Volume 3, Number 2
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 on the information herein.
Under Canadian income tax laws, new immigrants to Canada are able to shelter income from Canadian tax for a period of up to 60 months through an immigrant trust.
An immigrant trust is an international trust established by a person who has immigrated to Canada, and who has not previously been resident in Canada for 60 months during his lifetime. The immigrant may establish the trust, either before or after becoming a resident of Canada, with a contribution of property to the trust. However, if the trust is established after he becomes a resident, the 60-month tax exempt period is reduced by the number of months in which he was Canadian resident. In addition, if the property contributed to the trust has appreciated in value, then the immigrant will be subject to capital gains tax in Canada on the appreciation when the property is transferred to the trust.
The beneficiaries of an immigrant trust are typically the immigrant and family members who have moved to Canada.
The tax consequences on a contribution of property to an immigrant trust in the immigrant's country of origin should be kept in mind in the design of the trust. For example, persons moving to Canada from the U.K. may remain subject to U.K. inheritance tax for five years. If not carefully structured, this tax, at 20%, can be a very unwelcome surprise.
An immigrant trust is typically established in a tax favourable jurisdiction, and therefore no tax is payable on the income or capital gains earned by the trust. In this way, income accumulates on a tax-free basis in the trust, which becomes part of trust capital under trust law principles. Capital can be paid to beneficiaries tax-free, and therefore the accumulating income once capitalized, will not be subject to Canadian tax, even if distributed to Canadian resident persons.
Although the immigrant trust was designed to last for five years, it can be useful to keep the trust beyond this timeframe. If a beneficiary later ceases to be Canadian resident, the departure tax rules could be avoided for property held by the immigrant trust. It may also be possible to distribute income to non-residents and thereby prevent Canadian tax in the trust once it loses its exemption.
Following the expiration of the 60-month tax-exempt period, the immigrant trust is deemed to be Canadian resident. These rules provide that the exemption period ends at the beginning of the calendar year in which the settlor completes the 60th month of his Canadian residency. Therefore, without proper tax planning, the actual exemption period could be less than 60 months.
Planning is available to ensure that immigrants benefit from the entire 60-month tax-exempt period. For example, by changing the residence of the immigrant trust to Canada, the trust would be deemed to have a year-end immediately before the date on which the trust became Canadian. The preceding period would be tax-exempt. In addition, there is a step up in the cost base of the trust assets at that time, and thus the appreciation in the underlying value of the trust assets is not subject to Canadian tax. Alternatively, the immigrant trust could be wound up immediately before the end of the 60th month. The trust assets could be distributed on a tax-free basis to the beneficiaries as capital distributions. As stated earlier, capital distributions are not taxable to Canadian residents.
As many as 200,000 people immigrate to Canada each year. Of those, a sizeable number have over $1 million in investable assets (the threshold to make this planning feasible). Many do not take advantage of the opportunity.
This planning can also be applied to executives who come to Canada to live, but earn a component of their salary from outside Canada. This foreign salary can sometimes be structured to be income of the trust, making it free of Canadian tax.