Wealth and tax matters

Transcription

1 Wealth and tax matters for individuals and private companies 2013, Issue 1

2 Contents 2 Home sweet home: claiming the principal residence exemption 8 Buying a new home? What you should know about the GST housing rebates 12 Donations of cultural property: the fine art of reducing tax 16 Philanthropic planning with charitable remainder trusts 22 Baby, please don t go: when trust beneficiaries give up Canadian residency 26 Streamlining your way to US compliance 28 Being an executor of a Canadian estate See How to get Wealth and tax matters on page Wealth and tax matters 2013 Issue 1 PwC

3 Editorial The first edition of Wealth and tax matters for 2013 marks my start as editor. Nadja Ibrahim has done an outstanding job in this role for the past several years, and will continue to contribute interesting and useful articles. Thanks, Nadja. This edition offers seven articles relevant to private businesses, executives and entrepreneurs. As always, colleagues listed at the end of this publication are happy to answer any questions that you may have. We begin with two articles about residential properties. The first highlights the principal residence rules, which are surprisingly complex and warrant careful planning to maximize the benefit. The second deals with the GST/HST new housing rebate and rental rebates. These can significantly reduce the purchase cost of your new home or rental property. Next, philanthropy. Read about the special tax breaks that may be available if you donate certified cultural property certain art, books and archival material to Canadian institutions. Learn how a charitable remainder trust may be an effective tool to help you achieve your philanthropic goals in a tax-efficient manner. Two articles cover cross-border issues. One addresses those that arise when a beneficiary of the trust you so carefully set up as part of your estate plan decides to leave Canada. The other sheds light on the new streamlined voluntary disclosure program for non-compliant US citizens living outside that country. Finally, you may feel honoured when a friend or relative asks you to be an executor of his or her estate but do you really understand what is entailed? Our last article highlights some of your duties and responsibilities, should you decide to accept. Welcome back to Wealth and tax matters for another year! Susan Farina Tax Partner Editor, Wealth and tax matters Jason Safar Leader, National High Net Worth Practice Wealth and tax matters 2013 Issue 1 PwC 1

4 Home sweet home: claiming the principal residence exemption Troy Berdahl and Erick Preciado Death and taxes: most of us do our best to avoid both. One type of tax that many Canadian residents can readily mitigate is that on capital gains earned on their homes. 2 Wealth and tax matters 2013 Issue 1 PwC

5 Land size how big is too big? To get a tax break on such a capital gain, you must designate the property as your principal residence. As well, in most cases it must also be ordinarily inhabited by you, your current or former spouse or common-law partner, or your child. The following properties qualify as a principal residence: a house an apartment or unit in a duplex, apartment building or condominium a cottage a mobile home a trailer a houseboat a leasehold interest in a housing unit a share of a co-operative housing corporation, if the sole purposes of acquiring the share was to obtain the right to reside in a housing unit Even the land on which the housing unit is located will qualify as a principal residence, as long as it isn t too large (see box). 100 metres The principal residence normally includes land of up to one-half hectare 50 x 100 metres, roughly 1.25 acres, or half the size of a baseball field. Even if the land exceeds that size, it can qualify as part of the principal residence, but only if you can clearly demonstrate that the excess land is necessary for the use and enjoyment of the housing unit as a residence. For example, municipal bylaws may have minimum lot size restrictions that require the excess land. (In this example, however, you might have to demonstrate to the Canada Revenue Agency (CRA) that it is not possible to sever the excess land.) In the 2011 decision in Cassidy v. The Queen, the Federal Court of Appeal held that if zoning restrictions apply in a particular year (such that the land meets the necessary for the use and enjoyment test in that year), the taxpayer may designate the entire property as a principal residence for that year, even if zoning provisions subsequently change to allow the taxpayer to obtain a severance of the excess lands in a later year. If you acquire the excess land simply to support a particular lifestyle, the excess land will not be considered necessary for the use and enjoyment of the housing unit for tax purposes. And because the tax exemption is directed at principal residences, any sort of commercial aspect to the property (such as claiming income or expenses related to the excess land) would weaken the position that the excess land contributed to the use and enjoyment of the housing unit. If the excess land does not meet the necessary for the use and enjoyment test, the excess land will not qualify as being part of the principal residence, and it will be necessary to calculate the gain on the non-qualifying portion separately and to pay tax on it. 50 metres Wealth and tax matters 2013 Issue 1 PwC 3

