OFFSHORE INCOME:  REPORTING RULES

What Are You Required to Report?

World-Wide Income

A fundamental principle of the Canadian income tax system is that Canadian residents are obliged to report and pay tax on their worldwide income, including both domestic and foreign-source income. Therefore, the income of a resident of Canada that falls within the gambit of the Income Tax Act is subject to Canadian income tax regardless of the country in which the income is earned or generated. Many other countries also levy income taxes on worldwide income.

The main impetus for the requirement to report specified foreign property that exceeds $100,000 was a growing perception that Canadians are able to escape Canadian taxation by making investments in tax havens. Canadians are investing offshore with increasing frequency and there are indications that some are not reporting their foreign income to Revenue Canada and are therefore, not paying tax on that income. This violates the basic principle that residents of Canada are taxed on their worldwide income. It also creates inequities for taxpayers who are reporting all of their income from domestic and foreign sources because they must shoulder a greater portion of the tax burden.

Canada is not the only country facing this problem. In a recently released report, Harmful Tax Competition, An Emerging Global Issue, the OECD recommends that countries that do not have foreign reporting rules consider adopting them. The recommendation is aimed at introducing measures that will assist countries in obtaining information about the foreign activities of their residents, such as transactions with related foreign payers, the ownership of foreign property, and transfers to and distributions from certain foreign entities.

The report pointed out that tax authorities require information in order to be able to administer the income tax system properly. Obtaining information concerning taxpayers' foreign activities is especially difficult because such information is often located outside a country's jurisdiction.

The report went on to say that countries face public spending obligations and constraints because they finance outlays on, for example, national defense, education, social security, and other public services. Those who invest in tax havens that impose little or no tax but who are residents of non-tax-haven countries, may be able to use those tax haven jurisdictions to reduce their domestic tax liability. Such taxpayers are in effect "free riders" of general public goods created by the non-tax-haven country.

Many tax professionals are warning that there is a serious problem of non-compliance as a result of the use of tax havens and the underreporting of foreign-source income. This is occurring because taxpayers' don't understand their obligation to report worldwide income, they are creatively using transactions to avoid tax within the current rules, or they are evading their obligations by investing offshore with no intention of reporting the income.

The departments of Finance and National Revenue maintain that they need information to be able to identify these situations and to enhance compliance with the requirement in the Income Tax Act to report worldwide income. Without the reporting requirement, it is very difficult for Revenue Canada to obtain this information. The law currently requires those who pay interest or dividends to Canadians to file third-party information returns with respect to such payments, thereby effectively disclosing taxpayers' investments to Revenue Canada. However, Revenue Canada has great difficulty compelling foreigners to file these returns. It therefore believes that the best way to obtain the necessary information is to require Canadians to report their foreign investments.

Chronology of the New Rule

The 1995 Budget proposed the introduction of new foreign reporting requirements for individuals, corporations, trusts and partnerships for taxation years beginning after 1995 as part of the government's strategy to address the issue of tax havens.

Draft legislation and information returns to implement the 1995 Budget proposal were released on 5 March 1996. Following a consultation process that included taxpayers and tax professionals, several changes to the draft legislation were made. The legislation was included in a Ways and Means Motion introduced in the House of Commons on 5 December 1996. The legislation, part of Bill C-92, became law on 25 April 1997 when it received royal assent.

Under the reporting requirements, Canadian residents must disclose to Revenue Canada information on certain foreign property where the aggregate original cost exceeds $100,000, any interests in foreign affiliates and certain transactions with foreign trusts.

Some Canadians have objected to the requirement under section 233.3 of the Income Tax Act for Canadian residents to report specified foreign property over $100,000. On 2 October 1997, the ministers of Finance and National Revenue announced that the government was delaying the requirement to report specified foreign property over $100,000 from the first reporting date of April 1998 until April 1999. The other reporting requirements, however, remain intact. In the interim, the ministers asked the Auditor General of Canada to perform an independent review of the $100,000 specified foreign property reporting requirement.

What Must be Reported Under the Specified Foreign Property Reporting Requirement " Specified foreign property" includes foreign bank accounts, rental property outside Canada, Canadian securities held outside Canada as well as investments in foreign corporations, trusts, partnerships and other foreign entities. Neither property used exclusively in an active business nor personal-use property have to be reported.

Canadian resident individuals, corporations and trusts who own "specified foreign property" of $100,000 on an aggregate basis at any time in the year are required to disclose certain information about the property to Revenue Canada (the $100,000 threshold is per person, not per family). A partnership that is more than 10 percent Canadian-owned in terms of its entitlement to income must also file a return. The draft reporting form (T1135) requires the taxpayer to describe the foreign property, disclose its cost and whether any income was earned from the property during the year.

An individual is exempted from the reporting requirements in the year he or she becomes a resident of Canada. This exemption is intended to allow new immigrants an additional year to familiarize themselves with Canada's tax system and to gather the necessary information to be able to comply with the reporting requirement.

There are severe penalties under the legislation for failing to file the required information return with Revenue Canada or for making a false statement or omission on the return.

Examples - The following are examples of situations where a taxpayer would be required to file a T1135 return:

• An individual owns shares in a non-resident corporation with a cost amount of $75,000 and a bank account in the United States with $35,000 on deposit. The return should be filed as the total cost amount of all specified foreign properties owned exceeds $100,000.
• >A husband and wife have a joint foreign bank account and joint ownership of other foreign property. The total cost of the foreign property owned jointly is $180,000. The proportionate ownership of the foreign property will be based on the amount contributed by each person. If the contribution by either person is more than $100,000, then that person must file Form T1135.>
• An individual owns shares in non-resident corporations with a total cost amount of $250,000. These shares are held by a Canadian stockbroker. As the cost amount of the shares exceeds $100,000, the shares should be reported on Form T1135 regardless of whether the shares are physically held inside or outside Canada.
• An individual owns $200,000 in U.S. treasury bills. Indebtedness owed by a non-resident should be reported on Form T1135, even if the treasury bills are not held at year end.

Other Examples of situations where a taxpayer would not be required to file a T1135 return.

• A self-directed Registered Retirement Savings Plan that has over $100,000 in foreign securities, because a trust governed by an RRSP does not have to file Form T1135.
• Units in a mutual fund trust that invests entirely in foreign securities where the cost amount of the units is $150,000. If the mutual fund trust is resident in Canada Form T1135 does not have to be filed.
  
• A condominium in Florida with a cost amount of $120,000. If the condominium is personal-use property (used by the taxpayer or a related person primarily for personal use and enjoyment), it does not have to be reported on Form T1135. If the property is rented out with a reasonable expectation of profit, Form T1135 has to be filed.
• A warehouse in England with a cost amount of $900,000 owned by a Canadian corporation and used to store its products for distribution. The corporation does not have to report this on Form T1135 because the warehouse is used exclusively for storing inventory used in the corporation's business. Foreign property that is used or held exclusively in an active business is not " specified foreign property" and therefore does not have to be reported.

CCRA Non Resident Income - Link to information for non-residents and income reporting.

 

Offshore Reporting Rules Part 1