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Section 119: Flawed Relief from Departure Tax
Section 119 is designed to provide relief from double taxation when an
individual emigrates from Canada. Absent such a provision, an individual
might be subject to tax under both part I and part XIII of the Act.
Because relief does not exist in all situations, care should be taken
when one is analyzing a departure situation.
When an individual emigrates from Canada, subsection 128.1(4) deems him
or her to have disposed of certain property for proceeds equal to its
FMV at the time; any accrued gains are therefore subject to tax under
part I on departure. The taxpayer is then deemed to have reacquired the
property at this FMV.
Dividends paid to a non-resident are subject to withholding tax under
part XIII. Thus, any accrued gain on shares that is taxed at departure
may be taxed again when the inherent gain is distributed in the form of
dividends. This situation gives rise to the double taxation problem.
The dividend could cause a decline in the value of the shares, and thus a
loss might be realized on sale. If the loss were to be recognized for
tax purposes and allowed to be carried back to the year of departure,
part I tax would be eliminated and the double taxation problem would be
solved. (Pursuant to subsection 128.1(8), the carryback period for
non-resident individuals disposing of taxable Canadian property [TCP] is
not limited to the usual three years.) However, subsection 40(3.7)
reduces a non-resident’s loss from the disposition of property if
taxable dividends are received. Thus, double taxation relief is still
needed.
Such relief is provided by section 119, which applies to the withholding
tax on dividends subject to the stop-loss rules in subsection 40(3.7)
and provides a credit against tax payable in the year of departure. In
order to claim this credit, the taxpayer must file an amended departure
return to reflect the reduced tax payable. To understand how this
process works, assume that Ms. A owns shares of Canco with a nominal ACB
and an FMV of $100. Upon emigration, she recognizes the gain of $100
and pays tax of $25 under part I. The ACB of the shares is increased to
$100. Post-departure, Ms. A receives $50 of dividends and pays
withholding tax of $10. If she subsequently disposes of the shares for
$50, she will recognize a loss of $50, which will be reduced to nil
pursuant to subsection 40(3.7). In this situation, Ms. A has an economic
gain of $50 that is taxed under both part I and part XIII. By applying
section 119, she will receive a deduction, in computing tax payable,
equal to the lesser of the part I departure tax of $25 and the part XIII
withholding tax of $10. In other words, section 119 allows a deduction
equal to the relevant part XIII tax paid, up to the amount of part I tax
paid at departure.
Section 119 is a federal credit and has no counterpart at the provincial
level. Because no withholding tax is levied by the province, there is
no need for a credit to provide relief.
There are two flaws in the section 119 double taxation relief:
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For section 119 to apply, the property deemed disposed of under
subsection 128.1(4) must be TCP. Historically, the definition of TCP
included most private corporation shares, partnership units, and trust
units. However, the definition was amended in 2010 to include only those
properties that derive 50 percent or more of their value from real
property situated in Canada (and certain other Canadian property).
Although this amendment was intended to lighten section 116 compliance
obligations, the narrower definition restricts the taxpayer’s ability to
claim a section 119 deduction if the property disposed of is not TCP.
Accordingly, double taxation may still occur.
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The section 119 deduction becomes available only when the
property is ultimately disposed of, so the double taxation relief is
delayed. One solution is to elect under subsection 220(4.5) to post
security to the CRA and defer payment of departure tax until
disposition.
Henry Shew
Cadesky Tax, Toronto
hshew@cadesky.com
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