6 How does a principal residence qualify for the exemption? While you may own and ordinarily inhabit more than one residence, generally you and your family unit may designate only one housing unit as a principal residence for any year (as discussed further below). A family unit includes your spouse or common-law partner and your unmarried children who are under 18 years of age throughout the year. For this reason, if you ordinarily inhabit more than one property, you should get professional advice before deciding which property to designate. What does it mean for a residence to be ordinarily inhabited? Often Canadians assume that one must have lived in the home for a specified period, such as a week, a month or a year. But that s not the case. Whether the property was ordinarily inhabited is a question of fact. A housing unit may be considered ordinarily inhabited even when it is occupied for a short period. Assuming your main motivation for owning a property is not to gain or produce income, even a seasonal residence such as a cottage occupied only for vacation purposes might be considered to be ordinarily inhabited by that person. Incidental rental income will not in itself prevent a cottage from qualifying as a principal residence. The principal residence exemption does not differentiate between Canadian and foreign properties. Therefore, you can claim the principal residence exemption on a foreign property, as long as all the conditions are satisfied. What happens if there is a change in use of a residence? Unless you make an election under subsection 45(2) or (3) (discussed below), a change in use will occur when there is a complete or partial conversion from a principal residence to an incomeproducing property or vice versa. For tax purposes, when a change in use occurs, the property (or the converted portion, in the case of a partial change in use) is deemed to have been disposed of for proceeds equal to the fair market value and the property (or portion thereof) is deemed to have been reacquired at the same amount. Often this will result in a gain. However, in the case of a partial change in use, the CRA will administratively allow the entire housing unit to retain its status as a principal residence when the income-producing use is merely ancillary and certain other conditions are met. In the case of a complete change in use, the deemed disposition generally may be deferred if an election is made by filing with your tax return a signed letter specifying the tax rule (see the table) under which the change in use election is made. Principal residence Incomeproducing property Incomeproducing property Change in use Principal residence Subsection of the Income Tax Act Eligibility for continued principal residence exemption 45(2) Up to 4 years 45(3) 4 Wealth and tax matters 2013 Issue 1 PwC

7 To qualify under either provision, you must: be (or be deemed to be) a resident of Canada, and not have claimed capital cost allowance in respect of the property throughout the period of ownership, both before and after the election is made When an election under subsection 45(2) or (3) is made, the housing unit can qualify as a principal residence for up to four taxation years, even though the housing unit is not ordinarily inhabited during those years by you, your spouse or common-law partner, or your child. In the case of a principal residence that is converted to an income-producing property, provided a change in use election is made, the housing unit can be designated as your principal residence for up to four taxation years after the change in use. The four-year limit generally is removed if the change in use is due to employment relocation, provided you resume ordinary habitation of the housing unit during the term of the employment. In the case of an income-producing property that is converted to a principal residence, the property can qualify as your principal residence for up to four taxation years before the change in use which is covered by the subsection 45(3) election, if you and your family unit did not claim the principal residence exemption for any other property for those years and no capital cost allowance was claimed throughout the period of ownership. If an election is made under subsection 45(3), the net income from the property must still be reported for tax purposes. Can a trust claim a principal residence exemption? A personal trust may be able to claim the principal residence exemption. A housing unit can be designated as a principal residence of a personal trust if the trust is resident in Canada for each year in which the property is ordinarily inhabited by a specified beneficiary of the trust, or by the specified beneficiary s current or former spouse or common-law partner or child. The election must be made by filing prescribed Form T1079. A specified beneficiary is a person who: is beneficially interested in the trust (that is, any person who has a right as a beneficiary under a trust to receive income or capital of the trust), and ordinarily inhabited the housing unit owned by the trust (or whose spouse, common-law partner or child ordinarily inhabited the housing unit) Since 1997, a person who has the right to reside rent-free in a housing unit owned by the trust is also included. However, unlike an individual (detailed above), a trust is not exempt from the ordinarily inhabited rule when a change in use election is made. Care must be taken when deciding whether a trust should claim a principal residence exemption, because it can affect the ability of a beneficiary and his or her family unit to designate his or her own property as a principal residence. The rules for claiming a principal residence exemption for a trust are complex and it is prudent to seek professional advice. Wealth and tax matters 2013 Issue 1 PwC 5

8 Designation by spouse As previously mentioned, you and your family unit generally may designate only one housing unit as a principal residence for any year. However, before January 1, 1982, you and your spouse could each designate a separately owned property as a principal residence. As a result, you could shield two housing units, such as a cottage and a city home, from capital gains. The ability to designate two housing units for tax years before 1982 is still available if the ownership and ordinarily inhabited tests are met. The gain accruing prior to 1982 can be computed on a pro rata basis (that is, assuming the gain accrued evenly over the period of ownership) or based on the actual value of the housing unit on December 31, After December 31, 1981, two exemptions are allowed only if you and your spouse or common-law partner were living apart from each other throughout the year, under a judicial separation or written separation agreement. In that situation, each may designate a separate principal residence, beginning with the first taxation year in which the judicial separation or written separation agreement was in place throughout the entire year. The designation cannot be retroactive. Tax reporting The designation of a property for the purpose of the principal residence exemption must be included with your income tax return for the year in which the property is disposed. The exempt portion of the gain is generally computed as: the number of years 1 the property is designated as a principal residence + 1 the number of years 1 the property has been held The + 1 in the numerator takes into account that you might own two homes during the same year. For example, suppose you owned and ordinary inhabited a housing unit for 25 years, designated the property as your principal residence for 19 years, and realized a $250,000 gain on the sale of the property. The exempt portion of the capital gain is 80%, calculated as (1 + 19)/25. Thus, the exempt portion of the gain is $200,000 (80% of the original gain). Special rules apply to determine the exempt portion of the capital gain in respect of a housing unit for which a change in use election was made. While the principal residence designation is required to be reported on prescribed Form T2091, the CRA s administrative practice is that individuals need not complete and file the form, unless: 1. Include only years owned after Special rules apply if the property was acquired before Wealth and tax matters 2013 Issue 1 PwC

