Dual Resident Estate

Recently published in Canadian Tax Highlights - a Canadian Tax Foundation newsletter and republished here with permission:

 

For Canadian purposes, an estate is now deemed to be a trust under a 2013 amendment to the subsection 248(1) definition of a trust. My article on Hess (see “Trust or Estate?”, Canadian Tax Highlights, April 2012) is no longer relevant. A distribution from a foreign estate must thus be reported on CRA form 1142 – “Information Return in Respect of Distributions from and indebtedness to a Non-Resident Trust” where a testamentary trust arises out of an estate. This deeming provision may create complications in the case of a trust that is deemed to be a Canadian resident under subsection 94(3). An argument can be made pursuant to subsection 233.6(1) that an estate is not subject to T1142 filing as the language of subsection 233.6(1) excludes an estate that arose as a consequence of the death of an individual .

At the 2017 STEP Canada Round Table, the CRA was asked about the filing position for a US estate with a Canadian trustee. Under Canadian law, a US estate that is managed and controlled by a Canadian trustee is deemed to be a Canadian resident according to the factual test set out in Fundy Settlement (2012 SCC 14). The CRA referred to Income Tax Folio S6-F1-C1, paragraph 1.6, in which the CRA says as follows.

1.6 For example, when making a determination as to the jurisdiction in which the central management and control of a trust is exercised, the CRA will consider any relevant factor, which may include:

·         the factual role of a trustee and other persons with respect to the trust property, including any decision-making limitations imposed thereon, either directly or indirectly, by any beneficiary, settlor or other relevant person; and

·         the ability of a trustee and other persons to select and instruct trust advisors with respect to the overall management of the trust.

For this purpose, the CRA will look to any evidentiary support that demonstrates the exercise of decision-making powers and responsibilities over the trust.

   1.7 After an examination of all factors, it may be determined that a trust is resident in Canada even if another country considers the trust to be resident in that other country.

For US tax purposes, an estate is not a trust. Whether a US estate is a trust for US tax purposes will determine the US tax it will bear. Moreover, a US estate is taxed on its worldwide income, but a non-US estate is taxed only on its US source income and its ECI income. Whether an estate is a US estate is determined by looking at the surrounding facts and circumstances. In Rev. Ruling 81-112, 1981-1 CB, the IRS concluded that the estate was a US estate after considering the following factors: the domicile of the decedent at time of death, the location of the estate fiduciaries, the physical location of the primary beneficiaries, and the physical location of the estate’s major assets.

A non-resident trust is generally deemed to be a Canadian trust if it either had a Canadian resident contributor or has a Canadian resident beneficiary and a connected contributor. A connected contributor is defined as a person who contributed to the trust and within the 5 years before or after was a Canadian resident. The 5-year preceding period is amended to 18 months if the trust arose as a consequence of the person’s death.

For a non-subsection 94(3) trust, the competent authorities for Canada and for the United States consider all the facts surrounding the estate to determine whether the estate is a Canadian or US estate. However, for a subsection 94(3) trust, the CRA says that “It is generally the Canadian competent authority’s position that it would not be appropriate to cede Canadian residence of trusts subject to section 94 of the Act in the course of negotiations with the competent authority of the other Contracting State”. The CRA stands by this position as if it were somewhat like a treaty override. Section 4.3 of the Income Tax Conventions Interpretation Act - in force March 5, 2010 - clarifies that under Canadian law, a trust that is deemed to be resident in Canada by subsection 94(3) is a Canadian resident trust for the application of a tax convention. 

The CRA says that

Furthermore, given that section 94 of the Act anticipates full relief for the foreign taxes paid by the trust, if any, we understand the legislation does not contemplate the other country giving up its right to tax the trust’s income from non-Canadian sources. Accordingly, it is the Canadian competent authority’s expectation that the negotiation of these cases with a view to settle the question of dual residence will generally not be possible or advisable, particularly where both competent authorities are known, more broadly, to be at an impasse on the matter.

