In an abrupt change of policy, Budget 2014 proposed to eliminate the immigration trust regime. These trusts have been used for nearly 30 years to mitigate tax on the assets of a new immigrant to Canada. Draft legislation to implement this proposal was released on August 29, 2014.
The rationale in Budget 2014 for repealing the immigration trust regime is that such "benefits are not available to Canadian-resident persons who earn similar income directly or through a Canadian-resident trust. The 60-month exemption raises tax fairness, tax integrity and tax neutrality concerns."
There are several issues to consider before responding to these changes, including estate planning, asset protection, confidentiality, tax, trust administration costs and the impact on beneficiaries in other jurisdictions. Often, unless there are non-Canadian tax reasons for maintaining the structure, the immigration trust is wound-up.
This note provides high level comments on several considerations/options from a Canadian tax perspective. There is no perfect solution and the choice of alternative will likely depend on the facts and circumstances of each case. This is not an exhaustive list and other options may also be considered depending on each situation.
The draft legislation is effective from Budget day (February 11, 2014); and so no new tax-favoured immigration trusts can be established from that date. However, there is a transitional rule for existing immigration trusts under which a trust's favourable tax status will be eliminated from January 1, 2015. In order to benefit until year-end 2014, no contributions can be made to the trust (or underlying structure) after February 10, 2014 and before 2015. Accordingly, trustees should not accept additions to an existing immigration trust without taking advice in advance to quantify the implications.
Maintain trust outside of Canada
If no action is taken in 2014, the trust will become deemed resident and taxable in Canada on its worldwide (generally undistributed) income. The applicable tax rate will be approximately 43% for income and 21.5% for capital gains. The foreign trustee will be directly liable for tax in Canada and required to file tax and relevant information returns in Canada. Canadian withholding tax (at a rate of 25% unless reduced by treaty) would apply to income distributions to non-Canadian resident beneficiaries. If the trustee fails to comply with its Canadian tax obligations, Canadian resident contributors to the trust are jointly liable (generally without limit) for the unpaid tax and reporting obligations of the trust. Such joint liability of Canadian resident beneficiaries is generally limited to the amount of distributions received.
Migrate the trust to Canada
The migration of a trust to Canada can generally be achieved by having the foreign trustee resign in favour of a Canadian resident trustee and ensuring that the mind and management of the trust is located in Canada. The Canadian trustee would be subject to tax in Canada going forward on the trust's worldwide (generally undistributed) income at tax rates ranging from 39%-50% (and half that for capital gains) depending on the Canadian province where the mind and management of the trust is located. Canadian withholding tax would also apply to income distributions to non-resident beneficiaries.
Terminate the trust
Where the trust is wound up and the assets distributed to a Canadian resident beneficiary, the beneficiary will become subject to tax in Canada on the worldwide income generated by those assets. The highest marginal tax rates applicable to the beneficiary will be similar to those for a Canadian trustee. However, the beneficiary will benefit from graduated tax rates; while a trustee pays tax at the highest marginal rate. The beneficiary will want to review his will, enduring power of attorney in the event of incapacity and the provincial probate tax implications. Upon death, the beneficiary will be deemed to dispose of his assets at fair market value, giving rise to taxation of unrealized gains. On the other hand, trusts are deemed to dispose of their assets at fair market value 21 years after the day the trust was created (and every 21 years thereafter) resulting in the taxation of gains for the trust. An analysis of the practical consequences of such rules will be required to determine the best alternative.
Emigrate from Canada
It may be possible to avoid the trust being taxed in Canada if all of the settlors and beneficiaries emigrate from Canada in 2014 or all of the settlors emigrate and Canadian residents are excluded from benefit (or qualify as "successor beneficiaries" (as defined to generally include persons who become beneficiaries after the death of a contributor to the trust)) in 2014. A settlor includes any person who has made a contribution to the trust. In this event, all such persons must sever their ties with Canada prior to December 31, 2014. Also the trust cannot be effectively managed and controlled from Canada. The trust may remain resident in Canada if it has Canadian resident beneficiaries (broadly defined).
Step-up cost basis
In all cases (except perhaps where the family emigrates from Canada), the trustee should consider the manner in which the cost basis of the assets held by a trust and underlying company can be increased to fair market value for Canadian tax purposes for the trustee (if the trust remains extant) or for the beneficiary (if the trust is terminated).
Canada remains attractive where family members who do not own the family wealth live in Canada.
Gifts or bequests made by a non-resident to a Canadian resident through a trust are attractive for Canadian beneficiaries. The trust should not be deemed resident in Canada where the trust's sole Canadian connection is a beneficiary resident in Canada. Canadian resident beneficiaries should not be taxed on the receipt of capital distributions (as determined for Canadian tax purposes) including income and gains from prior years capitalised by the trustee. All distributions (whether of capital or income) must be reported by the Canadian beneficiary. By contrast, where a gift or bequest is made to the Canadian directly, the Canadian will be subject to tax in Canada on worldwide income (and gains) earned from the gift or bequest. Thus, non-residents gifting assets to Canadians or making provision for Canadian residents in their will should consider transferring the property to a trust for the benefit of the Canadian, rather than directly.