7 January 2004 External T.I. 2003-0019531E5 - Deemed disposition of property on emigration

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: General questions on
-the meaning of "acquired for no consideration"
-deemed TCP as a result of an election under former 48(1)(c)
-subsequent disposition of property and the release of the posted security

See document 2004-006184 for clarification of the calculation of the capital gain on the deemed disposition under paragraph 128.1(4)(b) of a beneficiary's interest in an inter vivos personal trust resident outside of Canada.

XXXXXXXXXX 	2003-001953
		Annemarie Humenuk
Attention:  XXXXXXXXXX 

January 7, 2004

Dear XXXXXXXXXX:

Re: Deemed Disposition of Property on Emigration from Canada

This is in reply to your facsimile transmissions of November 13, 2002, and December 2, 2003 concerning property held in a personal trust and the deemed disposition rules applicable for income tax purposes when an individual ceases to reside in Canada. We apologize for the delay in our response.

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act").

Your questions relate to various scenarios involving residents of the U.S. who were formerly resident in Canada. As explained in Information Circular 70-6R5, Advance Income Tax Rulings, this Directorate does not comment on transactions involving specific taxpayers except by way of an advance income tax ruling in respect of proposed transactions. When the situation involves a specific taxpayer and a completed transaction, the question should be directed to the appropriate Tax Services Office for their views, along with all relevant facts and documentation. However, we are prepared to offer the following general comments which may be of assistance.

Emigration from Canada

Since 1972, a person who emigrates from Canada is generally treated as having disposed of all the person's property other than "taxable Canadian property" immediately before the departure. Taxable Canadian property (referred to in this letter as "TCP") is a defined term for Canadian income tax purposes. The deemed disposition rules arising on the immigration to, and emigration from, Canada are meant to ensure that Canada can tax the gains that have accrued on a person's property while the person was resident in Canada.

The deemed disposition rules were amended effective October 1, 1996 to exclude property defined in subsection 128.1(10) as an "excluded right or interest" and to include certain types of TCP which were previously not subject to the deemed disposition rule on emigration. The exceptions to the deemed disposition rules on departure are based on the difference in the Canadian tax treatment of such property when it is disposed of by a non-resident of Canada. Since the property that is subject to the deemed disposition rules on departure is generally not subject to tax in Canada after its owner emigrates from Canada, the accrued gains on such property must be taxed before the person leaves Canada. In contrast, Canadian income tax is still payable on the gains realized on TCP (including TCP that is subject to the deemed disposition rule on emigration) and property that is defined in subsection 128.1(10) as an excluded right or interest after the owner leaves Canada. As a result, it is acceptable within tax policy terms that such property not be subject to the deemed disposition rules at the time of departure.

The deemed disposition rules apply to any person who is taxable in Canada as a resident of Canada, including a trust. The deemed disposition rules in paragraph 128.1(4)(b) apply to the property held by the person who ceases to be resident in Canada. Thus, where an individual holds an interest in a trust, it is only the property of that individual, and not that of the trust, which is potentially subject to the deemed disposition rule on departure, provided that the trust does not also cease to be resident in Canada as a result of the individual's departure. In the case of a non-resident trust that is deemed to be resident in Canada under paragraph 94(1)(c) or proposed subsection 94(3), such a trust would also be subject to the deemed disposition rules when it is considered to have ceased to be resident in Canada.

As noted below, a natural person who ceased to be resident in Canada prior to October 2, 1996 could elect to treat his or her property that would otherwise be subject to the deemed disposition rules as TCP. The effect of such an election is that the deemed disposition rule did not apply to the property at the time of the individual's departure and the property will be considered to be TCP until such time as the individual disposes of it or becomes resident in Canada again. More information on the rationale for the deemed disposition rules is available from the Finance Canada's News Release, 98-134, Backgrounder on Taxpayer Migration and Trusts: Detailed Proposals December 23, 1998, which can be found on their website at http: //www.fin.gc.ca/finsearch/finresults_e.asp?Who=News&Scope=1998.

Taxable Canadian Property and An Interest in a Personal Trust

In your initial submission, you noted that the deemed disposition rule for a person leaving Canada does not apply to certain property of that person, including Canadian real estate, rights to pension income and certain interests in a personal trust.