The combination of the characterization of an estate as a trust and subsection 94(3) can pose issues. Thus a US estate created by a US-resident decedent may be a deemed Canadian trust if the decedent died within 18 months of a move to the United States even if the person was US domiciled because he or she had expressed an intent to live there permanently. Can and should Canada lay a taxation claim to the estate of that former Canadian resident?

Sunita Doobay

TaxChambers LLP, Toronto

Tax Proposals - US and Canada

President Trump released his tax proposals today while in Canada the Morneau proposals consultation period will be ending soon on October 2nd, 2017. The Morneau proposals have caused many of us tax practitioners sleepless nights given how far reaching the proposals are. As I have stated in a presentation - the Morneau proposals discourage Canadians from operating their businesses through a corporation. A corporation is a necessary shield for liability purposes Canadians. Americans are often puzzled as to why Canadians operate through a corporation. We do because of the liability shield and  the preferential tax rate on the first $500,000 of active business income earned annually by a Canadian Controlled Private Corporation. The combined Ontario Federal rate for the first $500,000 is 15%. Aside from the tax rate and liability shield - a corporation is a necessity to access the R&D credit regime (SRED) of the Income Tax Act.

The sleepless nights caused by these proposals is that Canada does not have a limited liability company regime. Limited liability company (LLC) provide the same liability shield that a corporation would provide. The LLC is a structure adopted by the Americans from the Mexicans. It is a flow through similar to a partnership but at the same time provides liability coverage similar to that provided by a corporation. A Canadian limited partnership does not provide that level of coverage.

The proposals in essence leave us in a limbo in Canada.

The Trump Tax proposals focus, unlike the Morneau proposals, on economic growth. It allows for businesses who have made investments into capital assets prior to the 27th of September, 2017 to immediately write off the cost of such assets. The US which had the highest corporate tax rates of all OECD members is proposed to have a tax rate of 20%. And the proposals appear to copy Canada's exempt surplus regime making inversions into Canada not desirable anymore. The Code has implemented provisions to discourage inversions into Canada but who can forget the Burger King inversion in 2015.

The proposals also speak to the repatriation of funds held by US businesses outside of the US and to implement a regime making it less attractive for US companies to shelter their non-US profits in jurisdictions such as Ireland.

Last but not least - the Trump proposals speak to the repealing the U.S. estate tax.

Tax Implications of Cryptocurrency

Virtual currency or cryptocurrency has become popular in today’s financial markets and may be here for some time. Investors increasingly turn to virtual currency to fund transactions and provide portfolio diversity. The rising popularity of virtual currency has created some significant tax issues.

On November 30, 2016, the IRS was successful in its petition pursuant to Codesection 7609(f) in obtaining a John Doe summons to be served on Coinbase, Inc. The IRS is seeking information regarding all US persons who conducted virtual currency transactions on Bitcoin during the period January 1, 2013 to December 31, 2015, reminiscent of the 2008 John Doe summons granted to the IRS for information on US persons with accounts at UBS Switzerland. The July 2008 John Doe Summons resulted in the release by UBS to the IRS of about 4,500 names of US persons who held Swiss bank accounts. The issuance of the John Doe Summons against UBS severely compromised the offshore tax world and led to the implementation of FATCA and the CRS. The effect of the John Doe summons issued to Coinbase, Inc. will be watched closely.

Unlike other IRS summonses, a John Doe Summons does not list the name of the taxpayer under investigation because the taxpayer is unknown to the IRS. A John Doe Summons allows the IRS to obtain the names of all taxpayers within a certain group.

