If you are in the business of accounting, tax and/or law, you are likely experiencing an influx of clients who need help with IRC Section 965,  Mandatory Repatriation Tax. The rules are very complex, the results can be quite punitive, and the direction we have received from the IRS to-date has been vague, at best.

This one-time repatriation tax impacts the filings for the 2017 tax year if foreign corporations (non-US corporations) held by US individual or corporate shareholders have a calendar year end. The tax due was April 17, 2018 for US residents and June 15, 2018 for US persons resident outside of the US.

Based on the Conference Committee Report and the three IRS communications released so far, the recommendation is to attach a statement to the 2017 tax return showing the 965 income, tax, election(s), schedule of taxes due per year, tax due this year, etc. It is further recommended that electronic filers wait until on or after 2 April 2018 to file to account for any further system changes from the IRS.

Failing to submit returns that use the new guidance may result in rejection or delays in processing tax returns or the issuance of erroneous notices.

As cross-border tax experts, Hanson Crossborder Tax Inc. is at the forefront of developing innovative tools to assist our clients with complex tax rules like this one, and we are ready to assist your clients as well.

In response to this new tax, we have developed Section 965 Repatriation Transition Tax Software for Foreign Corporations with Calendar Year-End. As part of our service, we will:

  • Prepare the computation of Section 965 Repatriation Transition tax
  • Generate Section 965 Repatriation Transition tax statement to be attached to the shareholder’s US tax return
  • Determine the eligible portion of foreign tax credit to apply against Section 965 Repatriation Transition tax
  • Provide IRS-prescribed election statements, where appropriate

Since we are not preparing the tax returns, but rather computing taxes based on client information, the service is offered starting at a flat fee of $2,000 CAD.

Please call us at toll-free number 1-855-640-1730 or our Calgary office at 587-329-0481. Alternatively, you can email us at mail@hcbtax.com with your questions and contact information.

OVDP

On March 13, 2018, the IRS announced that it will be winding down its 2014 Offshore Voluntary Disclosure Program (“OVDP”) by September 28, 2018.  The OVDP is a modified version of earlier OVDP’s and was made available to taxpayers who wish to voluntarily disclose their offshore accounts and assets to avoid the risk of criminal prosecution and limit exposure to civil penalties.  Accuracy related penalties including penalties for failure to file and failure to pay are assessed.  In addition, the “offshore penalty” for failure to report all offshore financial assets is equal to 27.5% (50% in some cases) of the highest aggregate value of assets subject to the OVDP.  Pre-clearance with the Criminal Investigation Lead Development Center is required prior to participation in the OVDP.

“Taxpayers have had several years to come into compliance with US tax laws under this program.  All along, we have been clear that we would close the program at the appropriate time, and we have reached that point.  Those who still wish to come forward have time do so” said Acting IRS Commissioner David Kautter.

Shutting down the OVDP does not mean that the IRS has decreased its enforcement activity.  On the contrary, the IRS has developed a number of tools to detect non-compliant taxpayers such as the Foreign Accounts Tax Compliance Act (“FATCA”), cooperation by other non-US banks in disclosing accounts owned by Americans and whistleblower leads.  Nevertheless, “stopping offshore tax noncompliance remains a top priority of the IRS” according to Don Fort, Chief, IRS Criminal Investigation.

The IRS will continue offering the following options to comply with US tax and information reporting obligations:

  • IRS-Criminal Investigation Voluntary Disclosure Program;
  • Streamlined Filing Compliance Procedures;
  • Delinquent FBAR submission procedures;
  • Delinquent international information return submission procedures.

The Streamlined Filing Compliance Procedures (“SFCP”) have been very popular among those non-compliant US taxpayers who are not at risk for criminal prosecution and whose delinquency did not result from willful conduct on the part of the taxpayer.  The program is available to US individual taxpayers residing out the US and those residing in the US.  Unlike the OVDP, penalties are abated but the risk of an audit or scrutiny of years prior to the covered years under the SFCP and criminal prosecution is not eliminated.

As with the OVDP, at some point in time, the IRS has expressed that the SFCP may also be eliminated.  Therefore, there is still time to come forward either under the formal amnesties – OVDP or the other options for complying with the US tax obligations. Otherwise, the taxpayer will have no choice but to come under the more stringent traditional voluntary disclosure programs.

