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tax matters

Last week I introduced James and Kate – friends who will be moving to the United States in the new year. I reminded James that the U.S. can be a strange place with some crazy laws.

If you believe what you'll find on the Internet, it's illegal for chickens to cross the road (Quitman, Ga.), police officers are allowed to bite a dog if they think it will calm the dog down (Paulding, Ohio), it's against the law to sing off-key (North Carolina), and you're not allowed to eat fried chicken other than by using your hands (Gainesville, Ga.). The good news? James and Kate are moving to California – which is not on the list.

Nevertheless, James and Kate are moving. Last week, I spoke about how they should handle their registered retirement savings plans, tax-free savings accounts and registered education savings plan before leaving. Today, I want to share another idea for them to consider.

The facts

James and Kate are leaving for the U.S. because James has accepted a job offer south of the border. It wasn't an easy decision for them because Kate has a successful business here. She owns a retail store that sells jewellery and accessories. James will be heading to Texas the first week of January, while Kate is staying behind to complete the sale of her business and the sale of their home. She's expecting to join James in the U.S. three or four months after he moves.

The fact is, leaving Canada can give rise to an ugly tax hit because Canada imposes a "departure tax" on those who give up residency. Specifically, those giving up residency are deemed to have sold, at fair market value, most assets when they leave. This can give rise to tax on capital gains when those assets have appreciated in value. So, James and Kate could pay tax when they move to the U.S. There's a strategy that James and Kate are planning to use to reduce this tax hit.

The idea

James currently owns shares worth $400,000. His adjusted cost base (ACB) is just $220,000, so there's an accrued capital gain on the shares of $180,000. If James fails to do any planning, he'll trigger the $180,000 capital gain upon his departure from Canada and will face tax of about $44,500 since he's in the highest tax bracket in Ontario.

Here's what James plans to do: This month, prior to leaving Canada, he is going to transfer to Kate all of his shares. There will be no tax consequences when he does this because our tax law allows transfers between spouses to take place at cost, so that no capital gains are triggered. Now, when James leaves Canada, he won't face the departure tax on the shares he owned because they will be owned by Kate at the time of his departure.

When Kate leaves Canada, she'll face tax on the $180,000 capital gain due to the departure tax. The good news? She's in a much lower tax bracket than James, and will pay about $21,700 in taxes at that time. They will have saved about $22,800 in taxes – more than half of what James would have paid.

Normally, the attribution rules in our tax law would kick in and require Kate's capital gain to be attributed back to James to face tax in his hands, but not in this case since James will no longer be a resident of Canada.

The nuances

You should be aware that, normally, the taxman will consider two spouses to have given up residency in Canada at the same time when departing. If the taxman were to take this approach with James and Kate, they may not be able to transfer the departure tax bill to Kate as they did in my example above. So, James and Kate are building an argument that they are giving up residency at different times. And they have a good case because Kate has a valid reason for staying behind. She has to stay back to wrap up the sale of her business and their home.

Giving up residency in Canada is not as easy as simply leaving the country. While our tax law doesn't define the term "resident," there are court decisions and government publications (particularly Income Tax Folio S5-F1-C1, available at cra.gc.ca) that provide guidelines as to who will be considered resident here. There are primary and secondary residential ties that the taxman will look at to determine where you are resident. It's important to visit a tax pro to talk over a departure, and to properly plan to minimize taxes before you leave.

Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.