Do Canadians pay tax on an inheritance from abroad, overseas, our outside of Canada? This article will answer this question in detail, and provide a summary of inheritance tax in Canada.
Estate of Deceased Person outside Canada
When a person dies an estate, which is a type of trust, is automatically formed. The estate owns the assets of the deceased person. Over time, these assets are distributed to the beneficiaries of the estate, as per the instructions contained in the will of the deceased person.
In order to learn about the taxation of foreign inheritances received by Canadians, you must first understand the tax treatment of trusts as discussed below.
Canadian Taxation of Foreign Estates (Trusts)
In many instances, the estate of a deceased person earns and accumulates income from property before the property of the trust is actually paid or distributed to family members of the deceased. How is this income taxed? Well, the taxation of foreign trusts / estates in Canada is based on the residency of the trust:
- Resident trusts will be subject to Canadian income tax on worldwide income.
- Non-resident trusts (NRTs) are not taxable in Canada.
However, under Section 94(3) of the Canadian Income Tax Act, NRTs may be deemed to be resident in Canada under certain circumstances. This is very important, because a NRT (or foreign estate) that is deemed to be a resident of Canada must pay Canadian income tax on its worldwide income.
Recently, the Supreme Court of Canada held that a trust is resident where the central management and control of the trust takes place. This is generally determined based on the location of the trust’s executors and/or the legal representative in charge of making decisions on behalf of the executors. [Executors of a trust are often family members who are responsible for disbursing the estate’s assets in accordance with the will of the deceased person.]
A foreign estate will be considered a NRT for Canadian tax purposes if:
- The majority of the executors are located outside Canada or
- If the lawyer responsible for managing the estate is abroad.
If one of the above two scenarios apply to a foreign estate, then the estate will not be subject to Canadian income tax on its earnings.
The following documents should be reviewed to assess the residency status of an estate:
- Letter of administration to identify executors of the Estate,
- Locations of the executors and/or decision makers of the Estate,
- Any other documents that clarify the residency of the Estate.
An estate tax accountant should be always consulted to determine if the foreign estate of your deceased relative is taxable in Canada.
Tax on Foreign Inheritance in Canada
How the trust distributions (i.e. inheritance from the foreign estate) are taxed in Canada depends on whether the income earned by the estate is taxed at the trust level or in the hands of the beneficiaries (who are usually the family of the deceased person).
If the estate’s income is taxed at the trust level, then the foreign inheritance received by Canadian relatives of the deceased person will not be taxable in Canada. On the other hand, if the estate’s income ‘flows through’ the estate and is taxed in the hands of the beneficiaries, then the Canadian family members of the deceased person will pay Canadian tax on the foreign inheritance received.
In most cases, the foreign estate of the deceased person is responsible for paying taxes to the foreign country where the foreign estate is located. For example, a Nigerian estate pays tax in Nigeria, so the Canadian family members of the Nigerian estate will not pay inheritance tax in Canada.
To determine whether a foreign estate paid tax in the foreign country, your estate tax accountant should review any trust returns, trust deeds, official executors’ resolutions and the will of the deceased person.
Reporting to Canada Revenue Agency of Foreign Inheritance
Below, I discuss the reporting requirements in Canada of a foreign inheritance.
Foreign Inheritance Received over $10,000
Your financial institution will be required to report to the Canada Revenue Agency (CRA) any foreign fund transfers of $10,000 or more. The CRA may require additional information regarding the source of the monies and how it was earned. In this event, you may have to provide the necessary documents to support the non-residency status of the estate and the tax treatment of estate distributions.
If the distributions from the estate are not taxable in Canada (for the reasons discussed above), then the distributions from the estate do not have to be reported on your T1 personal tax return.
Foreign Income Verification Statement
Since you did not pay anything to become a beneficiary of the foreign estate of your deceased relative, you will not be required to file form T1135, Foreign Income Verification Statement, in respect of your foreign inheritance.
Instead, you will have to file Form T1142 – Information Return in Respect of Distributions from and Indebtedness to a Non-Resident Trust, to report any distributions (i.e. inheritance) received from the foreign estate of your deceased relative. Form T1142 has to be filed when you ultimately receive distributions from the trust. If you receive the foreign inheritance in 2014, you will have to file Form T1142 by April 30, 2015 (when your 2014 personal tax return is due).
Failure to file Form T1142 can result in penalties of up to $2,500 per year.
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.