Law Times

Law Times • August 10, 2015 Page 7 www.lawtimesnews.com COMMENT tax consequences underscore need to ask clients about U.s. citizenship By alan liTwack For Law Times here are nearly two million U.S. citizens who live in Canada who are subject to U.S. taxation. Some of them will face potentially adverse U.S. tax consequences from transac- tions that are tax benign in Canada. To protect everyone involved, Canadian lawyers and accountants should be asking whether their clients and, for that matter, their spouses, children or grandchildren, are U.S. citizens. Over the past few years, it has become a well- known fact that U.S. citizens are liable for taxation on their worldwide income and assets regardless of where they are resident. In fact, there has been considerable publicity as to the efforts of the U.S. Internal Revenue Service to ensure compliance by all U.S. citizens with reporting and paying U.S. tax. Canadian lawyers are seeing more and more situ- ations of people who are non-resident U.S. citizens who left the United States many years ago or may nev- er have lived there. In many instances, there may be nothing in how they conduct themselves that would reveal that they hold U.S. citizenship. The trouble begins, however, because there are a number of differences between the Canadian and U.S. tax systems. These differences can result in very serious adverse U.S. tax consequences for transactions that are benign for Canadian tax purposes. The first problem area to highlight relates to passive foreign investment corporations. On any sale of the in- terest in such a corporation, the profit is not subject to tax at the normal U.S. capital gains rates. Instead, the government applies the highest U.S. federal tax rate of al- most 40 per cent. To compound the problem, the gain is considered to have been earned on a straight-line basis over the period of ownership with interest calculated each year on the amount of profit recognized. The result is that over a period of time, the amount of tax, including interest, can exceed the proceeds from the sale. There are structures that can alleviate the oppres- sive consequences of being a passive foreign invest- ment corporation, but they must be in place upon acquiring the interest. The issue doesn't apply just to U.S. citizens living abroad; it affects every U.S. taxpay- er owning an interest in a passive foreign investment corporation. A problem is more likely to arise where professional advisers outside of the United States who are not familiar with the U.S. tax issues and how to deal with them set up the entity. In a classic Canadian estate-freeze transaction to limit capital gains on death, the transferor generally exchanges fully participating common shares for fixed-value pref- erence shares redeemable at the option of the holder at a redemption price equal to the then-fair market value of the common shares transferred. New common shares are then issued for nominal value either directly to members of a subsequent generation or into a trust for their benefit, and all future growth accrues to those shares. While this is a very common transaction in Canada, the types of shares taken back from the transferor do not qualify for rollover treatment under the U.S. Inter- nal Revenue Code and for U.S. tax purposes result in a taxable gain recognized by the transferor. The acquisi- tion of the growth common shares by members of the subsequent generation or the trust may also result in the immediate imposition of U.S. gift tax. There are similar problems of adverse U.S. tax consequences resulting from transactions that are otherwise benign for Canadian tax purposes. They apply not only to passive foreign investment cor- porations but to other entities, including those car- rying on active businesses. A number of additional problem areas to look out for on behalf of U.S. citizen clients include: • The provisions in the U.S. tax code dealing with amalgamations. It is important to review all amal- gamations involving shareholders who are subject to U.S. taxation to ensure they are not a taxable event to the shareholder for U.S. tax purposes. • The lifetime capital gain exemption on shares of a qualified small-business corporation has no equiv- alent exemption under the U.S. tax code. • Many transfers of assets to corporations and part- nerships do not necessarily obtain the same benefi- cial tax treatment under the U.S. tax code as with the Canadian tax rules. In addition to those specific problems, there are many others that result from the differences in the systems for income, corporate, death, and gift taxes. Given the potential issues, it is important at initial meetings with clients for lawyers to determine if they or any of their family members are U.S. citizens. With this knowledge in hand, they can restructure or avoid activities that are benign from a Canadian tax perspec- tive if they will create adverse U.S. tax problems. LT uAlan Litwack is a corporate lawyer and partner at Dickinson Wright LLP. He's available at 416-646-3839 or alitwack@dickinson-wright.com. u SPEAKER'S CORNER Originalist creed a problematic approach to assessing the law ggressive criminal justice policy has been one of the Conservative government's preoccupations since it came to office in 2006. A number of new proposals in advance of this October's election suggests the gov- ernment still considers this to be a bank- able way of getting votes. Whether or not we get a new federal government this fall, it's a safe bet that the courts will have the job of determining the constitutionality of Prime Minister Stephen Harper's crime laws for years to come. A couple of recent news items got me thinking again about the approach taken by our courts, especially our Supreme Court, in deciding whether a law conf licts with constitutional rights. On June 26, the United States Supreme Court handed down its decision in Oberge- fell v. Hodges that allowed same-sex mar- riage in all 50 states. The decision was close: Four justices dissented, with their common theme being that the people who adopted the 14th Amendment in 1868 hadn't con- templated gay marriage. Therefore, because 19th-century understandings of due pro- cess and equal protection wouldn't have included a right to same-sex