In particular, an interest in a personal trust resident in Canada is considered to be an "excluded right or interest" that is not be subject to the deemed disposition rules in subsection 128.1(4) provided that the interest was never acquired for consideration and the individual's interest in the trust did not arise as a result of a transfer of property to the trust by that individual on a "rollover basis". Likewise, an interest in a non-resident testamentary trust that was never acquired for consideration is an "excluded right or interest" within the meaning of subsection 128.1(10) and is not deemed to have been disposed of when the beneficiary ceases to be resident in Canada. You ask what is meant by the phrase "an interest in a trust that was not acquired for consideration" and ask for further clarification of the rules relating to the property that is held in such a trust.

A beneficiary's interest in a trust that is not acquired for consideration is an interest which the beneficiary acquired without payment or other transfer, assignment or disposition of property to any person in order to obtain such an interest. Such an interest would normally arise when an individual, the settlor, establishes the trust for the purpose of providing benefits to the members of the settlor's family who are named by the settlor in the terms of the trust deed or will. Subsection 108(7) provides that an individual who contributes property to the trust and who is also a beneficiary of the trust will not be considered to have acquired such interest for consideration provided that all other beneficial interests in the trust that were acquired by way of a transfer, assignment or other disposition of property to the trust were acquired by persons related to that individual. Thus, if a husband and wife contribute property to a trust of which the husband, wife and children are beneficiaries, the application of subsection 108(7) ensures that none of the interests are considered to have been acquired for consideration for the purpose of the certain provisions of the Act, including the rules relating to the deemed disposition on emigration from Canada. However, if a trust is established by contributions from two or more unrelated persons and those unrelated persons are beneficiaries of the trust, their respective interests in the trust would be considered to have been acquired for consideration.

Subsequent Disposition of Taxable Canadian Property

Your next two questions appear to relate to the Canada-U.S. Income Tax Convention (the "Treaty"). If an individual who is a resident of Canada holds an interest in a trust that is an "excluded right or interest" such that no gain or loss is recognized when the individual ceases to be resident in Canada, the subsequent disposition of all or part of that interest will only be taxable in Canada if the interest is also TCP and none of Canada's tax treaties with other countries prevents Canada from taxing such gain. Thus, while a non-resident's capital interest in a personal trust resident in Canada will be taxable in Canada when the non-resident beneficiary disposes of all or part of such interest subject to the application of any tax treaty Canada has with the country in which the non-resident beneficiary is resident at the time of such disposition, the gain, if any, on the disposition of an interest in a non-resident testamentary trust that is not TCP will not be subject to tax when the non-resident beneficiary disposes of such interest. For the purpose of this letter, we will assume that the Treaty is the only tax treaty that could possibly apply to the subsequent disposition of that interest.

Under Article XIII of the Treaty, the gain from the disposition of property by a resident of the U.S. will generally not be subject to tax in Canada unless the property is real property situated in Canada, an interest in a trust, estate, partnership or corporation that principally derives its value from real property situated in Canada or the property is used in a business with a permanent establishment in Canada. In addition, under paragraph 5 of Article XIII of the Treaty, Canada retains the right to tax the gain on the disposition of property not described in paragraphs 1, 2 or 3 of that Article where the property belongs to an individual who was formerly resident in Canada if

(a) the individual was resident in Canada for 120 months or more during any period of 20 consecutive years preceding the disposition of the property,

(b) the individual was resident in Canada at any time during the ten years immediately preceding the disposition of the property and

(c) the property, or property which the individual acquired in substitution for the property without the recognition of any gain or loss on that substitution, was held by
that former resident at the time the individual ceased to be resident of Canada.

If an individual who is resident in the U.S. disposes of property that was not subject to the deemed disposition rules on the individual's departure from Canada more than ten years after leaving Canada, the individual would normally not be subject to tax in Canada on any gain realized as a result of that disposition by reason of the Treaty. However, the individual would still be required to file form, T2062, Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property, under section 116 of the Act in respect of the disposition of such an interest in the trust.

