Articles

The desire to gift assets between parties where a personal relationship exists constitutes a non-arm’s length transaction. Gifting is often born from an innate wish to see those who are closest to you enjoy the fruits of your successful financial life. That’s true whether it’s to celebrate or commemorate a birthday, wedding, graduation, job promotion, anniversary, or other milestone – or just to share your generosity.  There are also other reasons why gifts may be made, such as:

1. Grandparents may want to help their grandchildren pay for higher education as college tuitions skyrocket.
2. Spouses may decide to retitle assets held in individual accounts into a joint account, for estate or tax planning purposes.
3. Parents often make a gift of down payment funds to help a child purchase their first home.
4. Sentimental art or jewelry can be passed from parent to child as a gift.
5. Aunts or uncles may want to gift an automobile to a niece or nephew.

But when viewing such scenarios through a cross-border lens, it’s vital to know how gifts may be affected by financial and taxation rules and regulations based on such things as the immigration, residency, and relationship status of the donor and recipient. The type of asset being gifted as well as where the asset is domiciled (for example, Canada vs. the U.S) should also be considered. The following article explains some of the nuances of non-arm’s length gifting including non-charitable gifts, and examines common scenarios to help you strategically plan your gifts for the greater benefit of both you and the designated recipient.

Grandparents Gifting Money to Grandchildren for College Education

---

Scenario A Assumptions

• Dual citizen grandparents and grandchildren residing in the U.S. 
• Cash domiciled in the U.S. represents the gift

In this specific case, one common gifting option suggests that the grandparents contribute funds to their grandchild’s 529 education plan. Details about 529 plans can be found in Cardinal Point’s Ebook: Cross-Border Implications of Holding a 529 Plan. For the tax year 2023, the annual gift tax exclusion to a non-spouse beneficiary is $17,000 USD. If both grandma and grandpa were to perform gift splitting, the annual gift tax exclusion is doubled. In the latter case, a gift tax Form 709 would need to be prepared and filed with the same due date as the grandparents’ U.S. income tax return. No gift tax would be owed given the current lifetime gift and estate tax exemption amount of $12.92M USD per person (2023). 

From time to time, grandparents choose to “front load” the 529 plan by contributing up to five years’ worth ($170K USD for 2023) of annual gift tax exclusion funds to a grandchild’s 529 account. In this case, no additional excludible contributions can be made for another five years. Even if front loading of the 529 plan via cash gifts beyond the annual gift tax exclusion took place, it is unlikely that gift tax would be owed − unless the current lifetime gift and estate tax exemptions dramatically fell or if grandma and grandpa had already used up their lifetime exemption. There will be an additional tax preparation cost, but that is normally not very significant.  Keep in mind that although the IRS does not allow a tax deduction for contributions to a 529 plan, some states do. Furthermore, some states also set contribution limits for 529 plans. 

Scenario B Assumptions

• Canadian citizen / U.S. Green card holder grandparents residing in the U.S.
• Grandparents properly exited Canada and filed their Canadian departure / exit tax return when they moved to the U.S.
• Canadian-only parents and grandchildren residing in Canada
• Cash located in the U.S. is the gift consideration

Unlike Scenario A, Canada has a separate college funding account mechanism called a Registered Education Savings Plan (RESP). For more information on RESPs visit Cardinal Point’s blog on Canada & U.S. Education Savings Options. The U.S. tax resident grandparents can help fund the RESP and allow those contributions to attract Canadian Education Savings Grants (CESG) from the Canadian government. 

From a Canadian tax perspective, neither the grandparents, parents, nor grandchildren need to report the gift. In instances other than a contribution to a registered plan, income attribution rules would need to be considered – but those complex laws are beyond the scope of this article. 

From a U.S. tax perspective, it is unlikely there would be a need to report the gift on a U.S. gift tax Form 709, since contribution limits on RESPs are much less than in the U.S. Although the amount of contributions are significantly less in RESPs than in 529 plans, the cost of tuition in Canada is typically substantially lower.

It’s important to note that there are U.S. income tax issues for U.S. tax residents when they are the subscriber on a Canadian RESP. Therefore, in this case, if the U.S. grandparents wanted to partake in subscriber duties, the income within the RESP would become taxable to them in the U.S., which is something to avoid. If a non-U.S. person were the subscriber the tax liability would be much lower.