9 a taxable capital gain on the disposition of the property remains after using the principal residence exemption, or the 1994 election (under which it was possible to make an election to recognize a capital gain of up to $100,000 on capital property) was used in respect of the property This administrative practice of not requiring the prescribed form to be filed does not apply to trusts. So When available, the principal residence exemption can provide significant tax savings. Planning opportunities are available to maximize the benefit of the principal residence exemption, so it is prudent to seek professional advice when you are selling your home or contemplating changing its use. Troy Berdahl troy.d.berdahl@ca.pwc.com Erick Preciado erick.j.preciado@ca.pwc.com Wealth and tax matters 2013 Issue 1 PwC 7

10 Buying a new home? What you should know about the GST housing rebates Wayne Mandel and Audrey Diamant The sale of newly constructed or substantially renovated residential properties is generally subject to federal Goods and Services Tax (GST) or Harmonized Sales Tax (HST). Therefore, the purchase price of residential housing includes a component of GST or HST. For many buyers, the New Housing Rebates or the Rental Rebate can partially offset this cost. 8 Wealth and tax matters 2013 Issue 1 PwC

11 Before the GST started on January 1, 1991, sales tax was embedded in the cost of new housing. The Federal Sales Tax applied to the cost of materials and equipment used in the construction of homes. Naturally, this cost estimated at 4% of the total would then be incorporated into a builder s selling price. The cost of housing increased when the Federal Sales Tax was repealed and the GST took effect at 7% of the selling price (although the GST rate dropped to 6% on July 1, 2006, and then to 5% on January 1, 2008). The cost of housing was further increased in the provinces that harmonized provincial sales tax with the federal GST. The New Housing Rebate To partially offset the additional cost of the GST on new housing and to preserve affordable housing for Canadians, the federal New Housing Rebate was introduced. This rebate is available to purchasers of newly constructed or substantially renovated homes. A substantially renovated home is one in which all or substantially all (typically more than 90%) of the property, other than the foundation, exterior walls, interior supporting walls, floors, roof and staircases, has been removed or replaced. Homes that qualify include new detached and semi-detached homes, rowhouses, duplexes, mobile homes, floating homes and condominium units. To be eligible for the New Housing Rebate the home must be purchased by an individual with the intention that it be occupied as the primary place of residence of either: the individual purchaser, or his or her relative, or current or former spouse or common-law partner Generally, for the home to be a primary place of residence, the resident must live in the home more than half of the time. Wealth and tax matters 2013 Issue 1 PwC 9

12 To qualify for the New Housing Rebate, the purchaser must pay GST on the acquisition of the home and the purchase price must be less than $450,000. The New Housing Rebate currently is 36% of the total tax paid on the purchase, to a maximum of $6,300 (corresponding to a selling price of $350,000, because 36% of the 5% GST on $350,000 is $6,300). For purchase prices above $350,000, the rebate is reduced, disappearing entirely at $450,000. In most cases, at the time of the sale the purchaser assigns the New Housing Rebate to the builder, and the builder either: pays the amount of the New Housing Rebate directly to the purchaser, or credits the amount against the total amount payable for the home Either way, purchasers do not have to apply directly for the New Housing Rebate and wait for the Canada Revenue Agency (CRA) to process the claim. Some of the provinces that have harmonized their provincial tax with the federal GST offer a partial rebate of the provincial component of the HST. Purchasers who acquire newly constructed or substantially renovated homes as their or their relative s primary place of residence may qualify. To complicate matters, these provincial New Housing Rebate calculations differ from those used for the federal New Housing Rebate. For example, in British Columbia (for homes where ownership is transferred prior to April 1, 2013) and Ontario, the maximum rebate amounts for a purchaser who pays HST for both land and building are shown in the table. % of the provincial portion of the HST Maximum rebate Maximum applies at and above B.C % $42,500 $850,000 Ontario 75% $24,000 $400,000 The New Residential Rental Property Rebate In 2000, the federal government introduced the New Residential Rental Property Rebate (the Rental Rebate ), which mirrors the calculations of the federal New Housing Rebate, using the same thresholds and phase-out amounts. In British Columbia and Ontario, the provincial Rental Rebate allows landlords to recover a portion of the provincial component of the HST, calculated in a similar manner to the provincial New Housing Rebate. Before the Rental Rebate, the full GST (or HST) was a cost to landlords who purchased new residential rental properties, because no input tax credits or other mechanisms were available to recover any of the GST (or HST) paid. The Rental Rebate is available to eligible purchasers or builders of new residential properties who intend to lease the units to individuals as their primary place of residence for periods of continuous occupancy of at least one year, under one or more leases. Eligible purchasers are those who paid the GST (or HST) on: newly constructed or substantially renovated rental properties additions to existing rental properties properties converted to residential rentals, or the leasing of land used for residential rental For leased residential land, the Rental Rebate is reduced, because it applies only to the land. Unlike the New Housing Rebates, purchasers cannot assign the Rental Rebate to the builder, and therefore builders cannot pay or credit the purchaser for the Rental Rebate. 10 Wealth and tax matters 2013 Issue 1 PwC

