Onerous tax obligations are causing 73% of Americans in Canada to consider giving up their U.S. passports, says a survey by Devere Group.
But the view’s very different for dual citizens from other countries, including the U.K., China and India. These clients are often happy to hang onto two passports.
That’s because dual citizenship is not a serious tax issue for non-U.S. clients, explains Ray Kinoshita, national global mobility services partner at Grant Thornton LLP in Toronto.
“The vast majority of countries categorize individuals for tax purposes on the basis of residence, not citizenship,” he says. “As a practical matter, if they aren’t U.S. citizens, we seldom need to worry about a client’s citizenship to determine his tax obligations.”
Residence status, Kinoshita notes, is generally determined through four tiebreaker rules: permanent home; centre of vital interests; habitual abode; and nationality. You’d look at the first rule, and if a client has a permanent home in neither or both countries of which she’s a citizen, then move on to the next; and so on (see “Tax Treatment,” AER March 2014).
If you have clients who are Canadian residents and they are dual citizens in other countries, here’s what you need to know.
Clients may come from countries where tax rules aren’t always set in stone, says Douglas Rosser, international tax specialist at MNP. He cites the Philippines, Thailand, Indonesia, China, Vietnam and India as examples.
“Actual tax rates may be negotiable with the tax authorities,” he says. That’s why advisors must explain how tax rules work here.
Mabel Ho, private banker at BMO Harris Private Banking, has seen cases where cultural values come into play. Some of her clients don’t believe in giving to charity. And Ho had one client who left money for her sons’ educations only, leaving out her daughters.
“If this is their culture, you have to respect it,” says Ho. “We can make suggestions but, in the end, it’s not our place to say how a client’s wealth should be drawn up.”
Trusts and pensions
While tax obligations aren’t a big concern for non-U.S. dual citizens, there are other challenges, including foreign pensions and trusts.
For instance, Douglas Rosser, international tax specialist at MNP in Kelowna, B.C., has a client who moved from the U.K. to retire in Kelowna. She has the option to receive her U.K. pension as a lump sum, which could cause a problem. “She’s looking at it from the U.K. tax perspective, where the pension is tax-free,” he says. “But if she takes it all out in a lump sum, Canadian tax would be in excess of 40% on a portion of the income.”
On his advice, she didn’t take the lump sum and, instead, continued to receive annual payments.
Also, if a Canadian resident contributes to a foreign trust, that trust can be deemed resident in Canada and subject to tax. And, due to rules taking effect after 2006, Kinoshita explains that the foreign trust becomes taxable in Canada even if a client contributed prior to becoming a resident.
And, it gets more complex. Clients can elect to treat only the portion of the assets contributed by a Canadian resident as a Canadian resident trust, for instance.
“You look at the trust and determine what portion of the foreign trust was contributed by the Canadian resident,” says Kinoshita. “It’s therefore possible that no portion of the trust has been contributed by a Canadian resident, so it isn’t necessarily going to be pulled into the net.”
One of Kinoshita’s U.K. clients, who’s planning to move to Canada, may actually benefit from our foreign trust rules. This client has an offshore family trust in a low-tax jurisdiction, which had capital gains in the past. “It appears that, under the U.K. rules,” explains Kinoshita, “the U.K. resident beneficiaries of the offshore trust would be subject to U.K. tax on those gains when amounts were distributed by the trust.
“So the client wouldn’t be subject to tax until the amounts were distributed by the trust,” he adds. “And if the client became resident in Canada, conceivably, those capital gains wouldn’t be taxed at all.”
That’s because, under our rules, those previous capital gains constitute trust capital for Canadian tax purposes when the trust becomes a resident trust. Any prior gain won’t be subject to Canadian tax.
“They were considering the possibility that this individual could come to Canada and receive this previously accumulated income free of Canadian tax,” says Kinoshita. “If it works, that would be a very good deal, but that’s a particular circumstance of this trust, which had generated capital gains in prior years.”
For clients holding family wealth in their home countries, Steve Harding, director, International Solutions, RBC Wealth Management in Toronto, establishes an inbound trust. Doing so lets a Canadian non-resident transfer the gift or inheritance directly to that trust, with the Canadian resident as a beneficiary.
“Canadian tax rules allow the income and gains earned within the trust to accumulate on a tax-free basis,” explains Harding.
He adds, “Access to the funds is maintained through capital distributions, which, although reportable on the tax return of the Canadian beneficiary, is not subject to any Canadian tax.”
Plus, income and gains can be reinvested inside the trust, he says. This allows Canadian resident beneficiaries to eventually receive such gains as capital distributions. And, if a client inherits from a deceased foreign relative, he won’t be subject to tax in Canada because taxes would’ve been paid through the estate to the country of jurisdiction.
But he could face foreign exchange risk and be subject to capital gains, depending on when he withdraws the funds, says Rosser. Say, for instance, a trustee tells your client he’s entitled to £10,000 on September 1. The client deposits it to a U.K. bank account, and then, on October 15, he transfers those funds to his Canadian account.
“If the £10,000 was worth $20,000 on September 1, and it’s now worth $22,000, he’d pay a capital gain on the spread,” notes Rosser.
Harding, who deals with clients whose assets exceed $3 million, notes those who have active businesses overseas can avoid paying double tax after moving to Canada.
Our global tax treaty helps businesses with international sales compete with companies located in lower corporate tax jurisdictions. The treaty cedes taxation of company profits to the jurisdiction in which it earned, explains Harding, and allows these overseas subsidiaries to repatriate surplus profits back to Canada without further taxation. These are known as the exempt surplus rules, and provides a level playing field for business owners immigrating to Canada.
Passport renewal challenges
The government might refuse to issue or revoke a Canadian passport if a client:
- is not a Canadian citizen;
- provides false information during the application process;
- is charged in Canada or abroad with an indictable offence;
- owes money to the Crown related to repatriation to Canada, or other consular financial assistance;
- permits another person to use the passport; or
- fails to pay child support or alimony.
Source: Government of Canada
Clients from some countries may still be wary about becoming citizens of Canada.
Shoshana Green, barrister and solicitor at Green and Spiegel LLP in Toronto, notes some may fear losing financial incentives from back home. In particular, people from countries that don’t respect dual citizenship, like Germany and Japan, risk losing their state pensions.
Others may want to pass citizenship on to their children, and becoming Canadian could create limitations. While Canadians can pass citizenship on to one generation that’s born abroad, not all countries allow this.
Meanwhile, clients from countries like Egypt, where there’s mandatory military service, are “anxious to acquire citizenship for [adult] children because they want to protect them,” says Green. “But if they return to their original countries, even on vacation, they may still have to serve.”
Since Canada recognizes dual citizenship, Green adds, and a Canadian passport is one of the best to hold since it makes worldwide travel easier, she’s never suggested a client renounce citizenship in his or her home country.
“And not all countries will even let you renounce,” she says, citing Iran as an example. “You can be a citizen here but, when you travel back, you present your Iranian passport.”
Her challenge is helping clients become citizens as quickly as possible, since permanent resident status only lasts five years.
After that, there’s a tedious renewal process, and clients can even lose residency when trying to renew.
Originally published in Advisor's Edge
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