A Planning Challenge: The US Beneficiary

1. A Planning Challenge: The US Beneficiary Prepared for the Vancouver Estate Planning Council - October 26, 2004 Benita Loughlin – KPMG LLP Elaine E. Reynolds – Legacy Tax & Trust Lawyers

2. Assumptions • Canadian Resident Personal Trust – Inter-vivos or Testamentary • Canadian Settlor • US Resident Beneficiary

3. Canadian Distribution Rules • Income versus Capital • Income – tax law vs. trust law • Capital for trust law – capital gains, redemption proceeds, stock dividends • Distributions of income taxable in Canada • Distributions of capital not taxable in Canada

4. Withholding under the Income Tax Act • Part XIII withholding at 25% on income distributions from estate or trust to non-resident • No withholding on capital distributions from estate or trust • Capital dividends paid to non-residents are subject to withholding tax • Only the taxable portion of capital gains allocated to beneficiaries is subject to withholding tax

5. Withholding under Canada-US Tax Treaty • Canada-US Treaty deals with trust withholding in Article XXII – Other Income • Canadian source income distributed to US resident beneficiary subject to 15% withholding

6. Withholding under Canada-US Tax Treaty • Foreign source income distributed to US resident beneficiary exempt from withholding e.g. dividends from non-Canadian corporation • Effective rate on capital gains 7.5% • Watch Part XII.2 tax

7. Part XII.2 Tax • Applies where one or more non-resident beneficiaries of a Canadian trust receive a distribution of designated income • Designated income includes • taxable capital gains on disposition of TCP • Canadian real property income • income from business carried on in Canada • Flat rate of 36%

8. Part XII.2 Tax • No treaty override • All beneficiaries subject to Part XII.2 tax if trust has non-resident beneficiary and designated income • Not applicable to testamentary trusts, non-resident trusts • Trustee is personally liable for Part XII.2 tax

9. In-Kind Distributions to Non-Resident Beneficiaries • In-kind distributions treated as a deemed disposition at fair market value • Trust may elect to defer payment of tax on gain realized as a result of making a distribution of TCP to a non-resident beneficiary • Trust must post security • Watch out for distributions to avoid 21 year rule

10. US Tax Issues for the Beneficiary • All distributions are taxable • Trustee designations as income or capital are irrelevant • Distributions of accumulated income can result in penalties

11. US Tax Issues for the Beneficiary • Reporting-Form 3520 – due April 15th • Penalty for non-compliance - 35% of distribution • Distributions through intermediaries are still taxed • State tax issues

12. Departure of Canadian Beneficiary to the US • Beneficial interest in Canadian resident trust typically exempt from departure tax • Watch out for anti-avoidance rule that applies to rollover trust where created in contemplation of departure

13. Stock Attribution • US beneficiary of Canadian trust owning shares in Canco • How does stock ownership attribute? • Canco earns passive income • Look through rules apply • Discretionary Trust – facts and circumstances determines percent ownership

14. Stock Attribution • Beneficiary required to pick up pro-rata share of passive income in US even if not paid out • Potential double tax • Beware of US impact of corporate reorganizations

15. US Estate Tax • Terms of trust will dictate inclusion in US taxable Estate • Watch out for general powers of appointment

16. US Estate Tax • On a positive note • Distributions from Estates are subject to less complex US taxation and reporting • Can avoid deemed disposition on in-kind distribution to US beneficiary by distributing to Canadian entity (e.g. NSULC) • Partnerships and NSULCs are useful to avoid the impact of US foreign corporation rules • Proper planning can avoid US estate tax liability for US beneficiary • Planning before a beneficiary departs is helpful

17. Questions?

18. Benita Loughlin KPMG LLP 604-691-3442 benitaloughlin@kpmg.ca www.kpmg.ca Elaine E. Reynolds Legacy Tax & Trust Lawyers 604-269-9446 ereynolds@legacylawyers.com www.legacylawyers.com The information contained herein A Planning Challenge: The US Beneficiary is of a general nature and is not intended to address thecircumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.