13 Avoiding surprises The New Housing Rebates and Rental Rebates may provide significant cost savings of the GST or HST on residential properties, if eligibility conditions and filing requirements are met. To avoid costly surprises, the following points should be considered: Both rebates must be applied for using prescribed forms within two years of the transfer of ownership to the purchaser. The CRA allows extensions in only very limited circumstances. In many Canadian markets, builders sell new homes on a tax-included basis, and pay or credit the amount of the New Housing Rebate against the total amount payable for the home, so that purchasers do not have to apply directly to CRA for the rebate. In these cases, both the builder and purchaser are jointly and severally liable to the CRA for miscalculated or inappropriately filed rebates. It is common practice for builders to include, in the purchase and sale agreement, the right to take legal action against purchasers who ultimately do not qualify but have been paid or credited the amount of the rebate. Consequently, to avoid legal ramifications, purchasers should ensure that they qualify. Builders cannot pay or credit purchasers of residential properties for the Rental Rebate, so purchasers must be prepared to fund the amount of the rebate until the amount is approved and refunded by the CRA. The Rental Rebate plus interest may be subject to recapture and may have to be repaid to the CRA if the property is sold within one year from the time it is first occupied, unless the sale is made to a purchaser who is acquiring the property for use as the primary place of residence of the purchaser or a relative. If the identity of the purchaser or the use to be made of the home is not known with certainty, to avoid recapturing the Rental Rebate the owner should consider waiting to sell the home for at least one year from the time the home is first occupied. The threshold and phase-out amounts used in computing the Rental Rebate are based on the fair market value at the time ownership is transferred to the purchaser rather than the purchase price. In markets where real estate values increase, this can cause hardship for purchasers who expect to receive the rebate to finance part of the purchase of a property and later realize they either do not qualify or may receive less than expected. Notably, in the case of a residential condominium unit, a gap of three or four years between the time that the purchase and sale agreement is signed and the time that the ownership is transferred is not unusual. In that period, the market value of the unit can substantially increase to a level that makes a purchaser ineligible for the Rental Rebate. Therefore, purchasers must be aware of this situation when planning the purchase of residential rental property and keep informed of market conditions. Often, the CRA will request that purchasers applying for the rebate obtain valuations by accredited professionals to substantiate the market value. The federal New Housing Rebate and the Rental Rebate, and their provincial counterparts, can provide significant tax relief to qualifying purchasers. However, to take advantage of these rebates, numerous rules and conditions must be met. Buyers should ensure that they meet the requirements. Wayne Mandel wayne.h.mandel@ca.pwc.com Audrey Diamant audrey.j.diamant@ca.pwc.com The New Housing Rebates and Rental Rebates may provide significant cost savings of the GST or HST on residential properties, if eligibility conditions and filing requirements are met. Wealth and tax matters 2013 Issue 1 PwC 11

14 Donations of cultural property: the fine art of reducing tax Marilyne D Amours and Jean-François Drouin It is not uncommon for Canadian families to own valuable works of art. Fortunately, in an effort to preserve Canada s cultural heritage and promote art conservation, our governments have put in place measures that include favourable tax treatment of some dispositions of those artworks. 12 Wealth and tax matters 2013 Issue 1 PwC

15 Tax considerations are rarely the motivation for acquiring art, but should not be ignored. If art is donated, rather than sold, the tax incentives and benefits can be considerable especially if the work qualifies as a certified cultural property. Two sets of income tax rules come into play: 1. Rules for donations in kind encompass not only art, but everything from food to electronics. 2. Specific rules for art (and some other things) apply only to certified cultural properties. These are more generous but qualifying for them is more difficult. Donations in kind Before going into the specific rules that apply to donations of cultural properties, we should briefly discuss the tax treatment of charitable gifts in kind. An individual who donates an object to a recognized recipient benefits from a 29% federal tax credit (15% on the first $200) and a provincial tax credit. The amounts of the tax credits are based on the fair market value (FMV) of the donated object, as indicated on the receipt issued by the qualified recipient organization. For example, suppose Raymond Johnson, a Quebec resident, donates an object to a registered charity. When filing his tax return for the year he made the donation, tax credits allow Mr. Johnson to recover about 48% of the asset s value. (The amount recovered depends on the donor s province of residence.) However, the savings generated by the tax credits are not the only factor to consider when calculating the net tax benefit. Any capital gain is generally taxable, and will reduce the net tax benefit. Wealth and tax matters 2013 Issue 1 PwC 13

