Mediation is mandatory in any Estate litigation commenced in the city of Toronto, Ottawa or in the county of Essex. Motivation to settle is often fueled by tax considerations. As part of the settlement does it make sense for it to be allocated to the spouse or the children of the deceased? Often, there is an argument about ownership of a joint account. The surviving joint account holder claims that the deceased intended that the surviving joint account holder would receive the monies by right of survivorship. The other beneficiaries to the estate generally claim that there is a presumption of a resulting trust and the monies in the joint account are held in trust for the estate. When it comes to dividing the pie it’s what each side nets at the end of the day that is most important. With that in mind, the authors wish to discuss joint accounts where a foreign based deceased who has Canadian assets holds an Ontario account in joint tenancy.
In mediation where assets held in Ontario are in dispute, it is very important to establish if the deceased was a resident of Canada for Canadian income tax purposes. Even if the deceased held real property in Canada or held other assets in Canada, this does not imply they were residents of Canada for income tax purposes if they had ties to another country. Identifying this point will drive the income tax considerations in mediation as the taxation of Canadian residents and non-residents are different on the disposition of assets held in Canada. This issue is more prevalent today than ever with the increase of foreign ownership of property in Ontario. The following will address what happens when a non-resident of Canada passes away while holding property in Ontario. Are there Canadian income taxes to pay? What are the filing requirements in Canada?
Before we answer this question, it is important to understand what happens to the property on the death of a Canadian resident for income tax purposes. Subparagraph 70(5)(a) of the Canada Income Tax Act (“ITA”) mandates that a Canadian taxpayer is deemed to have disposed of each of their capital property at fair market value (“FMV”) immediately preceding death. Where the FMV exceeds its original cost, there will be a capital gain and potentially income taxes owing.
Under Section 54 of the ITA, capital property is defined as property that can create capital gains or losses on disposition. Common examples include real estate, shares, bonds, mutual funds and trust units.
A relieving provision exists in subsection 70(6)(a) of the ITA, that if there is a surviving spouse or common law partner who is a resident of Canada for income tax purposes, there is typically no capital gain realized on the deemed disposition of the capital property of the deceased as it automatically rolls over to the survivor at its original cost. Therefore, income taxes owing on a deemed disposition of capital property will be paid by the surviving spouse.
Under the ITA, when a non-resident passes away, there is also a deemed disposition of capital property held in Canada yet the aforementioned rollover under subsection 70(6)(a) does not apply as it is only available to residents of Canada. However, non-residents are not subject to income tax on the disposition of all capital property. Subsection 3(c) of the ITA indicates that on the disposition of capital property, non-residents of Canada only pay Canadian income taxes when the disposition relates to Taxable Canadian Property (“TCP”). If the non-resident holds capital property in Canada that does not meet the definition of TCP, there is no Canadian income tax consequences on death.
Common examples of TCP include:
- Real or immovable property or resource or timber property situated in Canada whether depreciable or not. This would only include land if it is not considered inventory in a business;
- Property used or held in a business carried on in Canada;
- Shares of private corporations, an interest in a partnership, or an interest in a trust, if at any time in the previous 5 years more than half of the FMV of the property was from real or immovable property, or a resource or timber property situated in Canada;
- Shares of a public corporation, a share of a mutual fund corporation or unit of a mutual fund trust, if at any time in the previous 5 years 25% or more of the property belonged to either the taxpayer or someone close to them; and more than half of the FMV of the property was from real or immovable property, or a resource or timber property situated in Canada.
Thus, in many cases, there will be no income taxes to pay in Canada on the death of a non-resident taxpayer. For example, if a non-resident owns a portfolio of Canadian or foreign public company shares in a Canadian brokerage, there is likely no income tax consequences on death due to the fact the only way any public security would be considered TCP is if the taxpayer owned more than 25% of the total shares in the corporation over the last 5 years AND more than half of the FMV of the property was from real or immovable property, a resource or timber property situated in Canada. Therefore, it is easy to see why shares held in Canada of a public company would generally not be taxable to a non-resident taxpayer on death.
However, let’s say a non-resident owns a building or home in Canada or was the majority shareholder in a private corporation that owned TCP. In this case, the taxpayer owned TCP at the time of their death and would be required to report the deemed disposition of the TCP based on the FMV of that property at the time of their passing. Even if the non-resident never in their lifetime filed a Canadian income tax return, they would be required to file a return after their death. The due date is the later of April 30 in the year after death or 6 months after the date of death.
Some good news: It is important to look at the tax treaty between Canada and where the non-resident resides. In certain treaties, not all types of TCP as defined in the ITA are taxable in Canada on the disposition by a non-resident. In fact, the treaty can be more lenient to the taxpayer than the ITA. This could result in significant tax savings in Canada.
Some more good news: Certain tax treaties may allow for a spousal rollover to exist for non-residents. One should look to see if a tax treaty exists between Canada and the resident country of the deceased to determine if it allows for a rollover in Canada of assets at cost to a surviving spouse upon their death. Specifically, it should be noted that Article XXIX-B, paragraph 5 of the Canada US tax treaty allows the “spousal rollover” to apply on the death of a U.S. resident if they owned property which is subject to Canadian tax and is not treaty protected.
Now an example: Let’s say Mr. Smith, a resident of a country in which Canada did not have a tax treaty, owned a cottage jointly with his wife in Ontario. He bought the cottage in 1980 for $100,000. Mr. Smith passes away on November 30, 2016 when the cottage had an FMV of $800,000. In addition, Mr. Smith had Apple shares in his TD Waterhouse brokerage account that he purchased for $40,000 and had a FMV on death of $50,000. His wife did not own these shares jointly with him. In this case, Mr. Smith will have a deemed disposition on his share of the cottage. The FMV is $400,000 and his original cost is $50,000 and thus the deemed capital gain that is required to be filed on his Canadian income tax return due on May 31, 2017 is $350,000. Capital gains in Canada are taxed at 50% so his taxable income in Canada on death is $175,000. Assuming a 48% income tax rate (a 33% federal income tax rate plus the non-resident surtax), the income taxes owing on his death is $84,000. Note that there is no deemed disposition on the Apple shares as that is not considered TCP. The full cottage now belongs to Mrs. Smith with a cost base of $450,000.
In the previous example, if the Smiths were residents of the United States where a tax treaty with Canada is in effect, there would be no tax at all on the death of Mr. Smith as under the treaty, everything rolls over to the surviving spouse at cost.
Two more points of significance should be noted:
- If a tax return was required and was never filed after death and it is already past due, there is potential relief available under the Voluntary Disclosure Program.
- Even if income taxes are owing on the death of a non-resident taxpayer, the country where the taxpayer was a resident may allow for the Canadian income tax to be credited against the income tax owed in that country subject to that countries tax laws and tax treaty with Canada (if applicable).
At mediation with assets held in Ontario at stake, identification of the deceased residence for income tax purposes should be established up front as non-residents and residents of Canada will have different income tax obligations on a disposition of assets held in Canada. For non-residents of Canada, one should look to see if Canada has an income tax treaty with their country of residence for potential income tax relief.