By Puneet S. Kohli
According to a Budget proposal announced in February 2014, the Canadian federal government will be eliminating the immigrant trusts regime under which persons relocating to Canada could utilize these trusts to reduce their tax burden. The draft legislation to implement this proposal was released on August 29, 2014. It had been in effect for over three decades.
In general, the proposal will adversely affect all individuals who have relocated to Canada and have also established immigration trusts. More specifically, the provisions will impact US citizens who use US trusts in their estate planning – for instance, the revocable living trust and the irrevocable life insurance trust. In most instances, these trusts were so structured as to qualify as immigration trusts under Canadian tax laws.
Under the regime, an individual immigrating to Canada could establish an immigration trust to avoid Canadian tax on the income generated on the trust assets for up to five years. Its elimination has been sought as its raises fairness, integrity, and neutrality issues in taxation, especially because the benefits accruing to immigrants through these trusts are not available to Canadian citizens and residents, and Canadian-resident trusts.
The immigration trust was a specific tax benefit to immigrants, and exempted him/her from income and capital gains tax on income-producing assets for five years, provided these assets were transferred to an immigration trust. An important perquisite for the tax exemption was that the trust had to be located and controlled outside Canada.
The following are the typical characteristics of an immigrant trust:
- The trust is settled in a low-tax jurisdiction by way of a gift of assets from the immigrating individual which produces income or accrue capital gains
- The trustees are non-residents of Canada
- The beneficiaries may include the person immigrating
- All trust investments are made outside Canada (any investments in Canada may lead to Canadian withholding tax under Part XIII of the Act), and
- The trust indenture requires that the annual income be accumulated in the trust but gives the trustees the power to make capital contributions to the beneficiaries
The draft legislation stipulates that no new tax-favoured immigration trust can be formed from 11 February 2014 – the day the federal Budget was announced in the Parliament. The existing trusts have been provided up to 1 January 2015 to transfer their income-generating assets from a non-resident immigration trust to a resident Canadian trust.
Existing immigration trust will have to factor in these changes, and will need to have a transition plan in place before 31 December 2014. Thereafter, the trust will be deemed a resident in Canada and will be taxed on its worldwide income at the rate of 43% on income and 21.5% on capital gains. In addition, Canadian withholding tax up to 24% would apply to income distributions to non-Canadian resident beneficiaries of the trust.
Among the options available to immigration trusts are to migrate the trust to Canada, terminate the trust, and beneficiaries emigrate from Canada. The immigration trusts may be turned into a Canadian resident trust for the purpose of compliance with the new provisions and for tax relief. For this transition, the non-resident trustee has to relinquish control of the trust in favour of a Canadian resident, and the trust’s management and control has to be in Canada.
The tax rate applicable to the Canadian trustee after this transition on trust’s undistributed worldwide income would range from 39% to 50% and half of that for capital gains. Canadian withholding tax would apply to income distributions to non-resident beneficiaries.
It is also possible to terminate the immigration trust, and the assets distributed to Canadian resident beneficiary. In this eventuality, the applicable tax rates for the trustee will be on par with the highest marginal tax rates applicable to a Canadian trustee. However, the beneficiary may be able to avail graduated tax rates.
Those involved with such trusts should understand the implications of the new provision, and explore solutions to safeguard their interest by actively planning a strategy to mitigate their tax liabilities. The formation of the trust, the expiry of its five-year period, its assets would determine the future course of action, which would also be determined by whether the trustees can be changed, any contributions were made to the trust after 10 February 2014, and whether the trust can be unwound by 2014, and whether it transforms into a Canadian trust.