Article by Jonathan Wright. Click here for homepage.
In an increasingly global world it is becoming more common for estates to have foreign beneficiaries.
This type of estate poses certain challenges from a tax perspective. For clients with non-resident friends and family members it is important to identify potential issues for their estates in the planning stage. The purpose of this note is to highlight some of these potential issues and provide suggestions as to how they might be avoided.
Distributions from an estate are either from income or capital.
For income (dividends, rent, etc.), the Income Tax Act (the “ITA”) generally imposes a 25% withholding tax on the estate. This means that on distribution, the estate has to keep back 25% (or less if a tax treaty applies) and remit it to the government on behalf of the non-resident beneficiary.
The capital of an estate is the assets the estate holds. On distribution of capital to a Canadian beneficiary the property typically is transferred out of the estate at cost. In other words:
1. Archie passes away on January 1 with an estate worth $100 (100 shares of Chok’lit Shoppe Inc.);
2. Archie’s estate distributes the shares to Betty on March 1 when the shares are worth $200;
3. The result is that Betty receives the shares at their cost ($100) and no tax is payable by the estate on distribution.
However, on distribution to a non-resident beneficiary, generally speaking the provision above will not apply. There are two results of this:
1. Archie’s estate is considered to have disposed of (sold) the asset at fair market value; and
2. The beneficiary (Betty) is considered to have disposed of her interest in the estate+ at an amount calculated under a fairly complex formula.
In the example above, Archie’s estate would have a capital gain of $100 ($200-$100) and would be liable for tax on the distribution. For Betty, in most circumstances, the rules in the ITA would cause her not to have any capital gains.
Options for the Executor
One strategy for avoiding tax on distributions to non-residents (assuming it is possible under the terms of the will) is to allocate assets with high cost to the non-resident beneficiary. Cash is a good example. If it is capital under the estate, there will typically be no tax payable by the estate or the non-resident beneficiary on a distribution of cash.
Another option might be shares with a cost base close to its value, perhaps because the shares were recently purchased or have otherwise held steady in value since that time. For these also there will typically be low or no tax payable by the estate or the non-resident beneficiary on distribution.
Taxable Canadian Property
Another potential source of liability for estates with non-resident beneficiaries arises where the estate is composed in part or entirely of Canadian real estate.
A non-resident beneficiary’s interest in an estate may derive more than 50% of its value from Canadian real property (or certain resource or timber property in Canada). If so, her interest in the estate is considered “taxable Canadian property” (“TCP”) under the ITA and is thus subject to certain additional tax rules.
The TCP rules require a clearance certificate on the sale (or involuntary disposition, as in these circumstances) of TCP. If a non-resident receives a distribution of real estate from an estate and does not apply for a clearance certificate, the tax owing by the estate will be equal to 25% of the entire cost to the trust of her interest (in the example above, 25% of $200) rather than merely tax on the capital gains ($0).
The simple solution for this is to ensure that the beneficiary obtains a clearance certificate. This lifts the potential tax burden from the estate and ensures that the beneficiary is only taxed on the applicable capital gain.
If an estate has a non-resident beneficiary (and particularly if there is a significant amount of Canadian real estate in the estate), it may be worth contacting a tax professional to see how the rules in the ITA will apply and whether planning can achieve a better tax result.
If you are needing tax advice, including advice relating to estates, please do not hesitate to contact the author at firstname.lastname@example.org or 604.678.4459, or visit our website at wrightlegal.ca.