Scenario C Assumptions

• Canadian citizen / resident, non-U.S. citizen grandparents
• Dual citizen grandchildren residing in the U.S. who plan to attend college in the U.S.
• Cash located in Canada in Canadian dollars for gift consideration

This scenario is not as common as the first two. The tax benefits of an RESP for a child planning to attend a U.S. college are not consistent with Scenario B. That said, grandparents can gift funds to their grandchild’s 529 plan − but have the additional hurdle of FX rates to overcome. If this scenario were to occur, Cardinal Point has business relationships with online FX providers to optimize FX rates between CAD and USD. 

From a Canadian tax perspective, any income (not including realized capital gains) generated by the gift to the minor grandchild would technically need to be attributed back to the grandparent since 529 accounts are not recognized in Canada for their tax-sheltered status. 

If the Canadian resident grandparents subscribe to an RESP instead of a 529 plan for their U.S. resident grandchildren, be aware that the grandchildren will not be able to access the CESG (government grant) portion of the RESP unless they become Canadian residents while attending their university.

From a U.S. tax perspective, if the gift exceeded $100K USD equivalent, a “Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts” would need to be filed by the owner of the 529 account for the year of gift.

For these reasons, this scenario is uncommon.

Gifting in Estate Planning – Retitling Assets from Individual to Joint Tenancy with Rights of Survivorship

In many good estate plans, “will substitutes” are maximized in order to avoid probate. This is done by retitling assets owned individually into joint tenancy, so the surviving tenant can maintain full control of the asset after the death of the other. The transfer to the survivor happens outside of probate. This alleviates potential tax owed on the decedent’s ownership of the asset (if certain elections are made on the decedent’s tax return) and allows the survivor to avoid lengthy court proceedings to distribute their late spouse’s estate at a time when they are grieving the loss. Furthermore, probate costs are minimized. It should be noted that tax-advantaged plans such as an RRSP, TFSA, Roth IRA, and Traditional IRA, can only be owned individually. But retirement plans such as these can have beneficiary designations allowing the inherited funds to also avoid the probate process.

Assuming both spouses are comfortable with amalgamating applicable assets into joint titling, there is an unconscious “gift” that takes place. This is true whether the asset and/or person resides in Canada or the U.S. Multiple scenarios can quickly develop, and we will outline a few of those below.

Scenario A – Canadian citizen and resident spouses

Forms are required for non-real estate assets in order to reregister the individual bank and non-registered accounts into joint tenancy. There is a deemed disposition for the original owner at cost, resulting in a continuation of that spouse’s original book value for their 50% share of the joint account. Canadian income tax rules dictate that all income and capital gains within the joint accounts attribute back to the original owner prior to the reregistration. The original owner still reports all the income, but upon their death probate may be avoided.

With respect to changes in real estate titling, there are a couple of additional items to consider. The method of title transfer is a more formal process, typically via an attorney deeding the property title transfer. Secondly, there can be a land transfer tax, and in some jurisdictions (i.e., Toronto), there is both a provincial and municipal land transfer tax. This can easily result in tens of thousands of dollars of taxes when retitling, given the “deemed disposition” for these types of assets. Fortunately, in Ontario, retitling the property between spouses exempts the property from land transfer tax.  

Scenario B – Dual citizen spouses residing in the U.S. who plan on returning to Canada in a few years

As U.S. citizens, spouses are entitled to the unlimited marital gift tax exemption. This allows spouses to transfer an unlimited amount of assets or gifts between one another. Therefore, if all assets are domiciled in the U.S., any shift from individual to joint tenancy avoids income and gift tax altogether. There is no “deemed disposition” as there would be in the case of Canadian residency.  However, it is a good idea to file a gift tax return to report and document that the transfer is eligible for the unlimited marital exemption.

Scenario C – Dual citizen husband residing in the U.S. with Canadian citizen / U.S. Green Card wife residing in the U.S. There are U.S. “situs” assets only.

Without U.S. citizenship, special rules apply if the recipient spouse is a U.S. Green Card holder. For non-U.S. citizen spouses, the marital deduction is limited to $175,000 USD for tax year 2023. Therefore, attempting to create a smooth estate plan by retitling applicable assets into joint names could potentially trigger negative U.S. gift tax consequences. Let’s look at an example.

