How To Legitimately Defer The Worst Of Canada's ‘Departure Tax' When Becoming A Non-Resident And Moving To Another Country - Tax Authorities

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The Canadian Departure Tax Regime

Under subsection 128.1(4) of the Canadian Income Tax Act, aCanadian emigrating to another jurisdiction is subject to a"deemed disposition" on qualifying property. (This deemeddisposition is often referred to as Canada's "departure tax"). Where a taxpayer issubject to departure tax, that taxpayer is deemed to have sold andrepurchased qualifying property at its fair market valueimmediately before becoming a non-resident of Canada. Thus, anygain that has accrued on that property prior to becoming anon-resident is recognized for tax purposes, even though thetaxpayer has not actually disposed of any property. This isreferred to as a "deemed disposition." In essence, thedeparture tax is the Canadian tax system's method of assertingits jurisdiction to tax the accrued value of a taxpayer'sproperty while that taxpayer was resident in Canada.

The departure tax can create a substantial and unforeseen taxbill for the unaware emigrating taxpayer. And while tax planningservices from an expert Canadian tax lawyer can help to mitigate theoverall impact of departure tax on a taxpayer's finances, aCanadian emigrant will inevitably have to fund some departure tax.The Canadian tax system provides limited taxpayer relief under subsection 220(4.5) ofthe Income Tax Act by allowing qualifying taxpayers to postsecurity in lieu of paying the total amount of departure tax owingwhen emigrating from Canada.

What will qualify as adequate security, however, will depend onthe circ*mstances. As well, there is a very specific process whichmust be observed for electing under subsection 220(4.5) by filingForm T1244 with the Canada Revenue Agency ("CRA"). Thisarticle will begin by briefly exploring the rules concerning taxresidence in Canada and the conditions under which somebody canemigrate from Canada for tax purposes. It will then discuss theparticulars of subsection 220(4.5), and in particular, who can makean election under the subsection, what will qualify as adequatesecurity, and how the election must be made.

Finally, we will provide some pro-tax tips from our Canadian taxlawyers and frequently asked questions concerning Canadian departure tax and Form T1244.

A Brief Summary of Residence Rules for Canadian Tax LawPurposes

To understand how the Canadian departure tax works, it isnecessary to understand the concept of residence for tax purposes.Under subsection 2(1) of the Canadian Income Tax Act, an individual who isa resident of Canada is subject to tax on worldwide income. Incontrast, a non-resident individual of Canada is onlysubject to tax on Canadian-source income under subsection 2(3) andPart XIII of the Income Tax Act. Residence for tax purposes can bedistinguished from citizenship or nationality in that it is not anadministrative status determined by the Canadian government.Rather, residence for tax purposes follows veryparticular rules under the Income Tax Act and Canadian commonlaw.

For purposes of Canada's domestic tax laws, an individualcan be found resident in Canada:

where that taxpayer is "ordinarily resident" withinthe meaning of subsection 250(3) of the Income Tax Act; or
where that taxpayer is not otherwise ordinarily resident inCanada at any point in a given taxation year, that taxpayer is a"deemed resident" under paragraph 250(1)(a) of the IncomeTax Act.

Defining "Ordinarily Resident" in Canada

Under subsection 250(3) of the Income Tax Act, an individual isviewed as a resident of Canada where that individual is"ordinarily resident" in Canada. ("Ordinaryresidence" is often referred to as "factualresidence.") The Income Tax Act does not define what it meansto be "ordinarily resident," and so Canadian courts havearticulated conditions that are to be weighed when determiningwhether a person is ordinarily resident or not. Broadly speaking, aperson's ordinary residence is "the place where in thesettled routine of his life he [or she] regularly, normally orcustomarily lives." Other relevant factors for determiningsomebody's ordinary residence include a person's:

past and present habits of life;
regularity and length of visits in the jurisdiction assertingresidence;
ties within that jurisdiction;
ties elsewhere;
permanence or otherwise of purposes of stay abroad.

In addition, the CRA has published its own views in Income TaxFolio S5-F1-C1 ("Determining an Individual's ResidenceStatus") as to what factors will militate in favour of anindividual being a Canadian factual resident. While the CRA'spublished views on Canadian tax law do not have force of law inCanada, they have been recognized by Canadian courts as fundamentaltools for the interpretation and application of Canada's taxlaws to other taxpayers. Those views should not be ignored whenthey correctly interpret the law, and in particular, CRA'sIncome Tax Folio S5-F1-C1 has been cited with approval by the TaxCourt of Canada and reasonably tracks applicable case lawconcerning Canadian tax residency.

