This article was first published in the STEP Journal.
Canada is one of the preferred locations for emigrating UK residents. Wealthy individuals will be persuaded by Canada’s unique mix of European and American culture, proximity to the American market, and consistent placement at the top of international happiness and standard-of-living indices.
That said, the UK, with its tax system that remains favourable to non-domiciliaries, still holds great sway for wealthy Canadians. But tax is rarely the tail that wags the dog: wealthy families come to the UK because of its schools, its business opportunities and the City of London. Whether travelling east or west over the Atlantic, there will be tax implications in both the UK and Canada.
The first issue facing a Canadian individual who is considering a move to the UK is how to ensure that they cease to be a resident of Canada. An individual is resident in Canada if they are ‘ordinarily resident’ in Canada, defined by the Supreme Court of Canada as meaning that Canada is ‘the place where in the settled routine of his life he regularly, normally or customarily lives’.1 This is a factual test that the courts will determine on a case-by-case basis, but the Canada Revenue Agency will focus primarily on three ‘significant residential ties’: dwelling place or places that are available for occupation; spouse or common-law partner; and dependants. In most cases, these three ties will determine whether or not the individual is a resident of Canada.
There is also a statutory deeming test. If an individual sojourns2 in Canada for 183 days or more, the individual is deemed to be a resident of Canada. Should an individual find themselves to be a resident of Canada on either a factual or statutory basis, there is still an opportunity for that individual to escape the Canadian tax net if they are also found to be a resident of the UK, based on UK law. Should this occur, the individual’s residency will be determined by the tiebreaker rules in article 4 of the Canada-United Kingdom Tax Convention. The tiebreaker rules function on the basis of a simple, descending order. If an individual is found to be a resident of both Canada and the UK, then their residence is determined as follows:
- Permanent home: the individual shall be deemed to be a resident in the country in which they have a permanent home available for use.
- Centre of vital interests: if no permanent home is available, then the individual shall be deemed to be a resident of the country with which their personal and economic relations are closer. This is known as the ‘centre of vital interests’ test and is similar to the ‘ordinarily resident’ test.
- Habitual abode: if the centre of vital interests cannot be determined, then the individual shall be deemed to be a resident of the country in which they have a habitual abode. This test focuses on the frequency, duration and regularity of the stays in each country.
- Citizenship: if the individual has a habitual abode in both or neither country, then they shall be deemed to be a resident of the country in which they are a citizen.
- Mutual agreement: if the individual is a citizen of both or neither country, then the competent authorities of the two countries will settle the question by mutual agreement.
The Exit Tax
Once Canadian residency is terminated, the individual is subject to an exit tax. They are deemed to have disposed of all property for fair market value consideration, subject to the exceptions reviewed below, and then to have immediately reacquired the property. This deemed disposition causes the individual to realise any capital gains that have accrued while they were a resident of Canada.
There are five exceptions to the exit tax: situated Canadian property; Canadian business inventory; excluded rights or interests; the recent immigration exception; and the returning former resident exception. Excluded rights or interests include most pension plans,3 as well as beneficial interests in personal trusts, unless the property was transferred to the trust on a tax-deferred basis in anticipation of the taxpayer ceasing to reside in Canada.
Although the Canada-UK tax treaty will generally recognise the increase in cost base resulting from the exit tax, it may be wise to trigger the gain by virtue of a real disposition to ensure that the individual does not suffer from exit tax in Canada without receiving the advantage of a step-up in cost base in the UK.
While most pension plans are exempt from withholding tax in the UK, other income paid from Canada to the UK will generally be subject to a withholding tax at a rate of 10 per cent. New UK residents should also be aware that the sale of ‘taxable Canadian property’, which includes Canadian real property and shares of corporations that derive 50 per cent or more of their value from Canadian real property, will trigger Canadian tax, even if the individual is no longer a Canadian resident. Planning is available to address this tax exposure.
UK Tax Considerations
The general rule is that the UK provides no step-up to individuals moving to the UK; disposals are subject to capital gains tax (CGT) on the whole period of ownership, irrespective of how much of that period the individual was resident abroad.
However, under article 13(10) of the Canada-United Kingdom Tax Convention, where an individual ceases to be a resident of Canada and is subject to the Canadian exit tax, and then becomes a resident of the UK, the UK may tax gains on the property only to the extent that such gains accrued after the individual became UK resident. This treaty provision affords useful protection against double taxation of the same gain.
Individuals are often best advised to make actual disposals (such as gifts or sales) of assets before arriving in the UK. As stated above, they will be caught by the Canadian exit tax in any event. Alternatively, the Canadian-domiciled4 high-net-worth individual may realise the disposal by transferring assets into trust. Not only is this sensible from a UK-Canada CGT point of view, but, if structured as an excluded property trust (EPT) for UK tax purposes, will provide useful UK tax benefits. Even following the April 2017 changes to the UK non-domiciliary regime, an EPT will continue to enjoy UK inheritance tax protection in perpetuity (provided the settlor was not born in the UK with a UK domicile of origin).
There are no standard checklists or immediately obvious pitfalls when leaving the UK. For instance, there is no exit tax.
When leaving the UK, the tax risks are subtler. The key is for the advisor and the individual to survey the individual’s financial background to search for potential pitfalls. For example, we recently cautioned a client against the risks of emigrating, as the client had previously claimed ‘hold-over’ relief to defer CGT liability on business assets. If a client claims hold-over relief to defer CGT on business assets, the gain kicks in if they emigrate within six tax years from the end of the year of the gift. Individuals also need to be aware that, if they leave the UK, but return within five tax years, any gains made outside the UK during the period of non-residence will become chargeable on return to the UK.
Canada’s tax policies are favourable to individuals moving to Canada. Primary among the advantages of newcomers to Canada is the ‘arrival bump’ – effectively the opposite of an exit tax. Canada deems individuals to have disposed of and reacquired all assets immediately before moving to Canada. As this occurs before the individual is a Canadian resident, this deemed disposition results in no tax liability to the individual, but increases the cost basis of the individual’s assets to fair market value. Any gain that accrued on these assets before the individual became a Canadian resident will not be taxed in Canada.
However, there are pitfalls for income-generating assets that are left in the UK, as cross-border interest payments, dividends and most other payments will be subject to UK withholding tax. The Canada-United Kingdom Tax Convention will generally reduce this withholding tax rate to 10 per cent, but will not eliminate it.
Immigration, even between countries with such deep cultural, legal and economic ties as the UK and Canada, is fraught with potential tax liability, but proper planning can help emigrants enter their new homes with a minimal tax burden.
Thomson v Minister of National Revenue  CTC 51
A temporary stay in the sense of establishing a temporary residence. Sojourning includes visits to Canada for business and vacations, but not merely passing through Canada
Such as Registered Retirement Savings Plans, Registered Retirement Income Funds, Retirement Compensation Arrangements, the Canada Pension Plan and Old Age Security benefits
Under UK tax law, the concept of “domicile” is separate from residency. As such, an individual can be resident in the UK but domiciled elsewhere (often the individual’s place of birth). This presents certain tax advantages, as individuals resident in the UK but domiciled elsewhere may not be taxed on their worldwide income.
This article was co-authored with James Brockhurst of Forsters.