Case Study: Property, Immigration and an Offshore Trust

Introduction:

A person who has never resided in Canada but is about to become a Canadian resident can establish an offshore trust for the benefit of the members of their family. Income and capital gains earned on these Trust assets are specifically exempt from Canadian income taxes for a maximum 60 months.

The highest Canadian income tax rate is about 50%, therefore tax planning is essential! Ordinarily, Canadian tax laws (FAPI) requires Canadian resident beneficiaries to include in their income their share of the trust income regardless of whether the income is received or not.

In 1996, Mr. and Mrs. T were planning for their immigration to Canada. They have been married for less than a year and have no children. An analysis of their net worth (Canadian $) revealed cash and marketable securities of approximately $500,000, a jointly owned residential home worth $1,300,000 and shares in a corporation owned 100% by Mr. T, which holds commercial rental properties worth about $2,500,000.

They were interested in the offshore trust not only to save Canadian income taxes, but also to protect their assets with the 1997 changeover to Chinese rule and to avoid estate inheritance tax for their future children. However, they were discouraged with the thought of paying the very high Hong Kong stamp duty tax on the transfer of title of any of their properties to a trust and they still needed to budget for a house, car and everyday living expenses in Canada.

After evaluating the facts, the final proposal and plan was based on the following:

1. The trust deed named Mrs. T as beneficiary and contained a provision that allowed the trustees to add children in the future as beneficiaries. Additional beneficiaries will reduce the income tax exposure to Mrs. T after the 60 month tax exempt period.
2. In Canada, there is no income tax deduction for interest incurred on personal loans and mortgages. Therefore, it was recommended that the $500,000 cash and securities held be used for buying their home, car and personal effects.
3. The home in Hong Kong was not an ideal asset for the offshore trust. Mrs. T is a joint owner of the home and as such, trust assets will be considered reversionary making any future income or capital gain taxable to Mrs. T. It was decided to keep the home and to rent it out using the net rental proceeds for their everyday living expenses.

Section 48 of the Income Tax Act shelters the rental income by allowing capital cost allowance (depreciation) to be claimed based on the fair market value of the property at the time of their immigration to Canada. The Canadian income taxes ordinarily payable on the rental income without depreciation will be deferred until the property is sold.

4. The commercial property generating a significant net income was ideal for the trust. However, it was not necessary to transfer title and incur costly stamp duty tax. Instead, all the common shares held by Mr. T were transferred to the trust. The trust now controls the corporation that owns the property and will receive and accumulate dividends free of income tax offshore, generated by a positive rental cash flow.

The Benefits

• The home in Canada is fully paid and has no non-deductible mortgage interest expense.
• There is no Canadian income tax on the rent collected on the former home in Hong Kong.
• There is no Canadian income tax on the rent collected by the corporation, now held by the offshore trust for the benefit of Mrs. T. There is no tax on any capital gain on any future sale of the commercial property for a period of up to a maximum of 60 months.
• Beneficiaries can receive free of income tax, capital distributions form the Trust. Income taxes are payable only on income and capital gains incurred by the Trust after the maximum 60 month period or if the Trust distributes income within the maximum 60 month period.
• Reduced Hong Kong stamp duty tax and estate inheritance tax exposure.

Mr. T was able to refer a friend to the trustees, a resident of Hong Kong to be hired as the property manager. For purposes of Section 48 of the Income Tax Act and to minimize future capital gains tax, a written appraisal was obtained for the home in Hong Kong and the shares in the corporation.

New Canadian tax laws requires residents to disclose, even if there is no taxes to pay, ownership in foreign property worth over CAN$100,000 and any beneficial interest in, and distributions from foreign trusts.

© 1999 - 2002 www.offshoreplus.com. All Rights Reserved.