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Do you own US securities?

Do you own US securities (or other foreign stocks) in your personal portfolio?  Does your corporation own US securities (or other foreign stocks)?  If so, then pay careful attention to the information below.

Filing of prescribed form T1135

If you own US securities (or other foreign securities) in your investment portfolio you may be required, pursuant to section 233.3 of the Income Tax Act (the “Act”), to file prescribed Form T1135 with the Canada Revenue Agency (“CRA”) on a timely basis.  This requirement catches a lot of people by surprise given the somewhat mundaneness of investing in US stock.  However, subsection 233.3(3) of the Act reads as follows:

Returns respecting foreign property – A reporting entity for a taxation year or fiscal period shall file with the Minister for the year or period a return in prescribed form on or before the day that is

(a) where the entity is a partnership, the day on or before which a return is required by section 229 of the Income Tax Regulations to be filed in respect of the fiscal period of the partnership or would be required to be so filed if that section applied to the partnership; and

(b) where the entity is not a partnership, the entity’s filing-due date for the year.

As you can see, it is a “reporting entity” that is required to file such a form.  A reporting entity is defined in subsection 233.3(1) of the Act as follows:

“reporting entity” for a taxation year or fiscal period means a specified Canadian entity for the year or period where, at any time (other than a time when the entity is non-resident) in the year or period, the total of all amounts each of which is the cost amount to the entity of a specified foreign property of the entity exceeds $100,000.

A “specified Canadian entity” includes an individual resident in Canada and also a Canadian corporation.  In addition, the definition of “specified foreign property” includes a share of the capital stock of a non-resident corporation (which would include a US publicly traded stock).

Accordingly, to the extent that an individual (who owns such stock outside of their registered portfolio) or a corporation owns any foreign stock (including US stock) with a cost in excess of $100,000 at any time in the year then prescribed Form T1135 will need to be timely filed.

There appears to be a myth in the market place that there is an exemption for ownership of US stocks from the filing requirements for a T1135. However, no such exemption exists.

To the extent that prescribed Form T1135 is not timely filed, a person can be subject to a number of penalties.  The least onerous penalty is a $25 per day penalty to a maximum of $2,500 for failure to file pursuant to subsection 162(7) of the Act.  If the person knowingly or under circumstances amounting to gross negligence fails to file Form T1135, then an additional penalty becomes applicable under subsection 162(10) which will be $500 (or in some cases $1,000) per month that the T1135 is late filed to a maximum of 24 months.

In addition, a person can also be subject to an additional penalty under subsection 162(10.1) if the months that the T1135 is late filed exceeds 24 equal to five percent of the greatest of all amounts each of which is the total of the cost amounts to the person of the specified foreign property.

While these reporting rules have been in existence within the Act since the late 1990’s, the CRA was usually very lenient and did not usually charge such penalties if prescribed Form T1135 was late filed. However, such administrative leniency ended without notice in the mid-2000’s and there have been a number of reported cases where taxpayers have challenged the CRA’s application of such penalties. One interesting case is currently before the Federal Court of Appeal.  Click here for a copy of the lower court’s ruling.

Accordingly, taxpayers and their advisors need to be very aware of the possible need to file prescribed Form T1135 when investing in foreign stocks, including US stocks.

Possible exposure to US estate tax

An additional implication, for individuals, of investing in US stocks in your portfolio is that you could be subject to US estate tax even though you are not a US citizen.  This is true because US estate tax is applicable to anyone in the world to the extent that they own US-situs property.  US-situs property includes shares of US corporations.  As an example, consider the following example facts:

  1. Mr. Apple’s worldwide net worth is $10 million USD.
  2. Mr. Apple is a Canadian resident and Canadian citizen, and is not a US citizen.
  3. Mr. Apple’s investment portfolio includes $1 million USD of publicly traded stocks.
  4. Mr. Apple dies.
  5. The US estate tax rate for 2011 and 2012 is 35 percent with a $5 million USD exemption for US citizens.  However, non-US citizens are only entitled to a pro-rated amount of the $5 million exemption which is calculated as the percentage of their US-situs assets (“A”) to their worldwide assets (“B”) multiplied by the $5M exemption (“C”). In other words, a non-US citizen is generally entitled to an exemption of US estate tax calculated as (A/B) x C.

Given that Mr. Apple owns US-situs property, the legal representatives administering his estate must consider the need to file a US estate tax return and to pay any US estate tax.  As a very rough calculation, Mr. Apple’s US estate tax exposure would be as follows:

  1. US-situs property  – $1 million USD
  2. Mr. Apple’s worldwide net worth  – $10 million USD
  3. Mr. Apple’s US estate tax exemption entitlement – $1 million USD/$10 million USD x $5 million USD = $500,000 USD
  4. Therefore, Mr Apple’s estate tax would be computed as follows:
Value of US-situs property

$1M USD

Less: exemption entitlement

   -$500K USD

Amount subject to US estate tax

$500K USD

US estate tax rate

              35%

US estate tax payable

$175,000 USD

 

While the Canada-US Tax Treaty may provide some relief from possible double taxation, the treaty will often not provide full relief.  Accordingly, Mr. Apple’s legal representatives will need to look for ways, if possible, to reduce the overall Canadian tax and US estate tax exposure.

Conclusion

Be aware of Canadian foreign reporting requirements and US estate tax exposure when investing in US stocks.