Deciphering the CRA's foreign property question
Contributor: MRSB senior tax manager John Connolly, CPA, CMA
"Did you own or hold foreign property at any time during the taxation year with a total cost of more than CAN$100,000?"
Canada Revenue Agency (CRA) has been asking taxpayers this question on their personal tax return since 1998. If the answer is YES, then you must report the details of your foreign property to CRA on form T1135.
Unfortunately, what appears to be a simple question is a potential trap for the unwary or inexperienced. Those who are not familiar with the technicalities of the Income Tax Act can easily answer this question incorrectly. The result can be an expensive penalty for not filing form T1135 when it was required. Collecting unpaid taxes on unreported foreign income (accidental or deliberate) is the flavour of the month for governments looking to boost their revenue, and CRA is giving it a lot more attention now. So, let me provide you with some advice that can help clarify what each little word in the CRA’s foreign property question really means!
Sometimes the words “at any time” get overlooked as people (understandably) sometimes think only of what they owned at the end of the year. A person who owned foreign investments that cost over $100,000 on December 31st 2013, and sold it all on January 2nd 2014 is over the limit, and must file form T1135 for 2014.
Often, the broad meaning of “property” is not understood, as many people think of property only as real estate. They think the answer must be 'no', because they do not own any real estate outside of Canada, or they paid less than $100,000 for their foreign real estate. But “property” for tax purposes includes any type of physical object. It also includes intangible property such as shares of a company, bonds, units of a mutual fund, a patent, or a copyright. Property also includes money. A bank account, term deposit or GIC are all property. A personal loan is property even if you are not charging interest on it.
A life insurance policy is also property. A foreign life insurance policy is “foreign property” that counts towards the $100,000 and must be reported if you are over the limit. Its cost is not simply the total of the premiums that were paid. Rather, there are complicated rules in the Income Tax Act for determining its cost. Not only that, a foreign life insurance policy may cause taxable income while you are alive, and the death benefit may be taxable. Canadian life insurance companies follow complex rules in the Income Tax Act to ensure that this does not happen with most Canadian life insurance policies, and to ensure that their clients are fully informed when they buy a taxable policy.
Now that you have a better understanding of the word “property” from a tax perspective, let’s tackle “foreign”. You may think that your stock market investments are not foreign because you use a Canadian broker and have a Canadian dollar investment account. Shares and bonds of a foreign company are always foreign property whether you hold them personally, hold them in a Canadian brokerage account, or hold them in a foreign brokerage account. This is true regardless of whether or not the account is a Canadian dollar account. To make things a bit more confusing, the reverse is not true for shares and bonds of a Canadian company. Everything that is held in an investment account in another country is foreign property, including Canadian dollar deposits and shares or bonds of Canadian companies.
Whether or not a mutual fund is “foreign” depends on where it is resident regardless of what it invests in. A mutual fund resident in Canada is not foreign property even if the only thing that it owns is shares of foreign companies. A mutual fund resident outside of Canada is foreign property even if the only thing that it owns is shares of Canadian companies. Still with me?
Ok, here’s another one for you. The words “total cost” can be misinterpreted, because the cost of some properties involve a number of expenses incurred at different times. For example, if a person builds a cottage outside Canada and spends $20,000 for land, $5,000 for legal fees & permits, and $70,000 for construction, then the total cost of the cottage is $95,000. This sort of thing leads some people to misinterpret CRA’s question because they think of the total cost on an item by item basis. A person who owns that cottage and also owns shares of a foreign company that cost $10,000 may not realize that the “total cost” of their foreign property is $105,000. They are over the limit if the cottage is not for personal use.
Sometimes borrowed money causes a misunderstanding of what CRA is looking for in terms of “total cost”. The cost of a property is generally the amount that was paid for it regardless of where the money came from. Money borrowed to buy a foreign property is not deducted when determining its cost, even if the loan is from a foreign lender.
To complicate things a little more, the "cost" of a property for tax purposes is not always what was paid for it. The Income Tax Act includes a variety of rules that change the cost (for tax purposes) from the actual cost of the property to its fair market value when a particular event occurs. Receiving property as a gift or inheritance, immigration to Canada, and changing the use of a property from personal to income earning are some of the events that will trigger these rules.
Last but not least baffling, even CRA's interpretation of the words "own or hold" can be problematic. The attribution rules in the Income Tax Act say that if you give an income earning property or investment to a related minor, then you must report the income it generates on your tax return. From CRA's point of view, if you made such a gift of foreign property, you ust count that property's cost towards the $100,000 reporting threshold and report it on your T1135 if you are over the limit.
Personal use property does not have to be reported to CRA on form T1135, and does not count towards the $100,000 threshold. However, it is not always clear what is personal use property. A vacation property outside of Canada would typically be thought of as personal use property, but some people rent their vacation property for part of the year. If the property is available for rent more than half the year, or if the owner could reasonably be expected to make a profit on the rent, then CRA may not consider it personal use property.
Luckily, if you are a recent immigrant to Canada, there may be some good news. There is a one-year exemption from reporting foreign property the year a person "first becomes a resident of Canada". The word "first" is important. If the person was ever a resident of Canada in the past and is returning to the country, this exemption does not apply to them. Of course, the income earned on foreign property must be reported every year regardless of whether or not this exemption applies.
A person may be tempted to send CRA the T1135 form with copies of their investment account statements attached. Don't do it! If the information is not provided in exactly the same format as the form, CRA considers it incomplete. They can assess the same penalities as if the form were never filed. What you should do is contact your investment advisor and ask if they can provide a report in CRA's required format. If this isn't an option, your accountant can help you complete the form.
The amount of information CRA is asking for on the new T1135 form can be overwhelming for first-timers. When in doubt, do some extra research on CRA's website, call your investment advisor or pay your accountant a visit. Even if you don't have the time or energy to decipher the rules yourself, tax accountants like myself are always happy to translate them for you!