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Special Rules In The Canada-US Tax Treaty Apply To Cross-Border Death Tax Issues



Canada and the United States have very different regimes for imposing taxes on death. The United States imposes a Federal Estate Tax; however, Canada has not imposed any Estate Tax since 1971. Rather, Canada taxes accrued, but unrealized, capital gains on death, as part of its income tax system.

Most tax practitioners are not aware of the fact that there special rules found in Article XXIX-B of the Canada-United Tax Convention (“the Treaty”) that are aimed at providing relief in connection with certain cross-border death taxes issues.

Some of these are summarized below:

ENHANCED ESTATE TAX UNIFIED CREDIT FOR CANADIAN RESIDENTS-Article XXIX-B(2)

Normally, under the Internal Revenue Code, the estates of non-resident aliens are only entitled to a very small unified credit ($13,000), which is intended to equate to an estate of only $60,000.

This article allows estates of Canadian residents to have the potential to have a significantly enhanced credit. The credit allowed is the greater of:

(a) The credit that would be allowed to a U.S. citizen, multiplied by the value of the part of the deceased’s gross estate that is situated in the United States divided the value of the deceased’s entire estate.

(b) The credit that would otherwise be allowed to the estate of a non-resident alien.

SPOUSAL ROLLOVER ON THE DEATH OF U.S. RESIDENTS-Article XXIX-B(5)

Under subsection 70(5) of the Income Tax Act (“the Act”), the property that an individual owns at the time of his or her death is generally deemed to be disposed of by the deceased, immediately before death, at fair market value.
If the deceased was a non-resident of Canada, and if the property is “taxable Canadian property”(“TCP”) such as Canadian real estate, this can have the effect of levying tax at that time on accrued capital gains.

On the death of a Canadian residents, if the property passes to a Canadian resident spouse, or a “spousal trust”, a “spousal rollover” is allowed under subsection 70(6) of the Act. That is, the property is deemed to have been disposed of for proceeds equal to the deceased’s tax basis, and acquired by the surviving spouse or trust for that same amount. Thus, the recognition of any gain is deferred until the death of the surviving spouse.

This provision allows the “spousal rollover” to apply on the death of a U.S. resident.

FOREIGN TAX CREDIT IN CANADA FOR U.S. ESTATE TAX-Article XXIX-B(6)

If a Canadian resident dies owning property situated in the U.S., his or her estate could be subject to tax both in Canada and the U.S.-in Canada for income tax applicable to a deemed capital gain; in the U.S. for Estate Tax.
Since the U.S. Estate tax is not an income tax, Canada would not normally grant a foreign tax credit.

However, by means of a complex formula contained in this provision, all or a portion of the U.S. Estate Tax may effectively be applied as a credit against the Canadian tax.

CREDIT AGAINST U.S. ESTATE TAX FOR CANADIAN TAX-Article XXIX-B(7)

If a U.S resident dies owning TCP, his or her estate could be subject to tax both in Canada and the U.S.-in Canada for income tax applicable to a deemed capital gain; in the U.S. for Estate Tax.

In addition, if a U.S citizen is resident in Canada, a similar result could be applicable to all property owned-not just TCP.

This provision will allow Canadian (both federal and provincial) tax payable as a result of death in connection with property situated outside of U.S. to be credited against U.S. Estate Tax. In the absence of that provision, the Canadian tax would only be allowed as a deduction in computing the value of the estate, for the liability for that tax.

In accordance with Circular 230 Disclosure

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Mr. Atlas is a Toronto-based Chartered Accountant who practices as an independent consultant on a wide-range of international and domestic tax issues. Most of his practice consists of advising accounting and law firms on high-level tax issues. Prior to forming an independent tax practice in 1991, was Partner in charge of tax practice of major independent accounting firm in Toronto. Advises clients worldwide. Author of leading book, Canadian Taxation of Non-Residents, considered one of the few Canadian tax professionals, outside of the big accounting and law firms, who is an expert on high-level international tax matters.