Coinbase, Inc. provides bitcoin wallet services and is a virtual currency exchange who assists merchants and consumers to buy, sell, and use bitcoin currency. A consumer converts bitcoin payments to a fiat currency (legal tender backed by the government that issued it) that is then transmitted to the merchant. A virtual currency exchanger resembles a traditional currency exchanger, but it can exchange virtual currency for government-backed currency and vice versa. A virtual currency exchanger is linked to the conventional banking system and money transmitters: it can receive conventional checks, and credit card, debit card, and wire transfer payments in exchange for virtual currency. A virtual currency exchanger is governed by legislation such as FinCen, is deemed to be a money transmitter under the Bank Secrecy Act, and probably falls within the scope of the CRS, which results in the disclosure of information between more than 100 tax authorities. Wallet services allow a user to quickly authorize virtual currency transactions with another user through the use of a traditional money account held at the exchanger.

According to the IRS Notice 2014-21, a virtual currency is not legal tender but it is intangible personal property. The notice gives examples of the tax treatment of various transactions using virtual currency such as:

• ·       Wages, salaries, and other income paid to an employee with virtual currency must be reported on a form W-2, and is reportable by the employee as ordinary income and subject to employment taxes paid by the employer;

• ·         Virtual currency received by a self-employed individual in exchange for goods or services is reportable as ordinary income and is subject to self-employment tax.  A payer must issue a form 1099;

• ·         Virtual currency received in exchange for goods or services by a business is reportable as ordinary income; and

• ·         A gain on the exchange of virtual currency for other property is generally reportable as a capital gain if the virtual currency was held as a capital asset and as ordinary income if the virtual currency is held for sale to customers in a trade or business.

Reporting is effected in USD: thus whenever virtual currency is used, a barter transaction takes place, and the parties must know the FMV of the virtual currency on that day. A taxpayer must track which virtual currency lot was used for each transaction in order to properly determine the gain or loss for that particular transaction. Given that the valuation of a convertible currency is a peer–to-peer demand, the exact FMV in legal tender of a virtual currency is not always certain.

Shortly before the petition was filed with the US District Court for the Northern District of California to obtain the John Doe summons, on September 21, 2016 a report was issued by the Treasury Inspector General for Tax Administration (TIGTA), entitled “As the use of virtual currencies in taxable transactions become more common, additional actions are needed to ensure taxpayer compliance”.

The TIGTA report highlights that not much was done by the IRS to ensure tax compliance by US persons who use convertible virtual currencies despite the fact that, as of April 21, 2016, one bitcoin was equivalent to about USD$443, and bitcoins had a total FMV of more than USD$6.8 billion. The TIGTA report points out that the reporting requirements set out in IRS Notice 2014-21 are flawed in that the reporting payer and the recipient payee must report the payment and receipt of virtual currency in USD; information forms 1099-MISC, 1099-B, 1099-K, and W-2 do not inform the IRS that the payments were made in virtual currency. As a result, the IRS has one fewer means of tracking a US person with cryptocurrency on hand. Thus even though cryptocurrency is property for US tax purposes, no US mechanism requires a Bitcoin holder to report that holding to the IRS. Because the identity of the parties using virtual currencies is generally anonymous, the inevitable result is tax evasion.

The fear of tax evasion is confirmed by the IRS agent whose affidavit formed the petition for the John Doe summons to Coinbase, Inc. In his affidavit the agent cites two examples - of which he had knowledge - of tax evasion involving convertible virtual currency:

In the first example, Taxpayer I originally worked with a foreign promoter who set up a controlled foreign shell company which diverted his income to a foreign brokerage account, then to a foreign bank account and lastly back to Taxpayer I through the use of an ATM. Once Taxpayer I abandoned the use of his offshore structure in favor of using virtual currency, the steps described above were the same until his income reached his foreign bank account. Once there, instead of repatriating his income from an ATIM in the form of cash, Taxpayer I diverted his income to a bank which works with a virtual currency exchange to convert his income to virtual currency. Once converted to virtual currency, Taxpayer I’s income was placed into a virtual account until Taxpayer I used it to purchase goods and services. Taxpayer I failed to report this income to the IRS.

