Exporting assets.

The 1996 Auditor General Report raised "serious concerns about the administration of the Income Tax Act involving the movement out of Canada of at least $2 billion of assets held in family trust." The concerns arose out of an Advance Ruling given by Revenue Canada which apparently allowed a family (rumoured to be the Bronfmann family) to move $2 billion from Canada to the United States without any tax consequences.

Usually, when an individual taxpayer becomes a non-resident of Canada, there is a deemed disposition at fair market value of all of that taxpayer's property except for "taxable Canadian property". The departing individual is liable to pay capital gains tax in respect of this deemed fair market value disposition (departure tax). Generally speaking, taxable Canadian property is defined to include property which is situated in Canada, such as real estate; property which is not easily removed from Canada, such as business assets; or property which is not easily marketable outside of Canada such as shares of private Canadian corporations. Unlike assets which are easily moved out of Canada, these types of assets remain available for Revenue to seize if capital gains tax is not paid and is therefore not subject to departure tax but rather is only subject to tax upon its actual disposition by the non-resident.

Similarly, when a Canadian resident trust (i.e. the majority of its trustees are residents of Canada) distributes trust property to a non-resident, the trust is for income tax purposes deemed to have disposed of those assets at their fair market value and becomes liable to pay capital gains tax unless the property is "taxable Canadian property".

Clearly, the meaning of "taxable Canadian property" is critical when determining whether tax will be paid either when a taxpayer moves out of Canada or when trust assets are distributed to a non-resident beneficiary. In fact, it was Revenue's interpretation of the term "taxable Canadian property" that caused the concerns raised in the Auditor General's Report.

The Advance Ruling dealt with the following scenario:

1. A man established a personal trust (Trust1) having his children as the beneficiaries.

2. One of the beneficiary children transferred his interest in Trust1 to Trust2. All that Trust2 owned was an interest in Trust1.

3. Trust1 transferred its private company shares for shares to a public company and received shares of the public company as consideration. Trust1 and the public company elected to have certain "rollover" provisions contained in section 85 of the Income Tax Act apply to this exchange so that no taxable gains were triggered by the exchange.

4. Trust2 became a United States resident when the majority of its trustees became United States residents.

5. Trust1 distributed the public company shares to Trust2 in satisfaction of Trust2's interest in Trust1.

The Advance Ruling addressed two questions which arose out of this rather complex fact scenario. The first was whether Trust2 was liable to pay any departure tax when it became a non-resident of Canada. The second was whether Trust1 was liable to pay any capital gains tax when it distributed the shares to Trust2, a non-resident trust. Revenue Canada ruled that the answer to both questions was "no". This ruling was a direct result of the characterization of the public company shares as "taxable Canadian property".

While the term "taxable Canadian property" includes shares of a private corporation, it does not generally include shares of a public corporation. However, section 85 provides that when a taxpayer transfers "taxable Canadian property" to a Canadian corporation and as consideration receives shares of that corporation, then those shares are deemed to be "taxable Canadian property" as well. Revenue therefore concluded that because Trust1 transferred taxable Canadian property (being the private corporation shares) to a Canadian corporation (being the public corporation) for shares of that corporation then those shares are deemed to be taxable Canadian property.

The effect of this conclusion was twofold. First, when Trust2 became a non-resident it did not have to pay any departure tax because its only asset was its indirect interest in the public corporation shares held by Trust1 which were deemed to be taxable Canadian property and therefore exempt from capital gains tax. Second, when Trust1 distributed the public corporation shares to Trust2 no capital gains tax was triggered because the public corporation shares were considered to be taxable Canadian property. If the public corporation shares had not been deemed to be taxable Canadian property, then capital gains tax would have been payable at both stages.

The loss of tax revenue on $2 billion in assets caused the concerns raised in the Auditor General's Report. In response to these concerns Revenue Canada has frozen tax rulings for taxpayers who are moving out of Canada until a study can be completed to determine whether the Advance Ruling was correct. Essentially, Revenue wants to determine whether the characterization of the public corporation shares as taxable Canadian property was correct.

In order for Revenue's characterization to be correct it must be possible for a Canadian resident to hold taxable Canadian property. I think Revenue's characterization was likely correct as there are other provisions in the legislation which do suggest that Canadian non-residents can own taxable Canadian property.

In any event, it should be noted that in providing the Ruling, Revenue Canada retained the right to reassess the taxpayer involved for 10 years following the Ruling (which was given in 1991). That is, if the public corporation shares are determined to not be taxable Canadian property, then Revenue may get another chance to impose capital gains tax in the year Trust2 became a non-resident and Trust1 distributed the shares to Trust2.