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Case Study: Inheritance 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 his or her family. Income and capital gains incurred on these Trust assets are specifically exempt from Canadian income taxes (FAPI) for a maximum 60 months.
In addition to the above, an offshore trust established by a non-resident of Canada for a Canadian resident beneficiary, inheritance trust, can incur an indefinite tax free period as described below.
The Case:
The "W" family were busy planning for their immigration to Canada. Mr. W expressed a strong interest in acquiring a 60 month tax free offshore trust. However, after budgeting for a house, car, children’s university tuition and everyday living expenses, his net worth was not sufficient to allow for any disposable funds to be allocated to a 60 month tax free offshore trust.
During the discussions, Mr. W disclosed his father, who had no intention of immigrating to Canada, still controlled the family assets. Mr. W’s father was reluctant to transfer assets by way of a gift because he needed assets to maintain his living expenses while retired in Hong Kong.
The Solution:
After evaluating the facts, the final proposal and plan involved Mr. W’s father (not his son) settling an offshore trust that can provide an indefinite tax deferral beyond the 60 months mentioned earlier. Mr. W’s father agreed to establish an offshore trust for the benefit of his son and grandchildren resident in Canada.
The beneficiaries are liable for tax only if the trust distributes income. But if the trust accumulates the income and add it to the capital, it may from time to time make tax free capital distributions to the Canadian resident beneficiaries.
The Canadian 60 month maximum tax free rules do not apply here. For FAPI rules to apply:
(a) there must be someone who is resident in Canada who is beneficially interested in the offshore trust, AND
(b) the trust must have acquired property from a person who is resident in Canada and who is related to a person who is beneficially interested in the trust, or who is an uncle, aunt, nephew or niece of such person.
Since Mr. W’s father is not a resident of Canada as required in item (b), the trust is not limited to the 60 month tax free period nor is subject to any other FAPI rules except as stated above.
The highest Canadian income tax rate is about 50%, therefore tax planning is essential! This Inheritance Trust is the exception to the rule where -- Canadian resident beneficiaries are required to include in their incomes their shares of the trust income irrespective of whether such income is actually remitted to the beneficiaries.
The Benefits
- There is an indefinite deferral of income tax on income and capital gains earned and accelerated compound growth on trust assets.
- Canadian beneficiaries can receive income tax free, distributions of capital from the trust.
- Mr. W’s father has reduced his Hong Kong estate inheritance tax exposure.
Other Considerations:
Not all of Mr. W’s father’s assets were transferred to the trust immediately. It was recommended that the father’s will be restructured to transfer the remaining assets to the trust as an inheritance to continue to take advantage of this tax significant saving opportunity.
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.
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Enquiries can be made by e-mail: SChongCA@on.aibn.com 10/10/01