Advising non-resident Canadian clients

Given the number of Canadians who vacation in the U.S. each year, as well as those who move between borders for employment or other reasons, it’s important for financial advisors to be aware of the regulatory and income tax issues faced by clients who regularly spend time south of the border.

The regulatory landscape is structured in such a manner that traditional investment advisors in either Canada or the U.S. cannot directly serve such clients. My firm, Transition Financial Advisors Group, is one of the few in Canada and the U.S. that can work with clients who maintain investment and retirement accounts in both countries. In Canada, we use TD Waterhouse.

Institutional for our clients’ assets and TD Ameritrade in the U.S.

Even though some of the large Canadian investment advisory firms have U.S.-affiliated banks or operations, many of the advisors within these firms cannot directly work with clients who have moved to the States. In some cases, we have found a number of Canadian investment advisors working with Canadian-bank-owned firms who have met the U.S. regulatory licensing (Series 7) requirements and are able to serve Canadians who have moved to the States. However, many of these advisors, although legally entitled to work with these clients, do not fully understand the unique American and Canadian income and estate tax issues their clients will encounter.

Regulatory restrictions

In the U.S., the Securities and Exchange Commission (SEC) regulates investment-advisory firms, which are referred to as Registered Investment Advisors (RIAs). Individual states also regulate investment advisory firms and those who work within those firms.

Under the U.S. Investment Advisors Act of 1940, an investment advisor is any person who receives compensation to engage in the business of advising others, either directly or through writings, as to the value of securities or the advisability of investing in, purchasing and selling securities. The Act also regulates those who issue reports concerning investments and receive compensation as part of their regular business operations.

Under these regulations, it is unlawful for Canadian investment advisors to speak or conduct business with current clients who are temporarily or permanently in the States. Even accepting or placing a phone call to clients in the U.S. would be a violation of the Act.

However, there are exemptions that would apply if:

• You had fewer than 15 clients in the U.S. over the last 12 months
• You did not maintain an office in the U.S.
• You had no more than five clients in any one particular state
• You do not promote yourself as an investment advisor.

As long as you meet these requirements, you would be able to serve these clients in the U.S. without having to register there. However, most large Canadian firms who have many advisors and clients in the States would not qualify.

Even though you may not be required to register in the U.S. at the federal level, there are states that prohibit fraudulent conduct and require registration. Each state and protectorate (except Wyoming, the District of Columbia, and Puerto Rico) has licensing requirements for investment advisors. These licences would be obtained through filing federal Form ADV, registration fees and other state-required forms. States also require certain disclosures to clients, the maintenance of records and books, minimum net capital, bonding, and information relating to sales and marketing.

Given that Transition Financial is a Registered Investment Advisor (RIA) in the U.S., we have to provide Part 2 of Form ADV to all potential clients prior to signing an Investment Management Agreement. This part of Form ADV discloses our investment methodology, strategies and philosophy, how we are compensated, the types of clients we serve, educational and professional background, and any conflicts of interest that could arise through our investment management process. We see ourselves as financial advisors first, so we also create a comprehensive cross-border financial plan for all new investment management clients.

If you have clients contemplating relocating to the U.S., you should understand the implications of departing Canada from an income tax perspective. We often see Canadian investment advisors who have maintained Canadian accounts for former Canadians now living in the States. These are people who have exited Canada from a tax perspective, yet maintain non-registered Canadian investment accounts. The investment advisor does not want to lose the assets, so they provide a Canadian address on the account.

This can create significant problems, not only for the investment advisor and firm, but the client as well. If the client has previously filed an exit tax return with CRA indicating that they are a non-resident of Canada, yet the Canadian non-registered investment account still cranks out T3 and T5 forms, this could cause greater scrutiny from CRA. And as we learned above, the investment advisor is no longer permitted to serve this type of client and therefore would be breaking securities laws. If this is the case for you and some of your clients, speak with your manager or firm’s compliance officer.