And in the second example:

Two separate corporate entities with annual revenues of several million dollars traded bitcoins resulting in the under reporting of income. Both taxpayers admitted to disguising the amount they spent purchasing bitcoins as deductions for technology expenses on their tax returns. The bitcoin transactions were discovered after repeated requests for the original documentation necessary to substantiate the technology expense items claimed on the tax returns.  

US persons who reside in Canada and convert virtual currencies on exchanges other than in the United States, should be advised that their FBAR filings should disclose all of their holdings of convertible virtual currencies.

reprinted with permission from the Canadian Tax Highlights, a Canadian Tax Foundation Newsletter.

Two‐Year Holding of CCPC Options

Montminy (2016 TCC 110) is the first case to consider the interaction between regulations 6204(1)(b) and 6204(2) (c). The TCC concluded that the latter does not apply to negate the two-year

reasonable holding period in the former.

Were the taxpayers in Montminy entitled to a deduction whereby a CCPC employee defers the recognition of employment income to the year when he or she disposes of the CCPC's shares (paragraph 110(1)(d.1))? In conjunction with section 7, only half of the taxable benefit (simulating a capital gain) is taxed (paragraphs 110(1)(d) and 110(1)(d.1)). The 50 percent deduction is allowed if the shares are prescribed under regulation 6204.

The taxpayers were employed at Cybectec, a tech company in the competitive IT industry, which established a stock option plan in 2001 to retain employees. In 2007, Cybectec received an unsolicited offer from Cooper Industrial Electrical Inc. to purchase all of its shares; Cooper changed the offer to an offer to purchase all of Cybectec's assets. The founders of Cybectec sought to honour its employees' options by allowing the employees to exercise the options and immediately thereafter to sell the shares to a company related to Cybectec. The employees exercised their options in Cybectec and sold the shares the same day to the related company.

The taxpayers relied on paragraph 110(1)(d): paragraph 110(1)(d.1) requires that the shares be prescribed. The minister argued successfully that under regulation 6204(1)(b), the shares were not prescribed because once the options were exercised by the taxpayers, the shares were to be immediately purchased by the related company. Regulation 6204(1)(b) provides that a share is prescribed if the issuing corporation or "a specified person in relation to the corporation cannot reasonably be expected to, within two years after the time the share is sold or issued, as the case may be, redeem, acquire or cancel the share in whole or in part." The taxpayers acknowledged that the two-year holding period in regulation 6204(1)(b) was not met, but they said that regulation 6204(2)(c) allowed an exception to that requirement.

The TCC applied the SCC's guidance in Canada Trustco (2005 SCC 54), according to which an interpretation of a statutory provision must accord with a textual, contextual, and purposive analysis. The TCC concluded that regulation 6204(2)(c) does not disregard regulation 6204(1)(b): the former does not apply to the latter. Regulation 6204(1)(b) "raises a factual question," and the sole object of regulation 6204(2)(c) was, according to the TCC, "to disregard certain rights and obligations, notably to redeem, acquire or cancel the share, if all conditions of paragraph 6204(2)(c) are met." The TCC continued:

My conclusion that paragraph 6204(2)(c) of the Regulations does not disregard paragraph 6204(1)(b) is confirmed by the fact that paragraph 6204(1)(b) is applicable in cases where there is no right or obligation to redeem, acquire or cancel the shares at the time of their issue. For example, if, at the time of issue, a share is a common share without conditions, then the share is a prescribed share. However, if the facts show that the corporation knew that it would be redeeming its employees' shares within two years following the issue of the shares, then the share is not a prescribed share, since the expectation that the share will be redeemed is what triggers paragraph 6204(1)(b) regardless of whether the share has rights or obligations attached thereto. This shows that paragraph 6204(2)(c), used to eliminate from consideration certain rights or obligations, is not relevant to paragraph 6204(1)(b).

Moreover, contrary to situations in which there is a logical connection between the application of subsection 6204(2) of the Regulations and certain subparagraphs of paragraph 6204(1)(a), it is difficult to find a logical connection between the factual issue in paragraph 6204(1)(b), the two-year reasonable expectation, and paragraph 6204(2)(c), the purpose of which is to disregard the right or obligation to redeem, acquire or cancel the share or to cause the share to be redeemed, acquired or cancelled.