John is a U.S. citizen and Jane is a Canadian citizen with a U.S. Green Card. John has a taxable brokerage account worth $2M USD. John would like to minimize gaps in his estate plan and maximize future income tax splitting in preparation for his move to Canada, by adding Jane on the account title. If John were to follow through with that plan, he would be gifting 50% of the account, or $1M USD, into Jane’s name. However, this gift exceeds the maximum marital deduction to a non-U.S. citizen spouse by $825K USD. Essentially, John would have to file a U.S. Form 709 Gift Tax Return and decrease his lifetime gift and estate tax exemption amount from $12.92M USD to $12.09M USD or less. This may seem insignificant, but tax laws are in flux and in 2025 the current lifetime gift and estate tax exemption amounts are scheduled to revert to what they were prior to the 2017 Tax Cuts and Jobs Act. Future exemption levels could be substantially lower, resulting in John having a smaller unused Lifetime Gift and Estate Tax Exemption available at his death.

In Summary

Domestic or cross-border gifting strategies involving non-arms-length transactions can take many different forms, each requiring its own unique strategies and considerations. We’ve outlined just a few in this article, and with any type of gift the Canadian and U.S. tax issues and corresponding opportunities are important to understand and dissect. The immigration, residency, and relationship status of the donor and recipient have significant implications when it comes to cross-border financial planning. That’s why it is critical that you integrate and coordinate your gift giving plans in full alignment with your overall cross-border investment, tax, and estate planning. The educational insights provided in this article are general in nature, but to review your specific circumstances and objectives, please contact Cardinal Point. 

College funding for children is constantly on parents’ minds, as the cost of tuition continues to skyrocket with no end in sight. That has heightened parents’ and grandparents’ desire to maximize college savings, by utilizing financial tools such as the Registered Education Savings Plan (RESP) in Canada. But what happens if circumstances change and the family relocates to the U.S.? Or what if your son or daughter attends a university in the U.S.? How might your current RESP planning be impacted, and what strategies should you implement to overcome potential hurdles? This article speaks to these concerns while providing insightful examples to help you navigate the complexities of college savings in a cross-border context. 

Case Study Scenario #1: The RESP subscriber remains in Canada and the beneficiary attends a Canadian post-secondary education institution.

This is the simplest circumstance to dissect, since the RESP was designed for this specific scenario. As contributions, government grants, and earnings within the RESP accrue, buckets of income are formed. There are various withdrawal strategies available, based upon the beneficiary’s tax status, the number of remaining siblings who will attend college, and the subscriber’s utilization of accumulated income payments (AIP) to fund their RRSP (up to certain thresholds). For more information surrounding the basic mechanics of the RESP please read Cardinal Point’s article: Cross-Border Transition Planning – RESPs.

As post-secondary educational costs are realized, the taxation of RESP withdrawals is as follows:

• Original contributions (used for Post-Secondary Education or PSE) are non-taxable
• Grants and investment earnings (Education Assistance Payment or EAP) are taxable to the beneficiary and subject to certain withdrawal restrictions

Depending on the beneficiary’s part-time employment opportunities, it’s possible that they may owe taxes on some portion of the EAP bucket.

Case Study Scenario #2: The RESP subscriber is a U.S. resident and the beneficiary attends college in Canada.

In this scenario, the RESP is susceptible to annual taxation in the U.S., reported on the subscriber’s U.S. tax return and disclosure as an “other” foreign financial asset. This is due to the U.S. view of the RESP, which sees it as a standard taxable brokerage account. The subscriber needs to report any realized capital gains and/or dividends and interest income on their U.S. tax return. For this reason, some families transfer RESP subscribership duties to a close friend or family member who is a Canadian resident and not a U.S. taxpayer. There are pros and cons to this strategy, but it does alleviate the U.S. tax reporting issues for the U.S. subscriber.

