pay the trust's taxes, each Canadian-resident contributor will be jointly liable with the trust for the tax, unless the contributor has elected to be attributed and taxed on the income and gains on property he or she contributed to the trust (the concept of an "electing contributor" is new to the Draft Legislation). Canadian resident beneficiaries remain jointly liable for the trust's Canadian tax obligations up to the amount of distributions received, benefits enjoyed from the trust and, from 28 August, outstanding loans from the trust.
Relief for Contributions by Non-Residents - A non-resident trust's property will be divided into a "resident portion" (consisting of property contributed by Canadian residents and certain former residents) and a "non-resident portion." The trust will be taxed in Canada on the income and gains on the resident portion. Where there is an "electing contributor", the trust's tax liabilities will be reduced by amounts attributed to such electing contributor in respect of the trust. Any income arising from the non-resident portion (other than certain Canadian-source income) will be excluded in computing the trust's income for Canadian tax purposes.
Ordering Rules for Distributions - Ordering rules proposed by Budget 2010 in respect of distributions from deemed Canadian resident trusts are not included in the Draft Legislation. Under the proposals in Budget 2010, distributions to resident beneficiaries would have been deemed to be made first out of the resident portion of the trust's income and taxable in the hands of the beneficiary. Distributions to non-resident beneficiaries would have been deemed to be made first out of the non-resident portion and would not have been subject to tax in Canada (except in relation to Canadian-source income).
Treaty Residence - The Draft Legislation proposes an amendment to the Income Tax Conventions Interpretation Act to "clarify" that a trust that is deemed resident in Canada under the NRT rules will be deemed resident and subject to tax in Canada (and deemed a non-resident of the other contracting state) for tax treaty purposes. It is unclear how this proposal will affect treaty tiebreaker rules in cases of dual residence, or trusts with contributions by residents and non-residents.
"Five Year" Trusts - The Draft Legislation, like the existing NRT rules, provides an exception for "five-year immigration trusts". Generally, a non-resident trust will not be deemed resident and taxable in Canada under the NRT rules if all "contributors" (widely defined) have been resident in Canada for less than five years. The Draft Legislation bolsters this exception by exempting immigrant settlors to five-year immigration trusts from a domestic attribution rule which would otherwise attribute the income and gains of the trust to the settlor where the trust is revocable, the settlor is a beneficiary or the settlor retains control over distributions from the trust.
Trusts on Marital Breakdown - Following a submission by Stikeman Elliott, a new exception for trusts created as a result of a marital breakdown for the benefit of a non-resident former spouse has been included in the Draft Legislation.
Loans Repaid before 2011 - The Draft Legislation proposes that certain loans made on arm's length terms and repaid to a trust before 2011 will not be considered contributions to the trust.
Additional Measures - The Draft Legislation proposes relief with respect to the application of the NRT rules to tax-exempt entities, commercial trusts and loans made by Canadian financial institutions to non-resident trusts.
Effective Date - Controversially, the NRT rules proposed in the Draft Legislation are generally set to apply retroactively from 1 January 2007 (exceptions include (i) the attribution of income to an "electing contributor" and (ii) the changes to the Income Tax Conventions Interpretation Act regarding treaty residence, which will be effective from 5 March 2010).
Foreign Investment Entities (FIE) Budget 2010 abandoned the controversial draft FIE legislation (also originally proposed in 1999), which would have tightened the rules for non-controlling interests in foreign passive investments. The Draft Legislation proposes limited amendments to the existing offshore investment-fund property rules.
The existing rules apply where a taxpayer has invested in "offshore investment-fund property" and one of the main reasons for the investment is to reduce or defer the tax that would have arisen if income from the assets of the fund had been earned directly. Where the rules apply, income is imputed based on the taxpayer's cost amount multiplied by a prescribed interest rate. The Draft Legislation proposes the following:
- an increase in the prescribed rate to the 3-month-average Treasury Bill rate plus 2%; and
- a broadening of the rules requiring certain resident beneficiaries (likely of non-discretionary trusts) to report income on a modified accrual basis.
These measures are scheduled to apply for taxation years that end after 4 March 2010.
Change to the Definition of "Taxable Canadian Property"
The Budget 2010 proposals in respect of changes to the scope of "taxable Canadian property" were enacted on 12 July 2010. Dispositions by non-residents of shares of private Canadian companies, partnership interests or capital interests in Canadian resident trusts are no longer taxable or reportable where such shares or interests do not (and did not at any time in the previous 60 months) derive their value principally from real property in Canada, Canadian resource property or timber resource property.
In the trust context, this proposal will eliminate the need for a non-resident beneficiary of a Canadian resident trust or estate to file an income tax return and obtain a tax clearance certificate on capital distributions.
We are happy to assist with any questions arising under the Draft Legislation or Budget 2010.