Foreign Property Reporting & How To Sleep Better At Night: Voluntary Disclosure Process.
There is an old saying that “what you don’t know won’t hurt you”. However, this saying doesn’t apply when you’re talking about foreign property reporting requirements under the tax rules. In this case, it definitely pays to make sure you are compliant otherwise you are exposing yourself to a number of potential penalties not to mention that you’ll sleep better at night!
Recently, a number of tax agencies have stepped up their efforts to collect information about their taxpayer’s foreign property or financial holdings. The most vivid example is the U.S. crackdown on offshore tax evasion and an IRS investigation of Swiss bank UBS which resulted in a $780-million fine for the bank. The U.S. efforts have also resulted in criminal investigations and jail time for violators. European and other countries have also gotten into the act as it results in increased tax revenue in a time of need.
Under the U.S. rules, a U.S. person is required to file a Report of Foreign Bank and Financial Accounts (“FBAR” or Form TD F 90-22.1) if they have a financial interest in or signature authority over financial accounts in a foreign country where the aggregate value exceeds $10,000. The potential penalty for an inadvertent failure to file is $10,000 and a willful failure could cost as much as $100,000 and even result in jail time.
Since 1998, Canadian tax residents have been required to disclose ownership of foreign property if they had a total cost amount of more than C$100,000 at any time during the tax year. The specific question is on page two of the annual T1 Canadian tax return. If the answer is yes, then you are required to file Form T1135 – Foreign Income Verification Statement. This form is due to be filed by the due date of your tax return (generally April 30th of the year following the particular tax year). Please note that if you e-file, you still have to mail in a hard copy of your Form T1135 separately. The penalty for not filing this form (if required) by the due date is a fine of $25 per day to a maximum of $2,500 for each tax year. If you fail to answer the foreign property question honestly, there are other potential implications (including jail time) however this would generally be for situations where there is an intention to evade tax by hiding foreign assets.
Although the penalty for late filing of the T1135 has been in place since 1998, the Canada Revenue Agency has just recently stepped up their efforts to pursue non-compliance. This is consistent with their advance warnings that they will scrutinize foreign tax issues more closely. We have noticed that the CRA now automatically assesses the penalty for a late filed Form T1135. There is a computer generated letter which is mailed out assessing the maximum penalty. If you have already been assessed this penalty, there may be grounds to submit a claim under the tax fairness provisions depending on your particular circumstances. If you have not yet filed and your return will be late, then you should consider whether you qualify for the formal voluntary disclosure process to mitigate the penalty.
So what exactly is “foreign property” that is required to be reported on Form T1135? Generally, the definition is fairly expansive as outlined in the instructions to the form. Some common examples include cash, stocks, bonds, mutual funds, loans or any real property (land or building) not in Canada.
Let’s look at some other examples to provide more clarity. If you own a bank account in the U.S. then that is definitely a foreign property so you need to file T1135 if the cost amount is more than C$100,000. Remember that the C$100,000 amount is on an aggregate basis and not for each foreign property. So if you have a foreign bank account with C$50,000 and other foreign property with a cost of C$60,000 then you need to file Form T1135. If you recently moved to Canada and still own a home outside of Canada, then the foreign home will be foreign property for purposes of Form T1135 if not maintained exclusively for personal use (i.e. if it is rented out). The cost base of the home is the fair market value at the time you moved to Canada.
If you own mutual funds through a Canadian mutual fund provider (such as Sun Life, ManuLife, Investors Group or a Canadian financial institution) you are not considered to own foreign property, even if the mutual fund invests entirely in foreign stocks. The biggest area of concern is if you own stocks of foreign corporations (through a broker or an internet account). Stocks of foreign corporations are considered to be foreign property for purposes of Form T1135 and you may be required to file this form if you invested more than C$100,000.
How do you come clean if you now realize you were required to file Form T1135 for a prior year? The best option for submitting a late Form T1135 is through CRA’s formal Voluntary Disclosure Program (VDP). Unfortunately, just mailing in the required form with a remorseful apology doesn’t work with the CRA. The VDP is a formal process which gives taxpayers the opportunity to come forward to correct inaccurate information or to disclose previously unreported information without penalties or fear of prosecution. The submission can be made either on a no-names basis or with full information so you’ll need to consider the better strategy for your situation. The VDP process is not a do-it-yourself project and it is highly recommended that you seek professional advice. A valid disclosure must meet the following four conditions:
- The disclosure must be voluntary (i.e. you have not been formally asked by the CRA to complete the form)
- The disclosure must be complete
- There must be an application of a potential penalty
- The disclosure must generally include information that is more than one year overdue
Also, the disclosure must be in writing and should be sent to the tax services office that has jurisdiction over the area where the taxpayer resides.
If the VDP submission is accepted as a valid voluntary disclosure then the CRA will waive penalties that would otherwise be imposed. On a case-by-case basis, the CRA may also provide some relief on the amount of arrears interest outstanding. So, the benefits of being accepted into the VDP can be well worth the effort. Other than the foreign reporting requirements and past due tax returns, there are certain other items that may be accepted into the VDP process. For example, in the year of departure from Canada there is a Form T1161 which requires listing of certain property (such as a home or capital assets) you own at the time of ceasing Canadian residency. The maximum penalty for failure to file is $2,500 not including interest. Similarly, if you own Canadian real property as a non-resident and earn rental income from it then you will have a number of filing requirements (such as the Form NR6 election to remit withholding tax on a net basis). These types of items can also be submitted through the voluntary disclosure process (if the conditions are met) to mitigate potential penalties.
As noted above, the VDP process is not a do-it-yourself project and it is highly recommended that you seek professional advice. It will save you grief down the road and certainly result in better sleep.
For more information, please contact:
Mohammad Ahmad, LL.B.
T: 604-288-7700 ext.135