16 For capital gains purposes, the donation is treated like a sale at the object s FMV. Assuming an original cost of $10,000 and a FMV of $50,000, at the time of the donations, the net monetary benefit of the donation is calculated as follows: Combined federal and Quebec income tax $ Proceeds of disposition Less: cost 50,000 (10,000) Capital gain 40,000 Capital gain tax A 9,994 Tax credits for donation B 24,107 Net monetary benefit B-A 14, % of the capital gain is taxable. 2. Calculated at the maximum individual marginal tax rate (Quebec), which reflects a proposed tax increase not yet enacted at the time of publication. 3. Does not take into consideration the limit applicable to the first $200 donated. In this example, tax on the capital gain wipes out 40% of the $24,107 net monetary benefit resulting from the donation. Generally, the value of the gift cannot exceed 75% of the donor s income in the year the donation is made. This cap is raised to 100% in the year of death or the preceding year. If the donor does not owe enough income tax in the year the donation is made to benefit from the full tax credit, the unclaimed amount can be carried forward and used over the next five taxation years. A company is treated differently than an individual. Instead of receiving a tax credit, a company generally can deduct the eligible amount for donations from taxable income. Amounts donated in a given year can be carried forward and used over the next five taxation years (or over the next twenty taxation years for 1,2 3 Quebec purposes). Because this is a deduction rather than a credit, the tax savings resulting from the donation depends on the company s tax rate. That tax rate in turn depends on the province(s) in which the company is taxable and the type of income earned. Like an individual, a company will also be taxed on any capital gain resulting from the disposition of the property, which will reduce the net tax benefit of the donation. Certified cultural property As mentioned above, additional tax benefits apply to certified cultural properties. To qualify under federal tax law, the work must meet a number of criteria, such as being of outstanding significance and of national importance as defined in the Cultural Property Export and Import Act. Generally, to be of outstanding significance the work must have at least one of five characteristics: 1. a close association with Canadian history 2. a close association with national life 3. esthetic qualities 4. value in the study of the arts 5. value in the study of the sciences To qualify as a cultural property, it must be of such national importance that its loss to Canada would significantly diminish our national heritage. Certified cultural properties may include various art objects such as paintings, sculptures and engravings, but can also be applied to other types of property such as books, furniture and archival material. The object need not be of Canadian origin; if it otherwise meets the eligibility criteria it could have been created in another country. The donor is eligible for cultural property tax benefits only if the donation is to an institution or public authority designated by the Minister of Canadian Heritage. These are usually museums or other cultural institutions, such as archives or certain public libraries. For example, the National Gallery of Canada and the Canada Science and Technology Museum are recognized institutions. The full list is available on the Heritage Canada website at (Tip: Use the search tab and find Glenbow.) Obviously, the cultural property program is not available to everyone. Not every work of art will both meet the appropriate criteria and be of interest to an institution or public authority designated by the Minister of Canadian Heritage. And in light of the high cost of storing works of art and the need to hold diverse collections, many institutions have strict criteria for accepting cultural property donations. Nevertheless, given the large number of designated institutions and public authorities, it is rare that a firstclass work of art finds no taker. The required paperwork involves asking the Canadian Cultural Property Export Review Board (CCPERB) to certify that the object meets the cultural property criteria described above. The resulting Cultural Property Income Tax Certificate (T871) must be included with the donor s tax return for the year the property was donated. The recipient institution generally prepares the application to the CCPERB. The T871 certificate also includes the FMV of the property, as determined by the CCPERB. An appraisal by a recognized arm s length appraiser must be provided by the donor or the donee institution which will then be reviewed by the CCPERB. In the case of works whose estimated value is over $20,000, it is preferable that the appraisal be done by 14 Wealth and tax matters 2013 Issue 1 PwC

