Watch the taxes on foreign investments

When clients receive their T3 and T5 slips, be prepared to have an open and knowledgeable conversation with them should they ask why they are being asked to pay tax on the various income and/or capital gains amounts they’ve reported.

A recent tax case (Capancini v The Queen, 2010 TCC 581) released late last year involved Wayne Capancini, who was reassessed for the 2007 tax year by the Canada Revenue Agency and forced to pay tax on $5,101 of foreign dividends he was deemed to have received on his foreign shares.

Prior to the June 29, 2007 reorganization of Tyco International Ltd., a large company with head office in Bermuda but operations in the U.S. and elsewhere, Mr. Capancini owned 225 shares of the company.

On the reorg date, Tyco spun off two segments of its business into new corporations, Tyco Electronics Ltd. (Tyco E) and Covidien Ltd., together with a reverse stock split. Tyco E and Covidien were also Bermudian corporations.

Under the terms of the reorg, Tyco shareholders each received one Tyco E share, one Covidien share, and one new Tyco share for each four old Tyco shares that they held.

As a result of the reorg, Mr. Capancini received 56 Tyco E shares, 56 Covidien shares, 56 new Tyco shares and a small cash payment in place of his 225 old Tyco shares.

His broker, Northern Securities, issued him a T5 slip which indicated that he had received foreign dividend income of $4,647 US ($5,101 Cdn), which consisted of the fair market value of his 56 Tyco E and 56 Covidien shares on the date of issue.

Mr. Capancini was upset the CRA was forcing him to pay tax on an amount “that is not income to him, but simply what he already owned […] in a different form.”

Before the reorg, he owned 225 Tyco shares. After the reorg, he now owned shares in three corporations which represented “exactly the same ownership interest in exactly the same businesses” as did his 225 Tyco shares immediately prior to the reorg.

When he filed his 2007 tax return, he included a letter explaining he did not consider his receipt of the Tyco E and Covidien shares to be a taxable event. After he was reassessed, he filed a notice of objection with the CRA and also asked Northern Securities to amend his T5 slip to delete the value of these shares from the foreign income box on his slip.

Northern Securities refused to amend its T5 slip, citing a press release issued by Tyco on June 7, 2007, which referred to the spinoffs to Tyco E and Covidien as being effected through a tax-free dividend distribution to Tyco shareholders. The press release also mentioned that each of Tyco, Tyco E and Covidien are resident in Bermuda. Since Canada does not have a tax treaty with Bermuda, the special rule in the Income Tax Act that allows a Canadian taxpayer to defer tax on a foreign spinoff of shares does not apply.

The CRA’s position is that as a result of the reorg, Mr. Capancini received the Tyco E and Covidien shares as “dividends in kind,” and as a result, their fair market value at the reorg date is taxable.

Mr. Capancini’s position was that there simply was no dividend, in-kind or otherwise. His 225 shares of Tyco were a capital asset and the 56 shares of each of Tyco, Tyco E and Covidien which replaced them were also capital assets.

Fortunately, the Tax Court judge agreed. Relying on earlier jurisprudence, he found the new shares issued on the reorg were not a stock dividend because they are neither shares of the original company nor a dividend in kind, as would be the case if a wholly owned subsidiary is spun off by a distribution of its shares to shareholders of a parent company.

In Mr. Capancini’s case, the shares of Tyco E and Covidien were never owned by Tyco but rather were created in the course of the reorg and as a result, when taken together with the new Tyco shares he received, simply comprise the original capital of Tyco, albeit in a different form.

Good news indeed for Mr. Capancini and an important lesson for our clients, who may one day find themselves facing current tax on a foreign reorg — tax that perhaps could have been deferred until the time of sale, had they been as vigilant as this investor.

Jamie Golombek

Tax & Estate

Managing Director, Tax and Estate Planning, CIBC Private Wealth Team Jamie Golombek is Managing Director, Tax and Estate Planning with CIBC in Toronto. As a member of the CIBC Private Wealth team, Jamie works closely with advisors from across CIBC to support their clients and deliver integrated financial planning and strong advisory solutions. He joined the firm in 2008 after 12 years with a global investment company, where he was involved in both internal and external consulting on all areas of taxation and estate planning. Jamie has also worked for Deloitte as a tax specialist in the Toronto office, where he specialized in both personal and corporate tax planning. Jamie is quoted frequently in the national media as an expert on taxation. He writes a weekly column called “Tax Expert,” in the National Post, has appeared as a guest on BNN, CTV News, and The National, and for several years was a regular personal finance guest on The Marilyn Denis Show. He received his B.Com. from McGill University, earned his CPA designation in Ontario and qualified as a US CPA in Illinois. He has also obtained his Certified Financial Planning (CFP) and Chartered Life Underwriting (CLU) designations. In 2023, Jamie was named a CPA Ontario Fellow. The FCPA is the highest distinction that can be bestowed upon a CPA who brings distinction to themselves and to their profession through leadership and achievement in their professional, community or personal lives. Jamie is a past chair of the Investment Funds Institute of Canada’s Tax Working Group. He is also a member of CPA Ontario, the Illinois CPA Society, the Estate Planning Council of Toronto, the Canadian Tax Foundation and the Society of Trust and Estate Practitioners. For nearly two decades, Jamie taught an MBA course in Personal Finance at the Schulich School of Business at York University in Toronto.