Pay at­ten­tion to your for­eign as­sets to avoid tax trou­bles

The Globe and Mail (Alberta Edition) - - GLOBE INVESTOR - JONATHAN CHEVREAU Jonathan Chevreau is founder of the Fi­nan­cial In­de­pen­dence Hub and co-au­thor of Vic­tory Lap Re­tire­ment. He can be reached at jonathan@find­e­pen­dence­

Most high-net-worth in­vestors have ac­cu­mu­lated a good chunk of their wealth in non-reg­is­tered in­vest­ments. Once they max out RRSPs and TFSAs, there’s lit­tle choice but to add in­vest­ments to non-reg­is­tered, tax­able ac­counts.

If you opt to hold the most tax-in­ef­fi­cient as­sets – fixed in­come – in reg­is­tered ac­counts, odds are you’re hold­ing a lot of stocks out­side them. If they’re considered for­eign prop­erty, you need to pay close at­ten­tion to their cost base.

Reg­is­tered re­tire­ment sav­ings plans and tax-free sav­ings ac­counts shield us from a lot of tax, at least in the short term, but what’s less ap­pre­ci­ated is that reg­is­tered plans also shield us from a lot of tax-re­lated, form-filling pa­per­work.

Not so for non-reg­is­tered ac­counts. When you fill out your an­nual tax re­turn, there’s a ques­tion on whether or not you own more than $100,000 of “spec­i­fied for­eign prop­erty” (SFP). If you do and tick “yes” on the ac­com­pa­ny­ing box, you’re on the hook to file a T1135 form. Fail­ure to do so can gen­er­ate penal­ties of $25 a day up to $2,500, plus other pos­si­ble gross neg­li­gence penal­ties, says Frank DiPi­etro, as­sis­tant vice-pres­i­dent, tax and es­tate planning for Macken­zie In­vest­ments.

While a ca­sual read might lead you to think this box re­ferred only to for­eign real es­tate, such as a Florida condo you rent out, or busi­ness as­sets held out­side the Cana­dian bor­der, it’s more all-en­com­pass­ing than that, ex­tend­ing to many of the pub­licly traded in­di­vid­ual for­eign se­cu­ri­ties – in­clud­ing those in the United States – that in­vestors own in their tax­able ac­counts.

Your Cana­dian-based fi­nan­cial in­sti­tu­tion is re­quired to is­sue to both you and the Canada Rev­enue Agency T-3 and T-5 slips record­ing this in­come from se­cu­ri­ties trad­ing on do­mes­tic stock ex­changes. But the CRA also wants to keep tabs on U.S. or for­eign stocks that Cana­di­ans hold in U.S. ac­counts, and for these, do­mes­tic banks are not ob­li­gated to is­sue Cana­dian tax slips, says Brent Soucie, a vice-pres­i­dent at T.E. Wealth and cross-bor­der fi­nan­cial planning ex­pert. The T1135 form is the CRA’s way of keep­ing track of these kinds of for­eign in­vest­ments.

There’s a long list of items considered SFP, in­clud­ing in­di­vid­ual U.S. stocks and Amer­i­can de­posi­tary re­ceipts, but also U.S.-listed ex­change-traded funds and for­eign mu­tual funds.

If you wish to avoid the pa­per­work and not tick off the box on the tax re­turn, your SFP cost base must be less than $100,000 (in Cana­dian funds) – that’s the orig­i­nal cost, not cur­rent mar­ket value. (At re­cent ex­change rates, $100,000 is roughly $79,000 [U.S.].) If at any time in the year a Cana­dian res­i­dent’s SFP cost base rises above this thresh­old, then he or she must file the form, as is the re­quire­ment for Cana­dian cor­po­ra­tions and trusts.

(In­cluded in the list are in­ter­ests in part­ner­ships that hold SFP, for­eign rental prop­er­ties, tan­gi­ble and in­tan­gi­ble prop­er­ties lo­cated out­side Canada, life-in­sur­ance poli­cies is­sued by for­eign cor­po­ra­tions, and even pre­cious me­tals, gold cer­tifi­cates and fu­tures con­tracts held out­side Canada.)

For­tu­nately, SFP does not in­clude for­eign prop­erty held in Cana­di­an­based mu­tual funds or ETFs, so if you find your­self ap­proach­ing the $100,000 limit and don’t wish to ex­ceed it, you may want to put fu­ture for­eign in­vest­ments in Cana­dian-domi­ciled in­vest­ment funds, even if they in turn in­vest out­side the coun­try. Shares of Cana­dian pub­lic cor­po­ra­tions trad­ing on for­eign stock ex­changes are also not considered SFP if held with a Cana­dian bro­ker, Mr. DiPetro says.

Also not considered SFP is for­eign prop­erty held for per­sonal use and en­joy­ment – for ex­am­ple, a U.S. prop­erty that you own and don’t rent out – and for­eign prop­erty held in reg­is­tered plans such as RRSPs, TFSAs, reg­is­tered re­tire­ment in­come funds, locked-in re­tire­ment ac­counts and reg­is­tered ed­u­ca­tion sav­ings plans.

Mr. DiPi­etro says, as of 2013, a re­vised T1135 form re­quired that for each for­eign as­set, in­vestors must name the en­tity hold­ing the SFP, the max­i­mum cost base of the SFP dur­ing the year, and at year end, and any gains or losses gen­er­ated by it.

Things got tougher in 2015 for in­vestors with SFP with a cost base of $250,000 or more at any time in the year. This trig­gers the need to use the de­tailed re­port­ing method. (The first tier – be­tween $100,000 and $250,000 – is the sim­pli­fied re­port­ing method.) Un­der de­tailed re­port­ing, you must pro­vide a more pre­cise break­down of each SFP, in­clud­ing the as­set’s lo­ca­tion.

Mr. Soucie says go­ing from the sim­pli­fied to the de­tailed form cre­ates a lot of ex­tra pa­per­work. “It doesn’t mean any ex­tra tax, but it’s more of a pain.” Lit­tle won­der one bro­ker told me, “The T1135 is get­ting up the noses of a lot of peo­ple.”

All of which in my mind is good rea­son to avoid build­ing up a cost base of more than $100,000 in these se­cu­ri­ties. If you’re one half of a cou­ple with a jointly held in­vest­ment ac­count, it will be $100,000 each, as­sum­ing both have half-own­er­ship of the as­sets.

If this seems over­whelm­ing, you could choose to cease adding to non-reg­is­tered SFP po­si­tions if you’re even close to the bot­tom thresh­old, or sell off a few hold­ings. In­stead, be con­tent with hold­ing for­eign se­cu­ri­ties in reg­is­tered ac­counts, and use Cana­dian-domi­ciled in­vest­ment funds for non-reg­is­tered for­eign ex­po­sure.

What you do may hinge on your views on tax-ef­fi­cient as­set lo­ca­tion. An ad­viser friend of mine holds mostly fixed in­come in his reg­is­tered ac­counts, which forces him to put U.S. stocks in tax­able plans, even though for­eign div­i­dends are taxed like Cana­dian in­ter­est. “So I have no choice but to hold U.S. and for­eign stocks non-reg­is­tered and fill out the form.”

For him, the ex­tra pa­per­work is worth the po­ten­tially en­hanced re­turns. Oth­ers may con­clude it’s not worth the has­sle.

If you wish to avoid the pa­per­work and not tick off the box on the tax re­turn, your [spec­i­fied for­eign prop­erty] cost base must be less than $100,000.

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