What is the Departure Tax?
COVID-19 has grounded many Canadians from international travel and has created unforeseen tax issues related to residency. As winter approaches, many will find themselves dreaming of relocating to a sunnier destination with fewer confirmed cases. What you should know is that up-and-moving out of the country may have significant tax consequences, one of which is the little-known “departure tax”.
What is the Departure Tax?
The departure tax”is a tax levied on the assets of emigrants ceasing to be Canadian residents. For the purposes of section 219.1 of the Income Tax Act, the departure tax can also apply to corporations leaving Canada, usually enlisted to levy a 25% tax on funds that could have been distributed as dividends during the year the corporation ceased to be resident in Canada.
For the individual taxpayer, departure taxes capture gains on the emigrants’ taxable Canadian property that may or may not have been sold prior to emigration. Paragraph 128.1(1)(b) of the Income Tax Act notes the requisite criteria for the application of the departure tax with respect to individuals.
The application of the tax involves the deemed disposition of the assets at their fair market value (FMV). The asset is then deemed by Canada Revenue Agency (CRA) to have been reacquired by the taxpayer at FMV. The result of these artificial transactions is to trigger capital gains payment on the part of the taxpayer, theoretically to protect the Canadian tax base from erosion.
Who does the Departure Tax Apply to?
The Departure Tax applies to individuals who CRA deems to be emigrants. To be considered an emigrant for taxation purposes, a taxpayer must meet both of the following criteria:
- The taxpayer leaves Canada to live in another country; and
- The taxpayer has severed “residential ties” with Canada, which include
- a principal residence in Canada;
- a spouse or common-law partner in Canada;
- dependants in Canada;
- membership in social organizations;
- personal property such as bank accounts, a car or furniture; and
- documents of Canadian citizenship (driver’s license, passport, health cards, etc.).
If a non-resident Canadian keeps some residential ties to Canada, the non-resident may still be considered an emigrant pursuant to the tax treaty of the non-resident’s new jurisdiction with Canada.
What Kind of Property does the Departure Tax Apply to?
Departure Taxes can capture a wide variety of personal property, such as shares in a corporation, jewellery, artwork and many others. Personal property is a broad category that encompasses many kinds of “personal-use property” as defined by section 54 of the Income Tax Act.
In short, if you are emigrating out of the country, it would be prudent to consider broadly all items of significant value as personal-use property and then identify which of these assets may be captured by the departure tax.
Departure Tax – Tips and Tricks
Emigrants with property that had an FMV greater than $25,000 on the date the taxpayer ceased to be a resident of Canada must file a T1161. This form outlines several exclusions to this $25,000 amount, including cash, registered saving plans, certain personal property, and certain real property.
Pursuant to subsections 220(4.5) to 220(4.54) of the Income Tax Act, taxpayers may be eligible to defer payment of departure tax, so long as “adequate security” is provided by using a Form T1244. The Income Tax Act does not define “adequate security” but does provide a formula for calculating the requisite value a security must hold before being considered “adequate”. Deferral may be the best option for taxpayers who do not wish to emigrate from Canada permanently, as when subsection 220(4.5) is used in conjunction with subsection 128.1(6), a taxpayer can retrieve the security intact upon the emigrant’s return to Canada.
Subsection 128.1(6) of the Income Tax Act may also allow emigrated taxpayers who return to Canada to be treated as never having accrued gains, so long as they meet all eligibility requirements of the provision.
The Departure Tax and Tax Planning
Taxpayers with significant assets that could be subject to departure tax should ensure compliance with all reporting requirements during the year in which they cease to be Canadian residents. If this cannot be confidently or competently done without assistance, it may be prudent to seek tax planning advice from a legal professional. Subsection 128.1(6) does not insulate a taxpayer from penalties and interest stemming from non-compliance with the departure tax. Since interest is calculated at the compound rate of 5% per annum, this could result in serious debt obligations to CRA upon returning to Canada.
If you need assistance with non-resident tax planning, or you’re in doubt about whether your departure tax filing meets CRA’s reporting requirements or if you want to be sure your deferral security is in fact “adequate security”, it may be safer to seek guidance from a legally trained tax professional. Call us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.