Disposition of an Interest in a Personal Trust

In our conversation of December 1, 2003 (XXXXXXXXXX \Humenuk), you also asked about the tax consequences applicable when a resident of Canada holding an interest in a personal trust resident in the U.S. ceases to be resident in Canada. As stated above, an interest in a testamentary non-resident trust is generally not subject to the deemed disposition rules upon the departure of the beneficiary. On the other hand, if the non-resident trust was created during the lifetime of the settlor, or if anyone contributed additional property to a trust that would otherwise be a testamentary trust except as a consequence of the death of that other person, the beneficiary's interest in such a trust would be subject to the deemed disposition rules when the beneficiary ceased to be resident in Canada. However, provided that the trust was a personal trust and the adjusted cost base of the beneficiary's capital interest in the trust had not previously been adjusted under paragraph 53(2)(g.1) at any time in the past in respect of a forgiven debt, the beneficiary would generally not realize any capital gain as a result of the disposition of any part of such an interest because the adjusted cost base of the interest as determined under paragraph 107(1)(a) would normally equal the proceeds of disposition of that interest.

Disposition of Property that was Subject to an Election under Subsection 48(1)

In your facsimile transmission of December 2, 2003, you describe a scenario in which a former resident of Canada made an election under paragraph 48(1)(c) in respect of some of his property that would otherwise have been subject to a deemed disposition when he ceased to be resident in Canada in 1990. The individual subsequently transferred the property to a U.S. grantor trust in 1991.

The effect of making a T2061 election under paragraph 48(1)(c) in 1990 is that the property described in the election that would otherwise not be TCP (for example, the U.S. property described in your facsimile transmission of December 2, 2003) is deemed to be TCP by reason of subsection 48(2) with an adjusted cost base, or cost amount, based on the amount shown on the face of the election form. If the individual owned the property before becoming a resident of Canada, the adjusted cost base of the property would be its fair market value immediately before the individual last became resident in Canada. Refer to IT-451R, Deemed Disposition and Acquisition on ceasing to be or becoming resident in Canada, and paragraph 13 in particular, for an overview of the rules relating to this election.

In the scenario described in your facsimile transmission, the property that was the subject of the election is considered to be TCP. As a result, any capital gain realized on the property when it was disposed of by the non-resident is taxable in Canada under paragraph 2(3)(c) and section 115, unless the Treaty applies to exempt such gain from tax in Canada. Under the definition of "disposition" in section 54 of the Act as it applied in 1991, a transfer of property to a trust would result in a disposition unless, among other things, there was no change in beneficial ownership as a result of the transfer. If the transfer of the property to a trust in 1991 did not result in any change in the beneficial ownership of the U.S. property that was deemed to be TCP, Canada would have a right to tax the subsequent gain on the disposition of the former resident's interest in the U.S. trust because the interest in the U.S. trust would be property which the former resident acquired in substitution for the deemed TCP without the recognition of any gain or loss on that substitution and paragraph 5 of Article XIII would apply as explained above.

If the transfer of property to the trust resulted in a change of beneficial ownership, the individual should have filed a tax return for 1991, reporting the disposition of the property that was subject to the election. If this was not done, it should be done as quickly as possible to avoid additional interest charges. Once the tax return which includes the disposition of the property has been assessed, the security posted in respect of such property can be released.

In determining whether Canada still has a right to tax the accrued gain on a particular disposition, it should be noted that any change in the individual's residential status prior to the actual disposition of the property may affect Canada's right to tax the accrued gain on the property. For example, the individual could return to Canada for a period of time such that the conditions in paragraph 5 of Article XIII are met at the time of disposition or the individual could become a resident of a country other than the U.S., in which case, the Treaty would have no application in respect of that subsequent disposition.

The renewal or release of the security posted in respect of an election under paragraph 48(1)(c) is the responsibility of the appropriate Tax Services Office serving the area where the taxpayer was located immediately before his departure from Canada. Hence, the taxpayer should consult the appropriate Tax Services Office for information with respect to the release of the security posted under paragraph 48(1)(c). However, in general, we would not expect that the security would be released until the capital gain arising from the actual disposition of the property in respect of which an election has been made, if any, has been reported on a tax return and the applicable tax has been paid, or the individual has become resident in Canada again.

We trust that these comments will assist you in determining the appropriate tax consequences for former Canadian residents holding an interest in a personal trust or property that was subject to an election under former paragraph 48(1)(c). However, as stated in paragraph 22 of Information Circular 70-6R5, the opinion expressed in this letter is not a ruling and consequently is not binding on the Canada Customs and Revenue Agency ("CCRA") in respect of any particular set of circumstances.

All CCRA publications referred to in this letter are available from the CCRA website at the following address: http://www.ccra-adrc.gc.ca/tax/technical/incometax/menu-e.html.

T. Murphy
Section Manager
for Division Director
International & Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch