May 2013

TaxMatters@EY

A guide to US citizenshipElizabeth (Beth) Nanton, Egan LLP – Vancouver

Given the complexity of US citizenship and nationality law, it’s not surprising that many people have no knowledge of their US citizen status. Such people are often referred to as “accidental Americans” because an individual can obtain US citizenship “accidentally” by birth in the US1, through birth abroad to a US-citizen parent, or as the result of a parent’s naturalization. If the legal requirements for citizenship are met, then a person becomes a US citizen by operation of law, irrespective of their intent.

Below is a brief summary of the current rules regarding acquisition and renunciation of US citizenship.

US citizenship by birth in the United StatesJus soli (the law of the soil) is a common law rule under which a person’s place of birth determines his or her citizenship. The principle of jus soli is embodied in the Fourteenth Amendment to the US Constitution and various US citizenship and nationality statutes, including the Immigration and Nationality Act (INA). Thus, nearly all persons born in the US are endowed with US citizenship. US citizenship may be acquired by a child born in the US even if his or her parents were in the country temporarily or illegally.

There is one exception. INA 301(a) provides that persons born in the US and subject to the jurisdiction thereof acquire US citizenship at birth. Therefore, children born in the US to foreign sovereigns, consuls, diplomats and other people who are not subject to US law are not considered US citizens at birth.

Birth abroadJus sanguinis (the law of the bloodline) is a civil law rule under which a person’s citizenship is determined by the citizenship of one or both parents. The principle is often referred to as “citizenship by descent” or “derivative citizenship.”

TaxMatters@EY is a monthly Canadian bulletin that provides a summary of recent tax news, case developments, publications and more. For more information on any of the items in the newsletter, please contact your Ernst & Young advisor.

In this issue

Facing up to tax risk8

Voluntary Disclosures6

Automobile allowances – driving within the limits4

A guide to US citizenship1

1 For citizenship purposes, the “United States” refers to the continental US, Alaska, Hawaii, Puerto Rico, Guam and the Virgin Islands [INA 101(a)(38)], as well as US ports, harbours, bays and other territorial waters. By virtue of Public Law 94-241, persons born in the Northern Mariana Islands after 4 November 1986 are also considered US citizens.

Refusal to grant rectification results in $11.8-million tax liability

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Jus sanguinis is not embodied in the US Constitution. Citizenship by descent is, however, granted under US statute. The statutory requirements for conferring and retaining derivative citizenship have changed significantly over time. In order to determine whether US citizenship is transmitted in a particular person’s case, you need to look to the laws that were in effect at the time the person was born.

Birth abroad to two US-citizen parents in wedlock

Pursuant to INA 301(c), a person born abroad to two US-citizen parents is deemed to have acquired US citizenship at birth if at least one of the parents resided in the United States or one of its outlying possessions prior to the child’s birth. No specific period of time is required. In this context, a child is considered to be born in wedlock if the child is the genetic issue of a married couple.

Birth abroad to one US-citizen parent in wedlock

A child born abroad in wedlock on or after 14 November 1986 acquires US citizenship if the child has one US-citizen parent who was physically present in the US or one of its outlying possessions for at least five years prior to the child’s birth. At least two of the five years must have accrued after the US -itizen parent reached the age of 14.

Under INA 301(g), a child born abroad in wedlock between 24 December 1952 and 13 November 1986 is deemed a US citizen provided that one US-citizen parent was physically present in the US for a period of at least 10 years prior to the birth of the child. At least five of those years must have accrued after the US-citizen parent reached the age of 14.