17 a CCPERB-recognized committee of experts, such as the Art Dealers Association of Canada. If not, two arm s length appraisals are required. The donee institution and the donor generally pay the appraisal fees. However, some institutions have a policy of paying all the appraisal costs. In the case of a disagreement about the property s FMV, the taxpayer can request the review board to redetermine it, and if unsuccessful, the taxpayer can appeal to the Tax Court of Canada. Tax benefits The additional tax benefits a donor gets when the work is a certified cultural property result from a federal cultural property capital gains tax exemption. Both individuals and companies can be eligible. In fact, the exemption is not limited to donations, but also applies to the sale of cultural property to a designated institution or public authority. Each province also provides a provincial tax credit for donations of cultural property, which will provide additional tax savings. In addition to the provincial tax credit for donations of cultural property, some provinces have special tax treatments. For example, in Quebec, the eligible tax credit amount for a donated work of art, whether certified cultural property or not, is increased by 25% if the work is given to a recognized Quebec museum. The 75% of annual income cap is not applicable to this donation of certified cultural property. How does the net cash benefit of donating cultural property compare with that from its sale through regular channels? In the latter case, it is generally necessary to deal with a private art dealer, which normally charges a commission (20% in the following example below). The $5,397 difference between the two sample scenarios is the net cost to the donor of donating the property as opposed to selling it. Of course, in real life the net cost will depend on many variables, including the value of the work as determined by the CCPERB, the state of the art market when the object is resold, the underlying capital gain and the commission. Often, as a strategy for realizing the value of a work of art, the tax program for donations of Canadian cultural property can be a good alternative to a selling through a gallery. Other tax considerations are specific to cultural property. Certain restrictions that normally apply to charitable donations also apply to donations of cultural property; others do not. In addition, special rules apply to donations of cultural property by artists and their estate. Professional advice should be sought before making any significant donation. Donating cultural property Income tax (combined federal and Quebec) Net cash benefit Proceeds of disposition Less: cost Donation $ 50,000 (10,000) Conclusion The conclusion is simple: Potential tax benefits from the cultural property rules give added impetus for owners of major works of art to consider in donating or even selling them to designated institutions. Marilyne D Amours marilyne.damours@ca.pwc.com Jean-François Drouin jean-francois.drouin@ca.pwc.com Sale $ 50,000 (10,000) Less: appraisal cost Less: commission 0 (10,000) Capital gain 40,000 30,000 Capital gain tax 0 7,496 Tax credit for donations/ proceeds of disposition 27,107 4,5 50,000 Less: commission 0 (10,000) Less: capital gains tax 0 (7,496) Net cash benefit 27,107 32, In this example, the appraisal costs are paid by the recipient organization % of the capital gain is taxable. 3. Calculated at the maximum individual marginal tax rate (Quebec), which reflects a proposed tax increase not yet enacted at the time of publication. 4. Does not take into consideration the limit applicable to the first $200 donated. 5. The 25% increase for a donation to a Quebec museum was applied. 2,3 Wealth and tax matters 2013 Issue 1 PwC 15

18 Philanthropic planning with charitable remainder trusts Stephanie Bernier and Brenda Lee-Kennedy Philanthropic planning by individuals comes in many shapes and forms. Some make charitable donations during their lifetimes. Others donate through their wills. Many do both. 16 Wealth and tax matters 2013 Issue 1 PwC

19 The charitable remainder trust (CRT) is a planned giving strategy. The charity gets a future monetary benefit while the individual donor gets immediate tax relief in respect of the charitable donation. Properly constituted and structured, a CRT established during a philanthropist s lifetime (i.e., outside a will) enables the individual to: make a contribution of an asset or bundle of assets (referred to as property ) for the benefit of one or more Canadian registered charities or other qualified donee(s) benefit from tax savings for that contribution, and retain use of the property and/or benefit from income earned on the property during his or her lifetime Wealth and tax matters 2013 Issue 1 PwC 17

20 Similarly, a CRT may be established through an individual s will. This can provide: a life interest in that testamentary trust 1 in favour of an individual or individuals identified by the testator, and a gift of a residual trust interest in favour of one or more charities once the individual(s) with a life interest passes away A CRT is not specifically referred to or defined in Canada s Income Tax Act (ITA); however, a CRT can be established through standard trust planning. Trust provisions and the administrative policies and interpretations of the Canada Revenue Agency (CRA) provide for its use. A CRT can be a great tax planning tool for high net worth individuals, particularly those that had already contemplated charitable bequest gifts in their estate plans but would benefit more from tax relief for the charitable donation during their lifetimes. The plan discussed below focuses on a CRT created during the philanthropist s lifetime. How the CRT can work for you The first step is to have an irrevocable trust settled to which you can transfer assets (e.g. cash, real property, shares, bonds, etc.). It is best to contribute assets that have little or no appreciated value, because the transfer to the trust is considered to be a disposition for tax purposes. Consequently, you will have to pay tax on any accrued gains. Assets that have not appreciated in value or appreciated nominally since the transferor acquired them, are good candidates for transfer. The trust identifies one or more Canadian registered charities as the remainder beneficiaries of the trust s capital. Typically, you and/or one or more persons you designate are specified as the trust s income beneficiaries. Under the terms of the trust, the gift of the property to the charity is irrevocable once the assets are contributed to the trust. The income beneficiaries will continue to enjoy the property contributed to the trust and/or receive income (e.g., dividend income, interest income, rental income, etc.) from the contributed assets until the end of their lives. Upon death, the full ownership and possession of the trust s property will pass to the charity on a tax-deferred rollover basis. If all of the conditions (as discussed below) are met, the charity will be in the position to issue an official donation receipt to you. The eligible amount for tax receipting purposes will be the net present value of the residual interest in the trust. Establishing that figure requires an actuarial analysis, which takes into consideration factors such as the current fair market value of the property transferred to the trust, the life expectancy of the income beneficiaries, the expected rates of return, future economic conditions and the types of any investments that the trust will hold. 1. A testamentary trust is a trust created on the death of an individual, usually under the terms of the will. 18 Wealth and tax matters 2013 Issue 1 PwC

