Tax Traps in Canada – U.S. Personal Tax Planning Jack Bernstein 416.865.7766
[email protected]
Aird & Berlis LLP Toronto 2013
Canadian Citizen Married to U.S. Citizen (both resident in Canada) and have children • Accumulate assets for asset protection in name of U.S. spouse • Canadian residence in name of U.S. citizen • Provides all assets to surviving spouse • Personal life insurance on both spouses • Use a Canadian discretionary irrevocable trust in an estate freeze – U.S. citizen children are beneficiaries • U.S. estate tax, throwback rule for trust
2
U.S. Citizen Married to Canadian Citizen and have Children • U.S. citizen puts house and other investments in name of non-U.S. spouse • U.S. citizen does Canadian style estate freeze – exchanges common shares for retractable preference shares with discretionary dividends. New common shares (future growth) issued to new Canadian family trust
• Buys homes for children • U.S. citizen forms an Ontario corporation to be holding company for passive investments • U.S. gift tax and CFC issues 3
Canadian Resident Purchases U.S. Insurance Policy • Mark to market vs. exempt policy
• No deferral of tax in Canada on accumulating income
4
Canadian Resident - Tax On Death • Dies with Canadian and U.S. assets
• Leaves all assets to spouse (non-U.S. citizens) • Accountant does rollover in Canada • Files U.S. estate return late and pay U.S. estate tax • No foreign tax credit in Canada for US estate tax if claim spousal rollover on Canadian tax on death
5
Canadian Resident - Instalment Sale • Instalment sale of U.S. property for 6 years
• FIRPTA withholding of 10% of price • Capital gains reserve claimed in Canada over 5 years • Canadian accountant files U.S. tax return in year 6 • Double tax as Canada requires reporting of gain over 5 years and US only report gain in year 6. • Lose FIRPTA withholding if don’t file within 2 years
6
Canadian Resident forms Barbados IBC to Carry on Business in U.S.
Canadian
IBC
• Carries on trade or business in U.S. • Avoids Canadian tax but attracts U.S. tax 7
Trust Traps • Canadian non-grantor trust for U.S. beneficiaries:
• FPHC • Throw back rules
• If resident in U.S., problem on 21st anniversary
8
Conversion of Canadian Limited Liability Company to ULC • Liquidation for US tax
9
Canadian and U.S. Residents Form Partnership • Non-Canadian partnership
• Impact on rollover - no rollover in Canada if any partner is a non-resident • Canadian withholding tax on rent paid to partnership • e.g., Canadian wants to develop his land. American will fund construction, Canadian wants to rollover land to partnership with American. No rollover
10
Green Card Holder in Canada • Tie breaker clause – impact on green card
11
Permanent Establishment • Canadian corporation with U.S. warehouse and sales representative doesn’t file U.S. return • Risk is loss of U.S. deductions
12
Incorporation of U.S. Real Property Interest Before
After
Canadian
Canadian
CANCO
U.S. C Corp
Partnership
U.S. real estate
U.S. real estate
U.S. C Corp
Partnership
• Wants to rollover shares of U.S. C Corp and U.S. partnership interest to a Canadian corporation (Canco) to avoid estate tax FIRPTA • Need to elect 897 i IRC to treat Canco as U.S. domestic corporation; then 85(1) ITA and 351 IRC can both apply and no FIRPTA; effective for estate tax 13
Canadian in U.S. Real Estate Partnership Canadians
Americans
U.S. Partnership U.S. Shopping Centre
• U.S. real estate
• Sell property and like kind exchange (defer tax in U.S. not Canada) • Refinance mortgage and distribute to partners (negative basis allowed in U.S., capital gain in Canada) 14
Canadian Citizen has Personal Account in the U.S. • Makes gifts to Canadian Children from U.S. account • U.S. gift tax
15
Canadian Individual Directly Owns U.S. Company Canadian
U.S. C Corp
• • • •
Estate tax U.S. Withholding tax at 15% Tax on dividends in Canada at 49.9% (top rate) If use Canadian holding company, no estate tax, U.S. withholding at 5% and tax on dividends from Canco 36%. No tax in Canco if exempt surplus
16
U.S. Condo Rights Canadian
Canadian Holdco
U.S. C Corp
• Sale of condos and dividends
• Better to wind up U.S. C Corp and avoid U.S. withholding on dividends 17
Regulation 105 Traps • Mixed use contract of software royalties and installation: Canadian withholding tax of 15% on all payments • Legal services in U.S. and Canada
18
Capital Dividend Trap U.S.
Canadian
Canadian Company
1)
Capital gain realized by Canadian company – capital dividend paid to Canadian and U.S. dividend only tax-free for Canadian resident, subject to 15% withholding if paid to American
2)
Canadian related shareholder forms Canadian Holdco to buy shares of U.S. - deemed dividend (withholding at 15%) rather than tax free capital gain 19
U.S. Real Estate Development
Canco
U.S. C Corp.
-
No employees Building homes FAPI not active business income
20
Passive Foreign Investment Company Canadian
U.S.
1/3
2/3
Canco
-
Sale of rental property and reinvestment of proceeds American taxed currently on sale
21
U.S. Personal Residence
Canadian Individual
Canco
-
U.S. Co.
BVI Co.
Taxable benefit in Canada based on prescribed rate times greater of cost and fair market value of property
22
No Consolidated Reporting Canadian Resident
Canco
CanSub #1
-
CanSub #2
CanSub #3
U.S. LLC
U.S. C Corp.
U.S. Partnership
U.S. Real Estate
U.S. Real Estate
U.S. Real Estate
Restructure with Canco owning a U.S. C Corp which owns all other U.S. entities 23
Restructure Canadian Resident
Canco
CanSub #1
CanSub #2
CanSub #3
Canadian Holdco
U.S. Co
U.S. LLC
U.S. C Corp.
U.S. Partnership 24
LLC Traps UK
US
US LLC
Canco
• No treaty relief for UK members
25
LLC Traps
Canco
American
LLC • • • •
Real Estate Development, less than 6 full-time employees Not active business for Canadian tax No foreign tax credit in Canada for 1446 withholding Proposed amendment to allow credit
26
LLC Traps
C Corp
NSULC
• Cash dividend 25% Canadian withholding tax
• Need increase and decrease in paid up capital of NSULC to get treaty relief (5% rate of withholding tax) • May also be possible to pay a stock dividend and get treaty relief
27
LLC Traps
LLC
NSULC
• No treaty relief • No ability to avoid IV(7)(b) with increase in paid-up capital
28
LLC Traps
Canco
LLC
US Business
• US corporate and full branch tax (no reduction under Article X for branch tax)
29
LLC Traps
Canadian Individuals
LLC
Rental Property
• Losses and sheltered cash flow locked into LLC. Distributions from LLC fully taxable to Canadian individuals. Exposure to US estate tax
30
LLC Traps
Canco
LLC
Only manager resident in Canada
• LLC managed and controlled in Canada. Not deemed to be US resident under Treaty • If C Corp instead of LLC, deemed resident for Treaty purposes but should have mind and management in US for exempt surplus 31
Canadians
Americans
LLC
• NOLs from business
• Canadians report loss on personal tax returns - mistake
32
Ownership of Canadian Cottage by Americans • Personal • Partnership • Canadian corporation • LLC • Trust • Taxable benefits • Tax on death
• 116 Certificate
33
Thank You Jack Bernstein Partner T 1.416.863.7766 F 1.416.863.1515 E
[email protected]
Doc No.: 14472999