Birth abroad of an out-of-wedlock child with a US-citizen mother

Under INA 309(c), a person born abroad out of wedlock is considered a US citizen if the mother was a US citizen at the time of the birth and physically present in the US or one of its outlying possessions for a continuous period of one year prior to the birth

Birth abroad of an out-of-wedlock child with a US-citizen father

Under INA 309(a), a person born abroad out of wedlock with a US-citizen father acquires US citizenship under INA 301(g) provided that the following conditions are met:

• A blood relationship between the person and the US-citizen father is established by clear and convincing evidence

• The father was a US national at the time of the birth

• The father was physically present in the US or its outlying possessions for at least five years prior to the child’s birth, at least two of which were after reaching the age of 14

• The father (unless deceased) has agreed in writing to provide financial support for the person until the person reaches the age of 18

• While the person is under the age of 18:

— The person is legitimated under the law of his or her residence or domicile;

— The father acknowledges paternity in writing under oath; or

— The paternity is established by adjudication of a competent court

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Birth abroad of an out-of-wedlock child with a US-citizen father under the “old” INA 309(a)

The “old” INA 309(a) applies to individuals who were 18 years of age on 14 November 1986, as well as individuals whose paternity was legitimated prior to that date.

People who were between 15 and 17 years of age on 14 November 1986 may elect to have their claim to US citizenship determined in accordance with either the old or the new INA 309(a).

A child born out of wedlock to a US-citizen father is eligible for US citizenship under the former INA 301(a)(7) — as made applicable by the former INA 309(a) — if the following conditions are met:

• Prior to the person’s birth, the father had been physically present in the US or one of its outlying possessions for at least 10 years, five of which were after the age of 14

• The person’s paternity had been legitimated prior to the child reaching the age of 21

Renunciation of US citizenshipOnce an individual acquires US citizenship, it is difficult to lose. The process of renunciation is quite complex and involves many considerations.

A person cannot avoid an outstanding tax liability by formally renouncing US citizenship, as renunciation can typically only occur after all outstanding tax filings and tax debts have been resolved. Moreover, individuals who renounce US citizenship may be subject to expatriation taxes and special reporting requirements upon departure.

It’s important to note that persons who renounce US citizenship will then be subject to US immigration laws and regulations, just like all other non-citizens.

In light of the potential consequences, it is recommended that anyone considering renouncing their US citizenship seek professional advice before taking any action.

If you have any questions concerning US citizenship or renunciation, please consult with a US immigration attorney at Egan LLP, a business immigration boutique firm allied with Ernst & Young in Canada.

For questions relating to the tax implications of US citizenship or renunciation, please contact your Ernst & Young advisor.

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Automobile allowances – driving within the limitsLucie Champagne and Bob Neale, Toronto

Recently, the Canada Revenue Agency (CRA) answered two questions dealing with automobile allowances paid to employees while they’re carrying on employment duties away from the employer’s regular place of business.

While the CRA reconfirmed its views with respect to assessing the reasonability of an allowance paid, it announced a new position in situations where the employee receives an allowance for only a portion of the kilometres travelled.

Background Under the Income Tax Act (the Act), a taxpayer must generally include in employment income all amounts received in the year as an allowance for any purpose, subject to certain exceptions. Specifically, a reasonable automobile allowance received by an employee who used his or her automobile in carrying out employment duties is excluded from the employee’s income provided it is based solely on the number of kilometres travelled in the course of the employer’s business.

The CRA benchmarks what it considers to be a reasonable allowance on the basis of the per-kilometre amounts in Regulation 7306. Other amounts may also be considered reasonable, but these must be supported by facts.

Reasonable allowance In technical interpretation 2012-0454131C6, the CRA reconfirmed that the automobile allowance rates used by the Treasury Board of Canada Secretariat (TBCS) are generally considered to be reasonable for purposes of paragraph 6(1)(b) of the Act. This position was first announced in CRA technical interpretation 2007-0235131E5.

This confirmation is good news for many employees, since the TBCS rates exceed the prescribed rates in Reg. 7306 for certain provinces. For example, for 2013, the per-kilometre TBCS rates for Ontario, Quebec and Newfoundland and Labrador are $0.55, $0.57 and $0.53, respectively, compared to a rate of $0.54/km for the first 5,000 km and $0.48 for any kilometres thereafter in Reg. 7306.

