Leaving Canada? Tired of the cold weather or the higher taxes, whatever your reasons might be, do not forget to pay Canada at your exit.
Yes, there is a departure tax whenever a tax resident of Canada emigrates (cease to be a Canadian tax resident) from Canada. In fact, this is the top inquiry of the people leaving Canada. You cannot leave it for the last minute, it requires a pro-active planning. Don’t worry, there are some exemptions too.
Departure Tax in Canada
The concept of departure tax in Canada is a critical element in Canadian tax system. particularly affecting those who are emigrating from Canada i.e. relocating outside of Canada.
This tax regime ensures that the Canadacollects taxes on any unrealized capital gains on certain types of property owned by individuals who are ceasing their Canadian residency. Essentially, upon departure, an individual is deemed to have sold these properties at their fair market value, which can result in a taxable event known as the deemed disposition. This mechanism ensures that Canadian tax gains accrued during the taxpayer’s residency period, even if these gains have not been realized through an actual sale.
This post is for informational purposes and is not tax advice. The Internet is a dangerous place to seek tax advice, only a professional income tax advisor who specializes in emigration-related issues can provide such advice. Readers must exercise caution while relying on this reading alone.
Tax Residency & it’s Interaction with Departure tax
Tax residency and departure tax in Canada are closely interconnected, and understanding this relationship is crucial for individuals planning to emigrate from Canada.
Tax Residency – Becoming Non-Resident of Canada
Understanding the implications of tax residency status on departure tax is vital for effective tax planning. Individuals planning to leave Canada should assess their residency status and understand how changes in this status will impact their tax obligations.
Tax residency in Canada is determined based on several factors, including the length of stay in the country, the existence of residential ties (like a home, family, and economic relationships), and intention to return or stay. In Canadian domestic tax law, they are considered primary and secondary residential ties. The Canada Revenue Agency (CRA) considers these factors to decide whether an individual is a tax resident of Canada.
If you still have ties with Canada but left Canada you may be a factual resident of Canada.
Now, there is another set of laws that can override the domestic tax law! Canada’s tax treaties with other countries can impact tax residency determinations, especially in dual residency scenarios. These treaties often contain “tie-breaker” rules to determine in which country a person is considered a tax resident. If an individual becomes a tax resident of another country because the tie-breaker rules decide the tax residency, such a person automatically becomes deemed a Non-Resident of Canada. This determination is crucial for departure tax obligations.
Trigger for Departure Tax
The departure tax comes into play when an individual ceases to be a tax resident of Canada.
Upon leaving Canada, residents are deemed to dispose of certain assets at their fair market value immediately before their departure. A “deemed disposition” occurs when you are considered to have disposed of certain types of property at their fair market value (FMV) at the time of ceasing to be a resident of Canada, even if no actual sale takes place.
This “deemed disposition” can result in a taxable capital gain, known as the departure tax. The departure tax essentially captures the unrealized gains on certain assets accumulated during the individual’s period of tax residency in Canada.
Can you avoid Departure Tax if you file tax returns as Tax residents of two countries?
If you keep on filing taxes as a tax resident of Canada even though you are a tax resident of another country, it can have severe negative tax consequences.
Canada requires worldwide income reporting for its tax residents. You must report your worldwide income to Canada, and in order to avoid double taxation , you can use foreign tax deductions and/or credits. Other country may require the same, and it can result in the double taxation. The problem arises with the sourcing of income. For example, a sole proprietor’s income is sourced to its country of tax residency.
Capital gains are sourced to the country of tax residency most of the times unless its a real property in another country. If the goal is to avoid departure taxes in Canada, you might end up accumulating more unrealized gains that might be taxable in two different countries without any relief from the double taxation.
Exemptions from Departure Tax
At the emigration, all the assets (other than the below) are subject to deemed disposition. Deemed disposition refers to an imaginary sale at the fair market value followed by an immediate imaginary purchase i.e. deemed reacquisition.
Not all the assets are subject to deemed disposition!
Two major categories of assets that are excluded from deemed disposition at emigration are:
- Excluded properties
- Exemption for short-term residents of Canada
Excluded right or interest of a taxpayer:
ITA Subsection 12.1(10) provides a list of “excluded right or interests” of a taxpayer for the purpose of departure tax.
A full listing is available here. Registered accounts are not subject to deemed disposition at emigration. These accounts include RRSP, RRIF, RESP, TFSA, FHSA, RDSP and different retirement accounts. It also includes interests in different personal trusts, employee benefit plans and certain life insurance policies.
Real Estate Properties Located in Canada
Real estate properties (or immovable properties) that are located in Canada are not subject to deemed disposition at emigration.
Be mindful that if you are using the property as a principal residence there is a deemed disposition and principal residence exemption is available to claim. Such a deemed disposition will also trigger an adjustment to the basis of the same property. Read more about principal residence exemption and moving from Canada here.