Florida Property

 First and foremost, a Canadian should not create an LLC to acquire FL real estate, or any US real estate for that matter.  This is the biggest mistake Canadians make as they fall prey to local advisors who have promoted the LLCs as the best vehicle to do business in the US or own real estate.   This is true if you are a US resident but not in Canada as LLCs are treated differently in Canada vs the US and the potential for double taxation is real.

 

 There could be a potential for US estate tax exposure of up to 40% of the value of the US real estate on death of the Canadian while owning US real estate. However, after the changes to the US tax law effective in 2018, if the Canadian’s worldwide net worth (including the US real property) is no more than USD11.2M (this is the 2018 threshold or exclusions from estate tax which is adjusted yearly for inflation and is extended to Canadians under the Canada-US Treaty), then the US estate tax should not be an issue although a US estate tax return must still be filed to clear the title.  The threshold is doubled if the Canadian is married and transfers the US property to the non-US spouse on death.  This is just a rule of thumb to follow.    These thresholds are only good until the end of 2025 after which the exclusions would revert back to current law (unless there are changes), which is USD5.6M in 2018 (subject to inflationary adjustments) prior to the Trump Tax Reform.  This is doubled for transfers of property to a non US spouse. Gifting US property during one’s lifetime creates double taxation in the US and Canada.

 

 If the intent is to occupy the Florida real estate as a vacation home and spend much of the warmer months in Florida to avoid the harsh winters in Canada, the Canadian has to be careful about staying in the US for 183 days or more in any calendar year to avoid becoming a US resident for tax purposes.  Although the Canada-US Treaty will protect the Canadian from being taxed as a US resident if the threshold is reached, the US will require a long list of information returns to report ownership in certain Canadian entities and investments, which is a compliance nightmare and may be very costly.   The 183 day rule should not be confused with the immigration rule that Canadians may visit the US for up to six months within a 12 month period.   Remaining in the US from July 1 to December 31 (184 days) in every calendar year may be permissible from an immigration perspective but this would cause the Canadian to be subject to US reporting requirements as a deemed US resident.

 

 Even if the 183-day test can be avoided, the Canadian “snowbird” can still be a deemed US resident if the “substantial presence test” is met in the US which is based on a formula involving a 3 consecutive year rolling average of US presence.  The US will count 100% of the current year (only if the Canadian was present in the US for at least 31 days), 1/3 of the year prior and 1/6 of the 2nd year prior to the current year and if the number of days add up to at least 183 days, then the Canadian is a deemed resident of the US only for tax purposes.  For example, if the Canadian was in the US for 130 days in 2017, 125 days in 2016 and 120 days in 2015, the Canadian is all of a sudden a US resident under the  “substantial presence test”.  He would have 192 days in the US which is the sum of 100% of 2017 (i.e. 130 days), plus 1/3 of 125 days in 2016 (i.e. 42 days) plus 1/6 of 120 days in 2015 (i.e. 20 days).  Again, the rule of thumb is to limit the stay in the US to less than 121 days in any calendar year.  If the 183 day is met but the Canadian is not in the US in the current year (2017 in this example) for at least 183 days, then the Canadian can rely on the “closer connection exception” in the US which essentially provides that for as long as the Canadian can prove stronger ties to Canada vs the US, the Canadian will not be treated as a US resident.  In order to benefit from the “closer connection exception”, the Canadians needs to file US Form 8840, Closer Connection Statement for Aliens, which is due June 15 following the end of the calendar year.

 

 If the Florida real estate is to be rented out, the Canadian will have US filing requirements, even if the property is generating losses.  A common misconception among Canadians is that no US tax return is required if there are losses.  This is incorrect  in that the IRS either requires a 30% withholding tax against rents (without the benefit of deductions) paid to the Canadian, or a filing of a US nonresident tax return that is due June 15 following the end of the calendar year in order to claim expenses and any resulting losses.  Without a US nonresident tax return, the gross rents are subject to a 30% tax that is required to be withheld by the tenant or the payor of the rent.  More importantly, when the US real property is sold, generally, 15% of taxes have to be withheld from gross proceeds regardless of whether the property is a vacation home or rental property.  The 15% is a temporary tax and all or some can be recovered when a US nonresident tax return is filed the following year.  The Canadian can elect to reduce the withholding tax by applying for a “clearance certificate” with the IRS, to limit the withholding tax to the maximum rate of tax applicable to the gain, if any.  The application has to be made before closing of the sale.