The CRA also confirmed that it has not instructed its auditors to automatically conclude that any allowance in excess of the amounts in Reg. 7306 is unreasonable. It is the CRA’s view that the limits in Reg. 7306 are simply a guideline to assess the reasonableness of an allowance received; it may be reasonable in certain circumstance to use a different amount.

While an employee may receive a higher amount, the employer can only deduct the amount computed in accordance with the Reg. 7306 in computing business income. Consequently, it will be interesting to see whether many employers adopt the TBCS rates.

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New administrative position In CRA technical interpretation 2012-0454141C6, the CRA reversed the administrative position in technical interpretation 2010-0387391E5 with respect to the payment of an automobile allowance that only covers a portion of the kilometres by the employee.

The earlier technical interpretation provided that where an employee receives an automobile allowance for a portion of the eligible kilometres travelled, the total distance travelled could be divided into two trips. For example, if an employee travelled a total of 60 km but only received an allowance for the last 20 km, the employee was considered to have received a reasonable allowance for those 20 km and this allowance was excluded from the employee’s income. The employee could then claim an automobile travel expense deduction under paragraph 8(1)(h.1) of the Act in respect of the first 40 km travelled.

Under the revised administrative position, which became effective on 15 July 2011, it is now the CRA’s view that in such a scenario the allowance received must be included in the employee’s income under paragraph 6(1)(b) of the Act. However, the employee may deduct from his or her income, under paragraph 8(1)(h.1) of the Act, automobile travel expenses in respect of the 60 km travelled.

The CRA’s new position seems to provide a better outcome for taxpayers. Intuitively, providing an allowance for only a portion of the eligible distance travelled raises questions as to whether this allowance is in fact reasonable.

Conclusion Automobile allowances and expenses are arguably one of the most frequently encountered employment benefits. Employers and employees should familiarize themselves with the CRA’s latest comments.

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Voluntary Disclosures Bob Neale, Toronto

The Canada Revenue Agency’s (CRA’s) Voluntary Disclosures Program (VDP) is intended to promote voluntary tax compliance. Under the VDP, individuals may correct inaccurate or incomplete information previously provided to the CRA or disclose information they have not previously provided. Because the CRA does not want individuals to use the VDP as a means of retroactive tax planning, it does not accept late-filed elections through the VDP.

Usually, an individual makes a voluntary disclosure as protection against significant penalties — or, in extreme cases, prosecution — that may result if the errors or omissions are detected by the tax authorities first. The VDP program allows individuals to rectify prior omissions in a manageable way. Indeed, the VDP program is an integral part of any successful self-assessment tax system, allowing citizens to come forward and self-correct information without being exposed to penalties or prosecution.

Where an individual makes a valid disclosure, he or she is liable to the taxes owing and related interest, but is not subject to penalties or prosecution. The CRA has legislative authority to waive or cancel penalties or interest. Based on current legislation, the ability to grant relief is limited to the 10 taxation years before the calendar year in which the submission is filed. For example, an income tax submission made on 1 May 2013 would only be available for the 2003 and subsequent taxation years.

For the disclosure to be valid, the disclosure must:

• Be voluntary

• Be substantially complete

• Involve at least one penalty provision

• Include information that is at least one year overdue or, if the information is less than one year overdue, the disclosure must not be made solely to avoid late-filing or instalment penalties

As implied in the first of these conditions, the submission must be initiated by the individual before the tax authorities have begun any inquiry. If an audit or investigation has already begun, or if the individual is party to a transaction that is under review by the CRA or any other authority or administration, a disclosure is not considered voluntary. With respect to the second condition, it should be noted that documentation may be required in order to verify the information disclosed.

Disclosure processAn individual who wishes to make a voluntary disclosure must do so in writing by mail or fax to the VDP at the designated Tax Centre that has jurisdiction over the area in which the individual resides. Form RC199, Taxpayer Agreement, should be used to make this initial submission.

