2010 Cross-border tax update

Vancouver

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Topic summary

US tax update: PFIC update – reporting Foreign Bank Account reporting Tax rate changes Voluntary Declaration process update CFC update Miscellaneous legislationCanadian tax update: Foreign tax credit generators Taxable Cdn property rule changes Tax avoidance transactions Stock option changes Quebec - model for Feds?

PFIC

Passive Foreign Investment Company(PFIC) UpdatePFIC shareholder must file annual return

Previously only when taxable event occurred or election made

Statute of limitations suspended INDEFINITELY for failure to file annual returnFurther, the statute of limitations is suspended

INDEFINITELY for failure to file ANY informational return (recently clarified)

PFIC

What is a PFIC?Canadian mutual funds – trusts v. corporation

If trust for U.S. purposes, not subject to PFICHowever U.S. person likely has U.S. trust reporting (subject to penalties)

If corporation for U.S. purposes, generally subject to PFIC determinationsLimited purpose trust, open ended, unincorporated, created for investment

purposes

Management of trust has powers to “vary the investments”

Certain Canadian corporationsJunior investment stock likely PFICs

IPOs

Certain REITsLikely not subject to PFIC if active property management by REIT itself

Most CEFs

Includes privately owned companies!

Information circulars (and other fund documents) are starting to report of their PFIC status

PFIC

Sample PFIC Calc – Non-QEF or Mark-To Market

U.S. Citizen Buys Canadian Junior Mining Stock in 2007 for $ 1,000 US

Sells all of the stock in 2010 for $ 10,000 US

The $ 9,000 US gain will be taxed at an effective rate of 37% in the United States*

The longer the hold of the stock, the higher the effective rate

Annual distributions can create “excess distributions” as well

*(assuming the underpayment interest rate in 2010 is the same as 2009)

FBAR redux

Additional Disclosure Required: new form“Specified Foreign Financial Asset” disclosure

Includes:Deposits (or custodial accounts) at foreign financial institutions

To the extent not held at a financial institution:Stocks or securities issued by foreign persons

Any other financial instrument or contract held for investment that is issued or has a counterparty that is not a U.S. person

Any interest in a foreign entity.

Aggregate value of the assets must exceed $ 50,000 USIf you can’t prove aggregate value, IRS will assume you met the

threshold

Congress does not believe this to be a duplicative reporting to FBAR (which is still in effect)

Failure to disclose is $ 10,000 US for every tax year

Statute of limitations is suspended INDEFINITELY if never filed

US tax rate changes

Changes to U.S. Individual FTCs -As of 2009

Foreign Dividends in excess of $ 20,000 US are subject to FTC stripping

Changes to U.S. Individual Tax Rates -As of 2011

Top marginal rate goes to 39.6%

Long-term capital gains rate to 20%

Qualified dividends ordinary rates - no longer 15%

Foreign tax credits – un-pooling, again

Impact for planning:

• foreign exchange rate implications

• Dividend tax credit issues

US tax rate changes

Personal Income tax rates: MFS: Over $70,000 but not over $125,000. $17,964.25, plus 36% of the

excess over $70,000.

Over $125,000....... $37,764.25, plus 39.6% of the excess over

$125,000. MFJ:Over $140,000 but not over $250,000. $35,928.50, plus 36% of the

excess over $140,000.

Over $250,000....... $75,528.50, plus 39.6% of the excess over $250,000.

US tax rate changes

US Healthcare bill: requires US persons to have healthcare coverage that meets US standard. Penalties for insufficient coverage – no exemption for U.S. persons living outside US.

Q:How does this impact US Persons living in Canada? Private insurance required?

2012: 3.8% healthcare surtax on investment income where AGI over $250,000 MFJ

Planning: analysis for high net-worth individuals

FTC strip + tax rate rates

Facts: Employment income $400,000 Cdn eligible divs $ 50,000** Actual amount

US tax consequences:

Taxes 2008 2009/10 2011 2012

Employment 118,000 118,000 118,000 118,000

Dividends 6,000 7,000 15,000 17,000

FTC:

Employment (118,000) (118,000) (118,000) (118,000)

Dividends ( 6,000) (5,000) (7,000) (7,000)

Net US tax Nil 2,000 8,000 10,000

US tax rate changes

Estate taxes Exemption $1M – 3.5M?• Retro-active?

• The estate tax exemption will drop to $1 million. • The GST exemption will drop to an inflation-adjusted $1

million (it is likely this amount will be at least $1,340,000).

• The top estate, gift, and GST tax rate will increase to 55% (60% for estate and gift tax transfers between $10 million and $17,184,000).

• The estate and gift tax system will again be unified. • The state death tax credit will be restored.