Assuming the beneficiary attends a higher education institution in Canada, the same income taxation results detailed in Case Study #1 apply.  But there is one exception. There would be no benefit gained by the student transferring a portion of their education credit to the U.S. parent (unless the U.S. parent had Canadian-sourced income and was required to file a Canadian tax return themselves). All RESP withdrawals are taxable to the beneficiary who then includes the T4A EAP distributions on their T1 as a Canadian resident. Keep in mind that each Canadian resident has access to annual basic personal amounts (BPA). This is a non-refundable tax credit that can be claimed by all individuals to provide a full reduction from federal income tax to all individuals on their taxable income up to the BPA. This is an important detail for Canadian resident students to note when withdrawing EAP while attending colleges and universities in Canada.

Case Study Scenario #3: Both the subscriber and beneficiary are U.S. residents, and the beneficiary plans to get their post-secondary education at a U.S. institution.

In both the second and third scenarios, it would have been necessary to open the RESP while both the subscriber and beneficiary were Canadian residents. Now let’s assume that the subscriber has not shifted their RESP duties to a Canadian resident and continues to report the annual RESP income on their U.S. tax return. All income, inclusive of capital gains within the RESP, needs to be converted to USD and reported and taxed in the U.S., which can lead to increased tax liability and tax preparation costs. Furthermore, if the aggregate total of the maximum market value of all foreign (non-U.S.) financial accounts is greater than $10K USD (a very low bar), an FBAR/FinCEN 114 disclosure report needs to be electronically filed. The taxpayer may also need to include a Form 8938 (higher thresholds) with their U.S. tax return. It’s debatable whether the RESP is considered a foreign trust, but recent IRS Revenue Procedure 2020-17 suggests that Forms 3520/3520-A are no longer required for RESPs.

From the beneficiary’s perspective, any income withdrawn from the RESP needs to be allocated to a specific bucket (PSE vs EAP). In the case of PSE, this is seen as a non-taxable return of capital to the subscriber. These payments represent after-tax contributions to the RESP. If withdrawals include EAP, then as a non-resident of Canada grants need to be repaid to the Canadian government and any earnings necessitate a 25% non-resident withholding tax payable to CRA on behalf of the beneficiary. But the beneficiary does not need to report the EAP on a U.S. tax return, since the account is only taxable to the subscriber.

Conclusion

Tax-related information is a powerful and essential tool to help you strategically plan optimal methods of navigating Canadian assets such as the RESP, RRSP, LIRA, and TFSA. As cross-border financial planners we are in a unique position to examine the intricacies of complex cross-border wealth management scenarios, including those regarding your RESP within Canada or the U.S. Although we only explored three commonly experienced scenarios, there are many other possibilities. To unpack your specific circumstances and learn applicable solutions and strategies, please contact Cardinal Point.

In today’s globalized workforce, many individuals find themselves traveling across borders for employment opportunities. For Canadians who work abroad, or foreign nationals who work in Canada, understanding the intricacies of residency and income sourcing is crucial for compliant and strategic management of their tax obligations. In this blog, we detail the complexities regarding these concepts and explore how they impact internationally mobile employees’ tax situations within a cross border wealth management context.

Residency: The Key to Taxation

Canada’s Income Tax Act (ITA) ties an individual’s tax liability to their residency status. Whether an individual is a factual resident, a deemed resident, a non-resident, or a deemed non-resident, their residency determines which income of theirs is subject to Canadian taxation.

• Factual Resident: Determined using common-law principles and CRA administrative guidance and considering factors like dwelling places, dependants’ locations, visits to Canada, personal property, and social ties.
• Deemed Resident: A non-factual resident present in Canada for a cumulative 183 days or more within a calendar year.
• Non-Resident: An individual not meeting the conditions for Canadian tax residency.
• Deemed Non-Resident: A Canadian resident taxpayer who is also considered a resident in another country under that country’s tax laws.

For more information on Canadian tax residency, see our blog titled Planning a move to Canada? Understand Canadian tax residency rules.

Income Sourcing: Understanding the Basics

Income sourcing is critical in determining the amount of income taxable in Canada in order to prevent double taxation for residents earning foreign income. It applies to various types of income, including compensation and stock options. 

Employment income is typically sourced between the different countries in which the employee physically provided the services that earned the income. Therefore, the location of the company that entered into the employment contract or the company for whose benefit the services were rendered generally does not matter. Two different methods are typically applied to determine the source of employment income:

1. Time Basis: Income that is sourced based on workdays over a specified period. Suited to income earned equally over time (e.g., salary, bonus).
2. Geographical Basis: Income that is fully sourced from a particular country and used for compensation solely tied to that country (e.g., housing allowance).