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Although many disclosures are made on a “named” basis (i.e., the individual’s identity is provided to the CRA when making the disclosure), it is also possible to make a “no-name” disclosure to initiate discussion with the CRA. A no-name disclosure allows the individual’s advisor to explore the implications of disclosure with the CRA on a hypothetical basis.

However, negotiations conducted before the individual is identified and the CRA has complete information are quite limited. The identity of the individual must be provided within 90 days from the effective date of disclosure. If all other disclosure conditions have been met, the individual is protected from penalties and prosecution, beginning on the effective date. A final and complete submission of the disclosure is also expected to be provided within these 90 days.

Once the CRA has a complete file, a VDP officer can make a decision and will provide the individual with written notice of the decision along with an explanation. If the disclosure is accepted, the CRA issues an assessment. If the disclosure is denied, the file is referred to audit or investigations.

An individual may request the director of the Tax Centre where the original decision was made to review and reconsider the decision. It is also possible to seek a Federal Court judicial review of the VDP officer’s initial decision or the decision of the director.

Individuals may appeal an assessment or reassessment made as a result of a disclosure, but not with respect to the waiver of penalty or interest.

To learn more about the Voluntary Disclosures Program, speak to your Ernst & Young advisor.

CRA to crack down on international tax evasion In an 9 April 2013 news release, Minister of National Revenue Gail Shea highlighted initiatives introduced in the March federal budget to strengthen the capacity of the Canada Revenue Agency (CRA) to crack down on international tax avoidance and evasion.

In the news release, the minister again called upon the International Consortium of Investigative Journalists to provide the CRA with the information they currently hold on individuals with income or property held offshore, including 450 Canadians. In addition, the minister noted the CRA is working with its international partners, including the United States, in exploring other avenues of addressing international tax evasion.

In closing, the minister stated “These new measures will provide the CRA with additional tools to combat tax cheats. Our Government is serious about cracking down on those who attempt to cheat the system.”

The budget proposes the following measures to combat international tax evasion :

• Launching a new Stop International Tax Evasion Program that will allow the CRA to pay individuals who report major international tax non-compliance a percentage of tax collected as a result of the information provided

• Requiring financial institutions and others who currently report information on international electronic funds transfers greater than $10,000 to the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) to also report those transactions to the CRA

• Streamlining the process for obtaining information on third parties in the course of conducting an audit to speed up the process and give the CRA faster access to information on unnamed individuals for the purposes of civil actions

• Introducing new requirements for Canadian taxpayers with foreign income or properties to report more information, and extending the amount of time the CRA has to reassess those who have not properly reported this income

For additional information, see our Tax Alert 2013 Issue No.10, Federal budget 2013-14.

US Justice Department highlights tax division’s enforcement resultsIn a news release also released on 9 April, the US Justice Department announced highlights of its work during the past year to defend and enforce the nation’s tax laws. The Internal Revenue Service and the Justice Department’s Tax Division have collaborated to carry out their combined tax enforcement missions in several critical areas, including prosecuting tax fraud and evasion, halting the spread of abusive tax shelters, tracking down tax cheats who use offshore accounts, and combating stolen identity refund fraud.

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Facing up to tax risk Extract from T Magazine Issue 10

Tax risk and controversy have never been higher on the corporate agenda. As governments around the world battle to restore public finances to health, they are doing all they can to raise tax revenues, close loopholes and share information that will lead to better compliance. As prominent taxpayers, companies are firmly in their sights. Tax legislation is becoming more stringent and many administrations are subjecting companies to more frequent and aggressive audits — sometimes jointly with one or more overseas tax administrations.

The public mood toward corporate tax has darkened. In the current environment, barely a day goes by without another multinational company being vilified in the media for taking an overly aggressive approach to tax planning. Campaign groups are also becoming increasingly vocal in their accusations. This negative attention can have serious reputational damage, even if the tax strategies that companies have adopted are completely within the law. With the economic recovery still highly fragile, few companies can afford the negative publicity that these campaigns and media coverage bring.

