Introduction – T1135s and Beneficial Ownership
The Canadian Income Tax Act requires that Canadian tax residents who own “specified foreign property” with a cost of $100,000 or more in Canadian dollars file an annual Foreign Income Verification Statement, or “T1135”, with that year’s tax return.
Specified foreign property as defined under the Income Tax Act includes, among other kinds of investment and passive income-earning properties, funds “situated, deposited or held outside Canada”, or any interest in or right to property that is specified foreign property. Thus, a taxpayer who holds beneficial ownership of specified foreign property (as opposed to purely legal title to property) generally must include that property’s value in calculating the threshold for filing a T1135 and must report that property when filing that T1135.
One recent case heard by the Tax Court of Canada, Chan v The Queen, 2022 TCC 87, illustrates the potential challenges in determining what might qualify as specified foreign property, and the serious consequences a taxpayer might face for failing to file a T1135 when required. 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.
Facts of the Case – A Father and Son Set Up a Foreign Bank Account
The taxpayer was a former financial analyst and treasury manager with extensive education in accounting. In 2011, the taxpayer opened a foreign bank account for his father in China under his own name. The taxpayer claimed that political restrictions in China on the taxpayer’s father prevented him from opening an account himself. The taxpayer and his father took a number of steps to provide the taxpayer’s father with control of the account:
- The taxpayer signed a power of attorney over the account in favour of his father, giving him online access to the account.
- The taxpayer’s father exclusively held the bank card and PIN associated with the account to access it. The taxpayer was only involved in accessing the account when the taxpayer’s father needed technical assistance.
- The taxpayer’s father held all bank statements related to the account.
- The taxpayer’s father used the account for account transactions and personal investments. The taxpayer held his personal investments in other accounts, and generally engaged in more high-risk investment strategies than the conservative investments the taxpayer’s father made using the account’s funds.
The taxpayer’s father was audited in 2016. The taxpayer did not file a T1135 with the CRA until 2016, and only then reported himself as the nominee for his father. By the time of the taxpayer’s father’s passing, the account had accumulated the equivalent of over $2 million in Canadian dollars. In concluding its tax audit, the CRA took the position that the account and associated funds belonged to the taxpayer, because the account had been opened in his name. In addition to penalties under paragraph 162(7)(a) of the Income Tax Act for failure to file T1135s from 2013-2015 as required, the CRA assessed the taxpayer for gross negligence penalties under paragraph 162(10)(a), on the basis that the taxpayer ought to have known that the filings were required.
Arguments Before the Tax Court of Canada – Who Was the Beneficial Owner of the Account Required to File T1135s?
After an unsuccessful CRA appeal by way of a notice of objection, the taxpayer’s Canadian tax litigation lawyer appealed to the Tax Court of Canada and mounted two arguments at trial. First, the taxpayer was not the beneficial owner of the account, given his father’s express intent that the taxpayer be his nominee and given the facts surrounding both his and his father’s activities involving the account. Second, the taxpayer held a reasonable belief that he was not the owner of the account, that he was duly diligent and not negligent in filings, and thus that any failure to file was an innocent mistake that could not attract either gross negligence penalties or penalties for failing to file Canadian income tax returns.
The Canadian tax litigator acting for CRA, arguing to uphold the CRA’s tax reassessment, argued that the taxpayer had failed to provide sufficient evidence to prove that his father owned the account. Specifically, as part of the CRA tax audit the taxpayer had agreed that he was the sole owner of the account, and the taxpayer had not provided any sufficient explanation as to why the taxpayer’s father was the beneficial owner of the account.
The Ruling of the Tax Court of Canada – Title to a Bank Account Alone Does Not Automatically Equal a Beneficial Interest
The Tax Court of Canada ultimately ruled in favour of the taxpayer and sent the matter back to the CRA for reassessment, on the basis that the taxpayer was not liable for either late-filing or gross negligence penalties. The Tax Court of Canada found that the factual circumstances involved (and listed above) were consistent with a view that the taxpayer’s father held beneficial ownership of the account up to the time of his passing in 2018.
The Tax Court of Canada also highlighted that the taxpayer’s father had arranged for the taxpayer to take ownership of the funds in the account on the father’s passing, which was rooted in his decision in 2011 for the account to be opened in the taxpayer’s name. Thus, given that the taxpayer’s father exclusively funded the account and exercised control and use over it, he was the sole beneficiary while the taxpayer only held legal title.
The Tax Court of Canada also accepted that the taxpayer, in the alternative, had reasonable grounds to believe his father held the beneficial interest in the account. Thus, the taxpayer was absolved of liability for failing to report the account to the CRA by filing the requisite T1135s.
Pro Tax Tip – T1135-Not All Taxpayers are Created Equal
Though the result was positive for the taxpayer in Chen, the penalties for failing to file a T1135 as required are nevertheless very strict. The taxpayer in Chen elected to proceed by informal procedure before the Tax Court of Canada, which means that the case result does not hold precedential value for future litigants. Demonstrating a lack of any beneficial interest in the property, or demonstrating sufficient due diligence, are very fact-specific inquiries that depend on the totality of evidence available.
Staying aware of your tax filing obligations when you own foreign property is crucial. Paragraph 162(7)(a) imposes a penalty of up to $2,500 per year for every year that a taxpayer does not file a T1135 as required, even though filing a T1135 alone does not create a tax liability. Taxpayers face additional penalties at the discretion of the CRA, as the taxpayer did in Chen, where the CRA believes the taxpayer knowingly or in circumstances amounting to gross negligence did not file a return, or where the taxpayer incorrectly reports property on a filed T1135. If you are a Canadian tax resident who owns foreign property, you should always consult with one of our knowledgeable Canadian tax lawyers to ensure that your tax reporting obligations are met.
- What is a T1135?
The Foreign Income Verification Statement, or “T1135”, is an annual information return that some Canadian resident taxpayers must file with that year’s tax return. The Income Tax Act requires a Canadian tax resident who own “specified foreign property” with a cost of $100,000 or more in Canadian dollars report those properties and their value to the CRA. The T1135 is an information return and not a tax return and does not itself create a tax liability when it is filed.
- What are the T1135 requirements of a beneficial owner of Specified Foreign Property based on the Tax Court of Canada ruling in Chan v The Queen?
The Tax Court of Canada ruled in favour of the taxpayer, finding that the taxpayer did not hold beneficial interest in the foreign bank account created under his own name. The Tax Court of Canada concluded on the evidence that the taxpayer’s father held the beneficial interest in the account, given the history of the account, the taxpayer’s father’s exclusive control and use over the funds in the account. The taxpayer could therefore not be assessed penalties for failing to file annual T1135s, because the taxpayer was never obligated to file information returns.
- What penalties could I face for failing to file a T1135?
Failing to file a T1135 as required can carry serious financial penalties. A taxpayer can face up to $2,500 in penalties for failing to file a T1135 for a given taxation year. The CRA may choose to assess additional penalties where it believes the taxpayer was grossly negligent or knowingly failed to file a T1135 as required.