While real properties in Canada are not subject to deemed disposition, the foreign properties are!
These assets ae sometimes referred to as Taxable Canadian Property (TCP) so be mindful that not all the TCPs are excluded properties. Individual taxpayers who own the real estate properties using a corporation a subject to departure tax on the deemed disposition of the shares of this corporation.
Capital Property of a business that has permanent establishment in Canada, including its inventory, is an excluded property. Do not confuse it with the shares of a Corporation that are subject to deemed disposition.
Returning Former Residents – Unwinding
If a taxpayer returns to Canada and still own the property that was subject to deemed disposition on last departure can elect to unwind the deemed disposition. Unwinding requires careful planning. This article discusses subsection 128.1(6) unwinding in later sections.
Exemption for Short-term Residents of Canada
To much relief, there is provision in the Income Tax Act (ITA) that allows an exemption for the short term residents of Canada.
Short-term residency period refers to under 60 months of an individual’s Canadian tax residency in the past 120 months. The exemption only applies to the assets that were owned before becoming the Canadian tax resident.
This is a very important planning tool for those who move to Canada and want to relocate within five years. However, the assets acquired during the Canadian tax residency are subject to departure tax including the shares acquired as a result of exercising employee stock options or through simple dividend re-investment of assets in their portfolio.
How to file and pay Departure Tax?
We already had an overview of the departure tax, the next question is how to report and pay. Is there a way to defer the payment?
When to file and Pay?
The deemed disposition of assets at emigration is reported on an emigrant tax return. An emigrant tax return is due at the same time as the individual income tax return (T1) is due in Canada in the year following the emigration.
For example, if you ceased to be a Canadian tax resident at a date in 2023, you will report deemed disposition and pay the taxes in 2024 (ignoring instalments for the time being). CRA does not accept emigrant tax returns electronically and requires the paper filing of the same.
The due date is April 30th.
The assets subject to deemed disposition are reported on form T1243 and this form is attached to the tax return. Another information return T1161 is required if the FMV of all reportable properties exceeds $25,000. Missing this information return is subject to a late filing penalty.
Point of caution for DIY tax returns: not all the assets at emigration are reportable. Please read the instructions of these forms.
There might be other forms and schedules for example claiming principal residence exemption or reporting Capital gains and losses as a result of deemed disposition.
Deferral of departure tax payment
Departure tax can cause a cashflow nightmare for many taxpayers. For such taxpayers, there is an option to ‘defer’ the payment of the departure tax. The taxpayer may need to post a security with the CRA and that may involve a lengthy procedure, therefore, this process must be started well before the due date to avoid interest and penalties.
If the taxpayer wants to defer the tax payment as a result of deemed disposition, it must file form T1244 with the tax return.
- If the tax owing as a result of Capital gains on deemed disposition is $16,500 or less, no security is posted. Simply fill up T1244 and attach it to your tax return. If filed before due date, the security is deemed to be posted and accepted by CRA.
- If the tax owing is more than $25,000, and the taxpayer wants to defer the tax payment, a security must be posted and accepted by the CRA . Interest on the tax owing will accrue until the date when CA accepts the security.
What is an acceptable security by CRA?
The three most common types of securities accepted by the CRA are:
- A letter of guarantee or credit by a Financial institution in Canada
- A mortgage on a Real property located in Canada. This mortgage must be up to 75% of the appraised equity performed by a third-party appraiser. There are certain other documents required by the CRA while accepting this security.
- Shares of a private corporation in Canada. This is a bit lengthy process that only secures the deferral of the tax as a result of the deemed disposition of the underlying corporation’s share. This form of security is only accepted if the value of shares is at least twice the amount of the tax owing (2:1) and all the shares of the corporation are provided as security. CRA requires corporate minutes, articles, financials, shareholder agreements and a signed Department of justice prepared security agreement among other things. Any dividends afterwards require approval.
When an asset that was subject to deemed disposition with departure tax owing on that asset deferred is eventually sold, the deferred tax owing is due in the following calendar year regardless of the security.
Unwinding of Deemed Disposition
Unwinding of deemed disposition allows individuals who have returned to the country and re-established residency to adjust the tax implications of their previously reported deemed dispositions.
This process enables them to potentially reduce or eliminate the departure tax incurred on their previous emigration from Canada. This election applies specifically to individuals who still own the properties subject to the deemed disposition upon leaving.
Unwinding of deemed disposition has different treatments for a Taxable Canadian Property (TCP) and other property:
1. Taxable Canadian Property (TCP)
A returning resident to Canada can elect to fully unwind the deemed disposition of Taxable Canadian Property (TCP) in the year of re-entry into Canada per Para 128.1(6)(a).