In some markets, companies also have to contend with a highly uncertain and unpredictable tax environment. Legislation can change quickly, and sometimes in unexpected ways. Companies may find that a structure that was perfectly legal and uncontroversial when they first set it up subsequently proves to be problematic when rules are changed, sometimes even retrospectively.

This is particularly true in rapid-growth markets, where the tax system is less mature and where legislation may be more dynamic and fast moving. Dealing with such an uncertain environment creates major headaches for tax and finance departments, and also means that companies can lack the certainty they need to make long-term investments.

The severity of the risk environment means that tax must now be a topic for frequent board discussion. Companies must ensure that their tax strategies are appropriate and suit their risk appetite. They must also be aware of the tax risks associated with any new investment, particularly in unfamiliar markets. This calls for frequent communication between tax directors and the senior executive team, as well as a platform for discussing the implications of tax risk issues at board level.

It may even call for new roles to be created, such as a head of tax controversy with a specific mandate to take a proactive approach to identifying and managing tax risks. Without these mechanisms in place, companies are running the risk not only of penalties and fines, but also of severe reputational damage.

In the 10th issue of T Magazine, we explore how tax risk and controversy have changed since the financial crisis. We look at emerging risk areas and explore how the relationship between companies and their external stakeholders, including the media, tax administrations and campaign groups, is evolving. Perhaps most crucially, we examine how companies are identifying and managing these risks.

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Refusal to grant rectification results in an $11.8-million tax liability Kanji et al v AGC, 2013 ONSC 781

Al-Nawaz Nanji, Toronto, and Jennifer Smith, Ottawa

The equitable remedy of “rectification” has gained importance in the income tax context since the landmark decision of the Ontario Court of Appeal in Juliar (2000) (50 O.R. (3d) 728 (C.A.)). There are a now a myriad of provincial court decisions that address the issue of the circumstances under which a court will permit the rectification of documentation to reflect the parties’ intended tax consequences.

The Kanji decision is an interesting addition to this jurisprudence and highlights the importance of adducing direct evidence supporting the parties’ intentions to increase the chances of success on a rectification application in Ontario.

FactsIn this case, Mr. Kanji set up a family trust to allow for his wealth to pass to his children in a tax-efficient manner. Unfortunately, the preparers of the trust deed made some critical mistakes that resulted in adverse tax consequences. Under the terms of the trust, Mr. Kanji was the settlor, one of the two trustees and a capital beneficiary. Further, Mr. Kanji could remove any of the trustees and appoint substitute or additional trustees.

A number of years after the trust was settled, Mr. Kanji consulted with a different tax advisor who informed him that subsection 75(2) of the Income Tax Act (the Act), the so-called “revocable trust” rule, likely applied to Mr. Kanji’s initial $5,000 contribution to the trust.

The revocable trust rule applies where a person transfers property to a trust in circumstances where the property:

• Can revert to the transferor,

• Can pass to persons determined by the transferor, or

• Cannot be disposed of without the transferor’s consent or direction.

If one of these conditions is met, income and capital gains or losses from the property are attributed to the transferor.

The initial $5,000 contribution was used to purchase shares and investments. Under the 21-year rule, the trust would be deemed to dispose of and reacquire all of its assets on 26 March 2013. The value of the trust’s assets had reached approximately $62 million at that time, and it was estimated that on a deemed disposition of the trust’s assets, capital gains tax of about $11.8 million would become payable.

Mr. Kanji could avoid the deemed disposition if the trust were required to distribute its assets to him before 26 March 2013. However, that would frustrate the purpose of the trust, which was to allow for the transfer of the assets to his children on a tax-deferred basis.

Mr. Kanji, his children and the family trust applied to the Ontario Superior Court of Justice to rectify the family deed to conform to the alleged tax planning intention. They also sued the law firm that provided the initial advice. The attorney general of Canada opposed the rectification application.

