In St. Clair County, we are just across the river from Canada. There are many Americans, including myself, who regularly cross the border into Canada for dinner, shopping or entertainment. With the American dollar usually so much stronger than the Canadian dollar, many Americans have purchased vacation homes, often on the waterfront, in Canada.
In Canada, as in the United States, the government uses a taxation system to fund government operations and programs. Although both countries legal systems have evolved from the English common law system, their methods of taxation have many differences. Over the years, I have worked with a number of Canadian tax attorneys and Chartered Accountants (Canadian equivalent to Certified Public Accountants) who have assisted my clients with tax and other matters related to their Canadian assets.
Earlier this summer, I attended the three day 55th Annual Probate & Estate Planning Institute sponsored by the State Bar of Michigan and the Institute for Continuing Legal Education. This conference focuses on the matters that Michigan estate planning and elder law attorneys encounter on a regular basis. In addition to experienced Michigan attorneys, the program featured nationally known speakers.
One of the speakers was Gerard P. Charette, a tax attorney with Miller Canfield PLC in Windsor, Ontario, Canada. He gave a talk on the Canadian income tax system. It was very interesting and good overview of Canadian income taxation. I thought a summary of part of his materials would be a good topic for my column.
Individuals resident in Canada are subject to income taxation through a federal statute, the Income Tax Act of Canada (Income Tax Act or the Act). Like the United States Internal Revenue Code, the Income Tax Act taxes income and capital gains. Unlike many states, Ontario and most provinces do not have an independent provincial income tax. The provinces depend on revenue sharing from the federal government.
The basis of Canadian taxation is residency. Canada taxes the worldwide income of individuals resident in Canada. This differs from the United States, which not only taxes the worldwide income of its residents, it taxes the worldwide income of all US citizens, regardless of where you may live. If you are resident outside of Canada, regardless of your citizenship, you are only taxed in Canada on your activities in Canada.
Residency in Canada is determined very similarly as in the United States. It is based on the facts and circumstances of your situation. Do you own a home in Canada? Where do you spend most of your time. Where are you registered to vote or have a driver’s license? Canada differs from the United States in that it looks at other factors which indicate your “center of vital interest”. Where do you own property or have bank accounts? Do you participate in Canadian social service programs? Are you a member of private or public organizations? Do you have family members in Canada? Do you work in Canada? What is your citizenship? All factors of your personal and economic ties are relevant.
The income tax rates in Canada are higher than in the US. The rates of tax for individuals in Ontario ranged from a low of 20% to a top rate of up to 53% for tax year 2013. This compares to the US rates of 10% to 39.6% in 2016. Even when you add in the Michigan income tax of 4.25% and Port Huron income tax of 1%, you still pay less here than in Canada.
Canada differs from the US in how it taxes estate assets. Canada has no federal or provincial estate or inheritance taxes or succession duties. In the US, the federal government taxes your estate 40% of the excess over $5.45 million (in 2016). Some states (not Michigan) also have estate or inheritance taxes.
What Canada does have is a capital gains tax at a taxpayer’s death. When you die, you are deemed to have disposed of all of your capital property immediately prior to death at fair market value. Your heirs or your estate then have to pay capital gains taxes on the difference between your tax basis and the fair market value of the property.
Currently, only 50% of the capital gains are taxed in Canada at your individual income tax rate. If you are a Canadian resident, the tax is on your worldwide assets. If you are not a Canadian resident, the tax is only on your Canadian assets. If the property is going to your spouse, your spouse can defer the capital gains taxes until his or her death.
Similarly, Canada does not have any federal or provincial gift taxes. In the US, if your lifetime taxable gifts exceed $5.45 million (in 2016), you have to pay 40% of the value of the excess gifts to the federal government as a gift tax. However in Canada, when you make a gift of a capital asset, you are deemed to have disposed it for fair market value and have to pay capital gains taxes on that disposition.
In Canada, a transfer of capital property to a trust, even your revocable living trust, is considered a deemed disposition which triggers the capital gains taxes. I had a client a number of years ago who self-funded her Canadian cottage into her revocable living trust. She was shocked when she received a $34,000 capital gains tax bill on the deemed disposition from Revenue Canada (the Canadian equivalent of the Internal Revenue Service).
Canada does not have very favorable treatment of trusts. With limited exceptions such as spousal trusts, all trusts, including revocable living trusts, are deemed to have disposed of all capital property at fair market value every 21 years. Capital gains taxes are due at each of these deemed dispositions.
Although Canada does not have any estate, inheritance or gift taxes, it really does through the deemed disposition capital gain taxes. And although only 50% of the capital gains are taxed at ordinary income tax rates, Canada does not have a $5.45 million exemption amount as we do in the US.
By Matthew M. Wallace, CPA, JD
Published edited September 4, 2016 in The Times Herald newspaper, Port Huron, Michigan as: Canadian taxes are different from ours.