Law Times

Page 10 OctOber 24, 2016 • Law times www.lawtimesnews.com Differences in tax codes could lead to problems Estate freezes complicated by American citizenship BY MICHAEL MCKIERNAN For Law Times A mericans hiding in plain sight are the big- gest danger for lawyers carrying out Canadian estate freezes, according to a To- ronto lawyer at a cross-border law firm. Ted Citrome, counsel to the Toronto office of Dickinson Wright LLP, says his first ques- tion to clients who want to im- plement an estate freeze is: "Are you an American citizen?" After that, he wants to know whether any of their intended beneficia- ries are U.S. citizens or residents, "or if there's a chance they might become one in the future," Citrome says. When properly performed, estate freezes allow matriarchs or patriarchs to minimize capi- tal gains tax exposure by ex- changing their interest in a busi- ness for fixed-value preferred shares. As part of the freeze, new common shares are created for the accrual of any subsequent growth in the company's value, held typically by beneficiaries through a family trust. However, when any of the parties is a U.S. citizen or resi- dent, the plan can fall apart without extra measures being taken, due to differences in the tax codes of the two countries. "You run into complications generally when the U.S. tax code has one set of rules that don't map neatly over the Canadian ones," Citrome says. "In solving the Canadian tax problem, you don't want to create a U.S. one. What works for one doesn't work for the other, and you can end up in a game of Whac-A-Mole. Without appropriate planning, the consequences can become adverse really quickly." At Dickinson Wright, Toron- to is the only Canadian outpost among the firm's 16 offices, with the rest dotted across the U.S. "It's a huge benefit for us, be- cause you really need U.S. tax expertise to navigate your way through it," he says. "I think cli- ents appreciate it because we can craft a cross-border solution to handle any eventuality." David Altro, managing part- ner of Altro Levy LLP, a firm with both Canadian and Ameri- can lawyers as well as offices on both sides of the border, says many of his clients come to him to clear up the mess after run- ning into problems with their Canadian estate freezes. "Numerous Canadian ac- countants and tax lawyers are just not aware of the problems, so it's not something they focus on when they're dealing with a typical reorganization and estate freeze. They don't realize you can't do it that regular way when there are Americans involved," Altro says. "We would prefer it if people came to us so that they avoid making terrible mistakes, because it's much harder to un- wind these arrangements than to do it properly from the get-go." Altro says many of his cli- ents consider renouncing their American citizenship in order to relieve themselves of their tax responsibilities south of the border, but for those that wish to retain their American con- nections, he says difficulties can arise in the context of an estate freeze in a number of circum- stances. For example, when the com- pany owner is an American liv- ing in Canada, the freeze works fine on the Canadian side, but the U.S. Internal Revenue Ser- vice takes a different view of the transaction and can view the value of the trust's shares as a taxable gift. Alternatively, the IRS may label the family trust as a "grantor trust" and take the view that the business owner still owns the shares contained in it, negating the effect of the freeze. "It's a total nightmare, with double taxation on the owner," Altro says. When any of the beneficiaries are U.S. citizens or take up resi- dence south of the border, they run the risk that the IRS will deem their interest in the family trust a PFIC, or passive foreign investment company — a non- U.S.-based company that earns the bulk of its income from pas- sive sources, such as investments. "The U.S. consequences of PFIC ownership can be very onerous," Citrome says, noting that fines per infraction of PFIC reporting regulations can cost as much as US$10,000. According to Altro, his firm has its own proprietary meth- ods for putting together an es- tate freeze involving American shareholders. "There can be a lot of prob- lems with a Canadian freeze, but we do have things we can do to neutralize the double taxation problem," he says. Altro says business is boom- ing for law firms with legal expertise on both sides of the border because of the recent crackdown on overseas earnings by the IRS, regardless of their country of residence. "The IRS has gotten very ag- gressive f lushing out Americans living abroad and penalizing those who don't disclose all their assets or file U.S. income taxes," he says. "We are very busy with Americans who are not compli- ant or who want to become com- pliant." According to Citrome, clients are also attracted to his firm for its American connections. "We see a lot of cross-border work generally, and I think there has been a trend to seeing more succession planning with a cross-border element to it, too," he says. "A lot of businesses cross the border, and with mo- bility being what it is these days, entrepreneurs are looking to get their affairs in order for retire- ment, while casting their gaze south to the sunny beaches and everything else the U.S. has to offer." LT FOCUS Ted Citrome says estate freezes to minimize capital gains tax exposure can fail if a party involved is a U.S. citizen or resident. THE SCENIC ROUTE IS ENJOYABLE BUT NOT IF YOU'RE PRESSED FOR TIME. Start with Practical Law Canada. Take the most direct route with proven Practical Law Canada resources. You can save time with up-to-date, straightforward how-to guides, annotated standard documents, checklists, and more. Our expert team of lawyer-editors creates and maintains practical resources across a broad array of practice areas to match the needs of practitioners in each area: • Capital Markets & Securities • Commercial Transactions • Competition • Corporate & Commercial Litigation • Corporate and M&A • Employment • Finance • Personal Injury Litigation Sign up for a FREE TRIAL now at practicallaw.ca © 2016 Thomson Reuters Canada Limited 00234QL-A53133-NK The IRS has gotten very aggressive flushing out Americans living abroad and penalizing those who don't disclose all their assets or file U.S. income taxes. 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