Broadly speaking, when considering both the common law andCRA's published views, the most significant factors forestablishing whether an individual is a Canadian factual residentwill include:

whether that individual has a "dwelling place" (i.e.a home or apartment) available for their long-term use inCanada;
whether that individual has a spouse or common-law partner inCanada; and
whether that individual has any dependents in Canada.

Other important secondary ties that can influence a finding thatan individual is a Canadian factual resident or not include thatindividual's personal property (i.e. furniture and vehicles),economic ties (i.e. bank accounts, investments, registered plans,credit cards and other debt), immigration status, governmentdocuments (i.e. health insurance, driver's licence, passport),and social ties (i.e. memberships to professional organizations orunions, or recreational clubs or religious organizations) inCanada.

It bears repeating that an individual's factual residenceremains a purely fact-specific determination. Canadian courts have,in certain circ*mstances, found a taxpayer to be a non-resident of Canada or to have ceased to bea factual resident in Canada, despite maintaining significant ties(i.e. a dwelling, spouse, or dependents) in Canada.

The "Deemed Residence" Rule

Paragraph 250(1)(a) of the Income Tax Act deems anindividual to be a resident of Canada throughout a particular taxyear if that person "sojourned" in Canada for 183 days ormore in that year. This is often referred to as the "deemedresidence" rule. The meaning of "sojourning" hasbeen broadly interpreted to mean that the individual was"temporarily resident" in Canada. A commuter can bedistinguished from a sojourner in that a commuter is only presentin Canada for purposes of travelling between destinations, like toand from work. A sojourner may stay in Canada, even casually orintermittently, but with some sense of permanence. Whether anindividual is a sojourner is a fact-specific analysis similar tothe factual residence test.

It is worth acknowledging that an individual can only be deemedresident in Canada where that individual was not otherwise afactual resident of Canada, and so the factual residence test mustbe considered before the deemed residence rule when determining anindividual's status as a Canadian tax resident.

Ceasing to be a Resident of Canada for Tax Purposes

An individual may be viewed as a factual non-resident where thatindividual's ties to Canada are minimal and demonstrate thatCanada is not that individual's settled, normal or customaryplace of living. For a Canadian factual resident to become anon-resident, that taxpayer will have to break enough significantresidence ties to Canada such that there is no longer a basis forCanada to assert its tax jurisdiction over that individual. Aswell, where a taxpayer sojourn in Canada for fewer than 183 days,the deemed residence rule will simply not apply. Breaking Canadiantax residence under the domestic Canadian tax regime can provequite difficult without appropriate tax planning services. A Canadian tax residentmust sever enough significant ties to Canada in a given tax yearand must also avoid returning to Canada to avoid being caught bythe deemed residence rule.

Further, an individual may be deemed to be a non-resident undersubsection 250(5) of the Income Tax Act in very specificcirc*mstances. Canada has formed a number of bilateral tax treatieswith countries worldwide, which contain provisions to help settlewhat countries' domestic tax laws will have claim to tax thatindividual, where that individual is a tax resident of bothcountries. Most Canadian treaties follow the OECD Model TaxConvention, which provides a number of standard and sequentialtie-breaker rules to determine where an individual is a resident.Under the OECD Model, an individual is deemed to be aresident in the jurisdiction:

in which the individual has a permanent home available;
in the jurisdiction of that individual's "centre ofvital interest";
in the jurisdiction of that individual's "habitualabode";
in the jurisdiction that individual is a citizen or national;or
where the above tests remain inconclusive, whatever mutualconclusion that the competent authorities of each jurisdictionarrive at (that is, the Canada Revenue Agency and the othercountry's tax authority will come to an agreement on theissue.)

To give effect to an international treaty determination, undersubsection 250(5) of the Income Tax Act, where a Canadiantax resident is deemed a resident of another country under abilateral tax treaty, then that individual is deemed to be anon-resident of Canada as of that day the treaty applied. In otherwords, the deemed non-residence rule will only apply where anindividual is resident in both Canada and another country and isnot deemed a Canadian tax resident under that treaty. Thus, where aCanadian tax resident is otherwise deemed to be a Canadian taxresident under a bilateral tax treaty, that individual's statusas a Canadian tax resident will remain untouched.