Withholding taxes

Under the Canada/U.S. Tax Treaty, a former resident of Canada who generates Canadian source investment income such as interest or Canadian dividend income is only subject to Canadian non-resident withholding taxes. Under the Treaty, interest income is no longer subject to withholding tax; however, Canadian source dividends are subject to a 15% withholding tax.

If a former Canadian maintains a non-registered investment account in Canada that distributes Canadian source dividends, he should file a Part XIII letter to the CRA along with payment of the 15% tax that should have been withheld at source. This would confirm to CRA that although he maintains a nonregistered account in Canada, he is at least complying with the Canadian tax rules through the payment of non-resident withholding tax. Failure to do so could be sufficient evidence to suggest your client is still maintaining Canadian tax residency and is therefore subject to tax on worldwide income.

If your client is no longer a resident of Canada for income tax purposes and lives in the U.S., rules enacted in June 2000 allow Canadian investment advisors to actively manage registered assets. Canadian firms may have to register for exemption in certain states, but most advisors can still maintain registered accounts for former Canadians in the States.

U.S.-qualified plans

What about Canadian clients who have accumulated assets in a U.S.-qualified plan, such as a 401(k) plan (an employer-sponsored, defined contribution retirement plan) or an Individual Retirement Account (IRA; similar to an RRSP)? As long as the client would not be deemed to be an American income tax resident (U.S. citizen, green card holder, U.S. work visa holder), it makes sense to transfer these accounts to Canada. Under specific provisions within the Canada/U.S. Tax Treaty and Canadian Income Tax Act, a distribution from a U.S.-qualified plan would be subject to a 15% American withholding tax.

This distribution could also be transferred or rolled over into an RRSP. This would require your client to file IRS Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding) with the custodian or trustee of the qualified plan. Failure to do so would require the imposition of a 30% U.S. withholding tax as opposed to the 15% tax provided under the Treaty.

We have seen U.S. custodians or trustees failing to properly process this form, leaving their clients with a higher level of tax withheld. If this is the case, your client would be entitled to file a U.S. non-resident income tax return called Form 1040NR the following tax year to request a refund of the excess withholding tax taken.

Although your client will ultimately get the American tax back, he will have to wait until the following tax year. If the money is mistakenly remitted to the IRS, there is no way to get it back other than with the filing of this return. We often hear from Canadian advisors who are working with clients who have U.S. Qualified Plans and are anxious to bring the money to Canada to manage. However, if the client is an American citizen, it’s generally not in her best interest to repatriate these assets to Canada. Under U.S. income tax rules, if she is under the age of 59 and six months, she could be subject to a 10% penalty on the value of the distribution—and full and ordinary income tax on the amount in the U.S.

If you are managing registered assets for former Canadians who now live in the States and are unlikely to return to Canada when they retire, it might make sense, given where the Canadian dollar presently stands against the U.S. dollar, to either encourage the client to fully distribute the RRSP and pay the requisite Canadian withholding tax or ensure that the RRSP is invested in American dollars. We often use U.S.-dollar ETFs for these clients. We also use this same strategy for our dual-citizen clients who might move to the States during retirement. With where the dollar is today, it’s a great opportunity to hedge for their future American-dollar lifestyle.

If you work with U.S. citizens who are residents in Canada or dual citizens, understand the U.S. income tax implications of some of the investment decisions that you make on their behalf. For example, TFSAs provide no U.S. income tax deferral for U.S. citizens and would be considered foreign trusts under U.S. income tax rules. The American client would have to include the income on their U.S. income tax return as well as file relatively onerous U.S. income tax forms with their U.S. income tax return. Failure to do so could create severe penalties. Therefore, under present law we recommend that American citizens do not hold TFSAs.

We often see Canadian investment advisors focusing on reducing their clients’ Canadian income tax position through the use of RRSP contributions and/or flow-through-share investments. Although this might reduce the level of net Canadian income tax, because these types of tax-planning strategies in Canada are not recognized under American rules, this could cause U.S. income tax exposure. Therefore, we recommend that any Canadian tax planning is coordinated with the client’s U.S. tax planning requirements.

Terry Ritchie is director of cross border wealth services with Cardinal Point Capital Management Inc. in Calgary.