For stock options earned over multiple tax years, income is sourced based on the number of workdays spent in each country, from the date of grant to the date of vesting. Where the Canada-U.S. Tax Treaty applies, the taxpayer can choose to source the stock option income from the date of grant to the date of exercise, if that is more favorable.

Foreign Tax Credit (FTC): Preventing Double Taxation

The FTC is vital for Canadian residents with foreign-sourced income. It prevents double taxation by applying the foreign taxes paid as a credit against Canadian tax liability. The FTC is applied on a country-by-country basis and is limited to the lesser of the:

1. Amount of foreign tax paid to the foreign country for the year, or
2. Canadian tax otherwise payable on the foreign income sourced to that country.

Unused FTCs related to non-business income (including employment income) cannot be carried forward or back to another taxation year. To keep from having any unused FTCs, try to plan the incidence of taxation on the income so it occurs within the same calendar year in both countries.

Outbound Assignments

During an outbound assignment, the taxpayer goes to a foreign country for employment and may cease their Canadian residency. However, a non-resident taxpayer may still be taxable in Canada if they have Canadian workdays during the taxation period or receive employment income that pertains to duties performed while a resident of Canada (e.g. a bonus for prior year services).

Inbound Assignments

Prior to an inbound assignment, the taxpayer is a resident of a foreign country and will travel and/or relocate to Canada for employment purposes, potentially establishing Canadian residency during that year. The taxpayer becomes taxable on all of their worldwide income in Canada starting on the date of Canadian residency. For the part of the year in which the taxpayer is a non-resident of Canada, they are only taxed on Canadian-sourced income.

Foreign Business Travelers

Foreign business travelers to Canada are generally taxable regarding the paid services performed while they are physically present in Canada. However, tax treaties between Canada and the foreign traveler’s home country may allow the employment income to be tax-exempt in Canada. For example, Article XV(2) of the Canada-U.S. Tax Treaty states that employment income is only taxable in the country of residence when the following conditions are met:

• Host country source income does not exceed $10,000, or
• The traveler spends less than 184 days in the host country in any 12-month period (beginning or ending during the calendar year), and, the remuneration is not paid or borne by a resident of or permanent establishment in Canada.

An inbound business traveler to Canada from the U.S. should consider the treaty exemption in order to determine whether they will ultimately be taxable in Canada. An outbound business traveler from Canada to the U.S. should consider whether there will be U.S. taxation, in order to determine whether they can claim an FTC in Canada.

Conclusion

Navigating the complexities of residency and income sourcing for internationally mobile employees is essential to effectively managing tax obligations. Understanding these concepts allows individuals to optimize their tax positions, prevent double taxation, and ensure full compliance with both Canadian and foreign tax regulations. If you find yourself in an internationally mobile work arrangement, seeking guidance from a cross-border financial advisory firm like Cardinal Point can provide you with the expertise needed to navigate these intricate tax matters.

When a Canadian resident decides to move to the United States, there are numerous cross border tax and financial planning considerations that need to be addressed. One area of concern for many is how their Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs), Locked-In Retirement Accounts (LIRAs), and Life Income Funds (LIFs) will be impacted by this move. In this blog, we’ll explore what happens to RRSPs/RRIFs/LIRAs/LIFs when an owner moves to the U.S. and we’ll reveal various available options for effective cross border tax and wealth management planning.

Reporting Requirements

One important note for Canadian emigrants moving to the U.S. is that they do not need to report on Form T1161 (List of Properties by an Emigrant of Canada) or Form T1243 (Deemed Disposition of Property by an Emigrant of Canada). However, it is essential that they file a Form 8833 with their U.S. tax return to disclose any tax treaty elections or positions under the Canada-U.S. Tax Treaty. If the maximum value thresholds are met on your Canadian registered accounts, it is also critically important that you report that on an FBAR/FinCEN 114 and on Form 8938 of your U.S. tax return.

Tax Planning Strategies

For Canadians relocating to the U.S., several tax planning strategies can help optimize the treatment of RRSPs and RRIFs.