marriage, 21st- century gays and lesbians wishing to marry were simply out of luck. Happily, this cramped vision failed to carry the day. In an odd coincidence, how- ever, June 26 was also the day on which the Canadian government announced the appointment of an originalist former law professor to the Ontario Court of Appeal. News of the appointment had already made the rounds earlier in the week, leading to a front-page story in the Globe and Mail about the originalist and conservative leanings of some recent Harper appointees. This is newsworthy because of its nov- elty. Originalism has never taken hold in Canadian courts, and to my knowledge no government until now has taken an interest in promoting the theory through its appointment power. While Lord Sankey had coined the slogan about the Constitution being a "living tree" in 1929, the idea behind it was nothing new even then. And in one of the first cases dealing with the Charter of Rights and Freedoms in 1985, then-justice Antonio Lamer ef- fectively declared originalism to be dead on arrival. Originalism has fared no better in the 30 years since then. In criminal law, our Supreme Court's non- originalist approach is evident in its high- profile recent decisions striking down some long-established laws that the framers of the Charter no doubt assumed were invul- nerable to attack. A year and a half ago, in Canada (Attorney General) v. Bedford, the court invalidated a number of prostitution provisions that had existed in one form or another since the government enacted the Criminal Code in 1892. And earlier this year, in Carter v. Canada (Attorney General), the court got rid of the ban on assisted sui- cide that had a similarly ancient pedigree. On an originalist interpretation of the Charter, neither of these decisions would have made any sense. In both cases, the court's concern was with the facts: causes, effects, and consequences. What's the point of the law? Who does it help and who does it hurt? Ultimately, do its benefits outweigh its consequences? Notably, in neither case did the court wring its hands over what the framers thought about prostitution or assisted suicide. Nor did it agonize over its institutional legitimacy in striking down a democratically enacted law. Compare this to the near-hysterical levels of institutional angst expressed by the four dissenters in Obergefell. "Just who do we think we are?" Chief Justice John Roberts asked at the end of his surprisingly strident dissent. This kind of institutional self- loathing is absent from the Ca- nadian decisions I've just men- tioned. Occasionally, someone will bang the drum of judicial restraint — as Justice Michael Moldaver did recently in R. v. Nur, the mandatory minimum sentencing case — but the gist of the criticism tends to be narrow. Further, no judge on the court has decried the institu- tional legitimacy of it pronounc- ing on a supposedly moral issue such as assisted suicide. The most relevant and persuasive critiques of cases such as Carter have also been on the practical lev- el, engaging with the court's cost-benefit analysis rather than questioning its right to resolve the question in the first place. Whether decriminalizing assisted suicide will do more harm than good is a matter on which we can have a reasonable debate. But I find it hard to comprehend how any- one could prefer originalism's fixation on the proclivities of dead ancestors to a prag- matic assessment of how a law affects the well-being of those currently alive. The appeal of originalism is supposed to be the constraint it places on activist judges in the name of democratic self-governance. Justice Antonin Scalia's argument suggests that if you don't like what the Constitution says, go ahead and amend it. But don't rely on the courts to invent new rights that the democratic process has never validated. But constitutions, by design, are very hard to amend. By the time a minority has enough numerical strength to pull off a rights-protecting amendment in its favour, it very likely no longer needs the protec- tion. Accordingly, it's the generally worded guarantees around equal protection of the law and the principles of fundamental jus- tice that protect the rights of minorities and despised groups like criminal defendants. The point of these open-ended provisions is precisely to allow them to adapt to the times. The framers obviously knew that. They were not themselves originalists. For that reason, originalism tends to fall apart on its own terms. The most litigated provisions of the Charter are the ones that need the courts to fill in their content. No one in 1982 believed that a new constitu- tional convention should take place every time someone proposed to identify a novel principle of fundamental justice under s. 7 or a different analogous ground of discrimi- nation under s. 15. The living-tree theory, in which the meaning of the Constitution evolves with the times, was firmly estab- lished in constitutional doctrine. For these reasons, the best originalist gloss on our Charter is really not originalist at all. The rhetorical appeal of originalism in the United States appears to hinge on that country's veneration of its founding fathers. For better or worse — I think for the bet- ter — we lack the same national mythology and are less prone to engaging in what for- mer justice Ian Binnie has called "ancestor worship." We're aware that the people who enacted our Charter of Rights in the early 1980s were ordinary politicians. Some of them were admirable, no doubt, but none of them was a visionary. It doesn't take an ideal- ized notion of the judicial role to believe that present-day judges are in a better position to decide what fundamental justice requires in 2015 than some hypothesized version of what people thought in 1982, let alone in 1791. The shrill protests by Scalia and his ilk against advances such as gay marriage are, I think, unlikely to convince many on this side of the border that our courts should embrace the originalist creed. LT uMatthew Gourlay handles criminal and regulatory matters at Henein Hutchison LLP with an emphasis on appellate litigation. He's available at mgourlay@hhllp.ca. A A Criminal Mind Matthew Gourlay T

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