Leaving Canada: Understanding Canadian Departure Tax Implications

In Part 1 of this series, I discussed how Canadian tax residency is determined based on residential ties, the 183 day deemed resident rule and tax treaty tiebreaker rules.

Once an individual ceases to be a Canadian tax resident, the next question is:

“What are the Canadian tax implications of leaving?”

Leaving Canada can trigger several important tax and reporting requirements. These may include reporting worldwide income up to the date of departure, disclosing certain assets and paying tax on unrealized gains under Canada’s departure tax rules.

This article provides a general overview of the Canadian departure return, departure tax and the related disclosure requirements.

1. What Is Departure Tax?

When an individual ceases to be a Canadian tax resident, Canada generally treats the individual as having sold their assets (with exceptions) at their fair market value and immediately reacquired those properties for the same amount.

This deemed disposition can create a capital gain even though the individual did not actually sell the property and did not receive any cash. The resulting capital gains and losses are generally reported on the individual’s Canadian tax return for the year of departure.

The general purpose of departure tax is to tax the appreciation that arose while the individual was a Canadian tax resident before the individual and the property leave the Canadian tax system.

2. Which Assets Are Generally Subject to Departure Tax?

Departure tax applies broadly to many types of assets.

Common examples include:

• Investments (e.g. stocks, mutual funds, cryptocurrencies, bonds, etc.) held outside registered accounts;

• Real estates located outside of Canada;

• Interests in private corporations and partnerships; and

• Valuable artworks, jewellery and collectibles.

The treatment of private company shares can be particularly significant. Determining their fair market value may require the involvement of a professional business valuator. Furthermore, being subject to the departure tax does not mean that the shareholder can extract funds from the company tax-free after departure. We’ll discuss some of the tax planning strategies involving private company shares in the following article.

Foreign real estate and other assets without a readily available market price may also require a professional valuation.

Taxpayers should retain documents supporting both the adjusted cost base and the fair market value of each property. Without proper documentation, it may be difficult to support the departure tax calculation if the return is later reviewed by the CRA.

3. Which Assets Are Generally Excluded from Departure Tax?

Some of the assets that are generally excluded from departure taxes include:

• Investments held inside registered accounts (e.g. RRSP, RESP, TFSA);

• Employee Pension Plans;

• Real estates located in Canada;

• Canadian business assets used to carry on business through a permanent establishment in Canada; and

• Assets owned by the taxpayer when they last became a resident of Canada if he or she was a resident of Canada for 5 years or less during 10-year period before their emigration date.

Canadian real property is generally excluded because Canada can typically continue to tax a future sale after the owner becomes a non resident. Nevertheless, the Canadian real properties still needs to be disclosed on Form T1161 with a fair market value at the time of emigration.

Although Canadian real estates are generally not subject to departure tax, there is another rule called ‘change in use’ rule that could nevertheless cause deemed disposition of the real property. This rule generally applies when a property’s use changes either from a personal use property (i.e. used for personal enjoyment) to an income producing property (i.e. rental property) or from income producing property to a personal use property. This rule often applies in the year of departure as individuals decide to rent out their primary residence once it is no longer being used by them.

4. What Is a Canadian Departure Return?

There is no separate income tax return called a departure tax return.

Instead, an individual generally files a regular Canadian Personal Tax Return for the year in which Canadian residency ends like they do for any other prior years. On this tax return however, the Taxpayer would provide additional disclosures such as the date of departure and submit Form T1161 and T1243 if applicable (see more details below).

The individual generally reports worldwide income earned from January 1 up to and including the departure date as they do for any other prior year.

After the departure date, the individual would generally not include any income earned thereafter on his or her Canadian Personal Tax Return unless they were employed or carried on business in Canada or disposed of taxable Canadian property after the departure date.

5. Forms T1161 and T1243

Form T1161 is generally required to be submitted as part of the departure tax return where the total fair market value of the individual’s reportable properties exceeds $25,000 on the departure date. It provides the CRA with a list of the relevant properties and their fair market values. Certain assets, including cash, bank deposits, registered plans and lower value personal use property, are generally excluded.

Form T1243 is used to calculate the capital gains and losses arising from properties that are deemed to be disposed of on the departure date. The resulting amounts are generally reported on Schedule 3 of the departure return.

The two forms serve different purposes. Form T1161 is primarily an asset disclosure form, while Form T1243 calculates the gains and losses subject to departure tax.

Form T1161 (if applicable) must be filed by the applicable tax return deadline. Late filing can result in a penalty of $25 per day, subject to a minimum of $100 and a maximum of $2,500.

6. Notifying the CRA and Canadian Payers

Individuals leaving Canada should notify the CRA, Service Canada, banks, investment brokers, pension administrators, RRSP or RRIF issuers and other Canadian payers that they have become non residents.

This helps ensure that benefits and credits for which the individual is no longer eligible are stopped.

Furthermore, various Canadian-sourced incomes are subject to a separate Canadian tax regime – Part XIII Non-resident withholding tax once the individual becomes a non-resident of Canada and notifying the relevant payer of these income allows the right amount of withholding tax to be withheld by the payer. Incomes that are subject to such withholding tax includes dividends, rents, RRSP withdrawals, CPP benefits and more.

Where a payer continues treating the individual as a Canadian resident and fails to withhold the appropriate tax, the individual may need to contact the CRA separately and request that the applicable Part XIII tax be calculated and assessed.

7. Ongoing Canadian Tax Obligations

An individual may continue to have Canadian tax obligations after becoming a non resident.

For example, a non resident who continues to own Canadian rental property may be subject to withholding tax on gross rent and may choose to file a Section 216 return to calculate tax on net rental income.

A non resident who later sells Canadian real property would also have section 116 notification and Canadian tax return filing obligations.

Final Thoughts

Leaving Canada is not simply a change of address for tax purposes. It represents a transition from Canada’s resident tax system, which generally taxes worldwide income, to the rules that apply to non residents receiving Canadian source income.

In practice, many post departure problems arise because the administrative steps were not completed when the individual left Canada. The CRA, Service Canada, banks, investment brokers and pension administrators may not have been notified, resulting in benefit overpayments, incorrect tax slips or a failure to withhold the required non resident tax.

Other issues may arise because assets were not valued at the time of departure, departure tax forms were missed or the tax consequences of renting out a former principal residence were not considered.

Departing Canada is a significant life event that should be accompanied by careful tax planning. A review before departure can help identify valuation requirements, reporting obligations, available elections and the Canadian tax rules that will continue to apply after the individual becomes a non resident.

In the next article, I will discuss a few strategies that may be available to address departure tax, depending on the individual’s assets and circumstances.

Warm regards, 

Francis Do, CPA, CA

Have any questions? Please contact Francis Do at Francis@francisdo.com or 416-572-9633.

Disclaimer: This article is not intended to be a tax advice. Always consult and verify with a tax professional.