Article XVIII(7) Election

Under Article XVIII(7) of the Canada-U.S. Tax Treaty, emigrants can elect to defer U.S. taxation on income accruing within their RRSPs/RRIFs/LIRAs/LIFs until distributions are received from the accounts. This election offers a unique advantage, particularly if the individual plans to take periodic distributions over time. 

Withholding Tax Considerations

The tax treatment of distributions from RRSPs/RRIFs/LIRAs/LIFs depends on the individual’s tax residency status. Canadian withholding tax rates for Canadian residents range from 10% to 30%, but if someone becomes a U.S. tax resident or non-resident of Canada, the Canadian withholding tax rate is automatically 25%. However, the Canada-U.S. Tax Treaty allows for reduced withholding rates of 15% for periodic distributions from RRIFs under specific guidelines. The Canadian non-resident withholding tax (Part XIII) on lump sum distributions from RRSPs/RRIFs/LIRAs/LIFs remains at 25%. Canadian Part XIII taxes are a final tax liability to Canada. Taking a distribution from RRSPs/RRIFs/LIRAs/LIFs with Part XIII tax withheld does not necessitate a Canadian tax return filing. The taxes paid to Canada will be available as foreign tax credits to reduce taxes payable to the U.S.

Non-Resident Canadian Income Tax Return

In certain cases, former Canadian residents might benefit from filing a Canadian income tax return as a non-resident under Section 217 of the Canadian Income Tax Act. Doing so enables non-residents of Canada to claim deductions and credits similar to those available to Canadian residents, thereby optimizing tax efficiency.

State Tax Implications

It’s essential to consider that some U.S. states, such as California, may tax annual income and realized capital gains within RRSPs/RRIFs/LIRAs/LIFs, irrespective of distributions. This is because some states do not adhere to the Canada-U.S. Tax Treaty, so the Article XVIII(7) Election does not apply at the state level. These potential implications should factor into your overall tax planning strategy.

Conclusion

Navigating the complexities of cross-border financial and tax matters requires a deep understanding of both Canadian and U.S. tax laws. If you’re a Canadian moving to the U.S. and wish to maintain your RRSPs/RRIFs/LIRAs/LIFs, it’s crucial that you work with experienced professionals who can help you develop a comprehensive tax plan tailored to your individual circumstances. Keep in mind that tax laws can change, so it is vital that you stay informed and seek consistent professional advice to ensure your financial health in both countries. Please see our blog titled Income Tax Implications of RRSP Withdrawals as a Non-Resident of Canada for more information, and contact Cardinal Point should you have any questions. 

If you are starting a new business you should be aware that there are numerous business structures available, and the most appropriate one will depend on your specific industry, situation, and objectives. Below is an overview of common business structures in Canada, excluding trusts, which are not commonly used for active businesses in Canada but are used in overall tax planning.

Sole Proprietors

Sole proprietors conduct business personally, reporting the business income on their personal tax returns. To deduct business expenses the taxpayer must have been doing business during the timeframe when the expenses were incurred. The Canada Revenue Agency considers that a business has begun once significant activity related to earning income starts, or other normal business operations commence.

Advantages:

1. Minimal startup costs – all that’s required is a separate bank account and business number.
2. Ability to deduct business losses against personal income for tax purposes, reducing your tax burden.
3. No costs for withdrawing business funds, as there is limited separation between business and personal finances.  While it is important to collect all business revenues in your business accounts and to pay your business expenses from those accounts, at the end of the day, all you need to do is to transfer available profits to your personal account.  You are encouraged to pay personal expenses from your personal accounts and not from your business accounts.

Disadvantages:

1. Personal responsibility for all business debts and liabilities. This means that if the business fails and creditors are owed, the taxpayer’s personal assets could be taken.
2. If the business is profitable, the taxpayer may pay a much higher tax than if the business was structured as a corporation. The highest federal personal tax rate for 2023 is 33% vs. the highest federal corporate rate of 15% (provincial/territorial taxes also need to be= factored in).
3. The business ceases to exist upon the taxpayer’s death.

Partnership

A partnership is a business relationship between individuals engaged in a common profit-oriented enterprise. Determining partnership status may require adhering to relevant provincial laws.