21 Conditions for a CRT A CRT can be used as a vehicle for giving if: the transfer of property to the trust is irrevocable the right to receive the property vests in the charity at the time of the transfer, which occurs if: the charity is in existence and ascertainable the value of the residual interest is ascertainable (which prevents the trust from authorizing any encroachment on capital to the benefit of anyone other than the residual interest beneficiary i.e. the charity), and any conditions attached to the property are satisfied the transfer of property is voluntary and no right, privilege or other consideration (other than the donation tax credit) is sought for, or received by, the transferor or a person designated by the transferor it must be clear by the terms of the trust that the full ownership and possession of the property transferred ultimately will pass to the charity, and the charity is a qualified donee If these conditions are met, the transferor will be considered to have made a gift to a charity equal to the net present value of the remainder interest and will be entitled to claim a donation tax credit for that gift. Wealth and tax matters 2013 Issue 1 PwC 19

22 Benefits and drawbacks The primary benefits of a CRT are: Retaining the right to use property and/or to receive income: A CRT enables the income beneficiaries to retain the right to use the property transferred and/or to derive income from the trust s property during their lifetimes. Immediate tax saving: When you transfer property to a CRT (other than a testamentary trust), you will benefit from an immediate donation tax receipt, which you can use to reduce your tax liability on income from other sources. As well, to mitigate the capital gains arising from the transfer, you can transfer capital property with accrued gains to the trust and elect to calculate the capital gain using proceeds of disposition of any amount between the cost and the fair market value of the property transferred. However, when that election is made, the eligible amount of the contribution for the donation tax receipt will be the lesser of the elected amount and the net present value of the remainder interest. Carry-forward of donation tax credits: You may claim a donation tax credit for your charitable contribution of property to a CRT which can reduce the tax liability on your other income in the year of the contribution or you can apply the balance of any unused donation tax credits over the subsequent five taxation years. This offers more flexibility in tax planning than when a charitable bequest is made through your will, which allows the donation tax credit to be used only in the year of your death or the year prior to your death. Minimizing taxes on death: Property transferred to a CRT during your lifetime is not part of your estate, so probate fees on those assets are avoided. Protection of property: Property transferred to a CRT is protected from your creditors and from claims for dependant s relief under provincial family laws. On the other hand, a CRT can have drawbacks: No turning back: Because the transfer of property to a CRT for the benefit of the charity must be irrevocable, transferred property or property substituted for transferred assets cannot revert to you. Accordingly, assets for transfer should be selected with care. Donation threshold: Charitable donations made during your lifetime are limited to 75% of your net income for the year, while the limit is 100% for those made by will. However, the donation threshold may not be an impediment depending on your tax circumstances during your lifetime and at the time of your death. Limitation of donations: The CRA considers that the gift made to the charity through the use of a CRT is the residual interest in the trust rather than the actual property transferred. As a result, any additional contribution of property to the CRT is not considered to be an additional gift to the charity. Therefore, if you want to use the same strategy to make another donation, you will have to settle a new CRT. 20 Wealth and tax matters 2013 Issue 1 PwC

23 Capital gains distribution: Income beneficiaries cannot encroach on any capital gains realized by the trust; therefore, to avoid taxation at the trust level, capital gains realized on the property held by the CRT must be paid or made payable to the charity. This however, will deplete the capital of the CRT on which income is earned, thereby reducing the income that can be derived from the transferred property that would otherwise be available to the income beneficiaries. On the other hand, if the capital gains are not distributed to the charity, the capital gains may be reinvested by the trust in order to produce further income. However, if the capital gains are not distributed, they will be taxed at the trust level at the highest marginal individual tax rate. The taxes payable by the trust on the capital gains may be paid from the proceeds of disposition rather than being paid from the income otherwise available to the income beneficiaries without jeopardizing the conditions for the trust to qualify as a CRT. Costs: Costs relating to the creation and administration of a CRT have to be taken into consideration, including compliance costs associated with trust reporting. Key considerations The following are some key considerations when making a charitable donation through a CRT: Life expectancy of the income beneficiaries: Because the value of the donation receipt takes into account the life expectancy of the income beneficiaries, a CRT is most beneficial for mature individuals with a life expectancy of 20 years or less at the time of the establishment of the CRT. Types of property to transfer: As stated above, the transfer of property to the CRT results in a disposition for tax purposes, so the property to be contributed to the CRT must be chosen with care. Capital properties with accrued losses or shares or debt of issuers that are not at arm s length with the transferor are not ideal because the loss will generally be denied. On the other hand, significant tax can arise if the transferred property has appreciated substantially. A better choice is property whose value at the time of transfer is approximately equal to its tax cost or that by its nature gets relief from capital gains tax, such as your principal residence. However, the favourable tax treatment available when you donate publicly-traded securities, certified cultural property or ecological property does not apply when the property is donated through a CRT. Type of trust to use: A CRT can be structured as an inter vivos trust or a testamentary trust. An inter vivos trust 2 has the benefit of providing donation tax relief during your lifetime. On the other hand, a CRT established by your will provides donation tax relief in your tax return for the year of death or the preceding year. The type of trust vehicle used to establish a CRT will determine not only the timing the tax benefit, but also whether the gift will be revocable during your lifetime. This decision will depend on your overall wealth management and philanthropic objectives. Planning today for a future gift Giving through a CRT can lead to tax savings and provide an income stream to you and those you select. However, you must be careful when deciding what types of property to transfer and what type of vehicle to use when establishing a CRT. This strategy warrants professional advice, to ensure that it meets your economic and wealth planning objectives and is compatible with your other planning. Stephanie Bernier stephanie.bernier@ca.pwc.com Brenda Lee-Kennedy brenda.lee-kennedy@ca.pwc.com 2. A inter vivos trust is a trust created by a living person. Wealth and tax matters 2013 Issue 1 PwC 21

