Immigrants to Canada who have significant personal savings and investments are often dismayed by Canada's high rates of personal income tax.  Canada's 35% to 55% tax on investment income and capital gains is often far in excess of the tax rate in the immigrant's home country.  For this reason many such immigrants will be interested in Canada's five year 'tax holiday' on investment income for new Canadian residents.  To take advantage of the holiday the immigrant must place his or her investment assets in a non-Canadian trust.  The tax holiday shelters the investment assets from Canadian tax for up to five years, but Canada's Income Tax Act imposes a number of complex technical requirements and new immigrants to Canada should therefore consult with their professional advisors to establish a plan for taking advantage of the holiday.  This article provides an overview of some of the main considerations and issues in establishing an offshore trust, but it should not be taken as a substitute for direct professional advice to take account of each immigrant's personal situation and objectives.

Who should be interested in an Offshore Immigrant Trust?

Anyone who is about to immigrate to Canada or who has immigrated to Canada within the last five years and who has investments or savings outside of Canada should consider an offshore immigrant trust.  In most cases an immigrant should have $500,000 or more to place into trust in order to generate sufficient tax savings to justify the cost of planning for and creating the appropriate trust structure.  It should be stressed that immigrants who are already in Canada can still make use of an offshore immigrant trust, although the benefits are reduced because the five year holiday begins to run from the time Canadian residency commences.

Why consider an Offshore Immigrant Trust?

Once an immigrant takes up residence in Canada, he or she win be subject to Canadian income tax on all of his or her world income.  Canada will tax investment income of the immigrant no matter where the income is earned.  As well, Canada's tax rules will generally look through a foreign trust or corporation controlled by the immigrant and tax the investment income of that entity as if it were the individual's own property.  The tax holiday on offshore immigrant trusts is an exception to these rules.

What are the rules for using the tax holiday?

Canada will not tax the investment income or capital gains of a non-resident trust in any given year unless:

1. the person who contributes property to the trust has been a Canadian resident at any time in the 18 months before the end of the year; and
2. that person has been a Canadian resident for more than 60 months at any time before the end of the year.

Therefore, no tax will be imposed on the trust until the tax year of the trust during which the immigrant's first 60 months of Canadian residency have elapsed.

It should be emphasized that the trust cannot be a resident of Canada.  This requirement is usually satisfied by placing the property in trust with an established trust company in a tax-free jurisdiction.  In this way the trust will not be subject to tax in its home jurisdiction.

What other concerns must be satisfied?

Canada's Income Tax Act imposes a number of technical rules on the use of private trusts.

These rules are not aimed specifically at offshore immigrant trusts, but they must be complied with in order to ensure that the offshore trust structure is accepted by Canada's tax authorities.  The rules are designed to prevent the use of a trust to:

1. split income between family members to reduce the overall tax imposed on investment income;
2. hold property in trust where the property may revert to the original contributor of the trust property; or
3. transfer investment income into the hands of non-residents, thereby escaping the reach of Canada's tax system.

In order to comply with these rules, it is often necessary to structure the offshore trust in combination with a foreign corporation.  A typical structure would be as follows:

1. the immigrant would not transfer his investment assets directly to the offshore trust;
2. instead, the offshore trust would incorporate a company in a tax-free jurisdiction;
3. the immigrant would then sell his or her property to the new company in return for preferred shares in the company;
4. the preferred shares would then be gifted to the offshore trust; and
5. no dividends would be declared on the preferred shares held by the trust during the five year tax holiday period.

It will not always be necessary to use this kind of corporate structure, which adds to the complexity and cost of taking advantage of the five year tax holiday.  However, in many cases it will be necessary to take these steps to ensure compliance with the rules described earlier.

Timing Considerations

The five year holiday period begins to run the moment the immigrant takes up residence in Canada.  It is therefore preferable to have the offshore trust structure in place before the immigrant arrives in Canada.  The trust can be established after taking up Canadian residence, but any delay will reduce the five year holiday.

Careful planning is also necessary with respect to the expiry of the tax holiday.  The trust will be subjected to Canadian tax for the entire calendar year in which the 60th month of the immigrant's Canadian residency falls.  It is therefore necessary to plan in advance of this time, and in many cases it will be advantageous to wind up the trust before the calendar year in which this 60th month falls.  This means that often the holiday period will actually be somewhat less than five full years.

Because of the complex rules surrounding offshore immigrant trusts, interested readers are urged to consult with their Canadian tax and legal advisors before putting such a trust structure in place.

The information contained in this Client Update is intended for general information only. For further information, please contact any  member of our Tax Department in our Halifax office.

Stewart McKelvey Stirling Scales
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