Ontario Superior Court of Justice The Ontario Superior Court of Justice found that to be successful for a rectification application, which is a discretionary remedy, the onus is on the applicants to show on a balance of probabilities that there was a common, specific intention to accomplish a particular result, and a mistake caused the document not to comply with their intention.

In this case, the court indicated that there was uncertainty about the intention based on the evidence. Only Mr. Kanji testified, and there was no evidence from his accountant, the lawyer who prepared the trust deed or the lawyer who provided subsequent advice. There were also no experts called to establish the reasons such a trust would be created.

Because of this lack of direct evidence, an adverse inference was drawn. Mr. Kanji failed to establish that at the time he settled the trust he intended to structure it in a tax-efficient manner to allow for a tax-deferred transfer of assets to his children in the future. There was no independent evidence supporting this intention, and it was only after almost 21 years after the creation of the trust that the rectification was being sought.

The court was not willing to infer the specific tax motivation in creating the trust, since the creation of a trust may or may nor not be tax motivated. Accordingly, the court dismissed the rectification application.

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The result in this case should be contrasted with that in McPeake et al v The Queen (2012 BCSC 132), in which the British Columbia Superior Court was prepared to make such an inference from the evidence and granted a remission which allowed the taxpayer to avoid the application of subsection 75(2).

A distinguishing factor in the Kanji case may be the long period of time between the establishment of the trust and the rectification application. That being said, it would appear that the Ontario courts are less likely to grant a rectification order without direct evidence of intention.

ConclusionKeep in mind that remission is a discretionary remedy and you have to convince the court to grant it.

There are some lessons to be learned from this decision:

• Document your intention contemporaneously with the transaction so that if a mistake is discovered later, your chances for rectification are higher. This is more effective than relying on people’s memory of what happened and why.

• Evidence is critical. If there is a mistake, the evidence of third parties, such as tax advisors who can acknowledge the common intention, may be crucial. In this respect, check correspondence, email, internal memos and draft step plans if they exist to see if you can establish a common intention.

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Tax Alerts — Canada OECD meets with business on BEPS project

2013 Issue No. 16

On 26 March 2013, the Organisation for Economic Cooperation and Development held a meeting with its Business and Industry Advisory Committee on the base erosion and profit shifting (BEPS) project.

Nova Scotia budget 2013–14

2013 Issue No. 17

Manitoba budget 2013-14

2013 Issue No. 18

Publications and articles 2013 Worldwide corporate tax guide

Our recently updated guide covers even more countries than before. Gain insight into each country’s tax system as well as recent corporate tax developments.

Rapid-growth markets

At last, there are signs that stability could be returning to the global economy. As a result, the risks to growth are receding and we can be more confident about our baseline forecast for rapid-growth markets (RGMs). International trade will drive world growth over the coming decade, and RGMs are set to play an ever more influential role.

Publications and articles

Websites Business immigration alerts and updates

For the latest information on Canadian and US business immigration issues from Egan LLP, a business immigration law firm allied with Ernst & Young LLP in Canada, visit EganLLP.com.

Global Center for Entrepreneurship and Innovation

Our Global Center for Entrepreneurship and Innovation connects and informs entrepreneurs of all shapes and sizes as they progress on their growth journey.

Online tax calculators and rates

Frequently referred to by financial planning columnists, this popular feature on ey.com/ca lets you compare the combined federal and provincial 2012 and 2013 personal tax bills in each province and territory. The site also includes an RRSP savings calculator and personal tax rates and credits for all income levels. Our corporate tax-planning tools include federal and provincial tax rates for small-business rate income, manufacturing and processing rate income, general rate income and investment income.

Tax counsel and litigation

For news and thought leadership from Couzin Taylor LLP, a tax law boutique allied with Ernst & Young LLP in Canada, visit CouzinTaylor.com.

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such as resource tax pools, flow-through shares, the successor rules, investment by non-residents in mining operations in Canada, and foreign branch and subsidiary operations. The provincial mining taxes imposed in British Columbia, Ontario, Saskatchewan and Quebec are also covered. Available May 2013.