When an entrepreneur dies owning shares or an interest in a foreign corporation, the executor is faced with a challenging situation. An estate with ownership or an interest in a foreign corporation raises specific and complex tax rules that leave the executor and family members hoping the deceased has a well-organized tax and estate plan in place.
Where to start?
The executor needs to be proactive. First, it needs to be determined whether the estate is dealing with a foreign affiliate or a controlled foreign affiliate:
- A foreign affiliate is a foreign corporation in which the deceased owns an equity percentage of at least 1% and the total equity percentage of the deceased and persons related to the deceased is not less than 10%.
- A controlled foreign affiliate is a foreign corporation in which the taxpayer (and all related persons) owns a sufficient number of shares to have voting control (more than 50%) or the taxpayer, along with four or fewer Canadian resident shareholders, have voting control of the foreign affiliate.
This is relevant because if a taxpayer (including the estate) owns shares in a foreign affiliate or a controlled foreign affiliate at any time during the year, Form T1134 must be filed within ten (10) months after the end of the reporting taxpayer’s taxation year.
Also, when dealing with a controlled foreign affiliate, the executor needs to know whether the income and capital gains of the foreign corporation constitute foreign accrual property income (FAPI) – this tax analysis is complex and requires tax advice.
Penalties for Failure to File Form T1134
Failure to file Form T1134 results in a penalty of twenty-five dollars ($25) per day to a maximum of two thousand five hundred dollars ($2,500). However, if it is deemed that the failure to file was done knowingly or the facts demonstrate gross negligence, additional penalties can apply.
The executor should also confirm that the deceased properly filed the T1134. If there was an omission by the deceased, the executor must seek professional tax advice. There may be a need to rectify previous tax filings of the deceased.
Taxation at death & FAPI
Since 2013, we now have a “part-year” FAPI rule resulting in the requirement to report FAPI up to the date of death. With the tax advisor, the executor must calculate the deceased’s FAPI for the year of death and report it on the final tax return.
Also, determining the adjusted cost base of the shares of the foreign controlled corporation can only be established by reviewing and analyzing the FAPI in previous years. This is relevant when calculating the capital gain or loss of those shares to be reported on the final tax return of the deceased.
Dividend & Tax Treatment
A dividend from a foreign corporation received by an individual or a trust (i.e. the estate) is taxable and the gross-up and dividend tax credit are unavailable. This treatment results in a greater tax liability payable by the individual.
Conclusion
The complexity of the rules governing the taxation of foreign affiliates and controlled foreign affiliates are quite complex. Professional tax and estate advisors must assist both the entrepreneur and the executor in navigating through the complex rules and reporting obligations under the Income Tax Act.
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