Many situations can cause an investor to get exposed to and possibly caught in the tax penalty net:
- diversified portfolios that include foreign holdings
- inheritances from abroad
- immigrants to Canada who have retained foreign assets
- Canadians abroad who acquire foreign assets
There's one key form that investors need to check whether they need to complete and file, the innocuously titled Foreign Income Verification Statement Form T1135. As can be seen below, the form asks mostly about assets though there is a question about total foreign income.
(click on image to enlarge)
Here are some of the basics of the T1135, bearing in mind that we have summarized and the official source of the government pages, mainly the tax collector, the Canada Revenue Agency, contains more complete information. A tax accountant can be extremely useful to interpret and give guidance on "what ifs" and other scenarios not covered. In case of doubt, it is best to get professional advice since the bad consequences of being wrong are so severe.
Who is subject to the T1135?
- individuals corporations, trusts and certain partnerships,
- who is resident of Canada (which is not the same as being a citizen) and thus liable to file a tax return in Canada, keeping in mind that a resident has to declare all world wide income. Potential Gotcha #1 - even if you have no income or foreign income to declare, or your income is too low and you know there will be no income taxes to pay, you might need to file the T1135 by the tax deadline anyway since the criteria is based on assets (see Q1 of this CRA page).
If the "who" above owned during the past tax year:
- specific foreign assets; "foreign" means either where the assets are held, or who issued securities, like stocks and bonds issued by non-Canadian / non-resident companies or governments. Potential Gotcha #2 - what's in and what's out can get tricky - any securities, including Canadian securities, on deposit with a non-Canadian broker are "foreign", as are any non-Canadian securities in a non-registered taxable account, including any that might happen to be traded on the TSX (see this list on TMX Money) but not a share of a Canadian company bought on a foreign stock exchange (there are many traded in the USA per this list on TMX Money)
- total value over $100,000 i.e. the sum of all assets together, not the value of any individual asset, but not counting any excluded property like what is in RRSPs and the like
- value at any time during the past tax year, not as of the filing date, so that an asset that was sold during the year counts towards the calculation
- cost, not the current market value so that investments bought for $80,000 and now worth $120,000 would be exempt
- dollars in Canadian currency, the conversion rate being that in effect on the purchase date or deemed acquisition date, such as when an immigrant becomes resident
- see more situations in the CRA Questions and answers about Form T1135 page
- amounts in foreign bank accounts;
- shares in foreign companies;
- interests in non-resident trusts;
- bonds or debentures issued by foreign governments or foreign companies;
- interests or units in offshore mutual funds;
- real estate situated outside Canada; ... but this is only when it's primary purpose is not for personal use (see exclusion below)
- other income-earning foreign property.
- US Roth IRA (probably, unless the proposed change mentioned here came about to exclude Roth IRAs)
- personal-use property, that is, any property used mainly for personal use and enjoyment, such as a vehicle, vacation property, jewellery, artwork, or any other such property; Potential Gotcha #3 - the vacation property exclusion gets tricky itself as it isn't cut and dried when a property is rented out part of the time to make a profit but is also mainly for personal use (see this answer in the CRA Q&A)
- assets used only in an active business, such as a business inventory or the equipment and building used in a business
- RRSP and other registered account - LIRA, LRIF, LIF, RESP, TFSA, RPP - holdings; though the CRA Q&A specifically mentions only RRSPs, the other types of accounts also presumably qualify for exclusion (which makes us wonder why the CRA would not want to be more completely explicit to avoid a lot of uncertainty amongst taxpayers); this provision lets out many if not most taxpayers from having to file the T1135
- Canadian mutual funds or ETFs that hold foreign stocks and bonds - a US resident ETF like ISHARES CORE S&P 500 ETF (NYSE symbol: IVV) is a foreign asset in a non-registered account but the iShares S&P 500 Index Fund (CAD-Hedged) (TSX: XSP) or the new non-hedged version XUS, both of which actually hold only IVV, would not be considered foreign since they are established in Canada. For more, read MyOwnAdvisor's excellent article on the T1135 with many examples of possible included or excluded assets.
- US Individual Retirement Accounts (IRA) and 401k
For not filing, or filing late, the penalties are severe per this CRA webpage, whether or not any foreign tax is owing or undeclared: $25 per day, up to $2500 per year, repeated for each year filing is missed, even when it is an innocent mistake (e.g. when all foreign income has been declared and tax paid!) is very harsh, as accountant The Blunt Bean Counter noted.
The CRA is unforgiving, as shown by the comments and laments on the T1135 Financial Webring thread, on this BritishExpats.com discussion, by this Advisor.ca post by Jamie Golombek on T1135-sparked court cases and another on a specific case where an honest first-time mistake did not escape the penalty. One lucky taxpayer did successfully fight the penalty but this more the exception than the rule. Potential Gotcha #4 - the fact that all foreign income has been declared and taxes paid does not excuse the necessity of declaring foreign assets and filing the T1135.
What to do?
- when in doubt, file the T1135; it seems that there are no penalties for sending it in even if it turns out not to be required; at worst the CRA may ask for more details on assets that aren't an issue. The CRA fillable and savable T1135 pdf is here ; incorporated instructions include the mailing address. Potential Gotcha #5 - right now the only way to file this form is by printing it out and mailing it in. The CRA's nifty electronic NetFile service does not include the T1135, though the CRA says it is working on making the T1135 electronically filable. Most of the NetFile certified software packages to prepare taxes aren't clear enough about the mailing requirement.
- buy Canadian-based mutual funds and ETFs in a non-registered account. This won't avoid the necessity of reporting for the past but it can avoid future hassles. As we noted above, such investments are not considered foreign property by the T1135 and there are plenty of fund alternatives for the main foreign asset classes. Though expense ratios are almost always higher than for US-based funds, owning a Canadian-dollar sold fund also avoids the cost and trouble of currency exchange and possible exposure to US estate tax.
With the April 30th deadline only a few days away, there's still time to comply and avoid unnecessary problems, even if your tax return has already been submitted. Figure out where you stand and take action.
Disclaimer: this post is my opinion only and should not be construed as investment or tax advice. This topic in particular can be complicated and it can have severe unwelcome consequences. The commentary rests on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.