24 Baby, please don t go: when trust beneficiaries give up Canadian residency Keith Young and Angela Ross Trusts are an important wealth management tool, and there s a good chance you are (or will be) involved in a trust in some capacity. Articles in Wealth and tax matters have discussed the basics of a trust s creation and tax-efficient administration. 1 This article outlines the Canadian tax implications of a common event: a Canadian resident beneficiary of a Canadian personal trust ceasing to be a Canadian resident. 1. For example, see Autumn 2008, Autumn 2009, Spring 2011 and Summer Wealth and tax matters 2013 Issue 1 PwC

25 Scenario Mr. Wise is a Canadian businessman who started the highly successful Wiseco. Years ago, he set up a family trust (Wise Trust) to own shares of Wiseco for the benefit of select family members, with a view towards income splitting. Most of the beneficiaries of Wise Trust enjoy the Canadian climate, but one of his children, aptly named Tarzan, eventually yearned for something more tropical, so he moved to Brazil, with little thought of the tax consequences. Departure tax When a Canadian-resident taxpayer emigrates, departure tax kicks in. The taxpayer is deemed to dispose of most property at fair market value. This rule can create a significant capital gains tax liability. The tax can, in turn, be difficult to fund, given that the taxpayer hasn t actually sold any property. Fortunately, with a few exceptions, an interest in a discretionary personal trust resident in Canada (such as the one Tarzan holds in Wise Trust) is excluded from departure tax. Even so, generally the emigrating taxpayer still has to disclose properties held at the time of emigration, irrespective of whether they are subject to departure tax. This list is due with the final personal tax return filed as a Canadian resident. Withholding tax When a non-resident beneficiary receives income from a Canadian trust, withholding tax will usually apply. For example, if Wiseco paid dividends to Wise Trust and Wise Trust flowed some of those dividends out to Tarzan, the trustees of Wise Trust would have to withhold Canadian tax from the amount paid, at a rate of 25%. That rate might be reduced under a tax treaty between Canada and the country where the beneficiary resides. For example, if Tarzan were resident in the US, the rate would be reduced to 15%, but there is no reduction for Brazilian residents. If Wise Trust distributed a capital dividend to Tarzan, withholding tax would also apply, whereas that same dividend would have been tax-free when he was a Canadian resident. The trustees of Wise Trust must remit any withholding tax to the Canada Revenue Agency (CRA) before the 15th day of the month following the month the amount was paid or credited to Tarzan. They also must file an NR4 statement with the CRA within 90 days of Wise Trust s year-end. Wealth and tax matters 2013 Issue 1 PwC 23

26 Section 116 certificate Even if the disposition does not result in Canadian tax, non-residents who dispose of taxable Canadian property (TCP) must notify the CRA either before the disposition or within 10 days after. Receipt of a capital distribution from a trust by a beneficiary is considered to result in a disposition by the beneficiary of the capital interest in the trust. Generally, a capital interest in a Canadian trust will be TCP if more than 50% of the fair market value of the interest was derived directly or indirectly from Canadian real or immovable property or resource property at any time in the past 60 months. Therefore, whether Tarzan s interest in Wise Trust is TCP will depend on the assets of Wise Trust and Wiseco. If Tarzan s interest in Wise Trust is TCP and he receives a capital distribution, the rules require him to file Form T2062 along with supporting documentation (and acceptable payment, if applicable). Tarzan will receive a document known as a section 116 certificate if all is in order. Without the certificate, Wise Trust must withhold 25% of the capital distribution and remit this to the CRA. Tarzan will be able to obtain a refund of this amount upon filing a Canadian income tax return. Part XII.2 Tax Tax on the designated income of a Canadian-resident inter vivos trust (such as Wise Trust) is levied at rate of 36%, if the trust has at least one designated beneficiary. A designated beneficiary includes a non-resident of Canada (such as Tarzan). Designated income, in general, is income from real property in Canada and taxable capital gains arising from the disposition of TCP. This Part XII.2 tax is meant to ensure that a non-resident cannot earn certain types of income through a Canadian inter vivos trust and pay less Canadian tax than if that income were earned directly. (Part XII.2 does not apply to testamentary trusts.) In our example, if the expected income of Wise Trust in any particular year consists only of dividend income earned on Wiseco shares, the trust would not earn designated income, and accordingly would not incur Part XII.2 tax. Nevertheless, any trust that has a designated beneficiary should always consider potential liability for this tax. When a Canadian-resident taxpayer emigrates, departure tax kicks in. The taxpayer is deemed to dispose of most property at fair market value. This rule can create a significant capital gains tax liability. 24 Wealth and tax matters 2013 Issue 1 PwC