The unwinding election for TCP allows the returning resident to treat the property as if it was never subject to the deemed disposition on emigration, effectively reversing the tax implications. This election essentially removes the TCP from the deemed disposition and reacquisition on emigration, subject to certain rules, especially “Surplus Stripping”. For the taxpayers returning to Canada who were long gone before 2010, there is a grandfathering rule available due to the changes in TCP definition over time.
Shares of a Canadian Corporation are considered TCP if they derive more than 50% of the value from real or immovable properties per the 60-month rule.
Basis Adjustments of TCP:
With TCP, another distinctive tax effect of deemed disposition is that it can have a basis adjustment at emigration but cannot have a step-up of basis at immigration. This can cause some planning issues.
- At the emigration, the adjusted cost basis (ACB) of the property is adjusted equal to the FMV. For example, if a TCP has an original cost of $10,000 and at the date of emigration FMV is $120,000, an accrued gain of $20,000 gives rise to the departure tax. The new ACB of this property is $120,000 now.
- Resuming a Canadian residency resets the basis of the properties owned by the taxpayer in general, however, this does not apply to the Taxable Canadian Property. Resuming the previous example, if the FMV at re-entry is $150,000, the new ACB is not $150,000, it stays the same as it was reset at the emigration i.e. $120,000
This specific treatment can leave some room for tax planning on the taxpayer’s part whether to unwind the deemed disposition or not. It grossly depends on the increase or decrease of the FMV of the property at the return.
Surplus Stripping Rules for TCP:
If a taxpayer elects to unwind the deemed disposition of a TCP, ITA Para 128.1(6)(b) applies special surplus stripping rules.
Generally, dividends paid from a Canadian corporation to the Non-Resident individual shareholder are subject to Part XIII withholding tax. Part XIII withholding tax (WHT) may have different rates depending on the tax treaty with the new country of residence and are generally lower than Capital gain tax rates. Surplus stripping rules recharacterize these dividend payments as capital gains. WHT is available to offset the tax owing as Capital gain taxes.
These surplus stripping rules become a bit of a challenge with a full unwinding.
2. Property other than TCP
The taxpayers can unwind deemed disposition of properties other than a TCP, by filing the election. The treatment is different than that of TCP. The key difference from TCP is that other properties do get a step-up of basis to the FMV at the re-entry to Canada.
This gives much of a planning room to decide whether to unwind the deemed disposition or not. If not, any deferred tax at departure becomes payable.
If yes, ITA Paragraph 128.1(6)(c) provides the adjustment to proceeds of disposition at emigration and ACB at re-entry. The adjustment reduces both of these amounts by the least of the following three:
- the amount that would, but for this paragraph, have been the individual’s gain from the disposition of the property deemed by paragraph (4)(b) to have occurred (capital gain at departure)
- the fair market value of the property at the particular time (when re-entered ), and
- the amount that the individual specifies for the purposes of this paragraph in the election
Election filing procedure
Since this is an election, it must be filed with the tax return for the year when returned to Canada, i.e. an immigrant tax return. In certain circumstances, CRA may accept a late election. Further, there is no time limit related to the return.
If an emigrant taxpayer is expecting to return in Canada after some years, it might be more convenient and better to post a security to request deferral of the departure tax. Reassessments are available even if the tax years are statute-barred.
Some Planning Options and Tips
Deemed disposition and the resulting departure tax causes a lot of planning challenges for the emigrant, now-nonresident, taxpayers. A few of them are discussed below, however, if you run into unique challenges you should reach out to an International tax accountant to assist you with that.
Important to note that only Taxable Canadian Property (TCP) is subject to Canadian taxes at actual disposition after emigration. Other properties are not subject to Canadian taxes after emigration as Capital gains are sourced to the country of tax residency of the taxpayer.
Deemed Disposition of Principal Residence
Real estate properties located in Canada are not subject to deemed disposition at emigration!
However, the emigrant elects to recognize the deemed disposition of Canadian real estate properties at departure, per ITA Para 128.1(4)(d). This is especially beneficial if the Canadian real properties have a drop in value and can result in Capital losses that can be further used to offset the Capital gains arising from other properties.
If a Canadian real property has increased in value an election for the deemed disposition of the same at emigration will result in a Capital gain. The taxpayer can then claim the Principal residence exemption, if eligible, to exclude those gains. The FMV will become a new ACB of that property. This is equally important to consider the tax treaty with the other country, as treaties do allow sometimes, step-up of basis in this situation. The U.S.-Canada tax treaty does!
Subsequently, when that property is sold, a Certificate of compliance must be required under sec 116 of ITA.
Shares of Canadian Corporation
Most of the time, in practice, we see the emigrant taxpayers scrambling to find a way to manage the departure tax and subsequent losses in the value of shares of the Canadian Corporation.