Subsection 220(4.5) and Delaying Departure Tax

As discussed above, when an individual who was a Canadian taxresident becomes a non-resident, then that person will be subjectto departure tax on qualifying property. A natural person whobecomes a non-resident would be required to file a Form T1161 withthat year's tax return, listing all properties owned at thetime of emigration if the fair-market-value of those propertiesexceeded $25,000 (subject to limited exceptions including cash andpersonal-use property with a fair-market-value of less than$10,000). A taxpayer must also prepare and submit Form T1243 withthat year's tax return to report the property subject todeparture tax in that year.

Under subsection 220(4.5), a "qualifying Canadiantaxpayer" (which includes a natural person or a trust) mayelect with the CRA to post adequate security in lieu of paying thatdeparture tax. The election under subsection 220(4.5) is onlyavailable for a tax that results from the deemed disposition ofqualifying property immediately before emigration and not any othertax payable for the year, like income tax payable on income earnedfrom an office or employment or a personal business run whileresident in Canada. In order to make that election, the taxpayermust file a completed Form T1244 ("Election, under Subsection220(4.5) of the Income Tax Act, to Defer the Payment of Tax onIncome Relating to the Deemed Disposition of Property") withthe CRA on or before the balance due date for taxes owing for theyear of emigration. Extending that deadline is subject to theCRA's discretion and may not be granted in all cases.

Under subsection 220(4.51) of the Income Tax Act, adequatesecurity will not be required for the first $16,500 of federaldeparture tax owing. For any remaining tax, the relevant securitymust be posted by the filing due date of the year followingemigration. If security is not posted, penalties and interest willaccrue on the tax due. If adequate security is posted, thedeparture tax is treated as paid, and interest will not accrue.

What qualifies as "adequate security" for the purposesof subsection 220(4.5) is based on the actual amount of departuretax owing. Broadly speaking, the Income Tax Act provides thatsecurity must be of an amount that is at least equal to the federaland provincial taxes owing as a result of the departure tax. TheCRA has discretion as to what form of security will be acceptablefor an election under subsection 220(4.5), but it will generallyaccept:

a letter of guarantee or a letter of credit issued by aCanadian financial institution;
shares in a Canadian private company, to the extent that thoseshares are the property giving rise to departure tax; and
a mortgage on Canadian real property, up to 75% of theappraised equity of the property.

A taxpayer may be motivated to make an election under subsection220(4.5) for a number of reasons. First, as discussed above, thedeparture tax can be quite substantial and can disrupt cash flowsfor a business or the lifestyle of a taxpayer. Posting securityprovides additional time for a taxpayer to organize personal andbusiness affairs to account for a sudden increase in taxes, wherethat taxpayer has not actually received any proceeds from disposingof property. Second, a taxpayer may wish to return to Canadasometime in the near future and take advantage of the unwindingrules under the Income Tax Act.

Under subsection 128.1(6), where a taxpayer emigrant of Canadareturns to Canada, that taxpayer may elect to claim back some orall of the departure tax previously paid or payable (as long asthose assets subject to departure tax are still owned by thetaxpayer). The election does not cancel the deemed dispositionitself, but it reduces the deemed proceeds by an amount that equalsthe least of the following three amounts: (1) the amount of thegain reported on the taxpayer's tax return in the tax year inwhich the taxpayer emigrated (i.e., the deemed disposition thatwould otherwise result); (2) the fair market value of the asset onthe date the taxpayer returns to Canada; and (3) an amount that thetaxpayer designates. If a taxpayer anticipates a return to Canada,then that taxpayer can elect under subsection 220(4.5) to deferdeparture tax and elect again under 128.1(6) when returning toCanada to substantially reduce the deemed proceeds received. Inthat way, a taxpayer can effectively avoid having to remit the fulldeparture taxes owing as a result of emigrating to Canada, only tohave some or all of those taxes refunded to the taxpayer.

It should be clear from the above that the process to postadequate security for departure taxes can take a substantial amountof time to complete and to obtain approval from the CRA. Startingthe process early is crucial to ensure sufficient time to obtainCRA's approval for proposed security before the applicable taxfiling deadline. It warrants discussing your goals and options withan expert Canadian tax lawyer to determine exactly how to go aboutplanning your departure from Canada so that you can avoid the fullweight of Canada's departure tax regime.

