Update on Tax Reporting for Trustees of Trusts with Canadian Connections
A developing tax and reporting environment in Canada is creating new concerns for trustees and global families. Whether under the newly enacted Underused Housing Tax (UHT) regime, new trust reporting rules, increased scrutiny on the reporting of trust distributions by Canadian recipients, new General Anti-Avoidance Rule affecting tax planning, or the often missed 21-Year rule creating a deemed disposition for trustees with Canadian real estate, there are plenty of traps for unwary trustees and global families with connections to Canada. This is particularly relevant to families in Hong Kong with offshore trusts for the benefit of family members in Canada or holding Canadian real estate.
New Underused Housing Tax (UHT) Regime
Canada enacted a remarkable (in many ways) piece of tax legislation as part of its new Underused Housing Tax (UHT) regime effective since 1 January 2022. This legislation introduced a whopping 1% annual tax on the value of vacant or underused Canadian residential property. For global families with condos or vacation homes in Canada, or trusts holding real estate in Canada, this new regime is of particular interest.
While originally intended to curb foreign real estate speculation in Canada by targeting the ‘unproductive use of domestic housing that is owned by non-resident, non-Canadians’, the final legislation is quite different and requires not only foreign owners but also a number of Canadian owners to file an annual UHT return and pay the 1% tax unless a specific exemption from the tax applies. Unfortunately, the list of available exemptions is limited, and the requirements to claim an exemption remain unclear. Meanwhile, the failure to file a UHT return carries significant penalties even where no tax is owing. Oddly, only Canadian citizens and permanent residents owning property directly are excluded from having to file a UHT legislation – meaning that any indirect ownership by Canadians requires a tax return to be filed and will expose the owner to penalties. For foreign owners, whether via trusts or corporate structures, this new tax is likely to generate a great deal of confusion (and frustration).
UHT returns for 2022 (the first year of application) were due on 30 April 2022. On 27 March 2023, the Canada Revenue Agency (CRA) announced that due to the ‘unique challenges’ it would waive penalties and interest for late-filed UHT returns or late-paid UHT payable for the 2022 calendar year provided the return is filed or the UHT is paid by 31 October 2023. It is not clear why the CRA is waiving the penalties and interest instead of simply extending the deadline, but in any event all foreign owners (and Canadian owners) should review their exposure to this new tax and take appropriate steps before 1 November 2023.
For foreign direct owners of real estate, or indirect ownership through corporation or family trusts, the new regime will require particular attention not only in determining whether the 1% tax is payable or not, but also in terms of the extent of the disclosure that is required as part of the UHT return itself. For example, under the ‘vacation home’ exemption, the owner-occupier is required to disclose the use of the property ‘as a place of residence or lodging’ and list the number of days of occupancy. Could a non-resident individual owner who personally uses a condo say in Whistler every year for 3-4 months expose the individual to a claim of tax residency resulting from the consistent and regular presence (and available dwelling) in Canada (even if well below the 183 days threshold)?
Many foreign owners are finding themselves exposed to this new tax despite doing everything they can to avoid having their Canadian property ‘vacant’ or ‘underused’. In fact, the UHT regime does not apply to ‘vacant or underused’ Canadian residential property; it really applies to property that is not being used in a certain way. For example, the legislation provides an exemption for property leased out under continuous occupancy for at least 180 days under a formula that requires a lease for this purpose to be for at least 1 month, excluding from the day count formula property leased out on short-term basis (i.e., less than a month) – it is not clear why a condo in Whistler that is made available to tenants on short-term leases only (whether intentional or not) should be caught under this new tax (especially where the owner were to be actively seeking out longer rental periods). In this case, a new 1% tax would act as a penalty for the failure to secure longer term leases, even if the property should be heavily used and not vacant due to the actual (short-term) rentals in the year. No matter that an NR6 election form is filed each year, and income tax paid on a net basis so as to prove that a given property is in fact not vacant or underused.
Another concern is that this legislation stands completely apart from the income tax regime, and uses concepts that are foreign to the income tax world. ‘Ownership’ does not necessarily mean ownership, it means whoever appears on the land registry. ‘Value’ does not necessarily mean value, it means the higher of the amount used for property taxation purposes and the property’s most recent sale price (i.e., not the fair market value – unless a specific election is filed along with a written appraisal report), ‘leasing’ does not necessarily mean leasing, it means leases of at least 1 month. ‘Residential’ does not necessarily mean residential. And so on.
The current list of exemptions from this annual 1% tax is also far from adequate given the aim and scope of the legislation as it was originally announced, and changes are widely expected. For example, trusts (whether domestic or foreign) with at least one beneficiary who is neither a Canadian citizen or permanent resident are required to file a UHT return and can be subject to UHT with respect to each residential property. If the property is used by a person who does not deal at arm’s length with the owner, one of the available exemptions requires having a lease in place providing for ‘fair rent’. ‘Fair rent’ is defined as 5% of the ‘value’. Doing so, of course, could have income tax implications if the rent is paid to a non-resident.
Despite the many uncertainties as to its scope, taxpayers are required to rely on the many UHT guidance notices by the CRA to help taxpayers navigate through the long list of problems associated with the UHT. To add to the pressure on Canada to amend this legislation, on 25 May 2023, a bipartisan group of members of the U.S. Congress went as far as to ask U.S. Secretary of State Antony Blinken to work with the Government of Canada to exempt Americans from the UHT, arguing that the current list of exemptions does not apply to many American owners, and that the rules for the listed exemptions are simply ‘unclear’. According to their request, the UHT is ‘unfairly impacting Americans who own property in Canada and putting the strong bond between our countries in jeopardy’. It is not clear how excluding owners based on their nationality can be achieved if the intention remains about limiting speculation, but it is clear that the scope of the legislation should be reconsidered, and that the list of exemptions should be revamped.
In any event, wealth planners and trustees should review the manner in which Canadian real estate is held, and whether an exemption can be found. They should carefully take into account the requisite disclosure that comes with the obligation to file a UHT tax return. This is particularly relevant to foreign trustees of trusts holding residential properties in Canada (whether or not they have beneficiaries who are neither citizens or permanents resident of Canada).
Over the last decade, Canadian tax and private client practitioners have noticed a clear increase in the number of cross-border inquiries by the tax authorities. As a result, wealth planners and foreign trustees should be prepared to comply with legitimate and valid reporting requirements and queries arising out of Canada – not always an easy task given the state of legislation such as the new UHT legislation, let alone trustees having had to navigate through convoluted and complex rules such as the deeming provisions of section 94 of the Income Tax Act (Canada) (deeming otherwise non-resident trusts as tax residents of Canada). For foreign trusts with any nexus to Canada the best advice continues to be to monitor each case and make sure that any exposure to Canadian tax or reporting is carefully considered from all possible angles.