The TCC acknowledged that the two-year holding criteria did not apply to employees of public companies: tax policy dictates a different treatment for shares of public companies as opposed to those of private companies. The TCC noted the technical complexity of subsections 6204(1) and 6204(2) and said that "surely the time has come for a reform of these subsections."

The case is under appeal to the FCA.

Sunita Doobay, TaxChambers LLP, Toronto, Canadian Tax Highlights. Volume 25, Number 5, May 2017 ©2017, Canadian Tax Foundation.

US Country‐by‐Country Reporting

The US Treasury and the IRS implemented country-by-country (CbC) reporting requirements to ensure that US multinational enterprises (MNEs) are not subject to CbC filing obligations in multiple foreign tax jurisdictions. US CbC reporting requires the ultimate parent entity to annually file IRS form 8975, “Country-by-Country Report,” including schedule A, “Tax Jurisdiction and Constituent Entity Information.” The reporting period is for the ultimate parent’s annual financial statement that ends with or within its taxable year; if the parent entity does not prepare an annual financial statement, the reporting period is its taxable year.

Regulation section 1.60384( h) says that the reporting threshold is US$850 million. That amount is equivalent to the €750 million agreed to on January 1, 2015 under the OECD's BEPS Action 13: Guidance on the Implementation of Transfer Pricing Documentation and Country-by-Country Reporting. The July 18, 2016 Internal Revenue Bulletin (TD 9773) says that Treasury and the IRS expect other countries to acknowledge that the final BEPS report is inconsistent with a country's requiring local filing by the constituent entity of a US MNE whose revenue is less than US$850 million (paragraph 14). This is consistent with Canada's position. (See "Country-by-Country Reporting Is Here," Canadian Tax Highlights, March 2017: "The CRA administratively offers a Canadian filing exemption if the ultimate parent entity's jurisdiction 'has implemented a reporting threshold that is a near equivalent of €750 million in its domestic currency as it was at January 2015.'")

Fifty-seven countries had signed the OECD Multilateral Competent Authority Agreement on the Exchange of Country by Country Reports as of January 26, 2017. The United States is not a signatory to that agreement but has implemented CbC reporting. The preamble to the final regulations to Code section 6038 says that without the US implementation of CbC reporting, US MNEs would have been required to comply with the varying CbC filing rules applicable in foreign jurisdictions—for example, the cumbersome requirement to use local currency or language in filing. Treasury said the following in TD 9773:

In addition, CbC reports filed with the IRS and exchanged pursuant to a competent authority arrangement benefit from the confidentiality requirements, data safeguards, and appropriate use restrictions in the competent authority arrangement. If a foreign tax jurisdiction fails to meet the confidentiality requirements, data safeguards, and appropriate use restrictions set forth in the competent authority arrangement, the United States will pause exchanges of all reports with that tax jurisdiction. Moreover, if such tax jurisdiction has adopted CbC reporting rules that are consistent with the 2015 Final Report for Action 13 (Transfer Pricing Documentation and Country-by-Country Reporting) of the Organisation for Economic Cooperation and Development (OECD) and Group of Twenty (G20) Base Erosion and Profit Shifting (BEPS) Project (Final BEPS Report), the tax jurisdiction will not be able to require any constituent entity of the U.S. MNE group in the tax jurisdiction to file a CbC report. The ability of the United States to pause exchange creates an additional incentive for foreign tax jurisdictions to uphold the confidentiality requirements, data safeguards, and appropriate use restrictions in the competent authority arrangement.

The preamble to regulation 1.6038-4 discloses that the United States intends to enter into a competent authority arrangement to automatically exchange CbC reports with a jurisdiction with which it has an income tax treaty or tax information exchange agreement. According to TD 9773, Treasury and the IRS anticipate that information about the existence of competent authority arrangements for CbC reports will be made publicly available, in an as yet undetermined manner (paragraph 16).