A quick recap:
Shares of a Canadian Corporation are subject to deemed disposition at emigration except for TCP.
The only TCP that is excluded is if the underlying corporation has Canadian real estate assets that cause more than 50% of FMV of shares in the past 60 months at any time.
The taxpayer can defer the departure tax by posting the security if needed.
A returning resident can unwind the deemed disposition by electing on the return.
Post-Emigration Dividends and Actual Dispositions
Any dividends paid to non-residents are subject to Part XIII Withholding taxes as explained before.
A very common situation many taxpayers find themselves trapped in is when a corporation with retained earnings stops operations after emigration. Many small services-based businesses operate as CCPC in Canada, owner-manager businesses. Over the years, to avoid paying taxes at higher marginal rates, these owners take little or no dividends resulting in substantial retained earnings trapped inside their CCPCs.
Consider an IT consultant having the above corporation move to the U.S. Since she was the only person providing these services, there is no way that she can keep on providing services to her clients. At the time of departure, she will have to pay the departure tax at least on the retained earnings assuming there are no future cashflows. To extract the retained earnings, whenever dividends are paid out, a 15% withholding tax is payable. It appears that she is being subject to double taxation on the same earnings!
Important to note, that if the shares are not TCP, there is no loss carryback available.
If the shares are TCP, both at emigration and at the time of actual disposition, loss carryback is possible subject to Stop loss rules. Loss carryback allows the election under ITA 128.1(8). Stop-loss rules are provided in Subsection 40(3.7) that restrict the loss carryback where dividends are paid out to non-residents.
If you are expecting that the shares of private corporations will drop in value after emigration, consider disposing of them before emigration. The same is applicable for the shares that were TCP at emigration but are expected to lose TCP status at the time of actual disposition.
For non-TCP shares, post-emigration capital losses are dealt in accordance with the tax laws of the country of new residency. The taxpayers though carefully review what assets get step-up of basis. If there is no step-up available, the next planning option can be helpful.
Lifetime Capital Gains Exemption
Lifetime capital gains exemption is available for the emigrants if the underlying corporation qualifies as a QSBC.
Foreign Tax Credits where no Treaty Step-up of Basis
Most of the time, the treaty allows a step-up of basis and the post-emigration capital gains or losses are settled down per the new country of residency’s laws.
If the treaty does not allow the step-of basis, it will cause a double taxation of the same gain! To avoid this, Canada does allow Foreign tax credit (FTC) to be claimed against departure tax when the property that was subject to deemed disposition is actually disposed of.
- FTC may be available against the taxes paid to the countries where a treaty is in place, just step-up of basis is not there.
- FTC is available even if there is no treaty in case of a real property located outside Canada when that property was subject to deemed disposition in Canada.
FTCs generally have three years which a taxpayer can carry them back beyond the normal reassessment period. Therefore, the taxpayers where such FTCs may be available for carryback must plan the actual dispositions accordingly. The Income Tax Act, 152(4)(a)(ii), does provide a discretionary waiver option for taxpayers intending to keep a tax year indefinitely opened, but it is very risky, see technical interpretation.
Exception to Attribution Rules
When a taxpayer transfers or loan a property to their spouse, attribution rules kick in that require the taxpayer to recognize the income, gains and losses in the hands of the transferor.
Assume a scenario where the taxpayer is taxed on deemed disposition of the assets in the spouse’s name but later on FTCs and post-emigration losses are attributed to other spouse due to the legal title per the tax laws of the new country. To avoid these anomalies, ITA subsection 74.2(3) provides an exception to these attribution rules related to the deemed dispositions.
This is an election and the joint election must be filed.
Information related to Departure tax is available in the below sections and subsections of the Income Tax Act (ITA). Please note that these legislative references are not exhaustive.
- Section 128.1: This is the primary section on the tax consequences of individuals emigrating from Canada. It outlines the rules for deemed disposition and reacquisition of property upon leaving Canada.
- Subsection 128.1(1): Provides definitions relevant to departure tax.
- Subsection 128.1(4): Details the deemed disposition rules.
- Subsection 128.1(10): Defines “excluded right or interest” for the purpose of excluded properties.
- Section 116: Addresses non-residents disposing of certain types of Canadian property, which can be relevant for individuals subject to departure tax.
- Section 126: Relates to foreign tax credits, which may be applicable in the context of departure tax, especially if there are taxes paid in another country.
- Section 220: Contains provisions regarding the administration and enforcement of tax laws, including those related to departure tax
- Subsection 220(4.5): Pertains to the deferral of tax payment on deemed disposition.
- Section 248: Provides general definitions and interpretations for the Income Tax Act, which are essential for understanding the application of the departure tax rules.
- Section 260: Offers additional interpretations that help in understanding the departure tax provisions.
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