Volume 10, Number 1
The information in Tax Perspectives is prepared for general interest only. Every effort has been made to ensure that the contents are accurate. However, professional advice should always be obtained before acting and TSG member firms cannot assume any liability for persons who act on the basis of information contained herein without professional advice.
By Larry Frostiak, CA, CFP, TEP
Frostiak & Leslie Chartered Accountants Inc. (Winnipeg)
Suppose you are about to receive a foreign inheritance. Have you thought about the potential tax implications? Is the inheritance taxable? What has to be reported? These and other related questions are the subject of this article.
The first consideration: what type of property is to be inherited? Is it cash, marketable securities or perhaps real estate? Is it a one-time payment or an income stream? A simple transfer of cash (even where denominated in foreign currency) is the least complicated form of inheritance. When it is inherited directly from the deceased, there should be no reporting requirements for a Canadian resident beneficiary. But when the property is received from an estate, Form T1142 may need to be completed. In most cases, taxes will have been paid in the foreign jurisdiction, so the Canadian beneficiary will receive a non-taxable capital payment. But if the cash distribution represents an allocation of income from the foreign estate, it will be taxable in Canada.
The situation becomes a little more complicated where the foreign estate transfers assets "in kind" (such as a transfer of publicly traded securities). Such securities are considered to be received at a tax cost or adjusted cost base (ACB) equal to their fair market value at the time of distribution. The
ACB is determined in Canadian dollars, requiring that the relevant foreign exchange rate be applied to the fair market value of the securities when the inheritance is received. Effectively, the ACB is "stepped up" to the fair market value when the beneficiary takes ownership of the property. Valuation should not be difficult with publicly traded securities, but other types of property present a challenge.
Even if the securities are maintained in a foreign brokerage account, the beneficiary still has to report the income, gains and losses from the time of taking ownership onwards. Canada taxes its residents on worldwide income no matter where the income is earned.
Foreign investment income may give rise to foreign withholding taxes. Those taxes can be claimed as a federal foreign tax credit against the Canadian taxes payable on the foreign investment income.
If the foreign holdings have a cost of more than CAD 100,000 at any time in the year, Form T1135 (Foreign Reporting) will be need to be completed.
It is not uncommon to become a beneficiary of a foreign trust, with an entitlement to receive either income or capital distributions. Income distributions would be taxable in Canada as foreign income, while capital distributions are not. If the tax rate in the foreign jurisdiction is lower than Canada's, paying tax there and taking capital distributions will be advantageous.
Foreign Real Estate
The situation is different again if you inherit foreign real estate and retain it. Determining the ACB will depend on the property value at the time of ownership. It would be prudent to obtain a property valuation or appraisal by a licensed real estate broker at the time of the inheritance, which will be relevant should you later decide to sell the property.
Should you decide to keep the property for personal use, for example, as a residence, no annual reporting is opportunity to designate all or a portion of any future capital gain on sale for purposes of Canada's principal residence exemption.
If you decide to rent the foreign real estate out for profit, the rental income must be reported. Taxes paid to the foreign jurisdiction on net rents can be claimed as foreign tax credits on your Canadian income tax return.
If you eventually sell the property, you may have to file an income tax return in the foreign jurisdiction as well as report the gain for Canadian tax purposes. For instance, a Canadian owning U.S. real estate would file a U.S. 1040 NR income tax return and pay U.S. capital gains tax.
Do the Right Thing
Now, what happens if you have already received an inheritance and were not aware of all of the applicable rules?
The CRA has a Voluntary Disclosure Program, which permits taxpayers to come forward and disclose previously unreported income or gains and late-filed disclosure forms without having penalties or more serious sanctions imposed.
But your best defence is to follow the right procedures in the first place. Get the information you need, find appropriate help such as a tax professional familiar with the area and comply with all the pertinent tax rules.