Form 8975 is still draft: this is troublesome for US MNEs because most signatory countries require CbC reports in 2016. OECD guidelines say that a foreign subsidiary may be required to file a CbC report if its home country does not require reporting before 2017 (article 2(2) of action 13 of the BEPS report Action 13: Country-by-Country Reporting Implementation Package). In response, Revenue procedure 2017-23 was recently released to allow draft form 8975 to be filed as of September 1, 2017 for an earlier reporting period. The ultimate parent entity must file (or have filed) an income tax return for a taxable year that includes an earlier reporting period, but without a form 8975: procedures for filing an amended income tax return must be followed, and form 8975 attached, within 12 months of the end of the taxable year that includes the earlier reporting period. Ultimate parent entities are encouraged to file returns and forms 8975 electronically. The Revenue procedure says that the IRS will provide the software industry with specific electronic filing information on form 8975 in early 2017, with the intention of making the form available before the September 1, 2017 implementation date.

Sunita Doobay, TaxChambers LLP, Toronto, Canadian Tax Highlights. Volume 24, Number 4, April 2017 ©2017, Canadian Tax Foundation.

A Reflection on The Common Reporting Standards

With over 100 countries as signatories to the CRS Multilateral Competent Authority Agreement there will be little need for incidents such as the Panama papers (https://panamapapers.icij.org/) for tax authorities to find out what their tax residents were squirreling away. The CRS which stands for Common Reporting Standards is in essence an automatic annual financial information exchange tool for tax authorities. It allows a tax authority to inform another tax authority of the financial accounts held by their tax residents in the first mentioned tax authority jurisdiction.

As of July 1, 2017 the Canada Revenue Agency (CRA) will share, with members of the CRS Multilateral Agreement with which the CRA has formalized a CRS partnership, details of the bank accounts held by their residents in Canada. In return, the CRA will receive information on financial accounts held by Canadian residents outside of Canada from its CRS partners. Canadians investing significant assets overseas where banks pay higher interest rates than domestic Canadian banks will now not be able to remain undetected from CRA. These Canadians who have maintained accounts overseas without disclosing the income earned on such accounts must consider the voluntary disclosure procedures to see relief from penalties that will be levied by the CRA.

The Canadian Financial Institutions will provide the non-resident's account holder's name and address, his or her date of birth, the account balance or value at year end and certain amounts credited or paid into the account during the year to the CRA. Unlike the U.S. FATCA legislation, the CRS has no de minimis amount for reporting purposes.
The United States is not a signatory to the CRS Multilateral Competent Authority Agreement as its FATCA legislation has been fairly successful in uncovering accounts held outside the US by US persons. Although the U.S. is not a signatory to the CRS – it should be noted that the U.S. has an automatic exchange relationship with 43 countries whereby deposit interest paid to non-residents are disclosed to the tax authorities of these 43 countries. See https://www.irs.gov/pub/irs-drop/rp-17-31.pdf. The 43 countries are: Australia, Azerbaijan, Belgium, Brazil, Canada, Columbia, Czech Republic, Denmark, Estonia, Finland, France, Germany, Gibraltar, Guernsey, Hungary, Iceland, India, Ireland, Isle of Man, Israel, Italy, Jamaica, Jersey, Republic of Korea, Latvia, Lichtenstein, Lithuania, Luxembourg, Malta, Mauritius, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Saint Lucia, Slovak Republic, Slovenia, South Africa, Spain, Sweden and the United Kingdom.

It is often thought that the U.S. by not being a signatory to the Common Reporting Standards retained the taint of a tax haven. An argument can be made that it does for the tax residents of the countries who are not part of the "automatic exchange relationship". For the tax authorities of those countries - it will be only through a formal request under the tax treaty or tax information exchange agreement that information can be obtained on deposits held by US financial institutions in the U.S.

Sunita Doobay