Canada’s Foreign Transaction Reporting Rules

Canada’s Foreign Transaction Reporting Rules—A Canadian Tax Lawyer Analysis

Introduction

The Canadian Income Tax Act contains five basic rules requiring a Canadian resident to report either a transaction involving a foreign party or an interest in foreign property:

• Section 233.1 requires a Canadian resident to file a T106 if the resident entered a business transaction with a related non-resident.
• Section 233.2 requires a Canadian resident to file a T1141 if the resident transferred or loaned property to a non-resident trust or similar entity.
• Section 233.3 requires a Canadian resident to file a T1135 if the resident owns or has an interest in “specified foreign property.”
• Section 233.4 requires a Canadian resident to file a T1134 if the resident has a “foreign affiliate.”
• Section 233.6 requires a Canadian resident to file a T1142 if the resident is a beneficiary of—and receives a distribution from—a non-resident trust.

These reporting rules do not hinge upon tax liability. That is, these rules obligate a Canadian taxpayer to report a foreign interest regardless of whether that interest generates income that is taxable in Canada.

The Canadian government enacted these reporting rules as a means of gathering information. Before these rules came into existence, a Canadian taxpayer was not required to divulge his or her offshore holdings or transactions unless they resulted in a tax payable. As a result, Canada Revenue Agency had no means of auditing foreign assets or transactions to discern whether Canadian tax was indeed not payable. In short, these reporting rules alert the CRA to offshore assets or transactions that warrant a closer inspection.

In addition, section 233.6 exempts certain first-year resident individuals from the reporting requirements of sections 233.2, 233.3, 233.4, and 233.6.

Section 233.1—T106: Information Return of Non-Arm’s Length Transactions with Non-Residents

Section 233.1 requires certain persons and partnerships to file a T106 if that person or partnership enters a business transaction with a related non-resident. In particular, the reporting requirement under section 233.1 applies to the following entities:

• a Canadian-resident person
• a non-resident person carrying on business in Canada
• a partnership with a Canadian-resident partner
• a partnership carrying on business in Canada

A non-resident must file a T106 for a transaction that involved both (1) another related non-resident and (2) a business that the non-resident carried on in Canada.

A Canadian resident, on the other hand, must file a T106 for a transaction that involved both (1) a related non-resident and (2) the resident’s business—regardless of whether carried on in Canada.

Section 233.1 does not apply, however, if the total value of an otherwise reportable transaction is equal to or less than $1 million.

Section 233.2—T1141: Information Return in Respect of Contributions to Non-Resident Trusts, Arrangements, or Entities

Generally, section 233.2 requires a Canadian-resident individual to file a T1141 if that individual makes a non-arm’s length transfer or loan to a non-resident trust. Subsection 233.2(4.1) effectively extends this general rule to include a non-arm’s length transfer or loan from a Canadian resident to a foreign arrangement akin to a trust.

In particular, under 233.2(4.1), a Canadian-resident individual must file a T1141 if:

• [the individual] at any time, directly or indirectly, transferred or loaned… property to be held under [an] arrangement and the arrangement is governed by the laws of a country or a political subdivision of a country other than Canada…; and
• the transfer or loan is not an arm’s length transfer.

But subparagraph 233.2(4.1)(e)(ii) exempts a individual from filing a T1141 if “the arrangement or entity [is] a foreign affiliate in respect of which the [individual] is a reporting entity (within the meaning assigned by subsection 233.4(1)).” In other words, if section 233.4 requires the individual to report a foreign affiliate, the 233.2 reporting rule does not apply.

Section 233.3—T1135: Foreign Information Verification Statement

Generally, section 233.3 requires a Canadian-resident person or partnership to file a T1135 if that person or partnership owns “specified foreign property” with a total cost exceeding $100,000.

“Specified foreign property” includes “an interest in, or for civil law a right in, or a right—under a contract in equity or otherwise either immediately or in the future and either absolutely or contingently—to… a share of the capital stock of a non-resident corporation.”

But “specified foreign property” excludes “an interest in, or for civil law a right in, or a right to acquire, a property that is… a share of the capital stock… of a non-resident corporation that is a foreign affiliate of [the owner]… for the purpose of section 233.4.”

For more on the T1135 reporting requirement, see here.

Section 233.4—T1134: Information Return Relating to Controlled and Non-Controlled Foreign Affiliates

Generally, section 233.4 requires a Canadian-resident individual, of which a non-resident corporation is a foreign affiliate at any time in the year, to file a T1134.

At bottom, a non-resident corporation is a taxpayer’s “foreign affiliate” if the taxpayer owns at least 10% of that corporation’s shares, regardless of class or series.

For more on the T1134 reporting requirement, see here.

Section 233.6—T1142 Information Return in Respect of Distributions from and Indebtedness to a Non-Resident Trust

Section 233.6 requires a Canadian-resident taxpayer to file a T1142 if that taxpayer receives a distribution or loan from a non-resident trust in which the taxpayer has a beneficial interest. This reporting requirement still applies even if the taxpayer need not include the distribution in income—such as distributions from the trust capital.

Section 233.6 doesn’t apply if the non-resident trust is either a deceased individual’s estate or an “excluded trust.” A non-resident trust is an “excluded trust” if, for instance, the trust is exempt from tax in its resident country. In addition, a Canadian resident need not file a T1142 if the resident must already file a T1141, T1135, or T1134.

Section 233.7—Exception for First-Year-Canadian-Resident Individuals

Section 233.7 of the Income Tax Act exempts a first-year resident individual who would otherwise need to file under sections 233.2, 233.3, 233.4, or 233.6.

This filing exception does not apply to the reporting obligation under section 233.1. So, first-year residents must still file a T106 for a non-arm’s length business transaction with a non-resident.

In addition, the Canada Revenue Agency insists that the filing exception doesn’t apply to an individual who was previously resident in Canada (see CRA document no. 2009-0315911E5, July 20, 2009).

Tax Tips – Foreign Transaction Reporting

Because these reporting requirements don’t hinge upon tax liability, many taxpayers consider them to be unimportant. But the Income Tax Act imposes steep penalties on taxpayers who fail to file an information return per the foreign-reporting rules. For example, a simple failure to file can result in a penalty of up to $2,500 plus interest. But if the failure to file constitutes gross negligence, the maximum penalty can reach $12,000. Moreover, an additional 5% penalty may apply if a T106, T1141, or T1135 is over 24-months late.

Similarly, a false statement or omission on a filed information return can also draw hefty penalties. A $24,000 penalty may apply as a result of a false statement or omission on a T106. If the false statement or omission is made on a T1141, T1135, or T1134, the penalty is the greater of $24,000 and 5% of the reported amount.

An application under the Voluntary Disclosures Program (VDP) may allow you to avoid these penalties. Contact one of our expert Canadian tax lawyers to discuss whether a voluntary disclosure is a viable option.