“I have never had a client call me and complain that we talked to them too much.”
Dean Smith, president of Toronto-based Cadesky U.S. Tax Ltd., shared that comment at the Vantage Breakfast Series presented in Toronto by the Investment Industry Association of Canada and Winnipeg-based Knowledge Bureau Inc. on May 9. Smith was highlighting the importance of asking clients key questions to ascertain if they have cross-border issues. “I can guarantee that if you don’t talk to your clients, they will call and complain or – worst case – you’re going to lose them as a client,” he said.
Smith described cross-border clients dealing with the fallout of a failure to plan, with consequences ranging from aggravating to acute. Consider the client who moves to the U.S. and continues to be issued T3 and T5 slips, or learns too late that his or her Canadian-controlled private corporation (CCPC) has lost its tax status.
Financial advisors can recognize cross-border issues early if they proactively ask questions, Smith said.
For example, he suggested advisors ask clients if they want to retire to another country or expand their businesses internationally. If so, what markets are they looking at? Also, is the client’s child considering an international move or planning to study abroad?
Smith noted that cross-border clients likely will require portfolio changes. “Tax-deferred vehicles in Canada aren’t necessarily tax-deferred in a foreign country,” he said.
Smith also urged advisors to remain in contact with clients’ other advisors, including accountants and lawyers, to develop a cohesive plan. “You cannot be operating in a silo,” he said.
Cross-border issues
Ask new clients if they’ve moved to Canada recently, Smith said. If so, ask whether they’re former Canadian residents and were subject to departure tax when they left. Unwinding that tax may be possible with a special election.
He further recommended finding out whether the client has assets in the foreign country, and assessing whether those assets should be brought to Canada, especially in cases in which doing so would be relatively easy because the investments are held with a cross-border licensed firm. Maintaining investments outside Canada can be costly because of foreign reporting requirements (using form T1135 from the Canada Revenue Agency).
A client moving from the U.S. who might eventually return there doesn’t have to convert investments to Canadian dollars when moving to a Canadian financial institution, Smith said. Most such institutions can produce both U.S.- and Canadian-dollar capital gains reports.
However, investments should be restructured based on residency, considering tax-preferred options. For example, Smith said, many American clients coming to Canada have portfolios containing U.S. state and local bonds, which aren’t subject to U.S. federal tax but would be subject to Canadian tax.
He also highlighted that U.S. persons in Canada should avoid holding passive investments outside registered accounts, specifically passive foreign investment companies (PFICs), which include Canadian mutual funds and ETFs, because PFICs are punitively taxed. As such, advisors should always ask clients whether they’re U.S. persons, instead of relying on them to tick the appropriate box on their intake forms.
While clients can file an election to eliminate PFIC tax, many clients are unaware of the election or don’t make it within the first year of ownership, Smith said. Also, reporting is costly in cases in which a client holds several PFICs, and can be particularly challenging if the client holds a fund of funds.
If clients tell you they’re considering leaving Canada, consider whether departure planning is needed. A client who owns a CCPC, for example, will be subject to departure tax on the deemed disposition.
The advisor should also discuss how the move would affect the client’s business. For example, the corporation will no longer be considered Canadian-controlled and will lose CCPC status. If the client is moving to the U.S., the business will face an increased corporate tax rate – about 26%, the U.S. statutory corporate income tax rate. The business also will fail to meet criteria for clients to claim the capital gains exemption, affecting succession planning. Thus, advisors should consider whether gains should be crystallized ahead of the move, Smith said.
Succession planning could also be affected in cases in which a client’s child moves away from Canada to attend school, because tax issues could arise if a Canadian trust has foreign beneficiaries.
Another consideration is determining whether clients moving to the U.S. will become U.S. domiciliaries and subject to the U.S. transfer tax regime, including estate and gift taxes (with certain exclusions, deductions and credits).
Tomorrow’s tax burden
Another presenter at the event also stressed the importance of comprehensive client conversations, this time in a Canada-only tax context.
As Canadians face an era of rising taxes and interest rates, “tax efficiency matters,” said Evelyn Jacks, president of Knowledge Bureau. She detailed ways Canadians’ tax burdens will increase in the coming years.
While Canada already has relatively high tax rates – and had the seventh-highest marginal tax rate in 2017 among the 34 countries in the Organization for Economic Co-operation and Development – the tax burden is expected to increase as federal debt increases, she said.
For example, in 2035-36, Canada’s federal debt is forecasted to surpass the $1-trillion mark, increasing from a projected $732 billion in 2022-23, according to the Department of Finance.
To meet the rising costs of debt as well as that of federal programs, Canadians can expect to contribute more of their incomes to federal coffers, especially as the labour force shrinks, Jacks said. Based on federal budget numbers, revenue from income taxes is forecasted to increase more than 4% annually over the next few years.
In step with these trends, private corporations can expect more audits, because taxable active business income has exhibited strong growth in recent years, Jacks said. Audits also will be fuelled by the shift toward freelance work, which results in a less predictable income stream for the government.
To maximize a client’s investments and after-tax income requires advisors to engage in conversations about the client’s “lifelong journey,” using enhanced discovery processes and specialized knowledge from many disciplines, she said. In a 2016 survey by Toronto-based Sun Life Assurance Co. of Canada, growing wealth ranked as the top concern among high net-worth clients, followed by generating retirement income and tax optimization.
Addressing these client concerns creates a positive feedback loop. Tax-efficient planning, for example, typically requires that family members do their tax returns together, and as a result, advisors get the opportunity to understand the whole family better, Jacks said. Further, an intergenerational environment allows for vibrant discussions about the responsibility of wealth, which is helpful for younger family members as wealth beneficiaries.
However, advisors must find a way to make time for these conversations and to scale their businesses. The solution, although not easy, Jacks said, is to build on a “multi-advisory, multi-stakeholder approach.”