By Andrew Rogerson LLB (Hons) TEP
Offshore trusts were widely used in the past by Canadians to effect savings of domestic taxes. By degrees the Canadian Government has amended the Income Tax Act to attempt to deem offshore trusts, in certain circumstances, to be domestic trusts (with the tax consequences that follow for both trust and beneficiaries). Currently rules promulgated pursuant to s94 ITA deem the trust to be domestic if two conditions apply. Firstly, there must be at least one Canadian resident beneficiary. Secondly, person/s “contributing” assets to the trust (normally the settlor, but it may be persons who, after initial settlement, provide further funds to the trust) who are Canadian residents in the following categories:
(b) persons related to the beneficiaries and (c) extended relatives of the beneficiaries such as aunts, uncles, nephews and nieces. As to the Canadian residence of the contributor, in order to fall foul of these deeming rules, the contributor needs to have been a Canadian resident in the 18 month period before the end of the taxation year concerned, if the contributor is an individual, he must have been resident in Canada for any period or periods totalling 60 months. Accordingly, the residence requirement accommodates the immigration trust, which enables new immigrants to shelter income producing property for 5 years until they decide if they wish to remain permanently in Canada.
If the deeming provision under s94 applies, then the trust is treated as a Canadian resident taxpayer. In such a case, the trust is taxable on the following: (a) undistributed (that is, to beneficiaries) income from Canadian sources; (b) the amount that would be its “foreign accrual property income” if the trust were a foreign corporation owned by a Canadian shareholder and (c) income from an investment in a foreign investment entity” (“FIE”). The calculation of the amount of taxable income takes into account payment of relevant foreign taxes. So far as the income is distributed to beneficiaries, the trust secures a deduction under s94(4) (as would be the case if the trust were a domestic trust).
For some years, the Canadian Government has proposed changes to s94, and the Rules made thereunder, to make offshore trusts less attractive from the income tax perspective. The latest proposals were contained in a Notice of Ways and Means Motion in November 2006. If they find their way into law, they will be effective for taxation years commencing 2007. The amended s94 and Rules seek to widen the tax net considerably. For deeming to take place, it will now be sufficient for there to be a Canadian resident contributor – or – a Canadian resident beneficiary (provided the beneficiary is ‘connected’, as before, to the contributor. (The previous regime required both). The residence requirement has been changed somewhat. Much simplified, the contributor must not have been a resident of Canada in the period of 5 years prior to the contribution being made.
Generally, non-resident trusts established by Canadian settlors (contributors) to benefit non–resident beneficiaries are caught by the new rules.
The above is all predicated on the basis of a “contribution” being made to the trust. If the trust acquires assets at arms length, then there is no nexus to trigger the deeming provisions. Also excluded from the ambit of the rules are offshore trusts established by Canadian residents to (a) look after beneficiaries with mental and physical deformity; (b) provide for a child upon the breakdown of a marriage; (c) provide benefits for non resident employees and (d) certain types of investment trusts. Separate from the above rules, there will be a deemed disposition upon transfer of assets into trust as with a conventional domestic trust settlement. This will also occur upon death of the settlor, after 21 years and upon the death of a beneficiary. This will not increase the level of tax levied, as the cost base of the assets increases each time. Nothing above impacts upon, say, overseas grandparents, who have never lived in Canada, establishing an offshore discretionary trust for their Canadian resident children and grandchildren. Payments to such beneficiaries of capital and capitalised income will be free of Canadian income tax.