PRO TAX TIP

Electing for the Deemed Disposition to Apply to ExemptedProperty Using Form T2061A May Offer Additional Tax PlanningOpportunities

Canadian real or immovable property, Canadian resourceproperty, and timber resource property;
Canadian business property, including inventory, if business iscarried on through a "permanent establishment" inCanada;
"excluded rights or interests," broadly includingpension plans, annuities and registered savings plans like registered requirement savings plans("RRSP"), tax-free savings accounts ("TFSA"),and employee security options subsect to Canadian tax; and
property owned when that person last became a resident ofCanada (or property inherited afterward) if that person was aresident of Canada for 60 months or less during the 10-year periodbefore emigrating.

With respect to Canadian real or immovable property, or Canadianbusiness property, the Income Tax Act grants taxpayers the rightunder paragraph 128.1(4)(d) to elect for the deemed disposition onemigration to apply to those particular assets. That election mustbe made in the prescribed form using Form T2061A ("Election byan Emigrant to Report Deemed Dispositions of Property and anyResulting Capital Gain or Loss"), and which should be filedwith the tax return for the year in which the taxpayer emigratedfrom Canada.

A taxpayer may be motivated to make this election for a numberof reasons. First, making this election in respect of property mayhelp to crystallize any accrued losses and to offset gains fromproperty that cannot escape the departure tax regime. This line ofthinking will require considering stop-loss rules under the IncomeTax Act, however. Second, making this election for a principal residence will allow a taxpayer toclaim the principal residence exemption for the property beforethat property is actually sold, which may offer tax advantages inspecific circ*mstances. It is to a taxpayer's benefit thatexpert Canadian tax counsel be consulted early in the process todetermine whether an election under paragraph 128.1(4)(d) mightoffer tax planning opportunities, and if so, for what propertiesexactly the election should be made.

Frequently Asked Questions

What conditions are required for a Canadian taxpayer to"emigrate" from Canada for tax purposes?

The concept of residence can be distinguished from citizenshipor nationality in that it consists of an individual's variousties to Canada as opposed to that individual's Canadianadministrative (i.e. immigration) status. A Canadian taxpayer canbecome a non-resident for tax purposes where that taxpayer ceasesto be a factual resident of Canada, such that Canada is no longerthe individual's settled, normal or customary place of living.As well, under subsection 250(5), where a Canadian tax resident isa resident in both Canada and another country, and under anapplicable bilateral tax treaty that individual is deemed aresident of the other country and not Canada, then that individualis deemed to be a non-resident of Canada as of that day the treatyapplied.

What types of property are not subject to the Canadian"departure tax" regime?

Under subsection 128.1(4) of the Income Tax Act, specificproperties owned by an emigrant for tax purposes are exempted froma deemed disposition on becoming a non-resident of Canada. Thislist includes: (1) Canadian real or immovable property, Canadianresource property, and timber resource property; (2) Canadianbusiness property, including inventory, if business is carried onthrough a "permanent establishment" in Canada; (3)"excluded rights or interests", broadly including pensionplans, annuities and registered savings plans like registeredrequirement savings plans ("RRSP"), tax-free savingsaccounts ("TFSA"), and employee security options subjectto Canadian tax; and (4) property owned when that person lastbecame a resident of Canada (or property inherited afterward) ifthat person was a resident of Canada for 60 months or less duringthe 10-year period before emigrating.

What is Form T1244?

Under subsection 220(4.5) of the Canadian Income Tax Act, a"qualifying Canadian taxpayer" (which includes a naturalperson or a trust) may elect with the CRA to post adequate securityin lieu of paying departure tax owing after emigrating. Thatelection must be filed in the prescribed form with CRA using FormT1244 on or before the balance due date for taxes owing for theyear of emigration. Extending that deadline is subject to theCRA's discretion and may not be granted in all cases, and theCRA must accept the security posted for the election to beeffective. It warrants discussing your emigration goals with expertCanadian tax counsel and starting the process early to ensure thereis sufficient time to obtain CRA's approval for any proposedsecurity before the applicable tax filing deadline.

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.

How To Legitimately Defer The Worst Of Canada's ‘Departure Tax' When Becoming A Non-Resident And Moving To Another Country - Tax Authorities - Canada (2024)