If so, do you want to minimize your Canadian taxes on the future income to be generated from such overseas inheritance? If your answers to both questions are “yes”, you will have to initiate your planning process before the death of the person from whom the overseas inheritance is expected to come.
How is Canadian inheritance taxed in Canada?
In Canada, when a person dies, the deceased person is deemed to dispose of all of his/her assets to an estate at their fair market value immediately before the deceased person’s passing. The deceased person’s legal representative will have to file his/her final and optional returns to report all income, including the gains and losses from the deemed dispositions, for the period from January 1 of the year of death to the date of death. There are exceptions to these general rules for properties left to a spouse or common-law partner or a qualifying spouse trust.
An estate is a trust and is formed automatically upon the death of the deceased person to own all of his/her assets. If the deceased person owned a life insurance policy, the life insurance proceeds would be distributed to the name beneficiaries directly. Income earned on the estate assets should generally be reported in the estate’s return. Over time, the estate assets are to be distributed in accordance with the will of the deceased person and received by the beneficiaries of the estate free of Canadian taxes.
How is overseas inheritance taxed in Canada?
As noted above, inheritances whether from non-resident relatives overseas or Canadians are not taxable income to the Canadian resident beneficiaries. However, as Canadian residents are subject to Canadian taxation on their worldwide income, any future income to be generated from such overseas inheritance will be subject to taxation in Canada. This is the case even if the overseas inheritance or the related income is not remitted to Canada.
In order to prevent Canadians from deferring or avoiding tax by earning investment income indirectly through offshore trusts, Canada has complex non-resident trust rules that generally come into operative whenever a Canadian resident makes a “contribution” to an offshore trust. In general terms, such trusts are deemed to be resident in Canada for most purposes of the Act and subject to Canadian taxation on its worldwide income. The Canadian contributor is jointly liable with the trust for any Canadian tax liability. Therefore, if a Canadian resident beneficiary contributed his/her inherited property to a trust set up in a zero tax jurisdiction, the trust would be subject to Canadian tax and the Canadian resident beneficiary would be jointly liable for any Canadian tax.
A structure or technique commonly used to avoid Canadian taxes on the future income from such inherited assets is generally referred to as an “Inheritance Trust” or a “Granny Trust”. It is a trust to be formed generally in a zero tax jurisdiction pursuant to the will of the deceased relative for the benefits of the Canadian resident beneficiary. Under the Canadian common laws, in order for such inheritance trust not to be considered as resident in Canada, it is critical that the mind and management of such trust not to be exercised in Canada. In that case, such non-resident trust should not be subject to Canada’s non-resident trust rules as long as no Canadian resident has ever contributed any property to the trust.
In summary, an inheritance trust is a perfect legal way to avoid Canadian taxes on any future income from inherited assets, even if the income is remitted to Canada. However, this tax plan can only be implemented with proper advanced planning of the will of the relative from whom your overseas inheritance is expected to come. In addition, the effectiveness of this plan is subject to the mind and management of the inheritance trust to be exercised in the zero tax jurisdiction.
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We are a Toronto Chartered Accountant firm with 20 years of specialized experience in Canadian domestic and international taxation. We can assist with
- Cross border taxation;
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- Corporate tax planning and reorganization;
- Retirement planning;
- Estate planning and inheritance tax advice; and
- Tax audit dispute and resolution.
The information in this article is general in nature and does not constitute professional advice. We recommend that you obtain the appropriate professional advice before acting on any of the information contained herein.
Claudia Ku is a Chartered Accountant and the principal of a boutique full service accounting firm based in Toronto. As a tax specialist for over 20 years, Claudia provides valuable tax services to help her clients to minimize taxes and maximize net worth. In addition, Claudia provides accounting and business consulting services to help business owners to grow their businesses. If you find this information useful, kindly +1 and follow Claudia Ku on Google Plus to share the information with your circle.