Canada’s latest budget proposes increasing tax authority resources, toughening beneficial ownership reporting requirements for trusts, and further amending rules to limit the advantages of holding passive savings in a corporation.

In its 2018 budget plan, announced February 27, the Canadian Department of Finance focused on measures to ensure a “fair tax system for all Canadians,” noting the Canada Revenue Agency’s recent efforts to target noncompliance in the highest-risk areas, including wealthy Canadians holding offshore accounts.

To that end, the CRA had examined 187,000 large money transfers worth more than C $177 billion between Canada and eight countries, and is now carrying out more than 1,000 offshore audits and more than 40 criminal cases related to offshore transactions, according to the budget plan.

As a result, the government will set aside C $90.6 million over five years for the CRA to handle the extra caseload, and provide C $41.9 million over five years to the Courts Administration Service to help support the Tax Court of Canada.

“We can’t have an economy that works for everyone, if everyone doesn’t pay their fair share,” Finance Minister Bill Morneau said in his budget speech. “That’s why we’ve given the Canada Revenue Agency $1 billion in our first budgets to crack down on tax cheats and offshore tax havens. And with every dollar we invest, we expect $5 in recovered revenue.”

To further help the CRA and other authorities tackle aggressive tax avoidance, tax evasion, and money laundering through abuse of corporate vehicles, the government wants to introduce enhanced income tax reporting requirements for some types of trusts, requiring additional information to be provided annually for 2021 and later tax years. Specifically, the additional requirements would apply to Canada-resident “express trusts” and to nonresident trusts that are currently required to file T3 returns.

The government also seeks changes to the Canada Business Corporations Act to enhance the availability of beneficial ownership information, according to the budget plan.

To crack down on taxpayers who try to sidestep their Canadian income tax obligations by shifting property income into foreign resident corporations, the budget provides measures limiting the use of “tracking arrangements” that allow these taxpayers to track the specific benefit they receive from assets they contribute to a foreign resident corporation.

The budget also provides C $38.7 million over five years to the CRA to help it properly use in its offshore compliance activities the financial account data it obtains through automatic information exchange.

Moreover, the Department of Finance introduced two measures to limit the advantages that some businesses enjoy from holding passive savings in a Canadian-controlled private corporation (CCPC). The first measure would gradually reduce access to the small business rate for CCPCs with large amounts of passive savings. The government proposed lowering the tax rate for qualifying active business income of small CCPCs from 10.5 percent to 10 percent in 2018, then to 9 percent in 2019, to help free up after-tax income for small businesses owners to reinvest in their active businesses. The lower rate is less than the general corporate rate of 15 percent and applies to up to C $500,000 of a CCPC’s qualifying active business, also known as the “business limit.” The first measure would reduce the business limit on a straight-line basis for CCPCs that have between C $50,000 and C $150,000 in investment income, according to the budget plan.

The second measure would curb the tax advantages that bigger CCPCs enjoy. Large CCPCs would no longer qualify for refunds on taxes paid on investment income while distributing dividends arising from income that is taxed at the general corporate rate, according to the budget plan. The two proposals would apply to tax years after 2018.

“We are changing the rules for 3 percent of private corporations, because the wealthiest Canadians should not be able to use private corporations to pay less tax than the middle class,” Morneau said during his speech.

The Department of Finance first announced it would address tax planning via CCPCs in its March 2017 budget. It launched a consultation in July on proposed legislative changes to crack down on three tax planning strategies involving CCPCs.

After extensive cross-country consultations, Morneau announced additional changes to help assuage concerns from middle-income small business owners who use CCPCs for legitimate business purposes, including a C $50,000 per year threshold on passive income.

In December the Department of Finance announced further amendments to its proposals, in particular those related to “income sprinkling,” a strategy that involves funneling income from a wealthy individual using a CCPC to other family members who may not have any role in the corporation and who are subject to lower personal tax rates or are not taxed at all. The changes included bright-line tests to limit the potential effect of anti-income-sprinkling rules on those who make legitimate contributions to affected businesses. The revisions took effect January 1.

By Stephanie Soong Johnston