Advantages:

1. Income earned in a partnership flows through to each of the partners, based on their partnership percentage.
2. Losses incurred by the partnership flow out to the partners, and can be claimed for immediate tax savings.
3. Limited liability partnerships offer liability protection to their partners, based on the amount they each contribute to the partnership.

Disadvantages:

1. If the partnership is a limited liability partnership, losses are restricted based on the at-risk rules.
2. If the partnership is a general partnership, there is no limited liability for each partner. Partners are all responsible for each other’s actions and liabilities.
3. If certain criteria are met, a partnership must annually file a T5013 – Partnership Information Return.
4. The partnership ceases to exist upon the death of its partners or when it is deliberately and legally dissolved.

Corporation

Incorporation of a business creates a legal entity which most governments (including Canada and the U.S.) empower with legal rights similar to many that citizens have. It also designates persons or officers with the responsibility for assuming certain legal duties and decision-making capabilities on behalf of the corporation. Canada, but is not always the most efficient, especially for U.S. persons living or operating in Canada.

Most corporations utilize the issuance of both shares and debt for capitalization, but all corporations must authorize and issue shares. The appropriate share capital structure will be dependent on the shareholder’s income tax and other non-business objectives. The legal presumption is that all shares are equal with respect to votes, participation in assets, and profits of the corporation. That is why assigning shares specific rights and restrictions in the articles of incorporation is an important step to achieve the taxpayer’s objectives for the corporation. The amount that the shareholder invests in the share capital of the corporation can generally be returned to the shareholder tax-free, which is why the concept of paid-up capital is so important for tax purposes.

Among the many advantages of incorporation are these:

1. Since a corporation is a separate legal entity, there is limited liability for the shareholders. They are not personally liable for the debt of the corporation and can only lose what they invest in the corporation. However, the Canadian Business Corporations Act (CBCA) places a number of obligations on corporate directors, who can be held liable for certain acts or failures to act.
2. A corporation will continue to exist even if every shareholder and director dies. Its shares would simply be transferred to the shareholders’ estate or heirs.
3. A corporation has a greater ability to obtain financing and capital than an individual does. Corporations can issue shares or bonds and can often borrow money at lower rates, since financial institutions typically view loans to corporations as less risky than loans to individuals.
4. A corporation has lower tax rates than any of the other business structures, especially if it is eligible for the small business deduction. This allows the corporation to defer taxes by leaving the income it earns within the corporation, where it’s taxed at lower tax rates than it would be if were transferred to an individual or individuals – who are usually taxed at higher rates.
5. Corporations qualify for numerous tax incentives that other business structures are not eligible for, such as:
   1. Small Business Deduction: The federal tax rate is 9% on active business income earned within a Canadian-controlled private corporation making $500,000. By contrast, the personal federal tax rate (as of 2023) increases to 33% after $235,675 of taxable income − and provincial/territorial rates must also be factored in.
   2. Income splitting: A corporation allows income splitting between family members, subject to Tax on Split Income (TOSI) and “kiddie tax” rules. This is typically done by having the family members invest and become shareholders of the corporation, and by paying them dividends − or salaries if they legitimately work in the business.
   3. Investment tax credits: A corporation can qualify for various investment tax credits such as those for scientific research and experimental development.
   4. Capital Gains Exemption: If the shares of a corporation qualify, each shareholder is entitled to a $971,190 (2023) deduction on capital gains on the sale of the corporation’s shares. See our blog on the Capital Gains Exemption for more details.

Some disadvantages of incorporation are:

1. There is double taxation when a shareholder withdraws funds from the corporation. The profits are taxed at the corporate level and then subject to personal income tax at the shareholder level when a dividend is paid.
2. The start-up costs for a corporation are higher compared to any other business structure. A lawyer needs to create articles of incorporation, register the corporation, and authorize and issue shares. There will likely be continuing legal and accounting fees.
3. When a corporation first begins operations, it may generate losses for a significant period of time. These losses are trapped within the corporation until the business starts generating income, at which point the losses may be used to offset taxes on corporate profits.

Although this article focused on some of the most common business structures in Canada, as a cross-border wealth management firm we recognize that some of these structures may have limitations from a cross-border perspective. Each person and each business has unique needs and circumstances.  To review your own specific cross-border entity planning considerations, please contact Cardinal Point and take advantage of our depth of knowledge and experience in these areas.