Introduction – Digital Payment Services and Financial Reporting Obligations
Digital payment services like those offered by PayPal, which are used to facilitate money transfers domestically and internationally, are now well-integrated into our personal and professional lives. Whether your PayPal account is used for genuine commercial purposes, however, or for quasi-commercial or individual purposes could have a bearing on your Canadian tax reporting requirements.
More specifically, your obligations as a Canadian taxpayer to file a Foreign Income Verification Statement (otherwise known as the “T1135”) could be impacted by the nature of your transactions involving PayPal. If you are ever in doubt about your potential T1135 filing obligations as a Canadian tax resident, you should consult with one of our expert Canadian tax lawyers.
What Exactly is a T1135?
The T1135 is not a tax return in the traditional sense and does not create a tax obligation for a Canadian tax resident filing the T1135. The T1135 is used to ensure that Canadian tax residents report the existence of foreign property interests to the CRA, so that those interests can be monitored by the government.
Under subsection 233.3 of the Income Tax Act, any Canadian resident individual or corporation holding “specified foreign property” with a cost of $100,000 or more (in Canadian dollars) is required to file a T1135 with the Canada Revenue Agency (CRA). If you are a Canadian tax resident or a Canadian corporation, the T1135 is due at the same time as your yearly income tax return.
Not all foreign property needs to be considered for T1135 reporting purposes. “Specified foreign property” is a broadly defined term under the Income Tax Act, and includes (but is not limited to):
- Real property (land and buildings) located outside of Canada;
- Shares in foreign corporations, or Canadian corporate shares held internationally; and,
- Funds and intangible property “situated, deposited or held outside Canada”.
The Income Tax Act specifically excludes from the definition of specified foreign property any property held “exclusively in the course of carrying on an active business.” Generally speaking, a foreign tax jurisdiction is considered to have the right to tax the active business income-earning activities of Canadian tax residents in that jurisdiction, because that business benefits from local laws and economic conditions. A Canadian tax resident holding property passively in a foreign tax jurisdiction continues to benefit from Canadian laws and economic conditions but may be at an advantage to engage in unfair tax avoidance compared to other Canadian tax residents, or inappropriate tax evasion and income sheltering from Canadian tax authorities. The “active business” exception to T1135 reporting requirements makes it clear that the goal of Canadian tax authorities is not to overburden Canadian business operating internationally, but to prevent inequality among taxpayers who hold certain properties in other tax jurisdictions.
The “Active Business” Exception as Applicable to PayPal Transactions
Even though PayPal is not a bank, if funds are held for you in a foreign jurisdiction they are generally captured under the definition of specified foreign property. Not all PayPal transactions will necessarily trigger T1135 reporting requirements, however. As specified foreign property only considers foreign property, transactions and digital holdings completely within the borders of Canada will not affect T1135 reporting obligations.
Where you are involved in foreign or international transactions, the rules can be uncompromising. The $100,000 threshold to trigger T1135 reporting requirements is a cumulative ceiling. If at any point in a given tax year the value of your specified foreign property exceeds $100,000, then your T1135 reporting requirements have been triggered regardless of what combination of specified foreign property that you hold. Engaging in limited PayPal or other digital payment transactions abroad, while holding other kinds of foreign property, could bring you over the T1135 reporting threshold without you realizing it. For example, specified foreign property will include Cryptocurrency or non-Canadian real estate that is not used personally.
An exception to this reporting obligation, as mentioned above, may exist where the funds are held exclusively in the course of carrying on an active business. The Income Tax Act defines an active business as “any business carried on by the taxpayer other than a specified investment business or a personal service business.” A specified investment business (SIB) and personal service business (PSB) are very specific defined business structures that are structured to look like active businesses, so that they can earn additional tax attributes under the Canadian tax system, but which are not in the view of the law actually engaged in an active business. The definition of active business is generally quite broad, but whether a particular business is active or not, and whether those funds are being used exclusively in the course of that active business, are a question of fact that will need to be investigated in each case to adequately determine.
Pro Tax Tips – The Penalties for Failing to File a T1135 are Serious and Strict
Failing to file a T1135 on time can carry serious financial penalties. Late-filing or failing to file a T1135 as required can accumulate a penalty of up to $2,500 for every year the T1135 is not filed, in addition to interest and other possible penalties the CRA deems appropriate. Additional penalties may exist where property is misreported or underreported on a T1135. These penalties are strict and unforgiving, and even an innocent mistake can result in significant costs for a Canadian taxpayer.
If you are a Canadian resident taxpayer dealing in foreign business ventures personally, through a corporation, or through a partnership and you employ digital payment systems as part of your activities, then you should speak with our tax lawyer in Toronto to determine what obligations, if any, you may have to report your foreign property to the CRA.
- What is a T1135?
The T1135, or Foreign Income Verification Statement, is a statement that must be filed by Canadian resident taxpayers with their yearly tax returns. A T1135 must be filed if that taxpayer holds property with a cost of more than $100,000 (valued in Canadian dollars) in specified foreign property. “Specified foreign property” is defined by the Income Tax Act to include types of investments and property held abroad that are generally not involved exclusively in earning income from an active business, or which is used for personal use.
- Can my foreign PayPal holdings be considered “specified foreign property” for tax reporting purposes?
Foreign PayPal holdings may be captured under the definition of specified foreign property, as they may be funds “situated, deposited or held outside Canada.” Those funds may also be exempted from the definition of specified foreign property, where they are exclusively used in the course of carrying on an active business.
- What is “active business income” as defined by the Income Tax Act?
The Income Tax Act defines “active business” as “any business carried on by the taxpayer other than a specified investment business or a personal services business. Whether a business is an “active business” is a question of fact to be determined in light of the operations involved in that business.