Vol Dec update

Voluntary Disclosure Update• Mitigation of Penalties

Up to Audit Manager assigned to file

If “offer” rejected, proceed to audit

• Additional Requests

Account statements for 2003 through 2008Not all agents request thisSome won’t discuss mitigation unless we

provide this first

Copies of Canadian tax returns filedIncludes corporate returns of CFCs

Vol Dec update

Non-Compliance Going Forward• No “quiet disclosure”

IRS is setting up programs to trigger inspections of multiple/previous year’s filings

Is considered a willful failure to file and will be subject to no relief of penalties

• All non-compliance must be sent to Voluntary Disclosure departmentNo guidance on what the procedures and likeliness of

penalty mitigation at this time

CFC refresher IRC 951-957

What is a Controlled Foreign Corp?• 5 or fewer US persons with at least 10%

interest (combined filing allowed)

• Attribution rules (family, psps, trusts,corps IRC 318)

• Subpart F income = FAPI – dividend at ordinary rates (results in double taxation)

• Failure to file penalty: $10,000 per corp• Complex form – requires USD and US gaap

Recent case: CCA 200645023 – complexity not reasonable cause

CFC – IRC 954

IRC 954 Subpart F Income

What comprises PHC income?1. Dividends, interest, rents, royalties, and annuities; 2. Income equivalent to interest (without regard to the

exceptions for amounts apportioned like interest); 3. Foreign currency gains or loss (without regard to the

exception for gain or loss directly related to business needs);

4. Gain or loss from commodities transactions (without regard to the exclusions for qualified active sales and qualified hedging transactions); and

5. Gain or loss from certain property transactions (without regard to the exceptions for sales of inventory and dealer property).

CFC – IRC 954

Limitation:• The subpart F income of a controlled

foreign corporation for a taxable year cannot exceed the earnings and profits of the corporation for that year

• Claw-back rule for subsequent profits

CFC – IRC 954

IRC 954 fix for CFCs with Subpart F income:

ULCPros & Cons:• Income retains character in hands of US

person (capital gains, dividends)• Requires maintenance of portfolio in CAD

and USD• issue with US investments? Treaty? Code?

Miscellaneous legislative changes

Codification of economic substance:IRC 7701(o)Substantial penalties for transactions lacking economic

substance (20% - 40%)

economic substance is a conjunctive test—that is, a transaction (or series of transactions) to which the economic substance doctrine applies is treated as having economic substance only if (1) it changes in a meaningful way (apart from any U.S. federal income tax effects) the taxpayer's economic position; and (2) the taxpayer has a substantial purpose (apart from U.S. federal income tax effects) for entering into the transaction

Miscellaneous

Purpose of legislation:• sham transactions - sole purpose of obtaining tax

benefits and the transaction is devoid of any reasonable opportunity for economic profit

• sales leasebacks

Result: potentially wide-ranging – could impact typical reorganization planning

eg. Sale of US stocks to spouse

Miscellaneous

Adequate Disclosure (Rev Proc 2010-15)

a.k.a. why the cost of compliance just went up

Applies to all tax filers and preparers

Substantial understatement of tax: IRC 6662(1)

Individuals: understatement exceeds greater of 10% or $5,000

Corporations: understatement exceeds lesser of 10% or (or if greater $10,000) $10M

Miscellaneous

Inadequate disclosure includes:• Unclear descriptives• Compensation of officers (Sch E)• Repairs• Combining unlike items• Schedule A Itemized deduction details• Trade or business

Consider Form 8275 or 8275-R disclosure?

Miscellaneous

Restructuring at IRS• High net worth individuals (>$10M) now

part of “corp” audit group

Washington B&O tax• Sweeping changes to nexus rules – any

activity directed at WA residents/businesses

• If activity stopped “trailing nexus” for current + next year

Miscellaneous

Canadian trust – vacation propertyUS person or non-compliant snowbird meeting substantial

presence who is grantor or beneficiary of trust occupies

US ppty – fair market value of use of residence as distribution (taxable amt limited to net income but may have deemed rental income)

Canadian tax potpourri

Foreign tax credit generatorsProposed amendments: restrict entitlement

to deductions & credits for foreign taxes in respect of foreign-source income

Target: hybrid instrument structures

Unintended result? – partnership structuresDenial of % of FTCs if income under other

country rules is less than Cdn equivalent

Canadian tax potpourri

Taxable Canadian propertyNon-public company shares excluded unless

anytime in last 60 months more than 50% of FMV (direct or indirect) combo of:

1) Real or immovable property2) Resource3) Timber4) Options or interests in above

Similar rules apply to NR corps, psp interests, mutual fund trusts

Exchange taint under section 85• Shares received by transferor deemed TCP for

60 months following transfer

Canadian tax potpourri

Tax avoidance transactions:Following US and QC models?Meets two of three “hallmark” tests:1. Promoter/tax advisor fees (a) attributable to

benefit; (b) contingent on tax benefit; or (c) # of participants;

2. Promoter requires “confidential protection”;3. Taxpayer receives “contractual protection”;Result: any tax benefit sought not available until

reported and, if applicable, penalty for failure is paid.

Canadian tax potpourri

Employee stock options:• Elimination of deferral for pubco stock options

Result: better matching of Cdn & US tax consequences

• Remittance obligations – amounts must be remitted for stock option benefit as if cash payment (with reduction for 50%)

Applies: 2011 exercises

Exemption: a) stock options granted prior to 2011; b) entered to prior to March 4, 2010; and c) restrictions on disposition.

Canadian tax potpourri

TD Securities (USA) LLC v. Queen 2008-2314(IT)G, April 8, 2010

Held: US LLC was resident entitled to treaty benefits under former convention

Fact pattern: Two tier US C corporation blocker with LLC

Questions?

Questions?

Thanks for your time.