Avoiding Penalties in Canadian Expat Tax Filing

While servicing Canadian expatriates, my colleagues and I have come across various similar situations that pose a problem when a taxpayer either does nothing with respect to their departure year tax filings or files incorrectly. A common example occurs when a taxpayer is seen as a non-resident of Canada for tax purposes, either because he has limited ties or is deemed to be a non-resident of Canada under a tax treaty with another country.

Assume the taxpayer owns a home at the time of leaving Canada and rents the home to an unrelated person(s) at market value before leaving Canada. Also assume the taxpayer does not file a tax return for the year of departure, or files a regular T1 General tax return, because he is not aware of the filing requirements. What has the taxpayer done wrong?

The purpose of this article is to outline, without going through all of the detailed mechanics, what filing requirements the taxpayer has, and the penalties for non-compliance, that the Canada Revenue Agency (CRA) will likely charge the taxpayer.

Typically, filing a tax return late is not an issue if the taxpayer is in a tax refund position, since the late filing penalty is based on the tax owing at April 30 of the year following the year of departure. However, penalties can still arise in the case of an individual becoming a non-resident, since there are various additional forms and disclosures that are required to be filed by April 30 that carry separate late filing penalties not related to the tax owing on the taxpayer's return. The application of penalties by the CRA for non-compliance can be strict.

Disclosure of Property

Form T1161 – List of Properties by an Emigrant of Canada is a disclosure form that is required to accompany a part-year departure tax filing for the tax year an individual emigrates, if the fair market value of all properties the taxpayer owned when the individual left Canada was more than $25,000, except for certain assets that are excluded. An asset such as a family home is included in the list, and it is likely that the value is, in all cases, greater than $25,000. By not filing this form by April 30 of the year following the year of departure, the penalty accrues at $25 per day to a maximum of $2,500. This means that a married couple that has joint ownership in a property could be looking at a penalty of $2,500 each for simply not complying with this disclosure form.

Non-Resident Withholding Tax

Non-resident withholding tax on gross rental income earned from the property is required to be remitted by the 15th of the month following the month of rental. The other option is to file an NR6 – Undertaking to File an Income Tax Return by a Non-Resident Receiving Rent from Real Property every year, preferably before the first rental payment is received, in order to remit withholding tax on a net income basis (revenues less expenses). If the taxpayer was not aware of the withholding requirements and did not remit the withholding tax, either on a gross basis or a net basis by the due date, the CRA could assess as a penalty, an amount as high as the full 25% of the gross rent of the property.

Section 216 Non-Resident Rental Return

If the taxpayer withholds tax on a gross income basis, she has two years from the end of the year in which the rental income was paid to file a non-resident rental tax return (i.e., an s.216 return). If an NR6 is properly filed, she has until June 30 of the year following the year of rental to file the non-resident rental tax return. If she files after June 30, the penalty can be as high as 25% of the gross rental income of the property. By filing the NR6, the taxpayer is electing to file the s.216 return on time and if not, the penalty is severe.

Section 45(2) Election

The 45(2) election is an optional election that a taxpayer can file, which prevents a personal property from being considered deemed disposed of at the time the taxpayer begins to rent the property, and deemed disposed of again at the time the taxpayer reoccupies the property. Whether a 45(2) election should be filed or not is beyond the scope of this article. However, if the 45(2) election is not filed by April 30 of the year following the year of change in use to a rental property, it can be late-filed subject to the CRA's discretion, and a penalty of $100 per completed month that the election is not filed, up to a maximum of $8,000. Many taxpayers are shocked to find that, when they return to Canada to reoccupy the property, there is a deemed disposition and tax on a home they have not sold. In certain situations, the 45(2) election may be a benefit, but the benefit would have to be weighed against the $8,000 maximum penalty.

T1135

Form T1135 – Foreign Income Verification Statement must be filed by Canadian residents or departing individuals who own certain property outside Canada, with a total cost amount of more than C$100,000, at any time during the tax year. By not filing this form by April 30 of the following year, the penalty accrues at $25 per day to a maximum of $2,500. This means that a married couple that has joint ownership in a property could be looking at a penalty of $2,500 each for not complying.

Voluntary Disclosure Program

As part of Canada's pledge for tax fairness, the tax legislation provides the CRA with the ability to assess late filings on a discretionary basis without penalty under the Voluntary Disclosure Program. Therefore, if you have not been fully compliant with your Canadian filing requirements, you may in many cases still have the option of voluntarily submitting your outstanding filings with the CRA without penalty. Certain criteria must be met in order to qualify for this program, and the CRA will have the discretion to determine whether the late filings meet them. However, interest charges may still apply.

These are some of the more common tax filings that are required when an individual leaves Canada and becomes a non-resident. If a taxpayer finds himself in a situation like the one described above, he should try to take action before the April 30 filing deadline. If the April 30 deadline has passed, the taxpayer should contact a qualified accountant to determine if the CRA's voluntary disclosure process should be initiated. Professional advice should be sought before acting on any information provided in this article.

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